Emerging economies face challenging new cycle

By Zhang Monan Source:Global Times Published: 2017/5/4 21:03:39

Illustration: Peter C. Espina/GT

After the US Federal Open Market Committee decided in its mid-March meeting to further raise its benchmark interest rates and to reduce the Federal Reserve's $4.5 trillion balance sheet gradually, the world's major central banks also started to show signals of moving toward monetary policy normalization. In general, global monetary policy is likely to withdraw from quantitative easing and enter a new cycle, which is bound to have a significant impact on emerging markets.

Emerging markets and developed markets are the two poles of the world's capital flows and financial circulation. Over the years, the excess savings and trade surpluses of emerging market economies flowed into the US to make up for the imbalanced current account. Recently, a steady recovery of the US economy and the Fed's exit from quantitative easing have triggered capital outflows in emerging markets and have attracted a large amount of global capital into buying dollar-denominated assets.

In 2015, net capital inflows into the US reached $460 billion, up by 18.3 percent year-on-year, accounting for 38 percent of the world's total capital inflows. Meanwhile, the strengthening US dollar led to a drop in value for non-dollar-denominated assets held by various central banks. Also, given the huge tax cut plan proposed by US President Donald Trump, coupled with interest rate hikes, people may see large-scale industrial capital flows back to the US and capital outflows from emerging markets. Since the global financial crisis, the size of debt issued by non-financial enterprises from the emerging market economies in offshore markets has grown rapidly. Many enterprises from the emerging markets conducted arbitrage transactions by issuing bonds on the offshore markets through their offshore subsidiaries. According to the Institute of International Finance, from 2014 to 2018, the amount of corporate debt issued by enterprises in the emerging economies that needs renewal is estimated to reach $1.68 trillion, of which about 30 percent is priced in the US dollar. If the greenback enters into an appreciation cycle, the costs of renewing these emerging countries' bonds will increase sharply, pointing to growing debt risks accordingly.

In fact, it is extremely difficult to fully coordinate global monetary policy, but it is also uncommon to see long-term differentiation in the direction of global monetary policy. Although economic recovery cycles are different in various countries with unsynchronized financial cycles, different capital yields caused by the differentiation of monetary policy can generate widespread arbitrage activities, which will inevitably push emerging economies' monetary policy to follow that of developed economies.

In recent days, some Asia-Pacific countries have already started to make adjustments to their monetary policy. The Reserve Bank of Australia has tightened its loose monetary policy and India's central bank changed its monetary stance from accommodative to neutral for the first time since June 2015.

The US and other developed countries will gradually move to normalized monetary policy, which may lead to marginal tightening of global liquidity. Consequently, emerging market economies may witness a negative impact on their growth prospects, and some may even face multiple risks such as the devaluation of local currencies, capital outflows and increased financial volatility.

According to the Annual Report on the Development of Emerging Economies revealed in March at the Boao Forum for Asia, the average GDP growth of the 11 emerging economies (E11) - Argentina, Brazil, China, India, Indonesia, South Korea, Mexico, Russia, Saudi Arabia, South Africa and Turkey - was 4.4 percent in 2016, 1.3 percentage points higher than the global average and also much higher than that of the G7 countries. Yet, at the same time, the economic situation in some countries is still deteriorating, and there are signs of rising vulnerability in emerging market economies.

During this process, resource-exporting emerging economies characterized by high short-term foreign debt as well as deficits in their current accounts and fiscal accounts are more vulnerable to shocks. Bloomberg data showed recently that the volume of short contracts related to the MSCI Emerging Markets Index reached the highest level since October 2016, reflecting the growing investor concern over emerging markets. Therefore, with the global loosening of monetary policy facing a turning point, it is essential for emerging economies to take into account the prevention and control of potential spillover financial risks when adjusting monetary policy.

The author is a research fellow at the China Center for International Economic Exchanges. bizopinion@globaltimes.com.cn

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