Emerging market 'contagion' threatens rich countries

NEW YORK, NY - JANUARY 29: Traders work on the floor of the New York Stock Exchange after a Federal Reserve announcement on January 29, 2014 in New York City. The Fed announced a further curtailment of its easy-money stimulus, which would tend to suck money out of riskier economies. Photo/AFP 

In Summary

• On Wednesday, the director of the IMF's Monetary and Capital Markets department, Jose Vinals, stated: "This is not like May," when markets were hit by the first hints of a Fed policy change, "this is not a panic situation."

By AFP
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Financial turmoil in emerging economies risks contagion and damage in developed countries, notably by crimping growth, analysts say.

They note that the US Federal Reserve made no reference of possible upheaval in emerging markets, focusing only on the United States when it tightened monetary policy on Wednesday.

The Fed announced a further curtailment of its easy-money stimulus, which would tend to suck money out of riskier economies.

Barclays bank analysts in London commented that the Fed statement "sidesteps volatility" and that "no mention was made" of recent financial market volatility.

But with pressure on emerging economies rising by the day, despite defensive moves, analysts are wondering increasingly if the repercussions will spread to developing countries.

The volatility is the result of massive transfers of capital.

Initially, the Fed's cheap money policy spurred money flows into higher-return emerging markets.

But now that money is being made more scarce in the United States, funds are flooding out of countries such as Argentina, Turkey, Russia and South Africa. Each of those countries, though, also face individual internal weaknesseses exacerbating the flow.

Most of the central banks in countries on the front line of the pressure have used various techniques, most notably increases in interest rates, to attract the funds which have become vital to their economies.

Many of them depended heavily on the foreign investment fund to compensate huge external payments deficits -- and in some cases internal budget deficits.

The most spectacular recent example is Turkey, running a big payments deficit. Its lira currency has lost about a third of its value in six months.

Late on Tuesday, Turkey's central bank doubled its key interest rate to 10.0 per cent, but the boost to the lira was short-lived.

South Africa also implemented a rate rise, as did India earlier in the week.

Meanwhile Russia is trying to restrain a fall of its currency, now at historic low levels.

When a currency crisis last hit Asian economies in 1997, the effects scarcely spread beyond the region.

On Wednesday, the director of the IMF's Monetary and Capital Markets department, Jose Vinals, stated: "This is not like May," when markets were hit by the first hints of a Fed policy change, "this is not a panic situation."

But economists this time are becoming anxious, in part because emerging economies play an increasingly big role in the global economy.

The Organisation for Economic Cooperation and Development estimates that the share of developed economies in world output has fallen from 60.0 percent in 2000 to 51.0 percent in 2010, and is likely to fall to 43.0 percent by 2030.

Possible contagion via trade

At the French business school Sciences Po, Philippe Martin said that monetary tightening in several countries "will have a very negative effect on investment and consumption". It raises the cost of credit and would weigh on demand for products made in developed countries.

Additionally, if central banks decided eventually to allow their currencies to fall, many companies in those countries which had taken out loans in foreign currency, "will see their debt explode," he warned.

He said: "There would then be contagion via international trade" which would be significant at a time when the eurozone for example could not afford to lose 0.2 percentage points of growth.

Another "far more unpredictable" knock-on effect could occur through what could be considered the eurozone's own emerging economies, he said.

"If investors become generally risk-averse, they could pull out of Turkey and South Africa, but also maybe from Portugal and Spain and so on. And we would be at risk from the catastrophic scenario of a return to crisis in the eurozone."

At Natixis AM finance house in Paris, chief economist Philippe Waechter highlighted possible problems for European and US multinational companies which "have developed their production in these countries and could be weakened".

But he recalled that during the Asian crisis in the 1990s, "the crash was brutal but the recovery was rapid".

Now, he said, "it's a question of spotting which countries will recover and adapt quickly, and the others."