'Uneasy calm' may lead to turbulance over emerging markets

Bank for International Settlements says in new report there is risk of negative spillovers to emerging markets if Fed raises interest rates in Dec.

Photo by: Reuters
Photo by: Reuters

A new report by the Bank for International Settlements warns against an “uneasy calm”

The Bank for International Settlements has warned that an “uneasy calm” for emerging markets might be followed by turbulence after the expected US Federal Reserve interest rate hike on Dec. 16.

There is a risk of “negative spillovers to emerging markets” if the Fed does raise interest rates in December, the bank, which regulates international banking activity across the world, said in its quarterly report released late on Sunday.

Emerging markets stabilized after the summer, the report said, when volatility in China’s stock market and currency had upset markets in the developing world.

“Fears of a crisis centering on emerging markets faded in October as Chinese equity and currency markets entered calmer waters. Sentiment improved after policy interventions in these countries and on expectations of continuing monetary accommodation in developed markets, including the United States. Asset markets across the world staged a strong rebound and volatilities fell,” the report said.

“The short-lived market response might suggest that emerging markets could ride out the prospect of US monetary tightening,” it said.

“However, less favorable financial market conditions, combined with a weaker macroeconomic outlook and increased sensitivity to US interest rates, heighten the risk of negative spillovers to emerging markets once US rates do start to rise,” it said.

“Tighter financial conditions could also accentuate rising financial stability risks in a number of emerging market economies,” the report pointed out.

“Since then, market attention has begun to shift from the timing of a lift-off to the subsequent path of the policy rate,” the report said. “So far, the market is pricing in a very gradual tightening with short-term rates expected to remain below 2 percent until the end of 2018. But the uncertainty is large,” it said.

There is overall resilience among emerging markets to prospects of a tighter monetary policy stance in the US, it said.

“On the one hand, a solid US recovery, the basis for an interest rate hike, is likely to benefit emerging markets through trade channels. On the other hand, further dollar appreciation and increasing yields may pose additional risks to growth and inflation in some countries,” the report said.

“Tighter financial conditions may also increase financial stability risks in emerging markets. Credit growth in emerging markets has been strong over recent years, owing to favorable growth prospects and very easy global financial conditions. For example, the average credit-to-GDP [Gross Domestic Product] ratio in the BRICS [Brazil, Russia, India, China and South Africa emerging economies] has risen by close to 25 percent since 2010,” the report said.

Financing debt may become a challenge as the US dollar appreciates against emerging market currencies, according to the report.

The Federal Reserve has indicated that an interest rate rise is likely when the Federal Open Market Committee meets from Dec. 15 till Dec. 16.

In 2013, suggestions by the Fed that it might raise interest rates triggered an outflow of capital from emerging markets across the globe.