The Fed is winding down its economic stimulus at a steady pace, but movements across emerging markets have been anything but. Continuing from the year-end rout emerging economies experienced in late 2013, they have not fared much better in 2014, with the currencies and equity markets of many emerging nations seeing significant declines.
With reduced global liquidity as a result of the reins being gradually pulled in, the consequences among emerging and frontier markets have varied.
A February 2014 special commentary published by global ratings agency Moody’s reinforces that “they [emerging markets] are not a homogenous group.” The comment, “QE Tapering: Impact Differs Among Emerging Markets,” details the impact of the Fed’s actions, noting that the more robust nations of South Africa, Russia and Turkey have all fared quite differently. Overall, says Moody’s, countries with external imbalances or a reliance on external funding have been the most vulnerable to the effects of the Fed’s quantitative easing tapering and will remain so.
According to Moody’s, the impact on many key sovereign credit metrics among the emerging market nations has “so far been and will likely continue to be limited”. The negative effects on these economies, says Moody’s, will likely be temporary and part of their adjustment process back to normalization of monetary policy in the more advanced economies, namely the United States.
Brazil, which began its pullback and monetary tightening in 2013 before the Fed announced its tapering plans (much earlier than other nations, in May 2013) has not been as affected as South Africa and Turkey, for example, whose currencies have been hit by capital flow adjustments. Russia has also been somewhat shielded from the Fed’s actions mainly due to a larger current account surplus on hand coupled with its larger hard currency reserves, both of which have substantially protected its economy from the tightening of global liquidity.
The Negative Impact on Emerging Economies
Emerging nations are being dealt a blow as U.S. monetary policy continues to shift. In addition, Moody’s notes that “recent events also confirm previous expectations that the tapering process and its associated increase in U.S. and global financing costs will, on average, have a considerably greater impact on countries in emerging markets than on advanced countries.” The agency now estimates that emerging market economies could face a cumulative 2013-2016 GDP growth loss of between 2.8 percent – 3.1 percent depending on the speed of the tightening. This is nearly double that of advanced economies. However, Moody’s explains, “these negative effects will be relatively limited and temporary in nature.”
Among nations most exposed to a reduction or reversal of financial flows, emerging markets rank high, given that they were the recipients of large amounts of capital inflows during the quantitative easing period in the U.S. The historically low interest rates and ample liquidity in developed economies, particularly in the U.S., has helped to drive capital flows into many fast-growing emerging countries over the past few years. Bond market inflows are one good example. But as widely reported, global growth took a turn in 2013 leading the emerging economies on the whole to experience a major unwinding.
“This reversal in growth prospects and the ongoing reduction of excessive liquidity led to a fall in the differential return on assets in advanced and emerging economies. This led to capital outflows, which in turn triggered falls in equity and bond indices as well as currency depreciations in the very same emerging markets that had benefited from the original inflows,” the comment states.
In a separate note published in February, “Moody’s: QE tapering could further weaken liquidity of some EMEA emerging market companies,” emerging market companies were also examined in light of tapering plans and ambitions of the Fed.
“One main threat to liquidity of some emerging market companies as a consequence of U.S. government tapering may lie in policy responses that impact the domestic macroeconomic environment and financial systems, including local banks,” it reads.
Citing government and monetary policy decisions that could potentially raise interest rates as a key factor that could pressure corporate cash flows and also reduce headroom under financial covenants or credit availability where reliance is on uncommitted facilities, Moody’s also notes the reading of the EMEA Liquidity Stress Index, which rises if liquidity weakens. The index saw a slight increase to 14.7 percent in December 2013, primarily pointing to weaker operating performance for a few companies, despite the overall trend of credit stabilization.