This image shows why Fed taper is not the main problem for emerging markets

The striking picture above of what looks like a war zone from a long time ago is actually that of a street in Kiev, Ukraine, last week, where ongoing anti-government protests turned violent.

Ukraine has been gripped by protests for weeks now, and it’s not the only one. In Thailand, anti-government protests are also grinding the economy to a halt.

Last year, Turkey’s and Brazil’s governments also came under siege as their citizens took to the streets to express their discontent over a host of issues.

Discontent has been exploding over a range of issues, from the government’s poor handling of potential trade agreements (Ukraine) and revelations of corruption scandals (Turkey, Brazil) to increasing inflation (India) and stubborn unemployment (South Africa). 

A medley of reasons is causing social, political and economic unrest, which could potentially destabilise economies and stunt growth.

Most of these problems are not new; they have been simmering for years. Yet, most emerging economies continued to attract global investments, partly on the hope that the foreign funds would be put to good use (to improve infrastructure ,etc.) and partly on the realisation that developed economies were flat on their backs and couldn’t provide any worthwhile investment options. 

Plus, money was cheap, so global investors just glossed over the problems of emerging nations.

The real game-changer

Not any more. For the first time since the global financial crisis erupted in 2008, industrial nations are tipped to lead global economic growth in 2014. In particular, the US is expected to become the world’s growth driver this year.

With several companies in the West poised to churn out larger profits, global investors are once again turning their attention to developed countries.

That is the real game-changer. Over the past few years, emerging markets basked in the glory of little or no competition from developed markets, pulling in money from investors in search of high-yielding assets (which also carried relatively higher risks).

But with money set to become tighter (and the possibility of higher interest rates in the not-so-distant future), global investors are unlikely to continue investing willy-nilly in riskier (albeit more rewarding) emerging economies.

It’s not the Fed

Don’t blame the Fed for what’s happening. The Fed is not the problem here.

Truth be told, the Fed’s tapering plan only brought the bubbling-under problems of emerging markets to the forefront.

As Jose Vinals, director of the IMF’s Monetary and Capital Markets Department, notes, “many emerging economies have yet to complete their adjustment to more volatile external conditions and higher risk premiums”.

“Some of these headwinds may be homemade, and some others could come from abroad,” he was quoted as saying in an AFP report. He also said he didn’t believe the Fed’s taper is the trigger for the convulsions being witnessed in emerging markets.

Despite that, there’s little doubt the threat of a full-blown financial contagion is real. That could be sparked if, as The Economist notes in a blog post,”… more countries faced either social instability or a sense of political impasse, making tough reforms harder.”

Too little, too late?

Of course, reforms become that much tougher to implement when money is hard to come by. Yet, most emerging markets desperately need external funding.

Indeed, recent rate hikes in Brazil, India and Turkey aimed at persuading foreign investors to hold on to their local currency investments instead of exchanging them for US dollars may be too late.

Time is up now

Later today, we’ll find out if the Fed will taper its bond-buying programme by another $10 billion. If everything goes according to script, the Fed will wind down its entire bond-buying programme by the end of this year.

Given that so there are facing a variety of threats to their growth, emerging markets will require a darned good makeover if they want to attract the attention of global investors again. 

And that makeover starts with finding solutions to social/political/economic unrest.

That’s their real challenge, not the Fed taper.

[Image Credit]

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2 thoughts on “This image shows why Fed taper is not the main problem for emerging markets

  1. Pingback: Will emergency interest rate hikes restore confidence in emerging markets? | Wall of Money

  2. Pingback: Breakdown in global monetary co-operation? Why India’s RBI chief is wrong | Wall of Money

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