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Emerging markets cannot “afford” a repeat of the 2013 “taper tantrum” market disruption that occurred when the US Federal Reserve signalled a sooner-than-expected withdrawal of stimulus, sparking a surge in global borrowing costs, the IMF’s chief economist has warned.
In an interview with the Financial Times, Gita Gopinath sounded a cautious note as the Fed prepares to dial back its pandemic support, highlighting the economic pressures on low and middle-income countries, which have suffered disproportionately from the coronavirus crisis. She also warned of the potential fallout should inflation become a more pernicious issue in the US and force a sudden move to tighten monetary policy.
“[Emerging markets] are facing much harder headwinds,” she said. “They are getting hit in many different ways, which is why they just cannot afford a situation where you have some sort of a tantrum of financial markets originating from the major central banks.”
Gopinath’s comments come after Fed chair Jay Powell, in a speech at the virtual Jackson Hole symposium of central bankers on Friday, signalled that the US economy would be strong enough for the Fed to begin dialling back its $120bn asset purchase programme this year.
Business activity has picked up sharply over the past five months alongside a major Covid-19 vaccination drive. US consumer prices have also soared, propelled by booming demand and supply-chain bottlenecks that have led to an acute shortage of some goods.
Inflationary pressures have jumped higher and faster than most economists expected, although the Fed has long said they will fade over time. But policymakers have become more attuned to the risk that they could persist for longer, especially with the more contagious Delta coronavirus variant fuelling an alarming rise in Covid cases globally.
“A lot of the problems we’re facing, even with regard to inflation and supply bottlenecks, have to do with the fact that we have the pandemic raging in different parts of the world,” Gopinath said. If higher inflation lingers, “that can feed into inflation expectations and then have a self-fulfilling feature to it”.
“We are concerned about a scenario where you would have inflation come up much higher than expected, and that would require a much quicker normalisation of monetary policy in the US,” she added.
The IMF calculated in July that $4.5tn could potentially be erased from global gross domestic product cumulatively by 2025 by what Gopinath called a “double whammy” of new waves of infections for emerging markets, which have struggled to gain access to vaccines, and a “massive” normalisation of monetary policy in the US, although that is not the fund’s base case.
The damage would be particularly acute for low to middle-income countries, according to Maurice Obstfeld, a former IMF chief economist and a professor at the University of California, Berkeley, given the run-up in debt levels seen since the start of the pandemic.
Average government debt in large emerging economies rose from 52.2 per cent of GDP to 60.5 per cent in 2020, according to the Institute of International Finance. That was the biggest surge on record and helped countries weather through the pandemic.
Many are in better shape today than they were during the 2013 tantrum. Bigger foreign currency reserves and better budgetary and external balances have helped to fortify their defences, but a large shock could penetrate that.
“If they are hit by an abrupt increase in the tightness of dollar financing conditions and perhaps a reversal of capital flows, that could be pretty devastating in the midst of an ongoing pandemic,” he said.
More than $360bn flowed into EM stocks and bonds in the past nine months of 2020, according to the IIF. While the pace of inflows has slowed since then, many countries are still highly vulnerable to a swift change in investor sentiment.
Higher inflation has already forced several of these countries to raise interest rates — including Brazil, Hungary, Mexico and Russia — but additional tightening may be necessary to fend off capital flight and currency depreciation, inflicting more economic pain.
Gopinath said central bankers needed to provide “super clear communication” on a frequent basis about their policy path forward — something she said Powell has done effectively.
“One of the issues when [then-chair Ben] Bernanke made his statement in 2013 was not so much that quantitative easing would start unwinding, but that it was also mixed up with expectations that interest rates will start rising faster than was expected,” she said. “This time round, they’ve laid it out very clearly by saying that they will first start tapering . . . and then they will start raising interest rates.”