Unconventional monetary policies, which include large purchases of government debt, has been used to provide policy accommodation in advanced economies since the 2007 global financial crisis. However, these policies have had both positive and negative spillovers.
During a recent visit to India, International Monetary Fund (IMF) Chief Christine Lagarde, cautioned that “the unconventional monetary policies have had strong positive spillovers for the global economy, and by implication for India and other emerging markets.” However, “it is also true that these policies led to a build-up of risks.”
Between 2009 and the end of 2012, emerging markets received about US$ 4½ trillion of gross capital inflows, representing roughly one half of global capital flows. Such inflows were concentrated in a group of large countries, including India, which received about US$ 470 billion (IMF, 2015). As a consequence, bond and equity prices rallied, currencies strengthened, and spillovers to asset prices and capital flows were even greater than from earlier conventional policies (IMF, 2015). “The danger is that vulnerabilities that build up during a period of very accommodative monetary policy can unwind suddenly when such policy is reversed, creating substantial market volatility,” she told Raghuram Rajan, Governor of Reserve Bank of India (RBI) and audience at the headquarters in Mumbai, March 17.
I agree the next move for emerging markets is to prepare in advance to deal with this uncertainty. The reality is that as economic conditions improve in at least some advanced economies, portfolio rebalancing out of emerging market economies can be expected, and some volatility cannot be ruled out. Remember the surprise indiscriminate capital outflows from India mid-2013? With all eyes on US Federal Reserve change in posture, the timing of interest rate lift-off and the pace of subsequent rate increases can still surprise markets.
Photo source: voanews.com