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Business News/ Industry / S&P says Fed tapering may hit banks in emerging economies
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S&P says Fed tapering may hit banks in emerging economies

S&P forecasts that the Fed will keep tapering its asset purchases throughout 2014, possibly ending it by October

In its Thursday report, S&P also highlighted the spillover effects of unconventional monetary policies, especially as they start to getting wound down. Photo: BloombergPremium
In its Thursday report, S&P also highlighted the spillover effects of unconventional monetary policies, especially as they start to getting wound down. Photo: Bloomberg

Mumbai: The banking systems in Turkey and South Africa are the most vulnerable to the US Federal Reserve’s tapering of monetary stimulus, while those of Chile, India, Indonesia, and Peru will remain relatively resilient, rating agency Standard and Poor’s (S&P) said in a report on Thursday.

The agency is betting that the Fed will keep tapering its asset purchases throughout 2014, possibly ending it by October. “At that point, the Fed is likely to start normalizing US monetary policy through interest rate increases by the second quarter of 2015," said S&P.

On 19 March, the Fed brought down its monthly asset purchases to $55 billion, cutting it down by another $10 billion per month. The US central bank has now announced three reductions in its asset purchase programme from an original pace of $85 billion a month.

The Fed, which started to wind down stimulus programme in December, has found itself mired in a debate on the spillover effects of unconventional monetary policies adopted by developed markets, in response to the global financial crisis of 2008, on emerging markets.

On 10 April, Reserve Bank of India (RBI) governor Raghuram Rajan, speaking at the Brookings Institute in Washington, called for greater coordination between the central banks of the world, saying the current international monetary policy framework is a “non-system" and “a source of substantial risk, both to sustainable growth as well as to the financial sector".

Rajan argued in favour of greater international monetary policy coordination, asking that developed market central bankers build in the risk of “spillovers" while formulating their exit plans from unconventional monetary policies.

“In its strong form, I propose that large country central banks, both in advanced countries and emerging markets, internalize more of the spillovers from their policies in their mandate, and are forced by new conventions on the ‘rules of the game’ to avoid unconventional policies with large adverse spillovers and questionable domestic benefits," Rajan said at the conclave, which was also attended by former Fed chief Ben Bernanke.

Bernanke countered Rajan, saying that central bank governors from across developed and emerging markets meet multiple times a year at gatherings such as the Bank for International Settlement meetings. Bernanke also argued that unconventional monetary policies are beneficial for emerging markets as they are “demand augmenting".

Stronger demand in developed markets is positive for emerging economies which export goods to such markets, Bernanke argued.

In its Thursday report, S&P also highlighted the spillover effects of unconventional monetary policies, especially as they start to getting wound down.

“While our base-case scenario assumes that the Fed’s gradual removal of unconventional monetary support won’t derail the economic recovery in developed countries, we expect emerging markets to experience episodes of instability," said the report.

Banking systems in emerging economies would feel the impact of tapering directly through more limited access to external funding or through increasing costs to refinance external debt, it said. Banks may also feel the indirect impact of possible central bank actions such as an increase in rates designed to stem currency depreciation brought on by capital outflows.

“That, in turn, could hurt asset quality and profitability," said the report.

In a separate report, also released on Thursday, Fitch Ratings said that most major emerging market banking sectors will perform more weakly in 2014 than in recent years due to slower economic growth, higher rates, seasoning loan books and, in some cases, greater political uncertainty.

Fitch said the downside risk is greatest in China and India.

According to Fitch, Indian banks’ asset quality is likely to weaken further, with stressed assets set to rise from 10% (at mid-2013) of their total loan book to around 15% by March 2015.

“State banks are most affected and may need 3.8 trillion ($60 billion) of new equity by 2019 to achieve full compliance with Basel rules, although delayed implementation has reduced near-term capital pressure," Fitch said.

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Published: 17 Apr 2014, 02:02 PM IST
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