Two years since the Fed triggered a selloff of their assets in the so-called “taper tantrum," the finance chiefs of emerging markets left Washington meetings of the International Monetary Fund praising chair Janet Yellen for the way she is signaling plans to raise US interest rates.
The test now is whether developing nations have done enough to insulate their economies from the threats of a higher US dollar and capital flight once the Fed boosts borrowing costs for the first time since 2006. How successful they are will help determine the strength of global growth that’s already taking a hit from weaker expansions in China and Brazil.
“The Fed is trying its best to be as transparent as possible, to explain its considerations," Tharman Shanmugaratnam, Singapore’s finance minister, said in an interview. “But it doesn’t mean that ensures us of an orderly exit. One way or another there’s going to be some disturbance."
Yellen is seeking to avoid the May 2013 episode of her predecessor Ben S. Bernanke, when his suggestion that the Fed might soon wind down its bond-buying program prompted investors to flee the risk in emerging markets. India’s rupee and the Turkish lira both tumbled to record lows.
While Yellen didn’t speak publicly during the IMF’s spring gathering, officials said her message behind closed doors was reassuring. Russian finance minister Anton Siluanov told reporters that Yellen informed fellow Group of 20 officials that any US rate increases would be “transparent and understandable."
David Skidmore, a Fed spokesman, declined to comment on Yellen’s private discussions.
The latest Bloomberg survey shows 71 percent of participating economists expect the Fed to raise rates from near zero in September after a slowing of US activity diluted speculation it would act as soon as June.
“The Fed has been very clear about saying it would be a very steady process rather than an abrupt process, and I think that should calm people down," Reserve Bank of India Governor Raghuram Rajan said in Washington.
Malaysian central bank Governor Zeti Akhtar Aziz said in an interview that markets may be calmer following the Fed’s move than before. “I believe that when this interest-rate adjustment occurs, conditions will actually stabilize," she said.
Turkey’s deputy prime minister Ali Babacan said one reason for such confidence is Yellen’s signal that any eventual tightening will depend on the economy’s performance. “There is a broad consensus that the Federal Reserve is doing a much better job of communicating," he said.
The danger for emerging markets is once the Fed does lift its benchmark federal funds rate, investors will still punish economies that haven’t spent the past two years attending to vulnerabilities such as large dollar-denominated debts or current-account deficits.
IMF managing director Christine Lagarde said the taper tantrum taught countries that they “have to have macroeconomic fundamentals as solidly determined and anchored as possible."
Countries have already been pinched by a surge in the dollar which has propelled the Bloomberg Dollar Spot Index up 17% over the past year as the US economy accelerated.
The big worry is for a repeat of the mid-1990s, when tighter US monetary policy and a rising dollar helped trigger a worldwide financial crisis that devastated the economies of Thailand, South Korea, Russia and Brazil. By contrast, emerging markets largely absorbed the last round of Fed rate increases, which began in 2004.
In a sign of possible vulnerabilities, the IMF calculates debt has outpaced gross domestic product growth in each major emerging market since 2007. Dollar denominated corporate debt in such economies also has tripled over the past five years to $1.4 trillion.
Turkey, Indonesia and Brazil appear most at risk of any chilling of external finance, analysts at Pavilion Global Markets said in a report this month. Hungary, Brazil, Mexico, Turkey and South Africa are among those whose equity markets also have considerable foreign ownership, the Montreal-based brokerage said. India may be protected after it acted to reform its economy in recent years.
“At some point, those who managed themselves well will probably not suffer very much and those who went totally into short-term may well suffer for some while," Fed Vice Chairman Stanley Fischer said.
IMF officials spent much of the past week highlighting the risks of any sharp rise in the dollar or US bond yields as they suggested investors may still be underpricing how fast the Fed will raise rates.
In one report, the agency said a 1 percentage-point increase in the in 10-year Treasury yield was possible if the Fed acted more aggressively than investors anticipate, and that could “generate negative shocks globally."
As they warned swings in currencies risk undermining the world economy, G-20 policy makers also said countries could use capital controls “as appropriate" to deal with “large and volatile" flows in and out of their borders.
Emerging economies, which account for about 40 percent of the world economy and helped pull it from its last recession, need all the breaks they can get as the IMF predicts they will expand this year at the slowest pace since 2009. Their growth advantage over advanced nations is also set to be the smallest in 15 years.
“I keep my fingers crossed for the Americans to finally go ahead and hike," Poland’s central bank chief Marek Belka said in an interview in Washington. “Eventually, we’ll have to swallow this frog." Bloomberg