In an article just published in Foreign Policy (August 4, 2014), Prof. Kevin Gallagher of the Frederick S. Pardee School of Global Studies explains “why emerging markets are going to hate Janet Yellen.”
“The big question that emerging markets are now asking is how quickly and how suddenly interest rates will go up ['tapering']… When U.S. monetary policy tightens, it will wreak financial havoc in some emerging markets. Higher interest rates in the United States will cause capital to flock into the U.S. market and away from developing and emerging-market countries—drying up credit and sometimes worse. Morgan Stanley has dubbed Brazil, India, Indonesia, South Africa, and Turkey the “fragile five.” But it is not just these countries that are worried. No emerging market is completely safe.”
Prof. Gallagher, who co-directs the Global Economic Governance Initiative (GEGI) and whose recent book is Emerging Markets and the Regulation of Cross-Border Finance, points out that “on paper, the global economy is in a better place than in 2007, but much still needs to be done to ensure that when the United States sneezes, emerging markets don’t get the flu.” Here is what he thinks the emerging markets are worried about:
“When interest rates rise in the United States and the rest of the industrialized world, it could trigger a sudden stop of financial flows to emerging market and developing countries, followed by capital flight as investors seeking higher interest rates and safer markets move money back to the industrialized world. This would depreciate emerging markets’ currencies.When the holders of all the debt from the surge have to pay their creditors back in foreign currency, their debt burden bloats in proportion with the currency depreciation. Currency depreciation not only jeopardizes the corporate and public sectors’ ability to pay down debt, but it also makes consumers angry because they can buy fewer imports.”
Read the full article in Foreign Policy, including Prof. Gallagher’s analysis of the tools that emerging markets now have to weather the coming storm.