The International Monetary Fund (IMF) warns that monetary policy in advanced economies, especially the United States, has a major impact on financial conditions in emerging markets, noting that a sudden change in the decisions of the US Federal Reserve could translate into a reversal of capital flows in these economies.
In a report published Monday, the institution chaired by Kristalina Georgieva anticipates that advanced economies should recover from the crisis caused by the pandemic faster than most emerging market economies, reflecting access to vaccination and more room to maintain supportive economic policies. It thus warns that divergent economic recoveries could make it more difficult for emerging market central banks if interest rates in advanced economies begin to rise, when conditions in emerging markets still warrant flexible monetary policy.
“Monetary policy in advanced economies – especially in the United States – still have a major impact on financial conditions in emerging market economies,” the report states, noting that monetary policy easing by advanced economy central banks at the beginning of the pandemic “provided much relief to financial markets in emerging market economies.”
The IMF points out that while a tighter monetary policy as a result of a stronger-than-expected US economy tends to be relatively benign for most economies, if adopted in a surprising way it tends to dampen global investor risk appetite and lead to capital outflows from emerging markets. In that case, he believes it could lead to “a reversal of capital flows to emerging markets, deleveraging of global banks, and a devaluation of emerging market currencies that exposes exchange-related vulnerabilities.”
On the other hand, positive news on US economic activity tends to have a relatively benign impact on financial conditions in emerging markets, it said, noting that positive news from the Covid vaccine trials had the same effect.
The IMF also says the analysis suggests that emerging market economies with lower fiscal vulnerability are more insulated to external financial shocks than other economies, and countries with more transparent and rules-based monetary and fiscal structures enjoy greater monetary policy autonomy.
“The prospects for a multi-speed recovery, with advanced economies recovering faster than most other economies, raise concerns about the effects of asynchronous withdrawal of monetary policy support constraining financial conditions in emerging markets and developing economies,” it warns.
