Doha: US Federal Reserve’s (Fed) recent decision to reduce its asset-purchasing plan (Quantitative Easing) has affected emerging markets (EMs), according to a QNB Group report yesterday. It cited a new International Monetary Fund (IMF) analysis.
The Fed decision started large capital outflows and a strong weakening of currency in EMs.
The IMF study explains the vulnerabilities of some countries like Argentina, Egypt, Poland and Ukraine, given that a large portion of their debt is in foreign hands. The IMF estimates total government debt of the major 24 EMs to be $9.6 trillion at end of June 2013.
Foreign institutions held US $1.4 trillion or 14.6 percent portion of the total government debt. Foreign asset managers held 80 percent of this. More than half ($800bn) of EM government debt held by foreign institutions has flowed in since 2010.
Stronger inflows were most probably a consequence of near-zero interest rates across advanced economies, which made higher sovereign yields in EMs attractive. The inflows were also less selective across EMs following the global financial crisis.
Relatively, the crisis did not affect most EMs which recovered quickly and their high growth perpetuated expectations for further currency appreciation, the study said.
This came to an abrupt end in May 2013 as the gradual reduction in QE raised the prospect of higher interest rates in advanced economies, thus reversing the capital flows into EMs.
This exposed the vulnerabilities of EM markets to capital outflows, particularly those with large current account deficits and high foreign debt ownership.
A number of EM currencies proved vulnerable to capital outflows in the second half of 2013. Since then, investors have started to differentiate more, with Argentina and Ukraine particularly badly hit, while Egypt and Poland have weathered the EM crisis better so far.
The IMF study examined a scenario in which foreign private investors maintain their exposure to EM sovereigns at the same level. It found that Egypt and Poland would require government funding of more than 3 percent of bank assets.
The IMF examined a second scenario in which private investors roll over only 50 percent of government debt holdings maturing in a year. In this case, Argentina and Ukraine would also become sensitive to foreign outflows. The IMF analysis has proved itself relevant in recent months with the currencies of Argentina, Ukraine and, to a lesser extent, Egypt all succumbing to vulnerabilities.
Argentina and Ukraine both have relatively high foreign ownership of government debt (30 percent and 46 percent, respectively) and have faced severe currency weakness.
Egypt has a lower level of foreign ownership (13 percent) and has not experienced such a severe depreciation. The Peninsula