Economists Donghyun Park and Irfan A. Qureshi from the Asian Development Bank (ADB) explore the factors that help emerging markets maintain financial stability and promote sustained economic growth, even as they navigate the challenges posed by global financial fluctuations. A key focus is the global influence of US monetary policy, which significantly impacts capital flows and credit growth in these markets, highlighting the importance of strong macroeconomic fundamentals and institutional quality.
The dominance of the US dollar in international trade, financial transactions, and central bank reserves means that US monetary policy continues to drive global financial cycles. This dominance often constrains the policy choices of financially integrated emerging markets. The global influence of US monetary policy was evident during the seven years of easing from 2007 to 2014, following the global financial crisis, and the subsequent 4.5 years of tightening triggered by the 2013 ‘taper tantrum.’ The pattern continued with three years of easing from 2019 to 2022, largely due to the Covid-19 pandemic, followed by significant tightening from February 2022 as the US responded to rising inflation.
Interest rates in the US and other advanced economies have reached levels not seen since the 2008-2009 financial crisis. These shifts in US monetary policy have global repercussions, often leading to destabilising capital outflows from emerging markets during periods of uncertainty and volatile inflows when returns in the US are low. Such episodes put pressure on the macroeconomic outlook of emerging markets, affecting their currencies, debt repayments, and overall capital flows. For instance, aggressive tightening by the US Federal Reserve in 2023 led to substantial depreciation of many currencies in developing Asia against the US dollar.
The resilience of certain emerging markets to these US monetary policy cycles is a central question examined in the study “The Performance of Emerging Markets during the Fed’s Easing and Tightening Cycles: A Cross-Country Resilience Analysis,” conducted by ADB experts, including Donghyun Park and Irfan A. Qureshi. The study empirically assesses how macroeconomic variables such as debt levels, and institutional factors like corruption, influence an emerging market’s resilience during different monetary cycles. It measures resilience by looking at factors such as the bilateral exchange rate against the US dollar, exchange rate market pressure, and the country-specific MSCI Index, and also considers the role of policy factors like exchange rate regimes and inflation targeting.
Research indicates that macroeconomic and institutional variables are significantly linked to the performance of emerging markets, with the determinants of resilience varying between tightening and easing cycles. Strong institutions are especially crucial during challenging periods, such as those following the global financial crisis and the taper tantrum. These findings suggest that cross-country differences in macroeconomic fundamentals and institutional quality can explain the varying resilience of emerging markets during different US monetary cycles.
Emerging market policymakers should, therefore, focus on key macroeconomic variables such as international reserves, current account balances, and inflation to bolster resilience against US monetary policy fluctuations. This reinforces the conventional wisdom that strong fundamentals are vital in protecting emerging markets from external shocks. Attention should be given to vulnerable economies with large external debt obligations and highly leveraged property markets, as these are most at risk when global financial conditions deteriorate, potentially worsening their already fragile fundamentals.
To safeguard their economies from the volatility induced by US monetary policy, emerging market policymakers must prioritise the strengthening of macroeconomic fundamentals and institutions. This approach is essential for ensuring long-term financial stability and fostering sustained economic growth amid global financial challenges.
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