Emerging Asia: Beware The Fed


Never mind the “taper tantrum,” beware the real thing. According to the World Bank, the coming U.S. liftoff in interest rates, possibly starting from September, could crimp capital flows to developing economies, sparking a new wave of market volatility in Asia and elsewhere.

Amid higher borrowing costs and lower commodity prices, developing countries are expected to face their fourth straight year of “disappointing” economic growth in 2015. Developing country growth rates are forecast to expand by a relatively sluggish 4.4 percent this year, down 0.4 percentage point from the bank’s January estimates, with growth then rising to 5.2 percent next year and 5.4 percent in 2017, according to the Washington-based lender’s latest “Global Economic Prospects” report.

With global growth remaining subdued, the bank has also cut its estimate for the world economy to a 2.8 percent gain in 2015, down 0.2 percentage point from January, with only a modest rise seen to 3.2 percent growth in 2016-17.

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Just as the initial announcement by the U.S. Federal Reserve of policy “normalization” caused financial market turmoil in 2013, the Fed’s long flagged policy tightening could see capital flows to investment-hungry emerging markets shrink by up to 1.8 percentage points of gross domestic product (GDP), the report said.

“Unless emerging markets have taken the prudent policy steps to be fiscally and externally resilient, they may face significant challenges dealing with the turbulence and other fallout that could be associated with a Fed tightening,” said Ayhan Kose, the World Bank’s director of development prospects.

The Fed’s next policy meeting starts today, although economists surveyed by Bloomberg News do not expect the first rate hike until September. Both the World Bank and International Monetary Fund have urged the Fed to delay its planned rate hike until next year, citing a mixed U.S. economy and the effects of higher credit costs on emerging markets.

According to the report, developing economies are facing the challenge of two transitions, as they adjust to the Fed’s anticipated monetary tightening along with monetary expansion by other major central banks, causing a broad-based appreciation of the dollar and exerting downward pressure on capital flows to developing countries.

“Many developing-country currencies have weakened against the U.S. dollar, particularly those of countries with weak growth prospects or elevated vulnerabilities. In some countries, this has raised concerns about balance sheet exposures in the presence of sizable dollar-denominated liabilities,” it said.

Yet despite the rising U.S. dollar, the weakening euro and Japanese yen have offered only “modest” prospects for improved competitiveness by emerging market exporters.

Meanwhile, falling oil prices have produced only “limited” benefits to oil-importing nations, while the oil exporters have faced sharply reduced activity and increasing fiscal, exchange rate or inflationary pressures. With other commodity prices also remaining soft, commodity exporters have faced a major increase in “domestic and external vulnerabilities.”

India Speeds, Others Slow

The report said divergences across major economies would narrow in 2015-16, as growth plateaus in the United States and strengthens in the Eurozone and Japan.

The bank cut its Japan forecast slightly, by 0.1 percentage point to 1.1 percent growth in 2015, rising to 1.7 percent in 2016 on the back of fiscal and monetary stimulus, declining energy costs, structural reforms and rising wages. However, the report said inflation likely would remain below the Bank of Japan’s 2 percent target through 2017, while potential growth in the world’s third-biggest economy “may be as low as 1 percent, as the working-age population shrinks.”

China is forecast slowing to 7.1 percent growth this year, 7 percent in 2016 and 6.9 percent in 2017 as it continues its transition from investment to consumption-led growth. While fixed asset investment slowed to 15 percent in 2014, down from 19 percent the previous year, it still remains the leading driver of aggregate demand in the world’s second-biggest economy, while producer prices have contracted significantly due to overcapacity.

“Continuing measures to contain local government debt, curb shadow banking, and tackle excess capacity may reduce investment and industrial output,” the report said, adding that measures to curb energy consumption and pollution could have the same effect.

However, there was better news for India, with the bank upgrading its growth forecasts to 7.5 percent this year, up 1.1 percentage point from January, rising to 7.9 percent in 2016 and 8 percent in 2017, helped by stronger confidence from reforms and lower oil prices.

“The slower pace of fiscal consolidation over the next few years means that fiscal tightening will prove less of a drag, while lower corporate taxes and base-broadening measures should also help support business confidence and lift private investment,” the report said.

For East Asia and the Pacific, the bank left its forecasts virtually unchanged, predicting slower growth of 6.7 percent this year and next due to China’s weaker expansion. Fiscal policy tightening in the major regional economies, political instability in Thailand, monetary tightening and election-related uncertainty in Indonesia, and budget bottlenecks in the Philippines have also contributed to the softer outlook, the report said, although the region remains a net beneficiary of cheaper oil.

Indonesia is seen slowing to 4.7 percent growth this year, down 0.5 percentage point from the January forecast, on the back of weaker commodity prices, before picking up to 5.5 percent in 2016-17 due to stronger investment and exports.

Thailand is expected to post 3.5 percent growth this year, with domestic demand remaining weak. Growth is expected to strengthen to 4 percent in 2016-17, helped by the recovery in high-income economies, the report said.

The region’s key challenges include China’s efforts to put growth on a sustainable track while improving financial stability, with the bank urging further financial sector reforms and the reform of state-owned enterprises, land ownership and labor markets.

Elsewhere, the bank said falling fuel prices created an opportunity to eliminate fuel subsidies, which have strained public finances and weakened current accounts in both fuel exporters and importers. It also urged further structural reforms to mitigate against the effects of slowing productivity growth and aging populations, as well as improving competitiveness in services through ASEAN’s regional integration.

Summing up the gloomier outlook, the report’s lead author Franziska Ohnsorge said: “After four years of disappointing performance, growth in developing countries is still struggling to gain momentum. Despite auspicious financing conditions, a protracted slowdown has been underway in many developing countries, driven by shortages in agriculture, power, transport, infrastructure, and other vital economic services. This makes the case for structural reforms all the more urgent.”

With the Fed’s planned move possibly only months away, the clock is ticking for developing economies as they brace to avoid its damaging impacts.

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