Analysis: Fed's bitter medicine may help heal emerging markets

Fri Jan 3, 2014 9:36am EST
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By Sujata Rao

LONDON (Reuters) - If the medicine tastes bad, it's probably doing you good. Emerging economies might console themselves with that thought when they're suffering market cramps and hemorrhaging capital as the U.S. ends its monetary stimulus.

The Federal Reserve will begin winding down, or tapering, its $85 billion-a-month money-printing program this month, and emerging markets are seeing foreign investment pull back as a result. Last year, around $30 billion fled emerging equity and bond funds tracked by EPFR Global, provisional data shows.

That is a blow, particularly for so-called deficit countries such as India or Turkey, which rely on foreign inflows to plug balance-of-payment gaps. The hope is the volatility induced by tapering will prod governments into reforms that ultimately reduce their sensitivity to shifts in global capital.

"Policymakers are under pressure to implement reforms that were put on the back burner. Tapering is at least getting that narrative going," said Manik Narain, a strategist at UBS. "It's too early to position for it, but if we do get reform it could be the start of the rebirth of emerging markets."

The Fed's $3.7 trillion expansion of its balance sheet was a mixed blessing for developing countries. Economic growth was pumped up by record-low borrowing costs and hundreds of billions of dollars in stock and bond market investments.

But with so much easy money coming in, most governments got away with very little labor reform, privatization, productivity gains or improvements to power and transport infrastructure. Progress in those areas will be key to attracting longer-term investment in manufacturing or services.


Past emerging-market crises - India in 1991, Mexico in 1994, Russia in 1998 and Turkey in 2001 - led to reforms that transformed those economies.   Continued...

A broker monitors share prices while trading at a brokerage firm in Mumbai August 22, 2013. REUTERS/Danish Siddiqui (