GRAPHIC-Taper conference puts emerging market funding source in the spotlight

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By Tom Arnold

LONDON, May 25 (Reuters) – Emerging economies from Peru to Romania are in the crosshairs as the looming U.S. cut increases the risk of local currency bond market exits, hitting a vital funding source for governments struggling to recover from the coronarvirus crisis.

As the US economy recovers, the Federal Reserve is grappling with the question of when to begin unwinding its $ 120 billion in monthly asset purchases that have flooded markets in the aftermath of the pandemic.

Any shrinkage could be bad news for some local emerging bond markets, which account for over 80% of the developing country fixed income universe and form the backbone of public finances. Local emerging debt has absorbed foreign flows of at least $ 149 billion over the past year, most of it to China.

Peru appears to be the most vulnerable, with around 53% of assets held by foreigners, according to data from the Institute of International Finance. The Czech Republic and South Africa are also at higher risk, with foreigners holding almost a third.

The memories of 2013 are fresh. At the time, the Federal Reserve withdrew its support for the US economy after the 2008 global financial crisis scared off yield-hungry investors.

It hit emerging markets, especially the “fragile five” – Brazil, India, Indonesia, Turkey and South Africa – as foreign capital retreated and their currencies fell.

“Increased dependence on foreigners not only increases the risk of capital outflows, but will also make it more difficult to finance still high budget deficits if foreign capital turns up,” Tellimer’s Patrick Curran wrote in a commentary. research note.

From a current account perspective, Turkey, Colombia and Romania are among the most vulnerable.

Turkey’s current account has barely grown since last year, and Deutsche Bank expects a current account deficit of $ 19 billion, or 2.7 percent of gross domestic product (GDP) for 2021. Colombia was demoted as junk by S&P Global Ratings last week, warning that its fiscal adjustment be longer and gradual than expected.

Romania and Colombia still rely heavily on short-term flows, said David Rees, senior emerging markets economist at Schroders.

“If fears of a Fed cut, or indeed some other unexpected development, rattled sentiment and caused capital flight, then these vulnerabilities would be exposed,” he said.

“At best, currencies would be under pressure. But large and persistent outflows could force central banks to raise rates in order to consolidate the capital account and imports would have to be cut, which in turn would result in lower domestic demand and possibly a recession. .

Years of limited capital flows have prevented emerging markets from creating large external imbalances as in 2013.

The recessions triggered by the pandemic caused a collapse in imports and a current account surplus. However, deficits are reappearing as the economic recovery takes off, although the investment overhang is not as large as in 2013.

“The extent to which global investors are overweighting local debt in emerging markets is very low at the moment,” said Angus Bell, senior portfolio manager of emerging market debt at Goldman Sachs Asset Management. “Risk indicators today are nowhere flashing to the same extent in red as they were in 2013.”

(Editing by Robert Birsel)

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