PH among the most vulnerable to US Fed policy reversal

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The Philippines is among the 10 emerging markets (EM) deemed “most vulnerable” to the shockwaves of the possible withdrawal of the massive monetary stimulus from the US Federal Reserve, analysts at Japanese investment firm Nomura said.

Nomura’s “10 struggling countries” list also included Brazil, Colombia, Chile, Peru, Hungary, Romania, Turkey, South Africa and Indonesia.

“We disagree with those who think the EM is in a more resilient position now than it was on the eve of the 2013 taper tantrum,” Nomura said in a dated global research note. for August 25, written by analysts Rob Subbaraman and Rebecca Wang.

The study highlighted new sources of vulnerability for emerging markets, citing a combination of chronically weak growth, rising inflation and a marked deterioration in public finances. And yet, he noted that real policy rates remain “deeply negative” in many emerging countries, referring to a situation where the inflation rate was higher than the interest rate.

“The prospect of a Fed’s monetary policy normalization amid the slowing Chinese economy is a terrible combination for emerging markets, which is only compounded by the three emerging market vulnerabilities we found hidden in the shadows, ”the research said.

Nomura warned of a growing link between banks and the sovereign debt of emerging countries, which increases the risk of a so-called bank-sovereign feedback loop, a situation in which weak banks could destabilize the governments that support them. , resulting in a “vicious circle”.

Nomura said Brazil and India seemed most at risk from such a catastrophic loop – the same phenomenon at the heart of the 2009-2010 European debt crisis.

“We refute the idea that just because emerging markets have attracted lower cumulative portfolio inflows since COVID-19, they are less susceptible to the flight of large capital. Measured by portfolio liabilities, as opposed to cumulative portfolio inflows, we show how many emerging markets are likely to be more susceptible now than on the eve of the 2013 taper tantrum, once asset revaluation effects are taken into account, ” indicates research.

From a savings-investment framework, Nomura also argued that the extraordinarily large budget deficits of emerging countries would likely spill over into large current account deficits, citing Colombia, Peru, Romania, Turkey. and South Africa as the most vulnerable.

Nomura warned that the economic fundamentals of many emerging markets, which have already deteriorated over the past year, could worsen further in the coming year, increasing the risk of financial crises with rising rates. global.

“We believe that many central banks in emerging markets may have overstepped their bounds by easing monetary policy too much, including diving into QE (quantitative easing) for the first time, which left foreign investors struggling paid for weakening economic fundamentals, ”Nomura said.

Quantitative easing refers to the injection of new money into the financial system by a central bank without changing the policy interest rate, for example by buying bonds held by banks.

An important lesson to be learned from the large number of past emerging market crises is that risk premia do not follow a monotonous process or rise steadily as risk increases, according to research.

On the contrary, investors’ perception of risk tends to develop in a binary “on or off” fashion, triggering a sudden reassessment of risk, he added.

In the 2013 taper tantrum, Nomura listed just five emerging countries on its “problem” list, namely Brazil, India, Indonesia, South Africa and Turkey.

“By bringing together all our analyzes, we now warn against a longer list of vulnerable countries that we have invented, the“ 10 troubled ”: Brazil, Colombia, Chile, Peru, Hungary, Romania, Turkey, South Africa, Indonesia and the Philippines, ”he noted.

If foreign investors start to worry more about the vulnerabilities highlighted in his report, Nomura said the resulting capital outflows and the depreciation of emerging currencies could have amplifying effects.

“One of the channels is the weakening of emerging currencies, which increases the cost of servicing the foreign currency denominated debt of emerging countries. Another is a deterioration in terms of trade for major commodity exporters in emerging markets, especially Latin America and the Middle East, if a stronger US dollar and weaker economic outlook in emerging markets results in a falling commodity prices, ”he said.

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