The International Monetary Fund wants emerging market economies such as India to prepare themselves for greater volatility in currencies and possible capital outflows as the US Federal Reserve readies to tighten monetary policy.
“The asynchronisity in monetary policies is going to have volatile effects on international markets,” said Christine Lagarde, IMF managing director in response to a query by RBI governor Raghuram Rajan at an interaction hosted by the central bank on Tuesday.
The Fed is expected to hike interest rates for the first time since 2006 on the back of strong economic data and, thus, put an end to accomodative monetary policy. At the same time, Bank of England and Bank of Japan could increase their accomodation further, keeping the liquidity glut sustained in global markets.
Lagarde said the central banks should also look out for geopolitical risks such as growing unease between Ukraine and Russia. With small countries accessing the international bond markets, more and more countries are becoming vulnerable to big movement in the dollar and euro.
Lagarde warned there could be a repeat of the episode of large outflows that emerging markets seen in 2013 following the Fed’s move to cut back on its quantitative easing (QE). “We already got a taste of it during the taper tantrum … I am afraid this may not be a one-off episode,” said Lagarde.
In 2013, most emerging economies saw a massive outflow of dollars from their markets after the Fed indicated it could soon start winding up its QE.
Foreign investors had pulled out a record $20 billion from the Indian bond marktes in just four months, sending rupee to an all-time low of 68.85/$. Lagarde said that India has managed to restore confidence by containing domestic and external vulnerabilities through various policy measures.