International Monetary Fund Managing Director Christine Lagarde has warned against “substantial market volatility” and “capital outflows” when the US Federal Reserve reverses the easy monetary policy and starts hiking interest rates in the near future.
Addressing a gathering at the RBI headquarters here, Lagarde said, “The danger is that vulnerabilities that build up during a period of very accommodative monetary policy can unwind suddenly when such policy is reversed, creating substantial market volatility.”
“We already got a taste of it during the ‘taper tantrum’ episode in May and June of 2013, when most emerging market economies suffered indiscriminate capital outflows. India was also affected,” the IMF chief said in a session moderated by RBI Governor Raghuram Rajan. Cautioning Indian regulators and markets, Lagarde said, “I am afraid this may not be a one-off episode. This is so, because the timing of interest rate lift-off and the pace of subsequent rate increases can still surprise markets.”
She said as economic conditions improve in at least some advanced economies, portfolio rebalancing out of emerging market economies can be expected, and some volatility cannot be ruled out. “Emerging markets need to prepare in advance to deal with this uncertainty,” she said.
On the ways to tackle the situation, she said, “Advanced economies can help. Clear and effective communication of policy intentions can reduce the risk of creating very large market volatility. While admittedly it is a difficult task, I would also agree that there is scope for greater international policy cooperation to minimise the negative spillovers.”
Second, emerging markets need to prepare well in advance.
Meanwhile, Rajan, too, expressed hope that central bankers of large economies will start extending better co-operation. “You might want anticipation (of monetary policy changes), the anticipation is very difficult when the issue seems far off and already central bankers have done a lot which is raising political concerns within their countries… Therefore, it may take actual volatility in markets to bring forth more co-operation,” Rajan said, adding he hopes co-operation will emerge.
Between 2009 and the end of 2012, emerging markets received about $4.5 trillion of gross capital inflows, representing roughly one half of global capital flows. Such inflows were concentrated in a group of countries, including India, which received about $470 billion.