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In December of 2013 the Federal Reserve (FED) announced that it would begin to taper its bond-buying program by $10 million per month. As a result of quantitative easing (QE), the FED had been purchasing $85 million in assets in order to stimulate the economy. As the Federal Reserve continues to reduce its monthly purchases, there will be certain effects on globalization. Since tapering was announced, emerging market economies have been struggling. As the FED continues to taper, emerging markets could continue to see and outflow of funds and fluctuations in their currencies.
During QE interest rates in the United States were very low, and as a result emerging markets saw a massive inflow of funds due to investors looking for extra return. As tapering occurs, yields in the United States will begin to rise and investors will return to the United States where the treasuries are considered risk-less. As emerging markets have begun to see outflows of funds, they have experienced a decline in the value of their currencies. For example, in January the Turkish lira fell 6% and the South African rand fell 7.5%. As the currencies in both countries fell, the central banks raised short-term benchmark lending rates in order to rally the currencies.
What is the effect of a depreciating currency on globalization? For one, it deters foreign investment by decreasing the profits made by foreign firms in emerging markets. As currencies weaken, inflation concerns arise which could slow economic growth. A second effect of tapering on the emerging markets is the cost of borrowing increases due to currency weakness and higher risks. Although the higher interest rates are supposed to entice investors, they can still slow economic growth. Also worrying investors is a potential slowdown in the Chinese economy. Not only is China the largest emerging market economy, but it is the largest buyer of exports from emerging markets.
As the FED continues to taper its bond-buying program, emerging market economies could continue to be at risk. Some investors are finding the sell-off in the emerging markets as an opportunity to invest in undervalued foreign investments. What do you believe are the long term effects on the emerging markets due to the current U.S. monetary policy?
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