Since the financial crisis, emerging markets have enjoyed some indirect benefit from the sluggish recovery of the developed world. The unprecedented stimulus unleashed by the largest central banks has depressed yields on safe assets, pushing investors to search for higher rates in ever more exotic locations. Between 2010 and 2013, private capital inflows to developing countries jumped to about 6 per cent of their combined gross domestic product.
This bonanza of funds is likely to slow down this year. The decision by the US Federal Reserve to taper its $85bn-a-month asset purchases will push up interest rates in the rich world, leading asset managers in the City of London and on Wall Street to rebalance their portfolios towards securities that are closer to home. While the prolonged monetary largesse by the European Central Bank and the Bank of Japan will reduce this exodus, companies and governments in emerging markets are expected to face higher borrowing costs. When the Fed threatened to begin unwinding quantitative easing last May, spreads on sovereign bonds of the likes of India and Brazil rose by 80 basis points in four months.
The key question for policy makers in low- and middle-income countries is just how sudden the “great reversal” will be. A report by the World Bank out this week offers ground for optimism. The World Bank predicts that the transition to higher interest rates in the rich world is likely to be smooth. Between 2013 and 2016, the slowdown in capital inflows to all emerging markets is predicted to amount to a mere 0.6 per cent of their combined national income. Indeed, the relatively quiet market reaction to the December taper seems to vindicate this optimism.