October 9, 2016

• Thailand, others have built up currency reserves
• Strong U.S. economy seen benefiting emerging markets
• Flexible exchange rates help absorb external shocks

Emerging market countries are well prepared to handle any fallout from a Federal Reserve interest rate increase according to central bankers taking part in an IMF seminar.

Countries such as Thailand have built up large foreign-currency reserves, which will help them absorb outflows of capital that could result from a tightening of Fed policy, said Bank of Thailand Governor Veerathai Santiprabhob. In Thailand, foreign currency reserves are three times as large as short-term external debt, he said.

“We have a sufficient buffer to deal with short-term, volatile capital flows” he said at a panel discussion on October 8 during the IMF-World Bank Annual Meetings in Washington D.C.

What’s more, the Fed’s latest projections show that its target for the federal funds rate is unlikely to rise much more from the current range of 0.25 percent to 0.5 percent, Santiprabhob said. “I think the market has internalized that as well, so we don’t expect to see a major disruption in capital flows,” he said.

Strong U.S. economy

Lesetja Kganyago, Governor of the Reserve Bank of South Africa, said a Fed interest rate increase could be positive for emerging markets if it is seen as a sign of U.S. economic strength. “A strong U.S. economy is good for the world economy,” he said. “So we would benefit from that.”

The so-called taper tantrum of 2013 occurred when then Chairman Ben S. Bernanke signaled that the Fed might soon start reducing, or tapering, its purchases of bonds, which it had been using to suppress long-term interest rates. As a result, investors pulled money out of emerging markets and bought U.S. assets in expectations of higher yields, sending the dollar higher.

At the panel discussion, central bankers agreed that the Fed has improved its communications since 2013, helping to prepare market participants for shifts in policy, such as the decision last December to raise the federal funds target for the first time since 2006.

“In the run-up to last year’s rate hike, the communication was very clear,” Kganyago said. “This time around the communication is also very clear,” he said, referring to expectations that the Fed will raise its key rate again before the end of the year.

Flexible exchange rates

More broadly, panelists said, emerging market central banks have adopted policies that have helped their countries absorb external shocks, such as the plunge in prices of oil and other commodities.

In South Africa, when world prices of metals mined in the country fell along with other commodities, the resulting decline in the value of the rand cushioned the impact when measured in local currency, said Maurice Obstfeld, the IMF’s Economic Counsellor and Chief Economist, who moderated the panel.

The situation was similar in Russia, which adopted a floating exchange rate in late 2014, said Ksenia Yudaeva, first Deputy Governor of the Bank of Russia. “It helped the economy adjust quite fast to this shock,” she said.

In Colombia, the central bank has allowed the currency to float freely since 1999, and it has taken advantage of periods when the peso strengthened to accumulate foreign currency reserves, said José Darío Uribe Escobar, governor of the Banco de la Republica of Colombia. He also argued that volatility in itself was not a problem, especially if associated with limited pass-through to inflation and low foreign currency exposures by households and corporates.

Like Thailand, South Africa started accumulating foreign currency reserves, but it uses them to intervene in currency markets only to smooth volatility and provide liquidity for large transactions, and not to steer the exchange rate, Kganyago said.

Such policies have helped emerging market central bankers deal with any eventuality, such as the surprise vote in Britain this summer to leave the European Union.

“Problems can come from any direction,” Yudaeva said. “Our job is to identify potential shocks and be prepared to react.’’