A prolonged period of cheap credit has caused corporate and sovereign debt to balloon in many of the world’s emerging markets (EMs), which are vulnerable to a flight of capital if interest rates start to rise according to the International Monetary Fund (IMF).
In comments to accompany the release of the IMF’s
‘Global Financial Stability Report’
, Jose Viñals, head of its capital markets department said that while the US Federal Reserve’s policy of gradual tapering appeared likely to achieve a smooth withdrawal of monetary stimulus, a ‘bumpy exit’ could not be ruled out. This could trigger a sharper rise in interest rates than anticipated, widening credit spreads and increased financial volatility
“Emerging markets are especially vulnerable to a tightening in the external financial environment, after a prolonged period of capital inflows, easy access to international markets, and low interest rates,” said Viñals.
EM corporations were particularly exposed to tighter financial conditions. “Rising interest rates, weakening earnings, and depreciating exchange rates could put substantial pressure on emerging market corporate balance sheets under our adverse scenario,” he said. “Indeed, in this scenario, EM corporates owing almost 35% of outstanding debt could find it hard to service their obligations.”
To mitigate the risk, the IMF recommended that policy makers in EMs should first work to improve their economies’ macroeconomic resilience “to stem the growing tide of concerns about the vulnerabilities that have built up during the past few years”.
“They should also stand ready to ensure orderly market conditions through adequate provisioning of liquidity in the event of turbulence,” said Viñals.
According to the IMF, investment from advanced economies into EM bonds reached an estimated US$1.5 trillion by the end of 2013. EM corporate debt tripled between 2009 and 2013, with debt levels in countries such as China, Hungary and Malaysia reaching or exceeding 100% of gross domestic product (GDP).
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