Federal Tapering in 2022/2023: Lessons Learned and Emerging Market Anxieties

August 22, 2023

Current Landscape: A More Measured Approach

The 2021 Federal Reserve tapering, initially anticipated to echo the disruptive “taper tantrum” of 2013, unfolded with surprising calmness. Unlike the abrupt announcement in 2013, the 2021 tapering was meticulously communicated, allowing markets to adjust and EM economies to prepare. Additionally, many EMs had strengthened their fiscal positions and built up forex reserves, creating a buffer against capital flight.

Beyond Preparedness: Diversification and Resilience

However, attributing the relatively smooth sailing solely to preparedness would be an oversimplification. EMs like India and China have actively diversified their export markets and reduced dependence on Western investors. This diversification provided a safety net when capital flows shifted towards the US. Moreover, internal reforms in some EMs, like reducing current account deficits, further bolstered their resilience.

The Fragile Fifteen: A Cause for Concern

While the overall impact of tapering seems muted, a group of 5 EMs, dubbed the “Fragile Five,” remain highly vulnerable. In addition, countries like Sri Lanka, Zambia, and Lebanon are grappling with unsustainable debt levels. The rising interest rates in the US coupled with weakening local currencies exacerbate their debt servicing costs, pushing them closer to default.

Beyond Economics: Geopolitical Clouds and Unforeseen Factors

The current geopolitical landscape adds another layer of complexity. The ongoing war in Ukraine and heightened global tensions create further economic uncertainty, potentially disrupting trade flows and impacting commodity prices. These unforeseen factors could exacerbate vulnerabilities in fragile EMs, triggering social unrest and political instability.

Looking Forward: Navigating Uncertain Waters

While the immediate impact of tapering appears manageable, EMs face a new set of challenges:

  • Navigating higher interest rates: The Fed’s aggressive rate hikes, coupled with potential global recessionary pressures, could further tighten financial conditions for EMs.
  • Managing volatile commodity prices:EMs heavily reliant on commodity exports or imports face heightened price volatility due to geopolitical tensions.
  • Maintaining social stability: The combination of economic hardship and political uncertainty could lead to social unrest, requiring proactive measures from governments.

Conclusion: Building Resilience Beyond This Wave

The 2023 tapering episode reinforces the importance of long-term resilience building for EMs. Diversifying economies, prudently managing debt, and fostering strong institutions are crucial not only for weathering immediate shocks but also for ensuring sustainable growth in the long run. Furthermore, international cooperation and support mechanisms like the IMF will play a vital role in assisting vulnerable countries navigate challenging times.