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Emerging Risks for Emerging Economies

The US Federal Reserve's pause on further monetary-policy tightening has fueled a revival of capital inflows. But, given the uncertainties about US policy and Chinese growth prospects, it is too early to conclude that emerging economies are out of the woods.

EDINBURGH – Suddenly it seems that emerging-market economies have gained a respite. Capital flows to these economies dried up in the second half of last year as the US Federal Reserve raised its policy rate for five consecutive quarters and shrank its balance sheet. But in January, the Fed announced a pause, which now looks to be extended: the dot plots of Federal Open Market Committee members currently indicate no rate rises for the remainder of the year. Moreover, the Fed has signaled that “quantitative tightening,” the process of allowing treasuries and mortgage-backed securities to roll off its balance sheet, will continue only through September. 

This means merciful relief for emerging economies, which have been buoyed by the resumption of capital inflows. A replay of the second half of last year, much less of the 2013 “taper tantrum,” now seems unlikely.

In addition, there is the rebound of the Chinese economy. Other emerging markets, linked to China through global supply chains and raw material exports, are highly leveraged on its growth. Thus, they had good reason to worry when Chinese manufacturing activity shrank in February for the third straight month. Chinese exports are down. Car sales are down. As recently as two weeks ago, all was doom and gloom.

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