Decisions of the US Federal Reserve matter not only in Washington but in emerging markets like New Delhi, Istanbul and Jakarta as well with the globalization of finance, the Financial Times reported. What was surprising for this year was the degree with which these markets sold off after Federal Reserve Chairman hinted in May that they planned to start reducing their monthly bond purchases or tapering.
The report said a connection that became readily apparent was the size of the sell-off and the reliance of these countries on foreign inflows. From May to September, the largest currency plunges occurred in countries that already have current account deficits. These include Indonesia, Turkey, India and Brazil. However, the more important factor was the size of their financial markets.
Citing a recently published paper by Barry Eichengreen of the University of California, Berkeley and Poonam Gupta of the World Bank, the report said more pressure on the exchange rates, equity prices and foreign reserves were felt in countries with larger markets. If it is much easier to divest bonds or currencies, these would probably be sold at stressful times. The report quoted the conclusion that Eichengreen and Gupta arrived at in their paper, "Having a large and liquid market can be a mixed blessing when a country is subject to financial shocks coming from beyond its borders."
However, the report asks why periphery economies in the Eurozone not affected by the talk of tapering this year when they were the most likely areas from which investors who were adverse to risk should have fled?
Despite their large financial markets, domestic investors have increasingly acquired the government debt of Spain and Italy. From experiencing deficits in their current account, these countries have moved to surpluses.
Will investors have a different reaction when the tapering actually happens? Maybe but the report said markets are already more prepared. Besides, moves that the US Treasuries take will most likely be modest.
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