Claudio Borio, Head of the Monetary and Economic Department at the Bank for International Settlements, seems to think so.
In a recent interview, he highlighted that Emerging Market Economies (EMEs) are now more vulnerable to international capital flows. Underlining that rising aggregate debt levels in relation to GDP are his “biggest concern”, he points out that further appreciation of the US dollar could make repaying dollar-denominated debts harder and exacerbate current EME vulnerabilities.
These are timely comments given ongoing developments in Turkey, which have captured the interest of financial markets this week. Geopolitical posturing and trade disputes have grabbed headlines, but the factors at play run much deeper than new tariffs. EMEs reaped the benefits of a decade of loose monetary policy in the US and Europe, seeing an influx of foreign investors seeking higher yields. The recent trend towards monetary policy normalisation, however, has put pressure on EME currencies which can make it more difficult for EME borrowers to finance the rising cost of servicing their debts.
Mr Borio is not alone in his analysis. Identifying risks to the UK financial sector, Mark Carney, Governor of the Bank of England, noted that the Bank’s June Financial Stability Report saw “headwinds to growth and increasing risks in some emerging markets” as a key concern.
While many analysts don’t see immediate contagion risk for financial markets in developed economies (currency hedging is expected to mitigate some of their exposure), the current difficulties faced by EMEs provides just one real-life example of how challenging and multifaceted the journey of post-crisis monetary policy normalisation might prove to be.
Scott Martin and Katelyn Geraghty
“I think EMEs will be at the forefront of what occurs. If you take a step back and look at the 2008 crisis, you will see that some countries were directly affected and others were not. In the affected countries, the private sector has deleveraged, reducing debt in relation to income. In the unaffected ones, pressures have continued to build, among other reasons because of strong capital inflows. Post-crisis, the level of dollar-denominated debt in non-banking sectors in EMEs has doubled. Some economies have strengthened their defences, but the risk is clear.”