Emerging nations should prepare for an eventual reduction in U.S. stimulus even as the Federal Reserve unexpectedly refrained from adjusting policy this week, World Bank Managing Director Sri Mulyani Indrawati said.
“They have to prepare, they don’t have any other choice,” Sri Mulyani said in an interview in Bali today, where finance ministers from the Asia Pacific Economic Cooperation member economies are meeting. “They are going to have to continue adjusting their growth, both in terms of level as well as model of growth.”
Asian stocks, currencies and bonds rose after the Fed yesterday held off from reducing the $85 billion pace of monthly bond buying, saying it needs more evidence of lasting improvement in the economy. The threat of diminished global liquidity from cuts in the Fed’s purchases had earlier sparked the biggest emerging-market currency selloff in five years, with the Indian rupee and Turkish lira hitting record lows.
Many emerging-market nations will need to adjust to a lower growth rate and refocus their economies after boosting domestic sources of expansion in the past three years post-global recession, Sri Mulyani said.
The countries had built “this domestic growth model that created the current-account deficit, budget deficit, which need to be watched very carefully,” she said. “They need to rebalance their economic-growth model.”
The MSCI Asia Pacific Index climbed 2.3 percent as of 2:46 p.m. in Tokyo, set for the highest close since May 22. Australian 10-year bond yields fell the most in more than six weeks. The baht gained 2.2 percent, the Malaysian ringgit rose 2.5 percent and the Indian rupee surged 2.6 percent.
The largest developing nations for the first time have the worst market opportunities as optimism for stronger growth shifts to the U.S. and Europe, according to a Bloomberg Global Poll this month. India fared the poorest, followed by Brazil, Russia and China, a worldwide poll of investors, analysts and traders who are Bloomberg subscribers showed.
“The emerging markets certainly face this new phase of the economy,” Sri Mulyani said. “The balance of risks is still on the positive or upside, and that needs to be watched carefully by them because even if the tapering off is going to be delayed, at some point, the policy adjustment is going to come.”
The market fallout in recent months in anticipation of Fed tapering has given emerging nations an understanding of what they need to do, she said. Some countries are imposing import tariffs, while others are better targeting their subsidies or scaling them back, she said.
Malaysia and Indonesia raised fuel prices this year to reduce subsidies and ease pressure on their budgets. Fitch Ratings cut Malaysia’s credit outlook to negative in July, citing rising debt and lack of budgetary reform.
“Implementation is going to be very important,” Sri Mulyani said. “Especially now, the markets will see in the next six months whether the policy announcement will be followed by the implementation.”
Brazil and Indonesia have embarked on a series of rate increases to buoy the real and rupiah, while the Indian central bank took steps to boost the supply of dollars to alleviate depreciation pressure on its currency.
“Higher borrowing costs are going to come because of the direction of adjustment on monetary policy in major economies, and also because of inflation factors,” Sri Mulyani said. “Especially because of domestic-demand growth that many of the economies adopted since the global financial crisis. The adjustment on that is going to be very important for governments, the private sector.”
Some developing nations have accumulated debt quite rapidly in the past three years, and that is a “source of vulnerability” as interest rates rise and growth moderates, she said. Countries will need to watch for balance-sheet risks at the level of households, corporates and the government, she said.
The Group of 20 countries repeated their concern this month that stimulus pullback in developed nations may prove damaging to global markets. The BRIC countries along with South Africa pledged this month to create a $100 billion pool of currency reserves to guard against shocks from the withdrawal of stimulus.
“The good side is, with the past three months’ reaction of the market to this speculation about tapering, at least emerging markets now know how the market will react,” Sri Mulyani said. “That provides policy makers good knowledge as well as understanding about how they should respond.”