World Bank Sees Volatile Shift to Higher Global Interest Rates

Global financial markets face more volatility in the short term as nations adjust to higher interest rates and emerging economies deal with a projected decline in capital inflows, according to a World Bank report.

“The gradual return of long-term interest rates in both high-income and developing countries to more normal levels should help reduce the excesses and vulnerabilities associated with a persistently low interest-rate environment,” the bank said in the report today. “In the near term, however, the transition to higher global interest rates could be volatile.”

Net private capital inflows to developing countries are projected to fall to $1.065 trillion this year from $1.078 trillion in 2013, the Washington-based bank said in the report. Financing conditions “are likely to tighten further in the coming months as monetary policies continue to normalize.”

“This, combined with a shrinking growth differential between developing and high-income countries, should translate into weaker capital inflows to developing countries this year,” the lender said in the report released as Group of 20 finance officials prepared for weekend talks in Sydney.

Should global borrowing costs rise more abruptly than expected or volatility become entrenched, “more disorderly adjustments could not be ruled out,” according to the bank’s report.

Fed Tapering

The Federal Reserve’s decisions in December and January to taper its monthly bond purchasing weren’t the cause of recent emerging-market turmoil, according to the report, though global financial markets will continue to react to U.S. monetary policy adjustments.

Unlike in mid-2013, U.S. long-term interest rates have declined since the start of this year. “These developments suggest a modest flight to quality and general rotation from equity markets into highly rated sovereign bonds,” according to the World Bank.

Policy makers in developing countries should be ready to respond to market pressures and reduce vulnerabilities, ‘including through tighter monetary policy and exchange rate adjustment supported by central banks’ reserve management policies, macro-prudential policies, and in some cases capital controls,’’ the bank said.

Political unrest could continue to be a major risk for developing countries, the bank said. This year there will presidential or general elections in 16 developing countries, including Brazil, South Africa and Turkey -- some of the most affected by last year’s market turmoil. Presidential elections are planned for 2015 in Argentina and Ukraine, according to the bank.

“A negative fallout from elections could act as a major restraining factor in terms of policy adjustments in many developing countries,” the World Bank said.

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