THE CURSE OF UNCONVENTIONAL POLICIES ON EMERGING MARKETS

Since the early 2000,Unconventional Monetary Policies (UMP) have been the major element of toolkit being used by the central bankers of advanced economies to counteract Deflation and Liquidity Traps.Such policies are used when conventional expansionary monetary policies fails to lower down short term interest rate to the extent of zero as people hoard cash in future expectation of adverse event. Out of all the advanced economies only U.S.A is seemed to have won the battle against deflation while Japan and Europe are still trying to find their feet. Such uncommon tools have brought the protest in emerging markets which bears the spillover effects of such policy.

There is a famous maxim “History Repeats Itself, First As Tragedy,Second As Farce”.Between 2000-2007, U.S.A  witnessed huge inflows coming from emerging markets in form of savings and thereby appreciating the Dollar.Appreciation made the exports costlier and imports cheaper thereby widening the current account deficit (CAD). Huge inflows from emerging markets to advanced economies made one thing clear that emerging markets were infested by savings glut.Apart from the currency markets even the physical assets saw the rapid rise in price thereby creating bubble which took no longer to burst in 2007.

Aftermath of Great Recession advanced economies came up with unconventional tools like quantitative easing (Q E),negative interest rate policy (NIRP), helicopter drops(unregulated distribution of cash) to achieve the growth rate of 2%. Such policies brought the yields on bond almost near to zero thereby making the domestic bond markets non-lucrative option to invest and compelling people to increase the consumption.However investors looked upon the emerging markets where the yields in bond market were very high. Now the people in advanced economies diverted their savings into emerging market economies thereby making their exports uncompetitive. Many BRICS nation have criticised that such policies promote protectionism and competitve devaluation. It has brought inflation in the emerging markets and has penalized their local industries.

 

The chart above shows that volatility in foreign exchange markets is not only limited to the influx of capital inflows but when such asset buying programs are rolled back then it causes foreign capital to flee the emerging markets. The chances of economic misery to occur get higher if inflows were received in form of loans denominated in foreign currency as the repayment will become more costlier as by then the emerging market currency will start depreciating making the chances of default higher. This is also called original sin in economics.Such capital flee causes central banks of emerging economies to build huge foreign exchange reserves to defend itself from any volatility in forex market.

Many emerging markets learning from their past have got themselves involved in currency wars(currency devaluation) to regain competitiveness in global market.For instance,China devalued yuan by 3% in august,2015. Even countries like Vietnam and Kazakhstan have braced themselves with tools promoting protectionism.

Contemporary economic scenario has raised the doubts over strength of globalization as countries are more often getting themselves involved in trade protectionism,currency wars,competitive devaluation,capital controls. The merits of globalization are becoming sore while demerits of Bretton Woods System are becoming sugary. Economies are moving nearer to disintegration.

 

BY: CHINTAN MATALIA

20 NOV,2016

SOURCE:http://www.asiapathways-adbi.org/2016/03/spillover-effects-of-unconventional-monetary-policy-on-asia-and-the-pacific/