The effects of a possible adjustment in the world economy poses a growing threat to emerging markets despite abundant liquidity in the international capital markets, Charles Dallara, managing director of the Institute for International Finance, warned yesterday.
The downside risks are rising, Dallara said in an interview with Emerging Markets.
Theres a clear signal that more challenging times are coming, he said, referring to the US twin deficits whose risks have been downplayed by analysts in recent months. Countries and investors need to be ready for [the adjustment].
Although the IIF is optimistic about economic growth prospects for Latin America, capital flows to the region will decline this year from last years record level, but will remain healthy. The institute forecasts GDP growth of 4.2% this year, up from 4% last year on average, partly thanks to an improvement in Brazils performance (at least 3.8% this year).
The magnitude of capital flows is not at issue, Dallara explained. Its about the availability [of capital] at a reasonable price that does not increase your debt burden, he said. Of course if investors become more risk adverse, this will put marginal countries in a difficult position.
The private sector, however, has mixed feelings about Dallaras prognosis. You wont have an emerging market crisis when you have such balance of payment surpluses, said David Rolley, vice president of Loomis Sayles. Citigroups global head of emerging markets analysis Donald Hanna did not sound too worried either: We may have more volatility but dont forecast any major problem in 2006 and 2007, he said.
The Brazilian finance ministry international affairs secretary Luiz Awazu Pereira does not believe in an external crisis scenario where all the variables go wrong simultaneously. But even if one them happens, Brazil is better prepared to sail through the possibilities of such an event, which is still remote, he said. Emerging markets are in a much better position than during the Mexican or the Asian crisis.
Nevertheless, serious imbalances in the global economy may spoil the capital markets party, Dallara argued: There will be more challenging days for emerging markets, as interest rates rise and possibly spreads tighten. This underscores the importance of reinforcing macro-stability and not allowing policies or performance to drift away from fiscal, monetary and exchange rate stability, he said.
The burden is on countries to reinvigorate structural reforms since access to capital markets at good prices could become constrained when liquidity dies up, Dallara said. On a cautionary note, he added: When you find that the winds are blowing a bit stronger against you and when the waves are getting a bit choppy, what do you do? You start bringing down the hatches, you dont loosen the ties of stability.