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Emerging Market Woes Follow US Fed Taper

The slowdown in emerging economies and the U.S. central bank’s decision to scale back monetary stimulus have many investors worried about the state of the world’s economy. Some blame the U.S. Federal Reserve for trimming its easy money policies too quickly, while others insist some emerging economies were unprepared for it. Economists say the reasons for market turmoil are as varied as the countries involved.

When the U.S. central bank started pumping billions of dollars into the economy to stimulate growth, investors took advantage - investing money in fast growing economies and countries where interest rates were higher. But amid signs of a strengthening U.S. economy, the Federal Reserve began scaling back monetary stimulus.

As a result, in the World Bank's global economic report, economist Andrew Burns said investments are flowing back into advanced economies as interest rates begin to rise.

“The analysis that we do in the report suggests that capital flows to developing countries, in a smooth transition to higher interest rates in the United States, are likely to decline as a percentage of developing countries GDP,” said Burns.

Slowing economies

The exodus of capital comes at a bad time; growth in developing countries from Brazil to India has slowed.

When its currency declined sharply last month, Turkey’s central bank tried to discourage capital flight - doubling interest rates to attract investors.

That briefly raised the value of the Turkish lira, though economist Ozlem Demirci says the cost is too high.

“Of course we will see some negative impact of this rate hike decision over growth, especially GDP growth, because the credit rate will probably increase, borrowing costs will increase,” said Demirci.

Meanwhile, Argentina’s central bank chose not to intervene - resulting in the Argentine peso’s biggest depreciation in more than a decade. The contagion spread quickly to other emerging markets, leading some economists to call it the "biggest sell off in emerging market currencies since 2009."

Multiple causes, ongoing issue

William Cline at the Peterson Institute said you can’t blame all of it on the Fed's taper.

"In Argentina, they had domestic inflation that was running very high and was disguised by the official figures in Turkey, the political scandals and the very large trade deficit," he said.

Given country-specific issues, Cline said the recent market turmoil may be a necessary correction. One example he cites is Brazil.

"After all, it was fairly recently that the Brazilians were complaining about a currency war, and they were saying that this wall of money coming at them because our interest rates were so low were making them uncompetitive. Now I think that their currency is more appropriately valued," said Cline.

On the other hand, China, the world's fastest growing major economy has been largely unscathed, perhaps owing to its large dollar reserves.

Given the interconnected nature of commerce, though, economists say the turmoil in emerging markets isn't over yet.