LAGARDE CALLS FOR MORE CRISIS "LINES OF DEFENSE" / THE FINANCIAL TIMES

August 23, 2013 7:59 pm

 

Lagarde calls for more crisis ‘lines of defence’

 

By Robin Harding in Jackson Hole

 

©AFP

 

The world needs to build “further lines of defence” against a possible emerging markets crisis but the International Monetary Fund stands ready to provide financial support if needed, its managing director Christine Lagarde declared on Friday.

 

Ms Lagarde’s remarks to the Kansas City Fed’s annual gathering in Jackson Hole, Wyoming, are a sign of growing concern among international policy makers about market turmoil in countries such as Brazil, India and Indonesia.

 

“Even with the best of efforts, the dam might leak,” Ms Lagarde was due to tell the central bankers gathered for the conference according to a text of her speech released by the IMF. “So we need further lines of defence – lines of defence that reflect our interdependence, our common purpose, and our mutual responsibility for the global economy.

 

“For the Fund’s part, we stand ready to provide policy advice and financial support, including on a precautionary basis through our various instruments,” she said.

 

The Fund has a range of precautionary tools that will fund governments if they lose the ability to borrow from markets, such as standby arrangements and flexible credit lines. Setting them up in advance of a crisis is intended to stop a crisis happening.

 

Ms Lagarde did not mention any specific country, suggesting that no action is imminent. But her reference to the Fund’s tools suggests that she thinks they may be needed if problems in emerging markets get worse.

 

The potential tapering of Fed asset purchases from $85bn-a-month has pushed up US interest rates and led to falling currencies in emerging markets as capital flows back to the developed world.

 

The Indian rupee, the Brazilian real, the Turkish lira, the South African rand and Indonesia’s rupiah have all weakened substantially since May, prompting a variety of responses from governments and central banks. In the most decisive yet, Brazil unveiled a $60bn currency intervention programme on Thursday.

 

In the absence of Fed chairman Ben Bernanke, emerging market wobbles are becoming one of the main themes of the Fed’s annual symposium in Jackson Hole.

 

Agustín Carstens, governor of the Bank of Mexico, called on developed countries to implement a more predictable exit from easy monetary policy and to co-ordinate as much as possible in order to make life easier for emerging markets.

 

“Reversals have happened and they could become much larger in the future,” said Mr Carstens. He said that the volatility of capital flows to emerging markets had been a problem since the crisis and affected by unconventional monetary policy.

 

The Fed’s talk about tapering led to a big shift in capital flows and emerging market yield curves, Mr Carstens said. “Countries with relatively weaker fundamentals have been affected the most.”

 

“Exchange rate flexibility will help, but not at all cost,” said Ms Lagarde. “Some market intervention may help moderate exchange rate volatility or short-term liquidity pressures.”

 

She also called for the use of macroprudential policies to halt frothy credit growth in emerging markets. “In some circumstances, capital flow management measures have been useful,” she said.

 

“There is scope for international policy co-ordination and co-operation to improve global outcomes. No country is an island,” said Ms Lagarde.

 

“As I said at the outset, in today’s interconnected world, the spillovers from domestic policy may well feed back to where they began. Looking at the wider effect is in your own self-interest. It is in all of our interests.”

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Stock markets were already under pressure from the beginning of the year as evidence of slowing Chinese growth increased, with commodity exporting countries particularly hit.

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Since May, when “taper” talk began, ETF and mutual funds have flowed out of emerging markets. This is not good, but it will be much worse if “sticky” money like pension funds decide to head for the exit.

These outflows, coupled with falling confidence in emerging market growth, has taken its toll on currencies. Those with weaker underlying fiscal and economic fundamentals, such as Indonesia, India, Turkey and Brazil, are introducing various measures to stem those declines, as the currency falls lead to higher import costs and domestic inflation.

But the situation could worsen further if foreign direct investment declines significantly, underscoring the importance for emerging markets to undertake difficult structural reforms that would encourage more inflows.

It is those countries that are suffering current account deficits that are the most vulnerable, and further currency declines and capital outflows threaten to exacerbate the problem.

However, those countries with stellar currency reserves – such as Russia and Brazil – have less to worry about. But many, such as Turkey, are using them to intervene in the forex markets to shore up their currencies. Central banks in the developing world have lost $81bn of emergency reserves since early May, according to Morgan Stanley.

As the reserves dwindle, worries emerge over how many months of imports their foreign reserves will cover.

The cost of servicing external government debt increases as local currencies decline. This weakens governments’ fiscal health, causing investors to demand higher returns.

It is not just governments with the external debt, companies and some households also face increased costs.

Weaker currencies help make exporters more competitive, which would help stabilise current accounts. But with a lack of solid global growth, it cannot be singularly relied on for economic expansion.

Emerging markets are still expected to grow at a faster pace than developed peers, but many economists argue they could grow much faster if governments in the developing world bit the bullet and undertook the serious structural reforms, such as liberalising certain sectors, that are acutely needed.

 

Copyright The Financial Times Limited 2013