Despite its best intentions, the much-awaited thrust from QE remains elusive in developed markets, primarily because the higher availability of credit has not been met by a higher level of borrowing. Instead, data from the Bank of International Settlements (BIS) shows that the growth of credit and lending to private borrowers (i.e., non-government entities) is occurring in emerging markets...... Specific effects and risks of QE on emerging markets
With the potential for European banks to rein in and repatriate liquidity amid risk aversion and fears of a euro collapse, it is easy to see why risk has morphed and embedded itself into emerging markets. More explicit consequences have already been felt, including: •Higher inflation. Investment flows into emerging markets slowed in 2011, reflecting investors’ fears about inflation. According to the Institute of International Finance (IIF), net private capital flows to emerging markets were $910 billion in 2011, declining from $1.04 trillion in 2010. Although it has dipped slightly in emerging markets thus far in 2012, inflation remains a significant threat to emerging markets, particularly if food and commodity prices—which constitute a higher percentage of GDP in developing economies than advanced ones—continue to rise. Inflation in emerging markets, and whether policymakers are reactive or preemptive, is an important investment variable. So one should be aware that emerging-market monetary regimes are not created equal. As shown in EXHIBIT 4, the difference between policy rates and inflation rates among individual emerging-market countries can vary considerably. •Currency depreciation. The sharp fluctuation in Brazil’s effective exchange rate during 2008 and 2011 (see EXHIBIT 5) is just one example of the level of volatility induced into foreign exchange markets by quantitative easing. It also reflects the disruptive effect on trade and investment flows from such currency fluctuations. The interpretation of the effective exchange rate is that as the index increases, the purchasing power of Brazil’s currency—the real—grows higher. In other words, the real strengthens relative to the currencies of Brazil’s trading partners. But a lower index means that the currency depreciated, or was devalued, so that the country needs more of its own currency to pay for imports. This is what Brazil and other developing economies are facing today. •The financialization of commodities. Emerging markets are one of the driving forces of commodities from both a supply and demand perspective. Thus, the effects of commodity price inflation on core inflation are more present and more sensitive in emerging markets than in advanced ones. One recent hallmark of global financial markets has been the increased correlation of asset classes, even among disparate ones. Nowhere is this anomaly more visible than the relationship between equity and commodity markets. Traditionally, these two asset classes have had a low degree of correlation. Yet recent evidence.2 has corroborated that commodities and equities are beginning to move in lockstep. If this trend continues, it could detract from the diversification benefits of commodities. Also, to the extent that commodity pricing becomes detached from real supply and demand factors and becomes linked to financial factors, the closer it comes to the direct influence that monetary policy can have on financial markets. Thus, the entrance of QE onto the world stage has the power to affect core inflation in emerging markets through the financialization of commodities. •Threats of retaliatory measures. In a world with heightened systemic risks elevated to a global scale, the consequences of QE should be a first-order concern in monetary policymaking. This is contrary to the current notion that central banks ought to focus on domestic variables and get their “houses in order. ” This practice can affect foreign exchange in a way that may disrupt trade flows and prove counterproductive. Retaliation in the form of explicit trade barriers and the introduction of capital controls is a sure way to unchain trade frictions that would, in the end, leave the world worse off.
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