Reduced Capital Injections Can Hurt Financial Stability Emerging Economies
According to the World Bank, a sharp dismantling of capital injections by the central banks can lead to a 80 percent reduction of capital inflows into the emerging economies, including Indonesia. This can cause serious damage or even a crisis situation in an emerging market because capital flows to these countries are more triggered by global factors than domestic ones. The winding down of the Federal Reserve's bond-buying program (quantitative easing) has been gradual for now but if interest rates rise quickly it can hurt emerging economies.
For now, the US central bank has decided to reduce the quantitative easing program by USD $10 billion per month to USD $75 billion (an amount which can be wound down further if the US economy continues its improving trend). A significant portion of this monthly financial injection is immediately channeled to emerging economies where growth is higher and thus can result in more lucrative returns. As these emerging countries have been getting used to this financial inflow, it can damage the countries' balance of payments when the inflow ceases.
The World Bank report, composed by Andrew Burns, states that interest rates in industrialized countries will be raised by 200 basis points as financial injections are wound down. This can lead to a 80 percent reduction of US dollar flows to emerging economies and a 0.6 percent reduction of GDP growth in these countries.
After Ben Bernanke, Chairman of the Federal Reserve, started speculating about an end to the US quantitative easing program in late May 2013, longer-term US interest rates grew by 100 basis points while international investors pulled about USD $64 billion of funds out of emerging economies, such as Indonesia, Brazil, India, Malaysia, Turkey and South Africa. These capital outflows emerged between June and August 2013. However, when the Federal Reserve officially announced its tapering in December 2013, effects were much less severe because investors had already reacted previously and due to the gradual nature of the tapering (an USD $10 billion reduction). However, according to Burns, the capital outflows that emerged between June and August 2013 constituted a warning sign as it showed that emerging economies are too dependent on the US dollar inflows.
The World Bank upgraded its forecast for global economic growth for the first time in three years as the major world economies, led by the USA and China, are showing improved performances of their economies. Its global GDP growth forecast for 2014 has been raised from 2.4 percent to 3.2 percent. The forecast for economic growth in emerging countries in 2014, however, was revised down from 5.6 percent to 5.3 percent.
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