Resilience Amidst Volatility: Diminished Sensitivity to Global Rates
In recent months, the global interest rate landscape has been tumultuous, particularly affecting longer-term government bonds. While yields on 10-year US Treasuries are rebounding from a 16-year high of 5 percent in October, interest rate movements in other advanced economies have been similarly pronounced.
However, amidst this volatility, major emerging markets have demonstrated notable resilience. IMF’s latest Global Financial Stability Report reveals that the sensitivity of the 10-year sovereign yield of Latin American and Asian emerging markets to US interest rates has significantly diminished compared to the taper tantrum in 2013.
Global Interest Rate: Factors Driving Resilience
This reduced sensitivity can be partly attributed to the divergence in monetary policies between advanced economies and emerging markets’ central banks over the past two years. Nevertheless, it challenges prior findings suggesting substantial spillovers from advanced economies’ interest rates to emerging markets. Notably, major emerging markets, particularly in Asia, have proven to be more insulated from global interest rate volatility than historical trends might imply.
Indicators of Resilience
Several indicators highlight this resilience. Exchange rates, stock prices, and sovereign spreads in major emerging markets have experienced modest fluctuations. Crucially, foreign investors have not withdrawn from their bond markets, as observed in previous episodes of global interest rate volatility, including as recently as 2022.
Strengthened Policy Frameworks: Building Resilience
This resilience is not mere happenstance. Many emerging markets have dedicated years to fortifying their policy frameworks against external pressures. They have bolstered currency reserves, refined exchange-rate arrangements, and embraced exchange-rate flexibility. Moreover, improvements in the structure of public debt and increased confidence among domestic savers and investors in local currency assets have reduced reliance on foreign capital.
Enhanced Central Bank Independence
Additionally, major emerging markets have enhanced central bank independence and credibility, in line with IMF recommendations. Since the onset of the pandemic, central banks in these countries have implemented timely tightening measures, effectively steering inflation toward target levels.
Facing Challenges Ahead: Potential Risks
Despite these successes, policymakers in major emerging markets must remain vigilant as they face several challenges ahead. Narrowing interest rate differentials may trigger capital outflows from emerging market assets to those in advanced economies. Quantitative tightening by major advanced economies could further dampen emerging market capital flows. Moreover, volatile global interest rates, influenced by investors’ reactions to central banks’ data dependency, pose risks to emerging market asset prices.
A projected slowdown in emerging markets, as indicated by the latest World Economic Outlook update, could compound these challenges, particularly through financial channels. Frontier emerging markets and lower-income countries face even greater hurdles due to limited external financing and high borrowing costs.
Opportunities Amidst Challenges: Growth Potential
Nevertheless, amidst these challenges lie opportunities for emerging markets. Expected growth rates remain higher than those of advanced economies, and capital flows to stock and bond markets continue to be robust. Furthermore, policy frameworks are continually improving.
Strategies for the Future: Maintaining Credibility
To navigate through these challenges, emerging markets should maintain their policy credibility, commit to inflation targeting, and remain vigilant in the face of global interest rate volatility. Implementing macroeconomic tools such as currency intervention and macroprudential measures will be crucial. Frontier economies and low-income countries should strengthen engagement with creditors and rebuild financial buffers to regain access to global capital. Ultimately, countries with credible fiscal plans and monetary policy frameworks will be better positioned to weather periods of global interest rate volatility.