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INVESTORS are becoming increasingly concerned about growing vulnerabilities in emerging market economies, especially China, as they reassess the global growth outlook, said the Bank for International Settlements (BIS).
"The Chinese authorities' decision in August to allow the renminbi to depreciate against the dollar gave markets a renewed jolt. The move intensified investors' concerns about growth prospects for China, emerging market economies more broadly and, ultimately, the global economy," it said in a quarterly review released on Sunday.
As a result, many currencies, especially those in Asia, came under pressure and implied volatilities spiked up across asset classes.
Oil prices resumed their downward trend after a brief respite in the second quarter of this year, most likely due to perceptions of falling demand as a result of weakening economic activity, although strong supply also played a part.
These, in turn, dented the growth outlook for commodity producers, leading to a renewed depreciation of their exchange rates, which was worsened by the strengthening of the dollar as a result of the US monetary policy outlook.
Before that, however, there were already shifts in international banking, securities and global liquidity earlier in the year, said BIS. "Global liquidity conditions were strong in the early months of 2015, particularly among advanced economies, but showed signs of weakening for emerging economies."
In the first half of this year, net debt securities issuance by borrowers in advanced economies rose to its fastest pace since before the financial crisis, but issuance by emerging economy borrowers slowed, it noted.
Emerging market economies are now facing a double whammy with China's economic slowdown and the appreciation of the US dollar: growth prospects, especially for commodity exporters, have weakened while the burden of dollar-denominated debt has risen in local currency terms.
In the meantime, diverging monetary policies continue to drive markets in the past few months, observed BIS. The Bank of Japan and the European Central Bank are continuing on their monetary stimulus programmes while the US Federal Reserve and the Bank of England move along the path towards an eventual increase in policy rates.
While the timing of the Federal Reserve's first move has become more uncertain as a result of the recent market turbulence, the interest rate differentials between the US and many other countries have remained wide, said BIS.
This has affected the behaviour of investors and borrowers. "With interest rates at or near record lows in the euro area, fixed income investors increasingly turned to higher-yielding dollar assets," said BIS.
In the first half of this year, flows into European exchange-traded funds linked to US bonds surged to US$4.8 billion, compared with US$4 billion for the whole of 2014 and US$3.4 billion in 2013.
Also, US firms are now increasingly issuing euro-denominated debt to benefit from the low borrowing costs. With the current European asset purchase programme weighing on the yields of government bonds in the core euro-area, yield-starved European investors have welcomed the rising supply of corporate debt, said BIS.