G-20 draft sees possible Fed rate hike as risk to global markets

[ANKARA] The prospect of higher US interest rates is looming large for emerging markets.

Finance ministers and central bankers from the Group of 20 nations are focusing on the potential disruption that the Federal Reserve could cause by raising borrowing costs for the world's largest economy as they gather in Ankara on Friday.

"In line with the improving economic outlook, monetary policy tightening is more likely in some advanced economies, which may remain one of the main sources of uncertainty in financial markets," according to a draft communique prepared ahead of the talks and seen by Bloomberg News.

While central bankers in Europe and Japan are mulling further action to boost prices as inflation dwindles, the Federal Reserve may raise interest rates for the first time in nine years as soon as this month.

The prospect of higher US borrowing alongside a deepening slowdown and devaluation in China are chilling investors' sentiment, roiling currencies and leaving the MSCI emerging market index down more than 16 per cent so far this year. The draft also cited "recent volatility in financial markets" and the need to monitor potential spillovers.

"The financial market volatility can't be ignored," said Andrew Bosomworth, head of portfolio management for Germany for Pacific Investment Management Co.

"With emerging markets slowing and the Fed on the verge of tightening, the focus will be on the links between the two."

Once the darlings of the world economy as they helped lift it from its 2009 recession, emerging markets from China to Brazil have now slid amid declining trade, mounting debt, falling commodity prices and a rising US dollar. The sell-off in equity markets is already prompting parallels to be drawn with the Asian financial crisis of the 1990s.

For evidence of the problem, look no further than the G-20's host.

Turkey saw its currency plunge more than 20 per cent this year while bonds and stocks also tumbled. Foreign investors pulled out more than US$5.5 billion from Turkish government debt and listed-company stocks from the beginning of the year through Aug 21, according to a Bloomberg calculation based on official data.

Capital flows into such emerging-market economies fell in August by the most since 2013, according to the Institute of International Finance. Meantime, Morgan Stanley this week cut its growth forecast for emerging markets in 2015 to 4.1 per cent from 4.8 per cent amid downgrades for China, Brazil and India.

"We expect global growth to remain moderate and likely weaker than we anticipated last July," International Monetary Fund Managing Director Christine Lagarde said on Tuesday, referring to the fund's current global growth forecast of 3.3 per cent for this year.

At the centre of the turmoil is China, responsible for 40 per cent of global growth last year yet on course for its weakest expansion since 1990. While its central bank has cut interest rates five times since November and told banks to hoard less cash, Oxford Economics warns its deceleration is threatening to impose a deflationary shock elsewhere.

Complicating the outlook is China's surprise August decision to revalue the yuan, which caused the currency to drop the most in 21 years, triggering exchange-rate declines elsewhere in the emerging world on concern a weaker yuan will hurt exporters.

"We are observing a weakening of the prospects for the Chinese economy," European Central Bank President Mario Draghi said at a press conference after the central bank's regular monetary policy meeting.

"We hope at least to know more in Ankara" as to whether this is the beginning of permanently lower long-term output, or simply a transitory phenomenon, he said.

And then there's the Fed.

Emerging-market leaders are fretting that higher US interest rates will prompt even more capital to exit riskier economies and push the dollar higher, undermining exporters and making debts denominated in the greenback harder to repay.

"We will continue to carefully calibrate and clearly communicate our actions, including the policy tightening, to minimize negative spillovers and mitigate uncertainty," the draft communique said.

BLOOMBERG