Fears are growing that the flood of cash into emerging markets could provide kindling for the next economic crisis and has already fueled simmering currency disputes.
Amid sclerotic growth in the traditional strong markets of Europe, Japan and the US, emerging giants like Brazil, China and India have become an increasingly attractive proposition to investors.
Billions have been poured into Brazilian bonds, Chinese real estate and Indian equities, which promise better returns than can be found in New York, Tokyo or London.
The Institute of International Finance has projected that around US$825 billion will gush into emerging economies this year, up 30 percent from last year.
While rapidly developing economies might welcome new investors, the sudden rush of cash is causing a host of problems from rising home prices to stronger currencies that make exports less competitive.
“Already a very significant amount of money is following into some emerging economies,” Asian Development Bank president -Haruhiko Kuroda said.
“If this situation intensifies it may become more difficult to manage,” Kuroda said.
However, it is not just the volume of cash that makes Latin American and Asian countries jittery.
“A lot of money flowing into emerging markets is short term, portfolio investment, bank loans and so on, which could quickly be reversed,” he said.
If the economies of Europe, Japan and the US were to pick up or any number of local crises struck, the bubble could quickly pop.
Facing these risks, ever-more countries have begun to take matters into their own hands.
Brazil has doubled its tax on foreign inflows, while countries from South Korea to Colombia have tried to sterilize the impact of flows on their currency by buying up US dollars.
“Measures must be introduced if necessary,” said Kuroda, who pointed to some success stories. “In a few countries like China the housing market has gone up quite sharply over the past few years, but even in China with various measures introduced by the government the housing market is adjusting.”
However, the measures are not always successful, according to Guillermo Ortiz a former governor of the Bank of Mexico, who recently addressed an IMF/CNBC forum.
“Brazil ... raised tax from two to four percent on foreign inflows and the real appreciated,” he said.
As the US and Japan move to pump more cash into the economy, the rush capital flows, subsequent appreciation and intervention, may increase.
“The central banks are pumping huge amounts of liquidity, interest rates are at record lows so all this money is chasing yield and it is going to emerging markets, and everybody is trying to stop appreciation,” Ortiz said.
“Until these tensions are resolved emerging markets will have to deal with volatility, high capital inflows and central banks will be under heavy political pressure to intervene, knowing perfectly well that this intervention are probably not going to get them very far. The only solution of course is to have some renewed spirit of cooperation,” he added.
Members of the IMF’s policy-setting panel this weekend vowed to “address the challenges of large and volatile capital movements, which can be disruptive.”
That is unlikely to be enough to allay the concerns of countries like Brazil, whose finance minister Guido Mantega has pointedly criticized the IMF for being “reluctant to draw practical conclusions from its analysis.
We tend to speak globally and act unilaterally,” Ortiz said.
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