Emerging Markets & Volatility: Lessons from the Taper Tantrum

IMF Blog, December 9, 2014

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Canonical URL: Emerging Markets & Volatility: Lessons from the Taper Tantrum

Authors: Ratna Sahay, Preya Sharma
Date: December 9, 2014
Key temporal markers:
- May 2013: Fed chair Ben Bernanke began discussing reduction of the Fed’s bond-buying program, triggering the “tapering episode.”
- 2015: Expectations of Fed tightening to begin in 2015 shaped forward-looking concerns about global spillovers.

Immediate market reaction in May 2013:
- Acute and systemic market volatility.
- Emerging markets were hit indiscriminately.
- Many emerging markets experienced rapid currency depreciation, higher external financing premia, falling equity prices, and slower capital flows.
Subsequent market behavior:
- Markets began to differentiate fairly quickly between countries with good fundamentals and those with economic imbalances.

Countries with more subdued market pressures after the initial reaction typically had:
- stronger fundamentals
- financial systems with more domestic services, products and liquid markets
- fewer foreign holders of domestic debt
- better growth prospects
Definition of “better fundamentals” used in the analysis:
- stronger current and fiscal account positions
- lower inflation
- adequate international reserve buffers
Policy environment enhancing resilience:
- tighter macroprudential policies prior to the taper talk
- capital controls prior to the taper talk

During booms and busts of capital flows, early and decisive action reduces vulnerability:
- Raise interest rates where inflation is high.
- Intervene in foreign exchange markets when foreign exchange reserves are adequate.
- Address current account deficits promptly.
Preparedness and institutional resilience:
- Strengthen fundamentals continuously.
- Build financial systems with deeper domestic services, products, and liquid markets.
- Reduce reliance on foreign holders of domestic debt where feasible.
- Maintain adequate international reserve buffers.
- Implement and maintain appropriate macroprudential frameworks and, where justified, capital flow management measures.

International organizations (such as the IMF) should:
- Help strengthen the global financial safety net through better cooperation with regional financial arrangements.
- Facilitate swap lines between central banks to ensure sufficient liquidity.
- Directly provide resources if requested.
Advanced-economy central banks and the broader international community should:
- Communicate exit from unconventional monetary support clearly and effectively to reduce excessive market volatility.
- Note: The Fed’s communication strategy improved after May 2013, contributing to more muted market reactions to the end of U.S. unconventional monetary expansion.

Normalization of monetary policy in the United States and other advanced economies is likely to cause some volatility in global markets.
Emerging markets should:
- Continue to strengthen fundamentals.
- Be prepared for a swift and decisive policy response to eventual market jitters.

Source: Emerging Markets & Volatility: Lessons from the Taper Tantrum (Ratna Sahay, Preya Sharma, December 9, 2014).