Emerging markets should be prepared for Fed tightening

Central Bank Governor Ajith Nivard Cabraal said he would not expect the US Federal Reserve to take account of its actions on developing economies when time comes for the end of quantitative easing and every emerging market should be prepared for Fed tightening.

“Every country will make their own decisions based on their own requirements,” Cabraal was quoted as saying to Wall Street Journal in a recent interview.

“As to whether it will be the most benign impact for other countries, I don’t think they have the luxury of contemplating. I think that’s something we all have to recognize and appreciate. If we understand that, and we build up our own cushions to deal with any kind of impact that follows such decisions, I think that’s the best way of handling these types of conditions.”

According to Wall Street Journal, Cabraal’s view of the obligations of central banks to each other is quite contrary to the viewpoint of Indian Reserve Bank Governor Raghuram Rajan who recently called on the Fed and other developed country central banks to plan for a normalization of monetary policy “whose pace and timing is responsive, at least in part, to conditions they (emerging markets) face.”

Hence, Cabraal argues that the only way to have prepared for a withdrawal of foreign capital when the Fed begins to tighten is not to have allowed very much of it into your country in the first place. “At the time QE commenced, we took a fairly calculated position that it would end at some stage,” he said. “We didn’t encourage huge inflows of capital. We didn’t change our limits on foreign investment. Our investors are there for the longer term.” Sri Lanka limits the share of foreign capital allowed in its treasury markets to 12.5 percent.

“We should always be conscious of what flows are necessary for an economy,” he said. “Low inflows could be one of the factors that would not provide you with sufficient resources. High outflows can cause many shocks. Always be conscious of that.”