Will Emerging Markets Remain Resilient to Global Stress?

Abstract

Emerging markets have shown considerable resilience to the credit turmoil that engulfed mature markets. However, sentiment remains fragile and financial strains from the global credit crisis continue to weigh on global economic prospects. External finance has become both more costly and restricted as credit risks have repriced, global banks’ lending capacity has shrunk, and, as a consequence, global investors have reduced leverage. Global growth is moderating, led by a slowdown in the United States. At the same time, global inflation risks have intensified amid sharply rising commodity prices, including record oil prices. Risks that higher inflation could become more entrenched have risen appreciably. Against this backdrop, emerging markets are subject to increased global stress. Economies with current account deficits financed by private debt or portfolio flows, where domestic credit and inflation have grown rapidly, are most at risk. Rising inflation increases macroeconomic risks and may induce financial instability in local financial markets in some emerging economies, especially where central bank inflation fighting credentials are less well established.