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Navigating a post-quantitative-easing world: a bumpy road ahead for developing countries

Written by Zhenbo Hou



2013 was a watershed year in the aftermath of the global financial crisis. This was the year that signs of recovery in the high-income countries have finally begun to surface after four years of loose monetary policies – led by the Federal Reserve to stimulate the world economy. Financial conditions in developing countries deteriorated in May 2013 as the Federal Reserve signaled it would start to withdraw the quantitative easing that it put in place to support growth after the crisis.

An eventual withdrawal of these unconventional monetary policies will cause negative spillover effects to the developing world, as analysed in ODI’s latest Shockwatch Bulletin on global monetary shocks. The latest World Bank report - Global Economic Prospects: Coping with policy normalization in high-income countries supports this view and adds that an improved global economic climate also provides potential opportunities for growth. Navigating through this rapidly changing environment will be one of the biggest tests facing policy-makers in 2014.

After the Fed’s announcement in May, the yield on 10-year US Treasury bills rose by 100 basis points, which sparked a significant readjustment of portfolios as investors quickly withdrew from risker and high-yielding assets such as developing country bonds and equities to now high-yielding US bonds. As a result of that, investors withdrew a net total of 64 billion US dollars from developing country mutual funds between June and August 2013.

The conventional thinking – that sub-Saharan African (SSA) economies are not financially integrated with global capital markets and are therefore only affected by shocks through trade – turns out to be false. For instance, before the Fed’s tapering talks, Foreign Direct Investment (FDI) to SSA is estimated to have risen by between 10% and 20% in 2013 to around 40 billion US dollars. Moreover, sovereign bond issuance in SSA has increased rapidly to 4.6 billion US dollars in 2013 – more than doubling its level of 1.7 billion US dollars in 2012. Encouraged by the significant increase in investment, such audacious utilisation of the capital markets for finance has been adopted by a number of SSA countries, including Tanzania, Rwanda, Nigeria, Ghana, Mozambique and Gabon.

This increase in appetite for investment in sub-Saharan African countries looks set to stall as growth prospects in high-income countries begin to improve, and the costs of capital for investors start to soar due to the end of loose monetary policies. Increases in the amount of interest paid on developing country bonds are already a cause for concern: Nigeria’s bond coupon rate was 3.64 in early 2013 but rose to 6.24 in June. The latest World Bank report suggests that the withdrawal of quantitative easing and a return to a tighter monetary policy in the high-income countries might have a relatively small impact on capital inflows to developing countries, reducing them from 4.6% of developing country GDP in 2013 to 4% by the end of 2016 – good news, according to the WB.

Although this only points to a 0.6% drop in capital flows in terms of GDP, policy responses by developing countries matter. Appropriate policy responses for countries with floating exchange rates could consist of market mechanisms, such as exchange rate depreciation to offset capital outflows; whereas countries with fixed exchange rates could resort to temporary capital controls in cases of excessive volatility. In the long run, monetary authorities in developing countries need to monitor global monetary conditions in order to determine better the timing for bond issuance as well as making sure they carry out the necessary longer-term reforms towards prudential economic management and investment in the sectors that will best allow structural change.

Indeed, unconventional monetary policies such as quantitative easing were emergency practices and they were never going to stay. Developing countries’ policy-makers should have prepared themselves long ago for this change, and not panic over such a normalisation of monetary policy in the rich world. Having said that, since developing countries will be on the receiving end of the negative spillover effects of these policy shifts in the developed world, it is therefore crucial for greater communication and coordination of macroeconomic policies in global fora like the G20, as Dirk Willem te Velde pointed out in August. The world economy is increasingly interdependent – including sub-Saharan Africa. Country or regional policy-makers acknowledging that they need to consider their policy adjustments in the light of negative spillover effects elsewhere would be a step forward in building a resilient world economy.