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For many Emerging Markets, May 22, 2013 is a day that will live in infamy.  It marks the start of the great Taper Tantrum, when Ben Bernanke’s carefully hedged remarks on prospects for slowing Fed asset purchases triggered a massive sell-off in EM bond and currency markets. Though the sell-off was widespread, it was not indiscriminate.  As the top figure above shows, EMs with large current account deficits were the hardest hit.  These were countries dependent on inflows of short-term capital facilitated by the $85 billion the Fed was pumping in monthly to buy Treasuries and mortgage-backed securities. So who is vulnerable now to a possible Rate Ruckus – an EM bond market sell-off triggered by an unexpectedly early or aggressive Fed rate hike? As the bottom figure suggests, many of the same countries are likely to be in the firing line – in particular, Ukraine, Turkey, South Africa, Peru, Brazil, Indonesia, Colombia, Mexico, and India.  Of these, only Ukraine has seen a significant improvement in its current account deficit, which has fallen from a whopping 9.2% to 2.5%.  Poland and Romania have moderate (2%) but higher deficits, and could receive a larger jolt this time around.  Only Thailand has moved into surplus, and looks likely to be spared. CFR Backgrounder: Currency Crises in Emerging Markets Financial Times: Fed Meeting May Add Pressure to Emerging Markets The Economist: The Dodgiest Duo in the Suspect Six Foreign Affairs: Taper Trouble   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

The big question for the December 16-17 FOMC meeting is whether to drop the pledge to keep rates at near-zero for a “considerable time.” Prior to the last meeting in October, two-thirds of primary dealers expected that language to be modified before the end of the year. Can history be any guide? Eleven years ago, at the January 2004 meeting, the Greenspan Fed faced precisely the same question, with the markets watching intently.  At that time it had been operating for 6 months under a pledge not to raise rates for a “considerable period.” As the figure above shows, measures of core inflation, which the Fed favors, were lower back then.  And unemployment at the time was almost precisely where it is now (except for U-6*, which was lower). And what did the Greenspan Fed do?  It dropped its “considerable period” pledge, saying instead that “the Committee believes that it can be patient in removing its policy accommodation.” If history is a guide, then, the Yellen Fed will drop its “considerable time” pledge on Wednesday, paving the way for a possible rate hike in the middle of 2015.   * Total unemployed, plus all persons marginally attached to the labor force, plus total employed part time for economic reasons, as a percent of the civilian labor force plus all persons marginally attached to the labor force Financial Times: Doves May Be Dismayed by Fed Chairwoman Janet Yellen’s Comments Wall Street Journal: 5 Things to Watch for at the December Fed Meeting The Economist: What Should the Federal Reserve Do? The Case for Opportunistic Inflation New York Fed: The 2015 Economic Outlook and the Implications for Monetary Policy   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”  

IMF GDP growth “projections” accompanying emergency lending programs are nothing of the sort; they are targets the level of which is necessarily set high enough to enable the interventions. Take Greece.  After committing to lending of €30 billion over 3 years in 2010, the Fund projected that the crisis-mired nation would return to growth by 2012.  As shown in the left figure above, Greece’s economy actually plunged by 7% that year – the year it completed the world’s largest sovereign restructuring, covering €206 billion of bonds. Take Ukraine.  After committing to lending $17 billion over 2 years in April, the Fund projected that its civil/Russian war would magically end and its economy bloom – achieving 2% growth in 2015.  Instead, its “adverse scenario” looks to be playing out according to script, with the economy on pace for a 7% decline.  There is now a massive $15 billion gap between what has been pledged by the official sector (IMF, World Bank, European Union, and others) and what is actually needed to fund the government. The point is not that the IMF is particularly incompetent or unlucky; few in the organization’s talented professional staff could be in the least surprised with how Greece and Ukraine have played out.  The point is that the IMF’s growth projections for crisis-hit client countries are deliberately being pegged at levels high enough to overcome its own prohibition against lending to countries that lack sufficient funding to cover government spending over the coming 12 months. This is a sound rule, intended to keep the Fund from getting sucked into the vortex of politics.  Greece’s insolvency clearly required write-offs and gifts; more debt, which is all the Fund has to offer, was never going to resolve the problem.  Ukraine requires at a minimum a cessation of hostilities.  By all means, the EU, U.S., and other friendly nations should step in financially and otherwise to show solidarity, but such is not the proper role of the Fund.  If it manages to avoid major losses on these interventions, it will only do so by having provided political cover for those who will – governments, such as those of Germany and the United States, which should have been up-front with their people about the likely cost and political purpose of their aid. Financial Times: IMF Warns Ukraine Bailout at Risk of Collapse Wall Street Journal: Ukraine Will Need More Bailout Funding, IMF’s Lagarde Says IMF: Ukraine Request for a Stand-By Arrangement IMF: Ex Post Evaluation of Greece's Exceptional Access   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”