New stimulus threatens emerging markets, economists warn

Emerging markets could become casualties of the $1.9-trillion COVID-19 relief bill passed by the US Congress on Wednesday, as rising US bond yields are likely to trigger a reversal of capital flows from the developing world, economists warn.

Wall Street and public-sector economists have revised up forecasts for US economic growth due to the massive relief package and the vaccine rollout. But they also worry that too much stimulus could lead to an overheated economy, inflationary pressures and rising interest rates, with consequences for financial stability.

Coming on top of the $900-billion relief package approved by Congress in December, US President Joe Biden's $1.9-trillion package means that the US economy would get fiscal stimulus of around 13 percent of the country's GDP in 2021, according to Desmond Lachman, resident fellow at the American Enterprise Institute and a former official at the International Monetary Fund.

"My view is that US market interest rates, like the 10-year Treasury bond rate, will now rise significantly because of the (new) stimulus," Lachman said.

"This will very likely cause capital to flow back to the US from the emerging markets since investors will now be able to receive a reasonable return on safe US Treasuries," said Lachman, adding that emerging markets have been hit hard by the pandemic and their public finances are in a dire shape.

The Organization for Economic Cooperation and Development also warned on Tuesday that rising US bond yields could trigger a reversal of capital flows and higher currency volatility, as experienced by emerging markets during the "taper tantrum" in 2013.

The Federal Reserve has pledged to hold its policy rate near zero and continue its asset-purchase program at least at the current pace of $120 billion a month until it sees "substantial further progress" in employment and inflation.

But former US treasury secretary Larry Summers recently warned that the Fed could be forced to raise interest rates next year, sooner than Fed officials and markets currently expect, as the latest massive stimulus could set off inflationary pressures of a kind "we have not seen in a generation".

Xinhua