IMF's Lagarde Warns Of Spillovers From US Rate Hike

(RTTNews) - Even if the process of hiking interest rates in the U.S. is managed well, the likely volatility in financial risks could give rise to potential stability risks and emerging markets must prepare for such uncertainty, International Monetary Fund Managing Director Christine Lagarde said Tuesday.

"The danger is that vulnerabilities that build up during a period of very accommodative monetary policy can unwind suddenly when such policy is reversed, creating substantial market volatility," Lagarde said in a speech at the Reserve Bank of India in Mumbai.

"We already got a taste of it during the "taper tantrum" episode in May and June of 2013, when most emerging market economies suffered indiscriminate capital outflows. India was also affected. I am afraid this may not be a one-off episode."

Advance economies can help such situation by "clear and effective communication of policy intentions", which can reduce the risk of creating very large market volatility, Lagarde said. She also sought greater global policy cooperation to minimize the negative spillovers.

The U.S. Federal Reserve is to meet this week and analysts expect the central bank to signal a rate hike in the near term, which could trigger capital outflows from emerging markets. Capital flight took hold of several emerging markets in 2013 after the Fed hinted that it is going to embark on "tapering" its bond-buying programme.

Citing research of the 2013 experience, the IMF Chief said emerging markets that had already addressed their economic vulnerabilities before the "taper tantrum" fared better during episodes of market volatility.

"In particular, higher GDP growth, stronger external current account positions, lower inflation, and more liquid financial markets helped dampen market volatility," she said.

"In addition, more resilient financial sectors contained the effects of such volatility."

Lagarde also said the reforms in India were in "the right direction, are very timely, but will also need to be pursued with the utmost speed".

Central banks must stand ready to act when market volatility materializes, she said, by putting to use measures such as targeted liquidity support, foreign exchange interventions and currency swap lines.

Praising the RBI for the decisive measures it took after the 2013 "taper tantrum", Lagarde said India successfully contained its domestic and external vulnerabilities more than many of its emerging market peers, in a very short time span.