TOKYO -- Many observers are quick to blame the U.S. Federal Reserve for recent turbulence in emerging markets, which investors have fled as the Fed gears up to scale back its quantitative easing.
But funds supplied by the Fed continue to grow, albeit at a slower pace, and many wonder how long the turmoil will last.
Flows of investor money into and out of emerging countries offer some hints. Net inflows plunged by half just after the Lehman shock but bounced back sharply in 2010, according to the Institute of International Finance. Inflows hit $1.23 trillion in 2012 -- nearly on a par with the pre-crisis 2007 level.
Massive monetary easing by developed nations is believed to have created large volumes of excess money. Moreover, emerging markets' growth potential played a key role in attracting investors. Inflows, which amounted to 8.4% of gross domestic product across all emerging markets in 2007, declined to 5% in 2012.
Inflows have slowed since last spring. This overlaps with the onset of emerging-market turmoil following hints from then-Fed Chairman Ben Bernanke that quantitative easing would be pared back. The inflows apparently shrank more than $110 billion on the year in 2013, while the IIF estimates that they could contract nearly $40 billion this year.
Primed for a turnaround?
Quarterly forecasts suggest that fund inflows will pick up at midyear, with a recovery on a yearly basis expected to come in 2015. Should this scenario play out, deepening merging-market turbulence is unlikely. The risk of a sharp appreciation in the yen, propelled by its status as a safe asset, then shrinks, provided that emerging countries work to fix structural problems and remain on an economic growth path.
The Fed's generous fund provisions fueled dollar carry trades, where investors borrow dollars at ultralow rates for investment in emerging markets offering ample earnings opportunity. Traditionally, "there shouldn't be a reversal in fund flows unless U.S. interest rates rise," an official at a major Japanese bank says.
With many expecting money growth to come to a halt this year, however, investors are becoming cautious about risk investment.
"The sheer quantity of funds born from monetary easing symbolizes how easy it is to pursue risk investment," says Mitsuru Saito, chief economist at Tokai Tokyo Securities.
Newly installed Fed Chair Janet Yellen may be attempting to scale back easy credit to help guide emerging countries toward a soft landing. It remains to be seen whether she can bring calm to financial markets vacillating between optimism and anxiety.