The document discusses how emerging markets can weather the expected first interest rate hike by the US Federal Reserve later in 2015. It summarizes the lessons that can be learned from the 2013 "taper tantrum" when the Fed announced a possible reduction in asset purchases. During the taper tantrum, emerging markets experienced significant capital outflows as investor money flowed back to the US, forcing many emerging markets to raise interest rates, adjust currency and tax policies, and accept currency depreciation to stabilize the situation and reduce large current account deficits. As another Fed rate hike looms, emerging markets are considering using a mix of monetary tightening, targeted legal changes, and managed exchange rate adjustment to ease outflows while achieving macroeconomic rebalancing.

1. Page 1 of 2
Economic Commentary
QNB Economics
economics@qnb.com
31 May, 2015
How can EMs weather the first Fed rate hike?
The likely date of the first interest rate hike by
the US Federal Reserve (Fed) draws ever
nearer. Janet Yellen, the chair of the Fed,
reiterated recently that it would be appropriate
to start the process of raising rates at some
point this year. The excessively easy
monetary policy in the US over the last seven
years has led to significant capital flows to
emerging markets (EMs) in search of yield. The
normalisation of US monetary policy could
reverse these capital flows, as it did in mid-
2013 during the so-called taper tantrum. What
lessons can EMs learn from the 2013 taper
tantrum ahead of the expected first Fed rate
hike later this year?
Portfolio Flows to Emerging Markets
(USD bn)
Sources: Institute of International Finance (IIF) and QNB
Economics analysis
In May 2013, the Fed triggered the taper
tantrum when it announced the possibility of
reducing the pace of its asset purchases
programme. Yields on US 10-year treasuries
rose from 1.7% at the end of April 2013 to 2.5%
at the end of June. As US yields rose, EMs
experienced USD29bn of net capital outflows
in June 2013 alone, compared with average
inflows of USD26bn per month in the prior 3.5
years. This forced EMs to react in three ways.
First, by the end of August 2013, a number of
major EMs had increased interest rates. India
was the most aggressive, raising its lending
rate 2% on July 15; Brazil increased policy
rates by 1.5%; Indonesia by 1.25%; and Turkey
raised its lending rate by 0.75%. Higher
interest rates may help to mitigate outflows in
the short term, particularly during a crisis.
However, they will also suppress economic
growth by making it more expensive to
borrow. For most EMs, prompt tightening of
monetary policy appears to have helped
stabilise the situation, with net capital inflows
recovering to an average of USD16bn since the
taper tantrum.
Second, some EMs made tax and legal changes
to encourage capital inflows and limit
outflows. Brazil eliminated a 6% tax on foreign
bond investment and a 1% tax on currency
derivatives (introduced a few years ago when
the Brazilian Real was appreciating too
quickly). India removed a cap on foreign equity
ownership in telecoms, introduced incentives
for non-resident Indians to deposit their
savings in India, and introduced restrictions on
gold imports to reduce the large current
account deficit.
Finally, capital flight led to sharply weaker
exchange rates, despite the fact that a number
of EMs intervened to support their currencies,
draining foreign exchange reserves. The
Indian rupee fell the most, down 22% by the
end of August; Brazil’s real fell 19%;
Indonesia’s rupiah fell 15%; and the Turkish
-30
-20
-10
0
10
20
30
40
50
60
2010 2011 2012 2013 2014 2015
Average MonthlyFlows
USD16bn
USD26bn
Taper
Tantrum

2. Page 2 of 2
Economic Commentary
QNB Economics
economics@qnb.com
31 May, 2015
lira was down 14% over the same period. The
benefit of weaker exchange rates is that they
make exports more competitive and imports
more expensive, helping to reduce current
account deficits. However, there are also
trade-offs as weaker exchange rates increase
the burden of foreign currency debt. In India,
where foreign currency debt is only 16% of
GDP, the weaker exchange rate probably
worked in the country’s favour helping reduce
the current account deficit from 4.9% of GDP
in 2012 to 1.7% in 2013. However, in Turkey,
where foreign currency debt is 47% of GDP,
the weaker exchange rate may have been more
of a drag on growth.
As EMs brace themselves for another possible
round of capital flight as the Fed tightens
monetary policy, potentially starting this year,
they are likely to look back at what lessons
they can learn from the 2013 taper tantrum.
The trade-offs between growth and stability
will differ from country to country, but a mix
of policies seemed to have guided EMs through
the taper tantrum. Tighter monetary policy as
well as temporary and targeted legal
restrictions should help to ease capital
outflows while allowing the exchange rate to
depreciate could help achieve a painful but
quick adjustment to the current account
deficit.
Contacts
Rory Fyfe
Senior Economist
+974-4453-4643
Ehsan Khoman
Economist
+974-4453-4423
Hamda Al-Thani
Economist
+974-4453-4646
Ziad Daoud
Economist
+974-4453-4642
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