Emerging markets not safe from financial crisis: IMF

It said that despite generally strong external positions, some concerns have arisen about dollar funding in Asia — particularly in Korea, Taiwan Province of China — and to an extent, in India.

“In India, some corporations have borrowed dollars and swapped the resulting debt into yen, increasing the difference between borrowing and lending rates, but leaving a large open exposure. Nevertheless, the risk to the Indian financial sector arising from these transactions currently appears manageable,” the IMF has said. It is being pointed out in a footnote that Indian corporations had net cross-border obligations of $31 billion as of September 2007, while Indian banks had very limited net exposure as of January 2008, according to the Bank for International Settlements.

The October 2007 GFSR cited estimates that up to one-half of Indian firms’ short dollar positions had been swapped into yen. Market sources suggest that the ratio of yen borrowing has likely diminished since then.

“Since July 2007, risk repricing and yen appreciation have prompted the unwinding of a substantial proportion of yen carry trades, but cross-border interest rate differentials have persisted, and lower US interest rates have increased the use of the dollar as a carry trade funding currency. The continued strength of a number of emerging market currencies, including the Brazilian real and the Indian rupee, suggests that some carry trades have persisted. This could present a channel of vulnerability in the event of future volatility spikes,” the IMF has said.

It noted that the events of the past six months have demonstrated the fragility of the global financial system and raised fundamental questions about the effectiveness of the response by private and public sector institutions.

And it suggested: “Nearly all emerging market countries should review the reliability and depth of detail in financial institutions’ public disclosures and the robustness of their accounting frameworks as uncertainty about the health of major financial institutions breeds financial instability.” The IMF report further said that a global slowdown, in turn, could lead to a decline in most types of capital inflows to emerging markets.

It said some supply side factors continue to favour emerging markets, with institutional investors in Europe and North America still seeking portfolio diversification, retail investors in Japan continuing to look for higher returns abroad, and institutional or sovereign investors in West Asia recycling oil-based surpluses.

In some Asian economies, steps taken to limit the pace of appreciation against the dollar may lead to monetary policy settings that are looser than would otherwise be optimal.

Despite the financial turmoil, some “Asia play” flows into currencies such as the Chinese renminbi and Indian rupee have continued, the IMF has said, going on to loosely define “Asia play” as purchase of Asian-currency-denominated assets on the view that local currency will likely appreciate against the dollar, especially if authorities are expected to reduce the scope of interventions.