Faster U.S. monetary tightening could trigger outflows, depreciation in emerging markets: IMF

The International Monetary Fund (IMF) warned on Monday that a faster tightening of U.S. Federal Reserve's monetary policy could lead to capital outflows and currency depreciation in emerging markets.

"While the global recovery is projected to continue this year and next, risks to growth remain elevated by the stubbornly resurgent pandemic. Given the risk that this could coincide with faster Fed tightening, emerging economies should prepare for potential bouts of economic turbulence," Stephan Danninger, chief of the IMF's Macro Policies Division in the Strategy Policy and Review Department, said in a blog with his colleagues.

"Faster Fed rate increases in response could rattle financial markets and tighten financial conditions globally. These developments could come with a slowing of U.S. demand and trade and may lead to capital outflows and currency depreciation in emerging markets," the IMF officials said.

The warning came as U.S. Federal Reserve officials anticipated earlier and faster interest rate hikes than previously expected amid elevated inflation, according to the minutes of the Fed's latest policy meeting released last week.

"Participants generally noted that, given their individual outlooks for the economy, the labor market, and inflation, it may become warranted to increase the federal funds rate sooner or at a faster pace than participants had earlier anticipated," the Fed said in the minutes of its Dec. 14-15 meeting.

The median respondent's projected timing for the first increase in the target range for the federal funds rate moved earlier from the first quarter of 2023 to June 2022, according to the minutes.

Meanwhile, most Fed officials expected the central bank to raise interest rates three time in 2022 from its current record-low level of near zero, up from just one rate hike projected in September.

In response to tighter funding conditions, emerging markets should tailor their response based on their circumstances and vulnerabilities, the IMF officials noted.

"Those with policy credibility on containing inflation can tighten monetary policy more gradually, while others with stronger inflation pressures or weaker institutions must act swiftly and comprehensively," the IMF official said.

In either case, responses should include letting currencies depreciate and raising benchmark interest rates. In addition, countries with high levels of debt denominated in foreign currencies should look to reduce those mismatches and hedge their exposures where feasible, they added.