Emerging market economies

30 June 2008

Growth in emerging market economies (EMEs) last year once again significantly exceeded that in the rest of the world. Foreign currency inflows were large, reflecting continued growth in current account surpluses and capital inflows in 2007. Nevertheless, the potential knock on effects of financial market turmoil in the major centres increased the risk of a slowdown in EMEs. At the same time, recent increases in headline inflation have caused inflation targets to be breached in many EMEs, reflecting the impact of steep increases in oil and food prices. As in the advanced industrial economies, these conflicting forces have created a major dilemma for monetary policy. Efforts to resist currency appreciation have introduced additional complications, having been associated with a sharp increase in foreign reserves and in credit growth in a number of EMEs.

Developments in the advanced industrial economies could also pose major challenges. First, a pronounced slowdown in the United States would hurt the EMEs which, although remarkably resilient so far, still depend significantly on external demand. Second, tighter conditions in global financial markets could constrain EMEs with large current account deficits, particularly those relying on more volatile portfolio financing. Countries heavily dependent on cross-border bank borrowing could also be especially vulnerable.