Issues in emerging market economies

During the year under review, growth in all the major emerging market regions was surprisingly strong, reflecting a better balance between external and domestic demand. Rapid growth put pressure on many critical raw materials, such as oil, but higher commodity prices did not lead to a marked resurgence of inflation. Interest rates in Asia and elsewhere remained low.

Have emerging market economies become more resilient to shocks? A number of considerations indicate that the answer is "yes". First, domestic demand has become less dependent on external demand. Second, there have been improvements in fiscal positions, in some cases supported by legislative reforms and the development of local bond markets. Third, inflation appears to have become more stable, in some instances reflecting greater monetary policy credibility. To the extent that countries have become less committed to an explicit exchange rate target, this too reduces their vulnerability to shocks. Fourth, many emerging market economies now have significant current account surpluses. Fifth, there have been improvements in banking performance.

Favourable cyclical factors have played a role, and a global slowdown could set back some of the recent progress. In contrast, should growth be maintained, inflation expectations in some countries might rise. The debt of some countries is still too short-term and this creates a vulnerability to a change in interest rates. But risks from external shocks have been considerably attenuated by high levels of official foreign reserves. Finally, banking sectors are still exposed to various risks, and improvements in the regulatory environment need to go further in some cases.