Emerging markets to weather capital outflows on QE3 exit

Formidable exit task

"To the extent that QE3 has lifted US growth, this provides support to the global economy," Felix Huefner, deputy director of Global Macroeconomic Analysis of the IIF, told Xinhua, adding that QE3 also introduces additional uncertainty to global financial markets, as reflected in the recent jittery financial markets.

The news of gradually ending QE3, the monetary stimulus program initiated in September 2012 to bolster lending and economic activity, has roiled global financial markets. US stock market sank after Bernanke's QE3 exit comment before stabilizing Friday. US Treasuries tumbled for three consecutive days, with the yield on the 10-year note hitting its highest levels in about two years.

"It was always clear that exiting from ultra-easy monetary policy would be a formidable communication challenge. In our view, it is too early to assess whether the Fed efforts to this effect have been successful, although it probably would have been beneficial to convey more new information in writing rather than verbally," Koepke said.

Since the onset of the financial crisis, the Fed has kept its short-term interest rate at the historically low level and completed two rounds of quantitative easing programs, known as QE1 and QE2. It is now purchasing longer-term government debt and mortgage-backed securities at a pace of $85 billion per month, dubbed as the QE3. Experts held that QE helped boost the US housing sector and employment, but it also made it difficult to wean investors off the addiction to the Fed's newly injected liquidity which could lead to asset bubbles.

Capital reversal

"In its early phase, QE3 has meant a weaker dollar and additional capital flows to EM economies. Now that markets focus on the end of QE3, the pendulum has swung to the opposite side," observed Huefner.

First, the uncertainty associated with the exit from QE3 results in greater volatility of capital flows. Second, the exit process is likely to be accompanied by some retrenchment of foreign capital from EM economies, with countries that depend on external financing most at risk, Huefner cautioned.