Global finance chiefs ready defenses ahead of Fed exit

By Anna Yukhananov and Alonso Soto

WASHINGTON | Sat Oct 12, 2013 4:58pm EDT

(Reuters) - Global finance chiefs on Saturday told the IMF to stand ready to aid emerging market economies that could be destabilized by a sudden flight of capital when the U.S. Federal Reserve and other central banks back away from ultra-loose monetary policies.

The International Monetary Fund's governing panel, after a semi-annual meeting, acknowledged the risks posed by a transition toward more normal policies in advanced economies, and it urged nations not to delay preparations.

"The key task is to focus on the transition, prepare ourselves well for this eventual normalization," the committee's chairman, Singaporean Finance Minister Tharman Shanmugaratnam, told reporters. "It's not imminent, but it will happen."

A wave of selling spread quickly through world financial markets this year after the Fed, responding to signs of stronger U.S. growth, said it could start winding down its economic stimulus program by year end.

The pain was felt most severely in developing countries as a gusher of cheap dollars that had poured into their economies dried up, sparking a sharp slide in stock prices and currencies and pushing up local interest rates.

Low interest rates in developed economies, engineered by their central banks in recent years, had spurred investors to hunt for higher-yielding assets, many of which were found in emerging markets.

When the U.S. central bank does move to reduce stimulus, the repercussions "may be even more significant," said Zeti Akhtar Aziz, chief of Malaysia's central bank. Aziz said the IMF's "policy toolkit" needed to expand to help cope with the fallout.

The U.S. central bank has held interest rates near zero since 2008 and has tripled its balance sheet to roughly $3.7 trillion. Over the last year, it has been pumping $85 billion into the U.S. financial system each month through bond purchases.

The IMF panel, which represents the Fund's 188 member nations, said these ultra-accommodative policies have supported world growth and remained appropriate for now.

Worries about the strength of the U.S. economy prompted the Fed to refrain from winding down its stimulus last month. But few doubt it will wait very long.

The panel urged developed market central banks to try to limit the damage to emerging markets when the time comes to move toward tighter policy, saying the shift should be "well-timed, carefully calibrated and clearly communicated."

The Fed faced criticism from officials in developing nations and from market participants for abruptly suggesting in June that it could soon move to scale back its stimulus. It surprised onlookers again last month when it opted to hold fire.

"Global financial stability is a shared responsibility," said Ewald Nowotny, a member of the European Central Bank's Governing Council. "The Fed should therefore clearly communicate the path of its intended policy actions to minimize negative spillovers" on developing economies.

'CONSIDERABLE TURBULENCE'

Russian Finance Minister Anton Siluanov said policymakers should prepare for another round of "considerable turbulence in financial markets" once a move toward tighter policy begins.

"The assumption that the asset price correction that began this summer has already been largely completed does not seem to be plausible to us," he said, referring to the sell off in emerging markets.

To protect themselves, finance leaders urged developing nations to act now to reform their economies and reduce vulnerability to unpredictable capital flows.

That's especially critical for countries where budget deficits make them dependent on unstable foreign capital flows.

"Fiscal consolidation remains a high priority in countries with large fiscal imbalances, while others should rebuild buffers, unless growth deteriorates significantly," the panel said in a closing statement.

While emerging markets' pace of growth has slowed of late, the IMF governing committee said it still expects expansion in these countries to account for "the bulk of global growth."

Advanced economies, including the United States and Japan, need to commit to medium-term deficit reduction plans while supporting near-term growth and job creation, it said.

The finance chiefs also called for completing IMF reforms to give emerging markets a greater say at the global lender.

Three years ago, the IMF's board agreed on changes that would cut Europe's representation, but they have been held up because the U.S. Congress has yet to sign off on them, and prospects for action before year-end are slim. Without ratification by the United States, the fund's biggest and most powerful member, the reforms cannot move forward.

"The governance reforms have entered a stage of complete paralysis and this has further eroded the fund's legitimacy and credibility," said Brazil's central bank chief, Alexandre Tombini.

"Emerging market countries have honored their part of this political agreement," he added. "It is time for the United States and Europe to deliver theirs."

(Reporting by Reuters' IMF reporting team; Writing by Steven C. Johnson; editing by Chizu Nomiyama)

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