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What Does Bernanke’s Big Move Mean for Emerging Markets?

For now, the cash spigot in Washington, D.C. will remain wide open and continue spewing dollars onto global markets. On Wednesday, Chairman Ben Bernanke announced that the Federal Reserve’s massive bond-buying program — better known as quantitative easing — will continue for the foreseeable future, a surprise move that sent stock markets to record highs. ...

Mark Wilson/Getty Images
Mark Wilson/Getty Images

For now, the cash spigot in Washington, D.C. will remain wide open and continue spewing dollars onto global markets.

On Wednesday, Chairman Ben Bernanke announced that the Federal Reserve’s massive bond-buying program — better known as quantitative easing — will continue for the foreseeable future, a surprise move that sent stock markets to record highs.

Emerging market currencies and stock markets also rose on the news, and in all likelihood more than one central banker in the world will be lighting candles tonight at his shrine to Bernanke.

While Bernanke’s innovative and controversial stimulus package has been primarily aimed at stimulating weak demand in the United States and papering over fiscal gridlock in Congress, the program has sent enormous amounts of money into emerging markets. By buying up $85 billion in bonds every month, Bernanke’s Fed has vastly increased liquidity, much of which has been invested over the past few years in emerging markets.

But with Bernanke’s announcement in May that the Fed would begin slowing bond purchases, much of the money that has rushed into emerging markets has begun to come back. That has put enormous pressure on emerging markets, depreciating currencies against the dollar. To get a sense of the scale of these cash flows, have a look at the graph below, courtesy of the Institute of International Finance:

With Wednesday’s announcement, emerging market currencies rallied across the board, bringing welcome relief to central bankers who had announced programs to prop up local currencies against pressure from the Fed’s withdrawal.

In Brazil, whose central bank governor recently committed $60 billion to propping up the country’s currency, the real saw gains of upwards of three percent:

The Turkish lira saw similar gains:

The Indonesian rupiah, whose recent decline had investors fretting, also rallied on the news:

The South African rand, another embattled currency, also jumped:

While currency appreciations aren’t always good news (see, export-dependent economies), Wednesday’s announcement provides a breather from a period that had seen wild fluctuations in emerging market currencies. In Latin America, stock exchanges saw broad increases, and Asian exchanges are set to open higher on the news.

One of the more interesting economic stories to watch in all of this is India, which was by far the worst hit by the recent capital flight. The Indian economy is currently struck by a combination of economic problems: India imports up to 80 percent of its oil, and with a declining currency, its current account deficit was rapidly becoming unsustainable. At the same time, rising food prices are creating a huge headache for the government, which provides large amounts of food at a subsidized cost. As if that wasn’t enough, a low rupee is contributing to increasing inflation. Wednesday’s announcement was not enough to send the rupee soaring — the currency bounced back and forth amid volatile trading — but it at least helped to halt its slide, for now.

Despite the cheers heard around the world today, at some point the party will have to end, and Uncle Sam will wind down what amounts to an ultra-loose monetary policy. The big question for emerging markets is how Bernanke — or his yet-to-be-named successor — will decide to turn out the lights. “For sure, the persistence of easy monetary policy increased the flow of capital to emerging markets, especially in Asia and Latin America,” International Monetary Fund chief Christine Lagarde said in an April speech. “Such flows can be beneficial to an economy, but they can also lead to financial stability risks. Even worse than the tide coming in is the tide going out — a possible sudden reversal of large capital flows that can overwhelm an economy.”

Countries like India will be praying that they are ready when that day comes.

Elias Groll is a staff writer at Foreign Policy. Twitter: @EliasGroll

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