As investors begin a mass exodus from developing economies, returning to the “safe haven” of American currency, Canadian economists are keeping a close eye on the global reaction to potential tapering of the U.S. Federal Reserve’s bond buying program.
Signs of increasing volatility in emerging markets have continued to surface this week, as both the the Indian rupee and Indonesian rupiah continued to fall on Wednesday to near record lows.
The rupee joins the rupiah (which had fallen more than 13% against the U.S. dollar as of August), and Brazil’s real in a spate of tough economic times for developing nations, particularly those with large current account deficits. In August alone the Jakarta Composite Index plummeted about 11% due to investors pulling away from the Indonesian economy.
Much of the negative economic news seems to be affecting places far beyond Canada’s borders, although economists have pegged our nearest neighbour as the culprit. Following Fed chairman Ben Bernanke’s comments regarding the tapering of quantitative easing this summer, funds previously invested in countries like India are being repatriated to the United States. In the past week, investor nerves have also been shaken by the potential for a U.S. military strike against Syria.
Canada’s currency has slipped a few cents in recent months in response to Bernanke’s comments, but as reported by Canadian Business in July, economists have determined that our currency is just getting back to normal.
As Camilla Sutton, currency strategist with Scotiabank, has pointed out though, it’s still important for Canada to keep a watchful eye on the Fed’s next steps due to our reliance on both the American economy, and global growth in general.
“Canada’s very sensitive to the global growth outlook,” said Sutton.
“The more pressure we have in emerging markets, the worse the outlook looks.”
Decreasing growth in other economies can have a negative effect on Canada for a very simple reason: our mass production and export of commodities. If the demand for commodities goes down, the prices will follow, and we may see a spillover into the Canadian economy.
Stephen Sapp, an associate professor of finance-economics at the Richard Ivey School of Business, noted that the effect on Canada will likely be indirect if the slowdown in growth is confined to countries we don’t trade with on a large scale.
“But indirectly, if we do start to see a global slowdown, then we will start to see an impact,” he added.
Fortunately for the global growth outlook, countries such as China have been showing some resilience as of late. The most recent results from China’s manufacturing index showed that the country is now in a positive state of expansion.
And the Fed’s tapering of quantitative easing also isn’t set to have the same effects on Canada as it has so far on countries such as India. While Brazil and Indonesia have both been able to offset some of the effects of Bernanke’s comments by raising interest rates (both countries increased their rates by 50 basis points in the past week), India cannot afford to do the same, and has seen an outflow of capital as a result.
“It just highlights that there’s this global ramification as the U.S. begins to tighten policy, and that’s also what we’ve felt in Canada, just in a different way,” said Sutton.
Canada will be impacted when the Fed decides to begin tapering, she added, “but it will be to a far smaller degree than what’s transpiring right now in India.”