Exits from unconventional monetary policies (think QE in the US, Japan, and soon the ECB) pose risk to emerging countries...
The following are highlights from a recent speech by Raghuran Rajan, governor of India's central bank, currently on leave from the University of Chicago, where he is the Distinguished Service Professor of Finance.
"Investment managers may fear underperforming relative to others. This means they will hold a risky asset only if it promises a risk premium (over safe assets) that makes them confident they will not underperform holding it. A lower path of expected returns on the safe asset makes it easier for the risky asset to meet the required risk premium, and indeed draws more investment managers to buy it – the more credible the forward guidance on “low for long”, the more the risk taking. However, as investment managers crowd into the risky asset, the risky asset is more finely priced so that the likelihood of possible fire sales increases if the interest rate environment turns. Every manager dumps the risky asset at that point in order to avoid being the last one holding it."
"Asset prices may not just revert to earlier levels on exit, but they may overshoot on the downside, and exit can cause significant collateral damage."
We recommend: 1) watch the above video, 2) check out "Ben Bernanke's Gift to Africa," and, 3) review our related whitepaper - Why QE3 Will Be a Boon to Africa's Frontier Markets.
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