Module Name: Global Integrative Project
Subject: A business commentator has advised, “What you will not be able to do with any global or emerging markets fund is to avoid ramped-up volatility this year”. Discuss and suggest how emerging economies might reduce exposure to economic and fiscal volatility. You should include at least one example in your answer.
Here is the additional information the lecturer recommends to be on the paper:
– As we discussed in class, a country that relies on foreign capital to finance its spending in excess of its income is subject to volatility. On the one hand, emerging economies tend to attract primarily portfolio investment (mostly short-term debt, or “hot money”) instead of foreign direct investment (long-term debt aimed at boosting growth in a country). Encouraged by a period of global growth, emerging economies will seek to expand their economies and will offer higher interest rates in order to attract the hot money from overseas investors. On the other hand, at the first sign of a downturn in world trade, the speculative investors will want to take their money out of the emerging economies quickly.
– Matters are not helped by the local banking system which is often more geared to local political convenience than the realities of a global economy (see my lecture notes). The weakness can be quickly shown up when foreign investors seek rapid withdrawal. If the country has a flexible exchange rate and the central bank does not have enough foreign reserves to meet these withdrawals, its currency will depreciate. If instead the country has a fixed exchange rate regime, rapid capital withdrawals by investors can cause a balance-of-payments crisis, forcing the monetary authority to devalue its currency and lose credibility on the world finance markets.
– Traditionally India, Turkey and South Africa have been amongst the most volatile economies in the world. India’s rate of inflation has been as high as 9% but has now dropped to 4.8% reducing its vulnerability to volatility. You could research why this has happened.
– For Turkey and South Africa, the main sources of vulnerability are their current account deficits and fewer foreign reserves than needed to avoid a depreciation of their currencies.
– There are lots of articles in academic and financial journals discussing the options open to emerging economies seeking to reduce exposure to volatility. See link for overview of the key issues.
– You are not expected to solve a problem which major economists and policy makers have been wrestling with for years. But you are expected to show that you understand the causes of volatility and recognise it where it manifests in the world. But above all you should aim to demonstrate your curiosity about volatility and your thoughts on the matter.
– Finally, remember, this essay is not asking you to import theories from other modules. This is all about your thoughts and reflections and your choice of examples.
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