The Institute of International Finance said Tuesday that the withdrawal of massive stimulus by the U.S. Federal Reserve and other central banks could lead to a "boom-bust cycle" in emerging markets if investors are unprepared.
"The risk of market participants being unprepared for a reversal of rates is real and needs to be seriously considered to avoid disruption," the IIF said.
Low interest rates around the world over the past five years have boosted investments into faster-growing emerging countries
-- where money can earn a better return.
The IIF sounded its warning in a report ahead of the World Economic Forum in Davos, Switzerland, where some 2,500 business and political leaders are gathering to discuss economic risks ahead this year.
The IIF predicted that falling unemployment and an improving economy in the United States may lead the Fed to start withdrawing some of its easy money policy in 2014. In order to shore up the economy in the face of an acute banking crisis, the Fed has cut its main interest rate to near zero percent and pursued policies which have greatly expanded the money supply.
Many other banks around the world cut their interest rates to record lows too and have backed policies to make up for the drying up of private sector credit that has been one of the hallmarks of the global economy over the past few years. Despite subdued economic recoveries around the world, many economists say such policy action prevented a repeat of the 1930s.
So far, there are few indications that the world's central banks are about to change course anytime soon. On Tuesday, the Bank of Japan bowed to pressure from government to raise its inflation target that will likely mean it has to increase its money supply, while the European Central Bank and the Bank of England are both under pressure to do more to help their ailing economies.
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In its report on investment flows into emerging markets, the IIF said most emerging market governments may have the foresight to avoid the pitfalls of boom and bust. However, it said investors and some governments may not be so careful, leading to unexpected losses and market turmoil.
The institute suggested rich countries should coordinate rate policy -- and that failure to do so risks undermining investor confidence and more market turmoil.
The rise in flows have made many uneasy in developing countries, since the inflows can lead to rising exchange rates for the countries that are on the receiving end. The higher exchange rates have the potential to hurt their exports.
The IIF said Tuesday that capital flows to Latin America and emerging Asian economies such as China, Indonesia and India are now 30 percent above the level in 2007, before the global financial crisis.
It raised its figure for capital flows for 2012 to $1.080 trillion from $1.026 trillion estimated in October and said money movements picked up sharply in the last months of 2012 and will likely rise in 2013 to $1.118 trillion and again in 2014 to $1.115 trillion.
The IIF, which is based in Washington, D.C., has 450 members, including major global commercial and investment banks, insurance companies, investment funds, hedge funds, and other finance-related institutions.
Press; By DAVID MCHUGH]
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