Emerging markets have bounced back following last year's Federal-Reserve-induced taper tantrum, but with the U.S. central bank gradually shifting its focus to potential rate hikes are these markets at risk of another bout of capital flight?
Indonesia and India were among the worst-hit emerging markets last year after former Federal Reserve Chairman Ben Bernanke first broached the possibility of tapering the Fed's quantitative easing program a year ago. Indonesian stocks fell around 27 percent from their May peak to their August lows in 2013, while the Indian rupee tumbled to record lows against the U.S. dollar.
While both markets have since recovered as policymakers worked to correct macroeconomic imbalances – wide current account and fiscal deficits – and amid optimism around a change in political leadership, these markets remain hostage to Fed policy with potential near-term tightening moves likely to spark capital outflows.
However, while business leaders and policymakers say further capital outflows are to be expected when the Fed signals an imminent rate hike, the scale of will be smaller compared with May-September 2013.
"Like it or not, there will be a possibly of capital outflows because when the U.S. raises interest rates people will look for returns," Chatib Basri, Indonesia's finance minister told CNBC on the sidelines of the World Economic Forum in Manila on Thursday.
Higher U.S. interest rates typically lure investors to dollar-denominated assets as they are seen as more attractive than emerging market assets from a risk/reward perspective. The Fed is expected to begin hiking rates at some point in 2015.