With demand for exports falling, investment slumping, and cross-border lending drying up in a spreading economic crisis, emerging market countries are increasingly concerned about protectionism, according to the International Monetary Fund (IMF).
The "spectre of trade and financial protectionism was a rising concern," it said in an analysis prepared for the Group of Twenty (G-20) industrialised and emerging market countries including India ahead of their April 2 summit in London.
"Notwithstanding commitments by G-20 countries not to resort to protectionist actions, there have been worrying slippages," the IMF analysis released on Thursday said, noting many emerging market economies are likely to face prolonged capital account pressures.
As the crisis becomes more prolonged, a growing number of emerging economies will find room for policy manoeuvre becoming increasingly limited. "Large-scale official support is likely to be needed from bilateral and multilateral sources," it said.
Referring to interventions in advanced economies, the Fund said lines were being blurred between public intervention to contain the impact of the financial crisis on troubled sectors and inappropriate production subsidies to industries whose long-term viability is questionable.
In emerging economies, monetary policy has to balance the need to support demand against the risk of accentuating capital outflows and undermining financial stability, the IMF said.
With constraints on the effectiveness of monetary policy, fiscal policy-including increased spending on infrastructure, job creation, and cash transfers to the vulnerable-needs to play a central role in supporting demand, while remaining consistent with medium-term sustainability, the IMF recommended.
Emerging economies should prepare, on a contingent basis, plans to address the growing risks of large-scale corporate failures, the IMF advised. Comprehensive mechanisms are needed to reduce the risk of systemic solvency problems, along with a strengthening of corporate workout frameworks.
Overall, risks are largest for emerging economies that rely on cross-border flows to finance current account deficits or to fund the activities of their financial or corporate sectors, the analysis said.
Foreign direct investment is set to slow significantly, given the fall in private equity assets, the lack of credit available to finance acquisitions, and sharply deteriorating growth prospects in emerging markets, it said.
Corporate and banking sector vulnerabilities are becoming mutually reinforcing in several emerging economies, the IMF noted. Relatively high requirements to roll over debt in the year ahead could rise further as some debt claims are accelerated due to breaches in original covenants.
With falling commodity prices and growth slowing sharply, defaults in the corporate sector are widely expected to rise, which would further strain bank balance sheets. In this environment, many banks are already curtailing credit growth, exacerbating the financing constraints for companies and businesses, IMF said.