(Corrects ninth paragraph to say rates could fall “below the neutral rate” rather than “negative, or below the rate of inflation”)
By Dion Rabouin
NEW YORK, Oct 24 (Reuters) - Latin America and Brazil in particular are well-positioned among developing countries to withstand expected rate increases by the U.S. and European central banks in coming months, investors and economists said, while Turkey looks particularly vulnerable.
In the months after May 2013, when then-Federal Reserve Chair Ben Bernanke announced plans to reduce monetary stimulus, the JPMorgan Emerging Markets Global Bond Index dropped nearly 15 percent from its May high to its low for the year in September. MSCI’s index of emerging market stocks dropped 17.4 percent from its May high to its low point of the year in June.
But that pattern, since dubbed the “taper tantrum,” is unlikely to be repeated even as the Fed begins to unpack its $4.5 trillion of bond holdings and looks set to keep hiking interest rates, analysts said.
“If you look at the fundamentals this time around, you have a better situation than you had, for example, around the time of the ‘taper tantrum,'” said Sonja Gibbs, senior director at the Institute for International Finance.
Brazil in particular has seen inflation ease during a severe recession and has made some progress on structural reforms, boosting investors’ comfort with its plan to keep cutting rates even as the Fed tightens, she said.
Latin America’s largest economy was previously named by Morgan Stanley analysts as one of its “Fragile Five” - economies most vulnerable to capital flight.
But this time it is one of the best situated, other top officials and economists said.
Fed Governor Jerome Powell, a candidate on President Donald Trump’s shortlist to succeed current Chair Janet Yellen, specifically highlighted the country in remarks he gave touting the strength of emerging economies during the IMF/World Bank meetings.
The climate is benign enough that Brazil’s central bank and others in the region could move to real interest rates that are below the neutral rate, said Wim Vandenhoeck, portfolio manager for Oppenheimer’s emerging markets local debt fund.
“Inflation is so anchored right now that there might be an opportunity for some central banks to pull it off,” he said.
Long a largely closed economy that is not overly reliant on trade, the country has significantly reduced its current account deficit from 4.2 percent of gross domestic product in 2014 to 1.5 percent this year, according to International Monetary Fund data and projections.
The relatively rosy outlook is true for much of Latin America. In 2013, many of these markets were funding deficits with foreign capital and dollar-denominated debt.
Absent a major shock or policy regression, “there’s no reason capital needs to go out,” said Josephine Shea, director of emerging markets at Standish, a BNY Mellon subsidiary.
“So when will that gravy train stop? It might not be for a while,” Shea said.
Carlos Végh, chief economist for Latin America at the World Bank, said he does not see risks for the region from tighter Fed policy for a couple of years, when U.S. interest rates are expected to reach 2 percent and above.
If growth rates in some Latin American countries remain anemic, they could then face a “monetary dilemma” of whether to cut rates further, risking capital outflows.
“The region therefore will have to strengthen and to find its own sources of growth ... (and) will have to deepen the structural reforms,” he said.
Moritz Kraemer, chief ratings officer at S&P Global Ratings, said that the countries in best position to succeed are those “that depend least on the savings of foreigners.”
While Brazil, most of Latin America, as well as China and the Philippines also look well positioned from that perspective, Turkey is particularly at risk, he said.
The country’s $532 billion in external debt represents 67 percent of its GDP, according to a recent IMF report. That is four times China’s rate and almost twice as high as Brazil‘s.
Turkey’s large deficit and the fact that much of it is financed by external fund flows make it vulnerable to political shocks and other factors including global rate hikes, said Blaise Antin, managing director and sovereign group head at asset manager TCW.
Turkey’s currency also swooned recently following a diplomatic spat with the United States over security concerns.
Still, Antin said he increased his Turkish bond allocation earlier this year, citing price and its high local bond yields. And overall he’s “very constructive” on emerging markets.
Reporting by Dion Rabouin; Editing by Christian Plumb and Lisa Shumaker