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Prospects Weekly: US Federal Reserve will begin a gradual tapering of its asset purchase program, Initial market reaction in developing countries was relatively muted, An Agreement on Trade Facilitation was successfully negotiated

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The US Federal Reserve announced that it will begin a gradual tapering of its asset purchase program beginning in January 2014, initially reducing it from $85bn to $75bn per month. The communication around the policy change was effective, with most markets reacting calmly to the news. Stock-markets and currencies in selected developing countries had already come under renewed pressure in recent weeks, but did not suffer additional adverse effects with the announcement. The recent WTO trade facilitation agreement reached in December has the potential to significantly ease the transactions cost of moving goods across borders, with significant benefits to developing countries.

The US Federal Reserve decided this week to start gradually reducing its quantitative easing policies, reinforcing at the same time its commitment to maintaining short-term policy rates close to zero until at least mid-2015. The Fed decision reflects a convergence of factors including the decline in the US unemployment rate, improving housing markets and progress in fiscal negotiations in the US Congress. Markets reacted calmly to the news, taking comfort in the upbeat assessment of the outlook for the US economy and the reinforced commitment to keep short-term policy rates unchanged “well past the time that the unemployment rate declines below 6-1/2 percent”, which by the Fed’s own forecasts will not happen until the end of 2015. Given the role the US Fed has come to play on US bond markets (holding at present more than 50 percent of the outstanding amount of Treasuries of 8 to 10 year maturity), market volatility and potentially abrupt changes in yields and risk premia may yet arise. The process of withdrawing quantitative easing is expected to span most of 2014.

The initial market reaction in developing countries was relatively muted, as markets had been pricing in an eventual decision over recent weeks. Stock markets generally moved sideways on the announcement with currencies holding firmly on average. This resilience comes after renewed financial market pressures since end October, which affected among others Indonesia, Turkey and Brazil. These renewed tensions came about in the context of rising expectations of an eventual taper. Beyond the benign reaction to the Fed announcement this week, a period of heightened uncertainty and market volatility is possible in the months ahead, with potentially important ramifications for developing countries, including in terms of the size and nature of future capital inflows. Should they arise, adverse effects would concentrate among those countries that are more financially integrated and have the largest vulnerabilities.

An Agreement on Trade Facilitation, as part of the Doha Development Agenda (DDA), was successfully negotiated at the recently concluded WTO Ministerial Conference held in Bali. Trade facilitating reforms are an important component of developing countries’ structural reform agenda. Compared with high-income countries, imports into developing countries take about three times as long, cost twice as much and require twice as many documents. Hufbauer et al. (2010) had estimated that a WTO trade facilitation agreement could yield $117.8 billion in additional global GDP per annum, with the gains to developing countries outweighing those of high-income countries. While welcome, the trade facilitation agreement reached was among the least contentions of issues in the DDA. Progress on other issues important to developing countries has been lackluster. Disciplines on agriculture trade continue to remain a thorny issue, and rules on non-agricultural market access and liberalization of services trade are still unresolved.

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