Fed to emerging markets: Think on your policy shortcomings

WASHINGTON (Reuters) - The U.S. Federal Reserve on Tuesday acknowledged it likely triggered a financial market sell-off in the developing world, but said policies in countries such as Turkey, Brazil and India made them especially vulnerable to external shocks.

The Fed said in a report to Congress that the "stresses that arose in the middle of last year appeared to be triggered to a significant degree by Federal Reserve communications."

In mid-2013, the U.S. central bank said it could soon start winding down a bond-buying stimulus program, sending stocks, bonds and currencies plunging across many emerging markets. The announcement stoked global tensions over potentially destabilizing shifts in international money flow, as when India's central bank chief fretted that the United States should be more aware of how its policies affect the world.

In its report, however, the Fed pointed a finger back at some developing countries, saying they need to look in the mirror when assessing why their markets took a big hit.

Fed analysts built an index measuring economic vulnerability across 15 major emerging markets. They found Turkey was the most vulnerable, followed by Brazil and then India.

Indonesia and South Africa followed in the ranks of the most vulnerable. The index was based on six factors, including current account balances and foreign currency reserves relative to economic output.

The Fed analysis found that the most vulnerable countries tended to experience the biggest currency depreciations as well as larger increases in interest rates for government borrowing.

"This evidence is consistent with the view that reducing the extent of economic vulnerabilities is important if (emerging market economies) are to become more resilient to shocks," the Fed said.

The analysis highlighted how some developing economies have made strides to reduce their vulnerabilities. China, for example, was listed as one of the least vulnerable countries.

China has amassed a massive war chest of foreign currency reserves over the last decade and has a relatively low level of government debt.

The Fed said some developing counties have countered the market volatility by hiking interest rates, intervening in currency markets and other "stopgap measures."

It said global investors would be carefully watching which countries take steps to reduce "fundamental vulnerabilities."

"Continued progress implementing monetary, fiscal and structural reforms will be needed," the Fed said.

(For details on the Fed's analysis, see pages 28-29 of the report at http://www.federalreserve.gov/monetarypolicy/files/20140211_mprfullreport.pdf))

(Reporting by Jason Lange; Editing by Amanda Kwan)