Investors get wary as World Bank highlights stagnation in emerging market economies; urges for reforms

As the World Bank downgraded its global economic outlook for 2015 blaming contraction in emerging market economies and weaker performance in the U.S., investors got worried over emerging markets' ability to pay for ballooning obligations.

The bank's report specified that economic contraction in Brazil and Russia, as well as slower growth in Turkey offset growth in the eurozone and Japan.

Emerging markets are facing dangerous mix of headwinds, having borrowed heavily to finance their decade-long growth.

Since the Fed prepares to raise interest rates for the first time in nearly a decade, borrowing costs are expected to rise. That prospect has also driven a dollar surge, tightening the squeeze on developing-country governments and corporations that borrowed dollars but whose income is denominated in local currency. As their growth is slowing, investors question their ability to pay for mounting obligations.

As the Wall Street Journal reports, the Institute of International Finance, an industry group representing around 500 of the world’s largest banks, insurance firms, hedge funds and other financial institutions, estimates that capital flows into emerging markets will drop to their lowest level this year since the financial crisis.

Amid this data, investors get increasingly concerned about emerging market economies' ability to cover their mounting obligations.

Tumbling oil and sanctions against Russia have pushed the rouble down and forced the country into a deep recession. Brazil, where the Petrobras corruption scandal is reaching the highest levels of the government, is contracting as commodity prices fall and the country struggles rekindle growth prospects. Turkey’s recent elections has caused uncertainties over the country’s political fate, as the ruling AK Party did not win majority in the parliament.

As the World Bank economists projected, the Fed’s rate hike and long-term tightening cycle combined with domestic turmoils could fuel major swings in financial markets, capital outflows and contagion throughout emerging economies.

Thus, in these countries major economic overhauls are needed, such as opening up long-closed sectors, overhauling outdated or overly burdensome regulations and other policies that help markets work more efficiently - are often painful and politically controversial in the short term, with outcomes being hardly fruitful for years.

However, there is positive example of India.

Its authorities have promised, and enacted, a series of policies that have stimulated investor confidence, including decreasing red tape, slashing fuel subsidies and allowing more foreign investment in some industries.

While many investors say that work is to be fulfilled yet, the country has now beat China becoming the world’s fastest-growing large emerging market, and economists, including the World Bank, are raising forecasts for India’s growth.