With inflation still high in the United States, the Federal Reserve is raising its benchmark interest rate to cool the economy. Last week rate increase 75 basis points was the highest in decades and is expected to be higher. Because of the role that the United States and the dollar play in the global financial system, this tightening of monetary policy has affected the entire world.
We have seen stocks fall. We have seen the collapse of cryptocurrencies. We are seeing an increase in mortgage rates. And we are seeing capital outflows in emerging markets, with many currencies losing value against the dollar.
The good news is that we knew these US rate hikes were coming, and policy makers around the world, especially central banks, had plenty of time to prepare. What’s more, many of the things we see, such as higher mortgage rates, correct sizing of overvalued stocks, and the collapse of worthless Ponzi schemes like cryptocurrencies, are actually a good thing in the long run, even if they cause some people to a lot of pain right now.
As for other things, such as the currency volatility that many Southeast Asian countries experience when the Fed raises rates, these are predictable phenomena and we could see them coming from afar. In fact, many central banks in the region have foreseen this and have taken steps to prepare.
Basically, here’s what I think is going on. As the Fed raises rates, long-term Treasury yields begin to rise. Since US Treasuries are (rightly or wrongly) considered one of the safest assets in the world, as yields rise, investors tend to move away from assets that are considered riskier, such as emerging market assets. What we are likely to see then is a sell-off in emerging markets as investment flows are reallocated to higher-performing and presumably safer US assets.
The result of this is that the dollar is strengthening against most currencies and is likely to continue to do so. Countries with current account or budget deficits are more likely to see their currencies shrink. Over the past month, the Thai baht, Philippine peso, Indonesian rupiah and Vietnamese dong have depreciated slightly against the dollar.
Currency depreciation can be managed on its own, but if there is too much capital outflow and currency depreciation in a short period of time, it can trigger a balance of payments crisis as countries struggle to pay off debt and cover the cost of their imports. . It’s more or less what it is happening in Laosand some people think that more liquidity and debt crises may be on the horizon.
To make matters worse, many emerging markets have had to borrow more than usual over the past two years to finance large stimulus packages during the pandemic. This makes them even more vulnerable than usual to capital outflows and currency volatility, as many larger budget deficit than they otherwise would have.
Many central banks in the region have taken steps to prepare by building up foreign exchange reserves precisely so that they can support the currency during periods of volatility such as this one. The Bank of Thailand, for example, closed 2021 with $224.8 billion foreign exchange reserves available. Other countries, such as Indonesia, are seeing booming exports of commodities, helping to strengthen the current account and stabilize the currency in the short term.
In the meantime, we will almost certainly see interest rates rise across the region as central banks look to preserve capital or attract new capital flows by offering higher yields. This won’t be a problem in and of itself. But as monetary policy tightens, governments and firms that have been careless about using debt may start to feel out of place.
We saw, for example, some Indonesian state-owned enterprises. ran into debt problems during a pandemic and rising interest rates, it will not be easier for them. I have often said that the debt criticism of the Indonesian economic model is exaggerated, but if there is a lot of bad debt circulating there, in Indonesia or elsewhere, we will know about it soon enough when interest rates change. up.
It may be a bumpy ride, but most Southeast Asians should be in a relatively healthy position to deal with Fed rate cut risks, either because they’ve built up foreign exchange reserves or because an export boom will help shore up. their current accounts. As monetary policy tightens, bad debts will be more easily identified, but wider systemic contagion seems unlikely to me. Central banks in the region have learned the hard way that their fortunes are tied to the dollar, and unless they were asleep at the wheel, they had plenty of time to prepare.