With inflation still high in the United States, the Federal Reserve raised its benchmark interest rate to calm the economy. The last weeks rate hike 75 basis points was the highest in decades, and more are expected. Because of the role that the United States and the dollar play in the global financial system, this monetary tightening has affected the whole world.
We have seen stocks fall. We have seen cryptocurrencies crash. We are seeing rising mortgage rates. And we are seeing capital outflows from emerging markets, with many currencies losing value against the dollar.
The good news is that we knew these US rate hikes were coming and policymakers around the world, especially central bankers, had plenty of time to prepare. Plus, many of the things we’re seeing, such as rising mortgage rates, the resizing of overvalued stocks, and the implosion of pointless Ponzi schemes like crypto, are actually a good thing in the long run, even if it cause some. people are suffering a lot right now.
For other things, like 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 saw it coming and took steps to prepare for it.
Broadly, here’s what I think is going on. As the Fed raises rates, yields on long-term Treasuries begin to rise. Because US Treasury bonds are (rightly or wrongly) considered among the safest assets in the world, as yields rise investors tend to shy away from assets perceived as riskier, such as emerging markets. We are then likely to see a sell-off in emerging markets as investment flows are reallocated to higher yielding and supposedly safer US assets.
This causes the dollar to appreciate against most currencies and will likely continue to do so. Countries running current or fiscal deficits are more likely to see their currencies tighten. Over the past month, the Thai baht, Philippine peso, Indonesian rupiah and Vietnamese dong have all depreciated sharply against the dollar.
On its own, currency depreciation can be managed, 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 have struggling to repay their debt and cover the cost of their imports. . This is more or less what is happening in Laos, and some people think that more liquidity and debt crises could be on the horizon.
To make matters worse, many emerging markets have had to borrow more than usual over the past two years to fund major stimulus packages during the pandemic. This makes them even more vulnerable than usual to capital outflows and currency volatility, as many have run larger budget deficits than they otherwise would have.
Many central banks in the region have taken steps to prepare by storing foreign exchange reserves precisely so that they can support the currency during periods of volatility such as this. The Bank of Thailand, for example, closed 2021 with $224.8 billion in available foreign exchange reserves. Other countries, such as Indonesia, have seen their commodity exports soar, helping to strengthen the current account and stabilize the currency in the short term.
In the meantime, we will almost certainly see interest rate hikes in the region as central banks seek to retain capital or attract new capital flows by offering higher yields. This will not be a problem in itself. But as monetary tightening sets in, governments and companies that have been negligent in their use of debt could start to feel the heat.
We have seen, for example, some state-owned companies in Indonesia struggling with debt issues during the pandemic and rising interest rates are not going to make it any easier for them. I’ve often said that the debt-related criticisms of Indonesia’s economic development model are overblown, but if there’s a lot of bad debt floating around there, in Indonesia or elsewhere, we’ll find out soon enough when interest rates will fluctuate. to the top.
It may be a bumpy ride for a while, but most Southeast Asian countries should be in a relatively strong position to weather the downside risks of these Fed rate hikes, either because they have accumulated foreign exchange reserves, either because the boom in exports will contribute to consolidating their current account. As monetary policy tightens, bad debt will be more easily exposed, but broader systemic contagion seems unlikely to me. The region’s central banks have learned the hard way that their fate is tied to the dollar, and unless they’ve been asleep at the wheel, they’ve had plenty of time to prepare.