Interest rate hikes in the United States are unlikely to trigger a new financial crisis in Southeast Asia
Faced with soaring inflation, the US Federal Reserve has no choice but to raise its benchmark interest rate to control commodity prices. The consumer price index in the United States rose 1.3% in June, a total of 9.1% over the past 12 months to reach a 40-year high.
To achieve a so-called soft landing for the domestic economy, on July 28 the Fed raised its interest rate by 75 basis points and claimed that “another unusually large increase may be appropriate” in september. Over the past few months, it has raised its interest rate several times. After rising 0.25% in March, the interest rate rose to a target range of 0.75 to 1% in May.
On June 15, the Federal Open Market Committee stressed that it was “strongly committed to bringing inflation back to its 2% target.” To that end, it has decided to continue to raise interest rates and reduce its holdings of Treasuries, agency debt and agency mortgage-backed securities.
The Fed’s hawkish stance is a risky signal to others. Former US Treasury Secretary John Connally once said, “The US dollar is our currency, but your problem.” When a sovereign currency plays a dominant role in lubricating the global economy, accounting for around 90% of all foreign exchange transactions before the pandemic, the tightening of its supply will have profound implications for global capital flows. Specifically, when the value of the US dollar becomes its strongest in decades, it inevitably devalues currencies around the world. At the same time, as interest rates are now significantly higher in the United States than elsewhere, investors are motivated to hold relatively conservative investments such as Treasuries to seek higher yields.
Importantly, the risks from rising interest rates are never shared equally. The past few decades have been marked by several cycles of boom and bust in emerging markets – global investors settle in these economies during good times, but will suddenly pull back when recipient countries exhibit deteriorations in the macro economy or when United States will tighten the supply of capital. In other words, emerging markets often face more risk and vulnerability than wealth and prosperity when dealing with global finance.
That is why analysts also continue to monitor the impact that recently raised interest rates will have on Southeast Asian countries. Since they still have a loose link to the US dollar, the main challenge is that rising interest rates make payments to service existing debt more expensive, which can trigger an outflow of capital investment.
Historically, Southeast Asian countries experienced a similar episode 25 years ago. As the US economy recovered from a recession in the early 1990s, the Fed under Alan Greenspan began raising benchmark interest rates to stave off inflation. Consequently, the strong dollar made the United States a more attractive investment destination than Southeast Asia, which contributed to sudden capital outflows. Without denying the endogenous weaknesses of these economies, such as large current account deficits, insufficient foreign exchange reserves and excessive exposure to exchange rate risk, the rise in interest rates in the United States is indeed an essential trigger. Thus, in July 1997, when the Thai baht suffered a sharp devaluation, a shock wave quickly reverberated through the region. The Malaysian currency was heavily devalued and the Kuala Lumpur Stock Exchange index fell from 1200 to 260 points. Southeast Asian countries have paid a heavy price to recover from the turmoil.
However, while it is necessary to be alert to the potential impacts, it is unlikely that there will be another major financial crisis in the region. While pressure on exchange rates and bond yields is likely to persist over the coming months, strong evidence indicates that many economies are better prepared. First, they have accumulated sufficient reserves to cover the risks attributed to external debt. According to the World Bank, international reserves to total external debt stock in Thailand reached 126.4% in 2020, up from 24.5% in 1997. Similarly, total reserves were equivalent to 111.7% of the Philippines’ total external debt in 2020, up from 17.2% in 1997. Therefore, even though Sri Lanka recently declared national bankruptcy due to its inability to repay its external debt, it is more likely of an outlying value. Many countries in this region have learned from painful experiences of the past to build their resilience to strengthen their currencies and national economies.
In addition, many countries in the region have also strengthened their current account and fiscal balance. The current account to GDP ratio in Indonesia and Malaysia is 0.28% and 3.46% in 2021, respectively, compared to -2.26% and -5.93% in 1997. At the same time, the wave Global inflation can also benefit countries that export food and food products. goods.
Overall, despite the rising interest rate environment, Southeast Asia is in a relatively strong position. The overheating of the domestic economy could force the Fed to continue to tighten the money supply, which would trigger tensions and risks in emerging markets. Nevertheless, the impacts should not be overestimated this time around.