ANN – United States (US) interest rate hikes are unlikely to trigger another financial crisis in Southeast Asia.
In the face of the 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 US rose 1.3 per cent in June, or aggregately 9.1 per cent over the last 12 months to hit a 40-year high.
To achieve a so-called soft landing of the national economy, on July 28, the Fed increased its interest rate by 75 basis points and claimed that “another unusually large increase could be appropriate” in September. Over the past few months, it has raised its interest rate several times.
Following a 0.25 per cent rise in March, the interest rate amounted to a target range of 0.75 to one per cent in May.
On June 15, the Federal Open Market Committee emphasised that it is “strongly committed to returning inflation to its 2 per cent objective”.
Toward this goal, it decided to continue raising interest rates and reducing its holdings of Treasury securities, agency debt, and agency mortgage-backed securities.
The Fed’s hawkish position is a risky signal for others. Former US treasury secretary John Connally once said, “The US dollar is our currency but your problem.” When one sovereign currency plays a dominant role in lubricating the global economy, accounting for about 90 per cent of all foreign exchange transactions before the pandemic, tightening its supply will have profound implications on global capital flows.
Specifically, when the value of the US dollar becomes the strongest it has been over the past decades, it inevitably devalues currencies worldwide.
At the same time, as interest rates are now markedly higher in the US than elsewhere, investors are motivated to hold relatively conservative investments such as Treasury bonds to pursue higher returns.
Importantly, the risks derived from the raised interest rates are never equally shared. The last decades have witnessed several boom-and-bust cycles in emerging markets – global investors move into these economies during good times but will suddenly back out when the recipient countries expose deteriorations in the macroeconomy or when the US tightens capital supply.
In other words, emerging markets often face more risks and vulnerability than wealth and prosperity when dealing with global finance.
This is why analysts also keep tracking the impact the recently raised interest rates will have on Southeast Asian countries.
As they still have a loose peg to the US dollar, the primary challenge is that rising interest rate makes the payments to service existing debt more expensive, which may 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 to raise the benchmark interest rates to head off inflation.
Consequently, the strong dollar made the US a more attractive investment destination than Southeast Asia, which contributed to sudden capital outflows. While not denying the endogenous weaknesses within these economies, like large current account deficits, insufficient foreign reserves, and excessive exposure to foreign exchange risk, raising the interest rate in the US is indeed an indispensable trigger.