(LUO JIE / CHINA DAILY)
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 United States rose 1.3 percent in June, or aggregately 9.1 percent 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 said that “another unusually large increase could be appropriate” in September.
In recent months, it has raised rates several times. Following a 0.25 percent rise in March, the interest rate amounted to a target range of 0.75 to 1 percent in May.
On June 15, the Federal Open Market Committee emphasized that it is “strongly committed to returning inflation to its 2 percent objective”.
In pursuit of this, it continued raising 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.
As former US treasury secretary John Connally once said, “The US dollar is our currency but your problem.”
When — before the pandemic — one sovereign currency accounts for about 90 percent of all global foreign exchange transactions, tightening its supply will have profound implications on 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, and as interest rates are now markedly higher in the US than elsewhere, investors are motivated to hold relatively conservative investments.
Past decades have witnessed several boom-and-bust cycles in emerging markets — investors move in during good times but back out when the recipient countries are exposed to deteriorations in the macroeconomy or when the US tightens capital supply.
This is why analysts keep track of the impact the recently raised interest rates will have on Southeast Asian countries.
With a loose peg to the US dollar, a rising interest rate makes existing debt servicing payments more expensive, which may trigger capital investment outflows.
Southeast Asia experienced a similar episode 25 years ago, when Alan Greenspan’s Fed raised benchmark interest rates to head off inflation.
Consequently, the strong dollar made the US a more attractive investment destination than Southeast Asia, adding to capital outflows.
While not denying inherent weaknesses within these economies, like large current account deficits and insufficient foreign reserves, a raising of US interest rates is an undeniable trigger.
Hence, in July 1997, when the Thai baht was sharply devalued, a shock wave shook the region.
The Malaysian currency was devalued dramatically, and the index of the Kuala Lumpur Stock Exchange went down from 1,200 to 260 points. Southeast Asian countries paid a heavy price.
However, while it pays to be alert to potential impacts, there is unlikely to be another full-blown financial crisis in the region.
While pressure on exchange rates and bond yields is likely to persist over the coming months, some solid evidence indicates that many economies are better prepared.
First of all, they have accumulated sufficient reserves to hedge the risks attributed to external debt.
According to the World Bank, the international reserves to total external debt stocks in Thailand reached 126.4 percent in 2020, in contrast to 24.5 percent in 1997.
Similarly, the total reserves equaled 111.7 percent of total external debt in the Philippines in 2020, in contrast to 17.2 percent in 1997.
Hence, even though Sri Lanka recently announced national bankruptcy because of its inability to pay off external debt, it is more likely an outlier.
The painful lessons of the past have been learned and many countries in the region have strengthened their current account and fiscal balances, for instance Indonesia and Malaysia.
The worldwide inflation wave can also benefit countries that export food and commodities.
So, despite the interest rate hike backdrop, Southeast Asia is in a relatively solid position.
The overheated US domestic economy may force the Fed to continue tightening the money supply, but we should not overestimate the impacts of such a move this time.
The author is an assistant researcher at the Institute of World Economics and Politics at the Chinese Academy of Social Sciences. This article was contributed to China Watch, a think tank powered by China Daily.
The views do not necessarily reflect those of China Daily.