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Build buffers against rising US interest rates
2022-05-06 00:00:00.0     星报-商业     原网页

       

       WITH the persistent rise in inflation, a cycle of global monetary tightening has begun with the Federal Reserve (Fed) leading the pack. Many central banks in developing and emerging economies are also keeping their focus on the fight against higher and longer inflation.

       As the US monetary policy is a major driver of the global financial cycle and capital flow, the quantum of the federal funds rate increase and the degree to which the Fed surprises the market may pose a danger to emerging market economies (EMEs).

       Past experiences have shown that the rise in US interest rates, driven by expectations of more hawkish monetary actions, is a reliable predictor of financial stresses in EMEs.

       The episodes were demonstrated in early 80s Latin American crises, the Mexican crisis in 1994, the Fed’s taper tantrum in 2013, whereby the increasing interest rates in the United States and other advanced economies had led to financial crises and a sudden drop in emerging markets.

       The International Monetary Fund’s (IMF) study on “Monetary policy surprises” by the Fed or European Central Bank indicated that each percentage point rise in the US interest rates will immediately lift long-term interest rates by a third of a percentage point in the average emerging market, or two-thirds of a percentage point in markets with a lower, speculative grade credit rating.

       All other things being equal, portfolio capital will immediately flow out of emerging markets and their currencies depreciate against the US dollar.

       Can the EMEs withstand the US interest rate hikes?

       The increasing US interest rates happened at a time when the EMEs are being significantly challenged by a multitude of shocks from the persistent supply disruptions, inflation pressures, weak local currencies to the Russia-Ukraine war.Higher interest rates stemming from a hawkish Fed policy or inflationary pressures are much more disruptive. The hike in the US interest rate will tend to push up the value of the US dollar, and this will make it difficult for the EMEs on three fronts:

       > Borrowing costs – An increase in the real value of emerging debt and costs to service debt in the local currency. Higher interest rates and tighter liquidity limit will make it costly for governments and companies to borrow or refinance debt under sustainable conditions;

       > Capital flows – The higher interest rates in the United States could mean that capital will move away from EMEs and flow into the US Treasury securities in search of higher investment returns; and

       > Exchange rates – Higher interest rates will typically support the US dollar by making US denominated-assets more attractive to yield-seeking investors.

       The strengthening dollar, backed by better yield differential, will significantly pressurise the currencies of the EMEs .

       This was seen in 2018, whereby the Fed’s aggressive hiking cycle had exerted considerable pressure on many EMEs’ currencies, with some falling to record or near-record lows.

       We should not put all EMEs into the same basket of risks.

       The degree of generated adverse spillovers to EMEs would depend on the state of their economic and financial situation, inflation outlook, fiscal and debt as well as their current account position in addition to foreign reserves.

       Therefore, having ample monetary and fiscal space, strong recovery prospects, well anchored inflation, manageable fiscal and debt level, healthy current account balances as well as a strong war chest of foreign reserves of 3? to four months of retained imports are crucial for the EMES.

       In addition, their reserves should cover 100% of short-term external debt to insulate against a rollover risk in the event of a sudden decline in foreign-financing.

       However, the Covid-19 pandemic has weakened some countries’ line of defence against future shocks. Some of them have narrowed fiscal space, and are burdened with bloated government and corporate debt.

       While the central banks’ policy rate was at a historical low to counteract the pandemic, some have began to normalise their interest rates in recent months to contain rising inflation pressures.

       Malaysia has experienced several episodes of large and volatile capital flow reversals.

       During the 2008-2009 global financial crisis, it saw portfolio outflows of US$26bil (RM112.78bil) from 3Q08 to 1Q09 and the 2014 to 2015 oil price shock with portfolio outflows amounting to US$13.7bil (RM59.4bil) from 3Q14 to 3Q15.

       Bank Negara has deployed its international reserves to mitigate the significant withdrawal of foreign currency liquidity and prevented excessive ringgit exchange rate fluctuations that would have harmed the Malaysian economy and businesses.

       The central bank’s international reserves of US$114.4bil (RM496.2bil) as of April 15 will be able to cover six months of the imports of goods and services and are 1.2 times of the total short-term external debt.

       They are adequate to meet the potential foreign currency needs in the event of sizeable capital withdrawals.The flexible exchange rate regime will also allow the ringgit to adjust against the two-way capital flows.

       The banking sector remains strongly capitalised and the domestic capital market is efficient to mitigate the impact of capital-flow volatility.

       Malaysia’s participation in regional and global international financial safety nets had added another layer of buffer against foreign currency liquidity crisis. The government should move to alleviate structural fiscal deficit and reduce debt and liabilities to rebuild fiscal buffer against future shocks.

       Lee Heng Guie is executive director of the Socio Economic Research Centre. The views expressed here are the writer’s own.

       


标签:综合
关键词: capital     rates     reserves     shocks     inflation     emerging     currencies