If there was one character in literature who best reflected the power the US Federal Reserve wields over the global economy, it would be Gulliver. Although he was a good guy who meant no harm, his very massiveness presented a danger to everyone around him – in this case, the Lilliputians of the global economy: emerging markets (EM).
But unlike Gulliver, the Fed is constitutionally prohibited from heeding cries of Lilliputian savings when crafting interest rate policy. The Fed’s dual mission is narrow and resolutely parochial: to use monetary policy to fight US inflation and maximize the US labor market. Preventing chaos in emerging markets is simply not a consideration.
Still, some EM chaos can beckon. On Tuesday, Federal Reserve policymakers will begin their first two-day meeting this year.
As 2021 drew to a close, the Fed shifted its focus away from supporting job creation by keeping borrowing costs low and towards containing inflation – which is nearing its highest level in 40 years.
To achieve this, it has signaled that it is preparing for at least three hikes in its benchmark interest rates this year.
Since then, speculation has swirled that getting inflation under control may require four rate hikes, not three, raising the stakes not just for the US economy but also for emerging markets.
The last time this happened…
When the Fed raises interest rates, Americans end up paying higher rates on mortgages and credit cards, while American businesses also see their borrowing costs rise. But the effects of the Fed’s takeoff don’t stop at the US border.
When the Fed raises interest rates, borrowing becomes more expensive around the world. This is especially true for countries that have so-called “dollarized debt” – nations that took advantage of more than a decade of low interest rates by issuing dollar-denominated sovereign bonds, and now face the prospect of refinancing these bonds under much less favorable conditions.
This mix – Fed tightening combined with high debt or a misvalued currency in emerging countries – caused some difficulties in 2013, when the Fed began to “reduce” its post-2009 stimulus policy of buying US treasury bonds.
The impact, even in the biggest emerging markets, was swift and brutal as investors began moving dollars into “safe havens” like US Treasuries and exiting emerging investments. The outflow of US dollars from the Indian economy was so rapid that the rupee fell 15% in three months, forcing the Reserve Bank of India to raise rates.
India was not alone. Russia, Brazil, Turkey, Indonesia and other smaller emerging economies have suffered similar exits, sometimes exacerbated by political unrest or policy mistakes. As a market segment, emerging market bonds lost more than 10% of their value in 2013.
Different this time?
The Fed’s interest rate hikes simply cannot be ignored, if only for the reason that it is the steward of the world’s largest economy and global reserve currency, the dollar. Everything the Fed does has a ripple effect on stock prices, trade flows, supply chains, and sovereign bond and currency markets around the world.
Overall, economists and market analysts are confident that the improving state of emerging market balance sheets and generally good prospects for global economic growth in 2022 will limit the kind of upheaval seen in 2013.
Charles Robertson, chief economist at investment bank Renaissance Capital, told Al Jazeera that the Fed’s gradual tightening plan has been widely telegraphed, limiting the possibility of a “tantrum”. Either way, he said, “Fed hikes usually mean the global economy is doing well, which is good for emerging markets.”
Robertson, whose bank has a large presence in Russia, the former Soviet Union, the Middle East, North Africa and sub-Saharan Africa, said the strength of the US dollar, which could soar after the decision from the Fed and make it less likely that global traders will engage in a “carry trade” – an arbitrage strategy that prompts financial institutions to invest in high-interest emerging vehicles able to procure dollars from the Fed on the cheap.
Fed hikes usually mean the global economy is doing well, which is good for emerging markets.
But the tightening in Washington will limit the room for central banks and governments in emerging markets to continue to stimulate their economies. Rachel Ziemba, a well-known China expert and historian of emerging market economics, says the Fed’s rate hike will make it harder for many emerging economies to regain their pre-pandemic position.
As the year progresses, “it will become more evident that short-term international support for the most vulnerable developing economies has not translated into longer-term support”, she said. told Al Jazeera.
Ziemba noted that policymakers will need to address this issue at the upcoming April meetings of the International Monetary Fund and the World Bank as well as the upcoming Group of 20 summit: [debt service suspension] end and how do they cope with the lack of support from the private sector? Aggregate growth and domestic demand are struggling in many emerging countries, in part due to less stimulus capacity than in past crises, as well as market-based adjustments that incentivize fiscal and monetary policy restrictive.
But Ruchir Sharma, emerging markets specialist and chief global strategist at Morgan Stanley Investment Management, is a bit of an outlier, professing confidence that emerging economies could reverse a decade of slump this year despite Fed tightening.
HSBC, for its part, is monitoring what it calls the ‘fragile four’ – Indonesia, Brazil, Mexico and South Africa – for fear that their high levels of dollar indebtedness could make them particularly vulnerable. rising US interest rates. Analysts are also worried about Turkey, where soaring debt and a series of interest rate cuts last year in the face of soaring inflation – an unorthodox policy championed by President Recep Tayyip Erdogan – led the Turkish lira to collapse.
“President Erdogan is determined to challenge orthodox monetary policy,” Stephen Cook, Council on Foreign Relations expert on Turkey and the Middle East, told Al Jazeera. “It’s a recipe for more inflation, economic dislocation in the corporate sector and generally distrust of economic decision-making.” With Turkey’s foreign exchange reserves nearly depleted, its currency in freefall and its economy flirting with hyperinflation, Cook fears that any external shock could have disastrous consequences.
painful muscle memory
If this time is, indeed, different, one can hardly blame emerging-market central bankers and investment advisers who manage global capital flows for worrying, analysts say.
Ever since the implosion of the US mortgage bond market triggered the Great Recession in 2008, nations around the world have watched for signs that a sudden market turn or policy reversal would once again send shock waves. American economic policy, increasingly insular and rocked by populist dynamics unleashed by a decade of economic setbacks and futile wars, has ceased to claim to serve as a model for anything other than managing relative decline.
And 2013 was just the latest example of a Fed-triggered, US-centric global crisis. There was the 1994 “tequila crisis” in Mexico, which saw the collapse of the peso and a hastily organized US bailout; the Asian financial crisis of 1997-1998, which led to crushing recessions in the Philippines, South Korea, Thailand, Japan and Indonesia and contributed to the overthrow of the latter’s dictator, Suharto; and the Russian ruble crisis of 1998, which, in retrospect, wiped out post-Soviet free-market reforms and helped put President Vladimir Putin into office.
Kavaljit Singh, director of the New Delhi Public Interest Research Center, said analysts who dismiss a “Taper Tantrum 2.0” take an overly optimistic view of the economic strength of emerging markets amid the global coronavirus pandemic. . While Singh agrees that emerging market balance sheets are in better shape today than they were in 2013, he argues that the huge spending and growth spurts associated with pandemic relief and stimulus could offset these structural improvements in stocks. Emerging Markets and Developing Economies (EMDE).
“The uneven global distribution of COVID-19 vaccines has led most EMDEs to lag behind their advanced peers,” Singh wrote in the widely read economic Blog Thread. “The slow pace of vaccinations in EMDEs makes them increasingly vulnerable to new waves of infection and the spread of virus variants. The risk of future lockdowns is holding back investment and consumption, thus delaying economic recovery in EMDEs.
Markets continue to view the March Fed meeting as the most likely start to rate hikes as the Omicron variant of the coronavirus once again reminds global markets that there is more than one invisible hand at play. By then, US inflation may have eased somewhat and a clearer trajectory for US and global growth may have emerged, eliminating the need for sharp spikes that would almost certainly bring instability to emerging markets. .