Asia can weather any interest rate storm
The raising of interest rates by the US Federal Reserve should hold no fear for China, India and other Asian economies
When the US Federal Reserve announced this month it would raise interest rates for the first time in almost a decade, reactions from investors and commentators could not have been more divergent. While markets from the Shanghai Composite Index to Spain’s Ibex rallied, several pundits were quick to lament the effects of chairwoman Janet Yellen’s decision, especially in the emerging markets of Asia, where capital outflow is a niggling fear.
While their concern stemmed from plausible predictions of how “typical” FDI-dependent economies might react to an interest rate hike, their analyses always fail to consider the circumstances and capabilities which make Asia’s emerging economies anything but typical, and that could allow them to avoid much of the predicted panic.
Theoretically, an increase in interest rates and the end of so-called “cheap money” should encourage the movement of investment capital to wherever those higher interest rates exist (in this case, the United States), potentially devastating the economies that had become used to their positions as recipients of cheap capital (in this case, the developing economies of Asia).
However, what that theory assumes, and why it is best left in introductory economic texts rather than the editorial pages of prominent media outlets, is an inability of the recipient countries to take preventative measures via mechanisms like quantitative easing, the reduction of domestic interest rates or the use of their foreign exchange reserves.
Any substantive inquiry into the major emerging markets of East Asia illustrates the inaccuracy of that assumption.
India, Asia’s third-largest economy, seems particularly capable of mitigating any ill effects of Yellen’s announcement. Over the past weeks, unlike some other nations, its currency, the rupee, has not seen its value significantly diminished, and even appears to be on track to maintaining its relative strength against the dollar.
Notably, the few reforms which have passed under Prime Minister Narendra Modi have combined with the steady pace of the country’s infrastructure development to put India on a trajectory to achieve the world’s highest growth rate in 2016. This has placed the rupee in a positive long-term position even before the Fed’s announcement earlier this month.
Furthermore, low inflation in the world’s largest democracy has allowed the Reserve Bank of India to cut domestic interest rates four times this year, by a cumulative 125 basis points. It leaves the door open for further reductions to offset any potential capital outflows as Washington continues to raise interest rates throughout the new year.
If that were not enough to assure confidence, India’s foreign exchange reserves currently amount to about US$350 billion, and the Reserve Bank of India’s governor has not only deemed such reserves sufficient to meet even the most drastic relief requirements, but has shown a willingness to use them.
Across the Himalayas, China – although economically weakened by a chaotic year and with a currency that, unlike the rupee, has fallen considerably in value recently – is in not a drastically different position. While it cannot emulate New Delhi and rely primarily upon the power of its own innate economic momentum to weather this crisis, Beijing has access to a uniquely powerful toolkit to replace whatever “cheap money” might leave the country over the coming months.
First, on the problem India lacks, currency depreciation, the People’s Bank of China has managed to turn that comparative disadvantage into a strength, engaging in a controlled weakening of the renminbi on an almost daily basis in order to avoid volatility and, more importantly, to provide an immense boon to Chinese exporters, whose goods become more competitive as a result.
Second, like India, China has managed to keep a lid on inflation, preserving its ability to lower domestic interest rates without considerable fear and thereby to ensure relatively cheap access to capital. Beijing also still possesses the world’s largest currency reserves, about US$3.5 trillion, and has indicated a willingness to use them whenever necessary.
Third, China also has some of the most stringent restrictions on substantial capital outflows, which can serve as a backstop to whatever withdrawals may occur as investors react to American interest rate hikes. The combined power of these capabilities is undeniable, and even led The New York Times to claim that China has the greatest ability of any country to weather any impending interest rate storm.
READ MORE: ‘Measured’ fall in China’s yuan now justified with US Fed raising rates now and into 2016
Among the smaller emerging nations of East Asia, similar, albeit less pronounced, capabilities to adapt to a post-zero-interest-rate world are evident.
Throughout 2015, governments in Malaysia, Indonesia, Thailand and Vietnam, despite mixed economic records, have managed to curb inflation, and in some cases (Vietnam), even see inflation reach some of the lowest levels in the world. Just as in India and China, that creates an opportunity for each of these nations to loosen their respective monetary policies and mitigate the impact of the Fed’s decision without hindering their own economies.
In fact, realising this, Vietnam has already acted, with the State Bank of Vietnam lowering the dollar deposit rate offered by its local banks within hours of Yellen’s announcement, to prevent hoarding and to facilitate existing capital flows. Its Southeast Asian neighbours cannot be far behind, with Bank Indonesia expected to lower rates, and Bank Negara Malaysia set to meet next month. All of them clearly possess an ability, given their domestic economies, to take substantive action to lessen and potentially prevent any Fed-induced strain.
While the major emerging markets of Asia may be among the most vulnerable to harm from an interest rate increase, each is uniquely positioned to effectively respond. This is not to say that pressure will not be felt, as some problems will certainly be experienced. However, any prolonged and substantial crisis stemming from this announcement is almost entirely preventable, and the governments and state banks have the power to minimise any negative impact. But, they must first decide whether or not to wield it.
Steven Keithley is an alumnus of Georgetown University’s Asian Studies Programme and a former researcher for Pulitzer Prize-winning columnist George F. Will at The Washington Post