US Fed rate hike will test emerg­ing mar­kets

China Daily (Canada) - - LIFE -

The US Fed­eral Re­serve raised in­ter­est rates by 25 ba­sis points last week, tak­ing the first step away from its near-zero in­ter­est rate pol­icy. Led by its chair­man Janet Yellen, the Fed sought to defuse mar­ket ten­sions by sig­nal­ing a “grad­ual” pace of rate hikes to come. Yet the Dow plunged 367 points, while the S&P 500 and theNas­daq lost 1.5 to 2 per­cent.

In the United States, ris­ing rates will re­ward in­vestors but in­crease the bor­row­ing costs for con­sumers amid the earn­ings and rev­enue slump, and slug­gish growth. At the Fed, con­cerns linger over China’s growth slow­down. Be­sides, rate hikes will re­in­force the sharp plunge of en­ergy prices, while send­ing the US dol­lar climb­ing. So, what will be the im­pact on China? When the Fed be­gan its rate hikes about a decade ago, the Chi­nese econ­omy was about one-fourth of what it is to­day and its fi­nan­cial mar­kets were largely in­su­lated from the out­side world. Th­ese priv­i­leges are now gone. To­day, China is the world’s sec­ond-largest econ­omy and the ren­minbi has been in­cluded in the In­ter­na­tion­alMone­tary Fund’s bas­ket of elite cur­ren­cies. And de­spite con­trols, it is far more ex­posed to global cap­i­tal flow risks.

And what about the im­pact of the Fed’s ac­tions on China’s ex­ter­nal trade and in­ter­na­tional in­vest­ments? US crit­ics claim that a weak­en­ing RMB will make Chi­nese ex­porters more com­pet­i­tive. Yet things are now a bit more com­plex. In the past, the main­land’s growth re­lied on trade. To­day, with the slump of world trade and the re­bal­anc­ing to­ward consumption, net ex­ports play a less vi­tal role in GDP growth, while Chi­nese direct in­vest­ment has soared in­ter­na­tion­ally.

Ever since early 2014, the US dol­lar has strength­ened rel­a­tive to the RMB, which is ex­pected to weaken over the next year as well. That is partly be­cause of a slower 6.5 per­cent growth tar­get for the 2016 to 2020 pe­riod and partly be­cause of the Belt and Road Ini­tia­tive, which im­plies more out­ward direct in­vest­ment from China. In­Novem­ber, China’s for­eign re­serves fell by $87 bil­lion, though it still has $3.44 tril­lion in re­serves.

In the short term, that means mod­er­ate weak­en­ing and oc­ca­sional volatil­ity of the RMB; in the longer term, it means strength­en­ing of the Chi­nese cur­rency’s re­silience.

If the Fed’s rate hikes will test the en­durance of China’s re­bal­anc­ing and its “long land­ing”, the im­pact will be a lot worse in many emerg­ing and de­vel­op­ing economies.

Over the past three decades, the Fed’s rate hikes have re­duced US em­ploy­ment and out­put far more than an­tic­i­pated, while caus­ing “col­lat­eral” dam­age across the world. In the early 1980s, Paul Vol­cker, then Fed chief, re­sorted to harsh tight­en­ing that dev­as­tated US house­holds. In Latin Amer­ica, it re­sulted in a “lost decade”.

Later, for­mer Fed chief Alan Greenspan’s rate hikes un­der­mined the strug­gling sav­ings and loans as­so­ci­a­tions, forc­ingWash­ing­ton and US state gov­ern­ments to bail out in­sol­vent in­sti­tu­tions. In the early 1990s, Greenspan again seized tight­en­ing but then re­versed his de­ci­sion, which un­der­mined ex­pan­sion. In the first case, global growth de­cel­er­ated to less than 1 per­cent; in the sec­ond, it plunged to 4 per­cent be­low zero in de­vel­op­ing na­tions.

In the 2004 to 2007 pe­riod, the rate hikes by Greenspan and his suc­ces­sor Ben Ber­nanke con­trib­uted to the Great Re­ces­sion across the world. In low-in­come economies, growth stayed at 5 to 7 per­cent thanks to China’s con­tri­bu­tion to global growth.

Af­ter tra­di­tional mon­e­tary poli­cies were ex­hausted, the cen­tral banks of ad­vanced economies opted for new rounds of quan­ti­ta­tive eas­ing, driv­ing “hot money”— short-term port­fo­lio flows— into high-yield emerg­ing mar­kets, which had to cope with as­set bub­bles, el­e­vated in­fla­tion and ex­change rate ap­pre­ci­a­tion.

Now US hikes will at­tract “hot money” out­flows from emerg­ing mar­kets that are strug­gling with as­set shrink­ages, de­fla­tion and de­pre­ci­a­tion. In 2015, net cap­i­tal flows for emerg­ing economies will be neg­a­tive for the first time since 1988.

To­day, the world econ­omy is more frag­ile than ever. It does not need uni­lat­eral ac­tions with global con­se­quences but with­out in­ter­na­tional ac­count­abil­ity. What the mul­tipo­lar world needs is truly global mon­e­tary co­op­er­a­tion.

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