US rate hikes: Fears for emerging markets are overblown

 After years of close-to-zero policy rates and three rounds of quantitative easing, this will be a significant change.

Financial markets do not appear too concerned. One could even say they are being complacent. Nevertheless, the usual commentators are once again stating that Fed rate increases will bring the end of the world and emerging markets.

So who is right, the complacent markets or the doomsayers? At Standard Chartered, we think neither.

Using 20 years of data, we modelled the impact of a shock 100-basis-point increase by the Fed on economies and markets in Asia, Africa, the Middle East and Latin America, and found three interesting conclusions.

First, a change in Fed policy will be a significant event for the world. Even if Fed increases fail to raise long-term market interest rates at home, the Fed still matters.

Second, in most cases it is a country’s currency that reacts and absorbs the shock rather than the real economy. This is particularly the case for countries such as Turkey and Indonesia, whose currencies tend to weaken after a Fed shock.

 

Flexible exchange rates help

The fact that the main impact of a Fed shock is felt on currencies is not necessarily a bad thing. With the exception of Hong Kong, the economies we looked at all have flexible exchange rates. And flexible exchange rates after an external shock do what they are meant to be doing by being … well, flexible and moving to absorb some of the shock.

Large currency moves can be problematic for countries that have large foreign-currency-denominated debt with short-term maturities. Sharp currency moves in Turkey can therefore have some undesirable side effects. But economies in Asia are now in a much stronger position than they were in the 1990s. Net foreign assets (the difference between the value of overseas assets and the value of domestic assets held by foreigners) are now positive and large.

Asian economies are also in better shape today than they were in 2013 when the Fed started talking about tapering its quantitative easing programme. Current-account balances are now healthier and inflation is in check. Even in Indonesia, where the currency reacts the most and foreign-currency-denominated debt has increased, the maturity profile is much more favourable, with only 12 per cent of the country’s external debt due in less than a year.

Although currencies do move in response to an external shock, we also found that the impact, albeit sizeable, is not permanent. Moves pick up within five to six months after a shock, and then dissipate within a year.

 

Countries react differently to shocks

Third, it is important to differentiate: Grouping all countries under the emerging-markets bracket misses the fact that different countries experience very different dynamics.

India seems to be better insulated to external shocks, and this will likely continue to be the case. And South Korea seems to do quite well when the Fed shocks. It is important to remember that the Fed is likely to raise its rates when the US economy is doing well, and for South Korea the positives from a stronger US economy outweigh the negatives from interest-rate hikes.

After years of low-interest rates and three rounds of quantitative easing, a rate increase in the United States cannot be ignored, but not every country reacts the same, and we need to distinguish between market moves and crises.

Countries in Asia are in a much better position today than they were in the 1990s before the Asian crisis. Never mind the 1990s, they are in a much better position today than they were in 2013 when talk of Fed tapering caused significant market moves.

So, expect moves. But do not get carried away in the paranoia of doom and gloom.

 

Marios Maratheftis is global chief economist at Standard Chartered.