China Research

It seems obvious that the Fed in 2022 will have a couple of interest rate hikes which have been almost officially announced in recent weeks by Chairman Powell. This probable development may be necessary to be started in the U.S. for the attempt to re-balance the globally economy, both when it comes to the fight against the ongoing high inflation and to the deflation of unpleasant asset price bubbles in quite a number of countries (real estate, bond and stock markets).

However, welcoming higher interest rates in the U.S. – and at a somewhat later stage in Europe and other parts of the world – is really not an easy call, particularly since such a development also will dampen GDP growth somewhat in the global economy. Some kind of getting back to a realistic “new normal” for short-term rates has no alternative. But how can a “new normal” be found and defined? A safe answer cannot be given these days. Different markets (financial and labor markets, technological competition, etc.) will gradually lead us to more insight in this conundrum.

Higher U.S. rates bad news for (many) emerging markets

For emerging markets, tightening monetary policy of the U.S. is bad news in several respects. Matters of concern for emerging and less developed countries are, for example (at least theoretically and according to textbooks):

¤ Lower growth in OECD countries dampens imports from emerging countries
Higher interest rates have a negative impact on investors and consumers in advanced countries – followed by a similar reaction in emerging countries. However, in this case some new hope may arise from declining global bottlenecks on the supply side. Many emerging countries may benefit from weakening commodity prices in the case of slower growth in mainly the U.S.

¤ Many emerging countries are highly indebted in U.S. dollars
Higher short-term rates in the U.S. mean also ceteris paribus higher costs for the borrowing in USD by emerging countries. Reactions on bond markets are not really predictable.

¤ Higher U.S. rates will probably strengthen the dollar
Higher short-term rates in the U.S. make the USD stronger – and for emerging countries the costs for changing into USD more expensive. The open question is for how long time the dollar will surge.

¤ Declining foreign propensity to invest in emerging countries
Here we have really a high risk. We have seen such reactions in the past. Portfolio investors prefer often less risky strategies in (very) uncertain times. They wait for signs of recovery. Greenfield investors also tend to cut or delay their planned projects when uncertainty is increasing.

¤ Economically vulnerable countries are less resilient
Countries with healthy economic conditions and limited foreign debt are certainly more resilient against rising U.S. rates than the weak and vulnerable emerging and developing countries. Analysts should consider this distinction.

¤ How much will China be hit – and how much hits China emerging countries?
This question is not easy to answer. China stands now for 17 percent of the global economy. This is why China cannot isolate itself from developments in the U.S. and the global economy.

But how much will China be hit by the American hikes? Financially certainly to some extent, probably also (temporarily) by weakening exports to mainly the U.S. and other emerging countries. However, most of China’s problems are made at home by the worrisome conditions on the bubbling real estate market, the enormous domestic debt credit bubbles and all the well-known structural growth impediments -> see my previous article in this blog (chinaresearch.se). It is not a secret that China is overly dependent on the real estate market – even more than the U.S.

Altogether, developments in China will be very important to other emerging countries in 2022 and beyond – but not basically due to the interest rate hikes by the Fed. The main Chinese economic problems are purely made at home.

Hubert Fromlet
Affiliate Professor at the School of Business and Economics, Linnaeus University
Editorial board

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