Foreseen dangers half-avoided
Asia must be prepared for the impacts of US, EU monetary policy changes
The United States, the European Union and other developed economies are gradually scaling back from their quantitative easing policies to ease the growing inflation pressure. At present, the US Federal Reserve has raised interest rates twice, and the European Central Bank may raise interest rates for the first time as early as July. This will inevitably affect Asian economies and their capital markets, forex markets, bulk commodity prices and debts.
Despite differences in the timing, intensity and urgency, the US and EU economies are withdrawing from their ultra-loose monetary policies. In the short term, the frequent large-scale flows of international capital caused by this will affect the expectations of investors, which may lead fluctuations in the capital market and even cause financial crises. Stock markets in Mongolia, Syria and Sri Lanka, among others, are just going through a boom in 2021 and could plummet if international capital arbitrage accelerates. Sri Lanka's Colombo All-Share index, for example, has tumbled nearly 40 percent this year.
The US and EU withdrawing from their quantitative easing monetary policy will continue to strengthen expectations for the appreciation of the US dollar and the euro, which was one of the reasons for the depreciation of currencies in most Asian economies last year. This year, with their interest rates hiking, it may lead to the further appreciation of the dollar and the euro and more depreciation of Asian currencies. The different pace at which the US and the EU are rolling back their quantitative easing policies has caused the dollar to enter an appreciation cycle faster than the euro. The difference in expectations for the two currencies may aggravate the volatility of the global forex market.
Meanwhile, the Russia-Ukraine conflict is one of the important causes of the rising bulk commodity prices to record highs, which has further increased the imported inflation pressure faced by Asian economies. If the dollar continues to appreciate and bulk commodities remain in short supply, there will be mounting uncertainties for Asian economies, especially large importers such as China and India.
The US and EU have started or are about to start the process of raising interest rates. It will not only increase the financing costs of market players in Asia, but also the interest burden on their foreign debts denominated in dollars or euros. In addition, the conflict between Russia and Ukraine has further blocked the economic recovery, which may increase the risk of debt crisis among emerging markets. According to the Global Debt Monitor released by the Institute of International Finance on Feb 23, 2022, the global debt balance had reached a historical high level of $303 trillion in 2021. The debt-to-GDP ratio of emerging market countries was about 248 percent, an increase of over 20 percent from the pre-pandemic level. If interest rates rise faster than expected and economic growth slows, indebted entities in Asia may experience default risks similar to the Sri Lankan debt crisis.
China should take precautionary measures and come up with contingency plans beforehand in response to the normalization of US and European monetary policy.
The monitoring of abnormal cross-border capital flows should be stepped up. It is important to pay close attention to developments of the external environment and strengthen the monitoring of cross-border capital flows. The use of modern technological means such as big data, artificial intelligence and cloud computing should be combined with payment and settlement mechanisms to enable timely and dynamic oversight on capital flows both online and offline, domestic and international, and place all cross-border capital flows under financial supervision. It is important to develop a monitoring and early warning mechanism for abnormal cross-border capital flows, crack down on underground lenders, fictitious transactions and hidden funds, build a powerful anti-money laundering financial network, and target wrongdoers in the forex sector with a zero-tolerance attitude.
The two-way fluctuation in the exchange rate of the renminbi must be made more flexible. It is important to continue deepening reform in the exchange rate of the renminbi steadily in a market-oriented manner, giving priority to guiding market expectations and keeping the renminbi's exchange rate generally stable and at an adaptive and balanced level. Major risks in the forex sector must be prevented and resolved to maintain national economic and financial security.
The fluctuations in the prices of bulk commodities should be responded to with measures to ensure the stability in supply and prices. The nation should scale up efforts to steady the supply and prices of bulk commodities. Rapid rises in the prices of energy and raw materials such as coal and metals must be effectively curbed. In April, the gap between the industrial producer price index and consumer price index has been further narrowed, an indicator that previous policies have started to pay off and the pressure on the cost of commodity materials in some mid-and downstream manufacturing industries has eased. It will help increase the profits of mid-and downstream enterprises and improve the situation for smaller firms.
The external debt structure should be optimized. The major indicators of China's external debts remain relatively healthy. Going forward, China should continue optimizing the currency structure of its foreign debts, enable the balance of foreign debts in local currency to take up a higher share in the balance of full-scale foreign debts and reduce the risks of a currency mismatch. It is important to balance the proportion of medium to long-term debts and short-term debts in the full-scale external debt. In the long run, the key to ensuring the sustainability of foreign debts is to maintain steady growth in export revenues and a high-quality economic development.
The author is an assistant researcher with the Institute of World Economics and Politics at the Chinese Academy of Social Sciences.