Saturday, 19 December 2015 Can we sail through a ‘perfect storm’?

by **Cals** Mon 21 Dec 2015, 00:39

Saturday, 19 December 2015

Can we sail through a ‘perfect storm’?

BY SURESH R AMANATHAN
THE Fed raised interest rates by 25 basis points and there is another four more hikes in store for 2016 if one looks at the dot-plot path of the Federal Open Market Committee’s trajectory of short term interest rates.
While there is a plethora of analysis concerning the Fed’s decision on broad emerging market economies and its asset classes, we need to make a simple distinction before venturing further.
The Fed is raising rates because it intends to normalise monetary policy and it believes the US economy has recovered and is on the path of a steady and/or strong growth.
In the case of emerging markets, it is rather different. There are two camps of thought in the emerging market space, those that believe that the Fed’s decision has been priced in and interest rates being normalised in the US in an orderly fashion, and those in the camp that see the risk of capital outflow, narrowing interest rates differential and increased pressure points on domestic currency.If the Fed’s decision has been priced in, in the broad sense it would tell us it has been, but beyond a simple rate hike and the four anticipated hikes in 2016, there is very little one can gauge on the effects of the Fed’s decision will be on emerging market economies.
The smaller-sized emerging market economies that have a strong economic footing, such as high value add export led, interconnected financial markets and global services oriented economies would possibly witness a synchronised economy and financial market pattern with the US, implying rising tendency of its currency appreciating and its interest rates moving along a similar path, Hong Kong,
Singapore and the Philippines are the ones that have a very strong resemblance of moving along an US economic upswing, with a lesser extent being India, given its position as a global hub of services.
Next comes the larger-sized emerging market economies, China, Brazil, Indonesia, Turkey, Russia and South Africa, all mixed within the basket of manufacturing hubs and global commodity producers.
These are the economies that are likely to reel under pressure from risk of capital outflow, narrowing interest rates differential and increased pressure points on their domestic currency.
While there will be a tendency to experiment with interest rate policies either via raising or lowering policy rates, the broad picture thus far suggest these economies will face mounting pressure emanating from a weak currency.
Those tied to these large Emerging market economies will see a spill over effect, which brings us to Malaysia.
An economy that is neither large in size to other emerging market economies, and neither a large exporter of commodities but being an economy with low value added domestic related services sector, a large chunk of its external debt concentrated in the banking and financial sector, high household and government debt and the fact its trading pattern is heavily concentrated to China, Malaysia faces a multiple pattern of disequilibrium of sort.
The ringgit has raced ahead of the larger sized emerging market economies in witnessing a weaker currency, that itself tells us that the multiple disequilibrium pattern has already been in place, but the big question being would she be able to withstand further pressure when these larger sized Emerging market economies reel under pressure from the Fed’s normalisation of monetary policy in 2016?
It’s unlikely Malaysia would be able to withstand this normalisation of monetary policy by the US, for two simple reasons, one being its main export, crude oil is facing a supply glut in international markets with very limited possibility of oil prices staying afloat north of US$48 per barrel in the near future, which in turn puts its fiscal framework dangerously close for a revision and second, its gearing of external debt that is heavily concentrated in its banking and financial sector.
In relation to the large external debt that the banking and financial sector holds, any form of worsening external financial conditions could induce large scale pull out of wholesale deposits in local Malaysian banks, particularly by large privately owned corporates and individuals. As it is, the hoarding of US dollar by export receipts in foreign currency accounts has already played its part in keeping the ringgit weak.
Without any form of policies to limit further weakness on the ringgit, limited macroeconomic policy variables to manoeuvre, Malaysia seems to be sailing towards a perfect storm in the first half of 2016, unless she intends to buck the trend as she has always done, in previous recessions of 1985/86 and in 1997/98, via a countercyclical economic measure, the choice is hers.
Dr.Suresh Ramanathan believes unorthodox economic and financial policies works well in trying times. He can be contacted at [You must be registered and logged in to see this link.]