Putting systems thinking at the heart of a green and just global transition
As the Federal Reserve begins its cycle of raising interest rates and tightening monetary policy, many developed and emerging economies have also begun to tighten their respective monetary policies in response to soaring inflation and the return of capital. international markets in the US dollar market caused by the Fed’s rate hike. Currently, developed countries such as South Korea, Canada, New Zealand and the United Kingdom, as well as more than 30 emerging market economies such as Argentina, have started raising their interest rates. interest. The European Central Bank is also reducing quantitative easing and is expected to start raising interest rates in the second half of the year. Going forward, the dollar-dominated international currency will move from negative interest rates to zero, and the global economy is likely to show “stagflation” as well as prospects for recession. For China, which is in different economic and monetary cycles, the external monetary policy risks it faces have increased as the Fed accelerates the pace of interest rate hikes. In particular, the potential “double tightening” of international economic growth and monetary policy will not only impact its domestic economy, but also put pressure on the country’s “self-oriented” monetary policy. In addition, changes in the RMB exchange rate and capital flows will increasingly impact the Chinese economy.
Recently, Guan Tao, Global Chief Economist at Bank of China International Securities, introduced four stages of the impact of Fed interest rate hikes on the RMB exchange rate and cross-border capital flows. Initially, moderate and orderly Fed tightening led to a deceleration in foreign capital inflows into China and a slowdown in RMB appreciation. The second stage is a more aggressive rate hike from the Fed, which will even begin to taper at the same time. Guan Tao thinks this could lead to a drop in market risk appetite, leading to a capital outflow phase from China, in which case the RMB exchange rate could go up and down, with swings in both directions. . In the third stage, if the Fed tightens more aggressively than expected, it could prick asset bubbles and trigger a recession. At this point, China may not be able to stay away and the RMB exchange rate may come under further pressure. The fourth step is the resumption of monetary easing by the Fed. Under this change, the RMB exchange rate could enter another round of appreciation and lead to capital inflows. Guan Tao believes that the initial phase of the second stage has just begun, and the pressure on the RMB exchange rate is still increasing. Meanwhile, financial data for the first three months of this year also shows that financial capital is flowing out of the country, greatly increasing the risk of the domestic exchange rate and financial market. Guan Tao expects this pressure to be even stronger in the third stage.
The ANBOUND researchers expected a reversal in interest rate differentials between China and the United States and capital outflows as the Fed raised interest rates. At present, the impact of these problems on China is limited, as the RMB remains stable and monetary policy still has room to promote “stable growth” of the Chinese economy. However, as the weather changes, the trend of further deterioration in the external situation will inevitably put new pressures on the domestic economy and financial markets. Although the United States may not necessarily be in a recession, a growing number of emerging markets are already struggling, which puts China at greater risk. Therefore, in the case of a “double tightening” is increasingly likely, the lack of US dollar liquidity will force China to face unprecedented pressure and challenges, and even repeat the situation of the financial crisis of 1997 and 2008, forcing domestic monetary policy to adjust. Consequently.
The latest data from the United States shows that its inflation hit 8.5% in March, a new high in four decades. Data from the Bank for International Settlements shows that nearly 60% of advanced economies now have inflation above 5%, and more than half of emerging economies have inflation above 7%. In a context of high inflation and growing geopolitical risks, global economic growth could slow or even slip back into recession. Former US Treasury Secretary Larry Summers said a combination of high inflation and low unemployment has historically spawned a recession. He is skeptical of the Fed’s ability to chart a course that will see the country emerge from its inflationary funk without causing an economic downturn. He added that the chances of a “hard landing” in the next two years are certainly more than half, and most likely two-thirds or more. A “hard landing” of the US economy would drag the global economy down, as it did during the 2008 financial crisis. After all, financial market prices in the US and in developed economies are now far above what they were then. If this happens, US dollar liquidity will decrease further and the impact on other currencies will increase. For China, this would not only mean a contraction in foreign trade, but also turmoil in domestic capital markets as US dollar capital flees, putting further pressure on the RMB exchange rate. To deal with these worst-case scenarios, Guan Tao suggested that exchange rate reform, RMB internationalization, capital account opening, foreign exchange reserve management and foreign exchange management should be addressed to prevent changes in external risks.
ANBOUND researchers believe that to cope with the above risk scenarios, China needs to enhance the stability of the RMB and promote a “soft landing” of the economy as soon as possible, which is the basis of a series of financial policies such as exchange rate policy, interest rate policy and capital controls. Only when the economy is stable can the capital market and the exchange rate be stabilized, and various targeted management policies can play a role. Only by maintaining a stable domestic economy can the country create conditions for stable exchange rates and capital flows in the face of intensified changes in the external environment. Otherwise, China will have to raise interest rates and passively follow Fed policy adjustments. In the context of intensifying changes in the external environment and a potential “double hardening”, the country must be prepared for “risk prevention” from the formulation of its policy and its judgment of the situation, and be able to anticipate possible more difficult situations in the future. On the one hand, China should strengthen the factors of stable domestic economic growth, especially strike a balance between its fight against the COVID-19 pandemic and the increase in production, so as to prevent the economy from not be affected by inappropriate policies. On the other hand, it should strengthen its judgment on the market situation, maintain the foresight of policy adjustment, and formulate policies and policy combinations in advance to deal with various extreme situations.