The Impact of the US Interest Rate Hike on Emerging Market Economies and the Belt and Road Initiative

• Author: Biliang Hu,Qingzhong Pan,Shuyu Wu
• Published date: 01 May 2019
• Date: 01 May 2019
• DOI: http://doi.org/10.1111/cwe.12283

China & World Economy / 126–142, Vol. 27, No. 3, 2019

126

©2019 Institute of World Economics and Politics, Chinese Academy of Social Sciences

*Shuyu Wu, Assistant Professor, Emerging Markets Institute, Beijing Normal University, China. Email:

wushuyu@bnu.edu.cn; Biliang Hu, Professor, Emerging Markets Institute, Beijing Normal University, China.

Email: hubiliang@bnu.edu.cn; Qingzhong Pan, Professor, Emerging Markets Institute, Beijing Normal

University, China. Email: davidpan@sem.tsinghua.edu.cn. This work was supported by the Interdisciplinary

Research Project of Beijing Normal University (No. B10.1), the Fundamental Research Funds for the Central

Universities (2017) and the China Postdoctoral Science Foundation (No. 2017M610052).

The Impact of the US Interest Rate Hike on Emerging

Market Economies and the Belt and Road Initiative

Shuyu Wu, Biliang Hu, Qingzhong Pan*

Abstract

Since the end of 2015, the US Federal Reserve has raised its benchmark interest rate

nine times. This has led to capital outflows and asset depreciation in many emerging

market economies. The present paper examines the factors that determine the nancial

volatility of emerging markets in the face of external shocks. By calculating the capital

ows of 30 emerging markets from 1990 to 2018 and conducting panel regression, this

paper nds that countries with good infrastructure facilities, a sound banking system

and high economic growth have significantly lower cross-border financial risks. An

implication from the empirical analysis is that emerging countries would benet greatly

by actively taking part in the Belt and Road Initiative. The framework of the Belt and

Road Initiative allows emerging countries better access to China’s massive consumer

market to promote trade and long-term growth. Their quality of infrastructure can

be improved through cooperation with China in infrastructure investment. They can

also jointly establish a cooperative nancial framework to enhance regional nancial

stability. These strategies will reduce systematic financial risks and counteract the

negative impacts of US interest rate hikes.

Key words: Belt and Road Initiative, cross-border capital ows, emerging market economies,

US interest rate hike

JEL codes: F36, F55, F65

I. Introduction

In December 2015, the US Federal Reserve raised the benchmark interest rate for the rst

Impact of the US Interest Rate Hike on Emerging Market Economies 127

©2019 Institute of World Economics and Politics, Chinese Academy of Social Sciences

time since introducing quantitative easing policies in 2008. The rate was changed after an

increase in US economic growth from 2.6 percent in 2014 to 2.9 percent in 2015. Since

then, the US economy has witnessed consistent economic recovery. There has been an

upward trend in GDP growth, from 1.5 percent in 2016 to 2.9 percent in 2018 and the

labor market has been stable, with the unemployment rate hitting 3.5 percent, the lowest

level in the past 50 years.1 Much cross-border capital owed from emerging economies to

the US, pushing up the exchange rate of the US dollar. Against this backdrop, the Federal

Reserve raised the benchmark rates once in 2016, three times in 2017 and four times in

2018. The current benchmark rate has returned to a normalized level of 2.25–2.5 percent.

The US interest rate hike had negative spillover effects on emerging market economies.

In 2018, the Chinese RMB and Indian rupee depreciated against the US dollar by 5.4

and 8.3 percent, respectively (Figure 1). The Turkish Iira, Brazilian real and South

African rand depreciated more violently, approximately 28.5, 14.6 and 13.9 percent,

respectively, in the same year. Another spillover effect of the tighter US monetary policy

was the panic in emerging markets. As a result of pessimistic investor expectations,

interest rates in the bond markets surged, while in some emerging economies the stock

markets collapsed. Figures 2 and 3 show that Argentina had a booming stock market

index in 2017, but the market slumped in mid 2018. In June 2018, the index had dropped

by 25.5 percent compared to the beginning of 2018. Along with uctuations in the

stock markets, the short-term interest rate in Argentina surged from 26.3 percent

in Januar y 2018 to 60.3 percent in December. As a country that has also suffered

from unfavorable external conditions, Turkey had a short-term interest rate increase

of approximately 10 percent in 2018. Moreover, the Borsa Istanbul composite index

decreased by approximately 20 percent. The combination of unfavorable international

conditions and weak economic fundamentals has led to the accumulation of macro

financial risks in Turkey. By the end of 2017, the leverage ratio of the non-financial

sector in Turkey had reached 114.6 percent, compared to 80.5 percent in 2007.2 With

elevated leverage and a current account deficit, Turkey has been put at great risk, as

either the sovereign debt problems or the currency mismatches in the banking sector are

likely to break its growth momentum. Apart from Argentina and Turkey, the nancial

markets in some other emerging countries also slightly uctuated in 2018. For example,

the stock markets of Indonesia and South Africa were down by 2.5 and 11.4 percent,

respectively, in 2018, while their short-term interest rates were up by 222 and 12 basis

points during the same period.

1Data on the US economy was obtained from the CEIC database.

2Data on Turkey’s leverage ratio was obtained from the Bank for International Settlements (BIS).