Hanoi (VNA) – Policymakers must adopt a balanced, country-specific approach to navigate potential inflationary pressures, exchange rate volatility, and capital inflow dynamics, according to Matteo Lanzafame, Principal Economist at the Macroeconomics Research Division under the Asian Development Bank (ADB)’s Economic Research and Development Impact Department.
In his recent article assessing the impacts of the interest rate cuts by the US Federal Reserve (Fed) on September 19 on the Asia-Pacific region, Lanzafame said that Fed’s decision presents opportunities and challenges for central banks in Asia and the Pacific.
Fed kicked off a long-anticipated monetary policy loosening cycle at its September Federal Open Market Committee (FOMC) meeting, cutting interest rates by 50 basis points. Committee members project another 50 basis points of cuts this year, and that the Fed loosening will continue in 2025.
This can have significant consequences for the global economy, including for developing economies in Asia and the Pacific, the expert wrote.
According to Lanzafame, inflationary pressures have continued declining in the region this year, as commodity prices stabilised and the lagged effects of last year’s monetary tightening took hold. As a result, most of its central banks have paused their hiking cycle, with some switching to policy rate cuts. Others may now follow suit.
In shaping their policy stance, central banks in emerging economies need to take account of interest rate differentials with the US, which impact capital flows and exchange rates, Lanzafame said, adding that the Fed rate cut opens up the opportunity for more of the region’s central banks to loosen policy to stimulate domestic demand and growth, without triggering capital outflows and exchange rate depreciations.
Since the pace and length of the Fed loosening cycle remains uncertain, an appropriate policy response in Asia and the Pacific will require caution and a careful balancing act, for a number of reasons, he noted.
According to the expert, one option for central banks is to cut rates in the wake of the Fed. This would support growth, but it may also revive price pressures and encourage excessive borrowing in economies where household and corporate debt levels are already high.
Alternatively, central banks in the region can continue to maintain a relatively tight monetary stance - for example by cutting interest rates with a lag or less than proportionally with respect to the Fed.
In such a case, the lower interest rates in the US can increase capital flows to Asia and the Pacific, as investors adjust their portfolios toward assets with more attractive yields. This can boost equity and bond markets across the region, providing some breathing space to more vulnerable economies.
However, capital inflows can also present some challenges, as significant swings in short-term portfolio investment can increase financial market volatility.
Additionally, higher capital inflows may result in exchange rate appreciations compared to the US dollar in the region. This will benefit economies heavily dependent on oil and other commodity imports, reducing price pressures and improving trade balances. For economies with high US dollar-denominated debt, the depreciation of the US dollar will make it easier to sustain the debt burden.
The expert said, fiscal policy can be used the cushion the impact of falling exports. Depending on fiscal space, stimulus can be directed at several objectives, including boosting consumer spending; incentivising activity in particular sectors with stronger multiplier effects on the rest of the economy; and infrastructure, energy-saving, climate-adaptation, and other projects aimed at addressing structural gaps, which will also boost the economy’s productive potential.
Lower interest rates in the US and a weaker US dollar can lower import costs, boost financial markets, and spur larger capital flows toward the region. But these positive developments would not be without risks, including possible exchange rate volatility and renewed inflationary pressures.
Policymakers will need to adopt a flexible approach, remaining vigilant and proactive in taking advantage of the opportunities and addressing the risks, he concluded./.
