Expert: Possibility of global economic recession increases amid tightening liquidity, rising prices

Emerging markets must step up efforts to maintain financial stability as global economic and financial risks are rising amid the tightening policies of major central banks, experts said on Tuesday.

For China, the top priority in rising to the external challenges will be stabilizing domestic economic conditions and anchoring market expectations, they said.

Their remarks came after US Federal Reserve Chairman Jerome Powell hinted on Monday that the Fed could implement interest rate hikes of 50 basis points to tame inflation in the coming months, more aggressive than last week's 25-basis-points hike that brought key interest rates to 0.25-0.5 percent.

The Bank of England also raised interest rates by 25 basis points to 0.75 percent on Thursday. All this has strengthened expectations of looming tighter global liquidity amid major central banks' actions to counter soaring prices sparked by geopolitical tensions and pandemic uncertainties.

Hu Zhihao, deputy director of the National Institution for Finance &Development, a Beijing-based think tank, warned that the possibility of a global economic recession has risen amid the tightening global liquidity and pressure of elevated price levels.

"Global financial markets have also entered a period of high volatility," Hu said, because risky assets like equities will turn more volatile as interest rates climb.

Emerging markets could bear the brunt of the mounting headwinds, he said. Tighter US dollar liquidity could make it more costly and difficult for many emerging market economies that rely on dollar-denominated financing.

The capital outflow pressure facing emerging markets could also escalate as investors seek higher yields from dollar-denominated assets, Hu said.

"It is urgent for emerging markets to get prepared and rise to the potential external shocks brought by the world quitting quantitative easing," Hu said.

The Fed chair said on Monday that it would be appropriate to raise interest rates by more than 25 basis points, if necessary, citing the need to move "expeditiously" to tame excessive inflation, which is running at around a 40-year high.

"This round of interest rate hikes generally does good to the US economy, but for other economies, including China, the overall impact could be negative," said Cai Tongjuan, a researcher at the Chongyang Institute for Financial Studies at Renmin University of China in Beijing.

The debt level of emerging markets is at a historical high and therefore vulnerable to higher US interest rates, which could raise their costs in servicing external debts, Cai said, cautioning against potential increases in debt defaults.

Thanks to a vast domestic economy with robust fundamentals, in comparison with many other emerging markets, the Chinese economy is expected to withstand the challenges of major central banks' tightening, experts said.

But they still called for stepped-up policy efforts, including on the monetary front, to maintain the stability of the domestic economy and market expectations, which function as the fundamental buffer against external shocks.

An executive meeting of the State Council, China's Cabinet, called on Monday for efforts to closely watch international economic and financial developments, take precautionary steps to rise to new challenges and take targeted measures to boost market confidence.

"Overall, the impacts of the Fed's interest rate hikes on China will be controllable," said Cheng Shi, chief economist at ICBC International.

Rising interest rates in the US may indeed shrink the yield spread of China and US government bonds and exert capital outflow pressure on China and make the Chinese yuan less attractive against the greenback, Cheng said.

However, such pressure will be mitigated by the comparative advantage of the Chinese economy globally, especially considering that China has been ramping up macro policy support to boost the economy, he said.

According to Cheng, it remains necessary and possible for China to further ease monetary policy by injecting more liquidity and reducing borrowing costs. Even if the Fed takes aggressive steps to crimp inflation, as it has hinted, China may cut the interest rate fewer times but still ratchet up structural tools to boost loans.