Although several ASEAN countries recently joined a cross-border digital payment system, the fact remains that the global financial system follows the U.S. dollar. That means, like it or not, when the U.S. Federal Reserve raises or lowers interest rates it has a ripple effect on markets around the world. For proof of this, we need look no further than the wild ride that two major Southeast Asian economies have been on in recent years.
When the COVID-19 pandemic hit in 2020, the Fed dropped its benchmark interest rate to basically zero. This caused two things to happen. It pushed investment into emerging markets, which typically offer higher rates of return. It also pushed investment into equities. People were sitting around during lockdowns with limited opportunities to spend money, and because interest rates were at rock bottom many investors around the world put their money into the stock market.
This created a somewhat counterintuitive situation where, even though large portions of their economies were shut down and the borders were closed, countries like Indonesia and Thailand saw big investment booms. The value of all companies listed on the Indonesia Stock Exchange (IDX) rose by 18 percent in 2021. The Stock Exchange of Thailand (SET) saw its market cap surge by 22 percent over the same time period.
Low interest rates also drove big foreign direct investment (FDI) flows into the region, as investors chased higher yields wherever they could be found. The Bank of Thailand clocked foreign direct investment at $15 billion in 2021, a big leap compared to $5.5 billion in 2019. In Indonesia, the central bank reported $21 billion and $24 billion of direct investment inflows in 2021 and 2022.
Of course, this was only a temporary state of affairs. In 2022, the Fed began raising rates to cool inflation in the United States. And, as expected, this caused investment flows to start reversing out of Southeast Asian markets and into U.S. financial assets, which were now paying higher rates of interest. It also, generally speaking, caused people to dump stocks and move into bonds and other interest-bearing assets.
The thing about these hot money flows is they are fickle, and when conditions in the global financial system change so does the direction of the investment flow. Between 2022 and 2023 the market cap of companies listed on the SET contracted by 15 percent and the robust direct investment flows dried up. Through September 2023, the Thai central bank reported only $4.4 billion in new direct investment.
What’s interesting about all of this is that Indonesia has been far less impacted by the shift in U.S. monetary policy. Inward FDI is still strong, with direct investment inflows of $16 billion through the first nine months of 2023. The Indonesia Stock Exchange has also kept humming along, with the market cap of all listed companies increasing by 15 percent in 2022, and by another 8 percent through third quarter of 2023. So even though most markets follow movements in U.S. interest rates, they don’t always follow in the same way.
This is important to keep in mind as we enter 2024, since the U.S. Federal Reserve is almost certainly going to start cutting rates soon. Depending on how fast they cut, this could push investment back into emerging markets and equities as it did in 2021. It would not be at all surprising, for instance, to see the IDX continue gathering steam in 2024 and a wave of new IPOs on the exchange.
Lower U.S. interest rates are also important to Thailand. The new Thai government has been very vocal about pivoting away from exports and toward a model of growth anchored by investment and consumption. Falling interest rates in the United States could push capital flows back into Thailand later this year. So if the Srettha Thavisin government is serious about investment-led growth, now might be the best opportunity to prove it.