The US dollar has been serving as the global trade currency for decades. Historically, inflation-driven rapid interest rate hikes in the United States and worldwide have threatened the economic welfare of emerging markets and developing economies (EMDEs).
Sharp increases in US interest rates contribute to the rising foreign exchange value of the dollar, implicitly spilling over into EMDE borrowing costs. But the link between US interest rates and emerging markets is more nuanced and deserves special attention. Capital outflows, increased financial market volatility, elevated debt servicing costs, and imported inflation are only some of the challenges facing EMDEs.
Let’s examine what all this means and attempt to find the light at the end of this tunnel.
US dollar strength and debt
Over the past decade, EMDE corporations have accumulated about 90% of foreign-currency debt, mostly in US dollars. Against the current backdrop of geopolitical tensions and the Trump administration’s tariff tangoing, this has raised concerns within the expert community.
On a macro level, economists have raised concerns about the potential for intensifying debt pressures, fueled by an increasingly stronger US dollar. These pressures are felt more in countries with an elevated dollar-denominated debt.
In May 2025, the Federal Reserve launched its tightening cycle, broadly marked by a series of interest rate hikes. When it convened on May 7, the agency decided to maintain its interest rates in the ballpark of 4.25% to 4.50%. Reverberations of this will likely be felt in emerging markets, particularly Asia.
Many of the region’s developing economies are tightly linked to global trade and the US dollar, hence their vulnerability to higher volatility and potentially negative growth as the greenback strengthens. Having accumulated substantial dollar-denominated debt over decades, these countries face a high risk of default if the cost of their debt rises relative to the value of their local currency.
When the Fed hikes interest rates, US Treasury yields edge higher, making dollar-pegged assets more appealing to investors seeking higher returns with potentially lower risk. This dynamic spurs capital migration from emerging markets with a perceived higher degree of risk to the US, bolstering the dollar and weakening EM currencies.
This is particularly relevant to Asia’s EMDEs due to their exposure to foreign capital inflows. Central banks in these countries are often caught in the crosshairs of doubt: to hike or not to hike interest rates to rein in inflation, driven higher by the more expensive buck.
For example, Indonesia’s rupiah plunged to multi-month lows despite the central bank’s efforts to raise interest rates above the set 6% target. This is not a singular case, and it underscores how external factors like the US monetary policy can thwart domestic policy efforts.
Capital outflows and financial market volatility
On the back of high inflation and a stronger dollar, capital outflows and increased financial market volatility threaten stability across Asia’s EMDEs. Higher US interest rates reduce the appeal of emerging market bonds and equities, triggering portfolio withdrawals. This capital outflow can lead to a sharp depreciation in EM currencies and destabilise financial markets.
Countries like Indonesia and India, which are heavily reliant on foreign investment, are especially vulnerable. For instance, India, which has a large current account deficit and relies on US dollar inflows, saw its rupee plummet in late 2024 as investors recalibrated risk amid Fed monetary policy tightening.
Similarly, Indonesia witnessed significant capital outflows despite strong fundamentals. These are two examples of how volatility in capital inflows can feed through into domestic currency valuation and impact the overall economic climate in a country.
Trade challenges
Rising interest rates in the US and a strong dollar can also erode demand for emerging market exports, making EM goods more expensive globally. This is critical for countries reliant on exports, such as Vietnam, Thailand, Malaysia, South Korea, Japan, and China.
While export reliance varies across these nations, depending on their nuanced relationships with the US and each other, one thing is clear: exports are a key growth driver for these economies.
| Exports to the U.S. (% of GDP) | Country |
| 23.03% | Vietnam |
| 9.29% | Thailand |
| 8.85% | Malaysia |
| 6.24% | South Korea |
| 3.4% (in 2023) | Japan |
| 2.84% (in 2024) | China |
Additionally, US tariffs and regulatory changes could further pressure these countries’ supply chains, potentially disrupting the economy.
Imported inflation
Domestic currency depreciation increases the cost of imported goods and raw materials, raising inflationary pressures. Corroborated with global commodity price volatility forces the hand of central banks to tighten monetary policy.
However, hiking interest rates to control inflation can slow down economic growth and increase unemployment. This risky trade-off complicates policy decision-making and can lead to stagflation, characterised by stagnant growth and soaring inflation.
Outlook for 2025: Is there still hope?
Despite the undeniable challenges that the Fed’s stance to keep rates “higher for longer” poses to Asian emerging and developing economies, they also create opportunities:
- Lower export prices hold the potential to increase the attractiveness of Asian goods globally by making them more cost-competitive. Countries with diversified manufacturing hubs like Malaysia and Vietnam could attract foreign firms looking to steer away from China amid geopolitical turmoil.
- Emerging economies focusing on structural reforms to stimulate the business sector can attract foreign direct investment (FDI). FDI tends to be more stable and less sensitive to US monetary policy headwinds, underpinned by long-term fundamentals.
- Amid geopolitical unrest and economic uncertainty, more Asian emerging and developing economies are seeking regional trade agreements and financial cooperation mechanisms to reduce their dependence on the US dollar. Initiatives like the Regional Comprehensive Economic Partnership (RCEP) and currency swap arrangements among ASEAN countries help cushion the impact of dollar volatility. By stimulating trade and investment in local currencies while encouraging trading partner diversification, these programmes can enhance resilience against external shocks and reduce currency risk.
Final considerations
Without a doubt, rising US interest rates will likely create high volatility in Asia’s emerging markets. Although the risks are significant, with the potential to touch every aspect of the economy, from domestic business to employment and international trade, there are also opportunities to be seized in the long term.
Lower stock prices can offer cost-effective portfolio diversification to investors seeking competitive advantages across the global markets.
Navigating these opportunities in such a volatile environment requires comprehensive risk management and a nuanced understanding of the local economy.
Press release
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