Emerging market governments are nervous ahead of Thursday’s big decision – itself covered in a Geopoliticalmonitor.com article last week. The problem has to do with a widening dissonance at the heart of US monetary policy. The Fed is mandated to make its decisions based on the health of the domestic economy, where the ‘green shoots’ of yesterday are now maturing into trees. But in the age of globalization, the Fed is no island; its decisions will send ripples to some corners of the global economy and storm surges to others. And if the damage in emerging markets reaches a certain level, it will in turn impact the United States and derail the economic recovery that predicated a Fed hike in the first place.

An interest rate hike makes USD-denominated assets more appealing vis-à-vis their emerging market counterparts, creating an incentive for investors to move their money out of emerging markets and into the United States. The result is a depreciation trend in emerging market currencies. This dynamic is particularly pronounced so long as the relative strength of the US economy is much greater than that of emerging economies. There’s no real inventive for investors to remain and ‘stick it out’ in emerging markets, especially when there are indications that China, the post-2009 engine of global growth, is starting to cool off.

A Fed hike can thus be viewed as a factor compounding the general flight to safety from emerging markets by making this flight all the more lucrative to investors.

The key risk for emerging economies is, like so much of the modern world of finance, a question of debt. A recent Bank of International Settlements report found that US-denominated borrowing has spiked since the Great Recession to the tune of $9.6 trillion. If a Fed hike begins to leech capital from emerging markets into the US economy, the US dollar will appreciate (an expected consequence of interest rate hikes), and this debt will become harder to service for the banks, corporations, and governments that indulged during the glut of easy, central bank-printed money witnessed over the past seven years. The result will be a knock-on effect of depreciating currencies, central bank interventions, interest rate hikes, and negative economic outlooks in emerging markets. At worst it could trigger regional shocks in the same vein as the Asian Financial Crisis of 1997-1998.