Why Rate Hikes Hurt Corporate Productivity More Than Cuts Help in Emerging Markets

In a sweeping study covering 32 emerging market economies (EMEs), the Asian Development Bank’s latest working paper sheds light on the subtle yet significant ways in which central banks’ monetary policies shape corporate productivity. Titled “Monetary Policy and Corporate Productivity in Emerging Markets” and authored by Nuobu Renzhi and John Beirne, the report explores how interest rate shocks reverberate through company balance sheets, particularly among firms most vulnerable to financial constraints. Drawing on over two decades of firm-level data from the Orbis database, the researchers deliver a compelling message: monetary tightening causes long-lasting productivity declines, and these effects are far from evenly distributed.

Using a panel local projections framework, the authors identify exogenous interest rate shocks through a forward-looking Taylor rule, effectively filtering out central banks’ routine reactions to economic forecasts. They then track how these shocks affect total factor productivity (TFP), a measure of how efficiently firms turn inputs into outputs, over time. Their findings point to an immediate 0.3% drop in productivity following a 100-basis-point rate hike, with the damage persisting for four years or more. Crucially, not all firms are hit the same way.

Financial Frictions: The Critical Weak Link

One of the paper’s central arguments is that financial frictions amplify the effects of monetary policy. Firms with weaker financial positions, defined by lower cash-to-assets ratios, experience a sharper and more persistent productivity hit than their more liquid counterparts. For these firms, the peak productivity loss reaches 0.44%, and recovery is slow or nonexistent. By contrast, firms with strong liquidity show a milder decline of 0.25%, recovering within three years. These divergent paths emphasize the critical role of financial resilience in navigating policy shifts.

To strengthen this point, the researchers replace the cash ratio proxy with firm age, assuming younger firms face greater financing hurdles due to shorter credit histories and lower collateral. The results align: younger firms see productivity plunges of up to 3.1%, while older firms weather shocks with relative ease. In both cases, the conclusion is clear: the tighter a firm's financial leash, the harder it falls when interest rates climb.

Market Power and Sector Matter More Than You Think

But liquidity is just one side of the coin. The authors also probe how market power, reflected in firm markups, and sectoral characteristics influence the shock-absorption capacity of businesses. Firms with low markups, often operating in more competitive or price-sensitive environments, are far more sensitive to monetary shocks. They endure longer-lasting productivity declines, echoing the vulnerability seen in financially constrained firms.

In contrast, companies with high markups experience only a brief dip before stabilizing, likely thanks to their stronger internal funding capacity and pricing flexibility. Similarly, sectoral analysis reveals that service-sector firms are disproportionately affected, with productivity declines stretching over four years. Manufacturing firms, while initially hit harder, tend to bounce back sooner. This sectoral divide reinforces long-standing concerns about the fragility of service-driven economies in the face of credit shocks.

When Loosening Isn’t Enough: The Asymmetry of Monetary Effects

Perhaps the most sobering revelation from the study is the asymmetric nature of monetary policy’s impact. While tightening monetary policy leads to sharp and persistent productivity losses, loosening it, through interest rate cuts, fails to generate equivalent gains. Expansionary shocks do not statistically boost productivity for at least two years, according to the data. This one-sided effect suggests a troubling irreversibility: once productivity is lost to financial tightening, it is not easily recovered, even when conditions improve.

This finding challenges assumptions that central banks can simply toggle interest rates to stimulate growth after a period of austerity. Instead, it highlights how damage done during periods of high interest rates lingers, especially in economies where financial access is limited or uneven. For policymakers, this means that prevention may be far more effective than cure.

Policy Takeaways: Rethinking Interest Rate Strategies in EMEs

As central banks in emerging markets face renewed pressures to manage inflation without derailing growth, the insights from this study carry timely relevance. The authors urge monetary authorities to consider firm-level heterogeneity when designing interest rate strategies. In countries where small and young firms dominate the economy, aggressive tightening could undercut the productivity engine for years to come.

Additionally, the paper calls for complementary policies that ease financial constraints, such as improving credit access, especially for firms with limited market power or operating in vulnerable sectors. Supporting financial resilience, the study argues, is not just a matter of economic equity; it’s essential for protecting long-term productivity and growth.