Experts warn that the Federal Reserve’s efforts to reduce inflation in the United States could have a detrimental effect, perhaps lasting several years, by encouraging capital flight, raising rates on sovereign debt and destabilizing their currencies. by developing economies around the world.
On Wednesday, the central bank announced that the Federal Open Market Committee, which sets the benchmark federal funds rate, had voted to raise the target rate from 1% to between 0.75% and 1%. In addition, the Fed indicated that it aims to implement a series of additional half-point increases through the rest of the year.
“Inflation is very high, and we understand the difficulty it can cause, and we are moving quickly to bring it back,” Fed Chair Jerome Powell told a news conference after the committee meeting on Wednesday.
When Powell said an increase of more than 50 basis points is not currently part of the central bank’s plan, he offered some relief to those wondering whether the Fed might be considering an even bigger increase. Still, the prospect of the Fed going into full inflation-fighting mode has many concerned about the impact of its actions on developing countries.
There are several reasons why emerging markets may suffer when US interest rates rise.
A capital flight is likely. Investors who have invested in emerging markets to take advantage of higher rates of return may find investing in the US more attractive as rates rise, prompting them to move capital to the US.
Higher interest rates in the US can also result in higher rates globally. In April, the International Monetary Fund released a report that found that 60% of low-income developing countries were either already facing a debt crisis or were at high risk of doing so. “Previous episodes suggest that rapid interest rate increases in advanced economies could tighten external financial conditions for emerging market and developing economies,” the report warned.
Another threat to emerging economies in a rising interest rate environment is currency depreciation, which reduces purchasing power and increases the difficulty of servicing debt denominated in foreign currencies such as the US dollar.
Economic historian Jamie Martin, an assistant professor at Georgetown University, told VOA that there is a strong historical link between sharp interest rate increases in the US and disastrous economic consequences in developing countries.
In the years following World War I, rate hikes, held partly by the Fed and the Bank of England, helped reverse recessions in major industrialized countries. However, this resulted in several years of growth slowing in non-industrialized countries.
Similarly, the Fed’s aggressive rate hikes in the early 1980s successfully controlled double-digit inflation in the US, but drove global interest rates so high that many developing countries, especially those in Latin America, kept their debts under control. Missed.
In 2013, when then-Fed Chairman Ben Bernanke indicated that a rate hike was on the horizon, the impact on emerging markets was immediate, with capital flowing rapidly and currency volatility setting in.
“History must be treated with extreme caution,” said Martin. “Because, for more than a century, when the US Fed and other types of globally systemic central banks have moved aggressively to tighten monetary policy, almost every time, it has had a dramatic global impact. from what we call a developing economy.
Fed research supports concern
The impact of US rate hikes on developing countries is not always well understood. Federal Reserve Chairman Paul Volcker, who planned to raise interest rates to around 20% in the 1980s, would later say that his focus was on the US and the impact on the developing world was not part of his calculus.
“Africa was not even on my radar screen,” he said.
Now, however, the relationship between the actions of the Fed and the broader global economy is better understood.
In a 2021 article published by the central bank, Fed economists Jasper Hoek and Emre Yoldas, and Steve Kamin of the American Enterprise Institute noted that there are many instances in which rate hikes in the US can be “increased debt burden, triggering capital gains”. has been shown to do. outflows, and generally lead to tightening of financial conditions leading to financial distress.”
While he did not find that economic crises in emerging markets always resulted in a rise in US rates, one of his comments seemed to apply to current circumstances: “If higher rates are primarily inflationary or a sharp turn in Fed policy, … this is likely to be more disruptive to emerging markets.”
pushed ‘over the edge’
Organizations tracking the indebtedness of developing countries warn that conditions around the developing world are already dire. Notably, the global rise in food prices due to the war in Ukraine, along with the impact of the coronavirus pandemic, has already caused severe economic disruption.
A recent loan default by Sri Lanka has some worried that there could be further defaults.
Jerome Phelps, head of advocacy for the London-based Jubilee Debt Campaign, told VOA in an email exchange: “Many low-income countries have already been pushed into a deep debt crisis by the (a) pandemic and rising energy and food prices. “
“They are diverting vital resources away from health care and the needs of communities, often American and European banks, which stand to make huge profits when fully repaid,” Phelps wrote. “Rising US interest rates will push many people over the edge by suddenly making their loan payments more expensive, for no fault of theirs. We need to urgently cancel debt so that the country is a priority to recover from the many crises facing us. can give.”