US Interest Rate Hike: Beacons of Financial Quagmire for Emerging Economies

Insinuations of global financial markets being seriously rattled by the United States move to hike interest rates are on the rise.

The US Federal Reserve hike, which could seriously shake financial markets, trigger capital outflows and currency depreciation in developing countries, obviously hold grim implications for Nigeria and other emerging global economies.

To the International Monetary Fund (IMF), emerging economies must watch out and prepare for the likely economic upheaval that could arise from the US initiative, stating that the development, which will continue to keep the US robust growth in line and moderate its inflation later in the year, would have some significant negative impact on emerging economies.

Expected to release its 2022 global economic forecasts on January 25th, the IMF stated: “Faster Fed rate increases in response could rattle financial markets and tighten financial conditions globally. These developments could come with a slowing of US demand and trade and may lead to capital outflows and currency depreciation in emerging markets.

“The impact of Fed tightening in a scenario like that could be more severe for vulnerable countries. In recent months, emerging markets with high public and private debts, foreign exchange exposures, and lower current-account balances saw already larger movements of their currencies relative to the US dollar.
“The combination of slower growth and elevated vulnerabilities could create adverse feedback loops for such economies, as the IMF highlighted in its October releases of the World Economic Outlook and Global Financial Stability Report.”

The IMF advises policymakers to pull multiple policy levers, following the Fed actions and their own challenges at home, noting that some emerging markets were already adjusting monetary policy and preparing to scale back fiscal support to address rising debt and inflation.
“In response to tighter funding conditions, emerging markets should tailor their response based on their circumstances and vulnerabilities. Those with policy credibility on containing inflation can tighten monetary policy more gradually, while others with stronger inflation pressures or weaker institutions must act swiftly and comprehensively.

“In either case, responses should include letting currencies depreciate and raising benchmark interest rates. If faced with disorderly conditions in foreign exchange markets, central banks with sufficient reserves can intervene provided this intervention does not substitute for warranted macroeconomic adjustment,” the IMF further advised, stressing that for most of last year, investors priced in a temporary rise in inflation in the United States given the unsteady economic recovery and the slow unraveling of supply bottlenecks.

Sentiments, according to the multilateral agency, have shifted as prices are rising at the fastest pace in almost four decades and the tight labor market has started to feed into wage increases, just as the new Omicron variant was raising additional concerns of supply-side pressures on inflation.

“The Federal Reserve referred to inflation developments as a key factor in its decision last month to accelerate the tapering of asset purchases. These changes have made the outlook for emerging markets more uncertain. These countries also are confronting elevated inflation and substantially higher public debt.

“Average gross government debt in emerging markets is up by almost 10 percentage points since 2019, reaching an estimated 64 percent of Gross Domestic Product (GDP) by end 2021, with large variations across countries.
“But in contrast to the United States, their economic recovery and labor markets are less robust. While dollar borrowing costs remain low for many, concerns about domestic inflation and stable foreign funding led several emerging markets last year, including Brazil, Russia, and South Africa to start raising interest rates. We continue to expect robust US growth.

“Inflation will likely moderate later this year as supply disruptions ease and fiscal contraction weigh on demand. The Fed’s policy guidance that it would raise borrowing costs more quickly did not cause a substantial market reassessment of the economic outlook.

“Should policy rates rise and inflation moderate as expected, history shows that the effects for emerging markets are likely benign if tightening is gradual, well telegraphed, and in response to a strengthening recovery. Emerging-market currencies may still depreciate but foreign demand would offset the impact from rising financing costs,” it added, pointing out that broad-based US wage inflation or sustained supply bottlenecks could boost prices more than anticipated and fuel expectations for more rapid inflation.

Nigeria’s Central Bank Monetary Policy Committee meeting would hold before the end of January 2022.