Fed’s interest rate hike likely to hinder foreign economies
WASHINGTON — When the Federal Reserve raises interest rates — as it did this week — the impact doesn’t stop with U.S. homebuyers paying more for mortgages or Main Street business owners facing costlier bank loans.
The fallout can be felt beyond America’s borders, hitting shopkeepers in Sri Lanka, farmers in Mozambique and families in poorer countries around the world. The impacts abroad range from higher borrowing costs to depreciating currencies.
“It will put pressure on all types of developing countries,” said Eric LeCompte, executive director of the Jubilee USA Network, a coalition of groups seeking to reduce global poverty.
The managing director of the International Monetary Fund, Kristalina Georgieva, was worried enough last month to warn the Fed and other rate-hiking central banks to stay “mindful of the spillover risks to vulnerable emerging and developing economies.”
Citing the harsher financial conditions, the IMF recently downgraded the outlook for economic growth this year in developing and emerging market countries to 3.8%, a full percentage point below what it forecast in January.
The Fed on Wednesday raised its benchmark shortterm rate by half a percentage point to its highest level since the pandemic hit two years ago, and signaled that more rate hikes will come.
The U.S. rate hikes can deliver long-distance damage in a number of ways. First, they could slow the American
economy and reduce U.S. consumers’ appetite for foreign goods.
They also affect global investment: As rates rise in the U.S, safer American government and corporate bonds start looking more attractive to global investors. So they might pull money out of poor and middle-income countries and invest it in the United States. Those shifts drive up the U.S. dollar and push down currencies in the developing world.
Falling currencies make it more expensive to pay for imported food and other products, especially worrisome as supply chain bottlenecks and the war in Ukraine have already disrupted shipments of grain and fertilizer and pushed up food prices worldwide.
To defend their sinking currencies, central banks in developing countries are likely to raise their own rates. That can cause economic damage: It slows growth, wipes out jobs and squeezes business borrowers. It also forces indebted governments to spend more of their budgets on interest payments and less on things like fighting COVID-19 and feeding the poor.
The Fed is hoping to pull off a so-called soft landing — raising rates just enough to slow the economy and bring inflation under control but not enough to tip the U.S. economy into another recession.
The Fed does not have an impressive record of soft landings. The last one came in the mid-1990s, an episode that ended unhappily for many developing countries.
“The U.S. was able to manage inflation well and avoid recession,” said Liliana Rojas-Suarez, senior fellow at the Center for Global Development, “but at the same time created huge spillovers for emerging markets.”
What followed was a series of financial crises — in Mexico, in Russia and eventually across much of Asia.
Robin Brooks, chief economist at the Institute of International Finance, notes that many emerging market countries are in a much stronger financial position than they were back then. For one thing, many have beefed up their foreign currency reserves, which central banks can use to buy and support their countries’ currencies or meet foreign debt payments in a crisis.
But some countries remain vulnerable to financial shocks. Among them are those that rely heavily on imported oil and other commodities and that have low reserves compared to what they owe other countries.