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Fed Rate Hike and Its Effect On Emerging Economies - Prajesh Gupta - NMIMSMumbai - Jan
Fed Rate Hike and Its Effect On Emerging Economies - Prajesh Gupta - NMIMSMumbai - Jan
The recent announcement by Janet Yellen and the Federal Open Market Commission (FOMC)
regarding the U.S. central bank's policy-setting committee, which had raised the range of its
benchmark interest rate by a quarter of a percentage point was an expected one. The interest rates
have been hiked to between 0.25 percent and 0.50 percent. Though the rate hike was expected by
many, the assumptions of its effects are varying. While some experts state that it might cause
another slowdown in the U.S, other say that the hike will harm emerging economies.
Current Performance of Emerging Economies
China accounts for nearly 30% of the economic activity of emerging economies and it is the
largest buyer of commodities. The Chinese slowdown has led to decline in the rates of
commodities. The private sector debt has risen to extreme levels, especially in China, Thailand
and Turkey. On the other hand countries like Chile, Mexico, Hungary and Indonesia have high
foreign currency borrowing. India has been able to sail through this period due to oil price
decline and focusing on domestic demand. Corruption scandals in Brazil have rocked their
vulnerable economy. Brazils Real has lost half its value to the US dollar this year and the
Russian Ruble is at its lowest compared to the US currency. It is the emerging economies that are
displacing the developed nations as the most troubling cloud on the economic horizon.
Source: Bloomberg
Figure 2: Annual Default Probability from 5 Year Credit Default Swap Spread
The period of economic recovery had seen a rise in capital inflow of US $4.5 Trillion till 2014 in
these markets. The rate hikes could also lead to reversal of capital flow from emerging
economies. Political turmoil and high inflation of about 9% are already plaguing Turkey.
Withdrawal of capital due to rate hike can further harm the economy. South Korea has the benefit
of one of the largest current account surpluses in the region but its economy is vulnerable to
foreign shocks. Its majority of exports are to China, which has been facing a slowdown and
hence a rate hike by the Federal Reserve can amplify its losses.
Corruption is plaguing Brazil, while the oil price crash has already affected Russia. On the other
hand, Chinas private sector is ridden with debt. Even though it's foreign exchange reserves have
declined but the country still has the largest foreign exchange reserves and possesses ample
buffers to repay overseas creditors and honor import commitments compared to others. Actions
of US Federal Reserve will strengthen the dollar against the emerging market currencies.
Evidence from the past rate hikes shows that stock markets reacted positively, at least on eight
out of 10 occasions, for almost all the emerging economies. It should also be noted that the
equity markets saw a bullish phase. Increasing risk appetite among global investors made them
flock to emerging markets. It was only on two occasions that the stock markets reacted
negatively. Foreign investors who had already invested in these markets will fear that the
depreciation will wipe out their profits and hence capital outflow can be accelerated.
in commodity prices, will create additional headaches for emerging economies, most of whom
have not implemented the structural reforms to their economic policies.
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http://www.bbc.com/news/business-34475609
http://in.reuters.com/article/us-usa-fed-idINKBN0TY2EX20151218
http://www.marketwatch.com/story/us-economy-is-on-solid-ground-for-now-2015-12-20
http://www.investopedia.com/articles/investing/040115/how-strong-us-dollar-can-hurtemerging-markets.asp
http://ig.ft.com/sites/when-rates-rise/#faq
http://www.project-syndicate.org/commentary/fed-interest-rate-rise-emerging-marketsby-nouriel-roubini-2015-06
http://www.livemint.com/Opinion/W4n5HnqS5oTcVEJ0G8kAzO/The-positive-side-ofFed-rate-hike.html
http://www.firstpost.com/business/us-feds-first-rate-hike-in-9-years-after-crisis-is-this-asilver-lining-for-india-2548994.html