Impact of the Fed’s new lending rate on emerging economies


The last week of July 2022 saw an unanticipated slum in currency valuation for many emerging economies. Activities in the United States Federal Reserve System (Fed)- the country’s Central Bank- triggered shocks in the global financial sector. 

The Fed on Wednesday, July 27, raised its benchmark lending rate by 75-basis-point. That was its topmost back-to-back rate increase in decades, following 225 basis points in March. The move wobbled the currencies of some countries in sub-Saharan Africa against the greenback. In Nigeria, prices rose sharply from N660/$1 to N710/$1 in the black market within 24 hours after the Fed raised lending rates. 

Since the year began, the US has recorded its fastest increase in consumer prices in 40 years, dragging the economy into inflation. In a desperate move, the apex bank raised lending rates to rein the inflation and rein its economy. The spike in consumer prices is one of the indicators of an inflationary season. Inflation usually leads to a cut in discretionary spending as consumers become very sentimental about how they use money. So people tend to shift focus to spending on essential goods and services than on nonessentials. 

These trends have kickstarted in the US for months, and experts have warned that the country may enter a recession soon. As energy and grocery prices rise, many are cutting their spending on essentials. 

It is important to note that a strong US dollar abroad creates optimism at home. When the dollar dominates the global market, the Fed gains additional room to continue with an expansive monetary policy. That would further spur economic growth. In hindsight, Fed’s latest move positions American consumers to enjoy cheaper imported goods and lower oil prices, translating to more disposable income. 

What does a hike in dollar price mean for emerging economies?

Typically, a hike in the dollar price on the global market means that inflation would set in vulnerable economies. But this would also trigger some positives for people and economies on different levels. With surging dollar prices, emerging markets could be heading into a recession by default. That is the case currently but not entirely, as economic experts argue.

From the micro and macroeconomic points of view, Yannick Lefang, Founder & CEO of Kasi Insight, told us what the move would mean for emerging economies in Africa.

First, investment in Africa would decline. “On a macro front, Fed hiking of lending rates mean investors are now looking to park more money in the US for better returns, translating to less flow to emerging markets. It also means that African countries that borrow in US dollars must pay higher interest on these loans putting more pressure on their economies like Ghana – which is currently seeking IMF’s assistance. More so, depreciating African currencies versus the dollar means that exports from Africa are now cheaper.” 

From the microeconomic perspective, Lefang stated that data from the Kasi Index of Consumer sentiment showed that consumer sentiment in Africa’s largest economies (South Africa, Kenya, Nigeria, Cameroon, and Ivory Coast) is still at a level pre-COVID (+6 in May compared to +9 in January 2020). “But inflation is starting to weigh in on consumer spending. Sentiment dropped 12 points since reaching an all-time high (+18 in December 2021). It is now seating at +5 as of May.”

According to the economic expert, a continued slowdown in spending will put additional pressure on the African economies and cause a drop in revenue. Meanwhile, consumer outlook over the next six months remains negative in these large economies that his company tracked. 

“Overall, we believe the risk of a recession in Africa is low. Large economies are growing at a rate close to double digits (Ethiopia, Ivory Coast). The continental free trade can provide the much-needed offset by making the continent less reliant on imports and but export products out of the continent,” Lefang added.

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Publish date : 2022-08-05 13:34:38

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