By Chandeepa Wettasinghe
Credit rating agency Moody’s in a new report said that the US Federal Reserve could hike up its short-term interest rates by 0.25 percent today or in the coming months which could have mixed effects on emerging markets.
“A Fed move will contribute to downside risks for some emerging market sovereigns, particularly those that are more reliant on foreign investors to meet their operating and capital financing needs,” a report said.
The rates have been kept at near zero as the US Federal Reserve stimulated the post-2008 US economy by buying bonds of commercial banks.With the stimulus packages starting to dry up this year, rates have increased marginally, and the upcoming rate hike is believed to be a complete departure from such stimulation.
Sri Lanka also witnessed the effects of the speculation surrounding the rise of Federal Reserve rates, with over Rs.100 billion in foreign outflows from local bonds and net foreign outflows from Sri Lankan stocks.
“Although lower global commodity prices and possible volatility in capital flows will pose challenges to some emerging markets, a combination of reserve buffers and policy vigilance has the capacity to limit the negative sovereign credit impact,” Moody’s said.
Sri Lanka had already used up most of its foreign reserves to defend the rupee against the strengthening dollar this year. However, the rupee was let go recently, which resulted in a 4 percent decline against the US dollar since January. The US dollar jumped up 16 percent compared to September last year.
Moody’s said that the Federal Reserves’ short-term interest rates are expected to boom in the coming two years—which could spell further outflows from riskier emerging market shares and securities.
“We expect further interest rate rises to be very gradual, with the fed funds rate moving up by 150-200 basis points in the next two years. Longer-term rates are likely to go up by somewhat less with the yield curve flattening a bit, reflecting low inflation expectations for now.”
The report noted that the possible rate hike shows the US economy lining up for an above trend growth, likely to reach the top of the economic cycle rapidly in 2016.
This stronger dollar and rapid growth would mean cheaper imported product prices and greater consumption in the US, which could be harnessed if the Sri Lankan export sector prepares for it.
Over 24 percent of Sri Lanka’s exports are geared towards the US.
“Although currency depreciations can augur well for exports, they tend to be accompanied by turbulence in domestic financial markets, which can affect overall growth,” Moody’s warned.