BY ANTONY MUTUNGA
Last month the Central Bank of the largest economy in the world decided to hike its benchmark rate for the third time since the global financial crisis. The hike came just three months after its previous raise that was in December 2016. This highlighted the end of the easy monetary policies that the rest of the world was accustomed to having.
The Federal Reserve raised its benchmark rate in order to tighten its country’s monetary policies because the economy of the U.S was in a strong position. However even though this would help the U.S, it would also have dire consequences on the rest of the world.
As a result, of increasing connections in the global markets over the years, developing countries like Kenya will be the most affected by the hiking federal rate. This is due to the fact that they usually borrow loans and acquire them in the U.S currency. The increase in the federal fund rate causes the borrowers to end up paying more and the lenders to earn more as the dollar appreciates.
This also encourages investors to shift their money from developing countries and send them back to America whereby investments would fetch higher returns. When investment rushes into developing countries, it tends to drive up the prices of stocks, real estate, and other assets. As asset prices go up, company balance sheets look healthier and investments look less risky, creating the opportunity for additional borrowing and investment.
However, the opposite happens when investments start rushing out of the country. It affects government bonds and equity markets because of investors moving to safe havens like U.S. sssets, which are the safest in the world; the number of people willing to invest reduces. ‘Hot Money’ is the term used when a large number of investors withdraw from market over a short period.
According to Samuel Kiragu, a Financial Services Compliance Professional, We could witness US investors who are long on NSE-listed companies ship back their money to seek higher returns from their domestic assets. This will potentially lead to stock market’s volatility. The fed rate expects to hike two more times this year and the more it hikes the more the investors will pack up and leave the country. This will cause the prices of stocks and other financial assets to fall drastically.
The shift of investors will also harm start-ups, which really rely on their investments. For example, in Kenya, start-ups have been getting many help from foreign investors, who have invested a lot of money into different sectors. The hike is sure to minimize the investments, as investors will shift to a less risky market.
As a result of decreasing foreign direct investments, development decreases in these countries, because of an increase in capital outflow, which in turn causes the growth of the economy to decrease as well. However, countries like Kenya have been lucky to have a cushion to fall back on as they have been borrowing from Asia with whom they have created a good financial relationship. This has enabled the country to keep working on its slow development plans as it borrows from China and Japan.
On the other hand, Kenya still has to deal with the fact that they have borrowed in U.S dollars thus the strengthening of the dollar after the hike increases the public debt that each citizen has to pay for. Apart from borrowing, the country has also engaged in selling dollar denominated sovereign bonds, which are highly vulnerable. This was a move to acquire funds to run its economy but now due to the hike the debt will increase, and with it, the debt burden.
Other than increasing a country’s debt, the strengthening of the dollar also causes other currencies to weaken causing exports of a country trading with the dollar to be less competitive because they are more expensive. Other countries henceforth start relying on their local goods and minimize spending on imported goods.
In the case of Kenya, which relies mostly on imported goods, this becomes a problem, as imported goods will now be very expensive meaning the country will spend more. This will affect the growth of the country, since the more money goes to acquiring imported goods, the less it goes to the development of the country.
Paul Theuri, an economist in the banking industry, says, “A weaker shilling carries an implication of raising the cost of living for Kenyans given that the country is a net importer of goods. However, it offers benefit to exporter but it’s short-lived.”
The increase in prices of goods and the weakening of the home currencies will result in an increase in inflation. This will be harmful to developing countries whereby social unrest will mostly come up. For example, the current rate of inflation in Kenya for the year stands at over 9% but with the hike; it might go into double-digit mark. This will cause consumers to cut back on spending.
It will also affect companies that highly depend on the dollar as well, as the hike will cause lending rates to increase and in turn cause companies to find ways to minimize their costs hence a decline in company growth, employment and worse off in job layoffs. With the unemployment rate already standing at 40%; any more unemployment will see almost half of the population without jobs.
The government in a bid to put things back to order will eventually have to put up a tight monetary policy. Through this, they would be able to control the rising inflation by raising short-term interest rates. However, this in turn will cause the cost of borrowing to increase thus causing it to lose its attractiveness. Subsequently, the Central Bank rate (CBR) with shoot up and thus interest rates on loans will increase making it more difficult for people to borrow, eventually stunting growth of the economy.
Governments need to keep their forex reserves and inflation in check to survive the next raising of the fed rate. As the Federal Reserve has already hinted at two more hikes this year, central banks and governments need to put up measures to be able to handle ‘Hot Money’, which if not well handled can cause hyperinflation that might lead to a negative growth rate.
Kenya being especially poor at making early arrangements, it is high time to start planning before it is too late.