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This article has been translated from Arabic to English.
The US Federal Reserve raised the target interest rate by a quarter of a percentage point in May, bringing it to a range of 0.75 percent to 1 percent, the largest increase in US interest rates in over 22 years. This was the second interest rate hike in the United States this year, following a quarter-point hike in March, the first rate hike by the board since 2018.
Fitch Ratings recently changed its projection for US interest rates, predicting that they will reach 2% by the end of 2022, more than double the present target. In other words, the agency believes the recent two interest rate hikes are only the start of a pattern that will continue in the coming months in the form of quick and consecutive interest rate increases in the United States.
As these US decisions will come in tandem with rising interest rates in all developed countries, the main concern today is related to the catastrophic impact these steps will have on the economies of emerging and developing countries, particularly North Africa and the Middle East.
The relationship between interest rates and inflation
In effect, the Federal Reserve serves as the country’s central bank, with the authority to raise or cut interest rates as necessary to achieve its objectives. The Federal Reserve’s involvement in managing its monetary policy to handle the high inflation rate is only part of what we are seeing today in the form of consecutive and quick rising interest rates. Inflation rates in the United States increased to 8.5 percent this year, the highest level in more than 40 years. The Federal Reserve, like other central banks, is attempting to reduce excessive inflation rates by raising interest rates.
Since boosting interest rates is one of central banks’ favored methods for combating inflation and limiting market price increases around the world, it’s critical to understand the link between interest rates and inflation rates. Raising interest rates causes some of the liquidity in the market to be absorbed. This is due to a decrease in borrowing due to rising debt interest rates, as well as an increase in money absorbed by the banking system in the form of deposits due to high deposit interest rates. Raising interest rates to absorb liquidity may reduce market demand for goods and services, cutting inflation and raising prices.
All economies of the world will be affected
In short, by hiking interest rates, the US hopes to address domestic economic issues involving its markets, as well as the pricing of products and services. However, because dollar liquidity is the first to be affected by decisions to raise US interest rates, and because the dollar is the most traded currency globally, when US interest rates are hiked, markets around the world will inevitably be impacted.
Per the adage, “When the American economy sneezes, the rest of the world catches a cold,” it is inevitable that economies across the globe will experience severe and rapid changes as a result of the monetary policy that the US Federal Reserve is pursuing today. The economies of the Middle East and North Africa, which are developing and emerging economies and hence subject to such foreign shifts, are at the forefront of those adversely effected.
Before discussing the impact of rising US interest rates on emerging economies in the Middle East and North Africa, it should be noted that raising interest rates in developed regions of the world is not restricted to the US.
Raising US interest rates will encourage other developed nations to do the same in order to avoid capital and deposit migration to the US. As a result, higher interest rates in all Western countries and mature economies, not only the United States, will impact emerging and developing economies in the Middle East and North Africa. It should be noted that other Western nations, much like world at large, are experiencing high inflation rates and, like the Federal Reserve, are being pressured to raise interest rates.
The Bank of England, for example, boosted interest rates to a 13-year high earlier this month after six members of the Monetary Policy Committee voted in support of this strategy, while only three members backed a more moderate rise. Following the Bank of England’s lead, the European Central Bank began preparing for consecutive rises in European interest rates, first to keep up with increases in US interest rates, and then to rein in the European market’s high inflation rates. The Australian Central Bank has also decided to hike interest rates, with central banks in other industrialized countries expected to follow suit.
The expected impact on the economies of the Middle East and North Africa
To assess the impact of rising interest rates in the United States and other developed economies on emerging markets, notably in the Middle East and North Africa, we need revisit a scenario from 2015. Given the similarity of the circumstances, a review of prior history might help forecast the future consequences of US policy. At the end of 2015, after the US economy had recovered from the effects of the global financial crisis, the Federal Reserve began imposing gradual, consecutive, and rapid rises in targeted interest rates. To keep up with the United States, interest rates were raised across the developed world.
Developing nations and emerging economies began to experience a capital and liquidity crisis in hard currency in relation to the West, notably the American and European markets, at the time, as a result of rising interest rates in developed countries. It was for this reason that the Turkish lira and Egyptian pound saw a precipitous decline in value at the start of 2016. The Turkish lira fell 18 percent in 2016, while the Egyptian pound fell 59 percent in the same year.
The Nigerian naira fell sharply in 2016, owing to rising interest rates in the West and the flight of foreign currency the year before, hitting a low of 37 percent by the end of the year. The Argentine peso was also affected, falling 17 percent by the end of the year, while the Mexican peso fell 17 percent in 2016.
In brief, as a result of the acceleration of capital migration towards developed nations, rising interest rates in Western countries impacted the local currencies of emerging economies, especially Middle Eastern and North African countries such as Turkey and Egypt, during 2015 and 2016.
As for the case of Lebanon, fiscal policies by decision makers or lack thereof, expedited the country’s financial collapse. To avoid capital flight, the Central Bank of Lebanon was compelled to increase domestic interest rates at the time, especially as Lebanon has been dealing with a serious balance of payments issue since 2011. Given these examples, recent interest rate hikes in European and American markets are projected to exert significant pressure on emerging country economies, notably those in the Middle East and North Africa. The currencies of local developing economies will be the first to be impacted, as a consequence of the predicted scarcity of hard currencies in these markets following capital flight to the West, similar to what happened in 2015.
Another factor will be the cost of borrowing for developing nations’ governments, as well as their capacity to repay previous debts by borrowing again. It’s worth noting that the great majority of these countries have large sovereign debts and a policy of borrowing frequently to pay off existing debts.
These developments will undoubtedly increase these countries’ budget deficits, limiting their capacity to spend on social safety networks and investment initiatives. The impact of rising interest rates on the living standards of inhabitants in emerging nations, notably Arab countries, as well as the quality of public services will be felt. Finally, the private sector in developing nations would suffer as a result of excessive borrowing costs, whether for families and people, businesses, commercial institutions, or industrial and agricultural initiatives.
The signs we have begun to see today
It’s worth noting that many developing and emerging economies, especially those in the Middle East and North Africa, are already feeling the consequences of higher US interest rates. Turkey, for example, has been dealing with some of the world’s worst monetary, financial, and economic problems for years, mostly due to the value of its local currency, balance of payments deficits, and the high cost of public and private sector debt interest.
Following the recent increase in interest rates in the United States, the Turkish Central Bank is set to convene on May 26 to explore the prospect of boosting Turkish interest rates in tandem with those in the West in order to curb capital flight to developed markets. Given the links between the cost of production and the cost of borrowing, which is necessary to finance industrial projects, such a move would surely have an impact on the Turkish industrial sector and its capacity to maintain development. The country is particularly sensitive to crises in the value of its native currency in the case of capital flight to the West. In sum, Turkey risks compounding all of the difficulties it has been dealing with for years, including the currency rate, the balance of payments deficit, and the cost of government and private sector debt interest.
In the Gulf, numerous central banks, including those in Bahrain, Qatar, and Kuwait, have agreed to hike interest rates by varying amounts. This entails higher borrowing costs for individuals and governments, as well as increased depletion of state budgets to fund these nations’ sovereign obligations. Because their economies are so tightly connected to the dollar, these countries’ economies are particularly sensitive to US interest rate hikes. This leaves them completely exposed to any shift in the movement of liquidity in the dollar in global markets. Nonetheless, rising interest rates in the United States is expected to have a significant impact on the stock exchanges of these countries due to the transfer of part of the liquidity traded to developed markets. Meanwhile, the major economic projects undertaken by these countries will be affected in terms of the cost of borrowing from the financial markets, and the availability of hard currency in the markets to finance the projects.
The decision to boost US interest rates had a direct influence on the value of the Egyptian pound, as the Central Bank of Egypt was obligated to reduce the value of the local currency this year as soon as the US Federal Reserve began hiking interest rates. These events are projected to intensify Egypt’s economic issues, the first of which is the strain on its balance of payments and the impact this would have on the value of the pound. These changes will also raise the cost of Egypt’s national debt, whose interest consumes a significant portion of the country’s budget.
In the next months, the global economy will have to contend with a hike in US interest rates. This will put pressure on developing countries that already have balance-of-payments deficits. Increasing prices will force Middle Eastern and North African countries to confront impending problems.