The long-awaited US Fed rate hike has just been announced Wednesday evening by the Chairman of the US Federal Reserve, Janet Yellen. The FED rate was raised from 0% to 0.25% with a range of 0.25% to 0.5%. The US FED rate can be likened to Nigeria’s Monetary Policy Rate (MPR) which is the rate at which the CBN lends money to banks. By raising the rates the FED has finally rubber stamped the US economic recovery. Rates where cut to 0% in 2008 during the economic recession as the US Fed then under the chairmanship of Ben Bernanke attempted to revive an economy in recession by offering cheaper borrowing.
Economist around the world have been anticipating a rate hike since last year as US job numbers continued to increase month after month. Before now, each time investors speculated on when the next rate hike will be, the stock market took a plunge as they feared it could impact negatively on investments. But as time passed by the economy became stronger and investors grew bolder. US stocks rallied after the announcement with the Dow gaining about 100 points.
How it affects Nigeria
Emerging markets like Nigeria will not like the current rate hikes considering its potential impact on local currencies. The rate hikes means a stronger dollar against most of the worlds currencies including Nigeria. According to the Financial Times, “a stronger US dollar, backed by higher US interest rates, tends to depress the values of emerging market currencies at a time when many EM economies are already weakening and their currencies have already slumped against the greenback. The Fed’s rate rise could exacerbate the EM currency turmoil, and even help precipitate a full-blown crisis.” Nigeria currently does not have a free-floating currency and as such we may not immediately see the full impact of the hike. Nevertheless, the Naira has been under pressure at the black market hitting another all time high of N262. The CBN is also said to have over $4 billion and growing in unmet dollar demands.
Another way it could affect Nigeria negatively is through capital flights. Raising the US Fed rates by 0.25% could precipitate into capital flight out of emerging markets such as Nigeria with investors re-balancing their portfolios by holding more US investments as a hedge. It is also thought that the low interest rates had essentially blown up asset prices around the world in recent years as US investors borrow at 0% interest rates only to invest same in higher yielding emerging market assets. According to an article on Investopedia, “If investment returns in the rise in the U.S., international capital flows away from emerging markets could accelerate and make funding the “twin deficits” more difficult. This may already be happening, even before the Fed hikes rates. ” The Nigerian stock market has suffered a 65% drop in foreign portfolio investments partly due to the drop in oil prices, speculation about an impending devaluation and also in anticipation of the Fed hike.
The US Fed rate hikes could also posse negative headwinds for emerging market debt cost as interest rates on dollar denominated loans are likely to rise for both government and the private sector. According to the Wall Street Journal article on Tuesday, “Now, the widely-expected quarter of a percentage point rise in U.S. interest rates is compounding worries—particularly as past periods of tightening U.S. policy has often set off economic crises in emerging markets. Some are warning rapid rate rises this time around could do the same.”
Existing Nigeria’s dollar denominated loans could attract rate hikes if they are not hedged. For a government that is planning to fund a huge part of its budget via deficit funding, it is likely that it will have to borrow at a higher rate.
