There is an increasing expectation that the US Federal Reserve Bank will raise interest rates next month. Many African economists have been keeping an eye on the Fed and with good reason as a rate raise is likely to have an effect on frontier markets.
The precise effect is hard to determine but there are key elements we should be aware of.
First, a rise in interest rates will make investment in the US more attractive after the Fed pursued a zero interest rate policy for seven years. However, as the Financial Times speculates, because a rate hike has been anticipated for so long, the response to an actual hike may be muted.
From a Kenyan perspective interest rates could be cut to help the economy grow more robustly and boost domestic productivity or they could be maintained or increased to deter investors from taking their money abroad.
Second, a US rate hike will inform the value of the Kenya shilling. A stronger US dollar, which will now be backed by higher US interest rates, has tended to place downward pressure on the value of currencies in Africa.
Kenya has been battling a weak shilling for months and the currency seems to have finally reached some point of stability. An interest rate hike in the US may put all the effort put into stemming the Kenya shilling depreciation to waste.
The Central Bank of Kenya should expect the shilling to depreciate when the rate hike is announced and will now face a renewed challenge of stemming further plummeting, having already used most of the monetary policy tricks at its disposal.
Further, there is the risk that because the hike will strengthen the dollar, this may attract capital away from emerging and frontier markets. Emerging and frontier economies as a whole benefitted from an estimated $4.5 trillion gross inflow between 2009 and 2013. The thought of that scale of funds leaving is daunting.
Thirdly, Kenya has been accruing a great deal of hard currency-denominated debt because of low interest rates tied to the dollar. Rate hikes may present the challenge of making such debt unsustainable.
Any future sovereign bond issues by Kenya and other countries will not be nearly as favourable as was the case last year.
The serendipitous combination of plenty of quantitative easing (QE) informed liquidity and low interest rates in the US and Europe, from which Africa and Kenya have benefited for so long but is not likely to occur again in the near future. Kenya will have to price any debt it offers competitively to attract the scale of funds raised in the recent past.
However, a rate hike will be a clear signal that the US is well into recovery and thus American investors will be better placed and more confident in investing in general.
This is particularly good news for Africa given the challenges the Chinese economy has been facing in the recent past. Also, QE from the European Central Bank may buffer Africa and Kenya for a while as a fresh round of liquidity enters global markets from Europe this time.
Were is a development economist. Email: [email protected]