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US interest rates rise: a hard kick for African countries

By Samuel Baker - Posted on 7 January 2016

Samuel Baker, MSc Economics and Finance student at Strathclyde Business School, shares his thoughts following the rise in US interest rates last month and its potential impact on developing countries.

The Federal Reserve’s announcement in December to raise US interest rates may have been welcome by markets across the US, Europe and Asia, but for many developing countries it is a reason of concern. With a record low interest rate in the US, many African countries joined the borrowing bandwagon, issuing Eurobonds that had rather high yields; on December 16 the announcement from Fed chair Ms Janet Yellen must have been an itchy sound for many African governments. An increase in US interest rates will strengthen the US dollar which is bad news for countries such as Ghana, Rwanda, Kenya and Cameroon that borrowed in US dollars because, with weaker local currencies, they face a burden of servicing an expensive debt.

The problem goes beyond just debt repayment; with a prospect for higher returns and low risk in US investments, investors will most likely dump African markets. Indeed according to a Wall Street Journal report, investors have already withdrawn $500 billion from emerging markets around the world following the expectation of interest rates rising, therefore with a continued fall in oil and commodity prices, weaker global growth and a slowdown in China, African countries inevitably will be casualties in this capital exodus. Some countries, including Uganda, Zambia, and Kenya, have reacted to prevent this by increasing their interest rates to attract investors, while others such as Angola and Nigeria are imposing restrictions making it harder to take money out the country, but with increasing investment risks and uncertainty about political stability - not to mention the likelihood of default by some countries, it is unlikely that investors will be seduced. Also, a hike in interest rates will only increase the cost of borrowing for their citizens, discouraging consumption and thus decreasing aggregate demand and investment, making it less attractive to do business in these countries.

Generally, the appreciation of the US currency following the rate rise should make exports to the US cheaper; however according to the World Economic Forum, 2015 Africa Competitiveness Report, productivity remains at a record low which means that Africa has less to export while it continues to import more goods including staple foods. Imports from the US will therefore be expensive, adding pressure to households that mainly depend on these goods.

The Keynesian theory that it is good to borrow during periods of economic slack when interest rates are low might be a sound argument, but certainly it has not been a wise economic policy for most African governments to pursue; I might be right to argue that while borrowing in a foreign and stronger currency, caution (which most African governments lacked) is very important. It may be sensible for governments to borrow to invest in public infrastructure which has a positive impact to output in a short and long run, but for African governments, this hasn’t been quite the case – Ghana for example borrowed to cover pay increases for civil servants and this has left the country nothing but a high mountain of debt to climb.

The bottom line is that Africa’s economic future doesn’t look as promising as many under the “Africa Rising” narrative had predicted and the continent faces unprecedented challenges which need stronger solutions. Tightening monetary policy to only sway investors not to take out capital while ignoring other economic factors such as growth rate, inflation, demand and output is definitely not sensible and I hope that African policy makers have learned a lesson from the past experiences, and will avoid falling for the same trap and will look beyond the short term to provide long term economic solutions.

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