US rate hike has local repercussions

The US Federal Reserve (Fed) has raised interest rates terminating its near-zero rate policy that was launched seven years ago in the aftermath of the worst global financial crisis experienced ever since the Great Depression. Given the economic outlook, and recognizing the time it takes for policy actions to affect future economic outcomes, the Fed decided to raise the target range for the federal fund rate to 0.25 – 0.50 per cent effective from 17 December 2015. The Fed has indicated that more rate increases will come with gradual adjustments in its monetary policy stance.

When the US sneezes, emerging markets catch a cold. That is a fact.The United States, being the major source of global capital, any action by the Fed usually creates ripples in the financial markets. The impact will be felt mostly by the emerging market economies like Sri Lanka due to the shift of foreign capital from such volatile economies to less-risky investments in the US.

Specifically, the US rate hike will have greater adverse repercussions on emerging market economies which are handicapped by weak macroeconomic fundamentals and unfinished reform agendas. Sri Lanka is no exception in the context of its upcoming inflationary pressures, declining foreign reserves, prolonged fiscal imbalances and reform failures.

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