By Anzetse Were
There is an increasing expectation coming out of the USA that the Fed will raise interest rates in December this year. Many African economists have been keeping an eye on the Fed and with good reason as the rate raise is likely to have an effect on frontier markets. The precise effect is hard to determine definitively but there are key elements of which one should be aware.
Firstly, a rise in interest rates will make investment in the USA more attractive after the Fed having 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 there are two ways we could go in terms of our own interest rates to keep Kenya an attractive investment destination. Interest rates could be cut to help the economy grow more robustly and boost domestic productivity, or rates could be maintained or increased in order to deter investors from taking their money abroad.
Secondly, a US rate hike will inform the value of the Kenya Shilling. As has been seen in recent times, 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. Bear in mind that 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 KES depreciation to waste. Indeed, the CBK should expect the KES to depreciate when the rate hike is announced and will now face a renewed challenge of stemming the KES plummeting having already used most of the monetary policy tricks at their disposal. Further, although some say that investors may not react to a rate hike, there is the real risk that because the hike will strengthen the dollar, this may attract capital away from emerging and frontier markets. In short there may be a severe contraction of US dollars from global markets, especially frontier markets. Bear in mind the 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 emerging and frontier markets, Kenya included, is a daunting prospect.
Thirdly, Kenya has been accruing a great deal of dollar denominated debt and the government has largely been able to do so because of the leakage effects of the very low interest rates tied to the dollar. Rate hikes may therefore present the challenge of making such debt unsustainable. What can be sure is that any future sovereign bond issues by Kenya and other countries will not be nearly as favorable, with regards to interest rates, as was the case even last year. The serendipitous combination of plenty of QE informed liquidity and low interest rates in the US and Europe from which Africa and Kenya has benefited for so long, is not likely to occur again in the near future. Kenya will have to price any debt it offers particularly competitively to attract the scale of funds raised in the recent past.
However, the bottom line is that a rate hike will be a clear signal that the US is well into recovery terrain and thus US investors will be better placed and more confident in investing in general. This particularly good news for Africa, Kenya included, given the challenges the Chinese economy has been facing in the recent past. Also bear in mind that the QE from European Central Bank may buffer Africa and Kenya for a while still as a fresh round of liquidity enters global markets from Europe this time.
This article first appeared in my weekly column with the Business Daily on November 15, 2015