Fed rate hike wrong move for emerging economies

An expected first interest rate hike in almost a decade by the Federal Reserve on Wednesday could squeeze emerging economies' room for manoeuvre as they try to stave off recession, analysts warn.

The rise would mark "the end of a very big illusion," says Christine Rifflart, economist with French think tank OFCE.

Emerging economies have done well out of the Fed's latter day generous monetary policy but with the cycle seemingly about to turn many of them, already battling pallid growth, face further headwinds.

Many emerging states are large scale producers of raw materials and have ridden the boom of Chinese demand. With (Other OTC: WWTH - news) that having fallen off, growth has taken a hit.

Worse still, rising rates will penalise their debt financing conditions and push down their currencies, hitting export earnings.

So much for the economics -- but political crises also comes to bear, not least in Brazil where President Dilma Rousseff is battling to stave off impeachment while the fact South African President Jacob Zuma is on his third finance minister inside a week has caused confidence and the rand to plummet.

Developing nations' central banks are pinning their hopes on a moderate rise to ensure the Fed does not make their task of keeping their own situation on an even keel insurmountable.

A US rate rise risks increased capital outflow in emerging states who could respond by raising their own, in many cases already high, rates.

"If they want to retain a certain currency stability the emerging countries will have to raise their rates. Yet, as they are caught in an economic slowdown or even recession in some cases, they really ought to do the opposite," says Olivier Garnier, chief economist with Societe Generale (Swiss: 519928.SW - news) .

Brazil is a notable example with inflation in double figures and rates already sky high at 14.25 percent, leaving little margin for more upward movement.

"US monetary policy poses each time a problem in Brazil. Its economy is in recession and it should loosen monetary policy but that only reinforces capital outflows, a drop in currency value and hence (a stoking of) inflation," Garnier said.

But Capital Economics research credits emerging nations with more resilience, saying Monday they are "well placed to withstand Fed tightening" as previous evidence suggested "the onset of higher interest rates in the US does not necessarily trigger a rush to the exits."

The consultancy added that the impending rise comes against a largely favourable economic backdrop and has been priced in by traders.

- Rock and hard place -

Oil producing nations, hit by the price of crude tumbling to seven-year lows, likewise have to deal with the fallout of a US rates rise and accompanying dollar rise.

"The Gulf states, whose money is linked to the greenback, could find themselves saddled with an over-valued currency. To maintain their stability vis-a-vis the dollar they will in turn have to raise their own rates," thereby losing a growth-boosting monetary tool, explains Garnier.

In the case of oil producer Nigeria "as the Fed tightens and the dollar gets stronger, you will see more pressure on the Nigerian naira," predicts Fitch ratings agency director Jermaine Leonard.

"If we start to see more pressure on the naira, we will have to ask the question, 'how long can Central Bank of Nigeria defend the naira at the present level of just below 200 to the dollar?'

China may, in contrast, prove to be a special "emerging" case and fare better after any Fed decision to end the long months of rate rise rumble.

China's own central bank Friday indicated it believes the yuan's value ought in future to be less dependent on the dollar and more measured against a basket of trading partner currencies.

That could help the Asian giant as it battles its own growth downturn.

"Loosening its exchange objective would give it greater scope to manage internal demand better, to cut interest rates and to try to spread credit demand on the banking market," commented Rifflart.

"That would give (Beijing) the means to regulate its domestic demand," she concluded.