FEDERAL FUND RATE

• In the recent Federal Open Market Committee meeting on July 26, 2023, the Federal Reserve made a significant move by raising the targeted federal funds rate to 5.25-5.5%, marking a 25 basis points increase.
• This decision comes as the rate reaches its highest point in 21 years, surpassing the levels observed in 2001.
• Fed Reserve President Jerome Powell justified this action as a measure to curb inflation and maintain economic stability.
• Despite the interest rate hike, Powell also highlighted the positive trajectory of employment figures, underscoring the multifaceted implications of this decision.

2. About the Federal Funds Rate

• The federal funds rate holds a pivotal role within the economy, serving as a determinant of lending rates among banks.
• Emerging from near-zero levels post the global financial crisis, the rate remained subdued until 2015.
• However, the onset of the pandemic pushed rates down to a mere 0.05%. Since March 2022, a gradual increase has transpired, which has raised concerns about the global economy's ability to navigate such a swift ascent, amounting to over 450 basis points within a year.
• The Federal Reserve employs tactics such as bond purchases or sales to regulate and maintain the targeted rate range.

3. Global Ramifications on Developing Countries

• The repercussions of this Federal Reserve decision extend beyond U.S. borders, significantly impacting developing countries.
• In contrast to the burgeoning U.S. economic growth, much of the world remains ensnared by pandemic aftermath and mounting debt servicing apprehensions.
• The extensive expansion of advanced country central bank balance sheets post the global financial crisis translated into historically low-interest rates.
• This environment facilitated the carry trade, enabling entities to borrow in U.S. dollars and invest in emerging markets to capitalize on interest rate differentials.
• This phenomenon led to a doubling of external debt stocks in low and middle-income countries from 2011 to 2016, exceeding 200% of GDP by 2020.
• In the developing world, corporations seized the opportunity presented by the global low-interest rates to secure affordable loans.
• Of the total outstanding dollar debt held by non-financial corporations outside the U.S., approximately $5.14 trillion is attributed to emerging markets and developing economies.
• The surge in interest rates and subsequent currency depreciation now poses substantial risks for these corporations, especially for those with unhedged dollar-denominated debts.

4. Impact on Corporates and Developing Economies

• The repercussions of the federal funds rate hike resonate in the international economy, especially concerning private non-guaranteed (PNG) debt held by corporations.
• Simultaneously, governments continue to be prominent borrowers.
• The upward trajectory of interest rates in advanced countries could trigger foreign investors to abandon government securities in developing economies.
• This shift could contribute to currency depreciation and heightened borrowing costs.
• This scenario amplifies debt servicing concerns for developing countries, where foreign stakeholders play a pivotal role in the government securities market, setting these economies apart from countries like India.

5. Addressing Challenges and A Way Forward

• To mitigate the far-reaching consequences of the federal funds rate hike, a comprehensive and collective effort is essential.
• One crucial avenue involves reforming the international financial system and rectifying its inherent imbalances.
• It's imperative to acknowledge that the power of U.S. monetary policy extends globally, impacting a volatile international economy straddling the intersection of declining health and education infrastructure and escalating climate vulnerabilities.
• A key remedy lies in the substantial expansion of affordable, long-term development financing, complemented by a significant increase in contingency funding for vulnerable economies.
• This multifaceted approach serves as a critical shield against the mounting concerns surrounding developing nation debt, safeguarding climate goals from being stifled by financial limitations.

6. Conclusion

•  As the Federal Reserve's recent rate hike reverberates across the global economy, its effects on developing countries financial stability and climate goals come into sharp focus.
• While the decision is rooted in domestic concerns, the far-reaching implications underscore the necessity for coordinated international efforts to reform the financial system, provide necessary financing, and ensure that climate goals remain undeterred by financial constraints.
• The delicate balance between domestic priorities and global impacts underscores the need for a holistic and collaborative approach to addressing these challenges.