The Fed’s Interest Rate Decision – Implications for Mauritius

The US Federal Open Markets Committee (FOMC) decided on Thursday 17th September to keep on hold the key US interest rate of the Federal Reserve Bank of the US (Fed).

It was anticipated that, after having held the key interest rate at near zero levels since 2007 in the context of the economic downturn beginning at that time, the Fed was now ready to change gear by going for the first of a series of future interest rate hikes. Interest rates of other central banks in the West (European Central Bank, Bank of England, etc.) have also touched bottom since the economic crisis began so that monetary policy acting on the interest rate lever, as we know it, has become ineffective.

Already, we should be earning very little on our foreign exchange reserves, given prevailing low interest paid on reserve currencies. Diversifying into gold could have compensated us for this shortfall in interest income but the strong US dollar and falling commodity prices have brought the price of gold to the $1150 range, 30% below the peak of 2008, with little scope to make gains on swings in its price. It is tight manoeuvring on this front already.

The Fed explained its latest decision not so much by reference to US economic fundamentals that have been doing relatively well recently (with expected GDP growth of 2.4%+ for 2015). It highlighted rather the overall global financial market volatility as well as slowing global and Chinese economic growth as factors having determined its decision not to hike up the key US interest rate.

Mauritius is not directly impacted by the US Fed’s decision. However, we must read in between the lines to draw up our own conclusions and future course of action.

The Fed is saying that it refrained from taking the much-anticipated decision to hike the US interest rate, as warranted by its current economic condition. Having decided to do away with injecting more money into the system since 2013 by means of the policy called Quantitative Easing, the next thing for it was to raise the interest rate by slow degrees so as to create enough space for it to employ the interest rate as an effective monetary policy tool in future. It decided to prioritize instead the current fragility of the world economy by not going for an interest rate hike for the time being.

Indeed, as an exporting country of goods and services, we in Mauritius should bear in mind that the world economy is currently walking on a razor’s edge. In contrast to a 7% annual growth from the mid-1980s to 2005, global merchandise trade shrank by 13% year-on-year during the first 6 months of 2015. This is partly due to price effects, the US dollar having risen against most domestic currencies.

But even in volume terms, international trade grew by only 1.7% during the first half of 2015, well below its long-run average of around 5% a year. In other words, we are going through a persistent phase of slowdown of global trade. The international trade slowdown is happening despite oil prices having fallen and made trade transport costs cheaper. Structural factors have set in.

In such a global environment in which exporting countries from Indonesia to Brazil are slumping, policy makers would be well advised in a country such as ours to do their utmost to beef up our exports of goods and services and, what is more, do nothing that will hurt the sustainability of such trade. This is no time for shrinking our scope to export both goods and services. The damage could become permanent with negative implications for future economic growth and employment.

We also need to bear in mind that the Fed’s current decision doesn’t prevent it from proceeding with the much anticipated interest rate hike at its next meetings, scheduled for coming October and December. Many market observers expect the hike to start in December rather than in October.

Should the hike come about, positive US dollar interest rates will have the effect of drawing back huge amounts of funds from emerging countries back into the US dollar. Since the start of the economic crisis when the US authorities decided to reduce the interest rate to insignificant levels, it is estimated three trillion dollars of funds have gone out into emerging economies in quest of better earnings. US interest rate hike will shift them back from out of the emerging economies, seriously affecting these economies.

The latter, already in dire economic straits, would fall further behind and stock market volatilities might then set in more firmly. In such an internationally difficult environment, Mauritius would have even more efforts to make to get a share of global market exports, by way of introducing further economic reform policies and keeping costs down, if only to keep aloft a reasonable rate of domestic economic growth. It is this path of consolidation we should adopt.

Much of the world, including China, is struggling to grow. Commodity prices have been collapsing. This makes it more difficult for developing commodity exporting economies – quite a few of them in the nearby African region — to take on the coming economic challenge confidently. In such global market conditions, we might make some headway, keeping our prices well within international competitive range as a sine qua non for making export-manufacturing inroads.

Given the limited scope that following this path will have on our economic potential in the current circumstances, we would be well advised to look again to the improvement of our agricultural and service sectors as sustainers of future growth. More than ever before, we should employ our best diplomatic efforts to give concrete shape to our regional economic tie-ups, which should insulate us from a situation of even greater global uncertainty ushered in by the Fed’s decision not to go for the interest hike now but later.

The question is how prepared we will be to face the consequences when it finally kicks in and changes altogether the global economic landscape – not necessarily for the better!

 

Published in print edition on 25 September 2015

An Appeal

Dear Reader

65 years ago Mauritius Times was founded with a resolve to fight for justice and fairness and the advancement of the public good. It has never deviated from this principle no matter how daunting the challenges and how costly the price it has had to pay at different times of our history.

With print journalism struggling to keep afloat due to falling advertising revenues and the wide availability of free sources of information, it is crucially important for the Mauritius Times to survive and prosper. We can only continue doing it with the support of our readers.

The best way you can support our efforts is to take a subscription or by making a recurring donation through a Standing Order to our non-profit Foundation.
Thank you.

Add a Comment

Your email address will not be published. Required fields are marked *