Lanka, too, victim of aggressive interest rate hikes in US

By Rathindra Kuruwita

The U.S. Federal Reserve’s aggressive interest rate hikes are having an adverse effect on Sri Lanka’s economy, Professor Samitha Hettige, an international relations analyst, has said.

The Fed’s latest increase brings the federal funds rate to between 3.75% and 4% after sitting at 0% for more than a year during the coronavirus pandemic. This is not only affecting developing countries but other developed nations as well.

“The US interest rate hikes have applied strong pressure on the European economy, leading to higher inflation and energy costs. So, one can imagine the impact US interest rate hikes have on Sri Lanka,” Prof. Hettige said.

He said that because of the higher US interest rates, a large number of individuals who would have invested in Sri Lanka and other developing countries have decided to invest in the US.

“We have seen massive capital inflows to the United States and increased outflows from the developing world. If you look at the Sri Lankan stock market you can see this,” he said.

Sri Lanka is facing many macroeconomic vulnerabilities due to the COVID-19 pandemic which caused a sharp rise in public debt in developing economies, Prof. Hettige said.

“Given this interest rate hikes in the US makes external financial conditions for Sri Lanka adverse. The US did something similar in the 1980s.  The Volcker shock reduced inflation in the United States but drove up global interest rates. This caused many emerging economies to default on their debts. They are doing it again now,” he said.

Prof. Hettige said Sri Lanka can do nothing about the US rate hikes. Sri Lanka needs to rethink its economic strategy and focus on savings, he said.

“We have been focused too much on consumption. We have borrowed a lot. Maybe we should make this an opportunity to build a more resilient economy,” he said.