Stimulus packages and vaccine rollout has boosted the economic recovery in the US. But in anticipation, US treasury securities have surged from below a percent in Jan to a high of 1.75 percent in mid-March. Other developed economies like Eurozone and Japan had even raised their interest rates and then reversed them.

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However, emerging economies seem rather apprehensive about the rising rates. Their economic recovery is not as robust as they would have liked, simply because some of them cannot afford either stimulus packages or vaccines.

Are these fears justified?

In the World Economic Outlook, April 2021, an International Monetary Fund (IMF) research found that for emerging markets, what matters is the basis on which interest rates are increased. The research mentioned the following bases:

If rising US employment and vaccination drive interest rates: In this case, most emerging markets witness a strong portfolio inflow. Increasing economic activity in advanced economies also spur exports from emerging markets.

"Good economic news in advanced economies could lead to export growth for emerging markets, and the pick-up in economic activity tends naturally to lift their domestic interest rates. The overall impact is benign for the average emerging market," the IMF research said. However, the case would be different for markets that export less to the said advanced economy, the US in this case.

2. If rising inflation drives interest rates: When rising US inflation drives up the rates, the effect is still kind on the EMs.

"Their interest rates, exchange rates, and capital flows tend to be unaffected, probably because past inflation surprised have reflected a mix of good economic news, like a higher willingness to spend, and bad news, like higher costs of producing," the research said. The effect is not the same, however, when the central bank takes a hawkish stance.

3. If the hawkish central bank stance drives interest rates: For every percentage point rise due to Fed's hawkish stance, lifts long-term interest rates in EMs by a third of a percentage point. Ceteris paribus, portfolio investors immediately flows out of EMs and their currencies depreciate against the USD.

"A key difference relative to interest rate increases driven by good economic news is that the “term-premium”—compensation for the risks of holding longer-maturity debt—goes up in the US with hawkish monetary policy surprises, and with it, spreads on dollar-denominated emerging market debt," the research added.

Also Read: How rising US Treasury yields impact India’s economy?

(Edited by : Abhishek Jha)