A ‘higher for longer’ interest rate scenario, under which the U.S. Federal Reserve and the European Central Bank defer anticipated rate cuts to beyond 2024, would impact emerging economies’ currencies as well as growth and inflation outlooks, with India likely to see the most pronounced effects among Asian countries, as per an Asian Development Bank simulation.
India’s inflation could see an uptick of around 0.4 percentage points through 2024 and 2025, as per the simulation, while GDP growth may see a tad under 0.2 percentage point dip in 2025, compared with the ADB’s baseline projections. The ADB expects growth at 7% this year, before recovering to 7.2% in 2025-26, while it has projected an average inflation rate of 4.6% in 2024-25, followed by 4.5% in the next fiscal year.
“We simulated the potential impacts of a ‘higher for longer’ interest rates scenario… [and] this is particularly relevant since the U.S. inflation figure came in at 3.5% for March, which is above expectations and higher than the 3.2% inflation recorded in February,” said Abdul Abiad, director of ADB’s macroeconomics research division.
“The main channel of the effects on emerging economies comes through interest rate differentials, which then leads to an initial depreciation in their currencies,” he said. The relative appreciation of the U.S. Dollar and Euro in a ‘higher-for-longer environment’ would result in higher imported inflation due to weaker regional currencies.
This would add around 0.15 percentage points to inflation in high-income technology exporters and other developing Asian economies relative to the baseline in 2024 and 2025. While there will be a marginal impact on developing Asia’s inflation and a slightly lesser effect on growth, the impact would be “more pronounced and persistent for India, given the higher sensitivity” of its inflation to exchange rate fluctuations and its greater reliance on imported goods, the ADB concluded.
On the flip side, currency depreciation will provide some gains for India due to increased export competitiveness, which could add 0.05 percentage points to GDP growth this year. However, these positive growth effects could turn negative in 2025 and 2026 once monetary easing in the U.S. and Euro areas gradually kicks in, undoing their exchange rate gains.
Mr. Abiad also flagged risks from ongoing conflicts in the Middle East and the disruption in shipping routes due to strife in the Red Sea, compelling commercial vessels to take longer and costlier routes. Persistence of high shipping costs that had risen 82% between September and December 2023, and have been spiking afresh since February, could add to inflation pressures.
“The inflationary impact [in developing Asia] is persistent, peaking 13 months after the initial shock in October 2023. At that point, it is estimated to add about 0.4 percentage points to inflation, and then subsides subsequently, in the absence of further shocks,” the economist said.
