US Rate Dilemma Spells Trouble for Emerging Markets, Including Pakistan

The US Federal Reserve (Fed) is facing a difficult decision as inflation remains above its 2% target, but the labor market is slowing down. If they hold rates high, they risk choking off growth further, while easing policy could let inflation take root just as growth weakens into something closer to stagflation.

The July numbers show producer prices rose 4.7% year-over-year, a sign that the pressure hasn't cleared the pipeline yet. Nine members of the Federal Open Market Committee voted in July to hold the rate at 3.50-3.75%, while three wanted a quarter-point increase.

The situation is not confined to the US as higher-for-longer rates make dollar assets more attractive, pulling capital away from emerging markets and keeping their currencies under pressure. Countries with strong foreign-exchange reserves, deeper domestic capital markets, lower external debt, and large domestic economies would have greater capacity to withstand prolonged US monetary tightening.

Pakistan is closer to the exposed end of that spectrum, with reserves being rebuilt largely through fresh borrowing rather than exports or foreign investment. External debt remains heavy, and a firmer dollar adds pressure by pushing up the rupee cost of servicing existing external debt.