Why the Fed can’t stop hiking rates, no matter the emerging markets pain

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Bloomberg News/Landov
Raghuram Rajan, former governor of the Reserve Bank of India,

The Federal Reserve seems intent on hiking interest rates and emerging market economies will just have to cope, according to a former emerging-markets central banker who warned about the 2008 financial crisis before it hit.

Raghuram Rajan, former governor of the Reserve Bank of India, in an interview with CNBC, said the Fed isn’t in a position to hold off on rate hikes.

“In 2013, when we had the last bout of volatility, the Fed stayed off raising interest rate for some time. It is not clear it can do that right now because we have inflation numbers in the U.S. gaining strength,” said Rajan, who in 2005 went to the Fed’s Jackson Hole retreat and warned that the global economy faced the risk of a meltdown from risky behavior in the financial sector.

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“At this point, it seems to me the Fed is set on a path of rate hikes, and emerging markets will have to manage,” he added.

Some emerging markets countries have fiscal space to take the necessary policy steps, “but, of course, there are exceptions,” he said.

Rajan said it was too soon to say if Turkey’s currency crisis USDTRY, -4.3985%  was an early warning of wider problems in emerging market countries.

In many ways Turkey is “an outlier,” in particular because the quality of its economic policy “has been pretty bad,” Rajan said.

The best way forward for Turkey now is “the path of orthodoxy,” he said.

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That means the country should commit to raising interest rates to curb inflation and grant its central bank more independence.

The best thing the U.S. could do would be to pull back on its trade fights with China and other countries, Rajan said.

At the moment, there has been “a tick down” in the outlook for the global economy as a result of the trade disputes, but “not a major one.”

Removing trade uncertainty will result in more confidence that China’s myriad economic problems will not spill over into other emerging markets and then feed back into the U.S., he said.

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