The American central bank, the Federal Reserve (FED), raised interest rates yesterday by a quarter of a percentage point to a range between 0.25 percent and 0.50 percent. Additionally, it was announced that the interest rate is expected to reach 1.375 percent by the end of 2016. The decision to raise interest rates, after several years of extremely loose monetary policy, was justified by the good state of the labor market in the U.S. and expectations that inflation will rise to the target level of 2 percent.
What does this mean for Croatia and will the FED’s move affect our fragile public finances, we asked economic experts Damir Novotny and Drago Jakovčević.
Novotny summarized his thoughts in a brief message that the ‘honeymoon of low interest rates’ is over and that our Government faces a return to reality.
– The Fed’s rate hike is not that drastic and is unlikely to reach our markets quickly. However, what could be a long-term problem is that the rise in primary interest rates could produce a negative psychological effect on our creditors since the Croatian Government finances itself significantly in America and those debts need to be refinanced. When there was a lot of money in circulation, creditors had no problem allocating some funds for our bonds, but now the question is whether they will want to refinance those bonds maturing in 2017, around 25 billion kuna, which is a relatively large amount. In that case, this FED measure could indirectly reflect on our public finances as investors might seek a new credit rating and new ratings, and then they will be in doubt whether to invest money in the U.S. at higher interest rates or take the risk with us. To shorten it, this will have negative effects on public finances in Croatia in the medium term – emphasized Novotny, adding that the Government could turn, as it has announced, to the domestic financial market and that it could increase exposure to the public sector by another 5 to 6 billion kuna, but no more than that. This means that around 20 billion kuna will need to be found in the international market, which could be a problem, especially considering that borrowing from domestic banks is quite unfavorable for the Government compared to abroad.
