Why are Bolivia’s Currency Woes Amplified by the Federal Reserve’s Rate Hikes

Today the Federal Reserve will likely raise interest rates for a tenth consecutive time since early 2022. The impact of these rate hikes on regional US banks has been closely followed by the media, and for good reason. However, the Fed’s decisions have much more far-reaching impacts on the global economy, especially in emerging markets.

In Bolivia, a series of persistent economic issues are being magnified by the Federal Reserve, and in recent months Bolivian residents have formed massive lines at banks requesting withdraws in US dollars. Let’s break down how higher US rates are hurting Bolivia and countries like it:

First, rising US interest rates often leads to an appreciation of the US dollar, which reduces the value of a country’s foreign currency reserves. This is because foreign currency reserves are usually held in US dollars, and an appreciation of the US dollar means that a country’s reserves will be worth less in their local currency.

Second, rising US interest rates cause a phenomenon called the “flight to safety.” Simply put, rising rates lead to a shift in investment dollars from riskier investments like those in emerging markets to safer assets such as US Treasuries and Real Estate. Often, this means more capital is leaving a country like Bolivia, than entering it, exhausting currency reserves further.

Finally, rising US interest rates increase the cost of borrowing for countries that borrow in US dollars. This is because the real interest rates on US dollar-denominated debt will increase, making it more expensive for countries to service their debt obligations. If this debt can only be paid in US dollars, countries further reduce their reserves to pay off their debt.

The Bolivian Government has maintained their stance that the country has enough reserves to weather the situation. But their reserves are down nearly 80% from their peak and most of the remaining reserves are gold, which is more difficult to convert into currency. Although countries like Bolivia can fight currency headwinds through increased exports, more attractive infrastructure-based private investment opportunities, and reductions in public debt, it is unlikely to completely turn the situation around. Instead, they too are a victim of the old adage, “Don’t fight the Fed.”