September 28, 2022
  • September 28, 2022

Emerging economies “must prepare for Fed tightening and threats to global recovery”

By on January 10, 2022 0

The resurgence of the pandemic and the faster tightening of the US Federal Reserve pose risks to the global recovery and emerging economies should brace themselves for episodes of economic turmoil, according to the International Monetary Fund.

In addition to the endemic variant of Omicron, pressures from the supply side and the Fed’s decision to accelerate the reduction in asset purchases, emerging markets face high inflation and significantly higher government debt. , the Washington-based lender said in a blog post on Monday.

“The average gross government debt of emerging markets has increased by almost 10 percentage points since 2019 to reach around 64% of gross domestic product by the end of 2021, with wide variations across countries.” , said Stephan Danninger, co-author of the blog. and is Division Chief of Macroeconomic Policies in the Strategy, Policy and Review Department of the IMF.

“But unlike the United States, its economic recovery and labor markets are less robust. While dollar borrowing costs remain low for many, concerns over domestic inflation and the stability of foreign funding have driven several emerging markets last year, including Brazil, Russia and South Africa, to start raising interest rates, ”he said.

The global economy, which in 2020 entered its deepest recession since the 1930s, rebounded strongly last year thanks to $ 25 trillion in fiscal and monetary support from governments and central banks around the world.

In October, the IMF lowered its forecast for global economic growth due to weakening momentum, Covid-19 outbreaks, uneven access to vaccines, supply chain disruptions and risks of rising inflation. The fund revised its growth downward in 2021 to 5.9% from its estimate of 6% in July, while maintaining its projection for 2022 at 4.9%.

The uninterrupted spread of the coronavirus since November and the subsequent reintroduction of strict pandemic-related measures across much of Europe, Asia and the Americas have raised more questions about economic dynamics this year.

The continued disruption of supply in advanced economies and the worsening momentum of Omicron, which threatens to overwhelm health systems in low-income and developing countries, exacerbate economic weakness, the lender said.

The average gross government debt of emerging markets has increased by almost 10 percentage points since 2019 to reach around 64% of GDP by the end of 2021

Stephan Danninger, Division Chief, IMF Macroeconomic Policy Unit

History shows that the effects for emerging markets are likely to be mild if the Fed’s tightening is “gradual, well telegraphed, and in response to a strengthening recovery.” Emerging market currencies could depreciate further, but foreign demand would offset the impact of rising funding costs, the IMF said on Monday.

But a scenario of faster Fed rate hikes in response to widespread US wage inflation or sustained supply bottlenecks could shake financial markets and tighten financial conditions across the board. global. This could be accompanied by a slowdown in US demand and trade and could lead to capital outflows and currency depreciation in emerging markets, the IMF said.

“The impact of Fed tightening in a scenario like this could be more severe for vulnerable countries,” said Kenneth Kang, deputy director of the fund’s oversight, policy and review department, who is l one of the blog’s co-authors.

“In recent months, emerging markets with high public and private debt, currency risks and lower current account balances have seen already larger movements of their currencies against the US dollar. The combination of slower growth and high vulnerabilities could create unfavorable feedback loops for these economies. “

The IMF blog suggested that emerging markets should tailor their response to tighter financing conditions based on their circumstances and vulnerabilities.

Those whose policies are credible in containing inflation may tighten monetary policy more gradually, while others with stronger inflationary pressures or weaker institutions must act quickly and comprehensively, the IMF said.

“In either case, responses should include letting currencies depreciate and raising benchmark interest rates,” said Hélène Poirson, deputy division chief of the IMF’s macroeconomic policy unit and co-author of the blog.

“If they are faced with disorderly conditions in the foreign exchange markets, central banks with sufficient reserves can intervene provided that this intervention does not substitute for a justified macroeconomic adjustment. “

Emerging markets must take action now to strengthen policy frameworks and reduce vulnerabilities.

The measures should include clear and coherent communication of policy plans by central banks in order to increase public understanding of the need to pursue price stability. Countries with high levels of foreign currency denominated debt should seek to hedge their exposures and bond maturities should be lengthened to reduce refinancing risks, the IMF said.

The impact of Fed tightening in such a scenario could be more severe for vulnerable countries

Kenneth Kang, Deputy Director, IMF Surveillance, Policy and Review Department

Solutions must also be prepared for countries where corporate debt and bad loans were high even before the pandemic, he said.

“Defining a credible commitment to a medium-term fiscal strategy would help build investor confidence and regain room for budget support in a downturn. Such a strategy could include announcing a comprehensive plan to gradually increase tax revenues, improve spending efficiency or implement structural tax reforms such as revising pensions and subsidies, ”the lender said on the blog.

“Despite the expected economic recovery, some countries may need to rely on the global financial safety net. This can include the use of swap lines, regional funding agreements and multilateral resources. “

Update: January 10, 2022, 5:21 am