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USA | Jan 13, 2022

Higher US interest rates will hit developing economies hard

Al Edwards

Al Edwards / Our Today

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The US Federal Reserve in Washington. (File Photo: REUTERS/Jonathan Ernst)

Having to move to counter rising inflation, the US Federal Reserve is all set to raise interest rates which may have a negative impact on developing economies like Jamaica and other Latin American and Caribbean (LAC) countries.

Most of these countries have their debt denominated in US dollars which will now mean higher interest payments and an even higher debt mountain.

According to the IMF, a tough response from the Fed will send shockwaves through poor countries.

“For most of last year, investors priced in a temporary rise in inflation in the US given the unsteady economic recovery and a slow unravelling of supply bottlenecks.

“Now sentiment has shifted. Prices are rising at the fastest pace in almost four decades and the tight labour market has started to feed into wage increases. The new Omicron variant has raised additional concerns of supply-chain pressures on inflation. The Federal Reserve referred to inflation developments as a key factor in its decision last month to accelerate the tapering of asset purchases,” wrote the IMF.

Pedestrians walk past the International Monetary Fund headquarters’ complex in Washington DC. (AP Photo/Cliff Owen)

It now seems unlikely that Omicron will persist for the majority of this year, further severely hampering productivity. What has not proven to be transitory is inflation and the Fed will have to pull back on quantitative easing.

 The IMF continued: “Faster Fed rate increases in response could rattle financial markets and tighten financial conditions globally. These developments could come with a slowing of US demand and trade and may lead to capital outflows and currency depreciation in emerging markets.”

The Bank of Jamaica moved to dampen rising inflation figures by raising its interest rate and was heavily criticised. However, the IMF has observed that some emerging markets have already started to adjust monetary policy and are preparing to scale back fiscal support to address rising debt and inflation.

“In response to tighter funding conditions, emerging markets should tailor their response based on their circumstances and vulnerabilities.

“Those with policy credibility on containing inflation can tighten monetary policy more gradually while others with stronger inflation pressures  or weaker institutions must act swiftly and comprehensively,” advises the IMF.

Bank of Jamaica, in downtown Kingston. (Photo: JIS)

Right now, Turkey is experiencing inflation of 36 per cent and there is very little faith in its monetary policies. The IMF is of the view that that developing countries with fiscal constraints should consider letting currencies depreciate and raising benchmark interest rates.

Here note must be taken. Some say create aggregate demand and go all out to fund businesses in order to bolster economies. The IMF favours a more cautious approach seeing credit risks could impale banks and other finance houses if not kept in check.

“Extending support to businesses beyond existing measures may increase credit risks and weaken the longer-term health of financial institutions by delaying the recognition of losses. And rolling back those measures could further tighten fiscal conditions, weakening the recovery.

“For central banks tightening to contain inflation pressures, clear and consistent communication of policy plans can enhance the public’s understanding of the need to pursue price stability. Countries with high levels of debt denominated in foreign currencies should look to reduce these mismatches and hedge their exposures where feasible.”

The outlook for many developing economies is not looking good despite all the trumpeted optimism. According to the Financial Times, the World Bank expects 40 per cent of emerging and developing economies still to have national income below the 2019 level in 2023.

In Jamaica, one hears talk of increased income levels and high demand for residential mortgages translating to a booming economy. In fact what prevails is a virtual economy which belies what the World Bank is seeing with it estimating that real incomes in 70 per cent of emerging and developing economies will grow slower than those in advanced economies between 2021 and 2023.

Chris Giles in an article in the Financial Times entitled, ‘Monetary policy widens the gulf between poor and rich countries’, writes: “The problem for poorer countries is that tighter but still stimulative US policy might well spell trouble for them. As the World Bank notes in this week’s outlook for the Global Economy, tighter US policy is likely to exacerbate an already difficult outlook for emerging and developing economies.

“Poorer economies have struggled to recover as quickly as advanced ones lacking the same degree of trust and market access to borrow freely to protect their populations in the early stages of the pandemic. Without financial resilience and a generous  social security system, the downturns in emerging economies have been more persistent and recoveries weaker. The perfect storm was completed by the difficulties these economies have faced in gaining access to vaccines and in delivering them to their populations.”

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