Borrowing costs

Facing high inflation and high borrowing costs in emerging and developing countries

As the old saying goes, all good things come to an end. The days of low inflation and easy global financial conditions are over. Many emerging markets and developing economies (EMDEs) have recently experienced an unpleasant combination of high inflation and rising borrowing costs. At 8.5% in March 2022, inflation in EMDEs reached its highest level since 2008 (Chart 1). In advanced economies, inflation is now reaching its highest level since 1991. Global financing conditions are tightening as major central banks in advanced economies are expected to raise policy interest rates at a faster pace than expected to contain inflationary pressures.

Figure 1. Consumer price index inflation, 1990 – 2022

Sources: Ha, Kose and Ohnsorge (2021); World Bank.
Note: The latest observation is for March 2022 and includes group median year-on-year inflation for 81 countries, of which 31 are advanced economies and 50 are EMDEs.

Amid deteriorating growth prospects, EMDEs are likely to continue to face high inflation and more onerous borrowing conditions. To cope with high inflation and high borrowing costs, the policies of these economies will require prudent measures calibration, credible frames and clear Communication. This is easier said than done, especially when fiscal space is limited and financial vulnerabilities are high. However, sticking to certain policy-making principles can pay off big in making these economies more resilient as they navigate uncharted waters.

Monetary policy: tighten with caution

For monetary policy, it will be essential to calibrate policy levers within a clear and predictable framework to outpace inflation without stifling the recovery. Many EMDEs had already begun to tighten monetary policy long before the war in Ukraine to stem inflationary pressures. The average key rate in EMDEs is now higher than the average for the 2010s (Chart 2).

Figure 2. Monetary policy rates in EMDEs, 2019 – 2022

Chart of monetary policy rates in EMDE, 2019 - 2022

Sources: Bloomberg, Haver Analytics, World Bank.
Note: The sample includes 22 EMDEs and nominal policy rates using real GDP as weights. The last observation is from March 2022.

Going forward, clearly communicating monetary policy decisions, leveraging credible monetary frameworks, and safeguarding central bank independence will be essential to manage the circuit in these economies. To further anchor low inflation expectations, policymakers need to communicate effectivelynot only with the financial markets, but also with households and businesses.

Financial policy: containing risks

On the financial side, policymakers need to rebuild buffers and realign prudential policy to prepare for possible financial strains. During the pandemic, at least three-quarters of EMDEs have implemented regulations abstention measures to avoid a credit crunch. many governments supported business loans address liquidity constraints through loan guarantees and payment moratoriums.

In light of these past interventions, the banking system’s exposures to exchange rate and refinancing risks need to be carefully monitored and, if necessary, mitigated through macro and microprudential policies. Credit quality and non-performing loans should be reported transparently so that corrective action can be taken quickly. Banks’ capital and liquidity buffers need to be strong enough to absorb shocks. If deployed appropriately, buffers can help stem temporary exchange rate pressures.

Fiscal policy: committing to credible plans

Fiscal policy challenges have accumulated in many EMDEs. Fiscal positions have deteriorated sharply during the pandemic, and these deteriorations have not been fully reversed by 2022. Despite a strong initial rebound in growth last year, EMDE fiscal deficits are still 1. 1 percentage point of GDP to those of 2019, and public debt is 10 percentage points of GDP higher (Figure 3). Partly to contain fiscal deterioration, EMDEs have already tight fiscal policy in 2021reversing about half of the 2020 fiscal stimulus.

Figure 3. Public debt and fiscal deficits in EMDEs, 2019 and 2022

Bar graph of public debt and fiscal deficits in EMDEs, 2019 and 2022

Sources: International Monetary Fund, Kose et al. (2021), World Bank.
Note: Aggregates weighted by GDP in US dollars for 152 EMDE (public debt) and 155 EMDE (deficit). LHS means left scale and RHS means right scale.

The pace and extent of the further withdrawal of budget support should be finely calibrated and closely aligned with credible medium-term fiscal plans. In addition, policymakers need to address investors’ concerns about long-term debt sustainability by strengthening fiscal frameworks, improving debt transparency, improving debt management functions, and improving revenue and debt components. government balance sheet expenditure. Inflation expectations are unlikely to be well anchored if there are concerns about fiscal sustainability due to fears that monetary policy will be constrained, especially in cases where high interest rates imply instability. public debt dynamics.

If the the recent spike in energy and food prices persists, EMDE commodity exporters and importers will face diverging policy challenges. Commodity importers may need to contain inflationary pressures, which could weigh on growth, while managing the challenges associated with fiscal and external imbalances resulting from high commodity prices. Commodity exporters may need to rein in inflation amid strong growth thanks to rapidly expanding resource sectors. Some of the windfall spillovers from rising commodity prices should be invested in enhancing long-term growth, including human capital, rather than being used for distorting energy subsidies.

Other Interventions: Avoiding Distorting Measures

Export restrictions and disrupted global food markets due to war are expected to contribute to rising global food inflation. The use of trade policy interventions and price controls to protect domestic markets from food price shocks could aggravate international price volatility and lead to even higher domestic prices. To deal with food price volatility, EMDE policymakers need to strengthen social safety nets and improve the resilience of food systems, while refraining from counterproductive price control measures. Price controls were pervasive in EMDEs even before the recent spike in commodity prices. These controls tend to distort markets and have negative consequences for growth and poverty reduction, which often prove difficult to reverse after a crisis. If political considerations make price controls or untargeted subsidies unavoidable, their longer-term damage can be contained if introduced with sunset clauses.