Borrowing costs

Inflation, Monetary Policy, Borrowing Costs and Debt Sustainability – Opinion

“The start of this year is an ominous echo of 2021. A new variant of the coronavirus has caused infections to skyrocket in all regions of the world, threatening economic prospects for the year ahead. But rather than a repeat of the severe downturns we saw in 2020, the outlook is for high global inflation and rising interest rates, with serious risks for the most emerging and developing economies. vulnerable. An excerpt from a recent Financial Times (FT) article “Monetary policy is widening the gap between poor and rich countries” by Chris Giles.

Inflation has virtually become a global phenomenon mainly as a result of a global commodity supply shock. At 7%, the United States experienced the highest inflation rate in 39 years. A recent article by the FT “US inflation climbs to 7% for the first time since 1982” underlined in this regard that “consumer price growth in the United States has increased at the fastest rate for almost four decades in December… The consumer price index (CPI) rose at a 7% year-on-year pace last month, an increase from the 6.8% recorded in November and the biggest jump since June 1982.

Similarly, inflation in the Eurozone has also increased significantly and, at 4.9%, reached a level unprecedented in the bloc’s history, as highlighted in a Guardian article “Inflation in the euro zone rises to 4.9% – the highest since the introduction of the euro” from the first day of December last year as follows: “Inflation in the 19-member euro zone rose to 4, 9% in November… High gasoline prices and the cost of imported goods were blamed for the surge in inflation. … France suffered a 3.4% rise in inflation, its highest in a decade, but it was in Germany, among the bloc’s biggest economies, that prices soared, taking the rate of inflation at 6%. In Estonia, the inflation rate jumped to 8.4%, while in Lithuania it reached 9.3%.

In England, inflation has seen a huge increase and is now the highest for about 30 years. Another Guardian article “Inflation is back, and there are many more in the pipeline” pointed out in this regard: “Inflation was supposed to be yesterday’s problem. … It now stands at 5.4% – the highest in nearly 30 years – and has yet to peak. With the lagged impact of last fall’s supply chain bottlenecks trickling down to prices in stores and a likely 50% rise in national energy bills to come, inflation is sure to rise above 6% in April and could be closer to 7%.

In the wake of high inflation, a rapid and significant move towards monetary policy tightening is broadly emerging on the global horizon. Given the latest significant rise in inflation, the Federal Reserve would now expect at least four key rate hikes this year, up from three such reports a month ago. A recent Bloomberg article titled “Four Fed Hikes May Be Just the Beginning as Traders Boost Trade Bets” highlighted in this regard: “The drumbeat for the Federal Reserve to implement four quarter-point interest rate hikes this year — and with the speed at which markets move, traders may soon be looking to hedge against the risk of an even faster tightening. …Swaps already indicate that the central bank’s target will be 88 basis points higher by the end of this year…Bloomberg Economics economist David Wilcox thinks the latest forecasts for the unemployment rate and core inflation are consistent with six hikes this year and three more in 2023.’

Higher borrowing costs will worsen the already difficult debt situation in developing countries, including Pakistan, where external debt has increased significantly over the years. In addition, rising borrowing costs will also limit the ability of governments to increase development spending and stimulus spending. This, following high inflation, would mean that developing countries, which are also net importers of commodities that the global supply shock has had a huge impact on in terms of price and where the inflation component imported is also significant, would increase the overall risk of severe balance of payments and debt crises.

According to the same FT article by Chris Giles, tighter monetary policy on the part of the United States would mean a difficult economic outlook for developing countries as a whole, in which he pointed out: “The problem for the most poor is that the stricter, but still challenging, US policy might just spell trouble for them. As the World Bank notes in this week’s outlook for the world economy, the tightening of US monetary policy is likely to exacerbate an already difficult outlook for emerging and developing economies. … the World Bank estimates that recoveries in the poorest countries will be almost 6% lower than pre-pandemic expectations. This further limits their ability to repay existing debts, which have increased by 10 percentage points of national income since the start of the pandemic, according to the IMF. This will likely lead to a hard landing, over-indebtedness and social discontent in weaker countries. None of this is made easier by the possibility of the Fed hitting the brakes harder than expected this year…’

Therefore, it is important for the United States to adopt a less aggressive monetary policy, given the risks that such an approach could lead to a global debt pandemic. Rising debt-servicing costs would also reduce the already tight fiscal space for developing countries to make needed public spending and bolster stimulus spending, not to mention the further depreciation of currencies that this could cause. leading in turn to new inflationary pressures imported onto the net. developing countries like Pakistan that import raw materials such as oil. According to

the same FT article by Chris Giles, “The outlook is tough. The World Bank expects 40% of emerging and developing economies to still have national income below 2019 levels in 2023.”

China and Turkey, on the other hand, swam against the upward trend in policy rates; these two countries could provide a good balancing direction for countries as a whole to use a combination of fiscal and monetary policies to deal with inflation, which after all could subside as the supply shock worldwide is shrinking as a result of a receding pandemic and better regulation. In a recent Bloomberg article “China Goes Against the Tide” regarding rate cuts in China, it was pointed out that “China is heading in the opposite direction as other central banks are moving in the opposite direction. a tighter monetary policy. The People’s Bank of China on Monday lowered its benchmark rate for the first time in nearly two years, lowering the rate at which it provides one-year loans to banks by 10 basis points. … Further cuts in key interest rates and a reduction in the reserve requirement ratio, or the amount of cash banks must set aside in central bank reserves, will also follow, China watchers say. The rate cut is part of Beijing’s effort to put a floor on growth in a crucial year of leadership transition for the world’s second-largest economy. Therefore, rather than pushing the monetary policy tightening palette too forcefully, more emphasis should be placed on increasing inoculation rates – which are important anyway for the first priority of saving lives – and government interventions in markets have increased dramatically to reduce the footprint of ‘greed’ or unjustified profits in a global effort to reduce the global supply shock.

This is important to protect the world from a probable debt pandemic. Such a more balanced approach is important for both developed and developing countries so as not to undo the stimulus measures already injected during the pandemic, not to mention the need for more public and private investment to increase levels. much-needed purchasing power during the onslaught of inflation, especially in developing countries where poverty and inequality have increased dramatically during the pandemic. In the same article, Chris Giles underlined in this regard: “Two decades during which the standard of living of emerging economies caught up with that of their richer cousins ​​are now over. The World Bank estimates that real incomes in 70% of emerging and developing economies will grow more slowly than those in advanced economies between 2021 and 2023.”

Another important step in reducing reliance on monetary policy to deal with inflation and thereby increasing debt sustainability in developing countries is for rich countries and multilateral agencies to practice the “debt-for-climate swaps” in a significant way. A recent article by Project Syndicate (PS) titled “Debt-for-climate swaps make sense” underlined in this regard that “European Commission President Ursula von der Leyen said that “big economies have a duty to particularly towards the least developed and most vulnerable countries”. countries,” and International Monetary Fund Managing Director Kristalina Georgieva said “it makes sense” to seek to address debt pressures and the climate crisis together. The idea is to organize “green debt swaps”. … An ambitious “Green Brady Deal” could mobilize public and private flows for climate finance in countries suffering from both high debt and climate risk. It would not be a quick fix, nor the main course on the climate finance menu. But it could make a big difference for some of the most vulnerable countries.

Pakistan, for its part, should also seek to reduce the domestic debt sustainability problem by adopting a balanced approach that does not rely too heavily on monetary policy tightening. Such restraint in tightening monetary policy will also be important to raise the much-needed level of development spending and stimulus spending, especially given the presence of the Covid-19 pandemic. Yet, with little leverage over the State Bank of Pakistan after recent legislation, the government may find it very difficult to align these interests with Bank policy, especially in a timely manner. This aspect must be included in the amendment to rebalance the relationship. At the same time, the government must redouble its efforts in the direction of economic diplomacy to influence the big treasuries, and the multilateral agencies to adopt a less aggressive monetary position and rely more on other measures (some orientations indicated above), including greater vigor shown on measures that address both debt sustainability issues and the climate crisis.

(The author holds a doctorate in economics from the University of Barcelona; he previously worked at the International Monetary Fund)

He [email protected]

Copyright Business Recorder, 2022