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The International Monetary Fund warns of a mix of inflation and debt distress hitting economies trying to recover from the pandemic.
Stefani Reynolds / AFP via Getty Images
International Monetary Fund officials who keep a close eye on financial stability and fiscal risks are waving cautionary flags more feverishly as a dangerous mix of inflation, debt distress and precarious monetary policy maneuvering hit economies still trying to recover from the pandemic.
In a press briefing on Tuesday, Tobias Adrian, director of the IMF’s Monetary and Capital Markets Department, described an “environment of high risk.” One indication: More than 20% of emerging and frontier market sovereign debt was trading at distressed levels—higher than the peak reached during the pandemic.
Food importers are struggling amid soaring food prices as the war has exacerbated shortages on the back of the pandemic and climate change. Rising food and fertilizer prices creates even more stress on countries’ public finances and raises the risk of political and social unrest, officials said at this week’s spring meetings of the IMF and World Bank in Washington.
Debt levels are already rising, with almost 60% of the lowest income economies in debt distress or at high risk of distress, according to the IMF. Though public debt to GDP ratios narrowed a bit last year after total debt rose a record 28 percentage points of global GDP in 2020, the IMF expects debt ratios to stabilize at higher levels than prepandemic in most countries.
China’s debt levels are feeding into expectations that emerging markets public debt will be 18% of GDP higher in 2024—compared with 9% higher in advanced economies. If China is taken out of the mix, the increase in emerging markets debt is expected to be just 6% higher in 2024.
China’s debt complicates policy makers’ efforts to stabilize its property sector that has left some of the world’s largest property developers in distress. Policy makers are further challenged by strict Covid restrictions that are restricting economic activity further.
In a note to clients, TS Lombard economists note the pain caused by a lockdown that now affects regions accounting for 40% of the country’s GDP could have lasting impact on consumer sentiment while the overhang of unsold properties that still has to be dealt with could keep a lid on growth for some time. The
iShares MSCI China
exchange-traded fund (MCHI) is down almost 17% year-to-date.
IMF officials cautioned that liquidity risk related to China’s property market could morph into credit risk in China, especially as local governments are reliant on revenue from land sales and local companies and banks have relationships with the local governments. Policy makers, they note, may need to step up measures—including using fiscal measures to mitigate the hit to household and small and medium enterprises’ balance sheets.
Other central bankers are also struggling with difficult decisions, including the Federal Reserve—and that poses its own challenges for global markets. “It’s very important for the Fed to be data dependent and very clear in its communication about monetary policy going forward,” Adrian said, noting that the IMF is on watch for any disorderly tightening that manifests through dramatic market selloffs.
So far, tightening of monetary conditions in the U.S. hasn’t sparked a broad risk-off flight from emerging markets. But there is a divergence in capital flows in emerging markets, with commodity producers like Brazil enjoying inflows while those like Egypt, which imports wheat from Ukraine and Russia, facing outflows. Money has also flowed out of China lately, as investors have fretted about the country’s “strategic neutrality” in the war in Ukraine and companies—and governments—continue to edge toward some sort of decoupling.
Another area for caution: Cryptocurrencies. Trading volumes in crypto assets against some emerging market currencies have spiked following the introduction of sanctions against Russia. If these assets are used more widely, it could undermine emerging market policy makers’ efforts domestically, according to the IMF.
Through one of the draws of cryptocurrencies like Bitcoin has been that it is a way to circumvent the traditional monetary system, Adrian said there is little evidence so far that crypto assets are being used to undermine sanctions. However, it is something the IMF is continuing to monitor.
Write to Reshma Kapadia at [email protected]
