Faced with a darkening economic outlook: how the G20 can react
As G20 ministers and central bank governors meet in Bali this week, they face a significantly darkened global economic outlook.
When the G20 last met in April, the IMF had just cut its forecast for global growth to 3.6% for this year and next, and we warned that it could get worse given the potential risks of decrease. Since then, many of these risks have materialized and the multiple crises facing the world have intensified.
The human tragedy of the war in Ukraine has worsened. So does its economic impact, particularly through commodity price shocks that are slowing growth and exacerbating a cost of living crisis that affects hundreds of millions of people, especially the poor who do not cannot afford to feed their families. And it only gets worse.
Inflation is higher than expected and has widened beyond food and energy prices. This prompted the major central banks to announce further monetary tightening, which is necessary but which will weigh on the recovery. Ongoing pandemic-related disruptions, particularly in China, and renewed bottlenecks in global supply chains have hampered economic activity.
As a result, recent indicators imply a weak second quarter – and we forecast a further downward revision to global growth for 2022 and 2023 in our global economic outlook update later this month.
Indeed, the outlook remains extremely uncertain. Think of how another disruption in Europe’s natural gas supply could push many economies into recession and trigger a global energy crisis. This is just one of the factors that could make an already difficult situation worse.
2022 will be a difficult year, and perhaps an even more difficult 2023, with an increased risk of recession.
This is why we need decisive action and strong international cooperation, led by the G20. Our new report to the G20 outlines policies countries can use to navigate this sea of trouble. Allow me to highlight three priorities.
First, countries must do everything in their power to reduce high inflation.
Why? Because persistently high inflation could sink the recovery and further damage living standards, especially for the vulnerable. Inflation has already reached multi-decade highs in many countries, with headline and core inflation continuing to rise.
This has triggered an increasingly synchronized cycle of monetary tightening: 75 central banks – roughly three-quarters of the central banks we track – have raised interest rates since July 2021. And, on average, they have does 3.8 times. For emerging and developing economies, where policy rates were raised earlier, the average total rate increase was 3 percentage points, almost double the 1.7 percentage points for advanced economies.
Most central banks will have to continue to tighten their monetary policy resolutely. This is particularly urgent where inflation expectations are beginning to unanchor. Without action, these countries could face a destructive wage and price spiral that would require more vigorous monetary tightening, with even more damage to growth and jobs.
Acting now will hurt less than acting later.
Clear communication of these policy actions is equally important. This is about preserving policy credibility as downside risks abound. For example, continued inflationary surprises would require more monetary tightening than the market expected, which could lead to additional volatility and selling in risk assets and sovereign bond markets. This, in turn, could lead to further capital outflows from emerging and developing economies.
The appreciation of the US dollar has already coincided with portfolio outflows from emerging markets: the latter experienced a fourth consecutive month of outflows in June, the longest of its kind in seven years. This puts additional pressure on vulnerable countries.
When external shocks are so disruptive that they cannot be absorbed by flexible exchange rates alone, policymakers must be prepared to act. For example: through foreign exchange interventions or capital flow management measures in a stress scenario — to help anchor expectations. In addition, they should preemptively reduce reliance on foreign currency borrowing when debt levels are high. It is to help countries react in such circumstances that we recently updated the IMF’s institutional vision on this issue.
The Fund is mobilizing to serve its members in other ways as well. This includes providing advice on reserve asset management and technical assistance to strengthen central bank communications.
The goal must be to get everyone safely to the other side of this tightening cycle.
Second, fiscal policy should help – not hinder – the central bank’s efforts to reduce inflation.
Countries facing high debt levels will also need to tighten fiscal policy. This will help reduce the burden of increasingly expensive borrowing and, at the same time, complement monetary efforts to control inflation.
In countries where the recovery from the pandemic is more advanced, the abandonment of extraordinary budgetary support will help to dampen demand and therefore reduce price pressures.
But that’s only part of the story. Some people will need more support, not less.
This requires targeted and temporary measures to support vulnerable households facing new shocks, in particular from high energy or food prices. Here, direct cash transfers have proven effective, rather than subsidies or price controls which create distortions and usually fail to reduce the cost of living in a sustainable way.
In the medium term, structural reforms are also crucial to support growth: think of labor market policies that help people join the labor market, especially women.
The new measures must be fiscally neutral – financed by new revenue or spending cuts elsewhere, without incurring new debt and to avoid running counter to monetary policy. This new era of record debt and higher interest rates makes all of this doubly important.
Debt reduction is an urgent necessity, especially in emerging and developing economies with liabilities denominated in foreign currencies (FX) which are more vulnerable to tightening global financial conditions and where borrowing costs are rising.
Already, foreign currency sovereign bond yields have reached double digits in about a third of emerging economies, close to the highs last seen after the global financial crisis. Emerging economies that rely more on domestic borrowing, such as in Asia, have been more isolated. But a broadening of inflationary pressures and the concomitant need to tighten domestic monetary policy more quickly could change the calculus.
The situation is increasingly serious for economies that are over-indebted or close to over-indebted, including 30% of emerging countries and 60% of low-income countries.
Again, the Fund is there for its members, offering personalized analysis and advice, as well as a more agile lending framework to support countries in times of crisis. This includes emergency funding, increased access limits, new liquidity and credit lines, and the historic allocation of $650 billion in SDRs last year.
Beyond these efforts, decisive action by all concerned parties is urgently needed to improve and implement the G20 common framework for debt treatment. Major lenders, both sovereign and private, must step in and play their part. Time is not on our side. It is essential that the creditors’ committees of Chad, Ethiopia and Zambia make as much progress as possible in their meetings this month.
Third, we need a new impetus for global cooperation, led by the G20.
To avert potential crises and boost growth and productivity, more coordinated international action is urgently needed. The key is to build on recent progress in areas ranging from taxation and trade to pandemic preparedness and climate change. The G20’s new $1.1 billion fund for pandemic prevention and preparedness shows what is possible, as do the recent successes of the World Trade Organization.
Most urgent of all is action to ease the cost of living crisis, which is pushing 71 million more people into extreme poverty in the world’s poorest countries, according to the United Nations Development Programme. As concerns about food and energy supplies increase, the risks of social instability increase.
To prevent protracted hunger, malnutrition and migration, the world’s richest countries should provide urgent assistance to those in need, including through new bilateral and multilateral funding, including through the Program global food.
In the immediate term, countries must reverse recently imposed restrictions on food exports. Why? Because such restrictions are both harmful and ineffective in stabilizing domestic prices. Other measures are also needed to strengthen supply chains and help vulnerable countries adapt their food production to cope with climate change.
Here too, the IMF is helping. We are working closely with our international partners, including through a new multilateral food security initiative. Our new Resilience and Sustainability Trust will provide $45 billion in concessional finance to vulnerable countries, aimed at addressing longer-term challenges such as climate change and future pandemics. And we are ready to do more.
The particularly difficult conditions in many African countries at the moment are important to take into account. When I met with the continent’s finance ministers and central bank governors this week, many pointed to how the effects of this entirely exogenous shock were pushing their economies to the brink. The effect of rising food prices is being felt strongly, as food accounts for a larger share of income. Inflation, fiscal, debt and balance of payments pressures are intensifying. Most are now completely shut out of global financial markets; and unlike other regions, they do not have large domestic markets to look to. In this context, they call on the international community to come up with bold measures to support their people. It is a call that we must heed.
As the G20 gathers to navigate the current sea of turmoil, we can all take inspiration from a Balinese phrase that captures the spirit that is needed more than ever: menyama braya, “everyone is brother or sister”.
Source: IMF Blog