The International Monetary Fund has advised emerging economies including Nigeria to allow their currencies to depreciate in response to tighter funding conditions and an imminent policy tightening by the Federal Reserve Bank of the United States. The Washington-based lender also counselled the Central Bank of Nigeria and the apex banks of emerging economies to raise their benchmark interest rate in preparation for the Fed policy tightening. The IMF disclosed this in a blogpost titled, ‘Emerging Economies Must Prepare for Fed Policy Tightening,’ on Monday.
According to the fund, while changes in the global economic outlook appear positive, especially in the United States, these changes are uncertain for emerging markets. It noted that emerging markets with high public and private debts, foreign exchange exposures, and lower current-account balances had been seeing larger movements of their currencies relative to the US Dollar in recent months.
As a result, the IMF said the combination of slower growth and elevated vulnerabilities could create adverse feedback loops for the emerging economies. It said, “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.”
“In either case, responses should include letting currencies depreciate and raising benchmark interest rates. If faced with disorderly conditions in foreign exchange markets, central banks with sufficient reserves can intervene provided this intervention does not substitute for warranted macroeconomic adjustment.”
“Nevertheless, such actions can pose difficult choices for emerging markets as they trade off supporting a weak domestic economy with safeguarding price and external stability. Similarly, 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 financial conditions, weakening the recovery.”
The IMF said that to manage the tradeoffs, emerging economies must take steps to strengthen policy frameworks and reduce vulnerabilities now. It added that central banks needed to be clear and consistent in communicating its tightening measures to contain inflation pressures in order to enhance the public’s understanding of the need to pursue price stability. According to it, countries with high levels of debt denominated in foreign currencies must try to reduce it and hedge its exposures where feasible, and while reducing rollover risks, the maturity of obligations should be extended even if it increases costs. The IMF said heavily indebted countries might need to start fiscal adjustment sooner and faster.
It added that emerging economies were currently battling elevated inflation rates, and high public debt profiles. It said, “Beyond these immediate measures, fiscal policy can help build resilience to shocks. Setting a credible commitment to a medium-term fiscal strategy would help boost investor confidence and regain room for fiscal support in a downturn. “Such a strategy could include announcing a comprehensive plan to gradually increase tax revenues, improve spending efficiency, or implement structural fiscal reforms such as pension and subsidy overhauls.”
The Washington-based lender said the average gross government debt in emerging markets was up by almost 10 per cent since 2019, reaching an estimated 64 per cent of Gross Domestic Product by the end of 2021, with large variations across countries.