• Inflation has risen rapidly across the globe at rates not experienced in decades
  • Central banks are being forced to react quickly by raising interest rates to rein in inflation, though critics suggest it is too little too late and that the measures now required to tamp down at inflation will cause economic hardship
  • The IMF and World Bank joined that chorus last week as it raised alarm over a potential debt crisis in poor countries as global central banks begin to raise rates
  • The economic impact of the continue conflict in Ukraine continues to be felt around the world, with growth projected to be 0.8 points below the IMF’s January forecast

Issue

With global economies continuing to recover rapidly from their pandemic induced downturns, central banks have been forced to shift from enabling economic recovery to battling record inflation. That inflation has been induced by a combination of substantial fiscal stimulus, surging consumer demand and strained supply chains. Central bankers have begun to raise interest rates to combat inflation, with the US Federal Reserve Bank raising rates by 0.25% at its March meeting and hinting at a half percent increase in May. Developing countries that took on new debt to support their economies during the pandemic are facing financial strains as borrowing becomes more expensive.

With debt soaring, the World Bank Group pledged $170 billion in emergency financing to help vulnerable countries address a multitude of crises, including the pandemic, soaring inflation, and food and energy insecurity. The WBG hopes to have the first $50 billion distributed by June 30, 2022.

The G20 members were unable to agree on a path forward and, even though G20 countries backed the creation of the G20 Common Framework on Debt Treatment last year, no concrete mechanisms were outlined for debt relief.  Geopolitical dynamics also hindered progress in other forums. For example, to show Moscow's isolation from the rest of the world, G7 leaders, including U.S. Secretary Yellen, walked out of a meeting of the Development Committee when Russia’s finance minister began speaking.

 

What does it mean?

The rising rate environment and the stress it is beginning to place on the balance sheets of poor countries comes at a time when developing nations continue to support their population’s recovery from the pandemic amid an escalating global food crisis, driven most recently by the war in Ukraine. The IMF reported during its annual meeting that 60% of low-income countries are currently in or near “debt distress.” Rising debt burdens among poor countries combined with forecasts for an elevated rate environment raise the prospect of an emerging market debt crisis. And, unfortunately, geopolitical tensions continue to inhibit traditional forums such as the G20 from calibrating and a common response.

 

Why does it matter?

Despite recent suggestions that we may have seen “peak globalization” and should anticipate more protectionist economies moving forward, the fact remains that the global economic and financial system remains incredibly interconnected. A monetary policy decision in the US may elicit the most economic pain in developing nations, as borrowing rates rise and economic investment shifts from emerging market to developed economies that now offer historically attractive risk-adjusted returns. In raising the alarm over the impact of anti-inflation measures on poor countries’ debt, IMF and World Bank have added to the growing list of hard choices and unintended consequences facing central bankers as they wrestle what has quickly become macroeconomic priority #1.

And, if international institutions are not able to provide solutions, individual nations will likely turn more toward their own self-help measures, such as export bans, price controls, and protectionist industrial policies.

 

Where is it going?

Inflation is already garnering substantial mindshare from the likes of Fed Chairman Jay Powell to the everyday American consumer, but its share will increase even more as we head into the latter half of the year. Quickly approaching US mid-term elections all but guarantee to make the impact of rising grocery, gas and housing prices a central and deciding factor for voters. Meanwhile, roaring economies in the US and EU mean that monetary policymakers will need to react even more strongly if they will ultimately be successful in taming inflation. Those policy shifts may induce economic contraction—if not outright recession—in many countries. Add to that the IMF and World Bank’s alarm over a brewing debt crisis and you have an economic and political environment over the next 18-24 months that will likely add fuel to simmering populist movements around the globe. It remains to be seen whether traditional international institutions such as the G20 can take a leading role in devising solutions to help keep these simmering pressures contained.

Contributions from: Chris Donahoe and Everett Eissenstat