Opinion – Why? Economês in good Portuguese: Emerging economies, inflation and global slowdown

The IMF’s “World Economic Prospects” report, released today, brings a revision for the worse in the scenario for 2022: lower economic growth and higher inflation, compared to the January projections – discussed here in February. As director-general Kristalina Georgieva said last Thursday, the war in Ukraine represented a “substantial setback” for the global economic recovery.

The post-pandemic global economic recovery was already slowing when the Russian invasion of Ukraine triggered new commodity price shocks, at the same time causing a new wave of restrictions in supply chains. China’s ‘zero Covid’ policy, meanwhile, has also brought supply and supply shocks.

The downward revision to the global growth rate projected by the IMF in today’s report was almost 1%, with a greater negative impact in Europe than in the United States. The forecasted performance for the Emerging and Developing Economies (EMDE) cluster was also downgraded by more than one percentage point. In this case, however, with much greater heterogeneity. From the inflationary spike, on the other hand, no one escapes, and it brings with it pressure to raise interest rates.

EMDEs face a common set of external shocks: rising energy and food prices; tightening in global financial conditions caused by the prospect of sharper interest rate hikes and anticipation of “quantitative tightening”; and return of restrictions on mobility in China, on account of the Covid zero policy, leading to slump in growth and weakening one of the main growth drivers for EMDEs. Fiscal stimulus in China points in the opposite direction, but there are doubts about the sustainability of this policy.

However, the impacts of common shocks are being heterogeneous. Four subgroups can be distinguished among EMDEs.

First, of course, Ukraine suffering the destruction of the war, Russia under sanctions and the other economies in the region integrated to them. In addition to higher inflation, Russia will experience a worse recession than the 1998 crisis and the global financial crisis in 2008, albeit, paradoxically, with the highest current account surplus in the last 20 years.

Commodity exporters are benefiting from more favorable terms of trade. While this is not enough to fully protect them, strengthened public revenues provide fiscal leeway for measures to smooth the rise in domestic energy prices. Larger current account balances will also cushion the effect of tightening global financial conditions. Countries that are more advanced in the monetary tightening cycle, such as Brazil, are benefiting from the appreciation of their currencies.

Last week, the IMF had already drawn attention to the highest inflation in 15 years — as a result of the pandemic and the war in Ukraine — in Latin America’s largest economies: Brazil, Chile, Colombia, Mexico and Peru. The weight of import and commodity prices on Latin American inflation is greater than that of advanced economies. The growth projection for the Brazilian economy this year by the IMF has improved slightly.

Commodity importers, for whom manufacturing exports weigh, are suffering both the impact of higher energy and food prices and the slowdown in global growth. Slower growth, higher inflation, deteriorating public accounts and lower current account balances are forecast.

The fourth subgroup is that of developing economies grappling with the indebtedness inherited from the pandemic. Higher debt and less favorable global financial conditions are already making it difficult to roll over external debt service and finance current account deficits. Here, the volume of the current call to multilateral institutions —World Bank and IMF— should increase to consider the possibility of debt restructuring processes with external creditors.

The dilemma faced by central bankers between accepting inflation or slowing demand was made worse by the shocks triggered by the war. In March, US inflation reached 8.5%, its highest annualized level in 40 years. Projections of how much the Fed will raise key interest rates for the rest of this year range today between 2.5% and 3.5%.

A report also released by the IMF — on “global financial stability” addresses another dilemma: accepting inflation or risks of financial instability arising from sharp rises in interest rates. Important detail: the two dilemmas intersect. In the case of the United States, many analysts believe the Fed is late on its rate adjustment route. If it finds itself forced into steeper and steeper rises ahead, the bumps on high-leverage private corporate structures will be substantial. The same thing for emerging and developing economies dependent on external financing.