The International Monetary Fund (IMF) has advised emerging market economies to prepare for potential bouts of economic turbulence this year due to the US Federal Reserve’s policy tightening and ongoing coronavirus pandemic. 

While the global economic recovery will continue in 2022, faster rate increases could rattle the financial markets around the world and lead to capital outflows and currency depreciation, the IMF said in a blog published on Monday. 

It noted that the rapid spread of Omicron variant has posed additional concerns, and countries that have high public and private debt are likely to experience “more severe” impact.  

Moreover, some countries are already facing “elevated” inflation and “substantially higher” borrowings, with the average gross government debt in emerging markets rising by almost 10 percentage points since 2019, reaching an estimated 64 percent of the gross domestic product (GDP) by the end of last year. 

Rates are projected to increase multiple times this year starting this March after the US Federal Reserve indicated withdrawing monetary support and raising interest in 2022 on the back of strong economic activity. 

But unlike in the United States, the economic recovery and labour markets in emerging economies are still less robust, the IMF said. Last year, concerns about rising prices and stable foreign funding prompted several markets in the region, including Brazil, Russia and South Africa, to start increasing interest rates. 

“Prices are rising at the fastest pace in almost four decades and the tight labour market has started to feed into wage increases,” the IMF said. 

“The new Omicron variant has raised additional concerns of supply-side pressures on inflation… These changes have made the outlook for emerging markets more uncertain.” 

Likely scenarios 

If the Fed policy tightening is “gradual” and “well telegraphed”, the IMF expects less severe impact on emerging economies. Currencies in the region are still likely to depreciate, but foreign demand could offset the impact from rising financing costs. 

But a broad-based US wage inflation or sustained supply bottlenecks could trigger more price increases, the IMF cautioned. Faster Fed rate increases could then rattle financial markets and tighten conditions globally. 

“These developments could come with a slowing of US demand and trade and may lead to capital outflows and currency depreciation in emerging markets,” it said. 

“The impact of Fed tightening in a scenario like that could be more severe for vulnerable countries.” 

Emerging economies that have high borrowings and foreign exchange exposures, as well as lower current-account balances, are already seeing larger movements of their currencies relative to the greenback, the IMF said. 

“The combination of slower growth and elevated vulnerabilities could create adverse feedback loops for such economies,” it pointed out. 

(Reporting by Cleofe Maceda; editing by Mily Chakrabarty) 

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