Prepare for possible turbulence in 2022 financial markets, IMF says

Uganda, like all the other countries in the world, is focusing both on fiscal and monetary actions towards economic growth recovery and stable financial conditions.  

The First Deputy managing director of the International Monetary Fund (IMF), Professor Gita Gopinath said on January 26 while releasing updated World Economic Forum for 2022 in Washington DC that to address many of the difficulties facing the world economy, it is vital to break the hold of the pandemic.

Professor Gita said this will require a global effort to ensure widespread vaccination, testing and access to therapeutics, including the newly developed anti-viral medications. Currently, only 4 per cent of the population of low-income countries are fully vaccinated versus 70 per cent in high-income countries.

“In addition to ensuring predictable supply of vaccines for low-income developing countries, assistance should be provided to boost absorptive capacity and improve health infrastructure. It is urgent to close the $23.4 billion financing gap for the Access to Covid-19 Tools Accelerator and to incentivise technological transfers to help speed up diversification of global production of critical medical tools, especially in Africa,” she said.

“At the national level, policies should be tailored to country specific circumstances including the extent of recovery, underlying inflationary pressures, and available policy space. Both fiscal and monetary policies will need to work in tandem to achieve economic goals. Given the high level of uncertainty, policies must also remain agile and adapt to incoming economic data,” she said.

In the World Economic Outlook, the IMF said before Omicron, inflation pressure had become more broad-based in many economies. Central banks in some emerging markets and developing economies—and a few advanced economies—have already been raising interest rates.

For some, the IMF says the decision to tighten policy reflects a difficult choice, trading off the benefits of getting ahead of price pressures against the costs of potentially slowing an already subdued employment recovery. Policy responses will vary according to country-specific inflation, employment developments and the strength of central bank policy frameworks.

It says effective monetary policy communication is a key tool to avoid provoking overreactions from financial markets.

Price pressures

“ In countries where inflation expectations have increased, and there is a tangible risk of more persistent price pressures, central banks should continue to telegraph an orderly, data-dependent withdrawal. This is particularly important given the exceptional uncertainty around the impact of the Omicron variant. Central banks should clearly signal that the pace at which monetary support will be withdrawn may need to be recalibrated if the pandemic worsens again,” the IMF said.  

The Bank of Uganda (BoU) maintained the Central Bank Rate (CBR) at 6.5 percent in December 2021 and kept the band on the CBR at +/-2 percentage points. The margin on the rediscount and bank rates were unchanged at 3 and 4 percentage points on the CBR, respectively. Consequently, the rediscount and bank rates remained at 9.5 percent and 10.5 percent, respectively.

In the Monetary Policy report of December 2021, the Bank of Uganda said commercial banks’ interest rates rose in the quarter to October 2021 relative to July 2021, largely reflecting commercial banks’ risk aversion following the end of the Credit Relief Measures and the adverse impact of pandemic-related restrictive measures. The weighted average lending rate on the shilling-denominated loans stood at 19 percent, higher than the average of 17.6 percent for the quarter to July 2021.

Inflation likely to rise

“The inflation outlook is higher in this forecast round than in the previous. Core inflation is expected to average at 3.7 percent in 2022, while headline inflation is expected to average at 4.6 percent in 2022,” said BoU.

In the monetary policy statement of December 2021, the late governor Bank of Uganda, Mr Emmanuel Tumusiime Mutebile said the Bank of Uganda will maintain the Covid-19 Liquidity Assistance Programme to ensure financial stability until the economic situation normalises.

Professor Gita of the IMF expressed concerns that monetary policy is at a critical juncture in most countries stressing that where inflation is broad based alongside a strong recovery, like in the United States, or high inflation runs the risk of becoming entrenched, as in some emerging market and developing economies and advanced economies, extraordinary monetary policy support should be withdrawn.

“Several central banks have begun raising interest rates to get ahead of price pressures. It is key to communicate well the policy transition towards a tightening stance to ensure orderly market reaction. Where core inflationary pressures remain subdued, and recoveries incomplete, monetary policy can remain accommodative,” she said.

Professor Gita added: “As the monetary policy stance tightens more broadly this year, economies will need to adapt to a global environment of higher interest rates. Emerging markets and developing economies with large foreign currency borrowing and external financing needs should prepare for possible turbulence in financial markets by extending debt maturities as feasible and containing currency mismatches.”

She further advised that exchange rate flexibility can help with needed macroeconomic adjustment. In some cases, foreign exchange intervention and temporary capital flow management measures may be needed to provide monetary policy with the space to focus on domestic conditions.

With interest rates rising, low-income countries, of which 60 percent are already in or at high risk of debt distress, will find it difficult to service their debts. She said the G20 Common Framework should be revamped to deliver more quickly on debt restructuring, and G20 creditors and private creditors should suspend debt service while the restructurings are being negotiated.

Borrowing will be expensive

On the fiscal policy, the IMF said public finances will come under strain in the coming months and years, as global public debt has reached record levels to cover pandemic-related spending at a time when tax receipts plummeted, adding that higher interest rates will also make borrowing more expensive, especially for countries borrowing in foreign currencies and at short maturities.

 As a result, fiscal deficits in most countries will need to shrink in the coming years, although the extent of consolidation should be contingent on the pace of the recovery. If the pandemic worsens, consolidation can be slowed where fiscal space permits.

Where mobility restrictions are reintroduced, governments should reprise programmes such as lifelines for the worst-affected households and firms as needed and increase support for the most vulnerable segments of the population.

IMF said higher long-term growth will require deep structural reforms and remedial measures to offset the scarring impact of the pandemic. Most notably, lockdowns and social distancing have interrupted education for many children.

“This is most acute in low-income countries, where alternative teaching methods (such as online instruction) are less readily available. Unless these learning losses are remedied, the school closures are likely to have long lasting effects on individual lifetime earnings and economy-wide productivity growth,” said the IMF.