Developing countries strained by monetary tightening in rich countries

In 2002, China loaned Sri Lanka more than $1 billion for the Hambantota Port project, an ambitious development to attract container ships crossing the Indian Ocean, one of the busiest waterways in the world.

After the opening of the port, Sri Lanka failed to meet interest payments. Beijing has pressured the small island nation to return it as collateral under a 99-year lease from the Chinese. The port has become synonymous with debt diplomacyfears that China will burden poorer countries with unpayable infrastructure debt, then seize strategic commercial and military assets.

Yet today, Sri Lanka is approaching China again for $2.5 billion in loans, even as it pleads to restructure its existing borrowings. The country is caught in a deepening debt crisis, pushed to the brink by war in Ukraine and rising food and fuel prices. Moreover, before the pandemic, the former president engaged in a series of “white elephant» infrastructure projects, such as the port, which are coming back to bite.

“Coming out of the pandemic, they’re basically bankrupt,” said Richard Kozul-Wright of the United Nations Conference on Trade and Development (UNCTAD). “They can’t pay.”

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Sri Lanka is not just courting China. It is also in talks with the International Monetary Fund (IMF). And The Wall Street Journal reported that officials have met investment bankers de Rothschild and Lazard to discuss raising funds through floating debt or asset sales. This could be the most dangerous path of all. A Chatham House analysis found that the country’s debt overhang was most closely linked to borrowing on Western capital markets than any particularly predatory loan from Beijing.

The current cash-strapped Colombo crisis reflects the grimmer reality facing emerging economies in pursuit of international creditors: there are few good options. Chinese credit is expensive and IMF aid comes with strings attached. India has just extended a billion dollar facility for food and medicine imports, but its neighbor faces dwindling dollar reserves and a heavy debt burden that will not be easily unwound.

Now, sanctions imposed on Russia for its violent war in Ukraine, coupled with China’s worst COVID-19 outbreak since the pandemic began, have prolonged trade disruptions and driven up commodity prices.

THE FOOD CRISIS IS APPROACHING is presented as the inevitable consequence of an exogenous shock: war in the attic of the world. But for the developing world, it could be caused as much by the reaction of the economic and trade policies of advanced economies – monetary and fiscal tightening – as by the war itself.

Developing countries like Sri Lanka are facing deepening crises as rich countries cut pandemic-era monetary and fiscal supports and tighten their balance sheets. Stretched post-pandemic budgets, high debt and low foreign exchange reserves are a flammable mix.

The macroeconomic conditions that are now triggering food riots are the subject of a new trade and development report from the Kozul-Wright group at UNCTAD released yesterday, titled “Shrink in times of conflict.” The group’s economic outlook projections have a highly predictive track record, and this latest report downgrades growth expectations for 2022 in light of new risks to the global economy.

Sri Lanka, whose debt crisis has been brewing for several years, is a useful illustration of key dynamics. Remittances and exports have collapsed during the pandemic, which has also disrupted the crucial tourism sector. Slowing growth has strained the budget and depleted foreign exchange reserves, leaving Colombo now struggling to import oil and food.

Shortages are acute. Two septuagenarians died while queuing for fuel, Al Jazeera reported. Milk prices have risen and school exams have been canceled due to shortages of paper and ink.

As Sri Lanka struggles to repay the $45 billion in long-term debt it owes, of which more than $7 billion is due this year, it could join countries that defaulted during the pandemic, notably Argentina and Lebanon, which depend heavily on wheat imports.

The diagram illustrates the pro-cyclical dynamics of finance in developing countries: under more flexible monetary conditions, capital flows fuel debt, like those that financed the white elephant projects of the former president. He flees just as quickly.

REPORT TITLE refers to to the period in 2013 when the Federal Reserve and the European Central Bank (ECB), after pulling out of the 2008 financial crisis, reduced their bond purchases. In a so-called “conical tantruminvestors retreated from emerging markets like Brazil and Turkey in favor of advanced economies, where bond yields had started to look more attractive.

Now, as the Federal Reserve raises interest rates, it could once again suck capital from developing countries northward, causing the currency to depreciate with dangerous ripple effects. At the same time, tight monetary policy in rich countries can dampen domestic economic activity and lower demand.

UNCTAD refrains from predicting the results of interest rate hikes by the Fed and the European Central Bank. Another conical crisis is hard to predict, according to the report, because it would be triggered by herd behavior in the markets, not just fundamentals. But even in the absence of a rapid withdrawal of capital, developing countries are urged to re-adopt austerity budgets that could plunge them into recession.

The result, the report explains, is that the developing world will suffer a painful adjustment one way or the other, whether “through volatile cross-border financial flows driven by liquidity, or through the slowing of the decline in l political space, fiscal and monetary tightening and reduced incomes.

Yet even monetary tightening in the advanced world is not predetermined – or even necessarily the correct solution to inflation caused by real supply disruptions.

“Inflation has many causes, but the answer is orthodoxy. You have war inflation, but we choose monetary tightening, we are heading into recession only as a political choice,” said Pavlos Roufos, a German economic policy doctoral student who wrote a book on the Greek debt crisis. .

The coming months raise the question of what anti-inflationary policies will materialize, both in emerging markets and in major advanced economies.

“If you look at it from the perspective of capital, inflation is always bad, because it means wealth is degraded. If you look at it from the perspective of workers, inflation just means you have to find ways to meet the costs of reproduction. In the past, this meant that people went to [political] struggles,” Roufos said. Inflation can galvanize bottom-up protests that result in material gains for workers.

But proponents of a top-down Keynesian fiscal stimulus should pay attention to the public’s actual response to inflation, Roufos argued, where pro-worker moves won’t necessarily materialize. Emerging anti-inflation policy may instead emphasize hard money.

DEBT SERVICE SUSPENSION initiative initiated by the G20 in response to the pandemic has had pitiful results: In total, over the past two years, it has suspended certain $10.3 billion. Additional debt could still be on hold, as the program has been extended to the end of 2021. But in the first year of the pandemic alone, low-income countries racked up a debt burden totaling $860 billion. , according to the World Bank.

The United States also extended swap lines– exchanging dollars for foreign currencies – to the main foreign central banks during the last crisis. It has cemented the United States’ role at the heart of the global financial system, even as the People’s Bank of China has entered into yuan-denominated currency swap agreements with more than 30 developing country central banks.

The report’s findings imply that the tools for channeling dollars to the developing world need a deeper overhaul. Yet even ad hoc injections of aid have been slow to materialize.

Progressives in Congress have been calling for months for a new issue of Special Drawing Rights (SDRs), an IMF-issued international reserve asset that can be exchanged for dollars. Just as dollars are backed by the US government, SDRs are backed by the full faith and credit of IMF member countries – so they require no budgetary expenditure, just authorization. And unlike IMF lending programs, newly issued SDRs come with no strings attached.

Last summer, the IMF injected $650 billion in aid under the SDR program. Like much of the global financial architecture, SDR quotas are disproportionately skewed towards rich countries: Africa as a whole receives less SDR than German Federal Bank. Yet efforts are being made to redirect SDRs issued to rich countries, and the share that goes to developing countries can improve their creditworthiness and help them make crucial purchases.

Development economists say another injection is now needed to cushion the latest price shock. A reissue passed the House, but seems unlikely to clear the Senate. In his recommendations for executive actionCongressional Progressive Caucus propose a new SDR issue to help developing countries “purchase vaccines, treatments, protect public health budgets, and drive global demand for U.S. exports.”

The focus on boosting global demand is shrewd, as tighter monetary policy and shrinking fiscal space will move budgets in the opposite direction. But the struggle to rebuild resilience through countercyclical investment looks increasingly difficult.

The final and imminent threat announced by the report is the climate emergency, which could be a threat multiplier that “will exceed the will of the Federal Reserve in its recently adopted role as an unofficial lender of last resort”.

Although the war has halted decarbonization efforts, Kozul-Wright said, “the interplay of financial, energy and food pressures looks like an ominous glimpse of what lies ahead in a warming world.”

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