It is said that financially troubled emerging market economies approach the International Monetary Fund (IMF) for its conditional loans with as much enthusiasm as a patient visits his oncologist.
This explains why, over the past two years, emerging market economies devastated by the pandemic have borrowed relatively little from the IMF. With the world awash in cash following massive note printing by the Federal Reserve and the European Central Bank, why should they have to submit to IMF conditionality when they could finance themselves so easily on the international capital market?
With the Federal Reserve now on the cusp of a credit tightening cycle to put the US inflation genie back in the bottle, all of that is about to change for emerging economies. In a more difficult economic and international liquidity environment, they will need very substantial financing from the IMF to cover their deficits and repay their creditors.
A key question in 2022 will be whether the IMF will be adequately funded and whether it will have learned from its ill-fated past large-scale lending programs to Argentina and Greece to play its role as lender of last resort effectively. to emerging markets.
The main reason to believe that the international borrowing environment will soon deteriorate is that the world’s major central banks will have to start raising interest rates seriously to curb inflation. This is especially the case when you consider that interest rates have been allowed to get so negative in inflation-adjusted terms. With consumer price inflation in the United States now runs at about 7% and with policy rates close to their zero limit, the Fed will have to do a lot of hard work to get inflation under control.
If the Fed is indeed to raise interest rates this year by more than three times what it currently anticipates, one should expect a strong capital inversion away from emerging market economies, as happened during so many previous Fed tightening cycles. Emerging market economies may also find that they will have to deal with lower international commodity prices and tougher export markets if Fed interest rate hikes derail the global economic recovery in bursting the current asset price and credit market bubbles.
Still in the midst of the pandemic, public finances in emerging markets seem particularly vulnerable to a deterioration in the economic environment and global financial markets.
This likely means that emerging market economies will soon face severe balance of payments pressures as domestic and foreign investors question these countries’ public finances and send their money overseas. This is likely to prompt many countries to come knocking on the doors of the IMF for large bailout loans, as they are rejected by the international capital market.
A serious problem for the IMF is that the renewed demand for its large-scale support will become at the same time that the IMF will have difficulty in being reimbursed by Argentina, beneficiary of the Biggest IMF loan ever. This is sure to raise questions about the IMF’s assertion that it is not putting American taxpayers’ money at risk as well as the IMF’s lack of success in its previous large-scale lending programs with countries like Argentina and Greece.
If the IMF is to receive from its members the financial support necessary to carry out effectively its role as lender of last resort to the world economy, it will have to give assurances that it will avoid repeating the mistakes of its previous programs of large-scale lending. In particular, he will have to explain how he will ensure that there are adequate controls to prevent his money from being used to finance capital flight or to bail out private creditors when the country might have a solvency problem as opposed to to a liquidity problem.
Especially now that emerging market economies represent about half of the world economy, it is to be hoped that the IMF will be able to make amends in such a way as to reassure its main shareholders. Because if ever the world will need the IMF to help manage a global emerging market debt crisis, it will likely be in the next round of global liquidity tightening.
Desmond Lachman is a Senior Fellow at the American Enterprise Institute. He was previously Deputy Director of the Policy Development and Review Department at the International Monetary Fund and Chief Emerging Markets Economic Strategist at Salomon Smith Barney.