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IMF pushes countries to hike interest rates further

28 Jul 2022

  • Warns global economy nears recession, slowdown expected in 2022, 2023
  • Emerging and developing Asian economies to grow by 4.6% this year
  By Imesh Ranasinghe The International Monetary Fund (IMF) pushed central banks worldwide to raise interest rates, warning that the global economy is nearing a recession, as it forecasts the economy to slow down to 3.2% in 2022 and 2.9% in 2023, with major economies such as the US, China, and Europe stalling.  In the July update of the IMF’s World Economic Outlook, IMF Chief Economist Pierre-Olivier Gourinchas said that higher than expected inflation, especially in the US and major European economies, is triggering a tightening of global financial conditions. Further, he said that China’s slowdown has been worse than anticipated amid Covid-19 outbreaks and lockdowns, and there have been further negative spillovers from the war in Ukraine. The IMF forecasts that reduced household purchasing power and tighter monetary policy will drive growth down to 2.3% in 2022 and 1% in 2023 in the US, while in China, further lockdowns and the deepening real estate crisis will push the growth down to 3.3% in 2022, which is its lowest in more than four decades, excluding the pandemic period. “In the Euro area, growth is revised to 2.6% in 2022 and 1.2% in 2023, reflecting spillover from the war in Ukraine and tighter monetary policy,” Gourinchas said. The IMF has also forecasted emerging and developing economies in Asia to grow by 4.6% in 2022 and 5.0% in 2023, although President Ranil Wickremesinghe informed Parliament earlier this month that Sri Lanka’s economy is expected to contract by 6.9% in 2022.  Gourinchas further said that many emerging and developing markets have already started raising interest rates, while the result of synchronised monetary tightening across countries is historically unprecedented and its effects are expected to result in global growth slowing and interest rates decelerating next year. He noted that tighter monetary policy by central banks will inevitably have real economic costs, but delaying it will only exacerbate the hardships, and therefore central banks that have started tightening should stay the course until inflation is tamed.  “With the current outlook, the world may soon be teetering on the edge of a global recession only two years after the last one,” the IMF Chief Economist said. Meanwhile, Institute of Policy Studies (IPS) Executive Director Dr. Dushni Weerakoon stated in a recent article on the IPS blog that an aggressive interest rate hike by the Central Bank of Sri Lanka (CBSL) that will lead to a recession is preferable to tolerating a prolonged inflationary spiral bordering on hyperinflation.  She stated: “Once inflation takes hold, the damage can be corrosive, especially its deeply regressive impacts on lower-income households. But a contractionary strategy to suppress demand will not achieve the desired outcomes if: (a) inflation expectations are not well anchored and people expect rapid price increases to continue; and (b) supply side factors remain unaddressed.” As of June 2022, year-on-year (YoY), inflation nationally is estimated at an all-time high of 59% while the annual inflation is lagging significantly behind at around 21%. “With runaway inflation, tightening monetary policy hard and fast was almost inevitable to anchor inflation expectations. The policy will work though only if fiscal adjustments evolve in line with monetary policy. Sharp interest rate increases make government debt even more expensive to service, and when interest rates exceed economic growth, a country’s indebtedness keeps rising,” Dr. Weerakoon said, adding that higher interest rates in the current context of a crisis of confidence overall in the economy, and especially on exchange rate risks, means that it will not be reflected in stronger capital inflows to stabilise the rupee either.  


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