Inflation likely to remain higher for longer: IMF

Inflation, which had already been rising in many countries as a result of supply-demand imbalances and policy support during the pandemic, is likely to remain higher for longer, the International Monetary Fund (IMF) points out in its 2022 annual report.

Financial conditions have also tightened significantly, putting pressure on a wide range of emerging markets and developing economies—through higher borrowing costs and the risk of capital outflows, the Washington-based institution says.

The development of vaccines and unprecedented monetary, fiscal, and financial support, including the IMF’s historic general special drawing right (SDR) allocation of about $650 billion, made a global recovery possible, the report noted, adding that “Russia’s invasion of Ukraine upended it, severely setting back global economic prospects.”

Economic risks have risen sharply as a result. “Geopolitical and social tensions have escalated as poverty and inequality have increased. Inflation in many countries has risen sharply, fueled by a combination of surging energy, food, and commodity prices, labor shortages, and supply disruptions”, the report says.

Public and private debt has reached new highs, the document points out, adding that with more limited fiscal space, countries will face increasingly difficult policy trade-offs as they tackle rising inflation, heightened macro-financial risks, and slowing growth.

Emerging markets and developing economies with large foreign currency borrowing and external financing needs will also need to prepare for possible turbulence in financial markets as the monetary policy stance in advanced economies tightens.

Today’s economic challenges—from the pandemic and spillovers of war to climate change and digitalization—reveal economic and geopolitical fault lines in the global economic and financial system, the IMF says.

“The economic fallout from Russia’s invasion of Ukraine is another massive setback to the global economy,” the document notes, adding that the toll on Ukraine is immense, but the impact stretches far beyond Ukraine’s borders.

“The severity of disruptions in commodity markets and to supply chains will weigh heavily on macro-financial stability and growth, adding to an already-complicated policy environment for countries still recovering from the COVID-19 pandemic.”

The war in Ukraine may contribute to the dangerous divergence between advanced and emerging markets and developing economies. “More broadly, it risks fragmenting the global economy into geopolitical blocs with distinct technology standards, cross-border payment systems, and reserve currencies,” the report says.

“Such a tectonic shift represents the most serious challenge to the rules-based system that has governed international and economic relations for the last 75 years, jeopardizing the gains made over the past several decades.”

The overlapping global crises of war, pandemic, and inflation are hitting the poorest countries hardest, it says, adding that low-income developing countries experienced significant declines in per capita income during the pandemic.

Now they are facing a sudden surge in energy, fertilizer, and food prices exacerbated by the war in Ukraine. This is contributing to an increase in poverty and inequality, widening the divergence between advanced and emerging markets and developing economies. While aggregate output for advanced economies is expected to return to its pre-pandemic trend by 2025, employment and economic activity in emerging markets and low-income developing countries are unlikely to recover in the medium term. “This suggests some permanent scarring.”

Regarding debt, the war in Ukraine is adding to the strain on public finances even as countries are still reeling from the pandemic. Extraordinary policy support during the pandemic stabilized financial markets and gradually eased liquidity and credit conditions around the world, contributing to the recovery, the document notes, adding that deficits increased and debt accumulated much faster than during previous recessions, including the global financial crisis.

Governments are now struggling with rising import prices and debt bills in a highly uncertain environment of elevated inflation and a slowdown in growth. As monetary policy tightens to curb inflation, sovereign borrowing costs will rise, narrowing the scope for government spending and increasing debt vulnerabilities, especially in emerging markets and developing economies. To complicate matters, the extent of liabilities and their terms are not fully known in many cases.

Regarding climate change, the international financial institution notes that it imposes large economic and social costs, in part by contributing to a higher frequency and intensity of natural disasters, affecting macroeconomic and financial stability.

To improve data and disclosure to more effectively price and manage climate risks, in 2021 the IMF launched the Climate Change Indicators Dashboard, which has since been further updated. The dashboard builds on collaboration with other international organizations and includes a range of distinctive indicators that demonstrate the impact of economic activity on climate change, making it a one-stop shop for relevant climate-change-related macroeconomic data.

On digitalization, the report notes that digital forms of money are diverse and evolving rapidly. “The opportunities are immense, but the challenges to policymakers are also stark, complex, and widespread.”

The most far-reaching implications are to the stability of the international monetary system. “Digital money must be designed and regulated so that member countries reap the potential benefits, including greater financial inclusion and more efficient payments across borders,” the report says.

Achieving these goals requires managing risks related to capital flow volatility and loss of control over monetary policy, the IMF points out, adding that international cooperation will be key to mitigating cross-border spillovers.

“Digitalization and mobile money are also rapidly transforming fiscal operations and policies through GovTech, an area of increasing IMF support to members,” the source says, adding that during the pandemic, governments accelerated digital delivery of key government services.

“Revenue administrations are increasingly using e-tax filing and e-payment systems and digital technologies to improve compliance management, helping to reduce tax evasion and boost revenue mobilization,” the report underlines, adding that digital technologies are also improving the efficiency and effectiveness of public financial management systems and processes, including budget preparation and execution, cash and debt management, e-procurement, financial reporting and audits, and administration of social programs.