By Lorenzo L. Perez
Developments in the World Economy in Recent Years
The Covid-19 pandemic led to millions of deaths, job losses, business failures and school closings over the course of two years, triggering the most encompassing global economic crisis in almost a century. Poverty rates soared, and inequality widened — both across regions and within countries, reversing the significant progress achieved in these areas in previous years. Disadvantaged groups that had limited financial resources to begin with and workers with lower levels of education — especially younger ones and women — were disproportionately affected.¹
The response by governments (particularly in the United States and other developed countries) included a combination of cash transfers to households, credit guarantees for firms, easier liquidity conditions, repayment grace periods for much of the private sector, and accounting and regulatory forbearance for many financial institutions. While these actions were mostly successful in mitigating the negative consequences of the Covid-19 pandemic on economic activity in the short run, the World Bank notes that these actions resulted in elevated risks going forward, including public over-indebtedness, increased financial fragility, and a general erosion in transparency. After fighting the pandemic, developing countries have been left with very limited possibilities of increasing expenditures or lowering taxes.²
The effects of Russia’s invasion of Ukraine this year — which has caused a tragic humanitarian crisis in Eastern Europe — have darkened again the economic situation. This negative shock to the world economy came when the global economy was on a mending path but had not yet fully recovered from the pandemic, with a significant divergence between the economic recoveries of advanced economies and emerging market and developing ones. In addition to the war in Ukraine, wide-ranging lockdowns in China to fight outbursts of Covid-19 in 2022 – including in key manufacturing hubs — have slowed activity there and caused bottlenecks in global supply chains.
1 World Bank: World Development Report, April 2022. This article relies on the information provided by the World Bank and the International Monetary Fund (IMF) in their reports for their Spring meetings in April 2022 and subsequent updates.
2 Emerging markets are considered to be countries that have many of the economic characteristics of developed countries such as India, China, Turkey, Argentina, Brazil, Chile, Colombia, and Mexico among others.
Not surprisingly, Russia and Ukraine are projected to experience large GDP contractions in 2022. The collapse of Ukraine is the direct result of the invasion, destruction of infrastructure, and exodus of its people. In Russia, the sharp decline reflects the impact of international sanctions against the Putin regime, with a severing of trade ties, greatly impaired domestic financial intermediation, and loss of confidence with many foreign investors leaving the country.³ The International Monetary Fund (IMF) notes that the economic effects of the war are spreading worldwide mainly through commodity markets, trade, and financial linkages. Russia is a major supplier of oil, gas, and metals, and, together with Ukraine, of wheat and corn, and the current and anticipated decline in the supply of these commodities has already driven their prices up sharply. Europe, the Caucasus region and Central Asia, Middle East and North Africa, and Sub-Saharan Africa are most affected. However, the food and fuel price increases are also hurting lower-income households globally, including in the Americas and Asia. Soaring food and fuel prices are the most excruciating form of inflation. Purchases of goods can be delayed or forgone, but people cannot stop eating and most people cannot walk to work or work from home.
Recent developments indicate that in addition to the supply shocks, the stimulus packages and the laxed monetary policy adopted in developed countries, particularly in the United States, have resulted in a rapid increase in the inflation rate reaching the highest levels in 40 years. After believing that the increase in inflation was due mainly to transitory factors such as supply disruptions associated with the Covid-19 closures, the Federal Reserve (the United States’ Central Bank) finally reversed course in 2022 and has started to tighten monetary policy aggressively by increasing policy interest rates. Other developed countries have also begun to tighten monetary policy. As a result, developing countries, who have borrowed in foreign exchange, are facing higher interest payments in their budgets.
Policy Challenges to the World Economy
Democracies in developed countries are currently trying to arrest inflationary pressures while avoiding a recession. At the same time, they need to avoid giving up on more medium-term goals like initiatives to fight climate change and supporting the rule of law in the world trade and financial systems. They also cannot turn their backs to the needs of developing countries where most of the world population lives. Developing countries need to improve the management of their public finances and take steps to avoid hunger and improve their health facilities. Countries need to address better corruption which is a worldwide problem, but particularly noticeable in many developing countries where undemocratic regimes exist.
3 International Monetary Fund: World Economic Outlook, April 2022.
Citizens of democracies in developed countries have to resist the temptation to turning to isolationist policies (e.g., export controls, not sharing adequately their Covid-19 vaccines, drastic changes in supply chains to bring back production to their countries, or ignoring the plight of hunger in poor countries). Currently citizens of these countries are bombarded by demagogic proposals from representatives of various parties that do not address the root causes of problems and ignore the impact it can have on the most vulnerable or in future generations.
In a recent interview, Pope Francis noted that either countries work together to climb out of the crisis or they are not going to be able to leave the crisis behind. The rest of this article discusses the challenges in developed countries in the monetary, fiscal and multilateral policies from the perspective of promoting the common good and Christian solidarity, including concern for future generations. A final section discusses the policy challenges in developing countries from the same perspective.
Developed countries policies
Monetary and financial policies
The objective of reducing inflation must claim priority in developed countries on the basis of promoting the common good and concerns for the poor. Persistently high inflation could sink the recovery and further damage living standards, particularly for those most vulnerable. Reducing inflation may involve central banks in these countries continuing to raise interest rates, something that could result in these countries falling into recessions. But not halting the inflationary pressures could result in these countries facing a destructive wage-price spiral that would require eventually more forceful monetary tightening, with even more harm to growth and employment. How much to tighten monetary policy depends on the circumstances of each country. The recently announced agreement between Ukraine and Russia — negotiated by the United Nations and Turkey — to exempt the shipment of Ukrainian grains to world markets from the Russian blockade in the Black Sea could help reduce food price pressures.⁴
A parallel agreement to permit the shipment of some Russian commodities and fertilizer (key for the world agricultural sector) could also have a favorable impact on prices. ⁵
On the financial side, there is also the need for early detection of significant financial risks. Because the balance sheets of households, firms, financial sector institutions, and governments are tightly interrelated, risks may be hidden. The World Bank notes that the share of non-performing loans has generally remained below what was feared at the beginning of the pandemic crisis. But this could be due to forbearance policies that delayed debt repayments and relaxed accounting standards.⁶ There will be a need to proactive manage distressed assets (e.g., loan in arrears) to avoid having problems lasting much longer than they should.
4 The agreement will enable Ukraine—one of the most important grain producers—to export 22 million tons of grain and other agricultural products that have been stuck in Black Sea ports due to a Russian sea blockade.
5 According to the Associated Press, the director General of the Red Cross has noted that over the last six months prices for food staples rose 187% in Sudan, 86% in Syria, 60% in Yemen, and 54% in Ethiopia.
6 Non-performing loans are loans that cannot be repaid according to the original terms of repayment and which force lenders to downgraded the value of these loans in their balance sheets. This in turn could put in financial difficulties the lenders. Forbearance policies of regulators of financial institutions provide flexibility to lenders regarding the timing of the downgrading of non-performing loans.
Fiscal policy must avoid hindering central bank efforts to bring down inflation. The fiscal outlook is subject to elevated uncertainty this year, as the full consequences of the war in Ukraine and spillovers from sanctions on Russia are unknown and will vary across countries. This high uncertainty and marked divergences across countries require a tailored and agile fiscal policy response. Fiscal policy in developed countries will need to be designed against the difficult background of high and increasing inflation, slowdown in growth and high debt and tightening credit conditions. Budget constraints are increasingly biding as interest payments rise due to central banks hiking interest rates to fight inflation. Following a huge and necessary fiscal expansion in many countries during the pandemic, debt levels are at all-time highs, and governments are more exposed than ever to higher interest rates.
At the same time, the need for fiscal consolidation should not prevent governments from prioritizing spending with well-targeted support for the vulnerable — including refugees, those struggling because commodity prices spikes, and those
affected by the pandemic. But these types of support should be deployed in ways that avoid exacerbating ongoing supply-demand imbalances and price pressures. New measures should be budget neutral — funded through new revenues or expenditure reductions elsewhere---without incurring fresh debt and avoiding working against monetary policy. Fiscal measures to address needs from high food and energy prices should not detract from action to tackle long-standing challenges such as climate change. The IMF notes that it is even more urgent now to ensure greater resilience through investments in health, food, and energy security from cleaner sources. Moving toward a more diverse, clean, and renewable energy matrix will ensure energy security and facilitate the green transition.
Global cooperation is more important now than ever — to address the consequences of the Covid-19 pandemic and energy and food disruption, to help refugees from war, to prevent and prepare for future potential pandemics, and to mitigate climate change.⁷ It will be crucial for countries to work together to address supply concerns related to food and fertilizers, like wheat, in order to support the most vulnerable populations. International cooperation in (a) corporate taxation (e.g., the recently internationally negotiated 15 % minimum corporate tax still subject to legislative approval by the United States and in other countries); (b) measures to promote transparency and exchanged information for personal taxation to prevent illegal tax avoidances; and (c) carbon pricing (urgent actions and coordination are required to curtail emissions) can mobilize resources to promote necessary investments, reduce inequality and promote a more fairly distributed tax burden.
In the spirit of solidarity and promotion of the common good, developed countries need to give financial and technical support to developing countries. It is urgent to reduce the debt of the countries with liabilities denominated in foreign exchange that are more vulnerable to the tightening of global financial conditions and where borrowing costs are surging. An IMF blog dated July 13, 2022, notes that sovereign foreign exchange bond yields have reached 10 percent in about a third of emerging countries. Emerging economies with a greater reliance on domestic borrowing, such as in Asia, have been more insulated. But a broadening of inflationary pressures and the attendant need to tighten monetary policy could quickly deteriorate the fiscal situation in these countries.
7 IMF Fiscal Monitor Report, April 2022, Executive Summary, page xii.
While developing countries are vulnerable to the negative external shocks discussed above through mostly no fault of their own, their governments maintain the primary responsibility of addressing the problems faced by their populations. In these circumstances, governments of developing countries need to frame their macroeconomic policies with realistic financing assumptions. Additional efforts to raise resources via taxation and other means must be made. Efforts to streamline expenditures are required, while prioritizing programs on behalf of the most vulnerable.
Carmen Reinhart, the former World Bank chief economist, acknowledged recently that it could take years before the growing number of developing countries under debt distress see any substantive reductions in their debts. Debt restructurings are likely to become more frequent and will need to address more complex coordination challenges than in the past due to increased diversity in the creditor landscape. China, for example, has become the main creditor for African countries and is becoming increasingly important in other regions. Private bondholders also play a much larger lending role today.⁸ Having mechanisms in place for orderly restructuring is in the best interest of creditors and debtors alike. This is urgent because the Debt Service Suspension Initiative (DSSI) for low-income countries expired at the end of 2021.⁹ A November 2020 agreement of the Group of 20 (composed of developed countries and some emerging market economies) calls for a common framework for debt treatments beyond the DSSI. Experience so far shows that greater clarity on restructuring steps, earlier engagement of official creditors with the debtor and with private creditors, a standstill in debt service payments during negotiations, and specifying the mechanics of comparability of treatment is still needed.¹⁰ In any event, it is the obligation of debt forgiveness candidates to have adequate economic programs ready to present to creditors to facilitate rescheduling negotiations.
It is clear that the economic outlook is worsening, particularly for developing countries. The final outcome of the crisis will depend on the government policy reactions. People of goodwill can rely on the principles of the Social Teaching of the Church to advocate for policies as discussed in this article that promote the respect of human dignity, the common good, and the solidarity with the most disadvantageous across the countries of the world.
8 For decades, the main developed creditor countries (the Paris Club) rescheduled the external debts of developing countries under the leadership of the French Ministry of Finance and with the assistance of the IMF and the World Bank. China has not joined so far, the Paris Club. In addition, the debt to multilateral institutions of heavily-indebted developing countries (mostly from sub-Saharan Africa) was forgiven around the turn of the century.
9 Under the DSSI, bilateral official creditors suspended debt service payments of poorer countries from May 2020 through December 2021 Forty-eight of the seventy-three eligible countries participated in this initiative and almost US$13 billion of debt payments were suspended.
10 IMF Blog of April 7, 2022.
Lorenzo Pérez, PhD. Economics, University of Pennsylvania is a retired economist who worked for over 30 years at the IMF, and prior to that worked at the Agency for International Development and the U.S. Treasury Department.
Dr. Perez is a resident columnist of El Ignaciano.