The IMF’s Chronicle of a Catastrophe Foretold

Yves Smith writes:

Yves here. Major international agencies try to put a positive spin on their economic forecasts, even when they are less than rosy. Jomo depicts a gloomy new IMF report as yet more confirmation of his warnings about looming economic crises in poor nations, with finance-obsessed tight monetary policies in advanced economies making this bad situation worse.

By Jomo Kwame Sundaram, former UN Assistant Secretary General for Economic Development. Originally published at Jomo’s website

The IMF warns of a decade ahead of ‘tepid growth’ and ‘popular discontent’, with the poorest economies worst off. But as with inaction on Gaza, little is being done multilaterally to avert the imminent catastrophe.

Grim IMF Prognosis

Noting the world economy has lost $3.3 trillion since 2020, International Monetary Fund (IMF) Managing Director Kristalina Georgieva announced this grim warning before last month’s Spring meetings of the Bretton Woods institutions.

Instead of prioritising economic recovery, finance ministers and central bank governors in Washington agreed to continue policies worsening the situation. After all, curbing inflation helps preserve the value of financial assets.

Current policies suppressing demand are justified as necessary for financial stabilisation. They do nothing to address the various ‘supply-side disruptions’ mainly responsible for ongoing inflationary pressures.

These include the ‘new geopolitics’, the COVID-19 pandemic, wars, illegal unilateral sanctions, and market manipulation. Thus, ostensibly counter-inflationary measures have worsened pressures perpetuating stagnation.

Brave New World!

The new Cold War of the last decade and other geo-political considerations increasingly shape economic and financial policies worldwide. Powerful nations have weaponised their formulation, implementation and enforcement.

Years of economic stagnation have diminished productive and competitive capabilities. Meanwhile, recent geopolitics has changed geoeconomic relations, hegemony and its discontents. Laws, regulations and judicial processes are increasingly deployed for political – and economic – advantage.

Thus, Western governments have generated inflationary pressures with their economic and geopolitical policies, even if inadvertently. Perceptions of strategic decline are mainly attributable to the ostensibly market-based policies pursued.

The European Central Bank has followed US Fed interest rate hikes from 2022. Both still maintain high interest rates, ostensibly to keep inflation in check. Unsurprisingly, most developing country monetary authorities have had to raise interest rates to reduce capital flight and bolster their exchange rates.

Such interest rate hikes by central banks have raised the costs of funds, squeezing both consumption and investment. Raising interest rates has proved blunt and limited, while more appropriate measures have curbed inflation more effectively.

Instead of checking inflation due to supply disruptions, higher interest rates have squeezed both investment and consumption spending by both the private sector and government. Such cuts have hurt demand, jobs and incomes worldwide.

Although interest rate hikes worldwide have been contractionary, other US macroeconomic policies since the 2008 global financial crisis have maintained full employment in the world’s largest economy, with limited gains for most others.

Policymakers’ Hands Tied

Many developing country governments borrowed heavily in the late 1970s, mainly from Western commercial banks. But after the US Fed sharply raised interest rates from 1979, severe sovereign debt distress paralysed many heavily indebted governments in Latin America and Africa for at least a decade.

Much more government borrowing, increasingly from bond markets in the decade before 2022, exposed many developing economies to debt stress. This can be much worse than in the 1980s, as debt levels are higher, with more diverse creditors.

With borrowing exposure much higher and more market-based, with less from banks, debt resolution is much more difficult. Many governments have also guaranteed state-owned enterprise borrowings, with some even doing so for well-connected private enterprises.

Meanwhile, policymakers in developing countries today are even more constrained by their circumstances. Vulnerable to market vicissitudes and with fewer macroeconomic policy instruments available, they face pro-cyclical policy biases due to market pressures and supportive institutions.

Besides financial market pressures for fiscal austerity, multilateral financial institutions like the IMF impose such conditions on countries seeking emergency credit and other debt relief.

All this has led to deep government expenditure cuts, especially for public investments, crucial for recovery of the real economy. Hence, governments commit not to spend despite the urgent need for such counter-cyclical expenditure.

Voluntary Vulnerability?

Central bank independence typically implies greater sensitivity to market pressures and private financial interests rather than national and government policy priorities.

Instead of strengthening national capacities and capabilities, central bank independence and autonomous fiscal policy authorities have disarmed developing country governments in the face of greater external vulnerability.

This toxic mix may well keep vulnerable governments in protracted debt peonage, unable to free themselves from its yoke, let alone give them the room to create conditions for renewed growth.

Economic liberalisation and globalisation have irreversibly transformed developing economies, with lasting consequences. Export opportunities have become more limited, not least due to the weaponisation of economic policies.

Meanwhile, most developing countries have turned to private creditors despite higher interest rates and borrowing costs. But even private market lending to the poorest nations has dried up since 2022 after the US Fed raised interest rates sharply.

With higher Fed interest rates, finance has abandoned developing countries for ‘safety’ in US markets. As debt service costs soared, distress risks have risen sharply.

Hence, many economies in the Global South are barely growing, especially after earlier collapses of commodity prices, which later worsened due to falling demand as supplies rose due to earlier investments.