Brace for Fed tightening, warns IMF

Moves could trigger capital outflows

Emerging economies must prepare for US interest rate hikes, the International Monetary Fund said, warning that faster than expected Federal Reserve moves could rattle financial markets and trigger capital outflows and currency depreciation abroad.

In a blog published yesterday, the IMF said it expected robust US growth to continue, with inflation likely to moderate later in the year.

The global lender is due to release fresh global economic forecasts on Jan 25.

It said a gradual, well-telegraphed tightening of US monetary policy would likely have little impact on emerging markets, with foreign demand offsetting the impact of rising financing costs.

But broad-based US wage inflation or sustained supply-chain bottlenecks could boost prices more than anticipated and fuel expectations for more rapid inflation, triggering faster rate hikes by the US central bank.

“Emerging economies should prepare for potential bouts of economic turbulence,” the IMF said, citing the risks posed by faster-than-expected Fed rate hikes and the resurgent pandemic.

St Louis Fed president James Bullard said last week the Fed could raise interest rates as soon as March, months earlier than previously expected.

“Faster Fed rate increases could rattle financial markets and tighten financial conditions globally. These developments could come with a slowing of US demand and trade and may lead to capital outflows and currency depreciation in emerging markets,” senior IMF officials wrote in the blog.

The IMF said emerging markets with high public and private debt, foreign exchange exposures, and lower current-account balances had already seen larger movements of their currencies relative to the US dollar.

The fund said emerging markets with stronger inflation pressures or weaker institutions should act swiftly to let currencies depreciate and raise benchmark interest rates.

It urged central banks to clearly and consistently communicate their plans to tighten policy, and said countries with high levels of debt denominated in foreign currencies should look to hedge their exposures where feasible.

Governments could also announce plans to boost fiscal resources by gradually increasing tax revenues, implementing pension and subsidy overhauls, or other measures, it added.

In a separate development, Pakistan has asked the IMF to delay a board meeting meant to consider the country’s sixth review until the end of January.

The meeting was meant to take place on Jan 12 to review the recommendation to release $1 billion of Pakistan’s $6 billion, three-year programme.

However, Pakistan has been so far been unable to pass recommended fiscal tightening measures tied to the funds’ release.

“As soon as the legislative procedures are completed, the IMF board will consider it for approval,” the Finance Ministry said in a statement in Islamabad, referring to a mid-year budget that slashes a number of duty exemptions and introduces new revenue measures.

The legislation was introduced to parliament late last month, but has met fierce resistance from the opposition amidst rising inflation and a widening current account deficit.