SEOUL — U.S. officials are still scrambling to contain the highest inflation the United States has seen in decades. But the world’s leading economic policymakers see another reason to worry ahead: Poorer economies could be swamped as the Federal Reserve tries to rein in U.S. prices.
Emerging market countries already faced mounting economic distress from the large amounts of spending required to fight the pandemic and, later, price spikes for food and fuel caused by Russia’s invasion of Ukraine. But tighter U.S. monetary policy will worsen those problems, because rising interest rates in the United States can push up the cost of financing debt for the dozens of low-income countries that borrow in dollars.
How U.S. and other Western policymakers respond could have major political and economic consequences, internationally and domestically. American exports could be imperiled if foreign markets deteriorate, and a global economic slowdown would threaten the U.S. recovery. Biden administration officials face questions about how aggressively to respond to these challenges. Yellen, for instance, is pushing China to allow nations in crisis to reduce what they owe to Beijing. But administration officials are also set to reject calls from other Democrats to back the disbursement of additional aid through the International Monetary Fund (IMF), action that would need the support of the United States.
Asked about high levels of government debt in the developing world, Yellen told reporters last week that tighter monetary policy “can make those debt problems, which already are very severe, more difficult.” Her comments were later echoed at meetings of the Group of 20 finance ministers in Indonesia by Kristalina Georgieva, the managing director of the IMF, which provides emergency financing. The European Central Bank’s surprise decision on Thursday to increase its benchmark interest rate by half a percentage point — the first such move in 11 years — could lead to poorer nations’ currencies losing even more value.
“With tightening financial conditions,” Georgieva said, “the debt service burden is a harsh — and for some countries, unbearable — burden.”
Countries considered emerging markets — typically defined by having some level of economic development but not yet “advanced” wealth — are already under the most pressure they’ve faced in roughly 30 years, many economists say. About 60 percent of poor countries are “in debt distress or at high risk” of it, the World Bank has said. Sri Mulyani Indrawati, Indonesia’s finance minister, warned at the opening of the G-20 of a “triple threat” facing the developing world: soaring inflation, the covid pandemic and the effects of the war in Ukraine. Already, the number of people worldwide who are hungry has exploded from 135 million to 276 million this year alone, a trend that is part of the deteriorating financial conditions in much of the world, she said.
“Every day, there’s something. Every day, there’s more news about developing economies’ debt stress, downgrades of global economic growth, and increases in poverty and hunger,” said Mark Weisbrot, an economist at the Center for Economic and Policy Research, a left-leaning think tank in Washington.
Poorer nations often borrow in U.S. dollars, both to help pay for imports that they cannot otherwise produce and to bolster the international credibility of their banking reserves. One downside is that “dollar-denominated debt” makes these countries vulnerable to fluctuations in the value of the American currency, changes that are beyond their control. When the Federal Reserve raises the interest rate, the dollar becomes more expensive relative to other currencies. This makes borrowing countries’ debt payments more costly.
The challenge is made more acute by the latest inflation report showing that prices in the United States rose at a red-hot rate of 9.1 percent in June; that report came out while Yellen was meeting with financial officials in Asia. The June report is expected to spur the central bank to hike rates even more aggressively when the bank’s leaders meet Wednesday. That in turn will make things even worse for low-income countries.
Yellen pointed out to reporters that a stronger dollar could have some upside for poorer countries’ economies, by making their exports to the United States cheaper and more attractive for U.S. consumers. And many analysts point out that emerging markets are, in general, in much stronger positions than they were during the liquidity crises of the 1980s in Asia and Latin America, which were triggered by the Fed’s massive rate hikes then.
But danger signs are emerging in many parts of the world. Between the beginning of the pandemic and now, the average ratio of public debt to gross domestic product in the developing world went from 52 percent to a record 67 percent, Weisbrot said. Some economists point to the revolt this month in Sri Lanka as evidence of the financial threat to emerging markets, although that country is in many ways vexed by idiosyncratic domestic challenges unrelated to the broader landscape.
One step that is getting new urgency is an attempt to push China into implementing a global agreement to provide relief to deeply indebted countries.
While in Japan earlier on her trip, Yellen criticized China for resisting the attempts of lower-income countries to renegotiate their repayment obligations. As countries faced debt stress during the pandemic, the G-20 nations in 2020 agreed in principle to a “Common Framework” meant to create new rules for restructuring sovereign debt when it becomes clear that it cannot be repaid. But as countries such as Chad, Ethiopia and Zambia have petitioned for help under the revamped guidelines, China has balked at implementation.
That reluctance has made U.S. and IMF officials increasingly exasperated. Briefing reporters in Indonesia ahead of talks, Treasury officials said they are emphasizing to China that it is in that country’s interest to accept the revamped debt terms — because if the debtor countries’ economies collapse, China is even less likely to recover its loans. South African Finance Minister Enoch Godongwana raised the issue with Yellen in Indonesia, according to his spokesperson.
Yellen told reporters last week that it was “quite frustrating” that China had not cooperated with debt restructuring efforts. Later, in Indonesia, she again pressed China: “More needs to be done to help the most vulnerable. … A key objective of this trip is to push G-20 creditors, including China, to finalize debt restructurings for developing countries now facing debt distress.”
The United States faces its own pressure to relieve the debt burdens of countries in distress. The African Union, which represents more than 50 nations, has called for another allocation of “Special Drawing Rights,” an IMF-run program that provides emergency capital to countries in need. Roughly four dozen congressional Democrats have also called for the administration to lead a disbursal of these drawing rights, similar to the $650 billion issued last year for pandemic assistance, arguing that economic conditions are more difficult now than they were then.
But the Treasury Department said in a statement that the administration does not support such a move, instead pointing to a smaller effort to offer loans on the basis of existing drawing rights. Republican lawmakers have characterized the IMF funds as a form of unwarranted economic aid that enriches the United States’ geopolitical foes. Rep. French Hill (R-Ark.) recently told Bloomberg News that such aid is a “giveaway to wealthy countries and rogue regimes” such as China, Russia and Iran. The Treasury statement said the United States might be open to supporting another allocation if global conditions change.
As the dollar rises, Treasury and IMF officials are also left trying to figure out how to respond to the sinking value of emerging market currencies.
Traditionally, the United States and its allies have largely discouraged nations’ attempts to manipulate their currencies’ value in attempt to gain commercial advantages, which is done by trading substantial amounts of the currency on international exchanges, artificially altering the market. Countries are similarly discouraged from imposing “capital controls” — legal limits on investor funds flowing outward — because those measures are regarded as inefficient and only likely to prolong nations’ underlying economic dysfunction.
In Nusa Dua at the G-20 meeting, however, Yellen emphasized increased flexibility in allowing these tactics. She stressed that such interventions should be extremely rare and used only in certain circumstances, when all other options had been exhausted. She backed new guidance from the IMF that embraces what defenders say is a more nuanced approach to such maneuvers.
That revised prescription may be soon put to the test. With the Fed dramatically increasing the strength of the U.S. dollar, countries could within months find themselves wrestling with a massive flight of investment toward the U.S. dollar. The Biden administration will face pressure to help craft the response to an unprecedented set of economic challenges.
“Even with sound fundamentals and strong institutions, financial flows can be volatile,” Yellen said. “… It can be beneficial to add to the playbook a wider set of policy tools.”