Dollar and debt dominate IMF-World Bank discussions

The ongoing strength of the dollar and the exceptional resilience of the US economy were two of the main topics of debate at the recent series of spring meetings organised by the International Monetary Fund (IMF) and the World Bank.

The event, which took place in Washington DC in mid-April, saw central bankers, finance ministers, academics and representatives of asset-management companies and hedge funds come together to discuss the global economic outlook, international development and the strength of the world’s financial system – in particular, the debt-related challenges facing a number of emerging-market governments.

The consensus view among investors and other participants tended to support the American exceptionalism story – the idea that the US economy will continue to outperform other developed markets while inflation remains above the Federal Reserve’s (Fed’s) 2% target, preventing imminent cuts in interest rates. Expectations were that this would, in turn, drive further rises in Treasury yields and underpin continued dollar strength.

However, it is not uncommon for any consensus established at the IMF-World Bank meetings to have a relatively short shelf life. Indeed, the surprise slowdown in US first-quarter GDP growth reported at the end of April may be the first indication that the US economy is succumbing to the pressure of tightened monetary policy. April nonfarm payrolls were also growing at a slower pace than what was the average in the pre-pandemic (2014-2019) period. Our view, based on a number of forward-looking indicators, is that consumer price inflation in the US will resume its downward trajectory in the coming months , allowing the Fed to make an initial rate reduction at either its July or September meeting.

The IMF-World Bank annual meetings in Marrakech last October took place in the wake of the attack by Hamas on Israel and were, as a result, dominated by geopolitical concerns and the prospect of further shocks to the global economy. These concerns have receded to some extent, as have fears of a deepening sovereign debt crisis in emerging markets and low-income developing countries.

Six months ago, investors’ questions focused on issues surrounding the ability of countries such as Kenya and El Salvador to meet repayment schedules, as well as whether the likes of Egypt and Nigeria would be forced to devalue their currencies to address deteriorating external imbalances. In the latest round of meetings, however, the tone was generally more optimistic. Developments in the final quarter of 2023 and the first three months of this year have put a number of countries on a path to stability. Fiscal orthodoxy has increasingly been the order of the day, with most governments coming to the realisation that this approach is less costly and arduous than committing to a painful restructuring process.

As a consequence, market access has opened up once again, with Kenya, Côte d’Ivoire, Benin and El Salvador all able to issue debt in the past few months. Finance ministers from Egypt, Angola and Nigeria have expressed a wish to come to the Eurobond market later this year, while the spring meetings related to emerging-market debt were well attended, in particular by hedge funds and other institutional investors – an indication of the increasing capital flows into these areas.

Meanwhile, the outlook from credit rating agencies with regard to emerging-market debt has become more positive than negative, and investors and sovereign advisers do not currently expect another default in 2024. It is our view that Zambia, Sri Lanka and Ghana will emerge from default before the end of the year: the IMF was positive on the progress made by Sri Lanka since its 2022 default, and it appears increasingly likely that Ghana will soon reach a deal with bondholders. ¹

It was also acknowledged at the meetings that a number of issues need to be resolved. For example, there appears to be a welcome acceptance among policymakers that the Common Framework, which was introduced in 2020 in the hope of helping emerging economies overcome debt problems, has been ineffective and is in urgent need of an overhaul.²

Participants raised concerns about the potential unintended consequences of New York State’s proposed Sovereign Debt Stability Act³ on countries’ ability to restructure their debt. They warned that the planned legislation could lead to significant legal challenges. The IMF is also concerned about the possible impact of the unprecedented number of national elections that are scheduled to take place in 2024.⁴ The organisation points out that, in the past, governments in search of re-election have tended to relax fiscal policy to boost their appeal to voters – but stresses that such an approach could risk damaging public finances at a particularly inopportune time.

Finally, in the wake of the meetings, the IMF’s managing director, Kristalina Georgieva, said emerging markets could face further difficulties if interest rates in the US remain at their present high levels for much longer,⁵ especially if borrower nations end up reducing their own rates more quickly. However, there are signs that central bankers in emerging economies may be rethinking their approach to loosening monetary policy following the recent repricing of Fed cuts.

Focusing on the economic outlook for emerging markets, the IMF noted that recent strength in oil and other commodity prices had improved the growth prospects for a number of countries in sub-Saharan Africa, with Nigeria and Angola also benefiting from momentum from positive policy reforms. Senegal’s new government has committed to the existing IMF programme and signalled a more orthodox policy approach, although there are concerns about the outlook in Gabon and, following the most severe drought in 40 years, Zambia.

Growth in Latin America, meanwhile, has beaten the IMF’s expectations, with political risk the main focus in much of the region. Falling inflation and increased agricultural exports are expected to drive growth in Argentina, where President Javier Milei is making progress towards enacting a series of tax reforms.⁶ There are hopes of a more moderate approach in Colombia and of greater stability in Ecuador under President Daniel Noboa. However, it is unclear whether the expected new government in Mexico will pursue the much-needed fiscal reforms, and the political situation in Venezuela remains unpredictable.

1. https://www.reuters.com/world/africa/ghana-deal-with-bondholders-a-matter-time-says-imf-official-2024-04-19/
2. https://www.theguardian.com/business/2024/apr/21/world-bank-chief-economist-indermit-gill-g20-debt-relief-mechanism-common-framework
3. https://www.reuters.com/world/us/support-gathers-controversial-new-york-bill-sovereign-debt-ahead-legislature-2024-04-25/
4. https://www.imf.org/en/Blogs/Articles/2024/04/17/why-our-world-needs-fiscal-restraint-in-biggest-ever-election-year
5. https://www.cnbc.com/2024/04/30/imf-chief-warns-of-emerging-market-risk-with-high-us-interest-rates.html
6. https://www.ft.com/content/170af35f-4315-4725-b358-b466ff3ef34b