The World Bank has predicted that any decision by the United States to tighten its monetary policy will have an adverse effect on the economic outlook of countries such as Nigeria.
The global financial institution was reacting to the statement on Tuesday by Jerome Powell, US Federal Reserve Chairman that the country’s economy is both healthy enough and in need of a tighter monetary policy.
The Federal Reserve, earlier this year, noted that it may need to raise interest rates from the current zero percent floor ‘sooner or at a faster pace’ than officials initially envisaged. Many informed observers now expect a four-quarter point interest rate rise this year along with the Fed selling some government bonds it owns.
However, tighter monetary policy should not be confused with a highly restrictive monetary policy stance. The Federal Reserve indicated that a nominal interest rate of 1 percent would still stimulate demand, especially with inflation likely to be well above the Fed’s 2 percent target by the end of the year.
The problem for emerging/developing countries like Nigeria is that tighter, but still stimulative US policy might well spell trouble for them.
If last year served as any form of historical evidence, it revealed that advanced economies were more resilient than expected to Covid-19 waves. The Alpha and Delta waves, which were appalling for a large number of people’s health, hardly dented global recovery. With increased monetary and fiscal stimulus that proved necessary, the resultant implication was excessive demand and surging inflation.
The start of 2022 depicted a frightening reflection of 2021’s momentum. The new variant of the coronavirus (Omicron variant/Deltacron variant) sent infections rocketing through various parts of the world, threatening economic prospects for the year ahead. However, rather than a repeat of the severe downturns experienced in 2020/2021, the current outlook is one of high global inflation and rising interest rates with severe risks for emerging and developing economies like Nigeria.
Uche Uwaleke, a professor of finance and capital market and president of the Association of Capital Market Academics of Nigeria stated that Nigeria should expect further capital outflows as a consequence of the planned interest rate normalization in developed economies (the United States).
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He stated that the first implication would be that bond yields will rise leading to capital flow reversals in frontier and emerging markets. He further states that another implication would be the depletion of foreign reserves and a higher exchange rate of the naira as a result of exit of foreign investors which usually puts pressure on the forex market; thus providing further justification for the CBN to tighten monetary policy.
“When this happens, banks are likely to reprise their assets which may worsen non-performing loans position in the Banking sector. This will increase the cost of borrowing and reduce access to credit by businesses,” Uwaleke said.
Emerging economies have struggled to recover as quickly as their advanced cousins, though lacking the same degree of trust and market access to borrow freely to protect their populations in the early stages of the pandemic.
Without financial resilience and generous social security systems, the downturns in emerging/developing economies have been more persistent than the weaker recoveries. The perfect storm was however completed by the difficulties these developing economies encountered in gaining access to vaccines and in their delivery to their populations.
Two decades of emerging economies catching up with their richer cousins have finally come to an end. The World Bank estimates that real incomes in 70 percent of emerging and developing economies will grow slower than those of advanced economies between 2021 and 2025.
Also, weakness during the pandemic is also likely to leave much larger and more persistent scars. The World Bank estimates that recovery in developing economies will fall by almost 6 percent short of the initial pre-pandemic expectations.
This would further limit their ability to service existing debts, which have risen by 10 percentage points of national income since the start of the pandemic according to the IMF (International Monetary Fund).
“The anticipated rise in US interest rates and bond yields would further exacerbate the Nigerian government’s expense at servicing its huge public debt which is currently in excess of N38 trillion,” Uwaleke said.
“This development will further worsen the country’s current fiscal imbalance, jeopardize the 2022 budget as well as crowd out development funds,” he added.
This is also likely to bring a hard landing, debt distress, and social discontent in weaker developing economies.
None of this would be made easier by the possibility that the Fed will hit harder on the brakes than expected this year, rattling markets and tightening global monetary conditions.
The President of the World Bank, David Malpass indicated that the prospects in 2022 are unlikely to be favorable for Developing economies.
Emerging and developing economies are not alike in the conditions they face. For example, China has ample fire-power to cushion its economy in the short-term even if this comes at the expense of long-needed rebalancing.
Nigeria, however, is a prime example of a country vulnerable to a shock. High public and private debt alongside little credibility in its economic institutions is a very toxic mix. Countries in similar positions have already seen capital flight and face the threat of a vicious circle of increased vulnerabilities and weakening prospects.
The outlook, however, looks difficult as the World Bank expects 40 percent of emerging and developing economies to still have national income below the 2019 (pre-pandemic) level in 2023 and 2024. These are the conditions most likely to prompt a reckoning this year rather than further muddling through.
