Deep-dive with IMF’s Maurice Obstfeld: There is no collective meltdown in the EMs

From left to right: Deputy Minister of Planning, Monitoring and Administrative Reform Ahmed Kamali, IMF Economic Counsellor Maurice Obstfeld, IMF Senior Resident Representative in Egypt Reza Baqir

A few days ago, the International Monetary Fund (IMF) gave its green light to the disbursement of the upcoming tranche of $2 billion to Egypt, pending the Executive Board’s agreement, which would bring total disbursement of the $12-billion extended fund facility to $10 billion. Apparently, Egypt passed the IMF’s fourth review with flying colors.

“The Egyptian economy has continued to perform well, despite less favorable global conditions, supported by the authorities’ strong implementation of the reform program. GDP growth accelerated from 4.2 percent in 2016/2017 to 5.3 percent in 2017/2018 while unemployment declined to below 10 percent,” chief of the mission Subis Lall announced in a statement.

The IMF seemed pleased about the country’s economic performance and policies; however, Egypt was ranked the fourth most vulnerable emerging market (EM) in the face of what the media and economists have dubbed the “EM crisis”, according to Bloomberg Economics’ latest report.

In the wake of the report’s publication, economic counsellor and director of the Research Department at the International Monetary Fund (IMF) Maurice Obstfeld is currently visiting Egypt as part of an IMF mission. Business Forward sat down with Obstfeld to find out more about his take on the EMs’ performance, the future of debt and interest rates globally and how Egypt can remain resilient in the wake of key global developments.

“There is no collective meltdown in the EMs”
While Obstfeld believes that there are global market pressures that affect EMs more than other countries, such as financial tightening, tensions over trade and geopolitical and political challenges – namely the rising price of oil -, he does not believe that there is a collective meltdown across EMs.

In Bloomberg Economics’ report, Egypt was preceded by Turkey, Argentina and South Africa. The vulnerability ranking relies on five indicators: current account balance, short-term external debt and remaining maturity, reserve coverage, government effectiveness and CPI inflation and deviation from target midpoint. While the country scored best in the short-term external debt criterium (5 percent of GDP), government effectiveness – which is measured according to the World Bank’s Worldwide Governance Indicators – ranked lowest among 19 EMs (-0.62 score).

“There are certainly some [EMs] in which the market pressures have been more acute […] but even in the case of Turkey there has been no wholesale retreat of foreign lenders. I don’t think you can even call the Turkish case a full-blown crisis,” he explains. “But it is certainly true that EMs are facing pressure which make the trade-offs of their policymakers more difficult and which may lead to somewhat slower growth rates in the short-run.”

But what exactly is happening in the EMs? According to Obstfeld, the conditions are far from a crisis and more of a cyclical response to the US monetary position and the potential withdrawal of a combination of the European Central Bank and other factors.

While there are a few countries that are hit harder than others by those global developments, the economic counsellor highlighted that a number of EMs witnessed upgrades in the IMF’s growth assessments, such as Colombia, Peru, Chile, Bolivia, Thailand, Bangladesh, Taiwan etc.

EM conditions are far from a crisis and more of a cyclical response

“It is not a collective meltdown and I think any attempt to portray it [as such] is misleading. Our message [during the Annual Meetings in Bali] was that the high expectations we had for a number of very important countries seemed to have not been realized, and so we are in a situation of more unbalanced expansion than we thought we were seeing six months ago,” he elaborates.

“Egyptian government has taken good steps to remain resilient to global developments”
Regarding Egypt’s resilience to those challenges and global developments, Obstfeld believes that the Egyptian government has taken good steps by negotiating the IMF loan and consequently, unifying the foreign exchange market to a market-determined rate, raising the primary budget surplus, reducing the debt-to-GDP ratio and eliminating fuel subsidies as part of structural reforms. This would put Egypt “in a much better position in the future,” he explains.

Heavily indebted countries become very vulnerable to interest rate increases

“Some countries are moving towards reducing credit growth rate and credit-to-GDP ratio”
Another factor that has been rather noticeable is the vulnerability of governments worldwide due to the high debt they are facing. IMF director Christine Lagarde had previously mentioned the trend: “The bottom line is that high debt burdens have left many governments more vulnerable to a sudden tightening of global financial conditions and higher interest costs. For emerging market and frontier economies, concerns about debt levels in this environment could contribute to market corrections, sharp exchange rate movements, and further weakening of capital flows.”

Heavily indebted countries become very vulnerable to interest rate increases – while this seems like a warning sign to EMs in particular, given the financial tightening happening due to the US policy mix of a very expansionary fiscal policy and a Federal Bank that is raising interest rates to try to contain inflation, leading to a stronger US dollar.

“Our recommendation is certainly that governments in general reduce their sovereign debt levels and that in situations where the private sector debts have risen to very high levels, that there’d be some de-leveraging there,” Obstfeld states.

But is that movement towards lowering debt really happening? Are countries reducing their growth rate of credit and bringing down the ratio of credit-to-GDP? In a couple of countries, yes, he believes. “Notably in the Egyptian case, government debt has come down below 100 percent of the GDP. That has been a remarkable adjustment,” Obstfeld adds. “However, there are way too many countries in which this is not happening. The US, for example, is moving in the opposite direction.”

Is a movement towards lowering debt really happening?

“More interest rate increases expected in 2019 and maybe into 2020”
Given how many countries are currently suffering from high debt levels, it is essential to understand the development of interest rates over the short- and medium-term. Inflation in the US is at the Federal Bank’s target level, so Obstfeld expects some more increases in 2019 and maybe into 2020, but it could be “fairly moderate if inflation does not overshoot,” as low as 100 basis points.

The disruption for EMs could come from the fact that there is a “very big fiscal stimulus” in the US, putting upper pressure on wages. This could lead to a needed rise in interest rates in order to reduce demand enough in order to push inflation downwards, he emphasizes.

In concluding remarks at a seminar given at the American University in Cairo (AUC), Obstfeld recommended that countries build buffers and tackle medium-term challenges in order to boost resilience and potential growth, enhance fiscal and financial stability by reducing vulnerabilities, avoid protectionist reactions and seek globally cooperative multilateral solutions.

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