The swift tightening of monetary policy in advanced economies, especially the United States, in response to high inflation poses grave challenges to emerging markets and developing economies (EMDEs) such as Ghana.
According to the World Bank, the tightening of financial conditions in the United States and the associated increase in risk aversion spill over to EMDEs, leading to higher domestic interest rates and risk spreads as well as lower equity prices.
“Increases in U.S. interest rates also boost the cost of servicing dollar-denominated debt—both directly, by raising interest payments, and indirectly, by pushing up the foreign exchange value of the dollar, which increases the domestic-currency cost of repaying dollar debt”, it explained in its June 2023 Global Economic Prospects Report.
It added that currency depreciation may also exacerbate inflation, requiring additional monetary tightening by EMDE central banks.
These spillovers, it continued, can heighten the likelihood of financial distress in EMDEs, especially in those with pre-existing vulnerabilities.
“Indeed, these developments have already contributed to financial strains and even default in several countries. EMDEs have become particularly exposed to rising global interest rates, as the COVID-19 pandemic gave further impetus to a broad-based surge in debt levels in EMDEs, with government debt reaching record highs”, it added.
Increase in US interest rates due to inflation
The report further said persistently high U.S. inflation, along with the Fed’s pivot toward a more aggressive tightening stance, suggests that increases in U.S. interest rates over the past year and a half have been driven predominantly by inflation and reaction shocks.
“That said, the recent period of turmoil in the global banking sector has further complicated the path of U.S. monetary policy. If recent banking stresses were to intensify, the Fed could pause or even reverse its tightening of monetary policy”, it mentioned.