In reaction to tighter financial conditions and an impending policy tightening by the Federal Reserve Bank of the United States, the International Monetary Fund has encouraged emerging economies, including Nigeria, to allow their currencies to depreciate.
The IMF disclosed this in a blog post titled, ‘Emerging Economies Must Prepare for Fed Policy Tightening,’ published last Monday.
According to the IMF, emerging markets have already started to adjust monetary policies and are preparing to scale back fiscal support to address rising debt and inflation.
What the report is saying
The report said emerging markets with significant public and private indebtedness, foreign exchange exposures, and weaker current-account balances have seen bigger currency swings relative to the US dollar in recent months.
As a result, the IMF warned that the emerging economies’ weaker growth and increased vulnerability could produce negative feedback loops.
It stated, “In response to tighter funding conditions, emerging markets should tailor their response based on their circumstances and vulnerabilities. Those with policy credibility on containing inflation can tighten monetary policy more gradually, while others with stronger inflation pressures or weaker institutions must act swiftly and comprehensively.
“In either case, responses should include letting currencies depreciate and raising benchmark interest rates. If faced with disorderly conditions in foreign exchange markets, central banks with sufficient reserves can intervene provided this intervention does not substitute for warranted macroeconomic adjustment.
“Nevertheless, such actions can pose difficult choices for emerging markets as they trade off supporting a weak domestic economy with safeguarding price and external stability. Similarly, extending support to businesses beyond existing measures may increase credit risks and weaken the longer-term health of financial institutions by delaying the recognition of losses. And rolling back those measures could further tighten financial conditions, weakening the recovery.”
According to the IMF, emerging economies must take action now to enhance policy frameworks and decrease vulnerabilities in order to manage tradeoffs.
It added that central banks must communicate their tightening actions to limit inflation pressures clearly and consistently for the public to comprehend the importance of price stability.
