Fed rate hike ‘pours oil’ on ‘fire’ of global debt crisis

Editor’s note: He Weiwen is a senior research fellow at the Center for China and Globalization. The opinions expressed in the article are the authorit is personal opinions and do not necessarily represent those of CGTN.

The fourth interest rate hike in 2022 by the United States after the regularly scheduled meeting of the Federal Open Market Committee on July 27 – by 75 basis points (bps) – will undoubtedly throw new fuel on the “fire” of the a growing global debt crisis.

The worst inflation in 40 years still seems to be rising unabated. After the Federal Reserve (Fed) hiked a frenzied 75 basis points last month, the US Department of Labor reported that the consumer price index for June hit a new high of 9.1%, versus 8.6% in May. This leaves the Fed with no choice but to continue with drastic “Volcker 2.0” style rate hikes: not only at its July meeting, but also at its upcoming meetings in September, November and December. It also left the world with no choice but to fight “the Fed crisis”. The biggest risk ahead is a global sovereign debt crisis, with Sri Lanka just the tip of the iceberg.

The Fed’s rate hikes led to a sharp rise in the US dollar. Over the past five months, the dollar has risen 10.3% against the euro, breaking parity with the dollar for the first time since 2000. It also rose to 136 yen while the pound fell to only $1.20 last Friday. However, many emerging and developing economies are suffering the most. The Wall Street Journal estimated that the dollar rose more than 10% against most currencies in developing economies. Vietnam has earmarked $130 billion of its foreign exchange reserve to defend its currency. Chile used $25 billion to defend its peso. Turkey, India, Indonesia and Thailand have announced various measures to defend their currencies.

The strength of the dollar caused a massive outflow of capital from emerging markets. JP Morgan estimated that as of July 10, $52 billion of capital had flown out of emerging markets in recent months, the largest in 17 years.

The sovereign debt crisis of developing countries is spreading

Sharp currency depreciation and massive capital flight are worsening sovereign debt positions in many emerging economies, especially low-income developing countries.

Even before the current Fed rate hikes and rising dollar, the developing world had already been hit hard, twice. The first blow was COVID-19, which pushed 100 million people back into absolute poverty and increased the total external debt of developing countries by $500 billion. The second blow was the Ukrainian crisis. Soaring oil and gas prices have increased import bills and fiscal pressure in some countries in the Middle East and North Africa. Every $10 increase in the price of oil will add 0.3 percentage point to the budget deficit in Turkey and 1.3 percentage point in Lebanon. Egypt, Tunisia, Ghana and Kenya are also experiencing similar difficulties. Egypt, for example, saw its currency depreciate by 15% and turned to the International Monetary Fund (IMF) for financial assistance.

Soaring global food prices, after a sharp 40% rise in 2021, have compounded the difficulties of the developing world, particularly those in the Middle East and North Africa, South Asia and the United States. ‘Sub-Saharan Africa. Kristalina Georgieva, Managing Director of the IMF, and Antonio Guterres, Secretary General of the UN, warned of the danger of global famine.

The World Bank has already warned that a dozen least developed countries will experience defaults next year. It would be the biggest debt crisis in developing countries in 30 years.

The current Fed hikes and strong dollar are giving these developing countries fresh and mortal blows. As noted above, the rate hikes have pushed the dollar up significantly. This led to a sharp increase in the cost of servicing dollar debt for developing countries and huge capital outflows that depleted their dollar reserves. A recent IMF report found that the debt burden of middle-income economies was the highest in 30 years. Ten percent of all middle-income economies are already facing a debt crisis and another 50% are facing serious problems.

Sri Lanka provided a textbook case for all. Its economy was hit for the first time by COVID-19. Its exports, mainly of clothing, and income from tourism have fallen sharply. The country was then again affected by the Ukrainian crisis because it depends on imports of oil and food. Soaring food and oil prices quickly emptied its reserves. Once again, the rise in the dollar hit the Sri Lankan rupee hard which fell from 202.0020 per dollar on February 25 to 359.51 per dollar, a fall of 43.8%. As of May 19, Sri Lanka had only $2 billion in official reserves against a total external debt of $51 billion and declared state bankruptcy.

If the Fed hikes and their aftermath continue, there will be an extremely high risk of a chain reaction of the debt crisis in the world’s developing economies. Simultaneously, global financial turmoil and a recession accompanied by high inflation loom on the horizon. It also seems certain that the world will miss the target of the UN’s 2030 Sustainable Development Goals.

Global Joint Efforts Imperative

Faced with this major risk that threatens the world, all national governments and international institutions must immediately endeavor to avoid or minimize this debt crisis.

First, the US government, namely the Fed and the Treasury Department, should continue to exchange information and coordinate with other national governments on macroeconomic and monetary policies, in order to cushion the blow of each rate hike. . One of the major emergencies is the New Plaza Accord, which needs to be discussed and accepted by the developed and developing economies of the world, which may result in the collective intervention of the world’s central banks in the global currency markets to slow the rise of the dollar.

Second, multilateral mechanisms, including the IMF, the G20 and the Paris Club, should strengthen the necessary debt relief tools and policy coordination. IMF Special Drawing Rights lending, while effective, should also be more targeted to low-income developing economies. The 2022 G20 summit, scheduled for Indonesia in November, is expected to reach meaningful agreements on debt relief, waivers and rescheduling deals. Additional regional contingency payment arrangements should also be encouraged.

Third, globalization and multilateralism, instead of fragmentation, should be supported. Some Western countries have fabricated a completely unfounded story that China is responsible for Sri Lanka’s debt crisis. Most of Sri Lanka’s sovereign debt has been lent by the Asian Development Bank and other institutional investors, including some on Wall Street. China accounted for only 10% of Sri Lanka’s total external debt. The fragmentation approach will only outweigh the joint efforts of the whole world.

Fourth, reform of the international payment system must be accelerated. The current debt crisis shows us once again that the dominance of the US dollar in the global payment and settlement system is a global problem. Sovereign debt loans could be made in different reserve currencies, increasing the share of the euro, renminbi, pound and yen. The share of the dollar in the reserve currencies should be gradually reduced to less than 50% against 60% currently. Sovereign borrowings and payments must be made in baskets of currencies. Through this approach, the dollar risk and, therefore, the risk of a debt crisis, will be significantly reduced.

Robert P. Matthews