On debt and interest rates

Mahmoud Mohieldin
Tuesday 19 Mar 2024

Recent sharp fluctuations in international interest rates have posed tough challenges for the developing economies, with many now threatened by a vicious debt crisis that could leave them with crippling costs, writes Mahmoud Mohieldin


In the light of recent developments in inflation, unemployment, and growth rates, the markets are anticipating successive reductions in global interest rates in the second half of this year.

The cuts will most likely be limited – around a quarter of a percentage point each, bringing the US Federal Reserve-led global interest rate down by less than a percentage point by the end of the year.

This assumes a relatively smooth path ahead, free of sudden shocks or disruptions. It also assumes that the members of the Fed’s Monetary Policy Committee (MPC) will remain confident that the interest rate cuts will not negatively affect efforts to curb inflation in the US, which has yet to reach its stated long-term target of two per cent, and that they will tolerate slightly higher inflation rates than their short-term targets.

The MPC’s caution is understandable given the rise in inflation to rates unseen since the 1980s in the US and the controversy in the post-pandemic period over whether the inflation was only temporary and transitional or continuous and structural.

It will also be contemplating the debate over whether the surge in prices was due to supply-side disruptions and the consequent rising costs of supply chains, or to a surge in consumer demand thanks to monetary easing policies of the sort that the US economist Milton Friedman, in a 1969 discussion on the inflationary impacts of monetary expansion, likened to “dropping money from helicopters.”

If the predictions prove correct, the Fed’s lending and borrowing rates should fall from their current range of 5.25 to 5.50 per cent to around 4.50 to 4.75 per cent by the end of the year. Having followed the anticipated decisions of the major central banks last week, I share the view of the eminent Egyptian economist Mohamed Al-Erian that the Federal Reserve will not immediately lower interest rates but will instead, and more significantly, issue signals about the direction it will take regarding future cuts.

The Bank of England will probably follow suit, while the Bank of Japan may go ahead and raise its interest rates based on its sense of what could be best for the Japanese economy at this stage. A survey conducted by the German think tank ZEW found that two-thirds of those polled expected the European Central Bank to cut interest rates over the next six months in line with low inflation and lower growth in the Eurozone.

The sharp fluctuations in global interest rates during the past four decades have posed tough challenges for developing economies, and their performance has varied greatly, largely depending on the efficacy of their monetary and fiscal responses.

In December 1980, global interest rates reached their highest level of 20 per cent to combat the rampant inflation that was affecting the Western economies at the time. They then fell to zero when the global financial crisis hit in 2008 and stayed at zero during the Covid-19 pandemic in 2020.

Interest rate movements, whether hikes or cuts, have been generally predictable, and their repercussions have delivered no surprises. In August 2019, for example, I wrote the following on the downward trajectory of global interest rates some months before the outbreak of the Covid-19 pandemic. Cuts in interest rates became more necessary and needed to be implemented faster after it struck in 2020.

“If monetary policy is too slow to adapt as exchange rates stabilise, there will be an increase in short-term and sharply fluctuating flows of hot money, triggering nominal exchange rate hikes to attract them in, but only for such money to rush out again when interest rates abroad offer better prospects,” I wrote then.

“This volatility creates tension in the money markets. Lowering the interest rate on loans denominated in dollars could also tempt policymakers to borrow more from abroad or slow the pace of public debt restructuring. Such measures could have serious consequences if interest rates go up again.”

Many developing countries are currently suffering from what World Bank experts in February called a “silent debt crisis.” They described this as reminiscent of the troubles these countries experienced in the 1980s due to the rapid tightening of monetary policy in the US.

Although global interest rates are expected to fall, 28 developing countries with weak credit ratings and 31 with no credit rating at all will not be able to benefit from the relatively low-cost financing that becomes available in the international markets. This leaves one in three developing countries trapped with crippling debt and debt-servicing costs, which consume funds that would otherwise be available for education, healthcare, and development needs and thereby aggravating poverty, rising prices, and unemployment.

Many developing countries have paid dearly for their manner of public debt management. They have been overly reliant on loans of all sorts and slow in assessing them. They have embraced some long-term loans as necessary for development without having performed proper impact studies, while they have seized some short-term loans as forms of investment when, in fact, they were simply flows of hot money.

This leaves as rapidly as it enters, and it takes flight the moment there is the slightest downturn in potential yield. Astute monetary and fiscal authorities deal with loans prudently and in accordance with the potential benefits of a loan. They also take precautions against risks.

I believe that the reason for the silence surrounding the developing countries’ debt crises is that, although they are many and diffuse, like scattered fires, they have little impact and pose no systemic risks at the global level. International lenders can hedge against risks with the assurance that these local fires will not affect their portfolios.

Many believe that since the hunger and unemployment of the poor are not displayed on stock market screens, few are likely to care about them. But they have not thought this through clearly enough. The disruption of these countries’ economies would damage supply chains of basic commodities, raw materials, and goods, sending shock waves through the markets, and the socio-political repercussions of such crises would threaten international peace and security and aggravate forced migration.

So, what seems like a silent and diffuse crisis today could quickly escalate into a loud and concentrated one, causing widespread panic and confusion because of negligence and the inclination of many to bury their heads in the sand.


This article also appears in Arabic in Wednesday’s edition of Asharq Al-Awsat.

* A version of this article appears in print in the 21 March, 2024 edition of Al-Ahram Weekly

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