Aurelia Butler

Christine Lagarde said the European Central Bank would act in “a determined and sustained manner” to tackle record inflation in the eurozone, especially if there were signs of price expectations rising sharply among consumers and businesses. “Inflation in the euro area is undesirably high and it is projected to stay that way for some time to come,” the ECB president told its annual forum in Sintra, Portugal, on Tuesday, in a hardening of her comments on price growth. “This is a great challenge for our monetary policy.”“Inflation pressures are broadening and intensifying,” Lagarde added. Eurozone wage growth was expected to double to 4 per cent this year, she said, adding that supply bottlenecks were likely to be persistent and there was no sign of an end to high energy and commodity prices caused by Russia’s invasion of Ukraine.The ECB is planning to start raising rates in July for the first time since 2011, and Lagarde on Tuesday stuck to the bank’s plan to begin with a quarter percentage point increase before a bigger move in September unless there is a rapid improvement in the inflation outlook. The bank will also stop buying more bonds from Friday in response to record annual inflation in the eurozone of 8.1 per cent in May, quadruple the ECB’s 2 per cent target.While most western central banks have started raising rates, the ECB’s benchmark deposit rate remains at minus 0.5 per cent, though it has said it expects this to rise above zero in September.Lagarde said the ECB needed to act “in a determined and sustained manner, incorporating our principles of gradualism and optionality” — a shift from her previous comments that had put more emphasis on a commitment to raise rates only “gradually”.There were “clearly conditions in which gradualism would not be appropriate”, said the ECB president. These included a “de-anchoring” of inflation expectations or “a more permanent loss of economic potential that limits resource availability” — such as one caused by a cut-off of Russian energy supplies to Europe — and would require it “to withdraw accommodation more promptly to stamp out the risk of a self-fulfilling spiral”.Eurozone rate-setters face a difficult balancing act between reversing almost a decade of ultra-loose monetary policy to address soaring prices while trying to avoid another debt crisis in Europe after borrowing costs rose sharply in weaker countries such as Italy.Some hawkish rate-setters plan to push for a bigger rate rise of 50 basis points in July if price pressures keep rising. “If we see that the situation has worsened, that inflation is high and we see negative news in terms of inflation expectations, then in my view front-loading the increase would be a reasonable choice,” Mārtiņš Kazāks, Latvia’s central bank governor, told Bloomberg TV.This month, the ECB called an emergency meeting to announce it was speeding up work on a new instrument to tackle divergence in the region’s bond markets as it tried to prevent borrowing costs from rising so high that they risked triggering a financial crisis.

Without giving new details of the planned new instrument, Lagarde said it would “have to be effective while being proportionate and containing sufficient safeguards to preserve the impetus of member states towards a sound fiscal policy”.She said a new “anti-fragmentation” bond-buying tool could be designed to keep it separate from its other monetary policy instruments and to avoid one interfering with the other. “There is no trade-off between launching this new tool and adopting the necessary policy stance to stabilise inflation at our target. In fact, one enables the other.” Lagarde said that from the start of July, the ECB would start tackling any “unwarranted fragmentation” in bond markets by using flexibility in the way it reinvests the proceeds of bonds that mature in the €1.7tn portfolio of assets bought to counter the impact of the coronavirus pandemic.Economists are concerned that rising interest rates could tip the eurozone economy into a painful period of stagflation, especially if Russia continues to squeeze its supply of natural gas and forces governments to ration energy supplies for industry.Lagarde said the erosion of households’ spending power by high inflation could hit demand and “test the resilience of the labour market and possibly temper the expected rise in labour income”. But she added that, although the ECB had downgraded its growth forecasts earlier this month, it still expected “positive growth rates due to the domestic buffers against the loss of growth momentum”. More

The writer is head of emerging markets economics at CitiDeveloping countries live their economic lives at the mercy of the US Federal Reserve. This may sound blunt, but that makes it no less true. When US monetary conditions are loose, capital is pushed towards emerging economies, making it easier for these countries to fund themselves. And when the Fed tightens, as it is doing these days, the wave reverses course as capital seeks higher yields back in the US.This cycle is usually understood as resulting from the impact of higher or lower US interest rates on capital flows to developing countries. Yet it’s not just the yield on US assets that affects these countries; the dollar exchange rate also plays a big role in this drama.Here are four ways in which a stronger dollar makes life tough for emerging economies.First, a stronger dollar tends to depress global trade growth. It is the dominant currency for invoicing and settling a huge swath of global trade transactions. Since the purchasing power of non-US currencies declines when the dollar strengthens, an appreciation of the US currency tends to make the world poorer and less engaged in trade.Since developing countries tend to be what economists call small, open economies that are especially dependent on global trade, anything that puts downward pressure on that is likely to be unhelpful for them.Second, a stronger dollar tends to erode the creditworthiness of developing countries that have debt denominated in the US currency. Dollar appreciation makes it more expensive for countries to buy the US currency they need to service their debts. This is likely to be most painful for lower-income countries that typically have only a constrained ability to borrow internationally in their own currencies even at the best of times.Third, a strong dollar is likely to be inconvenient for China these days, and what’s bad for that country is generally unhelpful for emerging economies given their linkages to Chinese supply chains and commodities demand.Although it is superficially attractive to think that a weakening renminbi might be a convenient way of boosting Chinese exports, there are two bigger forces at work in the opposite direction.One is that by driving up the cost of imported commodities, a weaker renminbi makes life tough for small- and medium-sized enterprises in China that in any case have been facing a prolonged squeeze on their profitability. And another is that a weakening renminbi tends to trigger capital outflows from China, something that authorities in Beijing prefer to avoid as they seek to keep expectations on its currency positive.Finally, a stronger dollar now is likely to be more inflationary for emerging economies than was the case in the past. Recent years have allowed us to forget that currency depreciation in a developing country can quickly lead to inflation. That’s because the so-called “pass-through” from the exchange rate to inflation has indeed tended to be relatively low in recent years.

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Yet the past may not be a good guide to the present. One big reason why exchange rate depreciations haven’t proved inflationary in recent years is simply that global inflation was stubbornly low. That’s no longer true. It is worth worrying that at a time when inflation is accelerating, a currency depreciation is more likely to add a kicker to domestic price pressures. Add combustible material to a fire and you get more fire.The world economy is a fairly hostile environment for developing countries these days: rising recession risks in the west; an uncomfortable slowdown in China; diminished availability and higher cost of funding as investors become more risk averse; accelerating inflation almost everywhere; and increasing concern about the availability of food in a number of countries.And that’s just in the foreground. In the background, the prospect of de-globalising efforts by policymakers in the US, in Europe and in China to achieve supply chain resilience will come at the expense of future flows of foreign direct investment to emerging economies.With all this going on, a strengthening dollar is the last thing developing countries need. Yet the problem may not go away soon. In the early 1980s — the last time the US had a truly stubborn inflation problem to deal with — the dollar went up by close to 80 per cent. History may not quite repeat itself, but if the dollar is going to keep strengthening with anything like the ferocity of 40 years ago, the ride will be bumpy for emerging economies.  More

Within months of his election last year, Zambia’s president Hakainde Hichilema had succeeded in negotiating a $1.4bn IMF bailout for the debt-stricken southern African country. But hammering out a deal with all its creditors, chief among them China, could take much longer. With Beijing now the biggest bilateral lender to low-income countries, Zambia’s travails are a test case of its willingness to take the lead in restructuring the debt obligations of defaulting states. Until now, Beijing has negotiated with its borrowers behind closed doors, one to one.At a time of rising economic stress when Sri Lanka is in default and Pakistan is close to it, other countries that are heavily indebted to Beijing are keeping a close eye on proceedings in Lusaka, as are its other creditors. The Zambian crisis also illustrates how Chinese loans come from a variety of government institutions whose interests often vary, adding extra complexity to efforts to reach a deal.“The composition of the debts of developing countries has shifted dramatically over the past 10 years toward China and the private sector,” David Malpass, president of the World Bank, told the Financial Times. “China recognises that [engaging with Zambia’s other creditors] is an important way to work with the global community. It’s an important step in that China is recognising its role in debt restructurings.”Zambia became the first country during the pandemic to default, missing payments on $17bn-worth of foreign debt in 2020. After negotiating the rescue package with the IMF, Zambia needs talks with creditors to move swiftly so it can reboot growth and development. Before the fund can release the cash, it wants “assurances” from other official creditors — of which the biggest is China with an estimated $6bn in loans — that they will agree to debt relief. Little is known about the terms on which China has lent and how Beijing will behave.China is not a member of the Paris Club, set up to restructure loans granted by western governments, and has voiced concerns about the austerity measures the IMF imposes on cash-strapped debtors. Different Chinese entities from policy banks to commercial lenders issue loans, each with their own priorities. Deborah Bräutigam, director of the China Africa Research Initiative (CARI) at Johns Hopkins University, said it was important to understand that “there is no single China” but rather a “fragmented authoritarianism”.In the case of Zambia, the lenders include the China International Development Cooperation Agency and others led by Eximbank of China and China Development Bank. According to CARI, the loans were made under widely varying terms. Zambia’s president Hakainde Hichilema. After negotiating a rescue package with the IMF, Zambia needs talks with creditors to move swiftly so it can reboot growth and development © Spencer Platt/Getty ImagesThe likely lengthy debt workout in Zambia also points to a wider flaw in global handling of sovereign defaults, which the World Bank has warned could soon surge to levels last seen in the 1980s. This month Lazard, the French group advising Zambia, said that a common framework, set up during the pandemic by the G20 group of large economies to ensure that debt restructurings could be done quickly, was too vague. Lack of guidance on co-ordination “creates a lot of frustrations for creditors — be they private or official — but also for debtor countries,” Lazard said. Malpass, a frequent critic of China’s obstinance, has called for a rethink of the framework. He said commercial creditors should sit alongside their sovereign counterparts during debt negotiations, rather than being presented later with a fait accompli. But with the $1tn Belt and Road Initiative making China the most significant bilateral lender so far this century, reform appears unthinkable without Beijing’s buy-in. “China has the leverage to delay or potentially prevent the common framework from proceeding,” said Kevin Daly, portfolio manager for emerging market debt at abrdn and a member of a committee representing Zambia’s bondholders. “It’s not a stretch to say its success or failure hangs on Zambia.”Chinese lenders have adopted an approach different from that of other commercial creditors. They have been willing to extend maturities and grant payment holidays to struggling debtors, but reluctant to accept any reduction in the amount of money they are owed over fears, observers say, of the political backlash in Beijing. This puts them at odds with commercial creditors such as bondholders.

The likely lengthy debt workout in Zambia points to a wider flaw in global handling of sovereign defaults, which the World Bank has warned could soon surge to levels last seen in the 1980s © Waldo Swiegers/Bloomberg

Beijing recognises that it is under a lot of pressure to figure out new solutions. “Existing methods, led by loan extensions and debt relief [mainly of interest-free loans] are harder to continue,” a government adviser said. Yet China’s finance ministry and central bank, the People’s Bank of China, are at odds over what the solutions might be. “The finance ministry is in general more cautious in giving concessions as doing so would exacerbate its fiscal burden. As the biggest shareholder of policy lenders like China Development Bank and the Exim Bank, it will bear the losses of restructuring of interest-free loans and other low-interest policy loans,” the adviser said. “In contrast, commercial lenders like ICBC, which are regulated by the PBoC, and [so] by extension the PBoC, are open to a variety of restructuring methods that could help shore up losses sooner but may force lenders to write off some of the bad loans,” she said, adding that they were keen to work together to minimise losses.

Others advise caution. “Is this China coming into the fold? Absolutely not,” said Douglas Rediker, senior fellow at the Brookings Institution, adding that it would be “naive to believe that any one instance of China being co-operative will be transferable to any other instance”.A recent call between Hichilema and China’s president Xi Jinping was seen as a breakthrough and enabled talks, co-led by Beijing, in Paris earlier this month. French officials said the talks went well and that discussions would continue. “It is a commitment they have made,” said Emmanuel Moulin, head of the French Treasury and chair of the Paris Club. “But now they need to deliver.”These glimmers of hope mean Zambian officials are optimistic that a deal can be reached. “In view of the fact that China is finally on board and is speaking out about the need for the IMF to act swiftly,” said one official in Lusaka. “This is the time to give the process a bit more patience.” More

The writer is a senior fellow at Harvard Kennedy School and chief economist at KrollIt has been 10 years since then European Central Bank president Mario Draghi made his famous promise to do “whatever it takes” to hold the eurozone together. How ironic that the same man is now at the helm of the country that might just bring the currency union back into crisis. Italian 10-year government bond yields jumped after the ECB announced it would end its bond-buying programme by July, and then consider raising interest rates. The spread to German Bund yields, a chief measure of financial stress in Europe, reached its widest since 2013. ECB officials calmed markets by holding a crisis meeting to announce they will create an anti-fragmentation tool that works better than the two it already has. Unfortunately for Italy, and the eurozone, the third time may not be the charm. At the June 15 emergency meeting, the ECB announced it will reinvest maturing bonds “flexibly” under its pandemic emergency purchase programme (Pepp). But the mechanism for reinvestment is unclear. If Pepp reinvestments can be withheld (shrinking the ECB’s balance sheet temporarily) and then deployed in a single country all at once, it could be an incredibly powerful tool. But it’s unclear this will be allowed. There are significant political constraints as well. I doubt the German Bundesbank would be happy to swap Bunds with BTPs on its balance sheet. The second existing tool is Outright Monetary Transactions (OMT). Created during the 2012 debt crisis, OMT involves the ECB buying a country’s sovereign debt in the secondary markets — as long as that country has agreed to strict conditionality. It has never been used, largely because countries have made it clear they would not agree to take fiscal marching orders from the European Stability Mechanism (ESM). While it still exists, it is in effect defunct. And so the ECB governing council has tasked staff with devising a new tool to address fragmentation. They hope to announce it at the next policy meeting on July 21. I fear it will come up short. The Pepp reinvestment scheme is limited in size and free from conditionality, while OMT is unlimited and has strict conditionality. The new anti-fragmentation tool will fall somewhere in between. To reassure investors, the new mechanism will need to be surprisingly large. But how large is that? And to what end? As fiscal policies diverge in the eurozone, spreads between government bond yields should widen. How will the ECB define what spreads are appropriate versus unacceptable? If the ECB announces the spreads it is targeting, investors will test it. To overcome opposition from northern European countries concerned about moral hazard and avoid legal challenges, the anti-fragmentation tool must have conditions. Clearly the conditionality of a full programme under the ESM is too much. One option is only to allow countries to access the anti-fragmentation tool if they are not in an excessive deficit procedure for deficits or debts that are too high, or if they meet their Recovery and Resilience fund milestones. But government bond yields can move swiftly, while EDP and RRF reviews are political processes that take time. What’s more, one reason Italy is inspiring the hurried creation of this anti-fragmentation tool is that it might not clear this lower bar for participation. Its primary budget deficit (not including debt servicing costs) was just under 4 per cent of gross domestic product in 2021 and it has a relatively poor record when it comes to absorbing EU funds. Time is also not on Italy’s side. It has about €200bn in debt to roll over later this year and an additional €305bn next year. The average weighted maturity of Italian government debt is roughly seven years. This compares with about 18 years for Greece. Furthermore, Italy is due to hold an election by June 2023. Italian debt will seem even riskier if Draghi exits and populists maintain momentum. In March 2020, ECB president Christine Lagarde (in)famously stated the central bank is “not here to close spreads . . . There are other tools for that and other actors to actually deal with those issues.” That is wrong. The other tools are ineffective and the other actors — namely fiscal authorities — are not stepping up. Markets are calm at the moment, but with tepid growth, high inflation and high deficits and debt burdens in the eurozone, a damp squib for an anti-fragmentation tool could spark another crisis. More