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Macroeconomic Policies

In developing countries, policy tightening and economic adjustment produced by volatility in global financial markets over the past year has reduced short term risks and helped diminish external and domestic imbalances. But inflation remains stubbornly high in several middle-income economies and real interest rates extremely low, indicating the need for further monetary tightening. While fiscal policy is in general not a problem in itself, deficits and debt to GDP ratios have been rising and policy should be tightened in a number of countries to ensure resilience going forward.

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The monetary policy tightening induced by the volatility of the past year generated a welcome tightening in the stance of monetary policy in many developing countries, which, by restraining domestic demand, helped diminish both internal and external imbalances.

Policy tightening contributed to a slowing in the pace of real credit growth in East Asia (Thailand, Indonesia, Malaysia and China) and in Brazil as well as in smaller economies such as Armenia. However, adjustment remains partial and credit continues to expand very rapidly in Turkey, and available data show no significant slowing in South Africa. This trend seems to have reversed in May when a number of countries, including Turkey, Hungary, Armenia, and Serbia cut policy rates. Overall, and despite what have been some substantial rate hikes in some cases, real interest rates in many developing countries remain very low and even negative in some cases (figure 20).

FIGURE 20 Despite recent rate hikes real interest rates remain low in many countries
Source: World Bank, Haver.

In contrast to high-income countries average developing country inflation (consumption weighted) has been steadily rising over the past 15 years (figure 21).

To a large extent this pickup in developing country inflation is a middle-income phenomena (figure 22). Inflation in low-income countries and most middle-income countries has been stable or declined following commodity-price induced run-ups. But in about a third of middle-income countries, inflation has been slow to abate despite the fall in global food prices and broad stability in global energy prices in recent years.

FIGURE 21 Rising inflation in a few large middle-income countries has pushed the aggregate up over time
Source: World Bank, Haver.
FIGURE 22 Influenced by commodity prices, inflation in low-income countries has eased
Source: World Bank, Haver.

Among major economies in the Middle East and North Africa region (Egypt, Iran), and in Latin America (Venezuela and Argentina), high or rising inflation reflects regional or domestic political tensions, weaker currencies or severe macroeconomic imbalances.

In several larger middle income economies persistent inflation reflects excess demand pressures (due to easy policies and strong credit growth) in recent years, which have fed rising inflation expectations. In these economies inflation momentum has continued to accelerate and annual inflation has remained high in recent months (Brazil, Turkey, Pakistan, Mongolia, Belarus, Zambia Ghana, Uganda and South Africa). In India inflation momentum has increased, mainly reflecting rising food prices. Inflation is also on a decline in Indonesia due to positive base effects related to the removal of fuel subsidies during 2013. Nevertheless, annual inflation remains above the upper bound of central bank targets or objectives in many cases, including in Indonesia (figure 23).

FIGURE 23 Inflation has accelerated in some countries and remains above target
Source: World Bank.* implicit inflation target for 2015 for India.

Earlier exchange rate depreciations partly explain the stickiness of middle-income inflation. While depreciations can improve external balances by making domestic goods cheaper abroad and by raising the domestic price of imported goods, they also contribute to inflation.

An analysis of the pass-through effects of exchange rate depreciations among developing countries suggests that the depreciations that occurred in the summer of 2013 and early 2014 may have added between 1 and 4 percentage points to inflation in most developing regions and that the effect will begin to fade between June and December 2014, depending on the size and timing of countries’ depreciation — as well as the extent of slack in the economy (see box 9, and webpage "Exchange rate and inflation trends" for more).

While tightening monetary policy will help lower inflation, ease the pace of credit growth and reduce the likelihood of domestic financial crises, fiscal tightening is also called for in a number of countries.

Overall the fiscal position of developing countries has deteriorated significantly since 2007 (figure 24). Thirty seven percent of developing countries saw their fiscal deficits rise by 3 or more percent of GDP between 2007 and 2013. Currently, almost half of developing countries have a government deficit that exceeds 3 percent of GDP. Moreover, debt levels have increased almost across the board with debt-to GDP ratios in more than half of developing countries having risen by more than 10 percentage points since 2007 (figure 25).

Some fiscal tightening has occurred in recent years: the aggregate cyclically-adjusted budget balance for developing countries widened by 3.4 percentage points between 2005 and 2009 to -4.2 percent. Since then it has gradually narrowed to -3.2 percent in 2013, an improvement of nearly a third.

With output gaps having closed and most developing countries growing in line with potential, this suggests that more tightening will need to be done if debt-levels are to be restored to their pre-crisis levels and if fiscal space is to be created so that countries can respond effectively to future shocks, should they arrive. Despite some consolidation, structural fiscal deficits remain large in absolute terms in several economies in East Asia (Papua New Guinea, Cambodia, Laos and Mongolia) and also in large middle-income economies such as Ghana, India, Kenya, Malaysia, and South Africa.

Among middle-income countries with relatively open capital markets, a tighter fiscal stance will help take some of the pressure off monetary policy — while reducing sovereign vulnerabilities to an eventual increase in interest rates.

FIGURE 24 Fiscal deficits are much higher than in 2007 in developing countries
Source: World Bank.
FIGURE 25 Debt rose by more than 10 percentage points of GDP half of developing countries
Source: World Bank.

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  1. FIGURE 20Despite recent rate hikes real interest rates remain low in many countries
  1. FIGURE 21Rising inflation in a few large middle-income countries has pushed the aggregate up over time
  2. FIGURE 22Influenced by commodity prices, inflation in low-income countries has eased
  3. FIGURE 23Inflation has accelerated in some countries and remains above target
  1. BOX 9Exchange rate pass-through to domestic inflation in developing countries
  2. FIGURE 24Fiscal deficits are much higher than in 2007 in developing countries
  3. FIGURE 25Debt rose by more than 10 percentage points of GDP half of developing countries