IMF cautions emerging markets tailor response based on circumstances

With Covid curbs posing an upside risk to retail inflation and putting considerable pressure on the Reserve Bank of India to raise interest rates, the IMF has cautioned emerging markets should tailor their response based on their circumstances and vulnerabilities.

"Some emerging markets have already started to adjust monetary policy and are preparing to scale back fiscal support to address rising debt and inflation. 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," senior IMF officials said in a blog post.

The government is likely to release the monthly retail inflation numbers for December on Wednesday. Inflation is likely to increase by almost one percentage point from the last month's print of 4.91%.

Also read: IMF delays release of new forecast to Jan 25 to factor in Covid-19 developments

The IMF said continued financial policy support for businesses should be reviewed, and plans to normalise such support should be calibrated carefully to the outlook and to preserve financial stability. For countries where corporate debt and bad loans were high even before the pandemic, some weaker banks and nonbank lenders may face solvency concerns if financing becomes difficult, it warned.

The RBI's Financial Stability Report earlier this month said the gross bad loans of banks may climb to 8.1% in September this year from 6.9% in September. It may even go up to 9.5% under severe stress. The RBI has not raised rates since the onset of Covid in 2020 but economists fear such a rise in inflation and changing global monetary policy backdrop could force the Indian central bank to raise rates this year.

The US Federal Reserve has pointed to an aggressive rate tightening path.

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