ME conflict: supply shock, and IMF policy-I

On April 9, in her curtain-raiser speech for the Spring meetings of International Monetary Fund (IMF), and World Bank – now underway – the managing director (MD) of IMF, Kristalina Georgieva, as the first major communication of IMF with member countries, and coming more than a month later since the outbreak of the Middle East (ME) conflict not only reflects significant ‘delay’ in terms of response timing, but the speech itself is ‘disappointing’, and even ‘dangerous’ for global economic outlook.

More than that it reflects virtually not learning anything from the misgivings of policy response of IMF in the previous major supply shock situation caused by Covid-19 pandemic, and the Ukraine War; not to mention that lack of learning spreading over many decades.

The statements at the curtain raiser by the MD are quite telling in terms of reasons for build-up of this disappointment, where instead of IMF supporting countries in pursuing counter-cyclical policy, especially net oil importing developing countries, a number of which are already highly debt distressed, as pointed out by the MD in her speech, she emphasized providing only as much as their fiscal space allowed, where no mention was made on reducing price distorting taxes on petroleum products, for instance, and focus mainly remained on subsidy being provided on oil, in that it should be kept to the minimum, and temporary, when it is quite clear that governance limitations of developing countries mean likelihood of serious lack of efficiency of providing targeted subsidy in a meaningful way.

To quote the MD, with regard to some of these aspects, the following is indicated, ‘What should countries do? …This being a classic negative supply shock, demand adjustment is unavoidable. …So, I appeal to all countries to reject go-it alone actions, export controls, price controls, and so on, that can further upset global conditions. …The challenge will be to detect, if and when, changing conditions take us from one state of the world, to another. For now, there is value in waiting and watching, with central banks stressing their commitment to price stability, but otherwise staying on hold with a stronger bias to action, if credibility is in question. Fiscal authorities should provide targeted, and temporary support to the vulnerable, aligned with their medium-term fiscal frameworks. Next, if inflation expectations threaten to break anchor, and ignite a costly inflation spiral, then central banks should step in firmly with rate hikes. Fiscal support should remain targeted, and temporary. Rate hikes, of course, would further dampen growth. That’s how they work, and that is the right price to pay for price stability. Finally, in a severe tightening of financial conditions, they add a negative demand shock, to the supply shock, and then monetary policy returns to a delicate balancing act, while fiscal policy if and only if, there is fiscal space switches to well-calibrated demand support.’

Instead of targeting inflation from supporting governments through balance of payments, and budgetary SDR support, and pushing programme countries to quickly, and firmly enhance tax base, and shift towards greater income, and progressive taxation, in an overall effort to support developing countries in particular to adopt counter-cyclical policies, and (justifiably) tackle inflation, without damaging growth prospects, and overall raising risk of stagflation, the usual recipe of aggregate demand management is disappointingly being provided. Hence, contrary to the MD’s advice ‘to all countries to reject go-it alone actions’, countries should try to do that in ways, and extents that allow adoption of counter-cyclical policy, and applying needed level of price controls, along with putting administrative controls on non-essential imports. Moreover, economic growth lost even after application of a meaningful level of counter-cyclical policy is indeed the ‘right price to pay for price stability’, not the unjustified sacrifice of growth due to practice of over-board monetary and fiscal austerity policies. For instance, the MD could have indicated a revisionist mind-set in terms of stressing less on programme countries to meet primary surplus-related targets.

In addition, IMF’s chief economist, Pierre-Olivier Gourinchas, also adds to the frustratingly little-learning attitude of IMF, whereby it continues to more or less harp its traditional stance of neoclassical, and closely related, neoliberal, and austerity mantra, with little focus is placed by IMF on providing counter-cyclical policy which, in turn, has an important role for building resilience.

Here, it needs to be pointed out that while IMF is correct that the world has been resilient enough to avoid recession, yet that is at the global level, with developing countries very less prepared in terms of bearing shocks, especially oil related shocks, as compared to developed countries, which too have a long distance to go in this regard, where any prolonged shock may easily tip the scales towards not only recession, but stagflation.

IMF response with regard to stagflation was quite wanting in the press briefing by its chief economist, among others, where in response to a question ‘Are there any lessons from that period that we could use to avoid any possible stagflation, especially if the conflict in the Middle East continues further?’ Pierre-Olivier apparently remained focused on bread-and-butter IMF emphasis in general in terms of mainly caring about inflation, and not growth, or purchasing power related issues that stagflation brings, not to mention no support being brought to table by IMF to allow dampening the impact of supply-side caused rise in prices of commodities, and putting most eggs in the basket of central banks to get going on reducing aggregate demand to overall reduced inflation! His reply included the following: ‘So this is why in my remarks, I said, of course, central banks cannot do anything about the price of oil, but they can do something about preventing the emergence of wageprice spirals, a deanchoring of inflation expectations. And they’re expected to do that.’

First, with regard to delay, while the Middle East conflict started on February 28, the first response from IMF came in the first week of March – March 3 to be precise, in a statement ‘IMF statement on the Middle East’ – whereby IMF indicated that while ‘the situation… adds to an already uncertain global economic environment’ and that ‘comprehensive assessment’ will be provided – more than a month later from even that statement – ‘in our April World Economic Outlook’! Later, on March 30, an IMF published article ‘How the war in the Middle East is affecting energy, trade, and finance’’ only scratched the surface of the Middle East conflict with general reflections, lacking any deeper specifics on possible policy response guidance for countries, and if and how IMF will provide any financial assistance. Given the exceedingly important standing of IMF for not just economic policy in general for countries, along with financial markets globally, its probable impact analysis, especially in the wake of virtual closure of Strait of Hormuz, would not only have been informative for economic policy, but would have also likely acted as an additional weight for all direct parties involved in the conflict.

This, in turn, would have added to the pressure from the political base of each side to resolve the conflict, not to mention more data driven scenarios – on the lines currently being indicated in the ongoing Spring meetings with regard to the implications of the conflict if it were to get more prolonged, or less prolonged, or finished quite soon – for more focused public discourse, and choices made by political leadership. This is, of course, not to say that without this information there was not much clarity on the likely severe consequences of this conflict on life, and economy, but more specific details with regard to possible extent of impacts on economic growth, inflation, and unemployment, for example, from IMF would have brought greater clarity, and added burden on political decision-making, not to mention greater evidence from media, and wider public in framing more questions from political, and economic leadership of, more importantly, the involved parties to the conflict, but also more generally.

Delay in providing information turned into deeper disappointment when during the curtain raiser speech of the MD of IMF, and later presentations by IMF on global, and regional economies, and financial markets, there is more of survey information on likely economic scenarios, along with highlighting the limitations of fiscal space, and how only very limited/targeted subsidies should be provided for safeguarding consumption of the low-income groups in the wake of supply shock, which obviously countries know very well about these limitations, but what they are primarily looking from IMF is not policy advice to practice financial prudence – although obviously welcome – but the provision of financial support from IMF to mainly net oil importing emerging economies/low-income countries. But that never came quite shockingly, given the deep supply shock of not just oil, but also of fertilizer in terms of negative economic consequence for these significantly fossil-fuel dependent, and mainly agriculture-based economies.

(To be continued)