Macro-fiscal analysis

Mapping economic stability for countries in the Global South

Richard Kima
MAY 2024

In 2024, central banks worldwide are confronted with the challenges of juggling inflation control, economic growth, and the preservation of financial stability. A new report from the United Nations Department of Economic and Social Affairs (UN DESA) outlines many of the dangers the economy faces, and offers some solutions—particularly for the economies in transition and Global South economies, where it is critically important to the wellbeing of billions of people that policymakers get things right.

The report rightly notes that uncertainties in monetary policies, particularly regarding the course and length of monetary tightening by the Federal Reserve System, the European Central Bank, and other central banks in high-income economies, cast a shadow over both the real economy and financial markets. One implication is that policymakers in high-income economies need to be more cognizant of the effects their policy decisions can have on other countries and take steps to increase communication and policy coordination to minimize the potentially large adverse impacts. The complete effects of monetary tightening, including ongoing quantitative tightening, have yet to be fully felt due to significant delays in monetary transmission mechanisms—the time it takes for monetary policy changes to influence other important macroeconomic variables.In addition to monetary and quantitative tightening, central banks in the Global South face the additional challenge of shrinking policy space, tightening global financial conditions, growing balance-of-payments concerns, sudden capital outflows, and debt sustainability risks.

Macroeconomic stability enables a stronger focus on growth and employment

To address these challenges, the authors of the UN DESA report suggest that central banks can use a broad range of tools, including capital flow management, macroprudential policies, and exchange rate management to minimize the adverse spillover effects of monetary tightening by the high-income economies. Importantly, these negative effects include higher borrowing costs for Global South countries, which threaten to reduce the available financing for development and increase debt sustainability risks. Some countries have already successfully used these tools. The UN DESA report cites, for instance, Brazil, which reduced the tax on fixed-income investments to zero in October 2008 during the Global Financial Crisis, which successfully slowed down capital outflows. To limit the influx of foreign capital amid quantitative easing in the United States, Brazil reintroduced taxes on fixed-income and equity inflows. These policies effectively increased the value of domestic assets and insulated the financial market in Brazil from global fluctuations.

Another interesting illustrative example is that of the People's Bank of China, which has employed various exchange rate management methods to uphold the stability of the renminbi. These methods include direct interventions in spot and forward markets, setting the central parity rate each morning before trading begins, establishing a daily trading band of +/- 2% around the central parity rate, and implementing changes in capital flow management measures to assist with exchange rate management. The precautionary and preemptive deployment of these policies could create a buffer and increase flexibility in the monetary policy response that would enable policymakers to prioritize growth and employment over financial stability.

Approaches for emerging economies

Going forward, emerging economies need to maintain strong economic basics to become less vulnerable to external problems. How is this accomplished? By elevating their technical and institutional capabilities. This involves acquiring economic and financial data promptly and enhancing supervisory capacities to prepare for policy enactment. Further, leveraging a variety of early warning indicators and country risk frameworks can assist monetary authorities in identifying both domestic and external risks. Additionally, the development of crisis-specific models is paramount. These models enable the assessment of susceptibility to crises, prediction of potential economic repercussions—such as a decline in output—and evaluation of the duration and likelihood of recovery.

The execution of fiscal strategies the Global South—such as the adoption of cautious fiscal policies, counter-cyclical fiscal actions, and the formation of sovereign stabilization funds—can also serve as a buffer against global shocks. These measures not only stimulate overall demand, but also aid in regulating capital flows and drawing in steady investments. Notably, lower income countries need to increase public revenues to widen their spending capacity. Over the medium term, governments should focus on augmenting revenues through progressive income, wealth, and environmentally friendly taxes. Digital technologies are useful in curbing tax evasion and avoidance and can support revenue collection.Many countries should also consider options that enhance fiscal spending efficiency, better target subsidies, and improve social protection programmes. Those in or at risk of debt distress require debt relief and restructuring to avert severe debt crises. Curbing fiscal deficits and adopting prudent measures can relieve currency pressures, instill confidence in foreign investors, and stabilize volatile capital flows, which are influenced by larger economies’ monetary policies. These steps are especially significant given the observed decline in potential output growth across much of the Global South in the last decade.

While the array of solutions is extensive, it is worth noting that central banks can also bolster international monetary policy cooperation. A more collaborative approach among monetary authorities worldwide is essential to minimize the adverse effects that higher-income central bank policies have on the rest of the world. Key areas for international cooperation should include reinforcing the multilateral trading system, restructuring development finance and the global financial framework, tackling debt sustainability issues in low- and middle-income countries, and significantly ramping up climate financing.

The views expressed in this piece are those of the authors, and do not necessarily reflect the views of the Institute or the United Nations University, nor the programme/project donors.