Global economy on shaky footing amid high interest rates

“Many developing economies are struggling to cope with low growth, persistently high inflation and record debt levels. Yet new dangers, such as the possibility of wider spillovers from renewed financial tensions in advanced economies, could make the situation even worse for these countries. » said Ayhan Kose, Deputy Chief Economist, World Bank Group. “Policymakers in these economies should act quickly to prevent financial contagion and reduce national vulnerabilities in the short term. »

In advanced economies, growth is expected to decelerate from 2.6% in 2022 to 0.7% this year and remain weak in 2024, the report said. After growing 1.1% in 2023, the US economy is expected to decelerate to 0.8% in 2024, mainly due to the lingering impact of the sharp rise in interest rates over the past year and a half. In the eurozone, growth is expected to slow to 0.4% in 2023 from 3.5% in 2022, due to the lagged effect of tightening monetary policy and rising energy prices.

The report also provides an analysis of how increases in US interest rates affect emerging countries. Most of the rise in two-year Treasury yields over the past year and a half has been due to investor expectations for aggressive U.S. monetary policy to control inflation. According to the report, this particular type of interest rate increase is associated with negative financial effects in EMDEs, including a higher likelihood of financial crisis. Moreover, these effects are more pronounced in the most economically vulnerable countries. In particular, frontier markets – those with less developed financial markets and more limited access to international capital – tend to experience outsized increases in borrowing costs; for example, sovereign risk spreads in frontier markets tend to increase more than three times as much as those in other EMDEs.

Additionally, the report provides a comprehensive assessment of the fiscal policy challenges facing low-income economies. These countries are in a desperate situation. Rising interest rates have worsened the deterioration of their fiscal situation over the past decade. Public debt now represents on average around 70% of GDP. Interest payments are eating up a growing share of limited government revenues. Fourteen low-income countries are already in debt distress or at high risk of being so. Spending pressures have increased in these economies. Negative shocks such as extreme weather events and conflict are more likely to plunge households into distress in low-income countries than anywhere else due to limited social safety nets. On average, these countries spend only 3% of their GDP on their most vulnerable citizens, well below the 26% average for developing economies.