Use dollar-denominated forex reserves wisely, IMF urges emerging economies

Amid the dollar’s appreciation to its highest level since 2000, the International Monetary Fund (IMF) has asked emerging and developing economies to prudently use their dollar denominated foreign exchange reserves, allowing the exchange rate to adjust.

A joint note released on Friday by IMF chief economist Pierre-Olivier Gourinchas and deputy Managing Director Gita Gopinath said central banks should intervene on a temporary basis when currency movements substantially raise financial stability risks or disrupt the ability to maintain price stability.

“Given the significant role of fundamental drivers, the appropriate response is to allow the exchange rate to adjust, while using monetary policy to keep inflation close to its target. The higher price of imported goods will help bring about the necessary adjustment to the fundamental shocks as it reduces imports, which in turn helps with reducing the buildup of external debt. Fiscal policy should be used to support the most vulnerable without jeopardising inflation goals”, the note added.

Calling for resilience amid the turmoil in financial markets as emerging market assets face a sudden loss of appetite, the note asks emerging economies to reinstate swap lines with advanced economy central banks.

“Countries with sound economic policies in need of addressing moderate vulnerabilities should proactively avail themselves of the IMF’s precautionary lines to meet future liquidity needs. Those with large foreign-currency debts should reduce foreign-exchange mismatches by using capital-flow management or macro prudential policies, in addition to debt management operations to smooth repayment profiles,” the note says.

The note however appreciated the tightening of monetary policy by the United States Fed to rein in inflation as not doing so might damage central bank credibility, de-anchor inflation expectations, and necessitate even more tightening later and greater spillovers to the rest of the world.

“The Fed should keep in mind that large spillovers are likely to spill back into the US economy. In addition, as a global provider of the world’s safe asset, the US could reactivate currency swap lines to eligible countries, as it extended at the start of the pandemic, to provide an important safety valve in times of currency market stress,” the note added.