Fiscal Policy To The Fore As The Tightening Cycle Comes To An End

• After a sharp tightening of monetary policy over 2022, the hiking cycle is nearing an end across emerging (EMs) and developed (DMs) markets.
• While containing inflation will remain a key priority for policymakers, Fitch does not anticipate any further hikes after Q2 2023, with a number of EM central banks – mainly in Latin America and Mainland China– cutting interest rates to support economic activity.
• From a fiscal policy perspective, the Agency anticipates a slight widening in the aggregate DM fiscal deficit in 2023, as several governments maintain high levels of fiscal support against a backdrop of weaker growth and still-high inflation. 
• The aggregate DM deficit is expected to widen from an estimated 4.3% of GDP in 2022 to 4.4% in 2023, before narrowing to 3.1% in 2024 as economic activity recovers and governments phase out support measures. On the other hand, Fitch projects that the GDP-weighted average of EM fiscal balances will narrow from a deficit of 5.6% of GDP in 2022 to a shortfall of 4.5% of GDP in 2023.
• A combination of weakening economic activity and tight monetary conditions saw DM inflation slow for a third consecutive month in December 2022, coming in at a seven-month low of 6.9% y-o-y.
• However, easing energy prices and normalising supply chains were also key factors behind the slowdown in inflation. DM inflation is projected to ease further in 2023 and 2024 to an average of 4.6% and 2.4% respectively, from 7.4% in 2022 as economic growth slows down, as the lagged impact of higher interest rates fully kicks in and energy prices continue to fall. 

(Source: Fitch Solutions)