The global economy continues to face steep challenges and more than a third of the global economy will contract this year or next. In short, the worst is yet to come, and for many people 2023 will feel like a recession, warns IMF's World Economic Outlook report.

 

As storm clouds gather, policymakers need to keep a steady hand, says Pierre-Olivier Gourinchas, IMF's Economic Counsellor in a Foreword to the report.

 

The challenges are shaped by the lingering effects of three powerful forces: the Russian invasion of Ukraine, a cost-of-living crisis caused by persistent and broadening inflation pressures, and the slowdown in China, it says.

 

IMF's  latest forecasts project global growth to remain unchanged in 2022 at 3.2 percent and to slow to

2.7 percent in 2023 -- 0.2 percentage points lower than the July forecast -- with a 25 percent probability

that it could fall below 2 percent. 

 

The three largest economies -- the United States, the European Union, and China -- will continue to stall, it said. 

 

Russia’s invasion of Ukraine continues to powerfully destabilise the global economy. Beyond the escalating and senseless destruction of lives and livelihoods, it has led to a severe energy crisis in Europe that is sharply increasing costs of living and hampering economic activity. 

 

Persistent and broadening inflation pressures have triggered a rapid and synchronised tightening of monetary conditions, alongside a powerful appreciation of the US dollar against most other currencies. Tighter global monetary and financial conditions will work their way through the economy, weighing demand down and helping to gradually subjugate inflation, the report says.

 

So far, however, price pressures are proving quite stubborn and a major source of concern for policymakers.

 

"We expect global inflation to peak in late 2022 but to remain elevated for longer than previously expected, decreasing to 4.1 percent by 2024," said Gourinchas. 

 

In China, the frequent lockdowns under its zero Covid policy have taken a toll on the economy,

especially in the second quarter of 2022. Furthermore, the property sector, representing about one-fifth of

economic activity in China, is rapidly weakening. Given the size of China’s economy and its importance

for global supply chains, this will weigh heavily on global trade and activity.

 

The external environment is already very challenging for many emerging market and developing

economies. The sharp appreciation of the US dollar adds significantly to domestic price pressures and to the cost-of-living crisis for these countries. Capital flows have not recovered, and many low-income and developing economies remain in debt distress. 

 

The 2022 shocks will re-open economic wounds that were only partially healed following the pandemic. Downside risks to the outlook remain elevated, while policy trade-offs to address the cost-of-living

crisis have become acutely challenging. 

 

The risk of monetary, fiscal, or financial policy miscalibration has risen sharply at a time when the world economy remains historically fragile and financial markets are showing signs of stress, he said.

 

Increasing price pressures remain the most immediate threat to current and future prosperity by squeezing real incomes and undermining macroeconomic stability.

 

Central banks around the world are now laser-focused on restoring price stability, and the pace of tightening has accelerated sharply. There are risks of both under and over-tightening. Under-tightening would entrench further the inflation process, erode the credibility of central banks, and de-anchor inflation expectations. As history repeatedly teaches us, this would only increase the eventual cost of bringing inflation under control.

 

Over-tightening risks pushing the global economy into an unnecessarily harsh recession. As several prominent voices have argued recently, over-tightening is more likely when central banks act in an uncoordinated fashion. Financial markets may also struggle to cope with an overly rapid pace of tightening. Yet, the costs of these policy mistakes are not symmetric. Misjudging yet again the stubborn persistence of inflation could prove much more detrimental to future macroeconomic stability by gravely undermining the hard-won credibility of central banks. 

 

As economies start slowing down, and financial fragilities emerge, calls for a pivot toward looser monetary conditions will inevitably become louder. Where necessary, financial policy should ensure that markets remain stable, but central banks around the world need to keep a steady hand with monetary policy firmly focused on taming inflation.

 

These challenges do not imply that a large downturn is inevitable. In many countries, including the

United States, the United Kingdom, and the euro area, labour markets remain tight, with historically

low unemployment rates and high levels of vacancies. 

 

He mentions a few important principles. First, for countries where the pandemic is now firmly receding,

it is time to rebuild fiscal buffers. As the pandemic vividly illustrated, fiscal space is essential for dealing

with crises. Countries with more fiscal room were better able to protect households and businesses.

 

Second, fiscal policy should not work at crosspurposes with monetary authorities’ efforts to quell inflation. Doing otherwise will only prolong the fight to bring inflation down, risk de-anchoring inflation expectations, increase funding costs, and stoke further financial instability, complicating the task of fiscal as well as monetary and financial authorities, as recent events illustrated. 

 

Third, the energy crisis, especially in Europe, is not a transitory shock. The geopolitical re-alignment of energy supplies in the wake of Russia’s war against Ukraine is broad and permanent. Winter 2022 will be challenging for Europe, but winter 2023 will likely be worse. Fiscal authorities in the region need to plan and coordinate accordingly. 

 

Fourth, price signals are essential to help curb demand and stimulate supply. Price controls, untargeted subsidies, or export bans are fiscally costly and lead to excess demand, undersupply, misallocation, rationing, and black-market premiums. History teaches us they rarely work. Fiscal policy should instead aim to protect the most vulnerable through targeted and temporary transfers. If some aggregate fiscal support cannot be avoided, especially in countries hardest hit by the energy crisis, it is important to embed policy in a credible medium-term fiscal framework. 

 

Fifth, fiscal policy can help economies adapt to a more volatile environment and bounce back from adversity by investing in expanding productive capacity: human capital, digitalization, green energy, and supply chain diversification can make economies more resilient when the next crisis comes. Unfortunately, these simple principles are not uniformly guiding current policy, and the risk of outsized, poorly targeted, and broadly stimulative fiscal packages in many countries is not negligible.

 

For many emerging markets, the strength of the dollar is causing acute challenges, tightening financial

conditions, and increasing the cost of imported goods. The dollar is now at its highest level since the early 2000s. So far, this appreciation appears mostly driven by fundamental forces, such as the tightening of monetary policy in the United States and the energy crisis. The appropriate response in most countries is to calibrate monetary policy to maintain price stability, while letting exchange rates adjust, conserving valuable foreign exchange reserves for when financial conditions really worsen.

 

As the global economy is headed for stormy waters, financial turmoil may well erupt, prompting investors to seek the protection of safe-haven investments, such as US Treasuries, and pushing the dollar even higher.

 

"Now is the time for emerging market policymakers to batten down the hatches. Eligible countries with

sound policies should urgently consider improving their liquidity buffers by requesting access to precautionary instruments from the Fund," said Gourinchas.

 

"Looking ahead, countries should also aim to minimise the impact of future financial turmoil through a combination of preemptive macroprudential and capital flow measures, where appropriate, in line with our Integrated Policy Framework. Too many low-income countries are in or close to debt distress. Progress toward orderly debt restructurings through the Group of Twenty’s Common Framework for the most affected is urgently needed to avert a wave of sovereign debt crisis. Time may soon be running out," he warned.

 

Finally, the energy and food crises, coupled with extreme summer temperatures, starkly remind us of

what an uncontrolled climate transition would look like. Much action is needed to implement climate

policies that will ward off catastrophic climate change, he said. -TradeArabia News Service