In forecasts released today in Washington during the spring meetings of the IMF and the World Bank, the Fund announced that the gradual recovery of the global economy remains on track, but the path is getting rocky and financial risks have increased.
China’s economy is recovering strongly. Supply chain disruptions are easing, while tensions in energy and food markets caused by Russia’s invasion of Ukraine are easing.
Simultaneously, the massive and synchronized tightening of monetary policy by most central banks should start to bear fruit, with inflation returning to forecasted targets.
The Fund predicts in the latest World Economic Outlook that growth will reach 2.8% this year, before rising modestly to 3% in 2024. passed to 7% this year and 4.9% in 2024.
Growth
This year’s economic slowdown is concentrated in the advanced economies, especially the eurozone and the UK, where growth is expected to fall to 0.8% and -0.3% this year, before recovering to 1.4% and 1. %, respectively. On the other hand, despite a downward revision of 0.5 percentage points, many emerging markets and developing economies are recovering, with growth accelerating to 4.5% in 2023.
Scratchs
The recent banking instability shows that the situation remains fragile. Once again, downside risks dominate and the fog surrounding the global economic outlook has increased.
First, inflation is much stiffer than anticipated even a few months ago. While global inflation has eased, this mainly reflects the sharp reversal in energy and food prices.
Furthermore, activity shows signs of resilience as labor markets remain very strong in most advanced economies. This may require monetary policy to tighten further or remain tighter for longer than currently anticipated.
More worrying are the side effects that last year’s sharp monetary policy tightening is beginning to have on the financial sector.
The rapid tightening of monetary policy caused considerable losses in long-term fixed income assets and raised financing costs.
The stability of any financial system depends on its ability to absorb losses without resorting to taxpayers’ money. The brief turmoil in the UK gold market last autumn and the recent banking turmoil in the US and Switzerland underscore that there are significant vulnerabilities among banks and non-bank financial intermediaries. In both cases, the financial and monetary authorities acted quickly and firmly and, so far, avoided further instability.
However, the financial system may well be tested further. Nervous investors often look for the next weakest link, as they did with Crédit Suisse, a globally systemic but struggling European bank. Financial institutions with excess leverage, credit risk or interest rate exposure, excessive reliance on short-term funding, or located in jurisdictions with limited fiscal space could become the next target.
Public policy
More than ever, policymakers need a firm hand and clear communication.
With financial instability contained, monetary policy should remain focused on reducing inflation, but ready to quickly adjust to financial developments. On the bright side, the banking turmoil will help to slow aggregate activity as banks reduce lending. On its own, this should partially mitigate the need for further monetary tightening to achieve the same policy stance. But any expectation that central banks would prematurely give up the fight against inflation would have the opposite effect: lowering yields, supporting activity beyond what is warranted and, ultimately, complicating the task of monetary authorities.
Fiscal policy can also play an active role. By slowing economic activity, tighter fiscal policy would support monetary policy, allowing real interest rates to return more quickly to a low natural level. Properly designed fiscal consolidation will also help rebuild much-needed buffers and strengthen financial stability. While fiscal policy is less expansionary in many countries this year, more could be done to regain fiscal space.
Regulators and supervisors must also act now to ensure that the remaining financial frailties do not escalate into a full-blown crisis by strengthening oversight and actively managing market stresses. For emerging markets and developing economies, this also means ensuring adequate access to the global financial safety net, including IMF precautionary arrangements.
Medium-term growth prospects
Medium-term prospects are not very encouraging. The medium-term global growth forecast, 3% over a five-year horizon, is the weakest medium-term projection since 1990.
Part of this drop reflects slowing growth in previously fast-growing economies such as China or South Korea. This is predictable: growth slows down as countries converge. But some of the latest downturn may also reflect more sinister forces: the devastating impact of the pandemic, a slower pace of structural reforms, as well as the growing and increasingly real threat of geoeconomic fragmentation leading to more trade tensions, less direct investment and a slower pace of innovation and technology adoption in fragmented “chunks”.