The Financial Express

Rising risk of global recession

| Updated: September 29, 2022 21:33:04

Rising risk of global recession

Since the beginning of this year, slowing economic growth,  rising inflationary  pressures, the US led NATO proxy War in Ukraine and food and fuel supply shortages have created an environment where the possibility of a global recession has become a strong possibility. A report published last week by  the World Bank (WB) mentioned such a possibility.

The report says that  synchronised interest rate hikes  by central banks across the world led by the US Federal Reserve are pushing the global economy  into a recession in 2023 along with  a string of financial crises in emerging market and developing economies. The WB further added that the three largest economies, the US, China and the Eurozone have been slowing sharply, and even a "moderate hit to the global economy over the next year could tip it into recession".

One of the reasons for the  synchronised nature of  interest rate hikes by central banks around the world is that they are to respond to interest rate hikes by the Fed. Each Fed interest rate hike has mostly led to a rise in the dollar value and devaluation of other currencies causing import prices to rise leading to inflation. So, other central banks have to lift their interest rates to mitigate the fall in the value of  their currencies against the dollar.

Unless supply disruptions and market pressures subside, the global core inflation rate, excluding energy, could stay at about 5 per cent in 2023, almost double the five year average before the pandemic. To drive inflation lower, central banks may need to  raise interest rates by an additional two percentage points, on top of the two percentage point increase already seen over the 2021 average, the report said.

However, an increase of that size in interest rates coupled with financial market stress is estimated to slow global GDP growth to 0.5 per cent in 2023 or a 0.4 per cent contraction in per capita terms. That would meet the technical definition of a global recession.

Commenting on the report, World Bank president David Malpass said, "Global growth is slowing sharply, with further slowing likely to occur as more countries fall into recession. My deep concern is that these trends will persist, with long-lasting consequences. That are devastating for people in emerging market and developing economies".

Malpass further added that policy makers should shift their focus from reducing consumption to boosting production, including efforts to generate additional investment and productivity gains.

Also, Ayhan Kose, a World Bank Vice President said that the recent tightening of monetary and fiscal policies would help cut inflation, but the highly synchronised nature of the measures could compound the situation and steepen the global growth slowdown.

The World Bank report came at a time when the International Monetary Fund (IMF) also issued a separate warning. It suggested that central banks should continue to raise policy rates under most scenarios. Fiscal policies should strike the right balance between supporting the monetary policy stance and protecting vulnerable households and viable firms from income losses arising out of energy prices.

IMF spokes person Gerry Rice  said "We do expect some countries to face recession in '23. It is too early to say whether that would be a widespread global recession". He further added that even if some countries were not already technically in recession, it would feel like a recession for many people around the world.

High inflation always comes with a heavy economic price, particularly for low income earners. The current surge in inflation across the world  can be traced back to rising food and fuel prices. But prices are rising faster than costs because oligarch are controlling the market. Central banks, like chanting  a mantra, continue to raise policy rates.

But it is a blunt instrument, with no room to fine-tune specific corners of the economy. Jacking up interest rates or more precisely hiking borrowing costs is only successful because it slows demand across the board along with the economy and causes unemployment to rise.

It is now the conventional wisdom that central banks around the world  led by the US Federal Reserve have found a tried-and-true method of curing inflation. That is raising interest rates, not any other alternative methods such as wage-price freeze or rationing or a combination of both.

Last week both the US  Federal Reserve and the Bank of England jacked up key interest rates. The US Federal Reserve again raised its benchmark interest rate by  0.75 percentage points last Wednesday (September 21), bumping up the federal rate to a target range of 3.0 t0 3.25 per cent. The Fed has raised its benchmark rate five times this year already. The Fed's decision comes as inflation rages in the US economy at some of the highest annual rates in 40 years, reaching 8.3 per cent in August, down only slightly from the month before.

Besides raising interest rates, the Fed is also selling off huge slugs of its bond portfolio, thus reversing its preferred policy of quantitative easing (QE) to quantitative tightening (QT). This policy reduces the quantity of money in circulation and raises interest rates.

It is now generally accepted that the Fed will continue to raise interest rates until it restrains the economy and intends to keep rates at high levels until inflation is surely on its way down to the target level at 2 per cent. Policy makers in the Fed now expect that the economy will slow down and unemployment will rise.

Federal Reserve Chair Jerome Powell also insisted that the central bank will not succumb to political pressure to go soft prematurely and said, "We will keep at it until the job is done". The Fed now is determined to pursue what appears to be a longer period of raising interest rates.

The Bank of England also decided last week (September 22)  to raise interest rates by 0.5 percentage point  to 2.25 per cent despite it is widely believed that the UK economy is already in the early stage of a recession. According to the UK Office of National Statistics, retail sales declined sharply in August. This downward trend has been evident since the summer of last year, in fact, it is gathering momentum. In the worsening economic situation of the British economy, the British pound fell to its lowest level against the US dollar since 1985.

Yet, the Bank of England's  monetary policy committee  suggested that the Bank will need to go further in the coming months.  Like the Fed, the Bank's action went further than raising interest rates by initiating quantitative tightening (QT) by offloading its stocks of government bonds thus reversing the long standing quantitative easing (QE) programme.

Confidence in high interest rate's ability to tame inflation without causing recession has a very questionable track record. It is pointed out that  eight of the Fed's past nine monetary tightening cycles have ended up in a recession.

Market interest rates always move at much faster rates than the Fed's benchmark rates. Most of the time, US consumers' largest liability is their home mortgage loan and movements in mortgage rates can significantly influence housing demand and home prices. Therefore, disruptions in the commercial real estate market could in turn threaten financial stability through its interconnectedness with the financial system and the broader macroeconomy.

But rate rises is unlikely to bring down inflation. It is now generally agreed that the current inflationary surges do not reflect excess aggregate demand but the failure of aggregate supply to keep pace with the post-pandemic surge in aggregate demand pushing up prices. But that surge in aggregate demand now has faded but deficient aggregate supply continues.

It is not just that prices are going up because supply is constrained but prices are also going up over concerns that the Ukraine war will disrupt future supply. Therefore, inflation outcomes are likely to be influenced by structural changes stemming from both domestic and external factors.

At the Jackson Hole  meeting late last month, Agustin Carstens, the General Manager of the Bank of International Settlement (BIS) which serves as a bank for central banks, pointed out some of the longer-term structural shifts at work in the inflation surge. He said that the current inflationary surge was not driven by demand but was the result of supply side factors. These factors are likely to continue to  exert influence which means inflation will continue to persist.

He also said, "We are used to viewing the economy mainly through the lens of aggregate demand, with supply assumed to adjust smoothly in the background. But we need a more balanced approach. Signs of fragility in supply have been ignored for too long. Recent events have shown the danger of doing that".

Carstens further added that " the global economy seems to be at on the cusp of a historic change as many of the aggregate tailwinds that have kept a lid on inflation look set to turn into headwinds." If so, the recent pickup in inflationary pressures may prove to be more persistent.

Now signs of a global recession are slowly emerging. Because of its size and interconnectedness, developments in the US economy are bound to have important effects around the world, including developing countries like Bangladesh. In the US, one of investors' favourite recession indicators - the 10 year, 2-year Treasury yield curve  was inverted in July this year for the second time. Also, major stock indexes are in a bear market and business confidence at a record low. These are tell-tale signs of economic slowdown.

The looming recession in the US and other developed economies and region like the UK and the  EU will work as an exogenous shock for a developing country like Bangladesh. However, the transmission of that shock will be circumscribed by the ways Bangladesh is economically connected to the developed countries in Europe and North America prior to the recession.

Now a serious debt crisis is also developing in many countries in the Global South. They are hit hard by higher food and fuel prices, lower  tourism revenues, reduced access to international capital markets, trade and supply chain disruptions and depressed remittances. In fact, developing countries' debt has soared to 50-year high. The portents of economic crisis  in Sri Lanka were on display during the recent economic and political upheaval as the  country went into a US$35 billion debt default and severe food and fuel shortages. If the source of the recession is in the US and Europe, then it should follow that the impact of the recession on Bangladesh is set by the very nature of integration with those countries over the last 3-4 decades. Over this period Bangladesh trade exposure, particularly in terms of exports to these countries, has increased many-fold. Bangladesh's  principal export good, ready-made garments (RMG)  accounts for 82 per cent of total exports from the country and  of which almost 75 per cent go to the US and 8 EU countries..

World trade is experiencing its largest slow down in generations. Foreign direct investment (FDI) and other private capital flows are also declining and remittances are also expected to decline significantly.  To further compound the problem, a  recession in the North (developed world) will spur capital outflows from the Global South (developing countries) forcing them to devalue their currencies, thus adding to rising inflation and consequently to increase  interest rates. Therefore, Bangladesh is not in a comfortable position to address the consequences of the current global economic crisis which is likely to get even worse if a recession sets in  2023.

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