Global economy faces high uncertainty

The global economy is now grappling with a number of crises ranging from inflation, growth, trade, cost of living, housing, energy security, climate change and deglobalisation. Policy makers are faced with daunting challenges to address these multifrontal crises; more disturbingly they are likely to continue to confront them in the years ahead.

According to the IMF Blog (January 15), while headline inflation is falling in many countries, core inflation which excludes more volatile food and energy prices, has been revised upwards. According to the US Bureau of Labour Statistics (February 13) US core  inflation (less food and energy) rose to 3.9 per cent for 12 months ending in January 2024, unchanged from December 2023.

According to the German Federal Statistical Office the German economy shrank by 0.3 per cent year-on-year in 2023 after being hit by high inflation, soaring energy prices, and weak foreign demand. Ruth Brand, the Head of German Federal Statistics office also further added that  prices remained high at all stages in the economic process and put a damper on economic growth.

It is generally argued (including the IMF) that the persistence of high inflationary pressures is primarily caused by the continuing tightening of labour market. Therefore, tighter monetary policy is required to control price rises resulting in sharper economic slowdown. But the IMF blog (January 11) tells us that higher prices so far mostly reflect increases in profits and import costs, but labour costs are picking up. So, it is profits, not so much wages mostly contributing to rising prices so far.

Rising inflation has been the economic story since 2022 and is continuing. Rising food and energy prices have impacted the cost of living in both developed and developing economies. According to OECD Secretary General Mathias Cormann, while recessions will be avoided almost everywhere, there are risks that inflation will stay persistently high.

On macroeconomic issues such as inflation, the influence of general equilibrium theory, inflation-unemployment tradeoffs, and monetarism remain strong. But the root causes of inflation, as explained by economic theory, remain unsatisfactory. To dig beneath these general theoretical tendencies requires that we identify and analyse the factors which underlie and drive inflation. These factors are likely to include escalating food and energy prices, fiscal and monetary policy actions, non-competitive markets, inflation expectation, rising input costs, rising profit margins and others.

Despite central banks tightening their policy rates, inflation continues to remain above their target rates and their inflation target rates are yet to be achieved. It is generally suggested that the current inflationary pressure is largely caused by domestic demand pressures, rising input costs and above all as pointed out by the IMF the rising share of profits. These factors will continue to remain key challenges for central banks in their quest to restore inflation to targets in 2024. This means that there will be very few interest rate cuts in countries around the world and continuing tighter monetary policy.

Now the Red Sea crisis can push up prices further as energy and supply chains are disrupted. Ocean freight rates from Asia to Europe have already doubled over the last five weeks. Now soaring shipping costs and a rise in oil prices are stoking the fear of a revival of further  inflationary pressures around the world. The World Bank has already warned of surging energy prices, higher inflation and slower growth as the threat rises of disruption to global trade.

Such a prospect of rising inflation resulting from supply disruptions is likely to convince central banks to remain firm on high interest rates for a longer period than currently anticipated. High interest rates and heightened geopolitical and economic uncertainty will depress investment leading to further weakening of growth.

There are also rising concerns about rising interest rates continuing into 2024 and that could lead to delinquency and debt default across several loan categories. Loan payment delinquency refers to when a borrower misses a single payment owed for a certain type of loan, while loan default means when a borrower fails to keep up with the loan repayments terms and conditions such as insufficient to no payment at all. Widespread payment delinquencies and defaults could make it hard to maintain financial stability.

According to the United Nations (UN) and its Department of Economic and Social Affairs (DESA) developing countries face high levels of external debt and rising interest rates, making access to international capital markets difficult. Debt sustainability has also emerged as a critical challenge for developing countries.  In about a quarter of all developing countries, annual inflation is projected to exceed 10 per cent in 2024. Since January, 2021 consumer prices in developing countries have increased by a cumulative 21.1 per cent.

Rising geopolitical risk as reflected in the Russia-Ukraine conflict and the Israeli invasion of Gaza could push up oil prices, thus inflation as well. The OECD Economic Outlook published in November 2023 warned that the world economy is confronting new risks resulting from heightened geopolitical tensions amid the Israel-Hamas war - "particularly if the conflict were to broaden".

Indeed, the very recent supply disruptions in the Red Sea shipping lane leading to Suez Canal could severely impact global trade. Also, current tensions between China and the US over Taiwan could similarly affect even more important global supply routes through the South China Sea. All these events highlight how quickly geo-politics can play a very decisive role in impacting the global economic outlook.

According to the OECD, the global economy continues to confront the challenges of both low growth and elevated inflation. It projects global GDP growth of 2.7 per cent in 2024 below that of 2023. Also, over the longer term, as the projection indicates, there will be a significant rise in government debt, because of a further slowdown in growth.

But the World Bank estimate shows that global growth to slow to 2.4 per cent in 2024, the third consecutive year of deceleration - reflecting the lagged and ongoing effects of tight monetary policies to rein in decades-high inflation. It also indicated that the overall outlook for developing countries remained subdued as investment growth slowdown.

Food price inflation remains a very critical issue. This will further exacerbate food insecurity and poverty in developing countries. According to the UN estimate an estimated 238 million people experienced acute food insecurity in 2023, an increase of 21.6 million from the previous year.

Now rising inflation in developing countries will likely contribute to further worsening the food insecurity situation. Li Junhua, UN Under Secretary-General for Economic and Social Affairs said that "Persistently high inflation has further set back progress in poverty eradication, with especially severe impacts in the least developed countries".

Inflation pressures continue to remain high despite policy rate tightening. The IMF suggests that central banks need to raise real policy rates above the neutral rate and keep them there until underlying inflation is on a decisive declining path. But the forces of geoe-conomic fragmentation continue to rise severely impacting global flows of goods and services. Further intensification of the Russia-Ukraine conflict and continuing Israeli aggression and genocide in Gaza, and now the Red Sea crisis will add to further destabilising energy and food markets and fragment the global economy.

According to UNCTAD,  "Geopolitical friction, persisting inflation and lower global demand are expected to negatively affect global trade during 2023."  UNCTAD expressed a generally negative outlook for 2024 and said that the outlook for 2024 remains "highly uncertain and generally pessimistic".

Fyodor Lukyanov, the Editor-in-Chief of Russia in Global Affairs in an article published very late in December last year wrote, "This year (2023) began with one fierce military confrontation of global significance and ends with two. And there is no guarantee that they will not continue until the end of 2024. The chain of conflicts, seemingly territorial but essentially existential (at least in the perception of those involved), may prove to be quite long".

Overall, the global economic outlook looks uncertain not only because of greater than expected inflation persistence and slower growth prospects but also worsening geo-economic environment and the proliferation of conflicts. All these factors are pointing to a prolonged period of economic slowdown. Against this backdrop of the global economy now, to be even mildly optimistic, will require an "Orwellian imagination."

[email protected]