Samantha Amerasinghe sees a light at the end of tunnel for world economies

Speaking at the recent World Economic Forum (WEF) in Davos, IMF Managing Director IMF Kristalina Georgieva asserted that the global economy isn’t out of the woods yet. However, economists and world leaders remain cautiously optimistic that the worst of the global economic crisis may be over given the recent slowdown in inflation.

Much of the debate and discussion in Davos focussed on how the world will tackle the risks confronting the global economy this year. The risk of inflationary pressure from China’s reopening and the challenge of bringing inflation in Western economies down to two percent were among the key issues discussed.

Rising debt distress in the developing world, an escalation of the Russia-Ukraine conflict, and a brewing dispute between the US and Europe on subsidies for the green energy transition are some of the other risks that are expected to frame policy directions.

Many factors indicate that hopefully, the world economy may be at a turning point. The US and EU are now seemingly beyond the risk of a recession. Inflation in these regions was trending downwards, supply chain bottlenecks eased up and the risk of energy shortages in Europe due to the massive cutbacks in natural gas from Russia were averted.

The IMF’s latest economic update (World Economic Outlook – January 2023) claims that the global economy will slow down this year before rebounding in 2024. However, a global recession is not in its baseline.

Important aspects shaping the outlook on the downside are the war in Ukraine and the global fight against inflation while the reopening of China’seconomy may provide some upside. Global growth is expected to slow from 3.4 percent in 2022 to 2.9 percent in 2023 before bouncing back to 3.1 percent in 2024.

Global headline inflation is projected to drop from 8.8 percent in 2022 to 4.3 percent in 2024 but core inflation (excluding movements in food and energy prices) is expected to remain high.

Positive signals, particularly a recent chill in US inflation, have led to a shift in the Federal Reserve’s policy approach. Though inflation remains far from the Fed’s two percent target, it was at its lowest level of 6.5 percent since October 2021. After last year’s aggressive policy tightening, a modest 25 basis points (bps) rate hike is expected at the Fed’s March meeting.

The Fed is cognisant of fears that hiking rates too hard and fast could risk sending the economy into a recession. Lower inflation coupled with a better economic outlook (the US economy grew by 2.9 percent in the fourth quarter of last year) has kept alive the Fed’s hopes of a soft landing. However, Chairman of the Federal Reserve Jerome Powell expressed concern that services inflation – possibly driven by supply-related dislocations and not cyclical factors – will keep broader price pressures higher than what is acceptable and generally reflect the historically tight labour market.

Other central banks also appear to be staying the course on interest rate increases to cool down their economies and curb high inflation.

The European Central Bank (ECB) signalled that further large interest rate hikes are anticipated – a 50 bps rise is expected in March, followed by two 25 bps increases by the year end, which will take the policy rate to a peak of 3.5 percent. Its pace of monetary tightening will depend largely on the resilience of the Eurozone’s economy and persistence of core inflation.

A couple of more modest rate hikes are also expected by the Bank of England in response to stubbornly high services inflation and wage growth; but once again, the current hiking cycle is expected to come to a close in March.

Meanwhile, the Bank of Japan bucked the trend of other central banks – despite pressure in the markets to take on inflation – by opting to maintain an expansionary policy.

It appears that the global economic outlook is not as bad as feared a few months ago. According to Georgieva, interest rate hikes by the world’s major economies are “yet to bite.” Further challenges are imminent with rising unemployment becoming a real possibility and cash-strapped governments finding it harder to respond amply.

Another major concern is that China’s reopening following the abolition of its strict ‘zero COVID’ policy could threaten to push commodity prices up (oil and natural gas, for example) as demand picks up later this year. This could potentially lead to more inflationary pressure and weigh on global growth.

Inflation will continue to be on the radar of central banks over the course of 2023. Since it is still high, monetary policy clearly has more work to do to bring it down to the two percent goal on a sustained basis.

The worst times may arguably be behind us but it remains to be seen how much more central banks will need to go given the lagged effects of tightening on economies.