THE THREATS TO A RECOVERY

Samantha Amerasinghe explains why the Omicron variant will affect economic growth

Global growth forecasts for 2022 are shrouded in uncertainty due to COVID-19. The rapid spread of the Omicron variant and associated restrictions being rolled out in many countries have cast a cloud over the near-term outlook.

The new strain is expected to undermine growth this year but economists predict that it will cause only a short-term soft patch for consumer spending and broader economic development.

Another dark cloud over the growth outlook is ‘hot infla­tion’ and the need for central banks across the globe to tee up expected interest rates in their efforts to curb the phenomenon.

Let’s take stock of how the global economy fared in 2021 before making any predictions for 2022.

Considering the waves of uncertainty last year, the world economy came remarkably close to matching growth ex­pectations. The IMF has said that “the global economy is expected to rebound 5.9 percent in 2021 and then advance another 4.9 percent in 2022” after the deepest plunge of the postwar era in 2020 – down more than three percent.

To put these figures in perspective, a typical year for the world economy in recent times would see growth of a little above three percent. Part of that shortfall reflects the fact that some losses over the past two years in the services sector – such as travel, entertainment and restaurants – may never be recouped.

We expect the IMF to pare down its 2022 estimate, given that there are as many questions as answers about the Omicron variant. And OECD projections on world economic growth are slightly less optimistic at 4.5 percent in 2022 (compared to 5.5 percent last year), followed by a 3.2 percent expansion in 2023.

In addition, we remain cautiously optimistic about an uneven recovery as high inflation, supply chain bottle­necks and potential policy missteps remain key concerns. Developed nations in the G20 have spent some US$ 10 trillion to prop up their econo­mies during the pandemic while vaccinating the world would have cost only 50 billion dollars.

There will be marked dif­ferences in the recovery of countries – with some parts of the global economy rebounding quickly while others will be at risk of being left behind… particularly lower income nations where vaccination rates are lagging behind the world average.

So how worried should we be about high inflation?

Soaring inflation has rattled markets as investors fear central banks will raise interest rates sooner than expected. In fact, the US Federal Reserve is expected to wind down its accommodative policy stance. It’s still unclear as to how far monetary policy makers will tolerate inflation exceeding their targets.

According to the OECD, inflation in G20 countries is likely to rise to 4.4 percent this year compared to 3.8 percent in 2021, before reducing to 3.8 percent in 2023.

Some economists have a con­trarian view, suggesting that inflation will likely cool in 2022 due to three key drivers.

Firstly, an increased supply of semiconductors as manufacturers such as Taiwan Semiconductor Manufacturing Company (TSMC) ramp up production. Secondly, greater availability of labour that will likely help tame hourly wage inflation. And lastly, the winding down of stateside port congestion, which will mean a tempering of freight costs and potentially fewer price increases by businesses.

Unlike during the global financial crisis in 2007/08, emerging and developing nations are expected to carry deeper scars than advanced economies. This reflects in part their more muted policy responses. Developed countries with larger pandemic-related fiscal responses will inevitably experience smaller losses.

After accounting for income differences, economies that are more reliant on tourism and those with larger service sectors are projected to experience more persistent losses.

The year ahead is also likely to be very difficult in terms of dealing with debt. More aggressive restructuring will be imperative for existing debt burdens of developing countries not to become a long-term headwind.

Sovereign debt has risen 18 percent during the pandemic; and it will take decades to drop to pre-pandemic levels unless there is a much more thoughtful and aggressive policy approach by central banks.

Solid commodity prices sup­ported emerging market economies overall last year, alongside low interest rates and strong financial markets. While there were some very specific cases of financial strain such as in Turkey, EM equity markets generally rallied.

However, the steep upswing in inflation prompted many nations to start hiking interest rates. This process was rather aggressive in Brazil and Mexi­co, for instance.

Besides having to deal with the uncertainty of Omicron, many advanced economies will also be facing less gene­rous monetary policy settings. Financial markets are not flashing signs of serious concern on that front as yet, although the sustained negative long-term real bond yields are hardly a vote of confidence for the outlook.

Though Omicron is a hurdle to growth, it may not funda­men­tally alter the broader recovery picture. The policy priority will continue to be vaccine production and distribution; and until this is achieved, the path to recovery will remain precarious.