World economy face prolonged low growth amid multiple crises

GDP growth

Penang, 18 May (Kanaga Raja) — The world economy is facing severe headwinds amid weak growth prospects, elevated inflation and heightened uncertainties, a United Nations report has said.

According to a mid-year update to the UN’s World Economic Situation and Prospects (WESP) report, released on 16 May, a confluence of factors – the legacy effects of the COVID-19 pandemic, the lingering war in Ukraine, the ever-worsening impact of climate change and rapidly shifting macroeconomic conditions – are clouding the economic outlook, even as the global picture shows slight signs of improvement.

“Persistently high inflation has prompted the most aggressive interest rate hikes in decades, causing financial conditions to tighten sharply and exacerbating debt vulnerabilities,” it said.

Against a backdrop of multiple interconnected crises and heightened macroeconomic uncertainties, monetary and fiscal policy challenges have further intensified, the report added.

It said that as structural challenges including scarring from the pandemic, subdued investment, mounting debt vulnerabilities and funding shortages, remain unaddressed, the world economy is facing the risk of a prolonged period of sub-par growth.

“The current global economic outlook presents an immediate challenge to delivering on the SDGs,” said Mr Li Junhua, UN Under-Secretary-General for Economic and Social Affairs.

“The global community must urgently address the growing shortages of funding faced by many developing countries, strengthening their capacities to make critical investments in sustainable development and helping them transform their economies to achieve inclusive and sustained long-term growth,” he added.

GLOBAL MACROECONOMIC TRENDS

According to the UN report, uncertainties and poor growth prospects continue to bedevil the world economy.

It said a confluence of factors – the long reach of the COVID-19 pandemic, the lingering war in Ukraine, the ever-worsening impacts of climate change, and growing policy challenges – has pushed many countries to the brink, even as the global picture shows slight improvement.

Stubbornly high inflation in both developed and developing countries in the aftermath of the pandemic prompted the most aggressive interest rate hikes in decades, it added.

It said despite rising rates, household spending and employment – especially in the developed economies – have remained resilient, making it harder for central banks to tame inflation.

Against this backdrop, the UN said the deceleration in global growth for 2023 – as projected earlier – is likely to be less severe than previously anticipated, mainly due to persistently robust household spending in the largest economies, especially in the United States and the European Union, as well as the recovery in China.

Global growth is now projected to slow from 3.1 per cent in 2022 to 2.3 per cent in 2023 (up from 1.9 per cent forecast in January), it added.

The report said the global economy is predicted to pick up some momentum, expanding by 2.5 per cent in 2024, with inflationary pressures easing during the second half of 2023.

This rate is, however, well below the world’s longer-term (2000-2019) average growth rate of 3.1 per cent, the report added.

It said after declining steadily in 2022, consumer confidence slightly improved in recent months in most major economies, helped by lower international energy and food prices.

However, consumer confidence levels remain far below their long-term averages, it further said.

“At the same time, manufacturing activity, as measured by the Purchasing Managers’ Index, which saw an up-tick following China’s reopening, appears to have bottomed out.”

Meanwhile, global financial markets have remained largely resilient despite ongoing banking sector turmoil in the United States and Europe, said the report.

In March 2023, the collapse of the Silicon Valley Bank, the 16th largest bank in the United States by total assets, and Signature Bank as well as the Swiss government-brokered takeover of Credit Suisse, a globally systemically important bank, rattled financial markets worldwide, it said.

It said in early May, the United States Government seized control of First Republic Bank, with total assets of $212 billion and sold it to JPMorgan Chase.

The report said while governments and financial regulators managed to contain the turmoil, these developments show the potential of more systemic financial stability risks.

“Despite the market turmoil, the Federal Reserve and other developed country central banks continued to raise policy rates as core inflation has remained high and more persistent than expected.”

While the major central banks have slowed the pace of monetary tightening, further rate hikes remain likely in 2023, it added.

The report said the slightly improved outlook for global growth in 2023 primarily reflects upward revisions in the major developed countries and China.

It said in the United States, consumer spending and non-residential investment have proven more resilient than expected, prompting upward revision of the growth forecast to 1.1 per cent in 2023 (up from 0.4 per cent forecast in January).

“However, amid tightening financial conditions and further adjustments in house prices, consumer spending is projected to soften, weighing on growth prospects.”

It said that in Europe, lower gas prices and robust consumer spending, especially on services, have prevented the sharp slowdown that had been forecast in January.

The European Union’s economy is now projected to grow by 0.9 per cent in 2023 (up from 0.2 per cent forecast in January), said the report.

“After lifting COVID-19-related restrictions in December 2022, China’s GDP expanded faster than expected in the first quarter of 2023. Annual growth this year is now forecast at 5.3 per cent (up from 4.8 per cent forecast in January).”

The report said improved short-term prospects in the world’s three largest economies contrast with downward revisions to growth in many developing countries.

GDP per capita is projected to grow only marginally in Africa and Latin America and the Caribbean in 2023, reinforcing a long-term trend of weak economic performance, it added.

“Unsustainable debt servicing burdens, mounting balance-of-payments pressures, growing financing gaps and constrained fiscal space will continue to undermine near-term growth prospects of many developing countries.”

While inflation has been easing in recent months, it is expected to remain above central bank targets in 2023, the UN also said.

“Global inflation is projected to decline from 7.5 per cent in 2022 to 5.2 per cent in 2023, mainly due to lower food and energy prices and softening global demand. Inflation will, however, remain well above the 2000-2019 average of 3.1 per cent.”

In developed countries, headline inflation is expected to decline gradually from 7.8 per cent in 2022 to 4.8 per cent in 2023 but will remain well above central bank targets, typically around 2 per cent, said the report.

In the United States, headline inflation has been easing over the past year, falling to 5.0 per cent in March 2023, the lowest rate since May 2021, it noted.

In the European Union, inflation declined to 8.3 per cent in March, ranging from about 3 per cent in Luxembourg and Spain to 25.6 per cent in Hungary.

The UN said that while headline inflation rates have been falling, core inflation in the United States and Europe remains high, mainly driven by rising service prices (e.g., housing, insurance, transport) and robust wage growth.

It said that inflation is also trending downward in most developing countries amid lower commodity prices and reduced global supply constraints and depreciation pressures.

“Annual inflation will, however, remain well above the long-term average, especially in Western Asia, South Asia, and Africa.”

The report said that although global food prices have been declining since mid-2022, domestic food inflation has often stayed elevated due to a number of factors, including still-high import costs, local supply disruptions, and market imperfections.

According to the World Bank, food inflation in early 2023 remained above 5 per cent in about 90 per cent of developing countries.

Continuing high inflation in developing countries that are home to large numbers of people in poverty represents an additional barrier to poverty eradication, said the UN.

It also said labour markets in Europe, Japan and North America have remained tight, with low unemployment rates and recurrent worker shortages.

“Post-pandemic mismatches between labour supply and labour demand in these countries – exerting upward pressures on wages – pose additional policy challenges to central banks striving to bring down inflation.”

Except for the United States and the United Kingdom, employment rates in developed economies were well above pre-pandemic levels at the end of 2022, said the report.

“Global trade is expected to remain under pressure in the forecast period. The baseline scenario projects that the volume of global trade in goods and services will grow by 2.3 per cent in 2023, slightly higher than the previous forecast of near zero growth.”

This reflects the upward revision to GDP growth projections, said the report, adding that China’s reopening is expected to increase domestic demand and potentially boost global trade with increased imports of goods and services.

However, the lingering effects of COVID-19, rising geopolitical tensions, and monetary tightening will continue to hold back global trade, although supply chain constraints and high shipping costs have eased, it added.

However, it said trade in services experienced faster growth than trade in goods, supported by further recovery in travel and tourism sectors.

International tourism is set to consolidate its recovery in 2023, backed by pent-up demand, particularly from Asia and the Pacific as destinations and markets open up, it added.

“United Nations World Tourism Organization (UNWTO) estimates that international tourism arrivals could reach 80 to 95 per cent of pre-pandemic levels in 2023.”

With energy prices and inflation gradually softening, international capital markets have been expecting a pause or even a reversal of monetary tightening in the developed economies, said the report.

“While this has remained elusive, prospects of slowing inflation have reduced investors’ risk aversion as well as long-term interest rates.”

The report said capital flows to developing countries recovered, albeit with significant volatility, reversing the decline in the first half of 2022.

“New sovereign bond issuances from emerging economies totalled $39.8 billion in January 2023, the second highest level on record,” the UN said, adding that many developing country currencies also recouped some of the losses suffered throughout most of 2022.

Between October 2022 and March 2023, the nominal US dollar index against emerging market currencies fell by 6 per cent, but it still remains about 5 per cent above the level of January 2021.

“However, as major central banks further increased interest rates in recent months, global financial conditions have continued to tighten,” it added.

It noted that in March 2023, the collapse of Silicon Valley Bank (SVB) and Signature Bank in the United States and the near-failure of Credit Suisse sent shock waves through the global financial sector.

Rapidly rising interest rates exacerbated the asset-liability mismatches and exposed balance sheet vulnerabilities and failures in risk management in the failed banks, it added.

MONETARY AND FISCAL POLICY TRENDS

The UN report said the central banks in developed and developing countries have continued to tighten monetary policy in 2023 to anchor inflation expectations and maintain credibility.

However, most central banks have reduced the pace of their interest rate hikes as headline inflation figures have gradually eased, it noted.

In the United States, the Federal Reserve raised interest rates by only 25 basis points in January, March and May, after several earlier rate hikes of 75 basis points in 2022, and hinted at a pause in the tightening cycle.

The European Central Bank also shifted to a smaller 25 basis points hike in May, following three consecutive hikes of 50 basis points, said the report.

Several developing country central banks have also adopted a more cautious approach, while others – especially in Latin America – have paused rate hikes, it added.

“The recent banking sector turmoil in the United States and Europe has exposed the trade-offs between raising policy rates and preserving financial stability.”

A decade of ultra-loose monetary policy and near-zero policy rates has encouraged excessive leverage in the financial sector, the report emphasized.

“The sudden shift to monetary tightening and rising interest rates has exposed asset-liability mismatches and exposed the financial sector to significant duration risks.”

The report also said that over the forecast period, monetary policy stances are expected to diverge.

The report said in the major developed economies, the tightening cycle is well advanced: the Federal Reserve is projected to implement one or two more rate hikes this year while in the euro area, interest rates may peak in the third quarter of 2023.

An end to monetary tightening in developed economies would allow some developing country central banks to re-calibrate their monetary stances to support economic growth while others will continue to raise interest rates amid stubbornly high inflation, said the report.

In 2022, fiscal trends across the world were driven by continued economic recovery from the COVID-19 crisis, the impact of unexpected inflation on debt dynamics (which particularly benefited developed economies), and tighter fiscal stances as pandemic-related support measures were phased out, it added.

Average fiscal deficits and public debt levels as a share of GDP declined for a second consecutive year in both developed and developing countries, it noted.

“Commodity producers, especially oil-rich countries, experienced particularly large improvements in fiscal performance.”

Global public debt stood at an estimated 92.1 per cent of GDP in 2022, 7.6 percentage points below the 2020 level, but still notably higher than the pre-pandemic level of 84.3 per cent, said the UN.

These aggregate short-term trends should not obscure an increasingly challenging fiscal outlook, especially for developing countries facing weak and diminished growth prospects, it suggested.

“The aggressive tightening of global monetary policy since early 2022 has significantly exacerbated fiscal and debt vulnerabilities and further constrained fiscal space in many countries, especially in sub-Saharan Africa, South Asia, and Latin America and the Caribbean.”

Borrowing costs have risen sharply and the strong dollar – despite some softening in recent months – has pushed up the debt-servicing burden of dollar-denominated debt, said the report.

“In Africa, external debt service as a share of government revenue has risen sharply, while access to development assistance and private finance has diminished.”

The report said that “financing constraints will limit the ability of governments to invest in education, health, sustainable infrastructure and energy transition and accelerate progress towards sustainable development, while threatening to push a growing number of countries into debt default.”

EFFECTS OF UNCONVENTIONAL MONETARY POLICY

After decades of quiescence, high inflation made a comeback in 2022, said the UN, adding that major developed country central banks began to raise interest rates and also reduce liquidity in the financial market, by selling off assets on their balance sheets, pursuing a process known as quantitative tightening (QT).

However, the report said that QT has proved to be challenging given the years of ultra-loose monetary policy of quantitative easing (QE), undertaken through programmes that injected trillions of dollars of liquidity since the global financial crisis (GFC) in 2008.

“The transition from QE to QT in the developed economies will likely be particularly challenging for many developing countries as it will significantly tighten global financial conditions, increase their borrowing costs and exacerbate debt sustainability risks.”

Developed country central banks first resorted to unconventional monetary policy measures when policy rates reached or approached the zero lower bound, said the report, adding that by purchasing government bonds or other financial assets, QE aimed to increase liquidity and stimulate economic activity.

Notably, in response to a prolonged period of economic stagnation and deflation, the Bank of Japan (BoJ) first implemented QE in 2001, it noted.

During the GFC, QE – through asset purchases by central banks – became the monetary policy tool of choice.

In the United States, the Federal Reserve needed to restore the balance sheets of the too-big-to-fail banks, as many of them held trillions of dollars of mortgage-backed securities (MBS) that lost value before the crisis, it said.

“It recognized that lowering policy interest rates, though necessary, alone would not solve the balance sheet challenges of the banks that held these securities.”

“There was limited liquidity in the market to support the prices of these MBS. With sharply falling MBS prices, long-term interest rates surged,” the report explained.

The Federal Reserve began to buy these MBS – securities that no market participant wanted to buy and hold – to shore up the balance sheets of the banks and reduce long-term interest rates, it said.

“Other developed country central banks – notably the European Central Bank (ECB) and the Bank of England (BoE) – followed the lead of the Federal Reserve to support their financial sector during the crisis in 2008.”

The report said that in the aftermath of the GFC, QE has remained a key monetary policy tool for developed country central banks, with some changes in strategy, including announcement to taper asset purchases in 2013, and balance sheet normalisation in 2017 by the Federal Reserve.

“During the pandemic, with record-low policy rates, many central banks implemented massive QE as a way to provide economic stimulus, even though the balance sheets of commercial banks remained strong.”

Between January 2020 and December 2021, the Federal Reserve, ECB and BoE doubled or nearly doubled the assets on their balance sheets.

The UN said as of end 2021, the total assets of the Federal Reserve, ECB, BoE and BoJ reached about $8.8 trillion, $9.6 trillion, $1.5 trillion and $6.3 trillion, respectively, collectively representing about a quarter of world GDP.

“Facing deteriorating global financial conditions, large capital outflows and rising borrowing costs during the pandemic, 27 developing countries introduced QE for the first time during the pandemic in 2020,” it noted.

The report said with QE, the central banks pursued two objectives in the aftermath of the global financial crisis: (a) restore financial stability, and (b) boost investment and economic growth by lowering long-term borrowing costs.

According to the UN, the QE interacted with the real economy through multiple channels:

First, the liquidity channel, increasing money supply and liquidity with a view to easing financial market stress and preventing liquidity shortages particularly during the immediate crisis phase.

Second, the portfolio re-balancing channel, changing the relative prices of financial assets and encouraging investors to hold long-term assets by lowering their yields.

Third, the signalling channel, conveying the central bank’s commitment to stabilizing financial markets and supporting the economy.

“QE has been proven to be an important monetary policy tool to address financial distress particularly during crisis times,” said the report.

Between 2007 and 2021, broad money as a percentage of GDP increased from 79.5 per cent to 117 per cent in the United States, and from 90 per cent to 124 per cent in the euro area, it noted.

SPILLOVERS OF QUANTITATIVE EASING

According to the report, QE boosted global liquidity, adding that as long-term interest rates remained near zero in the developed economies, investors’ search for higher yields contributed to higher asset prices in the developing countries.

“Many developing country governments and corporates began to borrow in the international capital market.”

Increased external borrowing and inflow of foreign portfolio capital often led to exchange rate appreciation, making imports cheaper and exports more expensive and adversely affecting the balance-of-payments of many developing countries, it added.

“In principle, increased global liquidity could lower borrowing costs for some developing countries, especially those with access to international financial markets and strong macroeconomic fundamentals.”

Yet, while such inflows helped to bridge financing gaps in the short run, they also contributed to increases in external debt, said the report.

Between 2007 and 2020, total debt of governments, firms and households increased from 125 per cent of GDP to 243 per cent of GDP, said the report.

“During the same period, the stock of international bonds of the developing countries increased by over 200 per cent to about $7.5 trillion.”

Many developing countries continued to pay high and rising risk premia during QE, even though interest rates in the developed economies remained near zero during the decade before the pandemic, said the report.

“For instance, in 2007 before QE, Ghana issued a sovereign bond that paid 8.5 per cent interest, while in 2015 it issued a bond in the international capital market that paid 10.75 per cent interest,” it added.

Persistently high borrowing costs have exacerbated the debt sustainability risks of many developing countries, it said further.

“As of February 2023, 36 out of 69 countries covered by the Debt Sustainability Framework for Low-Income Countries were in debt distress or at high risk of experiencing debt distress.”

POLICY CHALLENGES FOR SOUTH

The report said QE in developed economies was associated with large capital inflows to developing countries, leading to currency appreciation and lower export competitiveness.

“Developing country central banks – aiming to keep capital flowing into the country – were often unable to take appropriate prudential measures to prevent excessive borrowing and consequent exchange rate appreciations.”

Instead, many central banks maintained tight monetary policy stances to prevent inflation and signal central banks’ commitment to maintaining financial stability, said the report.

This often required central banks to maintain higher than necessary interest rates to ensure a strong exchange rate and secure international investors’ confidence in the economy, it added.

“It also meant that actual output in the economy often remained below potential output during periods of large capital inflows and both domestic investments and exports suffered setbacks.”

The UN said that the prospect of QT is now posing an even greater challenge for the developing country central banks.

“With monetary tightening, the dollar has appreciated against most developing countries’ currencies during the past year, making imports more expensive and further fuelling inflation. This has compelled many developing country central banks to pursue faster rate increases than in the developed economies.”

Moreover, as developed country monetary authorities increased policy rates and began to implement QT, many developing countries began to experience quick reversal of capital flows, higher borrowing costs and increasing roll-over and debt sustainability risks, said the report.

However, it said developing countries, especially many low-income countries, have not yet recovered from the pandemic.

The report cautioned that rapid interest rate hikes and tighter global liquidity conditions – in tandem with rising pressures for fiscal consolidation to improve debt sustainability – will further delay their recovery and push them towards a low growth path in the medium term, making it ever more difficult for them to accelerate the progress towards sustainable development. - Third World Network