Ukraine war, rising food prices dampen Global growth outlook

Ukraine is expecting further Russian attacks in the east after troops pulled back from the Kyiv region. Reuters via DW News

Geneva, 19 May (Kanaga Raja) – The global economy is now projected to grow by only 3.1 per cent in 2022 and 2023, marking substantial downward revisions of 0.9 and 0.4 percentage points, respectively, from the previous forecast released in January 2022, the United Nations has said.

According to the World Economic Situation and Prospects (WESP) as of mid-2022, the global growth prospects have weakened significantly amid the war in Ukraine, rising energy, food and commodity prices, soaring inflation and tightening monetary policy stances by major central banks.

The UN said the downgrades in growth prospects are broad-based, including the world’s largest economies – the United States, China and the European Union – and the majority of other developed and developing economies.

The UN said growth forecasts for the United States, European Union and China have been revised downward, with the European Union registering the most significant downward revision.

The European Union economy – most directly hit by disruptions in the energy supply from the Russian Federation – is now expected to grow by 2.7 per cent in 2022, down from 3.9 per cent expected in January, it added.

The United States economy is expected to grow by 2.6 per cent, while China is expected to grow by 4.5 per cent in 2022.

“The developing countries, as a group, are projected to grow by 4.1 per cent in 2022, down from 6.7 per cent in 2021,” the WESP said.

“The war in Ukraine – in all its dimensions – is setting in motion a crisis that is also devastating global energy markets, disrupting financial systems and exacerbating extreme vulnerabilities for the developing world,” said UN Secretary-General Antonio Guterres.

“We need quick and decisive action to ensure a steady flow of food and energy in open markets, by lifting export restrictions, allocating surpluses and reserves to those who need them, and addressing food price increases to calm market volatility,” he added.

OVERVIEW OF GLOBAL ECONOMY

According to the WESP, the global economy may be on the cusp of a new crisis, while still recovering from the COVID-19 pandemic.

“The war in Ukraine has upended the fragile recovery from the pandemic, triggering a devastating humanitarian crisis in Europe, pushing up food and commodity prices and exacerbating inflationary pressures worldwide.”

Geopolitical and economic uncertainties are dampening business confidence and investment and further weakening short-term economic prospects, it said.

Against this backdrop, the UN said the global economy is now projected to grow by only 3.1 per cent in 2022 and 2023, marking substantial downward revisions of 0.9 and 0.4 percentage points, respectively, from its previous forecast released in January 2022.

“Our baseline outlook faces major downside risks from further intensification of the war in Ukraine, new waves of the pandemic and faster-than-expected monetary tightening in the developed economies.”

The United States economy is forecast to slow to 2.6 per cent in 2022 due to high inflationary pressures, aggressive monetary tightening by the Federal Reserve and a strong US dollar, worsening net export balances, said the WESP.

In China, GDP is projected to expand by 4.5 per cent, a downward revision of 0.7 percentage points, with stringent zero COVID-19 policies adversely affecting growth prospects.

Meanwhile, the UN said that there is an exceptionally heavy toll on the economy of the European Union: its GDP is projected to expand by 2.7 per cent in 2022, 1.2 percentage points lower than expected in January.

“The economic prospects for the Commonwealth of Independent States and Georgia are also sharply downgraded.”

According to the WESP, the Russian Federation’s economy is projected to contract by about 10 per cent in 2022, buffeted by unprecedented trade and financial sanctions that came into effect in March.

“Amid massive destruction of infrastructure, population displacement and disruption of economic activities, the Ukrainian economy is projected to contract by 30 to 50 per cent in 2022.”

The outlook for developing countries has also deteriorated, with GDP projected to increase by 4.1 per cent in 2022, 0.4 percentage points lower than the forecast in January, said the WESP.

Higher energy and food prices, rising inflationary pressures and slowing growth in the United States, the European Union and China are weakening growth prospects in developing countries, it said, adding that monetary tightening in the United States will sharply increase their borrowing costs.

The WESP said that a growing number of developing countries – especially the least developed countries – face stagnant growth prospects and rising risks of a lost decade, amid high levels of debt distress.

The outlook is compounded by worsening food insecurity, especially in Africa. Lower vaccination rates also make developing countries more vulnerable to new waves of COVID-19 infections, it added.

By the end of April 2022, the number of doses per 100 people in the developed countries stood at 190.8, compared to 143.5 in developing countries and only 35.5 in Africa.

The war in Ukraine and the sanctions against the Russian Federation have rattled commodity markets, exacerbating supply-side shocks, said the WESP.

It said that in 2022, global trade growth is projected to slow down markedly, after a strong rebound in 2021.

The conflict has directly disrupted exports of crude oil, natural gas, grains, fertilizer and metals, pushing up energy, food and commodity prices, it added.

“The Russian Federation and Ukraine are key suppliers of agricultural goods, accounting for 25 per cent of global wheat exports, 16 per cent of corn exports and 56 per cent of exports of sunflower oil.”

Food security concerns have also prompted countries to impose export restrictions, further constraining the supply of agricultural products and critical agricultural inputs, said the WESP.

Since the beginning of 2022, countries have introduced 47 restrictions on exports of food – grains, edible oils, meat, etc. – and fertilizer, of which 43 came into effect after the war in Ukraine broke out in February.

The Food and Agriculture Organization’s (FAO) composite food price index reached record levels of 159.7 and 158.5 in March and April 2022, respectively, surpassing the previous high of 131.9 in 2011.

The WESP noted that since the beginning of the year, the food price index rose by 22.9 per cent, with the vegetable oils price index increasing by 51.6 per cent.

Higher commodity prices, including base metals, have sharply increased production costs in automotive, electronics and other manufacturing sectors. The war halted the production of neon gas in Ukraine, which accounted for about half of the global output, said the WESP.

“As neon gas is a critical input for the production of semiconductors, this will likely worsen the semiconductor shortages, which have already negatively impacted the production of automobiles and electronics.”

The continued COVID-19 lockdown measures in China, including in major manufacturing centres and port cities, are also exacerbating production challenges. Even before the outbreak of the war in Ukraine, global supply-chain disruptions remained elevated, close to record highs, said the WESP.

The manufacturing industries purchasing managers index, a leading indicator of manufacturing output growth, fell sharply in the first quarter of 2022 across most G20 economies, it noted.

RISING INFLATIONARY PRESSURES

The world economy is facing substantial inflationary pressures. Global inflation is projected to increase to 6.7 per cent in 2022, twice the average of 2.9 per cent during 2010-2020, said the WESP.

Headline inflation in the United States has reached the highest level in four decades. In developing regions, inflation is rising in Western Asia and Latin America and the Caribbean, it added.

The WESP said soaring food and energy prices are having knock-on effects on the rest of the economy, as reflected in the significant rise in core inflation in many economies.

“Inflation began trending upward during the pandemic, as lockdown measures and border closures disrupted global supply chains.”

The WESP said that as progress in vaccination allowed countries – especially the developed economies – to ease pandemic-related restrictions, household demand quickly recovered to pre-pandemic levels or even further (e.g., demand for durable goods), but supply-side challenges persisted, which generated inflationary pressures in 2021.

Policymakers in the developed economies expected the pandemic-induced inflationary pressure to be transitory, but it has proved to be persistent, with the war in Ukraine – and new rounds of supply-side shocks – also fueling high inflation expectations, it added.

“We expect commodity prices to remain elevated throughout 2022 before easing somewhat in 2023,” said the UN.

Also, it said, lower fertilizer exports from the Russian Federation – coming on top of China restricting the export of fertilizers since July 2021, together with prices close to all-time highs – will likely result in lower global crop yields in the coming seasons.

It noted that the Russian Federation is one of the largest exporters of fertilizers to major agricultural producers, including Brazil and the United States.

The WESP said that tight labour market conditions – with unemployment rates at or close to record lows and acute shortages of workers – are also adding to inflationary pressures in developed countries.

In the United Kingdom and the United States, for example, inflation expectations are rising, while nominal wage growth has started catching up with overall price increases, increasing the risk of a wage-price spiral.

“In developing countries, inflationary pressures are compounded by balance-of-payments challenges and downward pressures on exchange rates.”

“A faster-than-expected global monetary tightening could trigger capital outflows, further weakening exchange rates and adding inflationary pressures through the import channel,” the WESP cautioned.

The current inflation cycle is clearly more pronounced and persistent than the global inflation spike in 2007-2008, and inflationary pressures are unlikely to subside significantly in the near term, it said.

The WESP also said higher inflationary pressures are prompting central banks to tighten their monetary policy stances.

Monetary tightening might exacerbate the persistent supply-side constraints, as higher interest rates will discourage investments that could ease some of the logistical bottlenecks that emerged during the pandemic crisis, it added.

“Lower business investments – induced by higher interest rates – during a period of economic recovery will only contribute to further delaying the full recovery.”

The WESP said higher interest rates in the developed economies will also adversely affect growth in the developing countries, especially in Africa and Latin America and the Caribbean where weak employment growth and higher unemployment rates relative to the pre-pandemic level continue to persist.

Higher borrowing costs will also weaken investment and worsen financing gaps between developed and developing countries, it added.

Rising inflation is posing an additional challenge to an inclusive recovery as it disproportionally affects low-income households that spend a much larger share of their income on food items, the WESP further said.

“The decline in real incomes is particularly pronounced in developing countries, where poverty is more prevalent, wage growth remains constrained, and fiscal support measures to alleviate the impact of higher oil and food prices on the vulnerable groups are more limited.”

Surging food inflation is worsening food insecurity and pushing millions below the poverty line in many developing countries that are still struggling with economic shocks from the pandemic. Rising poverty will inevitably worsen inequality, both within and between countries, in the near term, the WESP cautioned.

WORSENING FINANCING PROSPECTS FOR SOUTH

According to the WESP, the war in Ukraine and the global monetary tightening cycle are worsening the financing gaps in developing countries, particularly in poorer countries.

Since September 2021, capital flows to emerging economies have trended downwards, with net portfolio outflows reaching $9.8 billion in March 2022, compared to, on average, net monthly inflows of about $30 billion over 2021.

A faster-than-expected monetary tightening by the Fed could trigger quick “flight to safety”, adversely affecting domestic financial stability and growth in many developing countries, said the WESP.

“Developing countries are also facing the prospect of higher borrowing costs, which were already high before the pandemic.”

In developed countries, the average interest cost of outstanding government debt has fallen to 1 per cent, but the average cost for developing countries is over 3 per cent, said the WESP.

The least developed countries, which have had access to concessional lending, have however increasingly borrowed at significantly higher interest rates from the international capital market.

In 2021, African and LDC sovereign Eurobonds were issued with yields above 5 per cent – and in 40 per cent of African bonds, the yield was above 8 per cent.

Since early March 2022, hard currency yields of emerging market sovereign bonds have increased substantially, with more than 20 per cent of the bonds trading with spreads above 1,000 basis points on the secondary market, said the WESP.

“The monetary tightening and consequent increases in the risk-free US Treasury rates would further increase the already high yields on developing country sovereign debt, which will further raise re-financing or roll-over costs.”

The monetary tightening will not only raise borrowing costs but also constrain the fiscal space in many developing countries, particularly for net energy and food importers, said the WESP.

It said the current debt crisis in Sri Lanka, a net oil and food importer, is an example of the solvency challenges confronting many developing countries.

As of 31 March 2022, about 60 per cent of the least developed and other low-income countries were at high risk of or in debt distress, almost double the number in 2015, it said, adding that debt servicing burdens of the developing countries have risen considerably since the beginning of the pandemic.

The total debt-service payments on public and publicly-guaranteed debt of the poorest countries is expected to reach 35 billion US dollars in 2022, which is 45 per cent above the level in 2020.

While the Fed’s more aggressive tightening path will affect the LDCs and other low-income countries, many of these countries are also adversely impacted by the spillover effects of the war in Ukraine, said the WESP.

“Surging global fuel and food prices are affecting the most vulnerable populations in these countries,” it added.

The WESP said it will remain critical to scale up concessional finance and official development assistance (ODA) to ease their financing and balance of payment challenges.

“Major central banks in developed economies will need to calibrate their interest rate hikes to contain inflationary pressures, while minimizing their spillover effects on the borrowing costs and debt sustainability of the developing countries,” it said.

The WESP noted that amid strong consumer spending, the US Federal Reserve raised its funds rate by a total of 75 basis points in two consecutive rate hikes in March and May 2022 and signalled that it would embark on a more aggressive pace of rate hikes.

“The Federal Reserve will need to ensure that inflation expectations remain anchored, while avoiding a hard landing of the economy. The European Central Bank, which has kept its main policy rate unchanged so far, had signalled a more gradual monetary tightening approach,” it said.

“The spectre of higher inflation and rising borrowing costs poses major monetary and fiscal policy challenges for developing countries,” the WESP emphasized.

It said that since the second half of 2021, monetary tightening in developing countries has gained momentum.

According to the WESP, as higher interest rates raise borrowing costs and deter investments which will remain critical for steering the recovery, the developing economies will instead need to utilize other tools such as macro-prudential policies – including capital control measures – to limit their exposure to sudden changes in capital flows.

“Constrained fiscal space and high and rising debt servicing obligations will likely push many developing countries in the direction of austerity and fiscal consolidation. But a premature fiscal consolidation will derail the still fragile recovery and actually increase their debt distress risks,” it said.

Governments, even with constrained fiscal space, will need to provide targeted support to alleviate the effects of higher food and fuel prices on poorer segments of the population, while pursuing medium-term fiscal and debt sustainability. This will require comprehensive debt restructuring and debt relief for poorer countries, particularly the least developed countries, said the WESP.

The pandemic and the war in Ukraine have tested the limits of multilateralism and have confirmed that the current multilateral system is not fit for purpose, it added.

It said with millions around the world facing severe food insecurity – potentially joining the ranks of nearly a billion already living in poverty – multilateralism needs to rise to the challenges of stimulating inclusive growth, creating employment, taming food price inflation and boosting resilience, while providing debt relief to the countries facing debt distress.

According to the WESP, the need for macroeconomic policy coordination – through fair and inclusive multilateral processes – is more pressing than ever to address the scourge of rising hunger and poverty, reduce inequality, fight climate change, and put the world back on the trajectory of sustainable development.

- Third World Network