IMF: war sets back the global recovery

Downgrades to economic growth

For 2022, the IMF is now forecasting global economic growth of 3.6% (see Table 1), 0.8 percentage-points lower than projected in the January update and 1.3 percentage-points lower than in October. The 2023 world growth outlook has also been downgraded slightly, from 3.8% to 3.6%. A large combination of factors has led to this reduced forecast, with the IMF highlighting individual shocks interacting in ways which are difficult to predict. As a result, there are significant downside risks to the latest projections in the WEO.

Table 1 – The IMF’s latest World Economic Outlook Projections (% change)

Source: IMF

The IMF noted tighter financial conditions and a reduction in fiscal support as important factors in the downgrades to growth projections. Weaker demand as inflation reduces disposable income and impacts consumption was also a key factor. Countries which import large proportions of commodities, such as India, are highlighted as being particularly affected through this channel. Weaker demand due to lower disposable income will also lead to reduced exports. Contrasting this, the WEO highlighted that commodity exporters further away from the war will benefit from higher prices. Consequently, the IMF upgraded growth projections for Latin America and the Caribbean, and the Middle East and Central Asia. The WEO emphasised that countries with close economic ties to Russia are particularly affected by the war, resulting in large downgrades for the eurozone and Europe. The downgrade in Europe was also heavily influenced by the projection of a 35% and 8.5% contraction in GDP for Ukraine and Russia respectively, although there is a large amount of uncertainty regarding these numbers given the ongoing developments of the war.

Key forces shaping the short-term outlook

The invasion of Ukraine has generated significant headwinds to the global economy, as well as adding more uncertainty to an already uncertain outlook. The IMF stressed that the economic costs of the war are yet to be fully revealed, however, there are multiple channels through which they may present themselves. Russia and Ukraine’s key role in commodity markets has added upward pressure to prices, while trade with Russia has been restricted as sanctions have been imposed in an effort to deescalate the war. Many of the economic forces impacting the global economy were already doing so before the war began, but the effect they have on growth is now likely to be amplified. A fast end to the war would increase sentiment and ease pressure on commodity markets and supply chains. The WEO pointed to a higher probability of growth slowing further and inflation peaking at a higher level than currently expected.

The IMF also emphasised China’s slowdown as a risk to Asian economies and commodity exporters. The combination of Omicron being more transmissible than previous variants and China operating a zero-Covid policy increases the risk of more frequent lockdowns. There has also been a weak recovery in urban employment in China since the start of 2022, which has weighed on private consumption, while real estate investment remains weak. A loosening of fiscal policy may offset this according to the IMF; however, the projected slowdown was highlighted in the WEO as one of the largest downside risks to the global economy, particularly if prolonged lockdowns disrupt goods supply for the rest of the world.

The pandemic appears to be in a state of remission across the rest of the globe. The IMF points to part of the growth forecast downgrades being a result of the impact of Omicron in early 2022. Worker shortages and mobility restrictions intensified supply bottlenecks, lowering activity and adding to inflation. The WEO acknowledges the fading of this impact but highlights the emergence of a new variant as a threat to economic growth.

Tighter monetary policy is seen as appropriate by the IMF in order to prevent a cycle of prices pushing up wages and inflation expectations. This would run the risk of a wage-price spiral. Good central bank communication is viewed as key regarding the policy outlook, particularly with respect to anchoring long-term inflation expectations. Even before the war, high inflation had led to many central banks increasing interest rates and signalling more hawkish stances. In turn, this increased asset price volatility, hitting private balance sheets, consumption, and investment. According to the IMF, there is a risk that inflation pressures could increase more than anticipated and policy responses may have to be more aggressive as a result.

In response to the pandemic, there were record levels of fiscal spending. The WEO points to lower tax revenues in 2020-21 diminishing policy space, particularly with rising borrowing costs and the necessity for governments to rebuild buffers. As a result, the IMF expects fiscal support to decline in 2022 and 2023, despite increased pressure for social and defence spending. On top of this, higher interest rates create tighter financial conditions which will highlight debt vulnerabilities. The IMF emphasised the effect widespread debt distress could have through reduced trade, with a particular burden on emerging markets.

Uncertainty on the horizon

The recent release of economic projections from the IMF portrays a more negative outlook for economic growth worldwide. The WEO draws attention to an unprecedented number of shocks interacting in uncertain ways and slowing activity. The war in Ukraine and a slowdown in China are seen as the main detractors from growth, while a tightening of monetary policy to counter higher inflationary pressures, and the withdrawal of fiscal support will also be significant. According to the IMF, the impact of Covid appears to be fading, with the exception of China, although the emergence of a new variant would threaten growth further. These factors all contribute to tilting risks to the downside.