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Info Service on Finance and Development (Mar22/05) Geneva, 25 Mar (Kanaga Raja) – Global economic growth is projected to decrease from the earlier estimated 3.6% to 2.6% for 2022, on account of the war in Ukraine and tightening macroeconomic policies in developed economies, according to the UN Conference on Trade and Development (UNCTAD). In an update to its Trade and Development Report (TDR) 2021, UNCTAD said hardly any country will be immune from the deterioration of global growth prospects, although a few may benefit from higher prices and demand for their commodity exports. On the other hand, developing economies that were in a precarious situation due to debt obligations, supply shocks and term-of-trade and exchange rate swings, will see their economic performance deteriorate even further, it said. “The economic effects of the Ukraine war will compound the ongoing economic slowdown globally and weaken the recovery from the COVID-19 pandemic,” said UNCTAD Secretary-General Rebeca Grynspan. “Many developing countries have struggled to gain economic traction coming out of the COVID-19 recession and are now facing strong headwinds from the war. Whether this leads to unrest or not, a profound social anxiety is already spreading,” Ms Grynspan added. GLOBAL MACROECONOMIC OUTLOOK According to the TDR update, the global economy is, literally and metaphorically, staring down the barrel of a gun. It said stopping the war in Ukraine, rebuilding its economy and delivering a lasting peace settlement must be the priorities. But the international community will also need to deal with the widespread economic damage that the conflict is already causing in many parts of the developing world; damage that will only intensify as the conflict persists, it added. “The year 2022 already appeared to be one of decelerating and uneven growth. The unprecedented policy measures that helped economies around the world recover from the paralysis of the Covid pandemic have been asymmetric in their effects and short-term in scope, adding new challenges to an already testing policy environment.” UNCTAD argued that a return to pre-2020 conditions should not be the goal of policymakers. It would diminish the hope of achieving more inclusive and sustained growth and undermine the task of building economic resilience in the era of climate change. The threat of repeating the policy mistakes of the past is, however, rising as the fallout from the conflict in Ukraine spreads beyond its borders, it cautioned. “The economic, financial and political reverberations from the war are unfolding at a turning point in global policy discussions, as the supportive public policy stance necessitated by the pandemic gives way to fiscal and monetary tightening.” In the advanced economies, central banks are beginning to raise interest rates from historic lows and selling some of the assets they purchased during the decade of quantitative easing. Budgetary authorities, having issued large volumes of government debt during the pandemic, are turning their focus to reducing primary balances by raising taxes and cutting spending, said UNCTAD. In the face of long-standing structural problems and new geopolitical risks, macroeconomic tightening in the North, along with a general weakening of multilateral rules and practices, is set to stymie growth across the developing economies, particularly those that are closely integrated into the global financial system, it added. This will not only endanger their fragile recovery, but also undermine their long-term development, said UNCTAD. It said already in the closing months of 2021, inflationary and exchange rate pressures began to trigger monetary tightening in a number of developing countries, with expenditure cuts anticipated in upcoming budgets. A likely effect of the conflict in Ukraine is an acceleration and widening of these measures, with the purpose of retaining volatile foreign capital. According to the TDR update, two immediate impacts of the war in Ukraine have been exchange rate instability and surging commodity prices, particularly for food and fuel. The added pressure of price increases is intensifying calls for a policy response in advanced economies, including on the fiscal front, threatening a sharper than expected slowdown in growth. UNCTAD said the danger for many developing countries that are heavily reliant on food and fuel imports is more profound, higher prices threaten livelihoods, discourage investment and raise the spectre of widening trade deficits. It said with elevated debt levels from the pandemic, sudden currency depreciation can quickly make debt service unsustainable and tip some countries into a downward spiral of insolvency, recession and arrested development. “Whether this leads to unrest or not, a profound social malaise is already spreading,” said the TDR update. “As a result, the global economy, having entered 2022 on a “two-speed” recovery path, will not only shift down a gear in terms of growth but will also see many developing countries lose ground to advanced countries, while their vulnerability to shocks is heightened by rising geopolitical tensions and deepening economic uncertainty.” UNCTAD said the impressive growth of the world economy in 2021 notwithstanding, the post-pandemic world is looking increasingly fragile, with external shocks becoming more unpredictable and complex in nature. Even in peaceful times, unregulated and unbalanced international financial markets have been the source of much of that fragility for many developing countries. At a time of international conflict and heightened geopolitical risks, finance is a central mechanism for transmission and amplification of these risks, it added. UNCTAD said while the immediate financial consequences of the war and sanctions on the Russian Federation have not immediately triggered an international financial crisis or contagion effects signalling a crisis for emerging market economies, this cannot be discounted yet. The risks to countries’ financial systems are further amplified by the pressure to “rebuild fiscal buffers” by cutting non-military government spending. In fact, attempts to create fiscal space through budget cuts are bound to backfire. Building resilience requires reinforcing aggregate demand through investment and social protection, in a framework of appropriate multilateral institutions, it added. The existing crisis management mechanisms of the global financial architecture leave the developing economies in a particularly vulnerable position, said the TDR update. “The liquidity stresses that are likely to emerge in these countries in the coming phase of post-pandemic reopening, international conflict and climate emergencies, will exceed the willingness of the US Federal Reserve in its recently adopted role of unofficial lender-of-last resort.” Globally, the issuance of $650 billion of new SDRs (special drawing rights) in August 2021, of which around $275 billion were allocated to developing economies was a welcome development, but well short of the amounts required. UNCTAD said in the current geopolitical context, given the ambiguous role of the Fed – pressed on the one hand by its national mandate and by its de facto global function, on the other – as well as coordination difficulties at the level of the International Monetary Fund (IMF) in times of complex crises, it is vital that governments agree to the establishment of a rules-based system of multilateral policy coordination in finance. It said that ad hoc, highly selective international initiatives, such as those that were deployed in 2008-09 and during the pandemic crises, cannot provide a reliable solution for all in the coming era of complex shocks that are global in impact. As the war in Ukraine and its consequences have taken center stage, the budding discussions on decarbonization and long-term development have been again put on hold. But the intertwining of finance, food and fuel shocks stemming from the war in Ukraine is likely to be a preview of what is in store in an overheating world, it said. According to the TDR update, the threat from rising global temperatures is already causing serious economic damage and untold suffering across the developing world. “Mitigating this threat will require a profound change in the way the multilateral order safeguards global economic resilience on the one hand, and its ability to develop new policy mechanisms to respond to increasingly complex external shocks, on the other.” According to the TDR update, global growth prospects for 2022 will be affected by downside risks to both supply and demand, compounded by the war in Ukraine. On the supply side, persistent disruptions will continue to hamper economic activity. At the same time, macroeconomic tightening will weaken demand while rising prices will erode real incomes and dampen investor confidence. These pressures will only deepen the geographical, financial and socio-economic fractures that marked the recovery in 2021, it said. “Global growth in 2022 will, as a result, be slower, more uneven and more fragile than we expected in September 2021,” UNCTAD said. UNCTAD said that its estimates incorporate the two main new features of the world economic situation: the war in Ukraine and tightening macroeconomic policy in developed economies. Before the outbreak of the war in Ukraine, global growth was already projected to slow in 2022 with the recovery from the pandemic shifting to more normal rates, pandemic restrictions abating and supply pressures continuing. The economic reverberations of the war have led to significant downward revisions to growth figures, as incomes are squeezed further by increased food and fuel prices, global trade is curtailed by sanctions, and confidence and financial instability issues re-emerge, said UNCTAD. “As a result of the conflict, oil and gas prices have surged from already elevated levels, wheat prices have reached levels not seen since the late 2000s, and a wide range of other items including fertilisers, metals and manufacturing inputs are facing severe supply shortages.” UNCTAD said that the main advanced economies are in the process of reversing the stimuli enacted during the pandemic, by tightening policy rates, unwinding Central Bank asset purchases, and cutting furlough programmes, transfers and support to businesses and households. “These shifts will dampen domestic economic activity and weaken global demand. By implication, economies in the Global South, which have incurred larger costs to cope with the pandemic, face additional constraints to demand and in the balance of payments at a time when their recovery is struggling to take off.” UNCTAD said that the war in Ukraine compounds this situation, by adding constraints to trade, financial risks and economic destruction. Global growth, measured in constant United States dollars at market exchange rates, is expected to decelerate from 5.6 per cent in 2021 to 2.6 per cent in 2022, it added. It said of the 3-point drop, two percentage points are due to structural and policy factors pre-dating the war and one percentage point, amounting to approximately $1 trillion in foregone income, is due to the war, assuming that the sanctions and the supply chain disruptions will last through 2022, even if the war ends. According to the TDR update, the United States, while relatively isolated from the current shocks, will see further pressure on consumption expenditure from higher fuel and food prices and may introduce a fiscal response in the form of fuel subsidies. Consumption expenditures in the United States have returned to pre-pandemic trends, but the inflationary pressures together with flagging confidence will impose a deceleration, it added. “Investment has recovered strongly since the pandemic compared to European countries but the new sources of instability will likely shift resources to safe asset allocations instead of productive ventures.” UNCTAD said that these prospects will be made worse by monetary tightening. High energy prices are likely to stimulate some investment in extraction of hydrocarbons, likely crowding out any plans for a transition out of fossil fuels. Europe will be harder hit by both high commodities prices and the conflict in Ukraine. Across Europe, higher food and fuel prices will constrain domestic expenditure, weakening aggregate demand. The TDR update said that the German economy is highly dependent on imports of natural gas from the Russian Federation, and on its own manufacturing exports which will be disrupted by sanctions and the war. Increased military expenditure will provide a moderate addition to aggregate demand. UNCTAD said Eastern European and Central Asian economies too will be hit hard by the conflict. Higher food prices, falling remittances and large numbers of refugees will place these economies under strain. “The picture for the region as a whole is mixed, with some economies directly or indirectly suffering severe losses from the conflict and trade restrictions (induced by sanctions or by inability to reach exporting hubs), and others being able to gain market access and at higher prices.” The Russian economy faces stringent external constraints imposed by the sanctions. While the Russian Federation is still exporting oil and gas, and will therefore see compensating increases of revenue due to high prices, sanctions severely limit the use of foreign exchange earnings for the purchase of imports or debt servicing, said UNCTAD. “The Russian Federation will experience severe shortages of a wide range of imported goods, high inflation and a substantially devalued currency. While the state will likely act to cushion the shock and limit unemployment and the fall of household incomes, its capacity is limited.” UNCTAD said that trade with China and some other partners will continue, but they will not be able to provide substitutes for the wide range of imported goods that the Russian Federation currently cannot access. Assuming the sanctions remain in place through 2022, even if the fighting in Ukraine ends, Russia will experience a severe recession, it added. The Chinese economy was expected to continue with their long-term adjustment towards higher household income and consumption spending, alongside slowing of other growth components, said the TDR update. “Yet, Chinese growth will not escape the effects of the supply shock, with high grain prices, disruption to exports and manufacturing and a resurgent pandemic all contributing to lower growth.” While the authorities will be able to cushion negative external trends to an extent, through the usual channels of credit expansion and investment spending, the earlier announced target of 5.5 per cent will challenge policymakers, said UNCTAD. “Other economies in Asia will experience headwinds resulting from the conflict,” said the TDR update. It said the Republic of Korea and other relatively strong economies of East Asia would have needed a sustained rebound of manufacturing and trade services to regain strong momentum, but these will be shaken by the gyrations of international trade resulting directly or indirectly from the war (including the milder growth prospects for China, Japan and Europe). Meanwhile, as some of the other economies in South and Western Asia may gain some benefits from fast growth of demand and prices of energy, they will be hampered by the adversities in primary commodity markets, especially food inflation, and will be further hit by inherent financial instabilities. India, in particular, will face restraints on several fronts: energy access and prices, primary commodity bottlenecks, reflexes from trade sanctions, food inflation, tightening policies and financial instability, said the TDR update. “The picture is mixed in Latin American economies: consumption expenditures in Brazil, Argentina and Mexico remain below pre-pandemic levels, while Chile and Colombia have seen strong rebounds. Brazil, Argentina, Peru and Chile have seen strong recoveries in investment from the deep declines in 2020 and have benefited from the sharp rebound of global commodity markets.” At present, it is estimated that while Latin American growth figures will decline substantially from highs achieved during the pandemic rebound, the energy and commodity exporters of the group, which represents the bulk of regional output, will still see relatively strong growth compensations, said UNCTAD. Economies of Africa will be affected in mixed ways, but growth expectations for 2022 of the region as a whole will be lower than estimated earlier in the year, it added. It said the considerable weight of oil and gas exports of the region will stimulate growth through higher volume and prices, but commodities represent a mixed bag. Only a few of the staples exported by Africa are likely to help circumvent the bottlenecks resulting from the conflict in Ukraine, but for the most part African economies are either food dependent or face supply bottlenecks of their own. “And while minerals may see a rebound in prices and demand, some of these products face some investment and infrastructure bottlenecks. Overall, the global shock of commodities will imply a relatively negative shock for the region as a whole, especially through food prices and domestic consumption.” On top of that, while the stresses resulting from a continuing pandemic in the region had earlier in the year started to draw some attention and policy gestures from advanced economies, these have unfortunately faded away in the context of the conflict, said the TDR update. Australia, New Zealand, Canada and other developed countries closely “allied” with the United States and Europe in the current conflict will, on the one hand, experience some of the headwinds that affect most of these countries (inflationary pressures leading to tightening policy responses, high international prices of commodities, supply shortages, etc.) but, on the other hand, will see some windfall gains through export markets of their commodities and energy products, which will trigger positive terms of trade effects on domestic spending (including government spending) and hence growth, it added. POLICY TAPERING According to the TDR update, in late 2021-early 2022, the shift to tighter macroeconomic policy in the developed countries began. “This turn was triggered by concerns for inflation, which rose sharply in many of these countries as economies reopened, driven by supply chain bottlenecks, the shifting composition of consumer demand and environmental degradation. Expectations that these effects would fade quickly were, unfortunately, not fulfilled.” In this context, developing countries are in a particularly vulnerable position. The pandemic has led to a dramatic worsening of hunger and malnutrition. The TDR update said that rising prices of food and fuel will exacerbate the fall in real incomes for many. Poverty, which only deepened during the pandemic with an estimated additional 80 million pushed into extreme poverty, has become an even bigger problem confronting most developing countries. “The ability of developing countries to respond to these challenges is limited. Their policy space – already narrow due to balance of payments constraints – is being squeezed further by macroeconomic tightening in developed economies and the withdrawal of fiscal and monetary support.” UNCTAD said there are growing financial vulnerabilities: stocks of debt, particularly external debt, have risen in many developing economies, and deepening financial integration widens the socio-economic scope of the impact from the dynamics of the global financial cycle. “The war in Ukraine puts macroeconomic policymakers in developed economies in a conundrum. Higher inflation raises the pressure to tighten policy. Prior to the start of the conflict, the central banks of developed countries had been hawkish about the path of interest rates.” Following the 25 basis point rise in interest rates on 16 March 2022, the Federal Reserve is expected to raise rates to around 1.75 per cent over the next twelve months and up to 2.8 per cent in 2024, with the Bank of Japan likely to follow suit, said the TDR update. Alongside rising policy rates, central banks have begun the process of unwinding the large increases in quantitative easing enacted during the pandemic. By lowering the cost of public borrowing, quantitative easing helped governments in high income countries to issue large amounts of debt, thus funding unprecedented fiscal deficits. As monetary support is withdrawn and interest rates rise, the governments of high-income counties are also shifting towards fiscal tightening, said UNCTAD. “It is not obvious, however, that tighter monetary and fiscal policies are the correct response to inflation driven by supply-side bottlenecks. In developed countries, price controls and income support could help households cope with rising costs.” And while the shift to monetary tapering and contractionary fiscal policy in developed countries may turn out to be a policy error for them, it may have disastrous repercussions for developing countries if it triggers appreciation of the dollar, said the TDR update. In light of the dislocations caused by the war in Ukraine and the potential for financial disorder, central banks could still opt to postpone (or at least slow) tightening and instead, maintain or increase the provision of liquidity. A dual strategy of liquidity provision in the form of bond purchases, alongside higher interest rates, may emerge. “It is also possible that we will see divergence in the policy stances of advanced economies with the United States, which is not directly affected by the conflict and is facing higher inflation than Europe, going ahead with tightening, and the European Central Bank keeping policy accommodative to offset the impact of the conflict,” said UNCTAD. It said that rate hikes in advanced economies, alongside disorderly movements in global financial markets, would be a devastating combination for developing economies. It said volatility in commodity futures and bond markets alongside flights to safety would be reflected in higher risk premia on the financial liabilities of developing economies, in addition to the considerable pressures from rate hikes. “Even in the absence of disorderly moves in financial markets, developing economies will face severe constraints on growth. During the pandemic, public and private debt stocks in developing countries have increased. Issues that receded from view during the pandemic, such as balance of payments constraints, high corporate leverage and rising household debt, will resurface as policy tightens.” While the outlook for lower- and middle-income economies has darkened substantially as a result of the enduring pandemic, the dynamics of the next phase of the economic recovery remain uncertain, said UNCTAD. “Lessons from the experience of 2013 round of tapering point to a mixed picture: in 2013, the mere mention of monetary tapering by the Federal Reserve generated a major liquidity shock as investors withdrew funding from developing economies. This put severe pressure on exchange rates, foreign reserves and funding costs,” said the TDR update. “Today, the likelihood and timing of a similar episode in response to current policy tightening cannot be predicted with any confidence, given the role of volatile expectations, market sentiment and herd behaviour in such episodes. The ramifications of the conflict in Ukraine and sanctions imposed on the Russian economy further compound this uncertainty.” UNCTAD said that whether the coming period is characterized by volatile liquidity-driven cross-border financial flows, or by the slower grind of diminished policy space, fiscal and monetary tightening and squeezed incomes, it is people in the developing world who will be forced to take on a disproportionate share of the adjustment to the post- pandemic global economy. HIGH INFLATION & FISCAL SQUEEZE As consumer price inflation moved sharply up from the mid-2021 onwards in the United States and elsewhere, the debate has continued over its causes, likely duration, and the appropriate policy response. The debate has entered a new phase with the added set of price shocks from the war in Ukraine, said the TDR update. On the supply side, a range of factors have combined to produce shortages and bottlenecks. Global production and distribution were unable to adjust rapidly to the sudden surge in expenditure, particularly for durable goods, as economies reopened. Supplies of energy and raw materials, such as timber and metals, were unable to keep up with surging demand, and saw sharp price increases towards the end of 2021, said UNCTAD. Global energy supplies were placed under pressure by high demand in Asia, shortfalls of natural gas and reduced wind generation. War in Ukraine has pushed some energy prices to ten-year highs along with the prices of some key commodities such as wheat and corn. Bottlenecks and supply shortages are caused not only by supply-side issues: demand has played an important role, driven in, particular, by the shift in consumption from services to goods. Driven by direct cash transfers, demand for goods rose sharply in the United States, exceeding previous trends and spilling over onto global value chains. Production of key manufacturing intermediate inputs such as semiconductors remained relatively constant during the pandemic, but was unable to keep pace with surging demand for microchips in the production of vehicles and consumer goods, said UNCTAD. For many developing countries, currency devaluation against the dollar is an important driver of inflation: domestic currency depreciation raises the domestic price of imported goods and, therefore, headline inflation measures, it added. UNCTAD said that as the Fed and other central banks in developed countries tighten, the currencies of developing countries are likely to devalue further. “Policy tightening in the North, in response to supply-side bottlenecks, thus worsens the problem of rising prices in developing countries.” The TDR update also said in most developing countries, fiscal support in response to the pandemic amounted to a substantially lower proportion of GDP than in developed countries. Still, it said, developing countries are now facing the prospect of global macroeconomic tightening in a particularly perilous position, given substantial debt vulnerabilities. Many support schemes introduced during the pandemic will be withdrawn just as rising food and fuel costs consume household budgets and new pressures from the conflict in Ukraine arise, including on exchange rates and balance of payments. Developing countries’ debt service is projected to total $484 billion, 23.2 percent of the total external debt stock, in 2022. Public sector external debt vulnerabilities are substantial, especially in low-income countries, it added. Public and publicly guaranteed (PPG) external debts in developing countries represented 64.4 per cent of the total stock of external debt in 2020, increasing to 76.2 per cent in the case of low-income countries. UNCTAD said that short-term PPG debt servicing needs are concerning. Developing countries are projected to require $310 billion to meet external public debt service requirements in 2022 – equivalent to 9.2 per cent of the outstanding stock of external public debt at the end of 2020. “Developing country bond yields have been on the rise since September 2021. The increase is widespread and is a clear signal of tighter financial conditions.” Since the breakout of the conflict in Ukraine, yields have further increased for the developing countries by 36 basis points, on average, with countries heavily dependent on food imports experiencing higher increases, said the TDR update. According to UNCTAD, a total of 104 countries are net food importers. These countries had a total of $1.4 trillion in external public debt at the end of 2020 and they face $153 billion in projected debt service payments in 2022, which can be jeopardized if international food prices continue to rise. UNCTAD said as the consequences of tapering and the conflict in Ukraine unfold, a key question is whether they will lead to a “tantrum” of the kind seen in 2013. “The consequences for developing country governments would be severely damaging,” it cautioned.
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