Letter IEDI n. 1141—Global economy under the effect of the war and the pandemic
The Ukrainian war represented a significant setback in the projections for world economic recovery, to which should also be added the new COVID-19 outbreaks in China. Today's Letter IEDI summarizes the changes in the scenarios of the main multilateral institutions for 2022 and 2023 due to these events that were unexpected at the end of last year.
According to the IMF's baseline scenario, released at the end of April 2022, after the global recovery from the COVID-19 shock in 2021, when world GDP grew 6.1% versus a contraction of 3.3% in 2020, the world economy's pace will decelerate to 3.6% in 2022 and 2023. This represents a downward revision of, respectively, 0.8 percentage point (p.p.) and 0.2 p.p. in relation to the Jan'22 Fund’s outlook.
The OECD has not yet updated its projections for global growth, but its Interim Outlook of Mar'22 shares the IMF's assessment that the war should lead to a cut of something like 1 p.p. in world GDP growth. The new UNCTAD scenario, prepared after the outbreak of the war, is more pessimistic than the Fund's, with growth forecasted to reach only 2.6% in 2022 against 3.6% in its previous publication, of Sep'21.
In addition to causing loss of life, a humanitarian crisis and the largest refugee movement since World War II, the war in Ukraine has direct effects on the Ukrainian economy, but also on the economic performance of Russia and Belarus, as well as indirect impacts on the international economy through three main transmission channels, according to the IMF.
The first channel is the impact on global trade. Besides the expected slowdown from 10% in 2021 to 5% in 2022, the war reinforced the upward trajectory of commodity prices (mainly energy and agricultural products), since Russia and Ukraine are important producers and exporters of cereals, energy and some metals that are inputs for industrial production.
As a result, inflation in advanced economies (AE) and emerging market and developing economies (EMDE) is not only increasing, but will also remain at a higher level for longer than in the IMF's Jan'22 scenario. The impact on EMDEs will be more intense, according to the Fund, due to the greater participation of energy and food in the population's consumption basket.
The second channel, more localized, comprises the direct links to Russia and Ukraine via trade and remittances of immigrants, cases of Belarus and some Baltic and Caucasus' countries. These nations will suffer a strong contraction of foreign demand and reduction in remittances.
The third channel is the effect on global value chains. As primary commodities and their derived products exported by Russia and Ukraine are inputs to these chains, the conflict is also impacting economies with no bilateral trade ties to the two countries, reinforcing disruptions and bottlenecks in supply. More recently, new COVID-19 outbreaks in China, which has been imposing lockdowns in some important areas, tend to reinforce the disorganization of production chains.
In addition to these impacts, four trends previously already underway, but mostly intensified by the war in Ukraine, underlie the IMF scenario:
• The tightening of monetary policy, which started in some AEs and EMEs in 2021 and intensified in 2022 with the beginning of the rise in the Fed's base interest rate in Mar'22. As in the previous phases of money tightening, monetary and financial conditions for EMDEs deteriorated, but unevenly;
• The withdrawal of fiscal stimuli throughout 2022 and 2023, given the record levels of indebtedness reached after the pandemic, particularly in AEs;
• The slowdown of the Chinese economy, associated with the zero-tolerance COVID-19 policy and the deceleration of real estate investment;
• The evolution of COVID-19, since the base scenario assumes that the sanitary and economic impacts of the pandemic will dissipate in the second quarter of 2022.
The effects of the war and these previous trends are heterogeneous across major groups of economies as well as across different regions. The main determinants of these impacts, according to the IMF, are geographical proximity, trade and financial relations with Ukraine and Russia, the composition of exports and imports, especially the participation of commodities, the degree of integration in the international financial market and external vulnerability.
In AEs, the Fund's growth forecast declined from 5.2% in 2021 to 3.3% in 2022. The euro area will be hit hardest by the rise in oil and natural gas prices, as it is a net energy importer and heavily dependent on Russian supply.
In the case of the US, which has limited ties with Russia, the deceleration from 5.7% in 2021 to 3.7% in 2022 stems from the non-approval of the Build Back Better fiscal package, the disruptions in global supply chains, the lower growth of trading partners resulting from the war, and the ongoing monetary tightening.
In EMDEs, the deceleration will be more intense than in AEs: from 6.8% in 2021 to 3.8% in 2022. This is because, in the assessment of the IMF, the direct impact of the war, its international transmission channels and other ongoing trends have relatively greater repercussions on these economies.
However, the regional effects are already heterogeneous due to the interaction of the determining factors mentioned above. As expected, emerging and developing Europe (including Ukraine and Russia) will suffer the greatest impact and will be the only EMDE area to contract in 2022 (-2.9%).
Latin America and the Caribbean will record the second worst economic performance, with growth of 2.5% in 2022, after an expansion of 6.8% in 2021. In this case, the main determinant of the slowdown is not the war—given the limited direct links with Ukraine and Russia—but the tightening of monetary policy due to inflationary pressures. On the other hand, several economies in the region are exporters of commodities and will benefit from the rise in energy, food and/or metal prices.
The balance of risks of the current scenario, warns the Fund, has a negative bias. The IMF points to eight factors that can reinforce and further deteriorate short-term prospects: a worsening of the war, rising social tensions, resurgence of the pandemic, further deceleration in China, rising medium-term inflation expectations, higher interest rates resulting in debt crises in EMDEs, a deterioration of the geopolitical environment, and the climate emergency.
Faced with these risks, the IMF recommends a set of policy initiatives— such as calibrating fiscal policy, anchoring inflation expectations and actions to benefit structural and environmental transformation—to eliminate or mitigate them and ensure the recovery in the short term and the improvement of medium-term prospects.