Tue. Jan 18th, 2022


The start of this year is an ominous echo of 2021. A new variant of coronavirus has sparked infections in all parts of the world, threatening economic prospects for the year ahead. But rather than a repeat of the severe downturns we saw in 2020, the outlook is one of high global inflation and rising interest rates, with serious risks for the more vulnerable emerging and developing economies.

Last year showed that advanced economies were more resilient than expected against Covid-19 waves, even without effective vaccines. The Alpha Gulf has been devastating to human health, but has hardly hampered global recovery. With more monetary and fiscal stimulus than needed, the result was excess demand and inflation.

It should be easier to get through Omicron. Global case numbers are at record levels, but the number of deaths is still muted. Vaccines have been effective in preventing serious diseases and the community also has greater immunity to previous infection, so advanced economies should be better able to adapt. Despite this good news, the predictions of the IMF, OECD and World Bank – suggesting that advanced economies can return to the path of economic output forecasting before pandemic without any long-term damage – would probably be too optimistic.

High inflation shows there were severe bottlenecks in running a hot economy last year, fewer workers are looking for work, and two years of weak investment will hamper economies’ ability to deliver the productivity gains that drive non-inflationary growth. The greatest danger for 2022 and 2023 is therefore still inflation due to demand exceeding the available supply. Headline inflation rates will fall in the second half of the year as last year’s large price increases fall from the annual comparison, but the biggest risk to the world economy is that it remains too high for convenience.

The Federal Reserve is respond to this threat in the US where it is greatest, noting that it may have to raise interest rates from the current zero percent floor “sooner or at a faster pace” than officials initially thought. Many informed observers are now expecting four-quarter-point interest rate hikes this year with the Fed selling some government bonds it owns. However, stricter monetary policy should not be confused with a highly restrictive monetary policy stance. A nominal interest rate of 1 per cent will still stimulate demand, especially with inflation likely to be well above the Fed’s 2 per cent target by the end of the year.

The problem for poorer countries is that stricter, yet more stimulating, U.S. policies may mean trouble for them. As the World Bank notes in this week’s outlook for the global economy, tighter US monetary policy is likely to exacerbate an already difficult outlook for emerging and developing economies.

Poorer economies have struggled to recover as quickly as advanced, without the same degree of confidence and market access to borrow freely to protect their populations in the early stages of the pandemic. Without financial resilience and ample social security systems, the downturn in emerging economies was more persistent and recovery weaker. The perfect storm was completed by the difficulties these economies experienced in accessing vaccines and delivering them to their populations.

A line graph showing the deviation from output of pre-pandemic trends that the economic scars of the pandemic will be greater and more persistent in emerging and developing economies

Two decades in which emerging economies’ living standards have caught up with their richer cousins ​​are now over. The World Bank estimates that real incomes in 70 percent of emerging and developing economies will grow more slowly than those in advanced economies between 2021 and 2023.

Weakness during the pandemic is also likely to leave much larger and more persistent lesions. Compared to a (though optimistic) assumption of no scars in rich countries, the World Bank estimates that recovery in poorer countries will be nearly 6 percent less than pre-pandemic expectations. It further limits their ability to service existing debt, which got up with 10 percentage points of national income since the start of the pandemic, according to the IMF. This is likely to lead to a hard landing, debt crisis and social discontent in weaker countries.

None of this is made easier by the possibility that the Fed will hit the brakes harder this year than expected, rattling markets and exacerbating global monetary conditions. In what was somewhat of an understatement, World Bank President David Malpass said the outlook for 2022 “is unlikely to be favorable for developing countries”.

Emerging and developing economies are not all alike in the conditions they face. China has more than enough fiscal firepower to dampen its economy in the short term, even if it comes at the expense of long-needed rebalancing. Turkey is the prime example of a country that is vulnerable to a shock. High public and private debt coupled with little credibility in its economic institutions is a toxic mix. Countries in similar positions have already seen capital flight and are facing the threat of a vicious cycle of deteriorating prospects and increased vulnerabilities.

The prospect is difficult. The World Bank expects 40 percent of emerging and developing economies to continue to have national income below the 2019 level by 2023. These are the conditions that are likely to cause a settlement this year rather than become more confusing.

chris.giles@ft.com



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