Even with risks tilted to the downside and a slower momentum, the global economy is still not headed towards stagflation— a recession combined with high and rising inflation. In a keynote during the recently-held Finance China 2022, Steven Barnett, senior resident representative in China of the International Monetary Fund (IMF), said countries worldwide have made taming inflation a top priority, possibly averting a stagflation suffered in the ‘80s.
The edited transcript of the keynote:
Steven Barnett: I would like to thank the Asian Banker for inviting me to this event. I was looking forward to participating in-person but at the last minute had to go to California for personal reasons. My apologies for joining by video and I look forward to being back in China in a few weeks.
I will focus my remarks on global economic developments and prospects. Late last month, we published our World Economic Outlook Update. The subtitle of that report nicely summarizes our views on the outlook: Gloomy and more uncertain. We downgraded global growth for the third time in a row. We now forecast global growth this year to be 3.2%. This is 0.4 percentage points lower than we thought in April. And, for context, it is considerably lower than last year’s 6.1%. We also marked down growth for next year. Specifically, to 2.9%, which is 0.7 percentage points lower than we previously forecast.
Why the downgrades? The short answer is many of the downside risks we were concerned about in April have materialized. These downside risks included: the lingering effects of the pandemic. Especially here in China, where the lockdowns and COVID-19 containment measures had a strong impact on growth. Second, tightening global financial conditions. Or, more simply, the higher-than-expected inflation has resulted in many central banks raising interest rates at a faster pace than previously expected. And three, spillovers from the war in Ukraine. This, in particular, has had an impact on the outlook for Europe and lower-income countries.
I will address each of these in turn, including some policy considerations. First, China. By our math—specifically, using purchasing power parity (or PPP) weights—China is the world’s largest economy. What happens in China has a big bearing on our global forecasts. We revised our China forecast for 2022 and 2023. For this year, we forecasted growth to be 3.3%. This is 1.1 percentage points lower than we thought in April. For next year, we forecast 4.6% growth—down half a percentage point. The main reason for the revision is the developments in the first half of the year. Especially the impact of COVID-19 and China’s containment measures. As for the policies, one is of course to look for ways to reduce the economic cost of the pandemic. Another is to provide macro-policy support, especially using fiscal policy. China has room to support growth with additional fiscal stimulus, ideally focusing heavily on measures to boost consumption.
The second issue is global inflation. Our outlook for global inflation published in July was also more pessimistic than before. Focusing on fourth quarter (Q4) year-over-year inflation, we forecasted global inflation to reach 8.3% (up from our previous forecast of 6.9%. The upward revision was larger for advanced economies. However, inflation in advanced economies is generally lower than in emerging markets and developing economies. Specifically, 6.3% in the former versus 10% in the latter.
Our forecasts for 2023, however, are relatively unchanged. Again, this is focusing on the fourth quarter (Q4) year-on-year basis. This reflects our confidence that central banks’ tightening policies will succeed in reducing inflation and that energy prices will not continue to rise. And, by the end of 2024, we see inflation returning to pre-pandemic levels.
Regarding policies, we see containing inflation as the top policy priority. Price stability is a precondition for durable growth. And, the opposite, persistently high inflation could sink the recovery and further damage living standards. The appropriate monetary policy response, of course, depends on country-specific circumstances. But, in general, economies with rising inflation and inflation expectations will need to take decisive action to tighten monetary policy. Indeed, we have seen central banks raising interest rates. Since July of last year, some 75 central banks have raised interest rates. In emerging markets, rate increases have averaged around 3 percentage points and around 1.7 percentage points in advanced economies.
Regarding inflation, let me also pre-emptively answer two questions I often receive:
First, do we predict stagflation? Stagflation—a recession combined with high and rising inflation—is not in our baseline forecast. Our baseline forecast does not predict a recession, though it is clearly a risk. It is also true that higher interest rates will reduce inflation at the cost of lower real activity and higher unemployment. However, we also know from experience that acting now to contain inflation will hurt much less than acting later.
The second question is whether the inflation we are seeing today is the same as past episodes. In particular, people often have in mind the experience of the 1980s and the high-cost advanced economies paid at that time to tame inflation. Conditions now, however, are more favourable than in the 1980s. First, starting inflation is lower; second, inflation expectations have continued to be well-anchored and expectations are really important for driving inflation, and labour and product markets are more flexible. Thus, overall, conditions now are more favourable than in the 1980s.
The third risk I mentioned above was spillovers from the war in Ukraine. Spillovers that are leading, in particular, to rising food and energy prices. In this regard, it is important to recall that this has an especially large impact on low-income countries, as they typically spend a higher share of income on food and energy. Thus, it is not surprising that many emerging markets and low-income countries are now facing challenges.
More broadly, the pandemic has had a stronger impact on emerging markets and developing economies. They are experiencing larger and longer-lasting output losses. One way this shows up is in debt. Sixty percent of low-income countries are either in or at high-risk of debt distress. This is up from around only 20% a decade ago. Likewise, 30% of emerging market economies are also in or at high risk of debt distress.
What can be done to help emerging markets and developing countries? First, is a sound domestic policy response in these countries themselves. Countries should do what they can to ensure fiscal policy is sustainable, tackle inflation, pursue structural reforms to unlock their growth potential and protect the most vulnerable households.
Second, and actually, my final point and my key message, is that support from the international community is also essential. One area is international support to help countries address the food and energy crisis. To avoid further hunger, malnutrition, and migration, the world’s wealthier countries should provide urgent support to those countries in need. This could be bilateral or multilateral, such as by channelling money through organizations such as the World Food Programme. Another area is to help countries fight the pandemic. The key to minimising the costs of the pandemic is universal vaccination combined with widespread access to testing and treatments.
Finally, and also by way of concluding, let me highlight what the Fund has been doing since pandemic started. We extended substantial financial assistance through emergency financing and Fund-supported programmes: In the first two years of the pandemic, we approved $216 billion in loans to more than 90 countries, and more than half of recipients were our lower-income members. We also arranged for debt service relief for 25 of our poorest members through the Catastrophe Containment and Relief Trust.
In addition, our historic allocation of $650 billion in IMF Special Drawing Rights (SDR) in August last year was the largest ever. This benefitted all IMF members, boosted reserves, helped build confidence, and sent a powerful signal of a cooperative multilateral response to the crisis. For emerging markets and developing countries, the average allocation was equivalent to more than two percent of gross domestic product (GDP). Low-income countries are using up to 40 percent of their SDRs on essential COVID-19 related spending priorities, such as vaccines.
Finally, we also have created a new instrument—Resilience and Sustainability Trust—that will provide $45 billion in concessional financing for vulnerable countries—aimed at addressing longer term challenges such as climate change and future pandemics.
The IMF’s role is to offer a platform for our 190 members to work together. Thus, the steps I just mentioned reflect the actions of the global community. It also underscores how renewing the spirit of international cooperation is the best path toward solving the global economy’s greatest challenges. Thank you.