Is the world economy heading for a recession?

If Leo Tolstoy were writing about current business conditions, he might point out that happy economies are all the same, but each unhappy economy is in its own way.

China’s growth prospects have been shaken by the severe lockdowns adopted by the country in its effort to stop the omicron variant of Covid-19; the Fed (Federal Reserve), the central bank of the United States, is in danger of turning a boom into a crisis; European households are facing a persistent cost-of-living crisis; and the situation is even worse in many poorer emerging market countries, where food supply crises and even famines seem to be on the way.

These four different but complicated problems are hampering the world economy in its recovery from the pandemic, and it is not surprising that the mood is turning grimmer.

According to Robin Brooks, chief economist at the Institute of International Finance, the confluence of these shocks indicates that the world economy is already in trouble. “We’re living through another period of recession fear, except this time I think the risk is real,” he said.

Financial markets panicked. The MSCI index of international equities has fallen by more than 1.5% last week, more than 5% in May and more than 18% since its peak in early January. Dhaval Joshi, chief strategist at BCA Research, points out that, in addition to the difficult moment for equities, there have been waves of sales of bonds, securities protected by currency correction, industrial metals, gold and assets in the cryptocurrency market.

“The last time the stars aligned to create a ‘sell it all’ moment was in early 1981, when the Fed, led by Paul Volcker, beat inflation and turned stagflation into a stark recession,” Joshi said.

Defining what a global recession is is not an easy task. For individual countries, economists define a “technical recession” as two consecutive quarters of contraction in GDP (Gross Domestic Product). The Financial Times prefers a looser definition, as does the United States, where the National Economic Research Service defines a recession as “a significant decline in economic activity that spans the entire economy and lasts for more than a few months.”

On a global scale, definitions become even more difficult. The IMF (International Monetary Fund) and the World Bank prefer to characterize a global recession as a year in which the average citizen of the planet experiences a drop in real income. The two institutions point to 1975, 1982, 1991, 2009 and 2020 as the dates of the last five global recessions.

Although the official growth forecast for 2022 remains far from that definition – in April the IMF was forecasting growth of 3.6% this year – the projected number relates to both the recovery in the second half of 2021 and expectations for 2022. Regarding direct growth expectations during 2022, the IMF has already reduced its forecast from 4.5% in October last year to 2.5% in April.

Brooks calculates that the news that has emerged since this projection was released has been bad enough to cause the growth projection to drop to just 0.5% during 2022, less than the predicted growth in world population. “The growing global risk of recession is a major concern for markets, and this has important repercussions on investor psychology,” Brooks said.

China is the big economy that most economists worry about, and the past week has seen new data that reinforce those concerns about its outlook. Accounting for 19% of the world’s gross product, China is now so big that when the country gets Covid, the rest of the world can’t ignore its problems, especially given its impact on global supply chains and demand. for goods and services from other countries.

There are severe wear and tear that become increasingly apparent. With lockdowns spreading across the country, ships lined up at the entrance to Chinese ports and the country’s industry and retail sector began to contract. Retail sales fell by 11% in April, compared with the same month in 2021, and industrial production fell by 3%. Chinese domestic sales also fell more last month than they did in early 2020, as China’s economy reversed despite the central bank easing monetary policy to encourage funding and spending. Unemployment is on the rise.

Kevin Xie, senior economist at the Commonwealth Bank of Australia for the Asian market, says China’s economic data in April was disappointing across the board. While the outlook crucially depends on the spread of Covid, he adds that “falling employment and weakening confidence among businesses and households will constrain spending and bode ill for economic growth.”

In the United States, the other major power on the planet, the economy is suffering from the legacy of the pandemic and especially from excessive fiscal stimulus that may have overheated the economy and generated high inflation despite modest increases in energy prices. In addition, the labor market is heated, and the Fed has been forced to admit a mistake and has now clearly entered the phase of tightening monetary policy in order to slow growth and reduce inflation.

Jay Powell, the Fed’s chairman, expressed himself with crystal clarity this week as he announced that the central bank would continue to raise interest rates until it saw “clear and convincing” evidence that inflation was returning to its target of close to 2%. annual. He wasn’t worried about a “slight rise” in unemployment from its current floor of just 3.6%.

Powell added that his goal was a soft landing for the economy, but many in the financial markets believe that could be difficult to achieve. Krishna Guha, vice president of Evercore ISI, warns that the risk that harsh rhetoric from policymakers, economists and market participants will exacerbate the situation and help spawn a recession.

“Stating that a more or less smooth landing is possible is not the same as saying that it is inevitable or even reasonably likely,” says Guha. While he is not predicting a recession in the United States, Guha says, “getting inflation under control without a recession and without a big rise in unemployment … will be a challenge.”

On the other side of the Atlantic, Europe’s equally difficult problem is different. With the exception of the UK, inflation is being caused almost everywhere by higher energy prices rather than an overheated economy, and its origins can be traced directly to Russia’s invasion of Ukraine.

Unfortunately for the European Union, understanding the cause of Europe’s problems does not make its consequences any less serious. With annualized inflation of 7.4% in April, prices in the eurozone are growing much faster than the income of its citizens, which has shaken living standards and will limit consumption and recovery from the pandemic. New forecasts from the European Commission released this week brought very low numbers and imply that there will be stagnation in the second quarter of 2022.

The Commission expects the economy to weather this difficult period and return to reasonable growth of around half a percentage point per quarter starting next quarter, but many private sector economists believe the effects on personal income will be more lasting. Christian Schulz, economist at Citigroup, says official projections appear to be too optimistic and that growth is more likely to “be virtually zero for the rest of the year.”

If Europe’s difficulty is adjusting to much higher energy prices, in much poorer countries the even more difficult task is dealing with the rapid rise in food prices, which account for more than 30% of the consumption in emerging economies.

With Black Sea ports, used by Ukraine to export grain, closed, fears of a food crisis later this year are growing. António Guterres, UN Secretary General, declared on Wednesday that the conflict in Ukraine, which has added to existing pressures on food prices, “threatens to throw tens of millions of people into food insecurity, massive food shortages and waves of hunger”.

Sri Lanka, which faces other political and economic crises, serves as an example of the difficult choices facing many of the world’s poorest countries. His government decided this week to default on the country’s foreign debt, the first in its history. The authorities said this was necessary because they need their hard currency reserves to import food, fuel and medicine.

India, meanwhile, has intensified problems for other emerging economies by abandoning its pledge not to ban grain exports this week. Wheat prices are on the rise again, and are already up more than 60% this year.

Naturally, as recession risks mount, the best news for the world economy would be a Russian withdrawal from Ukraine and the end of China’s Covid zero strategy. It is not something that finance ministers and economic authorities in other countries can enact, and so they will once again have to fine-tune their responses to the difficult situations they face.

In Europe and emerging economies, this would involve alleviating the fallout from rising food and energy prices — with increases in benefits and subsidies for food and energy in countries that have strong enough public finances to do so. The United States and the United Kingdom may accelerate the cycle of monetary policy tightening, and China will seek to limit the negative effects of the wave of the omnitron variant in the country.

The position of most economists is that the defense against the global recession will win in 2022, despite everything. But they begin to place more cautious bets in the face of nonstop bad news.

Innes McFee, chief international economist at Oxford Economics, says there is little doubt that global economic expansion is nearing its peak, that it is slowing and that policymakers will have to calculate the necessary dose of tightening. But, he says, a recession remains unlikely for now, because policymakers still have the tools to offer support and stimulate the economy if things get worse.

“Recession risks will be higher next year, but they’re not great right now,” McFee said.

Translation by Paulo Migliacci