Economic headwinds mount as leaders weigh costs of confrontation with Russia

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BRUSSELS – The global economy is heading into potentially bleak times as rising costs, shortages of food and other basics and Russia’s continued invasion of Ukraine threaten to slow economic growth and to cause a painful global crisis.

Two years after the coronavirus pandemic emerged and left much of the world in a state of paralysis, policymakers grapple with ongoing challenges including clogged supply chains, lockdowns in China and the prospect of an energy crisis as nations wean themselves off Russian oil and gas. These colliding forces have some economists beginning to worry about a global recession as different corners of the world see their economies battered by events.

Finding ways to avoid a global slowdown while continuing to pressure Russia for its war in Ukraine will be the main focus of the Group of 7 nations’ finance ministers meeting in Bonn, Germany, this week.

The economic challenges facing governments around the world could begin to erode the united front Western nations have maintained in the face of Russia’s aggression, including sweeping sanctions aimed at crippling its economy and efforts to reduce dependency. to Russian energy.

Policymakers are balancing delicate trade-offs as they consider how to isolate Russia, prop up Ukraine and keep their own economies afloat at a time of rapidly rising prices and growth. slows down.

Central banks around the world are starting to raise interest rates to help tame rapid inflation, moves that will temper economic growth by raising borrowing costs and could lead to higher unemployment.

Global growth is expected to slow to 3.6% this year, the International Monetary Fund forecast in April, from the 4.4% it forecast before Russia’s invasion of Ukraine and China’s zero Covid shutdowns. .

On Monday, the European Commission released its own revised economic forecast, showing growth slowing to 2.7% this year, from an estimated 4% in its winter report. At the same time, inflation is at record highs and is expected to average 6.8% for the year. Some Eastern European countries are expecting much higher increases, with Poland, Estonia, the Czech Republic, Bulgaria and Lithuania all facing inflation rates above 11%.

Last week, Christine Lagarde, president of the European Central Bank, signaled a possible interest rate hike in July, the first of its kind in more than a decade. In a speech delivered in Slovenia, Ms Lagarde compared Europe to a man “who receives blow after blow from fate”.

Eswar Prasad, the former head of the International Monetary Fund’s China division, summed up the challenges facing G7 countries, saying his “policymakers are caught in a bind that any tightening of the screws on Russia by limiting energy purchases worsens inflation and hurts growth in their economies”.

“Such sanctions, for all the moral justification behind them, exact a heavy economic toll which, in turn, could have domestic political consequences for the G7 leaders,” he added.

Yet the United States should pressure its allies to continue isolating Russia and providing more economic aid to Ukraine despite its own economic difficulties. Officials are also expected to discuss the merits of imposing tariffs on Russian energy exports ahead of a proposed European oil embargo that the United States fears will skyrocket prices by limiting supplies. . Policymakers will also debate whether to pressure countries like India to roll back export restrictions on essential food items that are worsening already high prices.

Against this backdrop, there is a growing urgency to help support Ukraine’s economy, which the International Monetary Fund says needs an estimated $5 billion a month in aid to keep government operations running. . The US Congress is set to pass a $40 billion aid package for Ukraine that will cover some of those costs, but Treasury Secretary Janet L. Yellen has called on her European counterparts to provide aid additional financial.

Finance ministers should consider other measures to relieve Ukraine. There is growing interest in the idea of ​​seizing some of the roughly $300 billion in Russian central bank reserves that the United States and its allies have tied up and using that money to help fund Ukraine’s reconstruction. . Treasury Department officials are considering the idea, but they worry about the legality of such a move and the possibility that it raises doubts about the United States as a safe place to store assets.

Ahead of the G7 meeting this week, US officials have seen firsthand the economic challenges facing Europe. During a stop to meet senior officials in Warsaw on Monday, Ms Yellen acknowledged the impact of the conflict in Ukraine on Poland’s economy, where officials have raised interest rates sharply to fight inflation. Poland has taken in more than three million Ukrainian refugees and has faced a cut in gas exports from Russia.

“They have to deal with tighter monetary policy, just like countries around the world and the United States,” Ms Yellen told reporters. “At a time when Poland has embarked on significant expenditure to strengthen its security, it is a difficult balancing act.”

A slowdown may be inevitable in some countries, and economists are weighing several factors as they assess the likelihood of a recession, including a severe slowdown in China linked to continued Covid lockdowns.

The European Commission, in its economic report, said the EU “is the first of the advanced economies to be affected”, due to its proximity to Ukraine and its dependence on Russian energy. At the same time, it absorbed more than five million refugees in less than three months.

Deutsche Bank analysts said this week they thought a recession in Europe was unlikely. By contrast, Carl B. Weinberg, chief economist at High Frequency Economics, warned in a note on Monday that with falling consumer demand and output, “the German economy is heading into recession.” Capital Economics analysts have predicted that Germany, Italy and Britain will face recessions, meaning there’s a ‘reasonable chance’ the wider eurozone will also experience them. one, defined as two consecutive quarters of declining production.

Vicky Redwood, senior economic adviser at Capital Economics, warned that more aggressive interest rate hikes by central banks could lead to a global contraction.

“If inflation expectations and inflation prove more persistent than expected, and interest rates are set to rise further accordingly, then a recession will most likely be on the cards,” Ms Redwood wrote in a note. to customers this week.

The main culprit is the price of energy. In Germany, which has been the most dependent on Russian fuel among Europe’s major economies, the pressure is keenly felt by its industry-intensive industrial sector as well as by consumers.

Russian gas shipments “support the competitiveness of our industry”, said Martin Brudermüller, the chief executive of chemicals giant BASF, at the company’s annual general meeting last month.

While calling for a reduction in its dependence, Mr. Brudermüller nevertheless warned that “if the supply of natural gas from Russia were to stop suddenly, it would cause irreversible economic damage” and possibly force a halt in production.

The fallout from a gas embargo has been hotly debated among German economists and policymakers, with analyzes ranging from manageable to catastrophic. Power flow is just one of many supply concerns in the industrial sector.

The rise in food prices is another subject that worries finance ministers. The Treasury Department is expected to release a report later this week outlining plans by the World Bank and other international financial institutions to address food shortages.

The disruption of wheat exports from Ukraine and Russia, which together account for 28% of global exports, as well as supply chain disruptions, a severe drought in India that led it to ban shipments grain and Covid-related lockdowns in China, are also leading to soaring food prices and increasing hunger around the world, particularly in Africa and the Middle East.

The question for US and European policymakers is how to rein in soaring prices without sending their economies into recession. The Federal Reserve has started to raise interest rates to keep US inflation under control, and its chairman, Jerome H. Powell, has acknowledged that bringing prices down without seriously hurting the overall economy will be a challenge.

Charlie Scharf, the chief executive of Wells Fargo, told a Wall Street Journal event on Tuesday that “it’s going to be hard to avoid some kind of recession.”

This conundrum explains the European Central Bank’s reluctance to raise rates. In the plus column, the European Commission noted that unemployment in the euro zone was falling, as were public deficits, even as war-related costs rose.

As food prices rise around the world, the level of inflation varies widely. Food inflation was 2.5% in France and Ireland in the first three months of 2022 and 10% in Eastern European countries. while in Turkey and Argentina, 60-70% in March alone, according to an analysis by ING last week.

In a speech at the Brussels Economic Forum on Tuesday, Yellen said Russia’s actions are a reminder that nations should not trade national security for cheap energy. She argued that reducing dependence on Russia and China and accelerating investment in renewable resources is crucial.

“No country controls the wind and the sun,” Ms Yellen said. “Let’s make sure this is the last time the global economy is held hostage to the hostile actions of those who produce fossil fuels.”

Alan Rappeport reported from Brussels and Patricia Cohen from London.

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