War darkens global economic outlook as inflation picks up
The global economic outlook has been severely damaged, largely due to Russia’s invasion of Ukraine.
This crisis is unfolding even as the global economy has yet to fully recover from the pandemic. Even before the war, inflation in many countries had risen due to supply-demand imbalances and political support during the pandemic, leading to a tightening of monetary policy. The latest lockdowns in China could cause new bottlenecks in global supply chains.
In this context, beyond its immediate and tragic humanitarian impact, war will slow economic growth and increase inflation. Global economic risks have risen sharply and political trade-offs have become even more difficult.
Compared to our January forecast, we have revised down our global growth projection to 3.6% in 2022 and 2023. This reflects the direct impact of the war against Ukraine and the sanctions against Russia, the two countries expected to experience strong contractions. The European Union’s growth outlook for this year has been revised down by 1.1 percentage points due to the indirect effects of the war, making it the second largest contributor to the overall downward revision.
The war adds to the series of supply shocks that have hit the global economy in recent years. Like seismic waves, its effects will travel far and wide, through commodity markets, trade and financial linkages. Russia is a major supplier of oil, gas and metals and, along with Ukraine, of wheat and corn. The reduced supply of these products has caused their prices to skyrocket. Importers of raw materials from Europe, the Caucasus and Central Asia, the Middle East and North Africa and sub-Saharan Africa are the most affected. But soaring food and fuel prices will hurt low-income households around the world, including in the Americas and the rest of Asia.
Eastern Europe and Central Asia have significant direct trade and remittance links with Russia and are likely to suffer. The displacement of around 5 million Ukrainians to neighboring countries, particularly Poland, Romania, Moldova and Hungary, is adding to economic pressures in the region.
The medium-term outlook is revised downwards for all groups, with the exception of commodity exporters who are benefiting from soaring energy and food prices. Aggregate output in advanced economies will take longer to return to its pre-pandemic trend. And the divergence that opened in 2021 between advanced and emerging economies and developing economies is likely to persist, suggesting permanent scars from the pandemic.
Inflation has become a clear and present danger for many countries. Even before the war, it surged due to soaring commodity prices and imbalances between supply and demand. Many central banks, such as the Federal Reserve, had already decided to tighten their monetary policy. War-related disruptions amplify these pressures. We now expect inflation to remain high for much longer. In the United States and in certain European countries, it reached its highest level for more than 40 years, in a context of tight labor markets.
There is a growing risk that inflation expectations will drift away from the central bank’s inflation targets, prompting more aggressive tightening by policymakers. In addition, increases in food and fuel prices can also greatly increase the prospect of social unrest in poorer countries.
Immediately after the invasion, financial conditions tightened for emerging markets and developing countries. So far, this price revision has been mostly ordered. Yet several risks of financial fragility remain, raising the prospect of a sharp tightening of global financial conditions as well as capital outflows.
Fiscal space was already being eroded in many countries by the pandemic. The withdrawal of extraordinary budget support was to continue. Soaring commodity prices and rising global interest rates will further reduce fiscal space, especially for oil- and food-importing emerging markets and developing economies.
The war also increases the risk of a more permanent fragmentation of the global economy into geopolitical blocs with distinct technological standards, cross-border payment systems and reserve currencies. Such a tectonic shift would lead to long-term efficiency losses, increase volatility, and pose a major challenge to the rules-based framework that has governed international and economic relations for the past 75 years.
The uncertainty around these projections is considerable, well beyond the usual range. Growth could slow further while inflation could exceed our forecasts if, for example, sanctions extend to Russian energy exports. The continued spread of the virus could give rise to more deadly variants that evade vaccines, causing further lockdowns and production disruptions.
In this difficult environment, national policies and multilateral efforts will play an important role. Central banks will need to adjust their policies decisively to ensure that medium to long-term inflation expectations remain anchored. Clear communication and forward guidance on the outlook for monetary policy will be key to minimizing the risk of disruptive adjustments.
Several economies will have to consolidate their budgetary balances. This should not prevent governments from providing well-targeted support to vulnerable populations, especially given high energy and food prices. Integrating these efforts into a medium-term framework with a clear and credible path to stabilizing public debt can help create space to provide the necessary support.
Even as policymakers focus on cushioning the impact of war and the pandemic, other goals will require their attention.
The most immediate priority is to end the war.
On the climate, we must bridge the gap between stated ambitions and political actions. An international carbon price floor differentiated according to country income levels would coordinate national efforts to reduce the risk of catastrophic climate events. Equally important is ensuring equitable global access to the full suite of COVID-19 tools to contain the virus and to address other global health priorities. Multilateral cooperation remains essential to advance these goals.
Policymakers should also ensure that the global financial safety net works effectively. For some countries, this means ensuring adequate liquidity support to overcome short-term refinancing difficulties. But for others, a complete restructuring of sovereign debt will be necessary. The Group of Twenty common framework for dealing with debt offers guidance for such restructuring, but has not yet been followed up. The absence of an efficient and rapid framework is a flaw in the global financial system.
Particular attention should also be paid to the overall stability of the global economic order to ensure that the multilateral framework that lifted hundreds of millions out of poverty is not dismantled.
These risks and policies interact in complex ways over varying time periods. Rising interest rates and the need to protect vulnerable populations from high food and energy prices make it more difficult to maintain fiscal sustainability. In turn, eroding fiscal space makes it more difficult to invest in climate transition, while delays in dealing with the climate crisis make economies more vulnerable to commodity price shocks, which fuel climate change. inflation and economic instability. Geopolitical fragmentation compounds all of these trade-offs, increasing the risk of conflict and economic volatility and decreasing overall efficiency.
In the space of a few weeks, the world has again experienced a major shock. With a lasting recovery from the pandemic in sight, war broke out, potentially wiping out recent gains. The many challenges we face call for proportionate and concerted policy actions at the national and multilateral levels to avert even worse outcomes and improve economic prospects for all.