Global recessionary trends and challenges

Muhammad Mahmod | Published: September 07, 2024 19:47:45

Global economic growth, according to a UNCTAD forecast, will slump to 2.6 per cent in 2024, just above the 2.5 per cent threshold commonly associated with a recession. Inflation is expected to continue to cool, although in many countries the price pressure will take longer to unwind than it took to emerge.
Recent OECD forecasts also suggest that global economic growth will ease to 2.7 per cent in 2024, the lowest annual rate since the Global Financial Crisis (GFC). This low growth performance reflects the impact of tight financial conditions, weak trade growth, and lower business and consumer confidence.
Despite improvements in several key macroeconomic indicators in most developed countries, a heightened recession risk persists. After a rapid series of interest rate increases to tame inflation, the central banks in the US, UK and the Eurozone paused rate hikes for now, given the decline in respective consumer price indices (CPI) from their peak in 2022.
Central bankers remain very wary and may keep interest rates where they are for some time. The effect of these higher interest rates and uncertainty as to how long they will last, continue to impact the global economy. Higher interest rates are bad news for economic growth; they negatively impact on investment and consumer spending. UNCTAD also adds that the prevailing focus on inflation overshadows urgent issues like trade disruptions, climate change and rising income inequalities.
In view of current macroeconomic conditions, if a recession sets in, it will not be easy to quickly exit. A recession will place the governments in a very challenging position, where they will have to choose between high inflation or a strong economy. Therefore, attention is increasingly being directed to the recessionary trends in the global economy that gradually becomes stronger.
A job report in the US suggests that the weaker labour market in the past one year and a half has raised fears that the world's largest economy is heading for recession. America's stock markets have tumbled, with fear spreading to other countries. The Tokyo market experienced its biggest fall since 1987 stock market crash before rebounding. Germany's main index was also down.
As consensus shifts toward a "soft landing" in the US, risks remain across the global economy. In fact, Fed officials are reassuring that the economy is not moving into a recession. However, monetary policy in the US has become tighter even though the Federal Funds rate has remained unchanged. This is because, as inflation is declining, the real interest rate has risen, thereby causing a negative impact on credit markets.
Now many are arguing that there is no need for the Federal Reserve to go for further tightening of monetary policy while inflation is declining, and the economy weakening. Wall Street has also been calling for the Fed to start cutting interest rates at its next meeting this month by at least 25 basis points (0.25 percentage point) and possibly 50, followed by more cuts before the end of the year.
When America sneezes, everywhere catches a cold. So, with rising financial instability and growing fear of recession, all eyes will be focused on announcements of Fed chair Jerome Powell at the annual conclave of bankers later this month.
The slowing of the Chines economy suggests that
government and financial authorities would like to see a lowering of interest rates to provide some economic
stimulus. Now the Peoples Bank of China (PBoC) is moving in the opposite direction including selling bonds at lower prices to increase their yields. As the current weakness in the current Chinese economy is largely attributed to slow growth in domestic demand, the government needs to focus on stimulating domestic demand.
The Financial Times in the middle of last month warned that "China's bond market is now flashing urgent deflationary warning signs" and then added "policy makers would do well to take heed". The PBoC also now recognises the need for a change in its official policy.
According to a reliable report investor confidence has collapsed in the Eurozone and Germany. The ECB maintains an "open mind" about interest rate cuts which some consider an ambiguous monetary policy that creates high uncertainty. Furthermore, poor business data in the US, the Russia-Ukraine conflict and the prospect of military conflict in the Middle East also weigh in deceleration of the economy.
Much has been documented about the huge Japanese yen carry trade, the unwinding of which contributed to global financial market volatility recently. A carry trade is an investment strategy most often associated with foreign currency trading. It involves an investment strategy where an investor borrows money in a currency with a low interest rate and invests in another currency that offers a higher interest rate. The investor does so with the aim of profiting from the interest-rate differential between the two currencies.
Now with the Bank of Japan (BoJ) indicating a likelihood that interest rates would rise, an increase in the value of the yen has taken place. Many global investors have started to unwind carry trade positions, thereby putting downward pressure on the value of global equities while also exacerbating the increase in the value of the yen.
The rise in the value of yen led to the unwinding of carry trade, in which cheap Japanese money was used to finance investments in US financial markets. This has led to turmoil in financial markets resulting in deleveraging where investors used borrowed money cheaply and had to sell assets in one area of the market to cover losses
in another.
Reserve Bank of Australia (RBA) Governor Michele Bullock has cautioned the alternative to high interest rates in Australia as an economic recession. She is steadfast in her belief that higher interest rates are necessary to try and get on top of persistent inflation.
A slower than expected glide path on rate cuts by the Fed, which plays an outsized role in global financial markets, will have a larger impact on rate decisions by developing economies. These markets are more sensitive to the exchange rate movements than we have seen in the past. Weakening currencies relative to the U.S. dollar are inflationary for those economies.
As recession chances remain elevated, business and political leaders issue warnings for the financial gloom ahead. Recessions have tragic consequences for developing countries. The world economy is already in turmoil and developing countries are likely to bear the brunt of the turbulence.
The inflationary surges caused prices to rise across the globe, but its impact on the United States has an outsized role due to the dollar's importance in the international economy. In addition to making debt more expensive for developing countries, a rise in US interest rates also reduces the supply of US dollar in circulation, causing credit and lending markets to contract.
As interest rates increase, the cost of borrowing money becomes more expensive, and the cost of capital increases correspondingly. Expensive capital results in reduced investment and consumption. This impact will be the most profound in Asian economies like Bangladesh, a country which is now experiencing political crisis as well as facing rising inflation and a banking crisis.
A very recent (September 6) IMF blog said, "Capital flows to emerging markets and developing economies went through several boom-bust cycles in recent decades, partly driven by external developments such as monetary policy decisions in major advanced economies".
Bangladesh's external debt reached US$ 99.3 billion in March 2024 accounting for 23.6 per cent of the country's GDP in December 2023. While Bangladesh's external debt level remains within the IMF's debt sustainability limit, the burden of debt servicing is on the rise, thus creating a financial stress which is further compounded by the country's low foreign exchange reserves and the continuing negative balance in the financial account in the balance of payments.
According to the IMF, "the median low-income country is spending over twice as much on debt service to foreign creditors as a share of revenue than it did 10 years ago - roughly 14 per cent at the end of 2023 from 6 per cent 10 years ago". For many countries the proportion is much higher ranging up to 25 per cent or more. According to the IMF, Bangladesh's debt service-to-revenue and grants ratio stood at 71.8 per cent in the fiscal year of 2022-23.
In its one of the latest blogs, the IMF said that now was the time to help countries faced with liquidity challenges. Such calls have been made before, but IMF never explains why the crisis is getting worse and its policy initiatives to alleviate debt crisis are not working. The crippling effect of this rising debt servicing liability is clear -- cuts in public spending causing misery and distress for millions of people.
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