Šimkus: As global economic outlook falters, a concerted international response becomes crucial
Against a backdrop of high inflation, the global economy, including Lithuania’s, will grow significantly slower next year than previously forecasted, and downside risks are elevated, as shown by the latest International Monetary Fund (IMF) projections. According to Gediminas Šimkus, Chairman of the Board of the Bank of Lithuania, who is attending the IMF annual meetings in Washington, this environment requires a swift and coordinated response by central banks, governments and international financial institutions to the emerging challenges.
“With high inflation, driven mainly by exogenous supply shocks caused by Russia’s war against Ukraine as well as energy and political blackmail against the rest of the world, it is crucial that aid measures reach the most vulnerable countries, populations and businesses quickly. This will put pressure on governments to compensate for increased spending, but from a monetary policy perspective, it is important that state aid is targeted as much as possible at the most vulnerable social groups and economic activities,” said Gediminas Šimkus.
The IMF forecasts a 1.8% growth in Lithuania this year and a 1.1% growth in 2023. Compared to April, this year’s forecast has not been changed, but the forecast for next year has been cut by 1.5 percentage points, i.e. by more than a half. More sluggish growth will be mainly due to decreasing consumption, which is negatively affected by the decline in household purchasing power due to inflation. Another key factor is the slowdown in the growth of the major euro area economies, which is reducing external demand for the output of Lithuanian manufacturers.
Average annual inflation in Lithuania is expected to reach 17.6% this year. According to the IMF, price inflation, which peaked in the autumn, is expected to moderate next year, with average annual inflation falling to 8.4%. Rapid price growth is also observed in the euro area as a whole, where average annual inflation is expected to reach 8.3% this year, before falling to 5.7% next year. The main reason for the current surge in prices is the shock caused by Russia’s war against Ukraine which has led to a sharp rise in energy, food and commodity prices.
Global economic growth is also expected to slow down. The growth projection for this year has been decreased by 0.4 percentage points (to 3.2%) and by as much as 0.9 percentage points (to 2.7%) for next year. Historically, this is significantly slower than the average long-term growth rate of the global economy, which was 3.6% between 2000 and 2021. The IMF also estimates that as much as a third of the world economy is at risk of a technical recession between 2022 and 2023, which is triggered when gross domestic product (GDP) growth is negative for two consecutive quarters.
Slower activity is projected in all the world’s major economies. The euro area economy showed strong growth in the first half of this year, mainly due to the better performance in the southern economies, boosted by a strong recovery in tourism. Accordingly, the growth outlook for 2022 was revised upwards by 0.3 percentage points, and the euro area economy is expected to grow by 3.1% in 2022. However, slowing industrial sector turnover and deteriorating business and consumer expectations signal a significant economic slowdown in the second half of the year, which will continue into next year. Sluggish growth of just 0.5% is projected for 2023, and the IMF expects the two largest euro area economies – Germany and Italy – to experience a moderate recession. Annual growth in these countries will be -0.3% and -0.2% respectively.
The projection for US economic growth this year and the next has been cut by more than a half to 1.6% and 1% respectively. The main contributor to the slowdown in the US economy is the rapid rise in interest rates by the Federal Reserve Bank. In September, the rates were raised to the target range of 3–3.25% in response to high inflation, which the IMF estimates at 8.1% this year and 3.45% next year.
Contributing to the slower growth and price pressures is the ongoing pandemic, disrupting supply chains, especially in China, where the authorities continue to pursue a zero-COVID-19 policy. China’s real estate market, which used to account for around 20% of the country’s GDP, also adds to the uncertainty surrounding global growth. Recently, there has been a significant slowdown in activity in the sector, and a number of property developers are facing financial problems that pose risks to the wider financial sector.
Global inflation is set to accelerate to 8.8% this year and is expected to peak. Price growth is expected to slow down to 6.5% in 2023 and to 4.1% in 2024. High inflation will affect many developed and developing countries, and in the euro area it is expected to reach 8.3% this year and 5.7% in 2023. In the US, inflation will stand at 8.1% and 3.5% respectively, while in the group of developing countries, it will reach 9.9% this year and 8.1% in 2023. Central banks are raising interest rates at a rapid pace in response to elevated inflation. In the short term, higher interest rates will lead to slower growth because of the dampening effect on demand. However, the IMF stresses that this is the right and necessary response to ensure that price increases are contained and inflation returns to the 2% level that is essential for sustained economic growth in the long term.
The IMF also underlines that fiscal policy must support the monetary policy objective of containing inflation. Governments are recommended to support the most vulnerable social groups through targeted measures, ensuring that public money does not fuel inflation.