Downside Risks to Global Growth

By Stephen S. Roach

Stephen S. Roach, a faculty member at Yale University, is the author of Unbalanced: The Codependency of America and China (Yale University Press, 2014) and the forthcoming Accidental Conflict: America, China, and the Clash of False Narratives (Yale University Press, November 2022).

NEW HAVEN – The predictable downward revision cycle for the global economic outlook has officially begun. That’s the message from the semi-annual World Economic Outlook just released by the International Monetary Fund, which reinforces earlier revisions from several prominent private forecasting teams.

The revision, largely in response to the war in Ukraine, is a big one – a sharp reduction in world economic growth to 3.6% for 2022, fully 1.3 percentage points below the IMF’s global growth forecast of 4.9% made just six months earlier. To its credit, the IMF warned that this was coming, with an interim downward revision of 0.5 percentage point previously released in January. Even so, in looking back over the past 15 years, this is the third-largest cut in the IMF’s regular six-month revision cycle.

In April 2009, as the global financial crisis (GFC) was unfolding, the IMF cut its global growth estimate for the year by 4.3 percentage points (taking its pre-crisis projection of 3% positive growth down to an outright contraction of -1.3%). And, of course, as the COVID-19 pandemic erupted in early 2020, the IMF slashed its growth estimate for the year by 6.4 percentage points (from a pre-pandemic projection of +3.4% to an outright contraction of -3%). In both of those earlier cases, the outsize forecast reductions foretold sharp global recessions – in fact, the two worst recessions in modern history.

Yet neither the IMF nor most other forecasters believe that the current shortfall in global growth will push the world into outright recession. The latest World Economic Outlook calls for a perfect soft landing in the $96 trillion global economy. Following the recent downward revision, global growth is now expected to settle comfortably into a 3.6% growth trajectory over 2022-23, which is fractionally above the 3.4% average since 1980. Landings don’t get much smoother than that.

But that could well be wishful thinking, for several reasons.

For starters, forecasters were overly optimistic in extrapolating the sugar high of 2021 into the future. The 6.1% surge of global growth in 2021 was the sharpest rebound on record, according to IMF statistics dating back to 1980. But this followed the steepest plunge on record, a -3.1% collapse in 2020. Just as COVID lockdowns brought the bulk of the global economy to a virtual standstill in early 2020, reopening, in conjunction with aggressive monetary and fiscal stimulus, produced the mother of all snapbacks.

Forecasters, as well as investors, extrapolate current trends into the future, so it is important to look through the extraordinary volatility of 2020-21 to get a clean read on which trend to extrapolate. Over those two years, global GDP growth averaged just 1.5%, well below the official global recession threshold, widely thought to be around 2.5%. Needless to say, if world economic growth slows more toward that underlying trend than the soft-landing glide path, another global recession is hardly farfetched.

A second reason to doubt buoyant forecasts is that the China cushion has been deflated. China’s economy is currently growing well below the nearly 8% pace recorded from 2010 to 2019. The latest IMF outlook puts average Chinese growth in 2022-23 at 4.75%, only a little more than half the post-GFC trend when strong Chinese growth was literally the only thing that prevented the world from relapsing into recession over the 2012-16 period. As was the case back then, global resilience without a more vigorous Chinese economy is highly unlikely.

That’s the risk today. With China currently facing a trifecta of shocks – a new wave of COVID-19 lockdowns, the ongoing pressures of deleveraging (especially in its unstable property sector), and war-related collateral damage resulting from its ill-advised partnership with Russia – the world economy can no longer rely on China as a source of resilience. That, of course, cuts both ways. If China deepens its commitment to Russia, it will share in the isolation of its “unlimited partner.” For a Chinese economy that remains deeply reliant on the rest of the world, that could prove to be President Xi Jinping’s greatest challenge.

Third, the downshift in the global growth cycle is being accompanied by a major upswing in the global inflation and interest-rate cycles. The soft-landing crowd is dismissive of the consequences. As inflation surges to 40-year highs, there is loose talk of “peak inflation” – the fanciful idea that it is so bad now that it can only get better from here.

This superficial arithmetic argument misses the point. With the US Consumer Price Index surging by 8.5% in March, there is of course an excellent chance that this key barometer of inflation will be considerably lower by year end. But how much lower? Low enough to rescue the US Federal Reserve from its most irresponsible monetary-policy gambit since the mid-1970s and early 1980s?

Don’t count on it. While the Fed is now talking tough, talk is cheap. So far, it has delivered only 25 basis points, or just 10%, of the some 250 basis points of cumulative tightening that financial markets are expecting over the next six months. Even if the Fed moves as expected and boosts the federal funds rate to 2.5% by this November, the nominal policy rate is likely to be well below the inflation rate.

That means the real (inflation-adjusted) federal funds rate will remain in negative territory throughout the year, marking a 38-month period of negative real policy rates – far more stimulus than in earlier periods of über-accommodation under Alan Greenspan, Ben Bernanke, and Janet Yellen. Real interest rates matter in maintaining price stability and driving economic growth. When assessing risks to the global business cycle, the bottom line is that the upswing in real rates has much further to go.

All of this underscores the downside risks that are building in the global economy. As a recovering Wall Street forecaster, I empathize with the mindset of most forecasting teams, including the IMF’s highly talented professionals, who believe that they have factored in most conceivable risks. In this case, financial markets concur, convinced that an inflation-prone world, with still jaw-droppingly accommodative central banks, is somehow gliding gloriously toward a soft landing for the ages. But is this already-rosy scenario really supposed to play out without China? Dream on.