The collapse of Silicon Valley Bank in the US and the bailout of Credit Suisse in Switzerland have spooked the International Monetary Fund, denting its hopes that 2023 would see an end to the series of setbacks that have afflicted the global economy since Covid-19 was declared a pandemic about three years ago.
It’s fair to say the IMF wasn’t exactly super-optimistic about the prospects for the world economy even before SVB and CS conjured up unpleasant memories of the 2008 financial crisis.
But the turbulence in the financial sector – which the IMF thinks could affect hedge funds, pension funds and insurance companies in addition to banks – has made the Washington-based institution even more cautious about the outlook.
The potential danger, as the IMF sees it, is clear. Central banks are taking tough action to bring down stubbornly high inflation but ever-higher interest rates put pressure on financial institutions that had become accustomed to rock-bottom interest rates. The battle to ensure price stability, in other words, could put financial stability at risk.
Although inflation is proving stickier than expected, the IMF says it sees no sign of a wage-price spiral. What it has detected is companies taking advantage of the pick up in demand to boost profit margins.
The fear is that things could deteriorate rapidly. One key lesson from 2008 is that weakness in the financial sector can quickly cause problems for the rest of the economy. As a result, the IMF is concerned that growth could be even weaker this year and next than it expects.
There is an element of back covering in this. The IMF doesn’t want to be accused of failing to warn of the risks of a financial meltdown in the event that central banks precipitate a full-blown financial crisis by over-doing the interest-rate pain. Having been caught out badly in the run-up to the global financial crisis, the IMF is eager not to make the same mistake twice.
But it is not just the global economy’s short-term prospects that are worrying IMF staff. There are also concerns about the medium-term outlook, where there has been a marked slowdown over the past decade or so. The IMF’s forecasts for growth five years ahead have steadily declined since 2011, its economic counsellor, Pierre-Olivier Gourinchas, said.
In part this slowdown has been caused by an anticipated moderation in growth rates posted by China and South Korea. But that’s not the whole story.
As Gourinchas put it, the more recent slowdown in medium-term prospects might also reflect more “ominous” forces, such as: the scarring impact of the pandemic; a slower pace of structural reforms, as well as the rising threat of geoeconomic fragmentation leading to protectionism and trade tensions; less direct investment; and a slower pace of innovation and technology adoption across fragmented “blocs”.
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Brexit, the cold war between the US and China, and Russia’s invasion of Ukraine are signs of this splintering, according to the IMF’s world economic outlook.
The IMF was one of the cheerleaders for globalisation when it seemed unstoppable in the 1990s and early 2000s. Now it is warning that deglobalisation could have a cost.
“A fragmented world is unlikely to achieve progress for all or to allow us to tackle global challenges such as climate change or pandemic preparedness,” Gourinchas said. “We must avoid that path at all costs.”