Stark warning for the world economies - IMF says recession risk rising

World food and supply chains are still at risk because of the ongoing war in Ukraine. Photo / Getty Images

The world economy faces the increasing risk of a painful slowdown amid worries about the global banking system and concerns that rising interest rates could force banks to curtail lending, the International Monetary Fund said.

The warning follows weeks of turmoil in the global banking sector, which included two bank failures in the United States and UBS’ takeover of Credit Suisse, brokered by the Swiss Government. Fears that bank runs would ripple through the financial system have abated in recent weeks, but concerns that additional bank failures and tightening lending standards could slow economic output around the world remain.

In its latest World Economic Outlook report, the IMF slightly reduced its growth forecast for 2023 to 2.8 per cent, from 2.9 per cent in January. A year ago, it projected output of 3.4 per cent.

Growth projections for Japan, Germany and India were all lowered since the start of the year, when the IMF said a global recession would most likely be avoided.

The IMF and the World Bank have raised alarms in recent weeks that the global economy is facing a period of extended stagnation. The IMF expects growth to hover around 3 per cent for the next five years, which is its weakest medium-term growth forecast since 1990.

On Tuesday, the IMF expressed optimism that a financial crisis could be averted, but it lamented that inflation was still elevated and that the global economy remained fragile, facing a “rocky” road ahead. It suggested that a so-called hard landing, which could entail economies around the world tipping into recession, was increasingly plausible.

“A hard landing — particularly for advanced economies — has become a much larger risk,” the IMF report said, adding, “The fog around the world economic outlook has thickened”.

The dimmer forecast comes as top economic officials from around the world are convening in Washington this week for the spring meetings of the IMF and World Bank. The gathering is taking place at a moment of high uncertainty, with Russia’s war in Ukraine grinding on, prices around the world remaining stubbornly high and debt burdens in developing countries raising unease about the possibility of defaults.

Treasury secretary Janet L. Yellen is expected to meet other international regulators this week to assess the state of the global financial system. On Tuesday, she expressed confidence in the US banking system and the health of the economy, explaining that she continues to believe that the outlook is brighter than what many economists predicted last autumn.

“Here at home, the US banking system remains sound, with strong capital and liquidity positions,” Yellen said. “The global financial system also remains resilient due to the significant reforms that nations took after the financial crisis.”

Yellen said she remained “vigilant” to the risks facing the economy, pointing to recent pressures on banking systems in the United States and Europe and the potential for more fallout from Russia’s war in Ukraine. She is not seeing evidence that credit is contracting, she added, but acknowledged that it was a possibility.

“I’m not anticipating a downturn in the economy, although, of course, that remains a risk,” Yellen said.

Economists are still working to assess what effects the bank failures might have on the broader US economy. Analysts at Goldman Sachs wrote in a research note this week that bank stress could reduce lending by as much as six percentage points and that small businesses, which rely heavily on small and midsize banks, could bear the brunt of tighter lending.

The IMF attributed the strain on the financial sector to banks with business models that relied heavily on a continuation of low interest rates and failed to adjust to the rapid pace of increases in the past year. Although it appears that the turbulence in the banking sector might be contained, the IMF noted that investors and depositors remained highly sensitive to developments in the banking sector.

Unrealised losses at banks could lead to a “plausible scenario” of additional shocks that could have a “potentially significant impact on the global economy” if credit conditions tighten further and businesses and households have an even harder time borrowing.

“The risks are again heavily weighted to the downside and in large part because of the financial turmoil of the past month and a half,” Pierre-Olivier Gourinchas, the IMF’s chief economist, said at a briefing ahead of the report’s release.

Treasury Secretary Janet Yellen is keeping a close eye on the US economy has the risk of recession grows. Photo / AP

In the most severe scenario, in which global credit conditions tighten sharply, the IMF projected that global growth could slow to 1 per cent this year.

Gourinchas noted that the financial system was not the only cloud hanging over the global economy. Hopes for stronger growth have been hinging on China’s reopening after strict pandemic regulations, and changes to that policy could slow output and disrupt international commerce, he said. At the same time, Russia’s war in Ukraine continues to threaten the reliability of food and energy supply chains.

The IMF has been playing a leading role in trying to stabilise the Ukrainian economy, and last month it approved a $15.6 billion loan package for Ukraine, the first such financing programme for a country involved in a major war. But despite the efforts by Western nations to buttress Ukraine and weaken Russia, the IMF raised its outlook for the Russian economy, projecting it will grow 0.7 per cent this year and 1.3 per cent in 2024.

The IMF noted that Russia’s energy exports continued to be robust, allowing it to support its economy through government spending. The impact of efforts by the United States and Europe to cap the price of Russian oil at US$60 ($97) a barrel remains unclear because global oil prices have been falling amid recession fears. IMF officials said that because of lower oil prices, Russian oil was no longer trading at as much of a discount and that Russia had found ways to circumvent the price cap.

Even as it underscored the risks facing the global economy, the IMF urged central banks to maintain their efforts to contain prices while standing ready to stabilise the financial system, noting that inflation is still too elevated relative to their targets.

Despite the IMF’s warnings about a hard landing, Yellen sought to open this week’s meetings with a note of optimism. She pointed to signs that inflation is diminishing and the resilience of the financial system as reasons for hope.

“I wouldn’t overdo the negativism about the global economy,” Yellen said. “I think we should be more positive.”

She added: “I think the outlook is reasonably bright.”