More Pain Expected Despite Encouraging Developments

As 2021 progressed and more countries moved to open their economies, it became increasingly apparent that the dislocations caused by the COVID-19 pandemic would linger for much longer than initially expected. Despite growing demand, global economic activity was impeded by supply shortages and bottlenecks, logistical challenges at ports, inadequate labour, rapidly increasing shipping costs and rising energy prices, to name a few. In addition to constraining growth, these challenges caused global inflation to accelerate, imposing yet more hardship on developing countries, struggling businesses and low-income households. By the end of 2021, food prices as measured by the United Nations Food and Agriculture Organisation’s (UNFAO) Food Price Index, were 23.1 percent above December 2020 levels. Similarly, the West Texas Intermediate (WTI) oil spot price increased by 81.8 percent to US$77.27 per barrel (p/b) in the fourth quarter of 2021 from the same period in 2020 (Figure 1), while Henry Hub gas prices rose 88.5 percent to US$4.77 per million British thermal units (MMBTU).

These challenges were significantly intensified in the wake of Russia’s invasion of Ukraine in February 2022, prompting food and / or energy crises in several nations in the process, with both countries being major producers of agricultural products and Russia being a supplier of oil and gas. Global food prices increased by a further 17.8 percent between January and March, with considerable acceleration in the cereals (21 percent) and vegetable oils (35.4 percent) categories (Figure 2). Oil prices advanced by 41 percent and gas prices by 56.8 percent between the fourth quarter of 2021 and the second quarter of 2022 to average US$108.93 p/b and US$7.48 per MMBTU, respectively. The economic dislocations and the resultant inflationary pressures have been sucking a fair amount of momentum out of the global economic recovery, prompting the IMF to yet again revise its outlook for global GDP growth for 2022 down to 3.2 percent in July from 3.6 percent, just three months prior.

Figure 1: Energy Prices (US$)

Source: EIA

It’s not all doom and gloom however, as there has been some encouraging developments in recent months. In July, the UNFAO Food Price Index recorded an 8.7 percent monthly decline, which was its largest fall since October 2008, though it remained substantially above the levels of July 2021. This was the fourth consecutive monthly decrease since April and follows three marginal contractions. The latest fall was greatly supported by an agreement signed by Russia and Ukraine on July 22nd to unblock grain exports from the Black Sea ports. Ukrainian President, Volodymyr Zelenskiy indicated that the deal will allow the country to make US$10 billion worth of grain available for sale on the international market.

The ease in food prices was also partly related to increased supplies from other producer nations due to seasonal harvests. Prices in the energy sector also eased in July, with oil prices falling to an average of US$101.62 p/b during the month from the peak so far for 2022 (US$114.84 in June) while gas price decreased to US$7.57 per MMBTU from US$8.46 in May. The US Energy Information Administration expects oil prices to weaken slightly in the remaining months of 2022, with growing fears of a global recession and weaker energy demand in China, due to its strong COVID-19 response.

Understandably, many hope that some of these latest developments are harbingers of the desperately-needed lasting ease in the global food and energy crises, which will ultimately provide a boost to the global economic activity. However, given the number of challenges still plaguing the global economy, any meaningful improvement, may be some way off. Some of these issues will be addressed in the remainder of this article.

Figure 2: UNFAO Food Price Index (% Chg.)

Source: UNFAO

The first issue is the ongoing Russia-Ukraine war, which despite the recent unblocking agreement, six months in, shows no sign of ending. Even in the wake of the agreement, President Zelenskiy clearly stated that there will be no ceasefire until Ukraine retakes territories lost to Russia in the conflict. For its part, the Russian Federation’s resolve remains unbroken, notwithstanding the criticism it has received and the setbacks it has encountered during the invasion. Against this backdrop, the many uncertainties provoked by the war and the ensuing sanctions on Russia are likely to continue for the foreseeable future. Accordingly, there will be no surprise if the unblocking deal proves to be short-lived. In all this, there is perhaps one inescapable fact and that is, the longer the war goes on, the longer it will take for supply lines and the global economy to recover. Of greater concern, the war could potentially impact the global economy in a deeper and more transformative way than the impairment of key markets. In its April 2022 World Economic Outlook, the IMF stated that “the war has also increased the risk of a more permanent fragmentation of the world economy into geopolitical blocks with distinct technology standards, cross-border payment systems, and reserve currencies. Such a tectonic shift would entail high adjustment costs and long-run efficiency losses as supply chains and production networks are reconfigured.” This assessment is of course based on the global alliances that have been forming and are likely to strengthen in the wake of the war and the sanctions on Russia.

There is also substantial uncertainty regarding the production and supply of key commodities over at least the next year. For instance, even if the unblocking agreement between Russia and Ukraine holds, there is likely to be continued food shortages for some time, with producers in several regions, including North America and Europe now facing severe drought. Regarding energy, given Russia’s threats and action to reduce or shut off fuel supplies to several European nations, fears of the country weaponising its fuel supply in response to trade sanctions are materialising. Available evidence suggest that the reduced fuel supply has already begun to severely undermine economic activity in Europe, with fuel intensive industries hardest-hit. Russia’s strategy has been emboldened by the availability of alternative markets in Asia for its fuel exports. In any case, the EU has announced its intension to impose a complete ban on Russian crude by December 2022.

The International Energy Agency indicated that this could result in a 20 percent fall in Russian oil output. The extent to which the EU can secure adequate alternative energy supplies remains to be seen, but several of its members are working on contingencies in the very likely event of continued fuel shortages. This prospect is very concerning, with the winter months approaching. With more developing countries expected to seek their own interests in response to the difficult global environment, Russia may find additional alternative markets for its exports, including energy. All this combines to paint an opaque picture of the global energy market heading into 2023. Oil and gas prices are expected to remain elevated during the period, but will likely ease somewhat given softening economic conditions, providing only moderate ease.

In response to spiraling prices, major central banks started to adopt less accommodative monetary policy stances starting in early 2022, after it became clear that the pervasive inflationary pressures were going to linger well beyond initial expectations. Faced with its highest domestic inflation rates for more than 40 years, the US Federal Reserve (Fed), has been the most aggressive, increasing its policy rate four times so far in 2022, by a total 225 basis points. In early August, the Bank of England (BOE) agreed to a sixth consecutive increase in its policy rate (50 basis points), which was also its largest in 27 years. In July, the European Central Bank increased its policy rates for the first time in 11 years by 50 basis points. However, these actions have intensified recession concerns at both the global level and for these territories. In the case of the US, the fears seemed to have materialised, with the country recording a second consecutive quarter of real GDP contraction between April and June 2022. Nonetheless, the Fed has moved to assuage the disquiet, citing still strong employment figures as evidence of a sturdy economy. Over in England, at the time of its latest policy rate announcement, the BOE projected that the UK economy will fall into recession for five quarters, beginning in fourth quarter 2022. A global recession or even recession in these major economies is expected to cause some ease in commodity prices, as demand will likely decrease. However, against a backdrop of continued shortages for several commodities, the fall in prices is not expected to be substantial.

The monetary policy actions of major central banks will inflict harsh consequences on many emerging and developing countries. For instance, the increase in interest rates in the US has caused the dollar to appreciate against the currencies of developing countries with floating exchange rate regimes. This immediately increased the value of their external debt and thereby added to these nations’ debt burdens. The higher interest rates have also resulted in substantial capital flight from emerging and developing economies, undermining their growth prospects in the process. For countries with exchange rates pegged to the dollar, its appreciation means they now face greater downward pressure on their foreign exchange reserves to support the value of their domestic currencies. This is a cost many of these economies could hardly afford, given the erosion that occurred during the pandemic. Finally, higher international interest rates will also increase the cost of borrowing on the international capital market for such countries, many of which are already confronted by unsustainable fiscal accounts. In view of this, emerging and developing economies are likely to experience a further deterioration of their fiscal accounts, driven by the monetary policy actions of major central banks. It will be no surprise if some of them are eventually confronted by debt crises. These fiscal challenges are expected to combine with capital flight to suppress real GDP growth among these nations, which would be bad for the global economy.

While the recent fall in commodity prices is indeed encouraging, it will be some time before we can expect to experience any major relief. High inflation rates and slow GDP growth are expected to be a feature of the global economy for some time, due in part to the war and the uncertainty it continues to perpetuate. This will be compounded by the production challenges related to several commodities and the effects of monetary policy tightening. In short, while we welcome the positive developments, we should also expect more pain.