London: At the beginning of the year, business executives and economists expressed hope that the global economy might not slow down as much as they had anticipated. The reopening of China, resiliency indicators in Europe, and a decline in energy prices were all positive developments.
However, a banking crisis that surfaced last month has altered the equation. On Tuesday, the International Monetary Fund revised downward its estimates for the world economy, citing "the recent rise in financial market volatility."
IMF now anticipates a slowdown in economic growth from 3.4% in 2022 to 2.8% in 2023. It had projected 2.9% growth for this year in January.
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According to the organization's most recent report, "uncertainty is high and the balance of risks has shifted firmly to the downside so long as the financial sector remains unsettled."
Following the March failures of Silicon Valley Bank and Signature Bank, two local US lenders, and the subsequent loss of faith in the much larger Credit Suisse (CS), which was sold to rival UBS in a government-backed rescue deal, concerns about the economic outlook have grown.
The effects of high and ongoing inflation, the quick increase in interest rates to combat it, excessive debt levels, and Russia's war in Ukraine were already weighing heavily on the world economy.
Now added to the list are worries about the state of the banking sector.
The IMF stated that these forces "are now overlaid by, and interacting with, new financial stability concerns," adding that policymakers "may face difficult trade-offs" when attempting to control inflation and prevent a painful recession or "hard landing."
The IMF projects that global inflation, which it said was "much stickier than anticipated," will decline from 8.7% in 2022 to 7% this year and 4.9% in 2024.
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Investors are searching the financial sector for more areas of weakness. In the meantime, lenders might become more cautious in order to protect the money they might need to deal with an uncertain environment.
That would make it more difficult for businesses and households to access loans, which over time would have an impact on economic output.
The IMF, which is holding its spring meeting this week alongside the World Bank, stated that "financial conditions have tightened, which is likely to entail lower lending and activity if they persist."
Global growth could slow to 1% this year, the IMF warned, if another financial system shock causes a "sharp" deterioration in financial conditions. "Near-stagnant income per capita" would be the result. The group estimated that 15% of this happening.
The IMF acknowledged that in this environment, forecasting was challenging. It stated that "the fog over the global economic outlook has thickened."
It also stated that weak growth would probably last for years. Global growth is projected to be 3% in 2028, which is the lowest medium-term prediction since 1990.
The IMF cited the UK's decision to leave the European Union, economic tensions between the United States and China, and Russia's invasion of Ukraine as contributing factors to the slowdown, along with pandemic scarring, ageing workforces, and geopolitical fragmentation.
After the current period of high inflation has passed, interest rates in advanced economies are likely to return to their pre-pandemic levels, the IMF added.
The organization's prediction for world growth this year is now more in line with the World Bank's. According to Reuters, David Malpass, the outgoing president of the World Bank, told reporters on Monday that the organisation now expects a 2% increase in output in 2023, up from the 1.7% forecast made in January.
The IMF stated in a separate report released on Tuesday that while the swift rise in interest rates was putting pressure on banks and other financial institutions, there were fundamental differences from the global financial crisis of 2008.
Banks now have significantly more capital to withstand shocks. Due to stricter regulations, risky lending has also been reduced.
The IMF instead noted parallels between the current banking crisis and the US savings and loan crisis of the 1980s, when problems at smaller institutions undermined confidence in the larger financial system.
According to the IMF's blog post based on the report, investors are currently "pricing a fairly optimistic scenario," and access to credit is actually higher than it was in October.
Even though market participants believe that a recession is likely, they also believe that it won't be severe, according to the IMF.
But those hopes might be abruptly dashed. According to the group's blog, investors may believe that interest rates will remain higher for a longer period of time if inflation increases further.
The financial system might then experience stress again, it was noted.
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This strengthens the need for policymakers to take prompt action, according to the IMF. It demanded that oversight and regulatory gaps "be addressed immediately," citing the need for better deposit insurance policies and stronger plans to close down failing banks in numerous nations.