Has the Ukraine war plunged the global economy into a crisis spiral?

We face a severe shock—the only question is if our economies are robust enough to withstand it

June 15, 2022
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Moscow’s business centre. Image: Andrey Khokhlov / Alamy Stock Photo

The economic mood is turning increasingly pessimistic. In early June, the World Bank slashed its forecast for global GDP growth to just 2.9 per cent this year, keeping next year to just 3 per cent—and the same for 2024. Much of this is linked to changed forecasts for oil prices which, instead of stabilising as had been expected back in January, are now likely to be some 42 per cent higher overall this year, after a rise of 66 per cent in 2021. Non-energy commodity prices are forecast to be 18 per cent higher, after increasing by nearly 33 per cent last year.

The OECD has followed that with its own downgrades. Its latest economic outlook has the apt headline “The Price of War.” Many of the economies it covers are likely to see inflation double compared to the January forecast, to an average of 9 per cent across the OECD. Overall world growth, excepting some commodity producers, is at the same time being pushed sharply down, from the 4.5 per cent projected last December to 3 per cent—and to just 2.75 per cent in 2023. A notable warning is that the UK is likely to see the slowest growth in the G20 next year, bar Russia. In this respect its UK growth projection is not out of line with the Bank of England's own assessment in May that growth will peter out in the next couple of quarters. And it may indeed be quicker than that. Already March and April saw two consecutive monthly falls in UK GDP, meaning the size of the economy is just 0.9 per cent above its pre-pandemic level. That is a lot of lost output to make up, which can only be done by consistent above-trend growth—not likely to happen in a hurry, if at all, for the UK or for many other countries across the globe.

What about Russia itself? Interest rates have come down from their 20 per cent high in the aftermath of the invasion, originally to protect the rouble, and now that the currency has been strengthened by the increased value of oil and gas sales since the war, capital controls are also being progressively relaxed. But a look at Russian imports suggests that Russia itself is already in recession, with demand for many foreign luxury items falling sharply. Ukraine is estimated to have suffered a drop of 15 per cent of GDP in the first quarter, and more will surely follow as the war becomes more prolonged. Higher prices are rippling out all across the globe—even Japan, which had spent decades trying to fob off deflation, has seen prices creeping up. In this it is joined by another inflation outlier, China, where the contribution of energy to the headline inflation figure has been weak, and where there has been renewed output weakness in the last few months following a new Covid lockdown. 

And yet the argument goes that we are in a better position to withstand the shocks compared to where we were during the two oil shocks of the 1970s. The first part of the claim is that global core inflation today, excluding energy and food, is less than half the headline inflation figure and much lower than it was during the 1979-80 crisis. The second is that the financial sector is now in better shape. The Bank of England has just published an overall positive health assessment of Britain's major banks, which it believes could cope well with a new financial crisis.

The truth is that in real terms, oil prices, though higher than expected, are still below where they were around the previous peaks that caused a recession. And interest rates, even as they are likely raised further this week in the UK and the US, and for the first time since 2011 in the Eurozone next month, will remain hugely negative: a big difference from 1978-79. The World Bank calculates that as of May 2022, before whatever new nominal rate increases we may see in the coming weeks, real interest rates in advanced economies were at minus 5.2 per cent and in emerging and developing markets still at minus 3.2 per cent on average. That should provide at least some comfort.

Is this perhaps too optimistic a conclusion to draw? Nouriel Roubini, in an article written almost a year ago and so long before the Russian invasion of Ukraine, was warning of the underlying inflationary trends and the harsh recession that would follow. In his view it was inevitable that the massive monetary tightening that would have to come in its wake would sink economies not just into a deeper recession, but into depression. This risk has increased since Russia's invasion, which has led the OECD and others to sharply raise their inflation forecasts. Central banks seem to be gearing up for even sharper rate hikes than expected. And what we know from history is that depressions are much more difficult to get over and tend to leave longer-term scarring behind. 

For the moment, the likelihood of stagflation—stagnant growth and soaring inflation—has undoubtedly increased, and that brings with it serious costs. The World Bank is projecting that the deceleration in global growth between 2021 and 2024 will be twice that seen between 1976 and 1979, when the second oil shock happened. One reason for this is very weak investment. A second is that both monetary and fiscal support is being withdrawn right now.

More worrying still is the overhang of high debt accumulated since the financial crisis and added to during Covid, leaving many countries—particularly emerging economies—very vulnerable to external shocks. Indeed, the strengthening of western currencies as interest rates rise is raising serious concerns that debt denominated in dollars and other foreign currencies will hit lower-income markets hard.

So a new debt crisis looms. And as it comes on top of a worsening food crisis as a result of the war, one wonders how a weakened west will be able to deal with it effectively. In this case, comparisons with older crises may not be much comfort at all.