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The medium-term outlook for the world economy and financial risks

In its Spring World Economic Outlook, published last month, the International Monetary Fund offers an assessment of the global economy over the medium term, updated predictions, and a discussion of underlying risks and challenges.

The medium-term outlook for the world economy and financial risks

Earlier and more pessimistic estimates were made by the World Bank as well. Both institutions expect the medium-term picture to be more difficult.

After an extended period of easy monetary conditions, slower growth and monetary tightening create vulnerabilities in the financial system and elsewhere that require regular monitoring.

In the context of ongoing uncertainty, war and geopolitical rivalry support additional strains, maintain shortages, and encourage rising inflation.

Higher expenses brought on by the ensuing trade and technological decoupling will make it challenging for poorer countries, in particular, to retain their macroeconomic stability.

However, in order to boost global potential growth and address issues like the cost of living crises, climate change, and regional imbalances, significant international collaboration will be required.

With a growth prognosis that exceeds the average growth in the EU and inflation declining more quickly in contrast, Cyprus does relatively well in this scenario.

Compared to the time before Covid, economic growth will be slower this year, next year, and for the foreseeable future. The World Economic Outlook of the International Monetary Fund predicts that the world economy would contract to roughly 2.8% this year and only slightly expand to 3% in the following year.

The advanced countries, which are predicted to grow at 1.3% this year and 1.4% next, will be the main cause of this slowdown. According to the baseline scenario, growth in the Euro area and the European Union will drop to 0.8% this year, with certain countries like Germany and the United Kingdom entering mild recessions.

The emerging and developing world will have growth that is more robust this year, at 3.9%. China's growth rate will increase to 5.2% in 2023 from 3.0% last year, and India's growth rate will rise to 5.9% from 6.8%.

Although this is a constrained but generally benign scenario, there is still a high likelihood that the more developed nations, including the United States, will experience a slight recession in the second part of this year and early in the following.

The rate of global inflation will decline from 8.7% last year to 7% this year and 4.9 next year, but at a slower rate than previously predicted. The rate of inflation will fall to 4.7% in developed nations and to 5.3% in the Euro region. Inflation will continue to be high in the UK (6.8%), Germany (6.2%), and France and Italy (slightly lower at 0.7%). Cyprus's is predicted to be close to 4%.

More significantly, core inflation, which is headline inflation less the volatile energy and food costs, is still high even though overall inflation is dropping. Lower energy and commodity prices contributed significantly to the decline in headline inflation. The consequences of the initial shocks in energy and food prices have so far been stronger in the second round. There is minimal evidence of an unchecked wage-price spiral because nominal wages have been rising but slower than price inflation.

However, during a war that is already in progress or due to geopolitical pressures that may result in future supply chain disruptions, food shortages, and commodity shortages, inflation pressures can increase. Due to the scarcities it frequently creates, war itself is inflationary.

The large amount of tightening that the ECB and the Federal Reserve have already implemented will be the reason why core inflation declines by year's end. The ECB increased its policy rate from zero to 3.75% as of this writing over the course of about a year. The federal reserve increased its policy rate from a range of near zero to between 5 - 5.25%.

Future policymakers may have fewer options due to the probable trade-off between price stability and financial stability. Following the strains on the American banking sector earlier in the year and the collapse of Credit Suisse around the same time, combating inflation has been more difficult.

It might not be as seamless a transition as we would want from an unusually long era of zero or nearly zero interest rates and plenty of liquidity to a period of higher interest rates and less liquidity. Recent financial upheaval has exposed oversight and risk management flaws in several banks.

The domestic financial landscapes of today are substantially different from those of 2008, when the state required to recapitalize the biggest systemically important institutions. Small and midsize banks have financial difficulties, and in the future, we'll probably see further pressure and consolidation there.

An unstable financial system has been left behind globally as a result of the enormous monetary growth that followed the 2008 financial crisis. For instance, the G7 countries' central banks' balance sheets significantly increased. On the balance sheets of central banks, commercial banks, and non-bank financial institutions, the makeup of assets and liabilities has changed dramatically.

The disparity between foreign assets owned by local residents and local assets owned by non-residents, known as net international investment positions, has now significantly changed. In comparison to the other G20 nations, the G7 countries' respective net deficit widened significantly. The circumstances are not ideal for a smooth sail.

Financial stability cannot be sacrificed for price stability. In order to maintain financial stability and the availability of sufficient liquidity, central banks will continue to use financial policies and interest rates to combat inflation. The trade-offs between inflation and financial stability will become increasingly challenging for central banks if financial pressures increase.

The outlook and growth potential will need to be improved by a focused effort.

A sustained effort on many fronts will be required to improve the medium-term outlook and growth potential in the global economy.

First, in order to increase production, structural reforms are required, and it is urgent to speed up the digital revolution in all nations, but especially in the least productive regions.

Second, wealthy, developed economies need to take the green transition more seriously, and we need to provide financial support for developing nations to do the same. Massive investments in green initiatives would be needed at a time when resources are scarce in order to achieve the goals of the Paris Agreement.

The emotions in international quarters are still depressing following the conclusion of the International Monetary Fund and World Bank Spring Meetings in Washington last month. Core inflation is expected to stay persistently high while there will be a long-term slowdown in global GDP.

Growth and growth potential will be pulled lower by rising interest rates and shocks to the credit supply. Numerous underdeveloped developing nations are put at danger financially and by default due to rising interest rates and the value of the US dollar.

Geopolitical conflict and war have negative effects on prospective and actual global growth. Tragic effects of the war in Ukraine are being felt not only within Ukraine but even outside of it.

In especially in poorer places, the war leads to shortages, greater inflation, and cost of living difficulties. It eliminates the cold war peace dividend and causes friction in trade and finance. Trade fragmentation can have very high long-term consequences.

Fragmentation in technology drives up expenses even further. As a result, all of these issues constrain growth, which will drag downward if ignored.



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