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Rising Global Recession Risk And Energy Wars

Rising Global Recession Risk And Energy Wars

Downgrading its global growth forecast sharply the Institute of Finance says there is a rising global recession risk with the drag coming from Russia and Ukraine.

“We are downgrading our global growth forecast sharply. We cut our Euro area forecast almost two months ago on expectations of negative spillovers from Russia’s invasion of Ukraine. At 1% growth in 2022, this is a recession call as the statistical carryover from last year is almost 2pp.

“We are cutting China’s 2022 growth from 5.1% to 3.5%, given strict Omicron lockdowns that are likely to make GDP fall in the second quarter. Finally, given the sharp tightening in US financial conditions, we are also downgrading US and EM growth, which means that–overall–we expect global GDP to essentially flatline this year once adjusted for the statistical carryover.”

Much of the negative drag obviously comes from Russia and Ukraine, where activity is collapsing. However, aside from these two countries, weakness is broad-based and leaves little margin for error. Global recession risk is elevated. In this context, we expect non-resident flows to EM to slow significantly.

“We moved to forecast a recession in the Euro area nearly two months ago. Our sense was that the war in Ukraine would take a considerable toll on activity via elevated uncertainty, which would weigh both on firms and their investment decisions as well as consumer spending,” it says.

This has, indeed, been playing out in recent weeks, with forward-looking soft data such as the IFO’s expectations component falling sharply.

Recession forecast

Since the first recession forecast for the Euro area, the global picture has grown even more challenging (Exhibit 1).

The Omicron wave in China is more disruptive than we anticipated and will take a substantial toll on growth and capital flows (Exhibits 2, 11 & 12).

Separately, US financial conditions are tightening rapidly, with the rise in long-term real rates now comparable to the 2013 taper tantrum. Finally, the war in Ukraine is ongoing and could escalate.

The confluence of these shocks threatens the global economy and raises the risk of a recession. With this Capital Flows Report, we downgrade global growth significantly, leaving little room to avoid an outright contraction of global GDP should downside risks materialize (Exhibits 3 & 10).

Euro growth down

With the war in Ukraine turning out to be even more disruptive than previously expected, the Institute cut Euro area growth in 2022 from 3% to 1%.

Importantly, because the statistical carryover from 2021 into this year is 1.9pp, this is a recession forecast that anticipates falling GDP in the second half of the year (Exhibit 4).

“Forward-looking indicators like the IFO’s expectations component have fallen sharply, which, unfortunately, suggests that the Euro area’s economy is deteriorating in line with our view. Since we took this much more negative view, the Omicron wave in China is looking significantly worse than expected (Exhibit 5),” it says.

This signals a GDP contraction in the second quarter, with high-frequency soft data already pointing in this direction.

Furthermore, a disorderly tightening in US financial conditions is playing out, with the rise in real long-term US interest rates now comparable to the 2013 taper tantrum.

This rapid tightening risks further destabilizing the global growth picture, which is already teetering from Russia’s invasion of Ukraine and Omicron’s (re-)emergence in China.

“We are sharply revising down our 2022 growth forecast given these headwinds, such that–adjusting for the statistical carryover–the world is barely growing sequentially this year. Weakness radiates out from Russia and Ukraine, where GDP is collapsing, while the rest of the world trudges along at very low “true” growth,” it adds.

Compared to the Bloomberg consensus and the IMF’s latest forecasts in its World Economic Outlook, our growth downgrades are most notable for the Euro area, Emerging Europe, and China.

The rest of the world is impacted somewhat less adversely, given favorable terms of trade effects–especially in commodity-exporting Latin America–and less critical trade links to Russia and Ukraine.

Dim view of Central Banks

Risks to our forecast are tilted to the downside because markets are taking an increasingly dim view of central bank policy normalization.

“We have some sympathy for this as far as the Euro is concerned, given that a recession will likely limit second-round effects from supply shocks.

“Here, markets are lodging their protest by widening periphery bond spreads over German Bunds, while something similar is playing out in the US with the stock market sell-off. Either way, a rapid tightening in financial conditions is underway, further increasing recession risks.

“Given the uncertain global outlook and significant recession risk, we expect capital flows to EM to weaken significantly. We project non-resident capital flows to EM x/ China of $645 bn, down from around one trillion last year (Exhibits 6 and 7). In China, we expect a continuation of recent portfolio outflows.”

Russia’s war on Ukraine will have a meaningful impact on global growth and inflation through commodity prices.

Commodities where Ukraine, Russia, and Belarus account for a large share of exports, have seen prices soar in recent months.

Energy prices were already high in the run-up to the crisis and are expected to remain elevated. Risks are to the upside if the EU embargo on Russian crude oil exports goes ahead.

Energy wars

The risk of energy wars between Russia and Europe will also keep natural gas prices elevated. We worry about global food security with world food prices at a multi-decade high.

Russia has already banned exports of grains and sugar, and Ukraine, one of the largest exporters of important staple foods, could see the sowing season and harvest impacted by the war.

In addition, seaports, which account for around 80% of total cargo from Ukraine, will likely remain closed in the coming months.

Finally, India announced that it would suspend exports of key agricultural goods to guarantee sufficient domestic supply in a time of extreme weather. We expect the situation to be most challenging for countries in MENA and Sub-Saharan Africa.


Following Russia’s invasion of Ukraine, the international community responded with unprecedented and coordinated measures.

“We took stock of the initial round of actions, which include sanctions on financial institutions’ access to financial systems, cutting off several banks from the SWIFT, new sanctions on Russian sovereign debt, and technology-related export controls.

“We concluded that, while meaningful steps had already been taken at the time, room for more sanctions existed, primarily related to Russia’s financial industry, and oil & natural gas exports. With no end to the conflict in sight, Ukraine’s allies have “climbed the escalation ladder” and are discussing additional steps.”

These include new restrictions on the country’s financial system and sanctions on exports of coal, crude oil, and petroleum products.

The latter are essentially a reflection that the initial round of sanctions had a marked impact on Russia’s macroeconomic buffers—especially through the freezing of a significant share of reserves—but did not change the fundamental dynamic of large FX inflows due to commodity exports.

Unaddressed, and in light of soaring energy prices, Russia would be able to rebuild buffers in a relatively short period of time, rendering some of the sanctions obsolete.

“We now discuss our forecast revisions across different regions. As Exhibit 3 notes, our downward revisions for 2022 growth are most notable for the CEEMEA region, where we see activity falling by almost 6% due to the collapse of economic activity in Russia and Ukraine.

“Unlike consensus, we see China as a genuine source of weakness and have marked down our forecast to 3.5%. Growth will soften in the rest of EM Asia mostly due to spillovers from China, with more limited fallout from the war in Ukraine.

“We upgraded our LatAm growth forecast moderately to 2.0%, as we expect high commodity prices to benefit the region. Similarly, we see a certain degree of resilience in MENA oil exporters despite a challenging global growth picture,” it says.

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