Ukraine War among the factors impacting the 2023 global economic outlook

The outlook for the global economy in 2023 will likely be challenging. Economic headwinds from COVID-19 may start to recede, although the Russia-Ukraine War and other geopolitical flashpoints could have a lingering effect. Some supply-chain improvements are expected, which should help with the availability of goods and overall goods inflation. However, demand may start to weaken, which could collectively have a moderating effect on inflation.

Even though inflation may continue to fall, interest rates will likely remain elevated, which could hamper some areas of the economy. The services sector though is an area to watch as it’s somewhat constricted due to robust labor markets.

Inflation

The Russia-Ukraine War exacerbated inflation in 2022 as food and energy prices increased. However, inflation is starting to show some signs of moderation. Shipping costs have come back down. The cost to move a 40-foot container from Shanghai to Los Angeles jumped to more than

$12,000 shortly after the pandemic. It has since normalized to $2,000 bringing it roughly back to pre-pandemic levels.

The auto market also may see oversupply soon, especially if the global economy slows in the coming year. In addition, many of the input materials for construction are improving, potentially reducing the cost to build. Falling goods prices have in part helped U.S. inflation fall from more than 9% in 2022 to around 6.5% currently, according to data from the U.S. Bureau of Labor Statistics.

Energy prices are a wild card and could continue to be volatile. Although the trend favors falling inflation, services and energy could be spoilers. Shocks to oil supplies are not out of the question given the deterioration in U.S.-Saudi Arabia ties and broader geopolitical challenges.

Services also could remain under pressure, especially if labor markets continue to exhibit the same level of tightness. Meanwhile, select emerging markets are beginning see some moderation in inflation. For example, according to data releases from the Central Statistics Office, India’s inflation rate held relatively steady at 6% to 7% throughout 2022, below its developed market peers. Collectively, global inflation potentially should hold or moderate slightly.

Interest rates

Although inflation likely will moderate in 2023, interest rates are expected to remain elevated. Most central banks will need to keep monetary conditions tight until either their domestic inflation rate falls back within their target rate, or it is evident that price pressures are thoroughly eroding. The market now expects the Federal Reserve to begin easing interest rates later in 2023. However, if the unemployment rate starts to rise sharply or the economy contracts, the Fed may opt to cut rates sooner. The severity of those two factors could dictate the level of cuts.

Global rates also could remain elevated. Most other central banks have inflation mandates well below their current levels. These same central banks are still running negative real rates, which is the difference between inflation and the official interest rates. For many risk participants, this will be new territory, as many have not endured a period of elevated interest rates. Of course, there are knock-on effects of this, including a higher cost of capital, potential slowdown in deal flow as transactions become more expensive to finance, protracted weakness in risk assets (equities) and headwinds to housing.

Overall credit conditions could tighten further, and delinquencies in certain sectors of the economy could rise. This could be the case for revolving credit that has variable rates and for assets – such as automobiles - that witnessed abnormally elevated prices in 2021 and 2022.

Increased sovereign challenges

High interest rates and a slowing global economy could lead to sovereign distress in some markets. Countries may find it increasingly challenging to access liquidity, while others may face rollover risk of their existing debt. As borrowing rates reset in the higher rate market, the cost to service debt will likely go up.

Debt-to-GDP levels rose over the past few years because of COVID-19 related government stimulus spending. This was then exacerbated by the Russia-Ukraine War as some countries used fiscal spending to offset rising food and fuel prices for their citizens. As a result, some markets may start to face liquidity and sovereign challenges in the coming year.

One such case is Pakistan, which has seen a shortage of dollars available at the central bank due to a current account deficit and limited capital inflows, making it challenging for authorities to fund their external debt as well as finance the import of goods including food and fuel. Egypt, which is one of the world’s largest wheat importers, used to source 80% of its wheat import volumes from Russia and Ukraine. Higher food prices resulted in the government increasing the food subsidy provided to citizens. While this policy was meant to avoid domestic political turmoil, it could lead to elevated sovereign stress.

But not all emerging markets are the same. Based on data from the International Monetary Fund, India's debt-to-GDP surpassed 80% recently, but nearly all of this is locally funded in rupees through a robust domestic capital market. Then there are markets such as Vietnam and Thailand, which have built up a war chest of dollar reserves through their booming export markets. While both have also witnessed a rise in debt issuance, they are likely able to finance their borrowings.

Shailesh Kumar is head of The Hartford’s Global Specialty Insights Center. He may be contacted at [email protected].

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