The fight against inflation in the United States may end up leading to a financial crisis in emerging markets, according to the World Bank. The agency chaired by Ajay Banga since last week has raised the growth forecasts of the world economy for this year, but warns that the situation is "precarious", according to its World Economic Prospects report. The Washington-based entity devotes special attention to the impact that interest rate hikes in the United States can have on the finances of developing countries. In the case of Latin America, the agency warns that political uncertainty in some countries is weighing on the economy.
"The lessons of economic history are stark," the report said. "Rapid interest rate hikes, such as those that have occurred in the United States over the past year, are correlated with a higher likelihood of financial crises in emerging and developing countries," he continues. The agency indicates in a special chapter dedicated to this that the Federal Reserve's rate hikes increase the probability of sovereign, currency and banking crises in emerging countries.
"And if the current banking stress in advanced economies translates into widespread financial turmoil affecting emerging and developing countries, the worst-case scenario would have been reached: the global economy would experience a deep recession next year."
That is not the central scenario of the forecasts that the World Bank draws today. Its chief economist, Indermit Gill, presented the new forecasts on Tuesday in a call with reporters. Since its previous projection, published in January, the agency has raised its forecast for growth of the world economy for this year 0.4 points, to 2.1%, since the previous report, last January. That still represents a slowdown from 3.1% growth in 2022, but somewhat less abrupt than expected. For 2024, however, the forecast drops three tenths, to 2.4%.
"The surest way to reduce poverty and spread prosperity is through jobs, and slower growth makes job creation much more difficult," Ajay Banga, the new president of the World Bank, said in a statement. "It is important to note that growth forecasts are not destiny. We have the opportunity to reverse the trend, but for that we will all have to work together."
So far, most emerging and developing countries have suffered only limited damage from recent banking tensions in advanced economies, but are now "navigating dangerous waters," the World Bank says. With increasingly tight global credit conditions, one in four developing countries has effectively lost access to international bond markets, according to their calculations. The constraint is particularly severe for emerging economies with underlying vulnerabilities, such as low creditworthiness. These economies' growth forecasts for 2023 are less than half of what they were a year ago, making them highly vulnerable to further shocks.
Global growth could be weaker than expected in the event of more widespread tensions in the banking sector or if more persistent inflationary pressures prompted tighter-than-expected monetary policy, Gill and his team warn. Weak growth prospects and heightened near-term risks compound a long-term slowdown in potential growth, which has been exacerbated by the overlapping shocks of the pandemic, the war in Ukraine, and the sharp tightening of global financial conditions. "The world economy remains in a precarious situation," says the World Bank, which also fears that the resilience that activity has exhibited at the beginning of the year will fade.
The biggest slowdown will be concentrated in advanced economies, which would go from growing by 2.6% in 2022 to just 0.7% in 2023, to rebound to 1% in 2024. It is above all the euro zone that is to blame, going from the increase in gross domestic product from 3.5% last year to 0.4% this year while the United States goes from 2.1% to 1.1%. This, despite the fact that the World Bank has raised its growth forecast for this year (0.6 points for the US and 0.4 for the euro zone, compared to the January forecast).
Emerging economies, on the other hand, will accelerate growth this year thanks to the strength of China. As a whole, they go from a growth of 3.7% in 2022 to 4.0% this year, after the World Bank has improved 0.6 points the forecast for 2023. China, the largest emerging economy, accelerated from 3.5% to 5.5%, according to the new, more optimistic forecasts.
Politics holds back Latin America
But while Asia accelerates, Latin America stops in its tracks. The agency has raised 0.2 points the growth forecast for this year, to 1.5%, while cutting 0.4 points that of 2024, to 2%. But the growth forecast for this year does not even reach half of the 3.7% of 2022. With core and headline inflation above the targets of most central banks in the region, monetary policy is likely to remain tight in the near term, which will dampen growth. In addition, "political uncertainty in some countries is damaging business and consumer confidence."
The expected evolution and change in the growth forecast is very different by country. In the case of Brazil, the report raises the forecast for this year 0.4 points, to 1.2%, while cutting next year's 0.6 points, to 1.4%. "Uncertainty about fiscal policy continues to hurt business confidence and investment. Although agricultural exports are expected to grow strongly this year due to strong soybean and corn harvests, external demand is not expected to support growth significantly in 2023," the World Bank says.
As for Mexico, the World Bank raises this year's forecast 1.6 points, to 2.5%, and cuts that of 2024 four tenths, to 1.9%, compared to January, although in April it had already made some adjustment in the report on the region. "Investment and consumption, which were stronger than expected at the end of 2022, are expected to be somewhat more subdued this year as a result of high interest rates and inflation."
Faced with the great improvement in Mexico's prospects, the World Bank cuts Argentina's forecast 4 points since January and forecasts a 2% contraction in its economy for this year. In the April regional report, it already anticipated a stagnation. Economists improve the 2024 forecast by three-tenths to 2.3% as the economy recovers from this year's severe drought. "The drought has led to declines in soybean and corn harvests — the main export products — equivalent to 3% of GDP. The drought has also severely affected wheat production. On the other hand, this year's economic slowdown in Brazil, Argentina's main trading partner, will weigh on the country's exports of non-basic products. The resulting shortage of foreign exchange will create difficulties for importers, especially those in non-agricultural sectors. In addition, inflation has continued to rise, slightly exceeding 100% in 12 months," the report states.
Chile will accompany Argentina in the recession with a contraction of the economy of 0.4% in 2023, as a result of the drag of three quarters of decline in 2022. "This slowdown can mainly be attributed to the abrupt withdrawal of important monetary, fiscal and quasi-fiscal stimulus. Inflation peaked last year, but core inflation has been more persistent, prompting the central bank to maintain a tightening stance. Growth is expected to pick up to 1.8% in 2024 as monetary policy is eased.
Colombia will also suffer a sharp slowdown, from 7.5% in 2022 to 1.7% in 2023. The central bank started raising interest rates later than those in other countries, which has helped delay the peak of core inflation. Given high inflation and interest rates, consumption is expected to grow at a weak pace of 0.7% in 2023.
Peru is one of the countries singled out for political uncertainty, which "is negatively affecting consumer and business confidence, especially with regard to investment," but that will be offset by higher public spending. The growth forecast stands at 2.2% for this year. "Growth in 2024 is expected to reach 2.6%, but this depends on social tensions easing and investment recovering modestly," the report says.
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