The biggest loser of the energy crisis? Global economic recovery

With no resolution of the war in Ukraine or the energy crisis in sight, global financial stability will come under mounting pressure
Global policymakers must provide much more multilateral support to struggling nations as the world cannot afford another financial shock

David Brown

Published: 10:00pm, 12 Sep, 2022

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There will be winners and losers from the global energy crisis, but it’s a less than zero-sum game for the world economy as it slides towards possible recession in the next year.

Oil producers are reaping bumper revenues from the spike in global oil and gas prices, but it’s the net-energy-consuming countries that represent the bulk of the world economy that pose the greatest risk to recovery prospects as higher inflation takes its toll on global confidence. With the US dollar on a roll from rampant safe-haven demand and dollar-based energy costs soaring, there is severe strain on global trade imbalances, increasing the chances of a major sovereign debt default.

With no short-term resolution of the Ukraine crisis in sight, global financial stability will come under mounting pressure. It calls into question the central banks’ sudden shift to tighter monetary policy, forcing governments to keep fiscal stimulus in overdrive for much longer than anticipated.

The surge in global energy prices and the threat of disruption to oil and gas supplies is affecting business sentiment across all the major economies. From Europe to the United States and China, it is raising production costs, squeezing profit margins, sucking money out of consumers’ pockets and denting demand in the process.

The global economy is heading into a downward spiral of negative gloom, made even worse by serious drought conditions around the world. The threat of major power outages and growing food shortages as the cold winter months draw near is adding extra burdens to a global economy which is struggling to recover from the Covid-19 pandemic.

The major forecasting bodies seem behind the curve on spelling out how bad it might get over the future. The latest forecasts from the Organisation for Economic Co-operation and Development, the International Monetary Fund and the World Bank seem in a reasonable consensus that global growth will slow down from 5.7 per cent in 2021 to around 3 per cent for 2022 and 2023.

There might be strong headwinds to contend with, but the general conclusion is that global recession can be avoided if policymakers manage to intervene in time. The trouble is that global monetary and fiscal policies are heading in different directions now.

Whether the whole world falls into recession, as it did following the 2008 global financial crisis and during the Covid-19 pandemic, some parts of the global economy are clearly exposed, not least Europe. The severe squeeze on living standards from higher inflation is making its mark on European consumer confidence.

The key worry is how much of an impact any dislocation in oil and gas supplies from Russia will have on economic activity, especially if energy is rationed during the winter months. Germany has raced to stock up on key energy reserves to carry it through the cold weather, but any disruption to industrial output from power shortages could have dire consequences for the domestic market and the whole of the European economy.

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As a major part of the global economy, any cooling in European demand is bound to have serious implications for the rest of the world. In its summer forecasts, published in August, the European Union slashed its expectations for German growth in 2023 down to 1.3 per cent from its earlier projection for 2.4 per cent made in the spring, implicitly acknowledging the strong possibility of European recession.

The European Central Bank’s switch to aggressive interest rate tightening is bad timing in the circumstances, especially if EU governments are forced to take up the slack with radical fiscal reflation to ward off a deeper downturn. It means building up more debt.

World trade flows are already slowing down, and the US and China are starting to feel the ripple effects. The US economy is already in technical recession after two successive quarters of negative growth. China is likely to revise down its 5.5 per cent growth target for 2022 but could still avoid a recession.

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It is the developing world that will be most at risk, especially those countries which have high energy import needs while suffering major balance of payments shortfalls and carrying high dollar-based debt.

Global policymakers must provide much more multilateral support to these nations to avoid a systemic collapse in confidence. After the 2008 crash and the Covid-19 crisis, the world cannot afford another financial shock.

David Brown is the chief executive of New View Economics

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