Friday, August 19, 2022


OPINION: Is global economy heading towards stagflation?

In layman’s terms stagflation is a defined by prolonged periods of low growth and rising inflation characterized by high unemployment.

By Jaykhosh Chidambaran

Friday, June 17, 2022

Economic headwinds are buffeting global economies yet gain, soon after Covid-19 ravaged the world economy and brought it to a grinding halt in 2020-’21. The Black Swan event of coronavirus pandemic wiped out trillions of dollars of global economic output, disrupting supply chains by shutting down Trans-Atlantic and Trans-Pacific trade routes and the subsequent “Great Lockdown” causing widespread unemployment and loss of livelihoods. When the world enters into the third year of Covid-19, a post-pandemic world is still distant as new virulent strains emerge which threaten and procrastinate the return to normalcy of the pre-pandemic world. When economists and think-tanks believed that the worst is behind and the global economies are bracing towards recovery by riding the crest of vaccination drive, timely fiscal stimulus and unconventional monetary policies by central banks, another challenging economic phenomenon of stagflation is taking the centerstage. In layman’s terms stagflation is a defined by prolonged periods of low growth and rising inflation characterized by high unemployment. It is double jeopardy when it occurs and the world hasn’t witnessed one since the late 1970’s.

The ripples of stagflation are currently felt across the world. The malefactors of the new situation being food and energy inflation aggravated by the Russian invasion of Ukraine, supply shortages caused by Chinese shutdown of ports and businesses in line with their Zero-Covid strategy, rising interest rates and the bleak prospect of debt distress encountered by low income countries that are gradually spilling over to middle-income and emerging market economies. The World Bank in its latest forecast has downgraded global growth to 2.9% from 5.7% in 2021. This revised estimate suggests that developing economies will grow at a paltry 3.4% in 2022 as against the promising growth of over 6.5% registered in 2021. Historical data indicates that the poorer nations will be the hardest hit as these economies already grappling with rampant unemployment, depressed income and increasing poverty levels are dependent on natural gas for use in fertilizer and electricity grids. With supply constrained by the ongoing war in Ukraine, these economies will likely plummet into a food and energy crises on an existential scale that could in turn trigger social and political unrest.

The debt-GDP ratio is rising for emerging markets and developing economies since a decade exacerbated by the coronavirus pandemic when policy mandates to offer fiscal stimulus to revive economies often exceeded 10% of their GDP’s. The total indebtedness of emerging markets and developing countries are at 50-year highs, equivalent to almost 260% of government revenues. The Ukraine war has dampened outlook for most developing nations that are major commodity importers or highly dependent on tourism for their exchequer or remittances.

The recent Sri Lankan economic debacle is a classic case of exogenous shocks impacting an economy where supply shortages of crude and natural gas triggered a food crisis that resulted in hyperinflation and massive depreciation of its currency. This was compounded by a balance-of-payment default owing to depletion of its forex reserves that further decelerated imports. Citing mismanagement of funds, bureaucratic corruption and inefficiency of the incumbent administration, people thronged the streets besieging and besmirching public property in acts of wanton violence and arson. When masses are deprived of their existential goods, anarchy is often the consequence.

Another World Bank report forecasts that more than a dozen developing economies will default on their debt service obligations in the current fiscal. External debt has transformed from bilateral creditors in the form of governments thirty years ago to commercial private creditors in contemporary debt-obligations. Most of the bilateral creditors are invariably members of the Paris Club, an informal group of official creditors that offers coordinated and sustainable solutions for debt-servicing for those debtor countries that experience payment difficulties. In 2020, low and middle-income economies owed more than five times as much to commercial creditors as they did to bilateral creditors.

As a result, the debtor countries will not enjoy such debt-relief measures from the Paris Club in concessional rescheduling, debt postponement and reduction in debt service obligations for a determined time-period (flow treatment) or as of a consensually agreed date (stock treatment). To put things into perspective, of the 53 billion dollars that low-income countries will have to mobilize for debt-servicing in 2022 for their public and public-guaranteed debt, only 5 billion goes to Paris Club creditors. The interest on these debts are tied to variable rates and with escalating interest rates in developed markets in lieu of central bank’s monetary policy responses to inflationary pressures, defaults assume greater probability that will further strain their current account deficits.    

Oil is an universal intermediary good and its price fluctuations significantly impact cost-push inflation. Therefore, prices of commodities, services and transport sectors are soaring with the current oil price of benchmark Brent Crude hovering around $118 per barrel. Fuel inflation has spillover effects affecting wide range of industries from automobile, construction, retail to petrochemicals. Though wealthy Europe is particularly dependent on Russian energy, at 47% natural gas and 25% crude oil imports, most of the worlds importers of oil and gas are poorer countries. Economic recoveries since the onslaught of Covid-19 in these low-middle income countries in terms of output growth, income and employment are much slower owing to inadequacy in capital and financial resources to mount fiscal stimulus at par with advanced economies. With the US Federal Reserve increasing interest rates by 75 basis points, though is a necessary step to curb soaring inflation that has crossed 8.5% in Consumer Price Index (CPI), will effectively remove demand from the economy, thus further stagnating economic recovery and growth.

Even more dangerous are speculators placing their bets on food futures that will drive up food prices in the longer term. During the first days of Vladimir Putin’s military engagement in Ukraine, wheat futures in Chicago Board of Trade rose by 40%, the highest weekly increase in 80 years! Such wild appreciations in prices of cereal crops like wheat, maize and barley for which Russia and Ukraine are the largest global producers will adversely impact not only nations within the European heartland but even more gravely the consumption requirements of low- and middle-income country importers.

Multi-pronged strategic responses are warranted from governments, think-tanks, multilateral enterprises to stave off the imminent threat of stagflation. Foremost among them is truce and ramping up peace negotiations in the Russia-Ukraine war. Emergency crisis response systems aimed at ameliorating the plight of more than 6 million Ukrainians who are either internally displaced or as refugees seeking asylum in neighboring countries assumes priority. Policymakers should make concerted efforts to step up food and energy production and since markets are forward looking will help reduce inflation and stabilize prices in the near-term. With existing technologies and cross-border flow of capital, this is an achievable task on contingency basis. Global NGO’s, aid agencies, governments and multilateral charity organizations should team up to expand immunization and vaccination efforts in third world and poor countries. This is absolutely indispensable to curb the contagion effects of the emerging mutant strains of the virus that will preempt another “Great Lockdown” which, the world can ill-afford.

If there is one need the current inflationary stalemate resulting from extraneous factors like Russia-Ukraine war exposes, it is the diversification of global energy sources and a shift from fossil fuel dependence. Through multilateral treaties, national legislations and by designing attractive incentives, global behemoth corporations and public sector companies should strategize a world that by the next decade will only have limited commercial applications of the “Black Gold”. It is imperative that such a world exists not only to prevent inflation or stagflation resulting from oil cartels, wars and other political skirmishes but also to halt further environmental degradation that threatens the very existence of humans.

Disclaimer : The opinions expressed within this article are the personal opinions of the author. The facts and opinions appearing in the article do not reflect the views of TAS and TAS does not assume any responsibility or liability for the same.