Kevin Lynch and Paul Deegan

April 15, 2023

The state of global cooperation is often best divined from the inimitable press releases put out at the conclusion of international meetings. The April 14^th Statement of the IMFC (International Monetary and Finance Committee) at the conclusion of the IMF/World Bank Spring Meetings was duly informative.

At the wrap-up of this year’s IMF/World Bank spring meetings, in a world still coping with the economic impact of Russia’s illegal invasion of Ukraine, there was, strikingly, no unanimous condemnation of Russia or its actions, with the official statement noting that “there were other views and different assessments of the situation and the sanctions.” As Polish Prime Minister Mateusz Morawiecki succinctly put it: “There is a lack of global cohesion about Russia and China.”

To combat the turbulence and uncertainty so many economies are now facing, governments were much keener to extol the virtues of international cooperation than to commit to concretely work together — the shining exception being central banks, which are united in the fight to rein in inflation and preserve financial stability.

The schism between western democracies on the one hand and the “no limits partnership” of China and Russia on the other, supported by a number of emerging market countries that have been recipients of significant Chinese investment in the past decade, was further evident in the pressure to “consider” governance reform with respect to who has the power at the Bretton Woods institutions and who makes the rules around sovereign debt relief — China, which has systematically used its lending practices to leverage illiberal and fragile democracies into supporting its geopolitical ambitions (also known as “debt-trapping”) — wants a bigger say on both.

What about the state of the global economy? The IMF foresees a rocky road ahead, with the risks heavily skewed to the downside. Despite what a number of observers labelled as surprising resilience over the last six months – Europe weaning itself off Russian energy, robust labour markets in North America, a US economy so robust that this week’s Economist cover is Riding high: The lessons of America’s astonishing economy and the rebound in China after the abrupt ending of its zero-COVID measures — the consensus view was for slower, and more volatile, global growth. The turbulence will come from the ongoing war in Ukraine, tighter credit conditions due to financial sector stress flowing from high-profile bank failures in the US and Switzerland, the stickiness of core inflation in the face of large interest rate hikes, and the impacts on costs and supply chains of increased trade fragmentation.

Headline global growth is now projected to be just under 3 percent this year and no more than 3 percent in 2024. China and India will account for roughly half of this global growth as North America and Europe expand more slowly in the face of much tighter monetary policy and a number of emerging market economies are burdened by rising debt and falling exchange rates. Given the downside risks, an economic downturn is a distinct possibility later this year in both North America and Europe, although the IMF avoided a recession warning in its forecasts. And, while progress on lowering inflation is steady, it is slow. The IMF does not see core inflation rates falling back into the 2 percent target ranges by the end of next year –a view Bank of Canada Governor Tiff Macklem confirmed for Canada.

The IMF argues that the world economy will not return to the rates of growth that prevailed before the pandemic; a conspicuous worry for policymakers. It has significantly revised downwards its medium-term growth forecasts, citing: slower productivity, scarring from the pandemic, demographic aging, trade fragmentation and less willingness of governments to tackle structural reforms. For Canada, for example, the IMF sees medium-term growth at a mediocre pace of only 1.7 percent. The domestic implications are serious: weak or little growth in Canadian GDP per capita, more pressure on debt and deficits and fewer resources to modernize our public infrastructure to name only a few.

In a rather courageous act of ‘speaking truth to power’, the IMF analytically attacked the case for ‘friend-shoring’ advocated by US Treasury Secretary Janet Yellen and Canadian Finance Minister Chrystia Freeland.

Beyond the forecasts and the numbers, there is often much to be gleaned from the background analyses and discussions at the IMF/World bank meetings. This year was a treasure trove. Four topics are of particular interest.

Inflation is much stickier than anticipated. While headline inflation has receded,  largely due to declines in energy prices and the unwinding of supply-chain snafus, core inflation has been much slower to respond to the sharp increase in interest rates. Labour markets in North America remain surprising tight, while wages and market pricing by firms are embedding inflation in the services sector of economies. Fiscal policy, which is still stimulative in many western countries, including Canada and the United States, is not supporting tight monetary policy and this, too, will prolong the inflation fight. Assuming central banks remain committed to getting inflation and inflation expectations securely back into their target ranges, interest rates will stay high for longer than markets currently expect. The Canadian housing sector was flagged by the IMF as being at risk in such a scenario, given the high levels of household indebtedness.

Friend-shoring is not friendly. In a rather courageous act of “speaking truth to power”, the IMF analytically attacked the case for “friend-shoring” advocated by US Treasury Secretary Janet Yellen and Canadian Finance Minister Chrystia Freeland. “Fragmentation” was crowned as the word of the week as well as a key risk to robust global growth. While the idea of “moving supply chains to trusted countries” sounds inviting, Gillian Tett of the FT asked: “how do you define a friend?” She notes that the American Inflation Reduction Act is not very “friendly”, as it excludes other countries from participating in its supply chains. Not surprisingly, the EU is retaliating with its own exclusionary industrial policies, and China is way ahead of both in exclusionary measures in key sectors.

More broadly, what started as a focus on geostrategic security related to critical technologies and supplies has become a front for old-fashioned protectionism. And there are costs: the IMF estimates that world output will be 2 percent lower in the medium term if the global economy continues to fragment into blocs, with the US sharing in the pain (-1 percent). The biggest losers will not be China but developing countries. Raghuram Rajan, former governor of the reserve Bank of India and now professor at the University of Chicago, had a perceptive take: “The greatest contribution the United States could make to global development would be to limit fragmentation to strategic areas.”

Regional banking turmoil will slow US economy. The failures of Sun Valley Bank and Credit Suisse are not a replay of 2008, but they do point to the apparent complacency of regulatory oversight of mid-sized banks in the U.S. in a financial system that the Fed itself flooded with cash through quantitative easing. The search for yield by SVB and other regional banks led to dumb banking decisions to bet on interest rates staying low indefinitely. And there will be macroeconomic consequences because regional banks are sizeable lenders in the US economy. Somewhat paradoxically, it was noted, this constrained lending will help tame US demand and reduce the need for further interest rate hikes by the Fed.

Debt needs to be reined in. In contrast to recent years, the problems posed by skyrocketing government debt were front and center at these IMF/World Bank meetings. The policy advice of the IMF to governments was the imperative of well-designed fiscal contractions, both to align with and better support anti-inflation monetary policy and to rein-in rapidly rising debt, which is becoming much more costly with higher interest rates. On design, the IMF was equally blunt: it is the time to cut spending not raise taxes. In these circumstances, the IMF drew attention to general government (combined federal and state/provincial governments) levels of debt to GDP, and also to gross debt given the spike in global interest rates. While the federal government tends to shine a spotlight on Canada’s relatively low federal net debt, IMF data put Canada’s gross general government debt in 2022 at 107 percent of GDP, roughly on a par with the UK, certainly better than the US but decidedly higher than Germany.

To navigate this rocky road over the next several years, policymakers need a steady hand and clear public communications. Policy alignment among finance ministries, central banks and financial sector regulators will be essential. The last word is reserved for Kristalina Georgieva, managing director of the IMF, who, in her closing news conference warned policymakers of the possibility a new Cold War as they aim to secure their trade flows and supply chains amid geopolitical tensions between major powers.

Contributing Writer Kevin Lynch, a former Clerk of the Privy Council, previously Executive Director for Canada, Ireland and the Caribbean of the IMF, went on to become Vice Chair of BMO Financial Group.

Contributing Writer Paul Deegan, a former senior executive with CN Rail and BMO, also served as an economic adviser in the Clinton White House.