War and zero-Covid in China are double shock for world economy

War and zero-Covid in China are double shock for world economy

Global economic growth set to lose one percentage point

The prospects for global economic growth have dimmed substantially this spring since the start of the war in Ukraine on 24 February and the repeated lockdowns in many Chinese cities, especially in Shenzhen and Shanghai. Back in January, we forecast possible growth in global economic output of around four percent, but we have now revised this to a good three percent. Given the crisis in the European and global security order and the continuing pandemic, this may well only be the start of a cycle of downward adjustments in economic forecasts. It is important to take a sober view of the situation particularly as the risks are so difficult to model. The parameters on which forecasts are based (assumptions about commodity prices and availability, the course of the war and risks of escalation) currently tend to be more important than the forecast itself. This is another sure indicator of the degree of uncertainty that neither markets or governments, private households or enterprises can manage in a professional manner. Markets fear nothing more than uninsurable major risks that are often followed by financial instability. Warnings of new Minsky moments, sudden escalations and financial crises should be taken seriously as the winds blowing through the global capital markets could well turn even more harshly.

Higher risks of recession in the triad with global repercussions

The mix of a double shock to supply in terms of high commodity prices and disruptions to global production through China’s zero-Covid strategy is extremely toxic. The impact on price trends and economic activity has been drastic and swift. Disruptions in the three major economic regions of the world – a turnaround in interest rates in the United States, slumps in China and the consequences of war in Europe – are reinforcing each other and are intensifying the upward pressure on prices in particular, while growth is declining rather than moving in the same direction as it would be in a conventional boom period. Economic policy can therefore only attempt to respond in a complex, shortterm way rather than provide a clear course of expansion (or stabilisation) that would build trust. All this is a recipe for market uncertainty. A further escalation in the public health or security policy situation with even greater impacts on the price and availability of commodities could easily lead to a tipping point, plunging at least one region of the triad into recession that would, in all likelihood, have largescale international repercussions (Rogoff 2022). Europe, though very robust, is particularly at risk, as the impact of the supply shock would be felt most strongly here (Eichengreen 2022).

Downward adjustments as growth prospects are cropped substantially

Even if the situation does not escalate further, the agenda for governments and central banks is highly complex and difficult. The war has dampened growth prospects for the EU in particular, but growth in China has also fallen far below expectations at the start of 2022. The economy of the United States has also had a weak start to the year. Many developing and emerging countries are also suffering from indirect repercussions of the war and global disruptions to supplies.

Russia’s economic activity is set to tumble a good ten percent this year, while an even more drastic drop is expected for Ukraine (reduction of one third or more). Some developing and emerging countries will also suffer financial crises. Overall, global economic development is still marked by a recovery in certain service sectors following the lifting of Covid-related restrictions and a strong demand for goods but limitations on the supply side and substantially more expensive energy and agricultural

commodities in combination with dramatically increased inflation in many countries are dimming prospects significantly.

Effects of war on economy are complex and profound

The double supply shock is shaking up the global economy. While the war in Ukraine combined with the sanctions against Russia have additionally and drastically increased prices for fossil fuels, industrial metals, agricultural products and certain other goods (fertilisers, processed goods) and limited the availability of some interim products at least temporarily, the “dynamic zero-Covid strategy” of the Chinese government has triggered significant disruptions to the economic activity in China and consequently also in foreign trade, international shipping and global production.

The impact of the Ukraine war on global economic activity is profound and very complex. The various short-term effects can be categorised as follows:

- Weakening of real purchasing power of consumers for goods and services due to higher prices for energy and agricultural products

- Increase in production costs for enterprises due to the high prices for energy and inputs

- Weakening of global demand for capital goods and other goods

- Medium-term weakening of consumer and investment confidence due to uncertainty surrounding the war and knock-on reticence in purchases and investment that will curb demand in the medium term

- Deterioration of financing terms for industry with increasing interest rates, falling stock prices, more stringent conditions for bank loans and selective insurance difficulties

- Production and transport disruptions caused by disrupted production in the war zones with repercussions on supply chains and transport routes together with the rerouting of the normal air traffic routes between North America and Asia and Europe and Asia due to the war and the closure of Russian airspace

- Losses in foreign trade of trade partners with the Russian Federation and Ukraine, with a stronger decrease in exports than in imports

- Supply shortages in food, agricultural commodities and fertilisers in countries that used to source their supplies to a significant extent from Russia, Ukraine and Belarus, primarily including countries in North Africa, the Middle East, Central Asia and Sub-Saharan Africa

- Fiscal burdens on the destination countries of refugees, particularly in Central and

Eastern Europe due to humanitarian aid for Ukraine and for Ukrainian refugees seeking protection outside Ukraine.

In the medium term, the economic political response in Europe, particularly the strategy to diversify Russian energy supplies, will lead to a permanently higher prices for imported energy sources.

Impact of China’s Covid policy on global economy

The impact of China’s zero-Covid strategy is further curbing global economic activity, above all through the following factors:

- Disruptions in the production of industrial products and services in China

- Slump in demand on the Chinese market for consumer goods and services

- Restrictions in domestic Chinese goods traffic with repercussions on global shipping of exports and imports and on logistics in the main ports of the United States, Europe and

Asia

- Disruptions in the production of finished goods in Europe and in the United States through supply delays and planning difficulties regarding inputs

- Temporarily high costs for seaborne intercontinental transport due to disrupted logistics and higher freight rates.

Soaring commodity prices

The most pronounced impact of the war is on commodity markets. The prices for key commodities had already started rising with the recovery from the lockdown in spring 2021. In 2020, commodity prices dropped significantly due to the global Covid crisis. In 2021, the oil prices picked up strongly as demand recovered, while OPEC+ curbed supplies. As a result, the Brent oil price has surged by almost 150 percent since the beginning of 2021 (European Commission 2022: 18). The United States released a portion of its strategic oil reserves, and Washington and London already sanctioned Russian oil imports while the EU was still in discussions on the subject. The markets sanction Russian oil by not financing and insuring it and refusing to transport it, forcing Russia to find new customers at considerable cost and with impeded logistics.

The gas market, on the other hand, was already under strain before the war, particularly in Europe, as the production of renewable electricity has remained slightly below expectations and gas reserves in Europe are low. The gas prices here have increased by over 420 percent. In the United States, gas prices rose by 260 percent.

Key metal ores and agricultural products have also seen prices soar since January 2021. Nickel increased by 123 percent, copper and zinc by 75 percent and wheat and maize by more than 90 percent. Prices for metal ores rose by an average of 47 percent, and agricultural products by a good 80 percent. The prices for nickel (batteries), copper, zinc, palladium (catalysers), platinum, titanium and neon (production of semiconductors) as well as for wheat and maize rose again particularly after the war began as Russia and Ukraine supply one third of wheat worldwide, a fifth of maize, fertilisers and gas and eleven percent of global oil supplies. Russia and Ukraine accounted for more than 40 percent of the global supply of palladium, valued at around 30 billion U.S. dollars, just over one third of chromium (four billion U.S. dollars), a good 20 percent of vanadium (four billion U.S. dollars) and a good 25 percent of the market for nickel (14 billion U.S. dollars) in 2020 (OECD 2022). Russia is also a major producer of titanium, oats, plant oils, sugar and ammonia. The markets for non-energy commodities have also become extremely volatile as the sanctions, market exits of banks, market