Global Growth Outlook 07/2022: Double shock

Juni 2021 July 2022 GLOBAL GROWTH OUTLOOK

Juni 2021

Double shock GLOBAL GROWTH OUTLOOK

Juni 2022

Covid and war jeopardising global economic recovery

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The double shock of the Russian war in Ukraine and China’s zero-Covid strategy is fuelling inflation and cutting growth worldwide. There is no easy economic policy response to this situation.

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The global economy will only grow by about three percent this year. At the start of the year we forecast four percent. Global trade is expected to grow by a solid five percent, but this is only half the increase seen last year.

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The German economy is only expected to grow around 1.5 percent this year.

Our start-of-year forecast was 3.5 percent. Growth is likely to be only half that registered last year, with exports and investment activity greatly restrained.

Die amerikanische Lokomotive der Weltwirtschaft

▪ Transport and logistics prices are soaring globally due to the war and the panAufschwung im Norden, Risiken im Süden demic, leading to persistent supply bottlenecks. These problems are curbing industrial production.

▪

High inflation in the euro area and Germany needs a monetary policy response.

The European Central Bank is tightening the reins to bring inflation back down towards two percent by 2024.

▪

Federal Reserve opts for monetary policy normalisation to tackle very high inflation in the United States. If successful, this could lead to a soft landing in monetary policy. However, the turnaround in interest rates harbours recession risks for the United States next year.

Content War and zero-Covid in China are double shock for world economy ............................................. 1 Curbed growth prospects with substantial risk of recession ........................................................ 4 Regional outlook ................................................................................................................................. 8 Fiscal policy is cushioning impact of double shock ....................................................................... 9 High inflationary pressure in transatlantic region ......................................................................... 10 Financial markets in robust adjustment ......................................................................................... 12 Global industrial production ............................................................................................................ 14 Global trade........................................................................................................................................ 17 United States: Weak start to the current year ................................................................................ 18 China: Growth and supply chains under pressure ........................................................................ 20 Sharp growth slowdown for Europe ............................................................................................... 23 Germany ............................................................................................................................................. 25 Sources .............................................................................................................................................. 27

Double shock | Covid and war jeopardising global economic recovery 4/07/2022

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

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

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.

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

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

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

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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

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

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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

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

practices and shortages have complex effects. Finding alternative suppliers for non-energy metals is generally only possible in the medium term, particularly in the case of high-purity nickel, titanium and palladium.

Added to this are the impact of sanctions and secondary market sanctions on the costs of air and seaborne freight on the main shipping routes, particularly between Europe and Asia.

Rising commodity prices (1.01.2021 - 16.05.2022), change in percent Coal Natural gas (TTF Europe) Brent oil

Aluminum Nickel

Wheat Corn 0

50

100

150

200

250

300

350

400

450

500

Source: European Commission

Curbed growth prospects with substantial risk of recession The prospects for global economic growth have clouded over substantially this spring. We now expect global production to grow by only around three percent (3.2 percent), instead of the slightly over four percent we predicted at the beginning of the year, and even this forecast comes with significant downward risks. It matches the latest forecasts of the OECD and the European Commission and is much more sceptical than the spring forecast of the IMF. Our projection assumes no further substantial escalation in the Ukraine conflict with renewed knock-on effects on oil and gas prices and no sudden supply halt in Russian gas or oil. A deterioration of the situation to this effect would considerably dampen economic activity particularly in the EU to around 1.5 percentage points in the case of higher energy commodity prices and more pronounced slumps in the case of an embargo (European Commission 2022: 51-57). Such developments would also have a hefty impact on net importers of energy commodities outside of the EU. We expect global trade to recover moderately as the international trade in services should pick up strongly following the lifting of travel restrictions and the initially strong demand for goods will further boost trade. However, the war is bound to have a curbing effect here too. The IMF, OECD and the European Commission expect growth rates of a good five percent for the import of goods and services worldwide, while the WTO forecasts only half that (WTO 2022).

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

Forecast summary: Growth in real GDP 2022/2023 in percent 2022

2023

IMF1

OECD2

EUCOM3

IMF1

OECD2

EUCOM3

World

3.6

3.04

3.2

3.6

2.84

3.5

USA

3.7

2.5

2.9

2.3

1.2

2.3

China

4.4

4.4

4.6

5.1

4.9

5.0

Japan

2.4

1.7

1.9

2.3

1.8

1.8

EU

2.7

2.3

Euro area

2.8

2.6

2.7

2.3

1.6

2.3

Germany

2.1

1.9

1.6

2.7

1.7

2.4

France

2.9

2.4

3.1

1.4

1.4

1.8

Italy

2.3

2.5

2.4

1.7

1.2

1.9

Spain

4.8

4.1

4.0

3.3

2.2

3.4

U. Kingdom

3.7

3.6

3.4

1.2

0.0

1.6

India

8.25

6.9

7.4

6.95

6.2

6.5

Brazil

0.8

0.6

0.7

1.4

1.2

1.5

Russia

-8.5

4.3*

-10.4

-2.3

2.7*

1.5

1: IMF (April 2022) 2: OECD (June 2022), *December 2021, Forecast for India for fiscal year beginning April 3: European Commission (Mai 2022) 4: Forecast on basis of 70 percent world GDP (PPP of 2013) 5: Information on India for the fiscal year in current prices

Purchasing manager indices The sentiment indicators for the global economy have dimmed since the beginning of the year.

Although the overall index is still pointing to expansion, the index for manufacturing is only just over the threshold. Most recently, in the United States the index for industry was still going strong. The index for services has slipped, though at 55 it is still well within expansionary territory. In China, the lockdowns have caused the index for services and the overall economy to drop below 40 and even manufacturing is below 50. In the euro area, the index for services has recovered soundly while the index for manufacturing is still high but has decreased. The index for the overall economy is still at well over 50.

This is also true in the case of Germany.

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

Purchasing Managers` Indices* 75

Germany

70

65

60

55

50

45

40

35

Euro area

30

25

20

15

10

Manufacturing PMI Services PMI Composite PMI 75

Manufacturing PMI Services PMI Composite PMI

China

USA 60

65

55 50

55

45 45

40 35

35

30 25

25

Manufacturing PMI Services PMI Composite PMI

Manufacturing PMI Services PMI Composite PMI

*PMI Source: Market Source: Macrobond

Economic Managers` sentiment indicators*, OECD Purchasing Index* World 60

50

40

30

20 Manufacturing PMI

Services PMI

Composite PMI

*PMI Source: Market Source: Macrobond

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

The confidence indicators of the OECD have also turned around. Since spring 2021, consumer confidence in the United States, in particular, has dropped below its long-term average and in the euro area it has decreased especially since autumn from above-average to below-average values. This is also true of sentiment in industry.

Economic sentiment indicators*, OECD 103 101 99 97 95 93 91 Jan 20

Jun 20

Jan 21

Business Tendency Surveys (Manufacturing)

Jun 21

Consumer Opinion Surveys

Jan 22

May 22

Leading Indicator

*seasonally adjusted (index=100) Source: Macrobond

Growth slows in the major economic regions Growth momentum has diminished, particularly in the major economies. We forecast real growth of three percent in the United States, four percent in China. around 2.5 percent for the euro area and two percent for Japan. All four economic regions should therefore regain their pre-pandemic levels.

The economic development in other key industrialised countries is still recovering robustly. Australia, Canada, Singapore and the United Kingdom should grow by a good 3.5 to four percent, Taiwan by three percent and South Korea by 2.5 percent.

Growth of real gross domestic product in 2022 compared to previous year (in percent)

Global economy

+3.2

Euro area

+2.5

World trade

+5.0

EU

+2.5

United States

+3.0

Germany

+1.5

China

+4.0

Japan

+2.0

Source: BDI

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

Regional outlook The IMF and other international organisations have downwardly revised their start-of-year forecasts for economic development in the developing and emerging countries by a good one percentage point.

The soaring prices on the commodity markets have sharpened the divergence in the prospects for net exporters and net importers. On top of this, the pandemic is still causing considerable problems for some countries.

Despite the expected cooldown of the Chinese economy, the ASEAN countries should still grow by a good five percent this year, with the good three percent growth forecast for Thailand pulling down the average of the group as a whole. After its severe slump, India should bounce back to strong growth of around eight percent.

Latin America and the Caribbean are not likely to manage more than 2.5 percent growth. Mexico is expected to grow by a good two percent, Brazil by just under one percent. Columbia is set to grow by just under six percent, Argentina, Bolivia and Uruguay by around four percent, Peru by three percent and Chile and Venezuela both by 1.5 percent.

The Middle East and Central Asia should grow by a good 4.5 percent. Saudi Arabia will benefit from the high oil price and expand around 7.5 percent. Sub-Saharan Africa is forecast to grow by 3.75 percent. South Africa should grow by just over two percent this year while Nigeria is set to benefit from the high oil prices and grow 3.5 percent. Turkey’s economy is stuck in a deep inflation and currency crisis and could reach the growth rate of three percent in real terms expected by the IMF at a forecast rate of inflation of over 50 percent.

Regional economic outlook*

2022

2023

Europe, advanced and developing economies

-2.9

1.3

Middle East, Central Asia

4.6

3.7

Israel

5.0

3.5

Sub-Sahara Africa

3.8

4.0

South America

2.3

2.1

Central America

4.8

4.0

Latin America and Caribbean

2.5

2.5

Asia, advanced and developing economies

5.4

5.6

* Growth of real GDP over previous year in percent Source: IMF (April 2022)

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

Fiscal policy is cushioning impact of double shock The governments and parliaments in North America and Europe took swift action in the first months of the year to cushion the negative economic impact of the double shock for low-income households and energy-intensive companies. Most countries have introduced benefit payments and tax concessions for low-income households together with tax concessions on energy products, and price cuts and amended price regulations for energy. In general, targeted and temporary measures to aid low-income households and companies facing insolvency due to the high energy prices are useful whereas general measures to ease the financial burden tend to be unnecessarily expensive for the public purse. The packages of measures also ease the pressure on ongoing collective wage bargaining which, in turn, helps avoid excessive wage increases. Some countries, such as Poland, Romania and Germany, are additionally dealing with increased expenditure for humanitarian aid for Ukraine and for Ukrainian refugees.

Many of these packages have a moderate volume (0.5-1.5 percentage points of GDP). With these measures, many states have temporarily left the path consolidation in favour of supporting the economic situation, which is certainly appropriate in these circumstances. Consolidation will then move back up the agenda in 2023. From 2021 to 2023, the International Monetary Fund is expecting an improvement in the structural primary balance each year of around one percentage point of economic output in industrialised countries. While developing and emerging countries improved their structural primary balance by two percentage points in 2021, the IMF is expecting a deterioration of one percentage point this year and an improvement the year after (IMF 2022). There are distinct divergences internationally though. In the United States, the huge consolidation is being continued almost unchanged despite the double shock. In the EU and in the euro area, the general trend this year is expansionary (1.75 percent of GDP) with a slight contraction of 0.5 percentage points on the cards for next year. This forecast includes the investment momentum of the NextGeneration EU scheme. In the EU, the measures adopted to cushion the energy price shock should amount to 0.6 percentage points of economic output, and special humanitarian aid to 0.1 percentage points.

Overall, the budget deficits in the EU are still expected to drop from 4.7 percent down to 3.6 percent of GDP as the extra expenditure and reduced income from the Covid measures of 2020 and 2021 will largely have run their course. In 2023, the budget deficit is forecast to drop to only 2.5 percent (European Commission 2022: 45). Japan already adopted an overall package of measures in winter which will have an expansionary effect of a good 1.5 percentage points this year. The country will revert to consolidation next year.

Medium-term adjustments in consolidation difficult in view of new tasks In view of the steep rise in public debt in most industrialised countries during the Covid years, consolidation remains an exceedingly challenging task for most countries in the medium term. The weakened economic activity will make this all the more difficult. Furthermore, the positive impact of inflation on state revenues in the short term will be replaced by the negative impact on state expenditure in the medium term, especially as the costs to service public debt will gradually increase as capital market yields rise. Even before the crisis, public households faced substantial direct and indirect future burdens on account of the public investment required for decarbonisation and digitalisation. Now it is primarily Europe, which, in view of the new security situation and its objective to massively reduce its dependency on Russian energy imports, is facing permanently higher expenditure for defence, in many cases to the scale of half a percentage point of economic output, and

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

for new public infrastructure in the energy sector. This will demand permanent adjustments in public revenues and expenditure. National and EU-wide loan financing for certain priority projects could be possible in individual cases but will not be able to shoulder the bulk of the adjustment costs. This means that almost all countries will have to make painful adjustments to their budgets (OECD 2022, PisaniFerry and Blanchard 2022).

Financial policy can only mitigate impact Financial policy generally only has very limited scope to respond to a double shock, mainly in tweaking distribution. Stabilising aggregate demand by stimulating demand will not help counter the current supply shock. Conversely, stepping up consolidation risks snuffing out the already weakened pace of growth. Countries under particularly high inflationary pressure must also consider to what extent their fiscal course is boosting demand and therefore contributing to inflation.

Governments in developing and emerging countries have so far hardly adopted any packages of measures to mitigate the impact of the shock. Most of these countries are, in fact, going the opposite way and pursuing monetary tightening in response to the United States’ turnaround on interest rates.

As many countries have also seen growth and state revenues drop on account of Covid, there is very little leeway to implement measures to protect against higher energy and food prices other than those aimed at reducing poverty.

High inflationary pressure in transatlantic region The Ukraine war has fundamentally changed the outlook for inflation. Before the war, an increase in inflation rates seemed plausible given the supply bottlenecks and strong pace of growth. Since the war started, the inflationary momentum is unmistakeable with prices for energy and agricultural commodities and some metals shooting up within a very short space of time. Supply bottlenecks in the production of intermediate products have intensified further, as have the disruptions in international shipping and logistics in the wake of sanctions against Russia and the closure of Russian airspace. The situation is compounded by the problems in transport and logistics in China on account of the country’s zeroCovid strategy.

In response to such a broad increase in input prices, many industries around the world first compressed their margins or curbed production. This will gradually lead to rising producer prices and, ultimately, albeit to a lesser extent, rising consumer prices. The OECD estimates that between 40 and 50 percent of the price increase will be shifted onto consumer prices.

While industrialised countries only had an inflation rate of 0.7 percent in 2020, it increased to a good three percent in 2021. This year, inflation is expected to reach extremely high levels. The IMF (IMF 2022) expects inflation to reach 5.7 percent this year in industrialised countries and 8.7 percent in developing and emerging countries (1.8 and 2.8 percentage points more respectively than in January).

Core inflation most recently rose to four percent among industrialised countries and five percent among developing and emerging countries. The IMF expects inflation to calm down by next year already and drop back to 2.5 and 6.5 percent respectively. The OECD anticipates inflation this year to average 6.2 percent in the United States, 6.1 percent in the euro area, and around three percent next year (OECD 2022). Inflation has risen particularly rapidly in the United States, the United Kingdom and in countries of Central and Eastern Europe. In Europe, inflation is being fuelled by surging gas prices, in particular, whereas in the United States it is the oil prices. In almost all countries, the inflation rate has

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

also risen in the service sector as business returns to normal and service providers restricted during Covid initially struggle to find enough workers.

Risks that households and financial markets will be faced with permanently higher rates of inflation and higher wage rises have nonetheless also increased. The factors affecting inflation are usually outside the scope of influence of monetary policy. In the United States, the Biden administration’s highly expansionary approach has definitely helped drive inflation up further, whereas, in Europe, fiscal policy has not been too expansionary on the whole. The central banks of the United States and Europe are in a difficult position. For the first time in a long time, they now need to normalise monetary policy, reduce bond purchases, and increase interest rates in order to curb demand. Every currency area will have to take a differentiated approach as both the factors driving inflation and the consequences differ.

China is an exception here, with its central bank loosening monetary policy as the lockdowns have considerably weakened its economy. Japan is following the general trend but, with inflation at below two percent, it is no cause for major concern as yet.

Inflation rates should gradually decrease over the second half of the year and next year, at least if the energy prices ease off as signalised by the futures prices. Inflation is nonetheless set to be higher for longer than seemed plausible before the outbreak of the war. The central banks will therefore have to normalise their monetary policy to a greater extent in order to counteract the upward pressure. The OECD expects an average increase in base rates within its countries of two percentage points (comparison between annual average 2023 to 2021) (OECD 2022). Over the last few weeks, the pace of monetary tightening has accelerated in many countries in response to the unexpectedly high upward inflationary momentum.

U.S. central bank announces substantial monetary tightening Inflation has risen particularly steeply in the United States. In December, the Fed had already anticipated that inflation would exceed five percent, but the momentum has proved to be even stronger.

Inflation in May was at 8.6 percent with core inflation at six percent, triggering a strong reaction from the central bank. The Fed thus emphasised recently that, despite the expected weakening of economic activity on account of the war, a robust monetary policy response was now needed to counteract the various imbalances, the very tight labour market, and the broad pressure on prices (energy prices, pandemic effects, services, rents, wages). It has accordingly cut back its bond purchases (net) extensively since the start of the year and, on 4 May, increased the benchmark interest rate by 50 basis points to a target range of 0.75 to one percent as well as signalising two further interest rate hikes on the same scale until September. The Fed further resolved to reduce its balance sheet with net sales of assets (U.S. Treasury and mortgage-backed securities) beginning 1 June, initially on a small scale and then, from September onwards, at a volume of roughly 95 billion U.S. dollars per month. The Fed’s balance sheet had reached around 5.8 trillion U.S. dollars in government bonds and 2.7 trillion U.S. dollars in mortgage-backed securities and plans to cut it by around one trillion next year alone.

On 15 June, the Fed took the next step, increasing the benchmark interest rate by 0.75 percentage points to a range of 1.5 to 1.75 percent. Further interest rate hikes are on the cards. The midpoint of the target range of individual members’ expectations was up by 1.5 percentage points to 3.4 percent for the end of the year, and up by 90 basis points to 3.8 percent for next year.

The precise scale of the increase will depend on the upward movement of financing conditions and on the development of the labour market. The labour market currently has a very high number of vacancies compared to the number of unemployed persons. In view of the surging inflation and the little

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

experience in dialling back asset purchase programmes as well as uncertainties regarding economic development going forward, it will be extremely difficult to manage a soft landing in monetary policy by curbing demand without triggering at least a mild and brief recession in the course of 2023.

ECB normalises monetary policy Inflation also increased in the euro area, with annual inflation at 7.5 percent in April and core inflation at a more moderate 3.5 percent. Outside of the euro area, inflationary momentum was somewhat higher. The main factor fuelling inflation across Europe are the soaring energy prices with supply shortages compounding the situation. As an input cost for many activities, energy prices affect the prices of an extremely broad range of goods and services. Depending on the economic policy response of the individual countries, the cost increases have already been absorbed or, if not, will lead to price adjustments further down the line, including higher gas prices in particular. Food prices have risen by around 6.5 percent. In the euro area, import prices have increased particularly briskly but domestic prices are also following an upward path. The European Commission and the ECB are expecting prices to increase by more than six percent, with the ECB most recently forecasting 6.8 percent inflation for this year, 3.5 percent in 2023, and 2.1 percent in 2024. After twenty years of below-average inflation in the euro area and in the EU, this is an unusual situation and private households now expect higher inflation in the medium term (averaging at 2.9 percent) while professional market participants believe inflation will settle down in the medium term. Following several months of intense debate, the ECB decided on 9 June to end net asset purchases under its asset purchase programme as of 1 July and reinvest principal payments from maturing securities purchased under the pandemic emergency purchase programme until at least the end of 2024. The ECB also announced its intention to raise the key interest rate by 0.25 percent at its July monetary policy meeting and, depending on how the situation develops in the meantime, another increase of 0.50 percent in September, as well as further interest hikes going forward if appropriate. At an ad hoc meeting on 15 June, the ECB further announced the development of a new purchase programme to contain excessive widening of bond spreads.

Financial markets in robust adjustment The deterioration of the economic situation at the start of the year combined with the change in course of key central banks has triggered a continuous adjustment on the financial markets to the new parameters. The picture on the financial markets is characterised by sharp price drops on the stock markets and substantial yield increases on the bond markets with the U.S. dollar, above all, rising at the start of the year.

After the outbreak of the war, the global stock markets initially registered sharp price decreases, particularly in the United States and Europe. NASDAQ lost over 20 percent compared to its highest valuation in November last year, S&P 500 lost 15 percent. The European Stoxx 600 has lost a good third in value since spring 2021 and around 28 percent since the beginning of the year, while the Nikkei has only lost a good ten percent since its peak at the end of last year. The stock markets of emerging countries (MSCI EM) have lost more than 20 percent. Chinese stock markets also suffered price drops with the key index of Shanghai losing 15 percent since the beginning of the year and the stock market in Hong Kong ten percent. The valuation level (PER) in Japan and Europe has dropped to a range of between ten and 15. In the United States, the cyclically adjusted PE ratio of the whole S&P 500, despite a correction, is still at well above 30, which is a notoriously high level.

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

Stock market* 140

120

100

80 Euro area

USA

China

Japan

NASDAQ-100

Index: 1.01.2021=100 Source: Macrobond

The rising inflation and turnaround in monetary policy of the major central banks has, of course, been quick to affect bond market yields. In the United States, yields for ten-year bonds have increased from 1.5 to 3.5 percent since the beginning of the year. German bonds are back to plus 1.6 percent, Italian bonds at over four percent and French bonds at a good 2.2 percent. UK gilts are listed at 2.5 percent.

Bonds even increased in Japan by a slim 0.2 percent. They have also risen in emerging countries. In the United States, short-term yields have increased in particular.

Bonds 4

3

2

1

0

-1 2020 Germany

2021 Italy

France

2022 USA

China

Japan

Source: Macrobond

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

The financing conditions in Europe have on the whole become more problematic since the beginning of the war, outside of the euro area even more than within. Yields for corporate bonds also increased sharply while the conditions for bank loans were only tightened slightly and corporate lending and lending to private households grew by over four percent in both cases (compared to the previous year).

The leadership role of the United States in monetary policy has strengthened the dollar. The dollar has appreciated by two percent compared to a wide basket of currencies in real and nominal terms since the beginning of the year, while the euro, in contrast, has depreciated around two percent. The external value of the Japanese yen, in contrast, dropped by around ten percent both in nominal and real terms.

The plummeting initially after the outbreak of the war, the rouble has largely rebounded on account of the tough monetary policy and administrative measures taken by the Bank of Russia. At the end of April, the rouble was only five percent lower against the dollar than it had been at the start of the year.

Exchange rates against the U.S. dollar

1,25 1.25

1.0 1,0

1.20 1,20

0.8 0,8

1.15 1,15

0.6 0,6

7.4 7,4

140 135

7.2 7,2

130

7.0 7,0

125 120 1.10 1,10

0.4 0,4

6,8 6.8

115

6,6 6.6

110 0.2 0,2

1.05 1,05

105

6.4 6,4

100 1.00 1,00

0.0 0,0

Euro (left axis) Pound Sterling (right axis)

6.2 6,2

95

Renminbi (right axis) Yen (left axis)

Source: Macrobond

Global industrial production In 2021, global industrial production rose by 7.9 percent according to calculations by the Netherlands Bureau for Economic Policy Analysis (CPB). This more than compensates for the decrease in production caused by the pandemic in 2020. In the first quarter 2021, global industrial production was already higher than before the pandemic in the fourth quarter 2019. Following the strong rise in production in the first quarter 2021, activity stagnated during the next two quarters. In the fourth quarter 2021, industrial activity then picked up to come in at 1.3 percent above the previous quarter.

In the first quarter of the current year, global industrial production was 3.2 percent higher compared to the previous quarter. The consequences of the war in Ukraine and the lockdown in China only played into these figures marginally. The global manufacturing purchasing managers’ index is still indicating expansion but dropped to 52.3 points in April, its lowest level in 20 months, before recovering just slightly in May. The prospects for the further course of the year are on the moderate side on account

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

of the global political situation. For the year overall, global industrial production could grow by just over five percent if production levels recorded at the beginning of the year are maintained for the year as a whole.

Advanced economies: Recovery faltering since summer In the advanced economies, industrial production at the end of 2020 was still 2.1 percent below its pre-pandemic level. While industrial output in the United States, the United Kingdom and Japan, was still between 4.7 percent and 3.9 percent below pre-pandemic levels, output in the developed Asian countries excluding Japan output was already 5.1 percent higher than before the pandemic. The upward trend continued, with 4.6 percent growth in the first and 0.9 percent in the second quarter. For the year overall, industrial production in this group of countries was up by 9.4 percent and 13.1 percent higher than before the pandemic. In the group of remaining advanced economies, industrial production rose by 7.5 percent in 2021 and was 5.5 percent above pre-pandemic levels at the end of the year. While industrial activity in the United Kingdom still languished below its pre-pandemic level at the end of 2021 despite an annual growth of four percent, output in the euro area was 7.4 percent up on 2020, and, in the United States up by 5.5 percent, thus regaining pre-pandemic levels by the end of 2021.

Advanced economies: Industrial production*, Purchasing Managers Index 60

25

55

15

50 5 45 -5 40

other advanced economies Euro area Japan USA Purchasing Managers Index seasonally adjusted (left axis)

35

30

-15

-25 2019

2020

2021

2022

*Production index: two-month average, after calendar and seasonal adjustments, in percent, year on year Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis (CPB)

In the first quarter 2022, industrial production increased 1.4 percent in the advanced economies compared to the fourth quarter 2021. Production increased across all groups of countries. The purchasing managers’ index for advanced economies dropped for the third consecutive time, the third drop being a relatively pronounced drop of 1.3 index points in May. Standing at 55 index points at last count, the index is still indicating expansion. On account of the low statistical overhang and the

15

Double shock | Covid and war jeopardising global economic recovery 4/07/2022

continuing problems with logistics around the world, industrial production is only expected to increase by between one and two percent for the year 2022 overall.

Emerging countries Among the emerging countries, only China was producing more than before the pandemic at the beginning of 2021. The remaining Asian emerging countries followed suit with quarter-on-quarter growth of 1.7 percent in the first and 3.5 percent in the second quarter. Finishing off the year with a plus of 12.4 percent, growth in industrial production for this group of countries even outstripped China.

Industrial activity in Central and Eastern Europe also picked up, growing by 0.2 percent in the first quarter 2001 and 2.9 percent in the second. Growth in 2021 overall was 4.6 percent, which is below average for emerging countries. Industrial production in Africa and the Middle East had the largest gap between its pre-pandemic level. Following quarterly growth of between two and 3.5 percent in the first three quarters of the year and growth of 0.5 percent in the final quarter, industrial production was still below its pre-Covid level. For the year overall, industrial production in these countries only grew by 3.8 percent, putting it at 2.3 percent below its pre-pandemic level. In Latin America, industrial production was down for the seventh consecutive year. With a strong first quarter and moderate growth in the second half of the year, output in 2021 overall was up by 8.1 percent bringing it back up to prepandemic levels.

Emerging economies: Industrial production*, Purchasing Managers Index 60

20 15

55 10 5

50

0 45

-5 Africa/Middle East Latin America Central and Eastern Europe Asia (excluding China) China Purchasing Managers Index seasonally adjusted (left axis)

40

35

-10 -15 -20

2019

2020

2021

2022

*Production index: two-month average, after calendar and seasonal adjustments, in percent, year on year Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis (CPB)

At the start of 2022, industrial production in emerging countries expanded by 4.9 percent compared to the previous quarter. The main factor fuelling growth was the strong increase in industrial activity among Asian emerging countries and in Africa and the Middle East. In Latin America and Central and Eastern Europe, industrial production only increased marginally in the first quarter 2022. In March 2022, the manufacturing purchasing managers’ index for these countries sank below the expansion threshold for the first time in six months, going down to 48.1 points, its lowest value in 23 months. In

16

Double shock | Covid and war jeopardising global economic recovery 4/07/2022

May, the index rose clearly but stayed just below the expansion threshold at 49.5 points. In view of the low statistical overhang and the cool down on the horizon, industrial production in emerging countries is set to grow somewhat slower than the previous year at around six percent.

Global trade Global trade has picked up again following the pandemic-induced slump in 2020. According to the Netherlands Bureau for Economic Policy (CPB), the volume of global trade increased by 10.3 percent in 2021 compared to the previous year. In 2020, global trade contracted by 5.2 percent year on year and by 0.4 percent in 2019. Following an upward trend in the first six months of 2021, global trade then faltered in the third quarter. Recovery set in again in the fourth quarter, with global trade increasing by 2.7 percent compared to the previous quarter.

Emerging countries exported 11.8 more goods in 2021 overall than in the previous year. Exports from China registered the largest growth, expanding by 20.3 percent, followed by the remaining Asian emerging countries whose exports grew by 16.2 percent. Latin America exported 5.7 percent more goods than one year previously. Exports from Africa and the Middle East and from Central and Eastern Europe showed slim growth, rising by only 1.7 and 1.5 percent respectively.

World: Exports according to region of origin 30 25 20 15 10 5 0 -5 -10 -15

advanced economies emerging economies

-20 2018 2019 2020 2021 Index: two-month average, after calendar and seasonal adjustments, in percent, year on year

2022

Source: Macrobond

Exports from the advanced economies increased by a total of 8.9 percent in 2021. Among this group of countries, it was again those in Asia that contributed the most momentum. The strongest growth in goods exports among this group of countries was Japan with plus 11.8 percent and the remaining advanced Asian economies with plus 11.6 percent. The euro area exported 8.8 percent more goods than one year ago, and the United States 8.2 percent. The robust increase in both cases failed to compensate for the drops from the preceding two years. The export of goods from the euro area amounted to 0.6 percent less than in 2018 and exports from the United States to 4.1 percent less. The United Kingdom recorded a decrease in exports of 1.4 percent in 2021, its third consecutive drop with exports one fifth less than in 2018. Exports from the remaining advanced economies increased by a healthy 7.7 percent, more than compensating for the decrease recorded in the previous year.

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

The latest figures show trade activity continuing its upward path. In the first quarter 2022, global exports increased by 3.5 percent year on year. Exports from the advanced economies increased by 2.1 percent in the first quarter, clearly outperformed by exports from emerging countries which increased by 6.2 percent. For 2022 overall, global trade is expected to increase by five percent.

United States: Weak start to the current year Economic development After taking a hard beating from the Covid crisis in 2020 and contracting by 3.4 percent, the economy of the United States registered a solid performance in 2021. Overall growth for the year was 5.7 percent, the strongest growth seen since 1984. The main drivers were strong private consumption and private investment as well as expanding residential construction with the lifting of Covid restrictions and the general easing up of the pandemic. In the current year, growth is being hampered by the Fed’s interest rate turnaround, the tight labour market, China’s zero-Covid strategy, and the war in Ukraine.

Although the war in Ukraine does not have as strong an economic impact on North America as it does on Europe, the United States can also expect to feel negative effects in the shape of lower growth among key trade partners and higher commodity prices. According to the second estimate of the Bureau of Economic Analysis BEA, U.S. GDP contracted by 1.5 percent in the first quarter of 2022 (seasonally adjusted at an annualised rate). The reasons for the drop are a reduction in private inventory investment, exports, and government spending combined with an increase in imports.

Personal consumption expenditures and fixed investment, on the other hand, increased (BEA 2022a).

For 2022 and 2023, the OECD now expects growth of 2.5 percent and 1.2 percent respectively (OECD 2022). In April, the International Monetary Fund (IMF) forecast 3.7 percent growth for 2022, 2.3 percent in 2023, and a much lower 1.4 percent in 2024 (IMF 2022). The European Commission expects growth of 2.9 percent for this year and 2.3 percent for next year (European Commission 2022). We forecast overall growth in 2022 of three percent in real terms.

The unemployment rate in the United States was at 3.6 percent in May, which is almost the prepandemic level of 3.5 percent (BLS 2022a). At the same time, many Americans who withdrew from the labour market in the wake of the Covid crisis are not yet actively looking for work again. The labour force participation rate, which is the proportion of the working population that are either in work or actively looking for work, was at 62.3 percent in May and is therefore still below the pre-Covid level of 63.4 percent registered in February 2020 (BLS 2022b). The persistent labour shortage is putting upward pressure on wages and additionally increasing the risk of inflation. Total employment in the United States is expected to increase from 153.5 million in 2020 to 165.4 million in 2030, according to figures from the Bureau of Labor Statistics (BLS 2021). Unemployment is therefore likely to remain at a low level or even slightly fall further. The European Commission, for example, is expecting unemployment in the United States to come in at around 3.5 percent in 2023 (European Commission 2022).

Prices are rising steadily in the United States. In May, the Consumer Price Index (All Urban Consumers, CPI-U) was up 8.6 percent compared to the same month last year (before seasonal adjustment), according to figures from the Bureau of Labor Statistics. The price hikes in gasoline (April: up 48.7 percent compared to April 2021) and fuel oil (up 106.7 percent compared to April 2021) were particularly pronounced (BLS 2022c).

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

The high rate of inflation and rising interest rates are also weighing down consumer sentiment.

Sentiment among U.S. consumers has deteriorated overall, according to the U.S. Consumer Confidence Survey. In May, the Consumer Confidence Index stood at 106.4 points compared to the 113.8 points measured in January (The Conference Board 2022). Private consumption expenditure nonetheless increased steadily throughout the first quarter 2022, with the latest figures showing an increase of 0.9 percent in April compared to the previous month. At the same time, the household savings rate has decreased continuously, from six percent in January down to 4.4 percent in April.

During the acute phases of the pandemic, the savings rate had temporarily climbed over 25 percent (April 2020: 33.8 percent; March 2021: 26.6 percent) (BEA 2022b).

Foreign trade In the first quarter of 2022, the United States exported goods and services worth around 705 billion U.S. dollars. That corresponds to a growth of 2.7 percent compared to the fourth quarter 2021. Imports in the first quarter 2022 amounted to around 988 billion U.S. dollars. They increased significantly more than exports compared with the previous quarter: by 8.4 percent. In the first quarter of 2022, the trade deficit (goods and services) amounted to around 284 billion U.S. dollars (BEA 2022c). In light of the current strength of the U.S. dollar, imports are expected to carry on growing in the further course of the year.

Fiscal measures under the Biden administration and government debt Following the American Rescue Plan and the Infrastructure Investment and Jobs Act last year, there are currently no other extensive spending packages on the horizon. The Build Back Better Act, a key element of President Biden’s domestic policy agenda, sets out assistance for childcare and healthcare as well as investment in climate protection. The House of Representatives passed the legislative package in November 2021 with the votes of the Democratic majority. In the Senate, however, not all 50 Democrat senators whose votes would be needed to pass the budget reconciliation bill (together with the vote of the U.S. vice president) have been able to reach agreement as yet. It now looks like the Build Back Better Act as a whole has relatively little chance of being passed before the midterm elections in November. Individual elements of the original legislative package could be included in other pieces of legislation. The fiscal incentives that will now likely not materialise are another reason for the stunted growth prospects of the U.S. economy.

Without any further large-scale spending packages this current fiscal year, the budget deficit is set to decrease. According to forecasts by the Congressional Budget Office (CBO), it will drop from 12.4 percent of GDP in the fiscal year 2021 to 3.9 percent in the current year and 3.7 percent in 2023.

After 2023, the CBO expects the deficit to rise again, up to 6.1 percent by 2032. This would take the budget deficit to well above its 50-year average of 3.5 percent. According to CBO estimates, the debt ratio of 100 percent of GDP in 2021 will drop down to 96 percent in 2023. The rapid growth of nominal GDP, caused by both the high rate of inflation and real GDP growth, means that debt as a ratio of the economic output of the country will initially remain low. Given the increasing budget deficits projected by the CBO after 2023, the debt ratio will then rise steadily to reach 110 percent of GDP by 2032, which would be the highest rate ever. The main reasons for the expected increase are primarily rising interest expenses as well as rising expenditures for Medicare (health insurance for elderly citizens) and Social Security (federal pension insurance) (CBO 2022).

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

U.S. GDP growth, quarterly (annualised) 40

33.8

30 20 10

4.5

6.3

6.9

6.7 2.3

0 -1.5 -10

-5.1

-20 -30 -31.2 -40 Q1

Q2

Q3

Q4

Q1

Q2

2020

Q3 2021

Q4

Q1 2022

Source: Bureau for Economic Analysis

China: Growth and supply chains under pressure Following a relatively strong performance by the Chinese economy in 2021 with a growth rate of 8.1 percent compared to the relatively low basis value from 2020, expectations for 2022 have had to be pulled down.

Zero-Covid strategy restraining economic growth While restrictions imposed to stem the spread of the pandemic are being lifted or reduced all over the world and the situation appears to be easing off, the Chinese government is sticking fast to its zeroCovid strategy. Strict lockdowns were imposed on several cities and regions in response to recent outbreaks of infections, above all in April and May. Production, consumption, supply chains and logistics have all suffered sustained damage. The economic indicators for these months are therefore correspondingly poor. The impact of these lockdowns has rippled across with world with effects being felt slightly later down the line in terms of time and beyond China’s borders. In Europe, the lockdowns have led to supply delays, scarce availability of certain goods and higher prices.

The Chinese economy started out the year with unexpectedly strong growth of 4.8 percent, buoyed by an upturn in industry and exports in January and February. The second quarter figures will show a pronounced slump in growth. The poor performance in March, April and May will have a prolonged effect on overall growth. The ambitious growth targeted by the Chinese government of around 5.5 percent is well-nigh out of reach even with massive economic stimulus and infrastructure measures.

If the situation remains relatively stable for the rest of the year, annual growth could reach between 3.5 and four percent. In the case of more lockdowns or other economic shocks, growth could also well drop to below three percent.

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

Economic indicators mixed In May, the lockdowns and Covid restrictions brought the national volume of freight and passenger transport tumbling down to around 39 percent compared to the same month last year. Industrial value added decreased by 2.9 percent in April, according to official figures, and is likely to have dropped on a similar scale in May. In May, the producer price index (PPI) was 6.4 percent higher than one year previously. Costs of energy in mining and commodities have risen in particular. The consumer price index (CPI), on the other hand, only showed a moderate 2.1 percent inflation. Costs for transport have risen particularly, going up 6.2 percent. Real estate sales were down by 39 percent on last month in April. In 47 of China’s largest 70 cities, new-home prices were lower than in the previous month.

Consumption also plummeted on account of the lockdown. Retail sales for consumer goods were 11.1 percent lower in April this year than in April last year. The revenues of the large online retailers were even down by as much as 25.6 percent on account of supply and logistics problems. In May 2022, car sales in China dropped 12.6 percent, down to 1.68 million, following a deep slump of 47.6 percent in April. In the first five months of the year, car sales were 12.2 percent down on the same period in 2021. During the lockdown imposed on Shanghai, not a single new car was sold in the whole month. These figures indicate the scale of disruption to the Chinese economy. It remains to be seen whether performance will now pick up and make up for lost ground or whether supply and demand will continue to falter. A rapid bounce back in the retail and service sector is not on the cards in view of the low level of confidence among Chinese consumers.

Aggregated foreign trade for the period from January to May was at least up by a good 8.3 percent and is continuing to stabilise economic growth. Exports grew 11.4 percent and imports 4.7 percent.

China’s official manufacturing purchasing managers’ index (PMI) which measures sentiment among the large state-controlled companies recorded its lowest value in the medium term of 47.4 in April.

Although the index recovered slightly in May and climbed back up to 49.6 points and the PMI for services also improved considerably moving up from 40 points to 47.1 points, both indicators have remained under the expansion threshold of 50 points for months.

Announced fiscal and monetary policy measures In April, the Chinese central bank (PBoC) announced that it would additionally reduce the minimum reserves of banks and dip further into the monetary policy toolbox in addition to indicating lower interest rates. In May, the over-five-year loan prime rate (LPR), on which many lenders base their mortgage rates, was reduced by more than expected from 4.6 percent down to 4.45 percent. The one-year loan prime rate was left unchanged for the time being at 3.7 percent.

In mid-May, the Chinese government reinforced its fiscal efforts once more and announced a number of measures and support packages. The prime minister, Li Keqiang, held an unprecedented nationwide online conference in which more than 100,000 officials from the central, provincial, and local levels participated.

The additional quantifiable measures announced at the conference amount to a volume of around 0.5 percent of GDP. That includes 200 billion CNY for additional tax cuts and discounts, a reduction in social security contributions of 200 billion CNY, and an increase in railway construction bonds of 90 billion CNY. The volume of support actually given will probably be larger as other measures, such as the increase of infrastructure investment and the support of housing demand, have not yet been quantified.

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

Higher infrastructure investment expected At the meeting of the Central Commission for Financial and Economic Affairs Commission (CCFEA) in late April, indications were given that the government wants to scale up its infrastructure investment again. In the past, the combination of government debt and government demand has repeatedly been used to meet the growth targets set down in the annual plans.

The government is primarily planning to investment in regional airports, urban transport systems, ports and waterways, energy production and grids, healthcare and emergency services as well as oil and gas pipelines. These measures are designed to support economic growth in the short term and increase the competitiveness and productivity of China in the long term. These projects will only have the envisaged impact if the government first manages to completely contain the spread of Covid.

Failing this, these additional investments may be too slow or too late to take effect.

Liquidity squeeze in real estate continues Liquidity crunches already brought some property developers to their knees in China’s highly indebted property sector last year, most notably the construction company Evergrande. Although the sector has not collapsed completely as feared by some observers, the problems of the Chinese real estate market are continuing to plague the economy at large. Accounting for around one quarter of GDP when taken together with its impact on demand upstream and downstream, the property sector has until now been one of the most important drivers of growth. In view of the weak level of sales and strained financing conditions, the liquidity squeeze is set to continue.

International financial investors withdraw capital from China At the start of the year, capital in the two-digit billion (U.S. dollar) range was drawn out of China. This affected Chinese government bonds, bank bonds and corporate bonds as well as shares. The main trigger for this outflow of capital was the draconian restrictions imposed in the country to combat Covid, the geopolitical effects of Russia’s war of aggression in Ukraine, continuing tensions between the United States and China and the aftereffects of regulatory interventions, above all in the Chinese tech sector. The volume of venture capital financing also turned down in the first four months of the year, dropping as much as 44 percent compared to the same period the previous year, down to 24.7 billion U.S. dollars. That is almost twice as high as the decrease registered in the United States and almost four times as much as the global drop in venture capital financing. In 2021, China stacked up a record volume of venture capital investments of over 130 billion U.S. dollars despite the harsh government interventions. The turnaround in interest rates set off by the U.S. central bank will now put additional pressure on China’s capital markets and could become a grave risk for China’s further economic development.

Political course Back at the annual Central Economic Work Conference in December 2021, the government had already identified three main challenges for the economy which it then confirmed at the Two Sessions held in March 2022. These challenges are weak demand, supply shock and falling prospects. The latest economic figures underline this picture. The government is still sticking to security and stability this year even though its insistence on the zero-Covid strategy is having huge consequences on the economy.

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

On a political level, the government’s strategy for combating Covid, which has largely been contained since the middle of 2020, is a dilemma without a solution. After the lockdowns, the patience among wide swaths of the affected population has come to an end and unhappiness with the political course is growing, above all in cities such as Shanghai which have had particularly stringent and prolonged lockdowns. On the other hand, a widespread outbreak of Omicron would overburden the healthcare system and lead to a high number of deaths as the vaccination rate is too low particularly among the older population. Above all, however, the government wants to avoid the political costs of changing course ahead of the National Conference in autumn where Xi Jinping hopes to be re-elected for a third term.

Outlook for the second half of the year Growth is highly likely to continue suffering under the Covid restrictions in the second half of the year as no indication has been given that the government is planning to abandon its zero-Covid strategy any time soon. The Chinese government has already announced and initiated a row of measures to support the economy. Whether these measures will be able to unfold their effect in good time remains to be seen. Further interest rate cuts by the PBoC cannot be ruled out as there is still considerable scope for action by the Chinese leadership. Tax cuts have already been announced for small and medium-sized enterprises. The bigger focus on infrastructure investment will presumably increase government debt, particularly at the local level. The property market will probably only contribute marginally to supporting the economy and the future course of foreign trade remains shaky on account of the high geopolitical tensions particularly with the United States and the EU.

Sharp growth slowdown for Europe Up to the outbreak of the war at the end of February, the EU economy had been enjoying a robust recovery. Since spring, this also included the service sector, especially with the gradual easing of Covid-related restrictions. There was little standing in the way of a vigorous recovery in private consumption expenditure, including in services that had been restricted during the pandemic, and the tourism sector was looking forward to a vigorous summer season. Although key energy prices had already begun to climb in 2021 this alone would not have led to a substantial clouding of the outlook.

Growth outlook still robust in good case scenario The latest developments have led to a big downturn in economic prospects. Although we can still expect real growth to come in at around 2.5 percent (2.7 percent) provided the security situation in Europe does not escalate further and Russia does not cut off its supply of energy commodities to Europe. The EU however started out the year with a statistical overhang of two percent so the growth path since January is likely to appear very moderate. In the main scenario, Europe’s economy will get through the crisis a little bruised, but intact. Should the security situation escalate, however, the price for energy commodities could continue to rise significantly or the supply could even be cut off completely. The European Commission believes this scenario would probably reduce economic output in the EU by an additional 1.25 to 1.5 percentage points. Growth would then be down to 1.25 percent or even only just over zero. The main scenario anticipates the situation on the labour market to continue to improve slightly.

Like the pandemic, the double shock is affecting the individual European countries to different degrees.

This crisis is hitting some Eastern European countries, Germany and Italy particularly hard, while other

23

Double shock | Covid and war jeopardising global economic recovery 4/07/2022

countries further west, south or north are experiencing much milder effects. Trade connections with the conflict region, the share of energy imports that come from Russia, the size of the manufacturing sector and the number of Ukrainian refugees all differ significantly from country to country. The neighbouring countries of Ukraine have taken in the vast majority of refugees.

In the first quarter, real GDP in the EU and in the euro area put in a solid performance, increasing by 0.7 percent and 0.6 percent respectively. Confidence indicators show that the war has made private households, above all, much more pessimistic. There are still surplus savings that could bolster consumption this year and wage trends are largely normal, but the rising prices and the war are taking a harsh toll on consumer confidence. This is also reflected in the pronounced slump in the sales of durable goods such as cars in March and April. There is a broad gap between the service sector where business is starting to pick up and in manufacturing which has weakened considerably.

Consumption expenditure and investments should grow by around three percent Private consumption expenditure within the euro area should grow by around three percent in real terms (3.2 percent) this year according to the European, with less money being saved and the corresponding savings rate falling sharply again. Nominal incomes should increase by around 3.5 percent with employment rising, above all in the industries where activity was restricted during the pandemic. State consumption expenditure is set to grow by just under one percent (0.8 percent).

Growth forecast for the Euro area countries 12

14

10

12 10

8

8 6 6 4 2

2

0

0

Growth rate 2021 Forecast 2022 Forecast 2023

Germany Slovakia Finland Latvia Austria Portugal Lithuania Netherlands Spain Cyprus Belgium Italy Luxembourg France Slovenia Estonia Greece Malta Ireland

4

Growth rate 2021

Forecast 2022

Forecast 2023

Source: Macrobond

Investment activity is expected to grow by around three percent (3.1 percent) overall although residential construction investment is likely to drop as losses in real incomes and increasing interest rates will curb demand. Construction investment should grow by around 2.5 percent overall. Public investment should also increase a little further as many countries are now implementing the measures included in the NextGeneration EU programme. The outlook for investment in plant and equipment is darker as the uncertainty, supply bottlenecks and low growth prospects are curbing any upwind here.

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Double shock | Covid and war jeopardising global economic recovery 4/07/2022

Furthermore, the high producer prices are squeezing corporate margins as typically only around one half of the costs can be transferred to buyers. Following growth of almost ten percent in 2021, this year may see growth of just under three percent. The European Commission is still forecasting a vigorous expansion of five percent in exports and imports, which would see foreign trade contributing slightly to GDP growth. This could be rather too optimistic, particularly concerning export activity, while imports are likely to rise robustly due to the high volume and price of imported energy.

Germany The technical recession feared in Germany at the start of the year has so far not come about. The reason for this is the robust recovery in those areas of the service sector that were still strongly affected by the Covid restrictions this time last year. The manufacturing sector, however, is struggling to deal with the consequences of the pandemic. Material and supply bottlenecks have continued to intensify in the last few months and there is no sign of the situation easing up any time soon. The war in Ukraine will continue to cause problems for the supply chains of German industry for the foreseeable future.

German foreign trade is being affected considerably by the current shortages in supplies. This is the main reason why foreign trade failed to contribute to growth in the first quarter of the year. The aftereffects of the lockdowns in China that have since been lifted will probably still be felt into the summer months. The uncertainty created by the outbreak of the war in Ukraine is also weighing heavily on trade. In view of the weak performance in the first half of the year, exports of goods and services are unlikely to expand by more than 2.5 percent in real terms for 2022 overall. On the import side, this should lead to less intermediates being purchased. However, the strong increase in prices for energy and non-energy commodities will lead to a substantial deterioration in the terms of trade and will drive the cost of imports up considerably. The import of services is expected to grow strongly this year as travel picks up again. All in all, imports are expected to grow by 4.5 percent in price-adjusted terms, thus clearly outperforming exports.

The lifting of protection measures to combat the pandemic gave a boost to private consumption at the beginning of the year. High-contact services benefited particularly in the first quarter. The increased number of employees, the aid packages to compensate for the increased energy prices and the adjustment of pensions in the middle of the year should be sufficient to stabilise private consumer demand. Even if only one quarter of the savings accumulated during the pandemic is spent on consumption it would lift growth in private consumption by more than two percentage points. Despite the recent high price increases, which will weigh down consumption in real terms, private consumption expenditure is set to grow by 3.5 percent. Regarding public consumption expenditure, the federal government expenditure for the support of refuges from Ukraine and for support measures to compensate citizens for war-related burdens is set to to increase public consumption expenditure further. We forecast an increase here to the scale of 0.5 percent.

Despite the high volume of investment needed to bring about the digital and energy transformation, investment activity is heading for only moderate growth this year. The main factors curbing investment are the uncertainties that have increased on account of the war in Ukraine. At the same time, additional investment would not be able to contribute to expanding production given the current shortages in materials. Growth momentum from plant and equipment investment is therefore likely to be low. In the case of construction investment, we expect levels to stagnate this year with increasing material shortages keeping investment down. The planned residential construction projects will not be affected by the interest rate turnaround yet this year. However, price increases are weighing down on

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investments in public construction and the rise in building permits for commercial construction is purely fuelled by prices and has actually dropped off in real terms. Investment in other assets (software, research and development) has expanded by more than one percent already since the beginning of the year and should continue to recover in the further course of the year and grow by around two percent overall compared to last year. All in all, Germany’s gross domestic product is likely to increase by 1.5 percent in real terms this year compared to last year.

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Sources Blanchard, Olivier, Jean Pisani-Ferry (2022). Fiscal support and monetary vigilance: economic policy implications of the Russia-Ukraine war for the European Union. Bruegel. Policy Contribution 6/22.

Brussels.

Bureau of Economic Analysis (2022a). News Release. Gross Domestic Product (Second Estimate) and Corporate Profits (Preliminary), First Quarter 2022. 22 May. Washington, D.C. --(2022b). National Income and Product Accounts. Table 2.6. Personal Income and Its Disposition, Monthly. 27 May. Washington, D.C. --(2022c). International Data. May. Washington, D.C. Bureau of Labor Statistics (2022a). Unemployment Rate. Washington, D.C. --(2022b). Civilian Labor Force Participation Rate. June 2022. Washington, D.C. --(2022c). Consumer Price Index. June 2022. Washington, D.C. --(2021). Employment Projections: 2020-2030 Summary. September. Washington, D.C. Congressional Budget Office (2022). The Budget and Economic Outlook: 2022 to 2032. May. Washington, D.C..

European Commission (2022): European Economic Forecast. Spring 2022. Institutional Paper 173.

May. Brussels.

Eichengreen, Barry (2022). Europe’s Economy on a Knife Edge. Project Syndicate. April.

International Monetary Funds (2022). World Economic Outlook. April. Washington, D.C..

Lagarde, Christine (2022). Monetary policy normalisation in the euro area. EZB. Blog Post. Frankfurt. 23 May. Lane, Philip (2022). The euro area outlook: some analytical considerations. Rede. Bruegel. 5 May. OECD (2022). Economic Outlook. Juni. Paris.

Rogoff, Kenneth (2022). Die Welt in Rezessionsgefahr. Handelsblatt. 17 May. The Conference Board (2022). Consumer Conference Survey.

World Trade Organization (2022). The Crisis in Ukraine. Implications for the global trade and development. Genf.

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Imprint Bundesverband der Deutschen Industrie e.V. (BDI) Breite Straße 29 10178 Berlin T: +49 30 2028-0 www.bdi.eu German Lobbyregister Number R000534 Authors Dr. Klaus Günter Deutsch T: +49 30 2028 1591 k.deutsch@bdi.eu Stefan Gätzner BDI-Vertretung, Peking T: +86 1085 322862 s.gaetzner@bdi.eu Julia Howald T.: +49 30 2028 1483 j.howald@bdi.eu Thomas Hüne T: +49 30 2028 1592 t.huene@bdi.eu Matthias Krämer T.: +49 30 2028 1562 m.kraemer@bdi.eu Wolfgang Krieger BDI-Vertretung, Peking T: +86 1085 325421 w.krieger@bdi.eu Editorial / Graphics Marta Gancarek T: +49 30 2028 1588 m.gancarek@bdi.eu

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