Geoeconomics, geopolitics have worsened the economic outlook

The WEO chapter stresses how disruptions in global supply chains and rising geopolitical tensions have led to geoeconomic fragmentation in the world economy

In March, the World Bank released a book noting that the world economy is likely to face a lost decade in 2021-30. The International Monetary Fund (IMF) has followed the World Bank’s pessimistic outlook with its own. In April and October, IMF and World Bank hold meetings with member countries. In the meetings, IMF releases its flagship publications: the World Economy Outlook (WEO) and the Global Financial Stability Report (GFSR). While the WEO focuses on the global economic outlook and projects growth rates across the world, the GFSR discusses the global financial conditions and emerging risks to global financial stability.

IMF’s Managing Director Kristalina Georgieva in a recent speech gave us a glimpse of the upcoming WEO. She said: “We project global growth to remain around three percent over the next five years––our lowest medium-term growth forecast since 1990, and well below the average of 3.8 percent from the past two decades.” Most of the global growth will come from emerging economies, especially Asia where India and China are expected to account for half of the global growth in 2023. Within developed economies, 90 percent of advanced economies are projected to see a decline in their growth rate this year.

Many hills to climb

Georgieva quoted words from Nelson Mandela who seemed to have said: “I have discovered the secret that after climbing a great hill, one only finds that there are many more hills to climb.”  Taking a cue, she said that the world economy has to climb three hills: fighting inflation and safeguarding financial stability, improving medium-term prospects for growth, and fostering solidarity to reduce global disparities. While these three hills pose distinct challenges for the climbers (policymakers), there is one policy challenge which is making climbing the three hills more difficult and challenging: a significant rise in geoeconomics and geopolitical risks.

In both WEO and GFSR, the IMF also releases thematic chapters on current economic events and emerging policy concerns.  This time, the WEO has a chapter titled ‘Geoeconomic Fragmentation and Foreign Direct Investment’ and the GFSR has a chapter titled ‘Geopolitics and Financial Fragmentation: Implications for Macro-Financial Stability’. Both these chapters highlight how geoeconomics and geopolitics have not just worsened the current world economic outlook and global financial stability but have put the future in peril too.

The changing course of FDI

The WEO chapter stresses how disruptions in global supply chains and rising geopolitical tensions have led to geoeconomic fragmentation in the world economy. The geoeconomic fragmentation in turn is leading to fragmentation in foreign direct investment (FDI) and inward orientation.  It is natural that FDI will flow into peaceful countries and to where investment partners are aligned with each other. With rising geoeconomic fragmentation, there will likely be a slowdown in FDI flows.  As FDI is a crucial factor in boosting growth and technology, especially in the case of emerging economies, this will also result in a slowdown in emerging economies. The chapter notes that there are early signs of fragmentation. The flow of strategic FDI to Asian countries started to decline in 2019 whereas it remained more resilient in the US and Europe. By 2022, the new FDI flows to Europe and US were nearly double that of Asian countries.

The GFSR chapter makes similar points but focuses on financial stability. The rising tensions in geopolitics have led to global economic and financial fragmentation. The geopolitical fragmentation is likely to affect the cross-border allocation of capital, international payment systems and asset prices. High risks and volatility could lead to a rise in funding costs of global banks and a reduction in lending and profits. It could also lead to lower international diversification.

Lowering risks from fragmentation

Both chapters suggest policy solutions to lower the risks from the twin fragmentation of FDI and financial markets.

For FDI, one needs to reinforce the importance of multilateralism among member economies. There should be constant attempts to lower this uncertainty and foster peace among member economies. The fragmentation also gives opportunities for policymakers to promote higher domestic private investment. The policymakers could ease the doing business and investments making it attractive to bring both domestic and foreign investments.

For financial stability, the policy challenges are trickier as financial instability spreads quickly across geographies and markets. Thus, while one needs all the above-mentioned FDI measures for financial stability too, one has to also take more precautionary measures. There is a need to strengthen financial oversight and be watchful of geopolitical risks. The geopolitical risks and their transmissions need to be quantified and embedded in risk frameworks.  Economies which are highly dependent on external finance are at higher risk. The financial regulators in such economies should ask the regulated institutions to hold more capital and build buffers. The central banks should hold more reserves, establish central bank liquidity swap arrangements, and take precautionary credit lines from international financial institutions.

Georgieva ended her speech by again quoting Mandela. Mandela on realising that there he has many more hills to climb, said: “I have taken a moment here to rest, to steal a view of the glorious vista that surrounds me, to look back on the distance I have come. But...I dare not linger, for my long walk is not ended.” Global policymakers do not really have the time to rest and steal a view of the rising geopolitical risks and fragmentations. They need to walk the talk and act against these global concerns which threaten to undo several years of peace and economic progress.

Amol Agrawal is faculty at Ahmedabad University. Views are personal and do not represent the stand of this publication.