Middle East conflict and global economic outlook

The world is not getting ready

In the Spring Meetings of the International Monetary Fund (IMF), and World Bank that happened during April 13-18, one clear message coming out is that global economic outlook has worsened, with the IMF indicating scenarios depicting the likely extent of impact depending on how much, and how long the Middle East conflict continues, which started on February 28. 

While the complete April edition of the flagship bi-annual ‘World Economic Outlook’ (WEO) report, with specific sub-title for this edition titled ‘Global economy in the shadow of war’ will be released on April 30, the executive summary released in advance first of all rightly highlighted forecasting difficulty in these highly uncertain times, and its scenario-based reflections, pointed out ‘Given the difficulty of underpinning in real time a consistent set of assumptions for projections, this World Economic Outlook (WEO) report presents a “reference forecast”—in lieu of the traditional baseline—predicated on the assumption that the war will have limited duration, intensity, and scope, such that the disruptions will fade by mid-2026, consistent with commodity futures prices as of March 10. However, given the fluidity of the situation, the report complements the global reference forecast with scenarios in which the conflict lasts longer or expands. The likelihood of these scenarios materializing rises progressively as hostilities and associated disruptions continue.’

But under a weak level of multilateralism, a meaningful level of financial support is yet to come, especially for developing countries. Moreover, the misgivings of the practice of overboard monetary austerity policies in the wake of Covid-19 pandemic, and Ukraine War mainly supply-side-disruption-caused inflationary pressures led to many countries paying more than needed growth sacrifice for at-best short-term stabilization, along with built-up of debt in the wake of higher interest payments. Hence, a more balanced aggregate demand-, and supply-side policies need to be adopted to not make economic matters worse, especially for developing countries, with already limited fiscal space, and high debt distress in general.

Noted Financial Times (FT) columnist, Martin Wolf, in his April 15 published article ‘The mix of chaotic politics and a resilient economy can’t last’ indicated a high level of uncertainty, and scenario-building by IMF, pointed out ‘The IMF’s latest World Economic Outlook starts with a discussion of uncertainty. The current war in the Middle East is a big source of such uncertainty. The ups and downs of US trade policy under Trump are another, not to mention the war in Ukraine and the ruptures in the western alliance. Not surprisingly, various measures of political and economic uncertainty are elevated… Given this background, the IMF has in recent years taken a novel approach to its forecasts. Instead of the traditional “baseline”, it presents a “reference forecast”, based on the assumption that the disruptions caused by the war with Iran will fade by mid-2026. But it also adds “adverse” and “severe” scenarios. In the former, a more prolonged conflict would keep energy prices higher for longer. In the latter there would be even more extensive damage to energy infrastructure in the region.’ 

Hence, growth, and inflation projections under different scenarios were pointed out in the WEO report’s executive summary as ‘Under the reference forecast, global growth is projected to be 3.1 percent in 2026 and 3.2 percent in 2027, slower than its recent pace of about 3.4 percent in 2024–25, and to settle at about that rate in the medium term, slower than its historical (2000–19) average of 3.7 percent. …Under an adverse scenario with larger and more persistent increases in energy prices, global growth would slow further to 2.5 percent in 2026, and inflation would reach 5.4 percent. Under a more severe scenario in which there is more damage to energy infrastructure in the conflict region, the impact would be even larger: Global growth would be cut to only about 2 percent in 2026, while headline inflation would be just above 6 percent by 2027. The impact on emerging market and developing economies would be almost twice that on advanced economies.’

There is indeed a serious concern developing that given the main inflationary channel being supply shock, for instance, of oil, and fertilizer, the impact on the economy may become stagflationary– slowing down of growth, and rising inflation, along with rising unemployment. This will likely not only negatively impact countries’ economies in general globally, but especially net oil importing developing countries, like Pakistan, for instance in terms of higher import payments needs, increase in debt distress, and higher fertilizer prices producing negative shock in the agricultural sector in general, but also more specifically in terms of food security; not to mention the overall negative impact in terms of likely enhancement in poverty, and income inequality. 

Impact on debt is likely to be also because lack of any financial support announced by IMF for instance in terms of enhanced special drawing rights (SDRs) allocation, resulting in turn, creating larger pressures on an otherwise limited fiscal space of countries to provide much-needed subsidy to protect overall economic activity, and in terms of social protection of low-income groups against higher oil, and fertilizer prices for instance. Highlighting rising debt pressures, an April 15, New York Times (NYT) published article ‘Debt alarms ring as countries rack up more emergency spending’ pointed out ‘The risk is that the immediate economic costs of the conflict could balloon into a bigger fiscal crisis if governments increase borrowing to fund sweeping aid programs. Even after traffic eventually resumes through the Strait of Hormuz, the impact on supply chains for energy, fertilizers and other commodities could linger for months and possibly years. That means households and businesses would have to contend with sustained higher inflation and slower economic growth. At the same time, calls for more support will grow.’ 

But under a weak level of multilateralism, a meaningful level of financial support is yet to come, especially for developing countries. Moreover, the misgivings of the practice of overboard monetary austerity policies in the wake of Covid-19 pandemic, and Ukraine War mainly supply-side-disruption-caused inflationary pressures led to many countries paying more than needed growth sacrifice for at-best short-term stabilization, along with built-up of debt in the wake of higher interest payments. Hence, a more balanced aggregate demand-, and supply-side policies need to be adopted to not make economic matters worse, especially for developing countries, with already limited fiscal space, and high debt distress in general.