Threats to global economy and Sri Lanka

There are several threats to the outlook of the global economy. The worsening economic growth in China, the Russian invasion of Ukraine from the beginning of February and the US economy entering a possible recession. 

With an increasingly hawkish US Federal Reserve that is looking to aggressively tighten monetary policy in order to tame unprecedented levels of inflation, the impact on a certain island nation would too be dampened in the backdrop. One of Sri Lanka’s largest market trading partners would go under and drag others with them.

The bottom line is the GDP measure of US economic growth showed a decline of 1.4% in the first quarter, and the personal consumption expenditure index of inflation for March surged 6.6% on the year. The GDP figure may be revised upwards and the PCE inflation figure includes those volatile food and energy price increases Federal Reserve policymakers prefer to ignore; (“core” PCE gained 5.2% without those pesky things people have to buy). But on the face of it, those two data points point to stagflation – low or negative growth combined with high inflation.

Amidst growing fears on Wall Street over an economic recession, first officially pointed out by a report from Deutsche Bank, the market has entered volatile territory. Triggered by the Fed, as it looks to combat inflation, which is at the highest level since December 1981, the real economy is adjusting to realistic future expectations. Policymakers raised rates by 25 basis points in March, and have since signalled that sharper, half-point increases are likely in the coming months, beginning in May. 

“It is appropriate to be moving a little more quickly,” Fed Chairman Jerome Powell said last month during a panel discussion at the International Monetary Fund and World Bank spring meetings. “I also think there’s something in the idea of front end-loading whatever accommodation one thinks is appropriate. So that points in the direction of 50-basis points being on the table.”

This news is anything but a breath of fresh air to a system that dearly was looking forward to more monetary breathing space. Traders are now pricing in a 100% chance of at least a half-point rate jump when policymakers meet this week. It would mark the first time since 2000 that the US Central Bank raised the federal funds rate by 50 basis points. However, GDP figure may be revised upwards and the PCE inflation figure includes those volatile food and energy price increases by the Federal Reserve as any other CB policymaker would prefer to ignore. But on the face of it, those two data points point to stagflation – low or negative growth combined with high inflation.

Meanwhile, the European Central Bank is apologising for getting its inflation wrong. Inflation hit 7.5% in April, its sixth consecutive increase and a record high for the eurozone, putting pressure on the central bank to act. The ECB experts hold that their models have missed forecasting the sharp rise in energy prices, the disruption of supply-chain bottlenecks, and rapidly rebounding demand in the wake of the pandemic.

After ECB officials, led by President Christine Lagarde, and chief economist Philip Lane, ignored the need for higher rates until very recently; analysts now expect the central bank to start raising rates in July and to hike twice more before year-end. 

Two non-eurozone countries too have involvement. Britain and Sweden in this case are not waiting for the ECB to act. The Bank of England is expected this week to keep with its mini-hikes of 0.25 percentage points and raise its benchmark rate for the fourth consecutive policy meeting, to 1%. Similar to the case of Sweden.

What does this mean for the island across the pond? Sri Lanka too sees tightening effects in place with many unorthodox approaches to put out fires caused by successive regimes. However, as the world tightens with us, in relative terms our effects become subdued and in need of future revision.