Mohamed Fahad Hussain Alemadi
Today’s global economy is more dynamic than ever; various concerns are coming to the mind of many investors about the future of global economy related to the expectations of potential recession, further interest rate hikes, inflation, and the future of the dollarized world all of which will be discussed in this article.
The global economy is suffering from accelerating inflation reaching high levels which has no not been experienced since the last 40 years. Major advanced economies, including the eurozone, the United Kingdom, and the United States, are dealing with significant inflation, which peaked in the United States in June 2022 at 9%.
When we have a detailed lock at the main causes of inflation over various regions, we can notice that the main driver of higher prices is related to the supply side. Factors like supply chain disruption, the lockdown period, energy and food crisis arising from the Russian-Ukrainian war, all of which reinforced inflation.
As an attempt to mitigate inflation, the US Federal Reserve and other major central banks adopted tightening of the monetary policy tool by raising interest rates since March 2022 to reach around 5.5% in July 2023, which was also followed by a proportional increase by the Qatar Central Bank. This massive increase in Fed interest rates affected financial stability and caused several bankruptcies, like the collapse of Silicon Valley and First Republic Banks.
However, did leveraged interest rates succeed in combating inflation?
After more than a year of high interest rates, inflation has successfully decreased from over 9% to 3.18% in July 2023. But, despite this remarkable decline, are high interest rates the primary cause?
Unfortunately, no.
The reopening of major economies like China and the declining prices of food and energy are the main causes responsible for this sharp drop in inflation. On the other hand, we notice that core inflation, which excludes energy and food prices, is 4.65%, which is significantly higher than the target rate of 2%. As a result, we cannot expect to achieve the target inflation rate anytime soon especially with low unemployment rate of 3.8%, as historically high employment level complicates the Fed’s job.
Bank of America is predicting another 25-basis point rate hike this year, with expectations that the Fed would then maintain rates constant until May of the following year. However, rising interest rates could also be a factor contributing to inflation as they increase the financial burden on producers, which could be reflected in higher prices.
Accordingly, inflation is anticipated to reach the Fed’s objective by the mid of 2024, and rate cuts are anticipated to begin when the US could enter a recession by mid-2024, all of which will be reflected on Qatar’s economy.
Predictions are of a modest recession in the first or second quarter of 2024. The severity of the economic downturn will determine how quickly interest rates are reduced; in the case of a mild recession, a gradual rather than a rapid reduction is expected. In contrast, with GDP growth maintaining positive rates and unemployment close to its natural level, Bank of America and other large institutions are reassessing their previous calls for a mild recession in 2024 and increased chances for a soft landing.
However, even if the US avoids falling into a recession, the global economy will still suffer from lower demand as China, which the second largest economy and a main driver of global demand, is suffering from an economic slowdown. China’s post-Covid reopening bounce started to fade due to lower demand and a crisis in the real estate sector, which accounts for around 30% of China’s GDP, and real estate developers experiencing financial difficulties.
Additionally, demographic changes, a high rate of youth unemployment (21.3% in June), high capital outflows as a result of firms relocating, interest rate discrepancies, and a decline in economic activity are all problems facing China. As a result, foreign investors withdrew more than $10bn from the Chinese stock market and China’s potential GDP growth is expected to decline from above 6% to less than 5% in the upcoming five years.
Due to China’s economic decline, large economies in Asia, particularly Japan, are reporting a drop in their exports.
Qatar’s exports are also expected to get affected as exports to China is equivalent to $20.78bn.
China’s lower demand will act as disinflationary force helping countries like the eurozone, US and the UK to reach their inflation target but pulling the global economy towards economic downturn.
Other large economies like the UK and eurozone are also not in their ideal situations, with expectations of a substantial decline in growth rates to 0.5% and 1%, respectively, in 2024, compared to growth exceeding 3.5% in 2022. These several economic indicators suggest that the world economy is on the edge of a slump.
Emerging economies are heading into a debt crisis as a result of rising borrowing costs and a stronger dollar brought on by leveraged interest rates. The higher debt servicing costs along with the appreciating value of dollar are inflating their loans and increasing the financial burden on them. Countries like Lebanon, Egypt, Sri Lanka, Pakistan and Tunisia are suffering from high levels of debt.
Higher interest rates, along with weaker local and international demand, have a detrimental influence on corporations and the financial market. Leveraged rates are affecting corporate earnings as a result of higher debt servicing cost, which is reflected in share prices.
Although the US stock market has been robust, corporations and financial markets are still anticipated to decline further as more hikes are anticipated and high rates often have more significant consequences after six months. Additionally, the stock markets continue to become worse as a result of higher bond market yields pulling in more investors.
Speaking locally, we can say that the main cause of Qatar’s inflation tends to be more imported inflation. The country’s inflation rate has significantly decreased from 6% in October in the previous year to 3.1% in July with core inflation remaining relatively lower than many countries. Qatar needs to reduce the consequences of the Fed’s tightening policy because its core inflation is relatively lower and doesn’t need this level of tightness.
Thus, in light of the global increase in interest rates the QCB exempted customers from paying any additional costs on consumer financing, on loans given against customers’ salaries, and on loans given to some important sectors in the country like hospitality, housing, manufacturing and retail.
Expectations are that the non-energy sectors will substantially expand in 2023-24 with the PMI index moving in the right direction. Furthermore, the North Field expansion is expected to boost future growth as exports are projected to rise from by 33mn tonnes by 2025.
As a consequence, Qatar’s current account surplus should remain large helping the country to continue taking over more foreign assets.
The heavily dollarised financial systems, which make up more than 80% of trade on the global foreign exchange market, are attracting the attention of the Brics, who are making ongoing attempts to reduce the use of the dollar in their trade and have suggested the creation of a potential common currency among them. These efforts started to be taken more seriously, particularly after increased US sanctions on Russia following its invasion of Ukraine. As a step toward de-dollarisation, trade between Russia and India was conducted in their national currencies; however, due to exchange risk exposure and the low trading volume of the Indian rupee, Russia opted to halt trade in that currency.
To determine the possibility of uniting the monetary system, we should first have a comparison with the European Union, which demonstrates a successful version of unity.
Firstly, the euro nations have a high level of political and economic consensus, along with being geographically close to each other. Secondly, the eurozone countries enjoy a free trade agreement.
All of these are aspects in which Brics members fall short, as there is a lack of political harmony, particularly between China and India, with not all members being close geographically, and no free trade agreements taking place.
Thus, considering how fragmented these nations are, the idea of creating a single currency for Brics members and unifying the monetary system is unlikely to happen soon. Even if we assume that the concept of a single currency will soon exist, we may look to the possession of the euro since its introduction to get a sense of how robust the dollar dominance is given that, after more than 20 years since the euro’s introduction, its share of world trade is still not threatening the dollar’s dominance.
Since the formation of the Brics alliance in 2009, the dollar’s trade has been unaffected by these efforts and has maintained its dominance of more than 80% of trade in the world’s foreign exchange transactions, with this proportion being stable over the past 20 years. Meaning that, the dollar’s power has not yet been threatened by the Brics. The formation of the new development bank is intended to be an alternative for the IMF, particularly for Brics members, despite the fact that the bank is still issuing most of its lending in dollars.
Since the dollar is the most prevalent currency in the global debt market, additional de-dollarisation efforts are required, such as building a robust debt market away from the dollar, which means that the Brics should concentrate on issuing debt in their own currencies. As a step further towards de-dollarisation, the bank aims to increase local currency lending from about 22% to 30% by 2026.
Recently, in an effort to promote trade and de-dollarise the economy, the Brics invited six countries, including the UAE, Egypt, Saudi Arabia, Iran, Argentina and Ethiopia. Brics countries are continuously trying to reinforce trade in their local currencies, with expectations that more currencies like the Chinese yuan will play a greater role in the future.
On the other hand, we should keep in mind that the US has a long-standing global network of alliances and partnerships, particularly with potential new members like Saudi Arabia and the UAE, so a rapid and substantial de-dollarisation is not expected.
In conclusion, even if the United States managed to avoid a recession, this will help to lessen the severity of the upcoming downturn, but the global economy is still expected to experience a significant fall since other major economies are slowing down. Furthermore, inflation has surged recently, but declining population growth and artificial intelligence are strong disinflationary forces effecting long run inflation.
Even more, despite forecasts that other currencies may have a bigger role in the future, the dollar is still anticipated to be the primary reserve and trading currency. Developed countries have a list of long-term challenges including higher energy costs, transition to renewable energy, ageing population, high public debt and future pension obligations, surge in global debt and supply chain bottlenecks.
Mohamed Fahad Hussain Alemadi is senior student at Qatar University, studying Finance and Economics
