Russia-Ukraine war having a ‘massive impact on the global economy’: IMF Chief Economist

IMF Chief Economist Pierre-Olivier Gourinchas joins Yahoo Finance Live to discuss the impact the Russia-Ukraine war is having on the global economy.

Video Transcript

- China is a big part of the story behind the International Monetary Fund's new update on a world economic outlook which forecasts a significant slowdown in the global economic recovery, dragged down by shutdowns in China, but also inflation, the war in Ukraine, and of course, the ongoing pandemic.

Joining us now to break this down is IMF chief economist Pierre-Olivier Gourinchas. Pierre-Olivier, it's great to have you on the program. Give us a breakdown of the numbers that you released this morning, downgrading world economic output this year to 3.6%. What changed between the last set of projections in January?

PIERRE-OLIVIER GOURINCHAS: Well, thank you for having me, Brian. In one word, the war. The big difference between the January forecasts and the ones we are putting out today is the Russian invasion of Ukraine. And this is having a massive impact on the global economy. It's having an impact in the region, of course. Russia and Ukraine are first and foremost affected. But then through trade channels, remittances, refugees, and especially energy trade.

European economies and other economies in the neighborhood are very affected. And then more broadly we have increased in energy and food prices. And this is having an impact that is felt even far beyond the European borders. It's felt all around the world.

- So just to kind of follow up on that, you know, there's obviously a lot of noise going on right now. A lot of concern going on in the geopolitics that we're watching. You've downgraded Russia to a contraction of 8.5% this year. How do you see that ripping over, not just into the neighbors in Europe, Eastern Europe, but also Europe largely? How is that impacting the nations like, for example, the United States. Because we know that the commodities channel is so important between Russia and Ukraine to the rest of the world.

PIERRE-OLIVIER GOURINCHAS: Well, so yes, we have a very significant downgrade for Russia. It's an 11.5 percentage point reduction compared to the January forecast. So we are now projecting 8.5% contraction. There is an even bigger contraction in Ukraine in the range of 30%. And this is having an impact. And if you're thinking about how it's impacting the economies are not immediate neighbors, economies like the US and the rest of the world, it's going to be coming through mostly the surge in energy and food prices.

A number of poor countries are going to be very affected by that. But even advanced economies are hit by increased energy prices that are sort of adding another layer to inflation pressures that were already building up in many countries even before the war.

- Let's pick up on that point about energy because you lowered your outlook for the EU by 1.1% when you factor in the impact from the war. But I notice the baseline here factors in European countries' decisions to wean themselves off of Russian energy and not necessarily eliminate it altogether. So if you've got a country like Germany, for example, at one point that says, look, this pipeline of natural gas is just not tenable anymore. The longer this goes on, how much worse does it get for the continent?

PIERRE-OLIVIER GOURINCHAS: Well, it would get significantly worse. I mean, the short of it is right now many European economies are still very dependent on the supply of gas in particular coming from Russia. And there is no short-term substitute that you can have. So if you don't have that gas, you have to somehow adjust in terms of the demand. And that's going to be reflected in higher prices. But you're also going to have an impact on economic activity.

So in our baseline projections, we are not assuming that there would be an embargo on Russian gas and oil to, say, the European countries or elsewhere. We are sort of basing that on the sanctions as of March 31. But we are considering an adverse scenario where there would be a tightening of the sanctions against Russia. And in that case, we are anticipating this would also create some financial volatility.

This would also affect consumer confidence in European economies. And when you tally all of that in, we find a somewhat significant revision in the output level in the euro area. Another 3% decline in output level by year end 2023. So fairly significant impact if we were to have a tightening of the sanction against Russia, especially on the energy sector.

- Well, that sounds certainly like a more bleak outlook. And that seems to be the case even here in the United States with inflation. But we know that inflation is not just an American phenomenon. It's around the world as well. How important was that to a lot of the downgrades that you had, as you see areas like in the European Union, in the UK experiencing price increases that people haven't seen in decades?

PIERRE-OLIVIER GOURINCHAS: Well, that is right. And first, it's important to realize that a number of these inflation pressures were already there before the war. I mean, we have started talking about inflation in the US well before February of this year. And that's also the case in many emerging market economies. In Latin America, for instance, inflation pressures have been building up.

So it's a context in which central banks have started to address this issue which we characterize as a clear and present danger. Inflation is a clear and present danger for many economies, including the Federal Reserve. Now, the war adds another layer to this because of the increase in energy prices. And it makes it even more urgent to make sure that central banks embark on a tightening cycle in the coming month to make sure that inflation remains controlled at the horizon of let's say 2023.

- Pierre, I wonder if you can speak more to this really outsized impact we have seen on emerging markets. So many of these countries that borrowed on lower rates now seeing those rates go up, but in addition to that, seeing those costs go up because of that very factor you talked about, especially with food prices. Is this just kind of the tip of the iceberg? I mean, I'm thinking about a country like Sri Lanka, for example. They announced that they would suspend their foreign debt payments. Are we going to see more of those?

PIERRE-OLIVIER GOURINCHAS: We are likely to see more of those. I mean, especially the low-income countries are squeezed on two sides here. One is that they don't have a lot of fiscal space to start with. They have elevated debt levels. In some cases, barely sustainable. Then they're hit because the increase in energy and food price requires that they put in place support programs.

You can't let the population starve or be in a situation of food insecurity. You have to provide some subsidies. You have to do it in a way that is going to be least expensive if you want. But you have to do something. And then interest rates are starting to rise around the world. And that's increasing the debt service part of the budget. And so all of this is squeezing the space for fiscal authorities to really do their job.

And so we are anticipating that among the low-income countries, a number of which are already in a situation close to debt distress, some of them will need external assistance. They will need to restructure their debts. They will need to engage in discussions with official creditors to restructure their debt and make sure that they are put back on a sustainable path, and at the same time allowing them to address the vulnerabilities and support for low-income households.

- You mentioned higher rates. We know that the central banks, if anything, have gotten more aggressive in their messaging since your last round of projections in January. It's kind of a tightrope here because that's going to constrain growth. But it could also risk perhaps tilting some of these economies into a recession if borrowing costs go too high too fast. Are you concerned about that? Is the IMF worried about the pace of perhaps monetary tightening from the likes of the Fed and the ECB?

PIERRE-OLIVIER GOURINCHAS: This is certainly a serious downside risk. I mean, right now, central banks around the world, and the Fed in particular, have announced a fairly sizable tightening of monetary policy in the coming year, year and a half.

Baseline, we have something like 10 further hikes that are built in. And the danger here is that on one side, it may not be sufficient to control inflation pressures if these remain elevated. And on the other side, if you do it and you do too much, then you could tip the economy into a recession. That's sort of the fine line that central banks are trying to walk. And right now, we think that they're on the path where they can achieve some reduction in inflation without necessarily tipping the economies into a recession, in particular in the US.

Well, let's remember we're coming off '21, which was a very strong year. Labor market is very strong. There is a substantial labor market pressure here. So there is some room. And we are not anticipating under the baseline that the economy would go into a recession. But there are downside risks. If inflation is more elevated, central banks will have to come in more aggressively. That will weigh down on economic activity and growth.