‘The evolving crises of 2022 will shape 2023’

THE Financial Times has used the word “polycrisis” as a descriptor for 2022’s “overlapping and interwoven” crises. While the year started with a global inflation problem, Russia’s invasion of Ukraine compounded this into a crisis.

This prompted the largest, most co-ordinated monetary policy tightening in four decades.

The ensuing tightening of financial conditions saw asset prices fall, and markets and households suffer a relentless loss of value and incomes.

The outcomes of these events are still evolving and will have significant implications for economics and politics this year.

Inflation

Inflation was a known global challenge at 2022’s start, due to a succession of supply and demand shocks, starting with Covid-19 lockdowns and the disjointed reopening in 2020. The consequent supply chain disruptions that clashed with pent-up demand and large stockpiled savings saw goods price pressures start to build into early 2021.

Central banks’ initial miscalculation of these pressures as “transitory” meant monetary policy settings remained too loose, and price pressure spread through goods and into global services. By January 2022, US headline consumer inflation was running at 7,5 percent year-on-year (y/y) from 1,4 percent y/y the previous year.

From the start of 2022, developed markets’ inflation outcomes surprised on the upside.

This caused central banks to start raising interest rates . . . in the most relentless, coordinated fashion since the 1970s. The concurrent rise in inflation and policy rates placed incredible pressure on global economies’ spending systems, and it’s not yet over.

Russia’s Ukraine invasion

By end February Russia had invaded Ukraine, triggering a series of “polycrises”:

1. The impact on commodity prices, especially energy and food, created a simultaneous, reinforcing global inflation shock.

2. The war hit Europe, hard. Besides the traumatic invasion of a sovereign state on

European soil, the interrelated impact of proximity, influx of Ukrainian refugees, economic integration, dependence on Russian oil and gas, and political repercussions mean the challenges facing Europe are intense, complex and ongoing.

3. Geopolitically, the invasion strengthened relations within the North Atlantic Treaty Organisation, and cemented European members’ commitment to increase military spending, while assisting Ukraine’s war efforts. (However, this])further isolates Russia and its associates — an immense risk.

China’s zero-Covid policy

China persisted with its zero-Covid policy throughout 2022, locking down large cities, restricting travel and perpetuating supply constraints, affecting global inflation. President Xi Jinping’s verbal commitment to Russia and its implicit condoning of the Ukraine invasion further strained relations with the US and raised concerns of China’s ambitions to integrate Taiwan into China.

After Xi’s re-election as the Chinese Communist Party’s leader at end 2022, China abruptly ended its zero-Covid policy, materially reducing testing and movement restrictions. A huge spike in Covid infections and reports of a considerable loss of life (ensued).

However, it seems likely that as mobility normalises, so will business and consumer activity, and economic growth will rebound. In turn, the demand spike could see commodity prices rise, with implications for global inflation.

South Africa weathered the storm — mostly SA (largely) escaped the inflation shock incurred by the majority of developed and emerging markets in 2022, buoyed by a positive terms of trade shock and a relatively resilient currency. Nonetheless, headline CPI spiked to 7,8 percent in July from 5,7 percent y/y in January, pushed up by rising fuel and food inflation, and other goods and services prices.

Core price pressures broadened through 2022. Moderating fuel prices have seen headline pressures ease, but both measures of consumer inflation remain well above the Reserve Bank’s (Sarb’s) preferred target of 4,5 percent.

Earlier than its developed market peers, Sarb started a relatively aggressive policy normalisation cycle. By end 2022, the Monetary Policy Committee had raised the repo rate by a cumulative 350 basis points (bps), doubling the nominal rate from 3,5 percent to 7 percent.

SA suffered its own blend of a political and economic polycrisis.

The falling availability and reliability of electricity averaged 56 percent in 2022, leading to 208 days of loadshedding — its most severe outage ever. The economic cost of loadshedding . . . is estimated at 1 percent to 1,5 percent for the year, but was more severe in the third quarter (Q3), with Sarb estimating a 2,4 percent growth drag.

In addition, urban water supply, in part owing to interrupted energy supply and poor maintenance, has also come under pressure; while flood-damaged transport infrastructure is no longer functioning at capacity, and has faced escalating breakdowns. The political willingness and ability to deal effectively with these economic constraints is not yet convincingly evident.

The ANC (had) a contested election in December. While incumbent President Cyril Ramaphosa was re-elected and emerged with an executive more closely allied to him, party divisions remain clear.

SA’s economic challenges remain concentrated in the state’s ability to enable the economy to generate sufficient growth to tackle its myriad issues, especially poverty, inequality, and fiscal sustainability.

Unfinished events shape 2023

Aggregate inflation seems to have peaked, but the critical question for 2023 is the path by which inflation will return to central banks’ target ranges. On balance, developed market central banks slowed the pace of rate hikes at end 2022, but signalled that while inflation remains high, their job isn’t done.

Until inflation is clearly reined in, interest rates will likely keep rising and restrictive stances be maintained, keeping pressure on spending systems until the pace of price formation slows meaningfully.

Recession indicators remain mixed. The successive policy interventions and economic shocks initiated in the past few years are now squeezing developed economies into an increasingly constrained position, as cash-strapped households (slow) consumer demand. Investment and manufacturing are [thus] also starting to slow. Overheated property markets are showing signs of cooling in the US and UK, where mortgage rates have spiked to levels not seen since the financial crisis. Property activity has, therefore, slowed.

Available data doesn’t all suggest that large, developed economies are responding sufficiently to tighter policy stances for inflation to fall to target. In the US, the all-important labour market remains tight and wage pressure is concomitantly still elevated.

Profitability has been solid, suggesting labour retrenchment is still some way off, although recent data suggest a more pronounced slowing in growth is coming. The Federal Reserve is likely to slow the pace of tightening to 25bps increments in 2023, but has signalled it’ll continue hiking the policy rate to 5 percent or beyond, until inflation and its drivers see pressure ease.

The European Central Bank (ECB) outlook is also challenging. Inflation remains elevated due to the impact of energy prices (now about five times higher than pre-Covid). As this subsides, assisted by unravelling global bottlenecks, reduced global goods demand and prices, and more moderate wage formation in Europe, the ECB should be able to slow the pace of hiking too.

But it’ll be a difficult, if not impossible, balance for central banks to rein inflation back deliberately and decisively into range without moving into an uncertain “restrictive”stance, or risking a meaningful, painful impact on economic activity. This process will be complicated by mixed data showing unexpected resilience in Europe and more recent weakness in the US. Recessions in Europe, the UK and possibly the US are still a risk.

Though undoubtedly painful, the recessionary conditions should differ from the “balance sheet recessions” induced by the Global Financial Crisis. We’re likely to see a shorter, sharper downturn, but one more responsive to an ultimate easing in policy settings.

The short-term outlook for China is very uncertain. The recent policy shift should see the broad reopening put an end to the stop-start of repeated lockdowns. However, this was preceded by elevated infection as the relatively low immunity rises. Thereafter, probably in the second half of 2023, a combination of improved mobility, possible easing in housing market restrictions and a recovery in the property market, alongside better general consumer spending should offset the impact of weaker exports. Current forecasts suggest a consensus real GDP forecast of about a 9 percent annualised rate at that time and growth of about 5 percent for 2023.

SA’s economic political nexus continues

SA’s economic outlook is hostage to the increasingly inextricable link between politics and growth. Energy availability looks likely to remain deeply constrained through to Q2 2023. The persistent risk of breakage, unplanned maintenance and sabotage as well as high-stage loadshedding is expected to continue. Growth in 2023’s first half (H12023) will struggle to exceed 1 percent in real terms.

Despite current constraints, legislation passed late last year offers some hope. Gazetted changes to the Electricity Regulation Act (4 of 2006) provides for the exemption from applying for an electricity generation licence for all facilities, and the licensing threshold has been abolished. New generation investment registrations at Nersa have risen meaningfully.

We expect economy-wide non-Eskom energy availability to improve in H2 2023 as some early self-generation projects reach completion.

This won’t improve load shedding, but should shelter some productive areas of the economy from its effects. Eskom’s energy availability factor should benefit from the return to service of some generation units currently offline in H2 2023. Overall, we expect the system to remain highly constrained.

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