The conflicting forces at work in the global economy

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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.

The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy

Seemingly everywhere you look these days across economies and markets, a tug of war is playing out. On the one hand, there is a brighter outlook that boosts hopes for sustainable prosperity, attractive investment returns and genuine financial stability.

On the other is the legacy of over-indebtedness, low quality growth and policy mistakes. This must be dealt with while transitioning away from exhausted economic management approaches that fail to deliver durable and inclusive prosperity consistent with the wellbeing of our planet.

Fortunately, most of the historical burden is manageable. Where it is not, more timely responses from both the public and private sectors can make it so. Let’s start with the economic prospects. Advanced countries rightly anticipate a year of lower inflation, less costly borrowings and more ample funding. This means improved affordability and increased mortgage availability for households, while companies benefit from easier access to market financing at notably low levels compared with borrowing benchmarks.

The challenge for both sectors lies in handling the legacy of recent years. The full impact of central banks’ aggressive interest rate hiking cycle is yet to be felt, and household debt levels have risen to quite near worrisome levels. A looming debt “maturity wall” awaiting corporates will need to be refinanced at less favourable terms than originally contracted.

Robust demand underpinned by a healthy labour market is not sufficient to ensure the management of these historical challenges. Policymakers are also constrained.

Governments have limited fiscal space owing to high deficits, debt and more costly refinancing. Central banks, eager not to lengthen an already long list of 2021-23 policy mistakes, will be hesitant to aggressively reduce policy rates.

Additionally, there’s a growing recognition that old-style stimulus is not just less feasible but also less desirable now that we operate in a world of insufficiently flexible supply of goods and services — a vulnerability exacerbated by geopolitical shocks.

Despite some economic bright spots in Asia and among Gulf countries, the developing world lacks the capacity to act as a global growth engine that would help lift debt overhangs.

This is most striking in China. There has been some progress here in pivoting to “quality growth” through a focus on technological development, green energy and a transition towards more domestic consumer-led activities. But there is enormous pressure to crank up an old debt-fuelled, public sector-led growth engine that is inefficient and creates unintended consequences.

In financial markets, the excitement about new highs in the stock markets of a growing number of advanced countries must be balanced against the threat posed by the stock of overleveraged and unreasonably valued assets. The leading example is, of course, commercial real estate where the revaluation lower of projects underwritten in the heydays of floored interest rates is happening too slowly.

Fortunately, it is a problem that poses only limited risk to overall financial stability. Yet the longer it takes for overleveraged investors to grasp their unfortunate reality, the longer readily-investible funds will wait lest they be contaminated by the eventual recognition of large unrealised losses, and the greater risk of contagion to adjacent asset classes.

Stronger steps to overcome debt overhangs and revamp growth models would help pave the way for overcoming past mistakes and exploiting future opportunities.

It is a path that can be better secured by, first, timely government actions to help enable the new drivers of growth; second, greater realism on the part of some households, corporates and investors that we are not returning to a world of artificially low interest rates; third, better safety nets to protect the most vulnerable in society; and fourth, a more rapid restructuring of non-viable debt.

These challenges have been made harder by the darkening geopolitical backdrop, which fuels fragmentation, unleashes stagflationary winds and hinders international co-operation. This of course matters not just for the economic outlook. Ongoing wars have come to the boil in a shockingly destructive manner that has seen hundreds of thousands of innocent civilians lose their lives, livelihoods and homes. The economic and market tug of war will always pale in comparison with such profound suffering.