How banking crisis leads to slump in world economy

At the beginning of the year, corporate leaders and economists showed optimism that world economic growth might not depreciate as much as anticipated. Positive developments include the reopening of China, signs of resilience in Europe, and falling energy prices.

But last month’s banking crisis turned the tide. On Tuesday, the International Monetary Fund (IMF) degraded its outlooks for the global economy, noting “the latest increase in the financial market unpredictability.”

The IMF assumes that economic growth will decline from 3.4% in 2022 to 2.8% in 2023. Its January estimates were for 2.9% growth this year.

“Uncertainty is high, and risk balance has shifted to the downside as long as the financial sector remains unstable,” the organization said in its latest report.

Concerns about the economic outlook have increased after the bankruptcies of Silicon Valley Bank and Signature Bank, two regional US lenders, and a loss of confidence in the much larger Credit Suisse, sold in a government-backed rescue agreement to rival UBS.

The world economy has already struggled with the effects of persistently high inflation, rapid rate hikes to combat it, mounting debt, and Russia’s war in Ukraine.

Furthermore, now, there are concerns about the state of the banking sector.

According to IMF, these forces now overlap and interact with new financial stability concerns. They noted that policymakers are trying to contain inflation by avoiding a “hard landing” or a distressing deflation that “may face crucial trade-offs.”

Global inflation has proved “much trickier than expected,” according to the IMF. Hence, it should decline to 7% this year from 8.7% in 2022 and 4.9% in 2024.

Consequences of decline in economic growth

Investors are looking for more loopholes in the financial sector. Meanwhile, lenders could become more cautious about saving money they may need to weather an unpredictable environment. This step would make it more difficult for companies and households to access credit. It will have a corresponding effect on economic yield over time.

According to IMF, holding a spring meeting with the World Bank this week, financial conditions have tightened. This will likely lead to reduced lending and activity if this continues.

Suppose another shock to the global financial system leads to a “sharp” deterioration in the financial condition. In that case, global growth could decline to 1% this year, the IMF has warned.