A better but not happier year

2023 began amidst anxiety about a global decline. The outturn surprised the optimists on the downside and the pessimists on the upside. Central bankers threaded the needle between slowing and slumping the economy. Geopolitics disgusted all conscionable citizens of the world.

The 2020s have been memorably unkind to mankind so far – pandemic, inflation, war, extreme weather, diverse variants of international and domestic polarisation and counting!

Better than expected economy

World economic growth slowed with disinflation. The modesty of the slowdown amidst the fastest tightening of monetary policy since the 1980s implies the tighter-for-longer strategy was less costly than anticipated. Starting late in 2022, systemically important central banks were credible enough to convince people not to expect inflation to stay high. 

Labour markets in advanced economies are as buoyant today as they were at the outset. Real wages increased without a wage price spiral. Japan, the world's third-largest economy, is crawling back from decades-long stagnation, but China struggled getting back in full gear as the world's shock absorber. Emerging and developing Asia pushed back stagflation while the Middle East and North Africa succumbed (WEO, October 2023). 

Interest rates in major economies have paused from the upward sprint starting early 2022. Most advanced economies are near their peak. Energy prices have not soared despite the Israel-Hamas war and supply cuts by Russia and Saudi Arabia. There has been broad convergence in monetary policy with some exceptions. Egypt's central bank kept interest rates steady, Hungary's central bank cut rates and Turkey opted to hike after the experiment with rate cuts failed. Some forerunners on hiking in emerging economies, such as Brazil and Chile, are cutting.

Not normalised yet

A "soft landing", meaning lower inflation without a major downturn in activity, is now the baseline with no landing (reaching inflation target without recession) on the upside and a "hard landing" (protracted recession with potentially severe financial distress) on the downside. The economic risks are looking more double-sided than at the close of 2022 when downside risks were predominant. Global supply chain pressures have receded to record low levels and financial conditions have stabilised recently.

Rate hikes may not yet have fully delivered their hits to GDP growth. The proportion of advanced economies with rising unemployment reached 70% in 2023 relative to 15% in 2010 (World Bank, December 2023). Many low-income countries are in or near debt distress. The dollar is a major challenge for many in developing economies. 

Policymakers in advanced economies are beginning to consider when to start easing back to a neutral (neither contractionary nor expansionary) interest rate. The Federal Reserve Board of the US recently signalled 75 basis points rate reduction in 2024 depending on data indicating sustained progress on taming inflation but not necessarily down to 2%. The Fed may be wary of keeping rates too high for too long because rate changes take time to work out. Buoyed financial markets ended the year with herd-like exuberance.

The easy-money environment is passé. Even if inflation declines, soaring debt levels and an ageing population will keep rates higher in the near and medium-term than they were in the decade following the 2008 financial crisis. Central banks were caught in a trilemma of achieving price stability while avoiding a recession and a financial crisis. Their worst fears did not materialise.

Bloodier geopolitics

Not so on the political front. Two million Palestinians have been forced out of their homes. Larger numbers have been displaced in Ukraine, Congo, Sudan and Syria. The economic hardships caused by armed conflicts extended beyond the epicentres making 2023 another unhappy year for humanity and exposing double standards in North and South.

The geopolitical divide blurs sight of geo-economic integration. The share and complexity of global trade is far greater than ever before. China's role as the workshop of the world may be as hard to replace as the global role of the US dollar, surmises Nobel economist Paul Krugman. Hot or cold, war means more fragmentation of the global economy and more restrictions on cross-border flows of goods, services, capital, people, and all that move with these. 

Disruptive geopolitical rivalries show no sign of de-escalation. Minerals critical for the green transition and highly traded agricultural goods such as wheat and edible oil are especially vulnerable in the event of more severe geoeconomic fragmentation. A single commodity producer switching geopolitical allegiance or disruptions to shipping in one major route could trigger significant price fluctuations worldwide.

Frail commitments

2023 is officially the hottest on record. Extreme weather events made more likely or intense by the climate crisis claimed lives in many parts of the world. COP28 in December started with a landmark agreement on loss and damage but ended despairingly. An explicit reference to moving away from 'fossil fuels' in the UAE Consensus is hailed as "groundbreaking"! 

Divisions on fossil fuel run deep. Phase out and phase down are taboo in joint declarations. More than 100 countries support a phase-out in some form. Some oil-producing nations don't want any reference to reducing oil and gas, never mind that fossil fuel consumption is the main driver of the climate crisis. The bottom line on protecting the earth – setting emission to a declining trajectory – has continued to be the victim of inconclusive debates on balancing the tradeoffs in the transition to green energy. 

The world is off track to limit global warming to the crucial 1.5-degree threshold. The COP28 commitments, if fully implemented, would slash greenhouse gas emissions by less than one-third of what is required, according to an International Energy Association assessment. Speaking of short! Whatever it's worth, there was a consensus that inaction on climate change needs to change sooner than later.

Vulnerable political climate 

The improving economic climate is on a fragile footing. There is nascent optimism about getting inflation down, but the other ailments such as conflict, poverty, inequality, climate and repression are all up in the air. A reset from enduring rivalry between super power relations is farfetched. There is the "allure of populist authoritarianism", warns Chris Patten, Chancellor of the University of Oxford. Fears of a global recession have ceded place to rising concerns about geopolitical and domestic political issues.