The emergence of artificial intelligence and other risks to the global economy
MAPFRE Economics has revised its forecasts for the global economy, contained in the Economic and Industry Outlook 2023: Second Quarter Perspectives report. In general terms, the forecasts have been raised for all economies. As far as the global economy goes, the rise is 0.8 percentage points (pp) for 2023, to 2.6%, up from 2% at the beginning of the year. However, MAPFRE's research arm highlights a number of additional potential triggers for the global economy, listed below.
Global governance and geopolitical crisis
The global geopolitical situation in the first quarter of the year has consolidated some relevant dynamics that will possibly define its evolution in the current decade. New among the long-term geopolitical risks is the emergence of artificial intelligence (AI). This topic has garnered unprecedented attention with its deployment and widespread adoption in various fields such as economics, security and defense. AI raises significant challenges in terms of data security and privacy, usage ethics and biases and competition for technological supremacy among countries. AI also has implications for labor and society, which may have an impact on global stability and equity. There are now many voices clamoring to curb, at least temporarily, AI training in order to avoid potential risks. In this regard, Italy has banned the much-vaunted ChatGPT, an AI language model developed by OpenAI, on the basis of the General Data Protection Regulation (GDPR), which could have implications for the future of AI in Europe. Also, consumer groups in the European Union are demanding an investigation into ChatGPT, and whether the GDPR is being used to regulate AI, which could set a precedent for data protection rules to apply to AI, thereby affecting tech giants such as Google, Microsoft and Meta. The United States, meanwhile, is considering measures to address potential foreign technology threats through AI, with the introduction of the RESTRICT Act. This act would give the U.S. government the ability to take a variety of measures, from transparency rules to outright bans, if a threat to national security is identified. The first use case under this mechanism is the analysis of TikTok's influence in the country.
The issue of cybersecurity, meanwhile, remains a major global concern. Nervousness has continued to grow over suspicions that North Korea is attempting a SolarWinds style cyber-attack. However, information on this remains limited and incomplete.
Third on the list is the crisis in Ukraine and the absence of a pragmatic solution, even under the Chinese peace plan. As the war rages on, the United States has announced a $2.6 billion aid package, and Finland has cleared the last hurdle to securing NATO membership, with the Turkish Parliament unanimously ratifying its accession, making Finland an official member. Sweden is also expected to join NATO this summer, while efforts by Poland and the Baltic countries to accelerate Ukraine's accession have been met with reluctance by the United States, Germany and Hungary. This development of events seems to have eliminated any hint of concerted peacemaking, as was initially being promoted with China at the forefront. Moreover, Belarusian President Alexander Lukashenko confirmed reports that Russian nuclear weapons could be on their way to Minsk, raising concerns about the situation in the region.
Meanwhile, tensions between Taiwan and China have increased. Taiwanese President Tsai Ing-wen's recent visit to the US Congress stressed the need for military training in the event of a Chinese attack. With this, the tension between the United States and China receives a new twist, fueled by the $19 billion in support for the purchase of weapons, including HIMARS, F-16s, Javelins, Stingers and Harpoons, which has caused the Chinese condemnation.
As for Europe, the region is mired in a reset of leadership and relations, which affects several fronts, including the relationship with the United States in response to the Inflation Reduction Act (IRA), the war in Ukraine, as the use of military-grade weaponry escalates, Russia's rejection of the recent NATO expansion and the scrutiny of new sanctions, and finally, the timid approach to China that could lead to a paralysis of the Comprehensive Agreement on Investment (CAI), which was excluded from the most recent talks.
For its part, the situation in the Middle East is subject to two complementary readings. The first relates to how the extensive internal and external tensions in Israel reveal the fragility of its position in the region and the notable absence of its main supporter, the United States. The second concerns, China, which is gradually stepping up to fill the vacuum left by the United States. In a surprising move, China brokered a deal between Iran and Saudi Arabia, raising concern among US national security experts.
The most recent data continue to show inflation moderating across the board, driven mainly by falling energy and other commodity prices, slowing house prices, contained prices for everyday goods and the base effect. In contrast, prices in the services sector are still rising.
While this moderation is positive, showing that the worst seems to be behind us, underlying readings continue to show more inflexible dynamics. Despite this, inflation rates remain above central bank targets, is subject to erratic swings (the more volatile components are currently a greater counterbalance) and risks remain linked to the current uncertainty.
It should be emphasized that upside biases remain anchored to: (i) the development of geopolitical events, the uncertain energy outlook and the energy transition; (ii) the behavior of commodity prices in the face of China's reopening (as per the latest consumer and producer price data, there is the possibility of further stimulus to accelerate the rebooting of the economy); (iii) second round effects, mainly in the United States and to a lesser extent in Europe, given the resilience of the latest economic data and labor market tensions; (iv) a moderating fiscal policy, but still with large budget deficits; and (v) the correct transmission of monetary policy, the full effects of which are as yet incomplete.
Real estate markets
The outlook for the real estate market continues to deteriorate as the change in monetary policy is based on interest rates already in restrictive territory, weakening both the demand for credit on the consumer side and the appetite for risk on the investor side, leading to a rebalancing of tighter valuations, something that has been seen since the end of 2022.
The correction in most of the developed economies stands out, with Canada, Australia, Switzerland, the United States and the United Kingdom, among others, leading the adjustment in prices. Although the correction is expected to be moderate, due to limited supply and a tighter risk policy (both the initial level of overvaluation in some markets and the effects on the loss of purchasing power and reduced access to credit), it will continue to mark a more contained point of equilibrium. In turn, while the residential real estate sector would appear to be normalizing on the back of these dynamics, the commercial real estate sector faces more prolonged headwinds (increased telecommuting, online commerce, below-trend transactions and pre-Covid dynamics that have not fully recovered). Also, given the recent turbulence in the banking sector, the risk of an additional impact on credit dynamics with a more pronounced tightening is evident as an additional vulnerability that could amplify the ongoing correction.
At the end of 2022, global debt decreased by $4 trillion to around $300 trillion. Relative to gross domestic product (GDP), the figure reached 337.3%, around 25 pp below its 2021 peak. Compared to 2021, in developed markets the decline relative to GDP was 20 pp, led by governments (-10 pp) and financial companies (-5 pp), compared to -3 pp and -2 pp for non-financial companies and households, respectively. As far as emerging markets go, there was an increase in the debt ratio of 1.9 pp over GDP, largely due to higher indebtedness of non-financial companies (1.9 pp) and to a lesser extent by governments (0.7 pp), while the increase in borrowing costs and the accumulated depreciation of currencies against the dollar also contributed to the rise.
In the case of China, the debt ratio once again marked new record highs, reaching 346.3% of GDP. Contributions to the increase in this ratio continue to be recorded in all sectors and, to a greater extent, in non-financial companies and government (6.6 pp and 4.8 pp, respectively), largely due to Covid financing needs during the various lockdowns and the related economic paralysis.
Despite the reduction in the debt stock recorded in 2022, overall debt remains above pre-pandemic levels. This is due to continued economic expansion, the high inflation environment (as a dilution effect), a more cautious agent dynamic given the high uncertainty, the change in the monetary cycle characterized by higher rates and the reversal of balance sheets of the main central banks. While the dynamics are expected to remain positive, recent events in bond markets show the increased sensitivity of investors to deteriorating fundamentals, prioritizing those stability paths that are feasible and sustainable over time. Likewise, the need to recover some wiggle room to deal with counter-cyclical needs provides an additional incentive to stay on the consolidation path.
The dichotomy between price stability and financial stability is becoming increasingly evident, especially as monetary policy tightening approaches its peak, price stability reveals a softening in inflation and the effects of monetary policy, although staggered, activate fragilities in the financial system.
Generally speaking, and factoring in positive real interest rates gaining ground across the board in the coming months, the possibility of additional tightening is distant and caution is expected to prevail, sustaining current financial conditions for a while longer. However, risks are skewed both to the upside (higher inflation in the near term leading to an unanticipated tightening of financial conditions) and to the downside (a tilt in activity toward a less benign macroeconomic scenario or a broader financial crash). In both cases, the delays associated with monetary policy are driving a certain impatience around how smoothly it is transmitted and how certain its impact on the different channels is. This is because its influence on demand has been less accurate (as is evident from activity and employment data), and its consequences on the credit cycle may respond in a non-linear fashion and be quickly transferred to the real economy via additional tightening of financial conditions, triggering a hard landing.
All of this is reflected in a yield curve that remains deeply inverted, as well as in a combined volatility in both the terminal rates at the short end of the curve and in the middle and long legs, which determine how the momentum toward any of the proposed scenarios could be catalyzed relatively smoothly.
Sovereign-financial crisis in China
As the reopening of the Chinese economy continues to gain traction, economic growth is expected to accelerate on the back of consumer spending, led by a rebound in services (mainly those that are Covid-sensitive), supported by savings accumulated during the prolonged periods of lockdown, continued positive momentum in industrial production aided by an energy mix featuring more coal and Russian oil, counterbalancing the effects of accelerating domestic activity and allowing inflation rates to remain range-bound.
Consequently, the central bank's monetary policy could continue to be accommodative and focused on the recovery of economic activity, in line with the latest decisions to cut the reserve requirement ratio and liquidity injections, which could be a positive catalyst for future portfolio inflows, favoring the local currency.
Finally, regarding the real estate market, while the down cycle and uncertainty remain ongoing, early signs of stabilization in transactions, prices and climate indicators are beginning to reflect the continued housing easing measures undertaken by the government, although for the time being, it would appear that they remain unproven in terms of eliminating the associated tail risk.
The effects of climate change continue to be evident around the world in the form of both losses (2022 was the second consecutive year in which insured damages exceeded $100 billion) and uncertainty through the different channels (evolution, mitigation and transition, among others), involving micro and macroprudential regulators. This puts the stability of the financial sector itself at risk both directly (the chain of events through which climate risk factors affect exposures and counterparties) and indirectly (valuation effects on financial assets, underlying assets and coverage).
Since the beginning of 2023, energy markets have continued to release the tension accumulated in the wake of the geopolitical shock, despite its persistence over time. The factors behind this normalization are supported by lower global demand, mainly in developed economies, highlighting the phenomenon of high winter temperatures in Europe, which, together with support policies, energy efficiency plans and diversification of supply sources, have made it possible to sustain gas storage levels above the historical average.
On the Asian continent, flows from Russia have continued to favor the region, with India (favored by refining operations and exports to Europe) and China, whose reopening has continued to progress positively, although without pressure on input prices and supported by imports from Russia (around 2 million barrels a day in February), the accumulation of inventories and the still-low industrial activity and incomplete recovery of mobility and consumption.
Despite this, structural tail risks are likely to persist over time, linked to the ongoing energy transition, the need to safeguard security of supply and the race to dominate ownership of the new industry. This competition, manifested through U.S. "green protectionism" under the Inflation Reduction Act (IRA), the European Green New Deal and China's tight control over the production of many strategic inputs, will continue to generate additional tensions to those already latent in traditional energy markets affected by supply shortages, low investment and production subject to an increasingly adverse geopolitical framework. Furthermore, and following the recent OPEC decisions, the durability of the decline in inflation may be questioned if oil-producing countries are determined to sustain high oil prices, thus prolonging the tension in energy markets.