From Bad to Worse
By Professor Andrea Boltho, Kroll Real Estate Advisory Group Advisory
Board Member, and Emeritus Fellow, Magdalen College, University of Oxford.
April 2022
First a pandemic, then inflation, now war. The world economy has undergone three adverse shocks
in just two years. The last quarterly note stressed widespread uncertainties and a subdued outlook.
The present one stresses clear dangers and the possibility of significantly worse prospects. It is truethat on the pandemic front the situation in the advanced economies has improved, with the numberof new deaths declining for some time now. The developing world, however, remains a weak spot.
Vaccination rates are still low in many of the poorer countries, particularly in Africa, and this makes
them fertile ground for the birth of new variants. Europe may feel that it has achieved virtual mass
immunity and is relaxing many of its restrictions. This may, however, be a premature reaction given
the continuing danger of international contagion.
Inflation has risen almost everywhere to rates not seen
for many years in both the OECD countries and in mostemerging markets. The hope that much of this would beof a transitory nature has now been dealt an almost fatal
blow by Russia’s war on Ukraine. Apart from its appallinghuman cost, the war is having serious negative economic
effects. The first and most obvious consequence of both
the war and the concomitant sanctions on Russia has
been a sharp rise in the cost of energy. Natural gas prices
have soared and even the cost of an oil barrel has gone
above $100 in March and early April from a 2021 averageof $70. Further increases are quite possible shouldWestern Europe significantly reduce its energy imports
from Russia (a measure many are calling for) or should
Russia itself stop selling gas and oil to Western Europe.

The war is also generating additional inflationarypressures on many other commodities. Food is the mostobvious one. Russia and Ukraine together account forsome 25-30 per cent of world trade in wheat. There isuncertainty, particularly for Ukraine, on how much of thiswill be sold given transport difficulties and even on how
much will be sown this spring. Grain prices have alreadyrisen rapidly. In addition, the production of fertilizers isgas intensive. Rising fertilizer costs are bound to have anegative impact on agricultural production. Russia is alsoa main producer of many raw materials. Nickel and coalprices have risen sharply and some rare materials (e.g.,palladium) could soon be in short supply. Finally, there isalso renewed disruption to European supply chains which
involve Ukraine and Russia, and also to those reliant onrail transport from China.

The inflationary potential of the war is thus huge. And
this is bound to have two unfavourable consequences for
activity: central banks may have to raise interest rates byeven more than was expected before the war started(though the European Central Bank is, as yet, hesitating
at too drastic a reaction), and consumers will find theirpurchasing power significantly eroded given that wage
claims remain subdued, particularly in Europe.
Predicting future trends is clearly much more difficult
than usual. Radical uncertainty surrounds the courseand duration of the war. And there is uncertainty on
whether energy embargoes will be imposed, how foodshortages will develop, how severe the next winterwill be, whether new COVID-19 variants will emerge,etc. The table below shows tentative forecasts madeon the assumption that the war will, in some form orother, end by the autumn of this year. On that basis, thenegative effects on the world’s two largest economies,
the U.S. and China, will be limited. Output growth may
be 0.1 to 0.2 per cent lower than it otherwise would
have been in both 2022 and 2023. The slowdowns
that are expected in the two countries reflect the risein interest rates in the U.S. and the COVID-19-linked
lockdowns that are being imposed in China. At theopposite end stands Russia’s economy whose GDPby end 2023 could be some 10 to 15 per cent smaller
than it was in 2021. Western Europe would, of course,
be hurt. Growth in both the Eurozone and in the UK
would be up to 1 per cent lower over 2022 and 2023
than had been expected just before the invasion started.
Should the war be protracted and continue into next year,
the outcomes would, inevitably, be a good deal more
unfavourable, with GDP in the Eurozone, for instance,
3 to 4 percentage points below a non-war scenario.
Emerging markets, other than China, are also bound tosuffer, particularly in Eastern Europe where mounting
uncertainty will depress activity. Elsewhere, inflation isrising at an alarming rate in many economies, pushed
higher by energy and food prices. The latter could wellgenerate severe distress in some of the poorest countries.
In addition, U.S. interest rates are rising and will continue
to do so in the course of this year. Past experience showsthat this leads to capital flight from developing countries,generating, in turn, exchange rate depreciation. To counter
this, interest rate will almost certainly be increased further
thus also dampening activity. Some commodity producers
may reap gains from higher raw material prices,
but the overall outlook for the emerging world has
clearly worsened.
Prospects for the real estate sector will inevitably
also suffer. In China, the ongoing downturn looks likecontinuing. In the advanced economies, the combinationof lower growth and greater uncertainty, plus interest
rate increases in the U.S. and the UK and, later, also in
the Eurozone, are likely to deter both new construction
and the acquisition of existing assets. The upward
trend in house prices, which last year defied gravity
in numerous countries, will almost certainly give
way to some declines and the same is likely forcommercial properties.

GDP Growth Rates (%)
2020

2021

2022

2023

2024

Eurozone

-6.5

5.3

2.9

2.7

2.1

UnitedKingdom-9.4

7.5

3.6

1.7

2.2

UnitedStates-3.4

5.7

3.1

2.0

2.0

China

2.2

8.1

4.8

5.4

5.5

World-3.4

5.9

3.4

3.23.2

Note: These forecasts are much more uncertain than usual with thebalance of risks clearly skewed to the downside.
Source: Oxford Economics

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