5 economic challenges that await us in 2023

2022 was the year when the global economy was expected to recover from the mayhem unleashed by the COVID-19 pandemic. But then, Russia invaded Ukraine on February 24 and the economy was pushed into the throes of uncertainty.

The war in Ukraine and ensuing Western sanctions against Russia stoked geopolitical tensions, sent energy and food prices soaring to record levels and disrupted supply chains, throwing a wrench into the global recovery.

As inflation climbed to multiyear highs, central banks were forced to tighten the money taps at a frenetic pace by increasing interest rates in the face of an already slowing economy, further boosting the prospects of a recession in 2023.  

A recession is, however, just one of the economic difficulties that awaits us this year. Here's a look at some of the biggest challenges likely to confront the global economy.

An imminent recession

2023 is expected to be the third-worst year for global economic growth this century behind 2009, when the global financial crisis caused the Great Recession, and 2020 when COVID-19 lockdowns brought the global economy to a virtual standstill.

Analysts expect the world's major economies, including the United States and the United Kingdom, as well as the eurozone, to slip into a recession this year as central banks continue raising interest rates to temper demand for consumer goods and services in an effort to rein in raging inflation.

The head of International Monetary Fund, Kristalina Georgieva, has warned that a third of the global economy could be hit by a recession in 2023, which she described as a "tougher" year than 2022.

The eurozone, in the midst of a severe energy crisis as it looks to shed its reliance on Russian fossil fuels, and the UK are likely to witness a deeper recession than their peers.

"The severity of the coming hit to global GDP depends principally on the trajectory of the war in Ukraine," analysts from The Institute of International Finance wrote in a research note, adding that the conflict risked becoming a "forever war."

The contraction in advanced economies and a stronger American dollar will hurt exports, spelling trouble for export-oriented Asian economies.

The consolation is that any recession will likely be short-lived and won't be as severe as initially feared, causing only a modest rise in unemployment.

"Since inflation now seems to be receding all over the world, central banks should be able to take their feet off the brakes before long, allowing a recovery to begin late next year [2023]," analysts at Capital Economics said in December.

Stubborn inflation

Price rises will likely be moderate in 2023, helped by weakening demand, falling energy prices, easing of supply snarls and a decline in shipping costs. However, inflation will stay above central bank target levels, prompting further interest rate hikes. That means more pain for the economy, and it  risks worsening a global debt crisis.

Inflation in the eurozone is expected to come down more slowly than in the US. In Germany, the eurozone's economic engine, inflation is expected to fall thanks to measures like a cap on gas and power prices. But core inflation, which strips out volatile food and energy prices, could remain stubbornly high as a result of the government's cash transfers to help households deal with higher living costs.

"The resilience of the [eurozone] economy, and particularly the labor market, suggests that inflation could be higher for longer than we expect," said Andrew Kenningham, chief Europe economist at Capital Economics, adding that core inflation would fall more slowly as strong wage growth keeps inflation in the service sector high.

"There are several obvious risks to that forecast. 'Known unknowns' include what happens to energy markets, which in turn depends on the course of the Ukraine war and the weather, and how German manufacturers cope with high energy prices," he said.

China's COVID chaos

Just weeks before the start of 2023, China announced an exit from its controversial zero-COVID policy. The swift pivot has left the country's health care system overwhelmed amid an alarming rise in COVID cases.

Going by the experience of other countries, the deluge of infections is expected to cause short-term disruption to the world's second-largest economy. This could deal a blow to the fragile recovery in global supply chains. There is also the risk of a new coronavirus variant emerging and spreading to other parts of the world.

While the near-term prospects appear bleak, analysts expect the Chinese economy to end 2023 on a brighter note with a big boost resulting from Beijing's ditching of zero-COVID and its support for the country's ailing property sector, which accounts for nearly a quarter of China's economic output.

"Chinese recovery, combined with the regional reopening, means Asia could have a good 2023," Christian Nolting, Deutsche Bank's chief investment officer, said in a note to clients. The recovery could "stabilize the economies of neighboring and many commodity exporting countries (such as those in Latin America) given that China is the dominant commodities consumer."

An energy crisis

The precarious energy situation, especially in Europe, will continue giving headaches to governments in 2023. Europe might just manage to escape a complete energy crisis this winter thanks to milder-than-normal weather and consumers cutting their energy usage.

The lower demand for heating means the region's storage facilities, which were filled to the brim last year, might remain well-stocked at the end of this winter. That's likely to keep gas prices in check next spring, helping to pull down inflation. 

The situation could still become challenging ahead of next winter. Having spent hundreds of billions of euros last year scouting for alternatives to Russian energy and shielding consumers, Europe might struggle to once again fill up its storage facilities. The competition for liquefied natural gas will be especially tough as China reopens and traditional Asian buyers like Japan and Korea start looking for more sources of energy.

Nolting said energy remains the main risk factor for the region, "coupled with a possible shortage of gas in winter 2023/2024."

Geopolitical tensions, technology war

Military and political tensions will continue to remain among the biggest risks to the economy, much like in 2022. While there is no end in sight to Russia's war in Ukraine, US-China frictions over Taiwan, the world's top semiconductor manufacturer, and soaring tensions in the Korean Peninsula amid North Korea's missile testing are likely to keep investors on their toes this year. 

"Solutions to end Russia's invasion of Ukraine remain elusive. This in turn means no solutions to the knock-on effects of this conflict on areas such as migration movements, global supplies of fossil energy commodities and food; and potential geopolitical shifts extending far beyond the region," said Nolting.

The battle for technological supremacy between the US and China might get more intense in 2023. Last year, Washington banned the transfer of advanced US semiconductor technology to China.

"A trade conflict has now morphed into an effort to set the applicable long-term standards in highly important fields such as 5G, artificial intelligence and chips," said Nolting. "Success will expand the country's power base over the long term. So both sides will not want to yield ground easily."

Edited by: Tim Rooks