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Network News • 08-09-2022

Are we heading towards a recession?

Author: Dr Lina Klesper - Legal Assistant PKF Malta
Published on Malta Business Weekly: 8th September 2022

After Europe´s economy appeared to be finally recovering from the impacts of the pandemic, Europe is now facing an ordeal of struggles that keep piling up.  The European Union is undergoing crucial tests nearly on a weekly basis and if not handled correctly economic decline will be very real.

Economists are warning about winter with a recession heading our way late this year or early next year.  A recession is a period of temporary economic decline during which trade and industrial activity are reduced. Statistically, a recession can be identified by a fall in GDP in two successive quarters, which is usually caused by a sudden economic shock or as a result of uncontrolled inflation.

Like nearly all other economies, Europe is currently dealing with burning inflation that is putting an end to the post-lockdown “revenge spending”. In June annual inflation reached 9.6% in the European Union and in the euro currency countries, inflation went up to 8.6%. Additionally, in light of the volatile energy crisis that will especially materialize in winter, consumers are shifting into saving mode.   

Uncertainty is hanging above Europe like the sword of Damocles when it comes to access to energy which is highly dependent on Russia and Gazprom.  It has made the news that especially vulnerable countries like Slovakia, the Czech Republic and Hungary could take a GDP hit of 6% and fall into a severe recession.   

It has been forecasted that Germany would lose up to €220 billion over the next two years if Russia were to stop flowing gas.  A number of EU member states have experienced gas supplies from Russia entirely or partially cut off.

Hence, the European Commission already revealed its emergency plan to conserve gas for the next winter.  Whatever statement is coming from Moscow and even if flows resume, uncertainty will prevail and hold back investment and confidence leading to a disruption of the business cycle.

Topical is also the tightening of monetary policy in Europe since the ECB needs to ensure a level of price stability.  With credit conditions tightening at the same time a particular effect will be noticeable specifically in more indebted nations.  Moreover, the costs of climate change are not to be neglected.   A summer of heat waves is putting a damper on economic activity in several countries.

While wildfires are especially keeping Spain and France busy, Germany is struggling with water levels along its major trade artery Rhine River.  Nearly half of Europe´s territory is at risk of drought.  Furthermore, COVID-19 is not over yet and further waves especially during winter times may further disrupt economic activity making the pandemic still a major risk that needs to be taken into the equation.

When looking at the individual countries in Europe it quickly becomes clear how different the effects are on each state but at the same time how it all contributes to the perfect storm, we are in.

Germany is generally dependent on autocracies when it comes to energy and trade. Discussions are getting loud that the country needs to be more independent as first shown during the pandemic and now due to conflicts with Russia and China. The escalation of the conflict over Taiwan showed that German companies can no longer rely on their most important market.

This risk or perhaps more precisely the Chinese risk must be considered. Economic war with China would be expensive for Germany since experts suspect that a trade war with China would entail costs almost six times as high as Brexit, with the biggest loser being the automotive industry. In concrete terms, this would reduce Germany’s gross domestic product by around 0.81 per cent when any higher import duties and other trade barriers on both sides are taken into account.

While it is a prudent idea to become more independent the importance of globalisation and international cooperation are not to be abandoned completely.  In the event of a comprehensive relocation back to Germany, the German gross domestic product would fall by almost ten per cent.  Deglobalization would have devastating effects on growth and ultimately on the country’s political stability.

The key seems to be to enter into strategic partnerships and free trade agreements with like-minded nations, while fundamentally sticking to the business model of internationalization.

The UK seems to be feeling a particularly strong breeze of the storm that is building up since it is more exposed to the energy price shock and less protected by government measures than the eurozone.  Additionally, the UK economy is already damaged by the effects of Brexit.  The Bank of England is raising rates sharply with the biggest increase in 27 years following the footsteps of the ECB.  It is being warned of a 13% inflation by end of the year with the UK most likely facing a protracted recession over approximately 15 months and the biggest squeeze on living standards in 60 years.

It is forecast that the country’s GDP would shrink by more than 2 per cent from peak to trough.  Even though the recession will be shallower than the 2008 crash, a lot of households are in for a long and tough period of struggles over at least the next five quarters since unemployment will start to rise again next year.

The situation in Malta seems to be calmer at first glimpse since inflation in Malta is expected to remain the lowest in the Eurozone which can be explained by extensive government subsidies to keep fuel and electricity prices stable in Malta. The Maltese government is spending hundreds of millions to cover the difference and keep local prices stable.  However, maintaining the subsidy next year is likely to cost the taxpayers €400 million.  Considering Malta’s fragile recovery from the pandemic and the imminent challenges the usually all-so-calm Mediterranean Sea will roughen up rather sooner than later.

To sum up the headlines of the past months it is an unsolved energy crisis, red hot inflation, effects of climate change, political upheavals (especially in Italy and the UK), a slowing European economy and the tightening of monetary policy that is holding a grip over Europe. All of this is creating the perfect storm of uncertainty – in each state and in Europe at large.

Taking this into consideration it is not surprising that the exact risk of recession is difficult to predict.  It ranges from somewhat 30% for a full-fledged recession to 54% over the next year starting in June.

What is certain, however, is that there will be a sharp downturn in growth and each member state will have to simultaneously face its own struggles.

Author: Dr Lina Klesper - Legal Assistant PKF Malta
Published on Malta Business Weekly: 8th September 2022
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