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Info Service on Finance and Development (Dec25/02) Penang, 3 Dec (Kanaga Raja) — An increasingly challenging external environment is clouding prospects for the global economy, with global growth projected to decelerate to 2.6 per cent in 2025, down from 2.9 per cent in 2024, according to UN Trade and Development (UNCTAD). In its flagship Trade and Development Report 2025, released on 2 December, UNCTAD said that the rate of expansion is 0.4 percentage points below the pre-pandemic average (2016-2019), which was already sub-par. UNCTAD foresees the muted global growth dynamic to persist in 2026, at 2.6 per cent, as economies seek to adjust to the evolving external environment. The report shows that shifts in financial markets move global trade almost as strongly as real economic activity, influencing development prospects worldwide. It said that deterioration in the international environment affects the global South through trade and financial channels. Increased financial volatility due to sudden policy swings leads to greater instability in capital flows and exchange rates, impacting international financing conditions. UNCTAD said that global trade rose by about 4% early in 2025, driven in part by firms accelerating imports ahead of tariff changes, but also by structural shifts: services are expanding faster, supported by growth in the digital economy and artificial intelligence, and South-South trade is growing above average. Beneath these factors, underlying trade growth is estimated at between 2.5% and 3% and is expected to ease further as financial conditions influence production and investment decisions more strongly. More than 90% of global trade depends on bank finance. Dollar liquidity and cross-border payment systems are also crucial for international trading activities, UNCTAD pointed out. This deep reliance on financial channels makes trade closely linked to global financial and monetary conditions, it further said, adding that a shift in interest rates or investor sentiment in a major financial centre can affect trade volumes worldwide. For developing countries, the growing role of finance in trade brings real vulnerabilities. Currency swings make imports and debt more expensive. Shifts in global risk appetite can cut off credit and financial volatility tends to hit their markets harder and more often, it said. When prices move on financial signals rather than real economic conditions, their companies and producers compete on a more uneven playing field, it noted. The report also highlights a widening gap between developing countries’ growing weight in the world economy and their limited role in global financial markets. They now account for over 40% of global output and merchandise trade, and attract nearly 60% of global foreign direct investment (FDI). Yet, developing countries hold just 25% of global financial market value. Their smaller and less liquid capital markets make it harder for firms to raise money. Many developing countries also remain dependent on foreign banks, paying higher and more volatile interest rates, said UNCTAD. Advanced economies typically borrow at 1% to 4%, while many emerging markets pay 6% to 12% for similar government bonds, it noted. In a foreword to the Trade and Development Report 2025, UNCTAD Secretary-General Rebeca Grynspan said that: “Trade is not just a concatenation of suppliers. It is also the concatenation of credit lines, payment systems, currency markets and capital flows. Over 90 per cent of world trade depends on trade finance and cross-border banking infrastructure. While one system – the network of suppliers – has become increasingly decentralized and diversified, the other – the financial infrastructure enabling trade – remains remarkably concentrated.” “Developing economies remain vulnerable to currency volatility, financial infrastructure disruptions and shifts in risk pricing originating in distant financial centres. When major central banks adjust monetary policy, or investor appetite for risk shifts, these movements ripple through the global financial system, affecting the real economy and trade conditions across the global South,” she added. “The asymmetry is striking. Economies of the global South today account for over 40 per cent of global output, above 50 per cent of foreign direct investment inflows and more than 40 per cent of trade,” she said. “Their share of merchandise exports has grown from roughly 30 per cent in 2000, to over 45 per cent today. Yet, their position in global financial markets tells a different story. They remain peripheral to the equity and bond markets that finance long-term development: the North’s market capitalization stands at over three times that of the South, with 40 per cent of the global bond market residing in just one country.” “Sitting on the periphery means that developing countries access credit on far more expensive terms and operate with financial infrastructure lacking the depth and liquidity to support domestic capital formation,” she said. “This gap in access constrains fiscal space, limits domestic capital raising and reinforces external financing dependence, creating structural headwinds that domestic policy efforts can seek to navigate, though not fully offset, in the absence of complementary reforms in the global financial system,” Ms. Grynspan underlined. GLOBAL ECONOMIC OUTLOOK According to the report, the year 2025 has been defined by protracted and system-wide uncertainty over trade policy shifts and geo-economic challenges. Even as international policy discussions tend to focus on tariffs, the impact of the current reset goes beyond trade. International trade is deeply embedded in the global financial system: over 90 per cent of world trade depends on international banking and financial infrastructure. Yet, trade and finance are organized according to different systemic principles. Notwithstanding current tensions over tariffs, around 72 per cent of global trade flows continue to be governed by WTO most-favoured-nation (MFN) terms, the report maintained. On the other hand, it said that global finance is embedded in long-established market practices and conventions, networks of regulatory arbitrage and standard-setting functions delegated to private authorities. “In the short run, this interdependence can help avoid fracture and provide an effective signal for policy re-calibration, as happened, for instance, in April 2025.” Over the long-run, the disparity between the rules-based matrix of global trade and the centralized global finance system manifests a deeper imbalance in the global economy, the report noted. Although the imbalance between trade and financial architecture has a long gestation, it tests global economic resilience at a time of fading trust in multilateralism, polarization and slowing economic growth. It is particularly damaging to smaller and vulnerable developing economies which are asymmetrically affected by tariff escalation and face mounting debt service costs and climate crises, it said. “The ongoing reset of trade policy norms points to a deeper transformation of the global economy, a transition marked by uncertainty and geo-economic challenges.” Both factors amplify the effects of the absence of reliable drivers of growth. Subdued investment spending – aside from outlays concentrated in certain sectors, such as artificial intelligence technologies – as well as debt overhangs and constrained public spending persist in many countries. These factors weigh on growth prospects already weakened by shocks in recent years. Consequently, the report said global growth is projected to decelerate to 2.6 per cent in 2025, down from 2.9 per cent in 2024. The rate of expansion is 0.4 percentage points below the pre-pandemic average (2016-2019), which was already sub-par. UNCTAD foresees the muted global growth dynamic to persist in 2026, at 2.6 per cent, as economies seek to adjust to the evolving external environment. It said resilience in economic growth numbers observed in early 2025 reflects dynamism in certain sectors and more transitory forces. Strong investment and accelerating deployment of artificial intelligence technologies has boosted economic activity and prospects. At the same time, a notable front-loading of imports and purchases in anticipation of tariff measures – as firms and consumers brought forward purchases to get ahead of increased costs from importing goods – provided a significant albeit temporary support to growth trajectories in the first two quarters of 2025, it added. Front-loading had a transitory positive impact on outward trade flows to the United States and on production levels, which were ramped up to meet the fleeting up-tick in demand for certain goods. The subsequent drop-off, however, will likely negate some of the initial positive impetus from brought forward flows and purchases, the report suggested. “As a result, market resilience during the first half of 2025 may give way to a weakening in activity that will be more clearly reflected in subsequent quarterly data releases.” For its part, the impact of trade policy shifts on global value chains is ongoing and not yet fully internalized. Still, the vulnerabilities of these production processes to sudden shifts in trade policy are evident, it stressed. Likely disruptions to cross-border production lines will inevitably hurt economic activity. Economies dependent on value chains linked to the United States are particularly exposed to fallout from trade policy shifts, it said. It further said the policy volatility accompanying these shifts has also hampered growth. Uncertainty complicates firms’ decision-making, impacting business spending and capital expenditure as companies delay investment and hiring decisions amid a likely re-configuration of supply chains. Recent studies have demonstrated that elevated policy uncertainty, particularly around trade, tends to coincide with downturns in exports, investment spending and aggregate economic activity, said the report. Looking forward, it said the internalization of trade policy shifts undertaken during 2025 is expected to bring some degree of clarity to the international policy environment in 2026. Yet, disruptions and dislocations in international production processes and increasing economic fragmentation stemming from these shifts could continue to temper any potential rebound in global economic activity. “Moreover, the expected deceleration in activity after the front-loading of imports and purchases will spill over into next year, further dragging on growth numbers. The prospect of a positive impetus from investments in new technologies – most notably generative artificial intelligence – will not be sufficient to offset the deterioration in the global economic environment. UNCTAD foresees global growth to remain subdued in 2026, at 2.6 per cent.” While policy uncertainty has dropped from unprecedented highs in early April 2025, it nevertheless prevails at historically high levels. This reflects continuing volatility regarding, although not limited to, future shifts in trade policy, the report emphasized. “The tariff rates that took effect on 7 August have brought greater clarity to the new trading scenario. Yet, the potential for further rate adjustments – due to subsequent bilateral agreements, commitments in agreements that affect spending and investments, and the imposition of higher tariffs based on other considerations (as for Brazil, Canada and India) – suggests that while policy uncertainty has decreased, it will remain elevated and continue to weigh on firms’ spending and investment decisions.” Prolonged policy uncertainty will likely magnify associated negative effects on trade flows, capital expenditure and overall economic activity, and reverberate in increasingly volatile financial markets, it cautioned. GENERALIZED DOWNTURN The downturn in growth prospects cuts across countries. The direct impact of trade measures, along with their indirect effects through trade linkages and elevated policy ambiguity, has led to a general deterioration in the global environment, said the report. Certain regions and countries are, nevertheless, more vulnerable to the adverse international context than others. It said in the United States, economic activity is expected to slow as increased tariff rates on supply chains have a detrimental impact on industrial sectors and the services sectors that depend on them. Ongoing policy uncertainty continues to weigh on investment and private consumption. On the positive side, equity markets have rebounded from outsized losses in April while investments driven by artificial intelligence have proven particularly strong. These positive trends do not compensate, however, for the shortfall in consumption and other investment spending. UNCTAD expects the United States economy to register a substantial deceleration, expanding by 1.8 and 1.5 per cent in 2025 and 2026, respectively. In the European Union, growth is projected to remain sluggish. Despite reaching a deal with the United States to set tariffs for the bloc’s exports at 15 per cent – a significant improvement over the initial reciprocal tariff rate – trade frictions could dampen growth prospects, the report suggested. It said that while the agreed baseline tariff rate provides some policy clarity, the prospect of new sectoral tariffs and potential exceptions could keep policy uncertainty high and hinder business investment. Ongoing monetary loosening will likely help ease credit conditions and boost private consumption. “A significant expansionary pivot in Germany’s fiscal stance may provide some growth impetus, although this will not fully offset the deterioration in the external environment.” UNCTAD anticipates ongoing subdued growth in the European Union, with expansions of 1.3 and 1.4 per cent in 2025 and 2026, respectively. Meanwhile, it said in China, solid economic growth occurred at the beginning of 2025. In the latter part of the year, however, increased bilateral tariff rates have become a drag on output growth. A rapid diversification in export markets as exporters reroute goods shipments to alternative markets; expansionary fiscal policy focused on subsidies for consumption goods, transfers to households and increased outlays for infrastructure; and monetary loosening have all buttressed the expansion in activity. UNCTAD expects the growth rate to remain steady at 5.0 per cent in 2025, before moderating to 4.6 per cent in 2026. In the rest of the global South, a challenging external environment complicates the outlook. The deterioration in the international environment affects developing economies through both trade and financial channels, said the report. “Policy shifts reverberate in increasingly volatile international financial markets, leading to greater instability in capital flows and exchange rates and impacting international financing conditions.” Developing countries are particularly susceptible to movements in these variables, especially those with high external financing and refinancing needs and those with elevated external debt burdens, it added. According to the most recent International Monetary Fund (IMF) debt sustainability analysis, more than half of low-income countries – 35 of 68 – are currently in debt distress or at high risk of debt distress. Debt defaults have historically led to outsized, long-lasting reductions in output; a lack of access to international capital markets; and sharp increases in borrowing costs that hamper any subsequent economic recovery. UNCTAD expects moderate growth in the global South in 2025, with many developing regions experiencing a decline relative to 2024. Excluding China, growth in developing economies on aggregate is expected to remain at 3.7 per cent in 2025 before rising marginally to 3.8 per cent in 2026. It said amid the subdued global growth outlook, the developing economies of the global South are expected to contribute the lion’s share of global economic expansion in 2025, contributing just under 70 per cent of global output growth. Developing economies in Asia (excluding China) are projected to see a slowdown in growth, to 3.8 per cent in 2025, and to pick up to 4.0 per cent in 2026. Economic performance in South-East Asia is particularly impacted by trade shifts. On the brighter side, the report said the economy of India continues to exhibit strong growth amid continued robust public spending and private investment outlays. Western Asia is also projected to see a pickup in growth, to 3.1 per cent in 2025 and 3.7 per cent in 2026, on the back of increasing oil output agreed by OPEC+ countries as well as dynamism in specific non-oil sectors. In Latin America and the Caribbean, growth is expected to remain relatively weak, at 2.1 per cent in 2025 and 2026. The region’s exports are especially affected by trade measures in their principal destination markets, while elevated borrowing costs are weighing on domestic consumption and investment spending in several countries. The report said in Africa, growth is estimated at 3.7 per cent in 2025 and 4.1 per cent in 2026. A few African economies are experiencing rapid economic development, but a combination of global factors and idiosyncratic domestic conditions holds back the regional aggregate. POLICY RESPONSES In the current environment, proactive policy action is crucial to shield economies from the adverse effects of current shifts and an unpredictable international landscape. It must also lift economies out of their low-growth malaise, said the report. It said where fiscal pressures constrain critically-needed public spending and investments, particularly amid increasing debt-servicing costs and waning external financing, governments can look to boost public resources through enhanced and more efficient frameworks of domestic revenue mobilization. It said that failure to meet growing public investment needs is likely to have longlasting detrimental impacts on growth and development prospects, while unaddressed public spending constraints severely limit the capacity to enact countercyclical policies to manage demand shocks. Internationally, regulatory arbitrage – including tax avoidance, base erosion and profit shifting, particularly by larger corporations – continues to drain fiscal revenues from developing countries and can undermine financial stability, it said, adding that greater international tax cooperation is vital to address these harmful practices. Furthermore, increased concessional financing is needed to support development objectives, particularly in the most vulnerable developing countries. Coordinated global policy actions – encompassing concessional financing and debt relief – are critical to mitigate growing financing vulnerabilities. A key factor in reducing exposure to prevailing trade shifts is through deepening regional integration and export diversification. When a country’s exports have multiple destination markets, businesses can more easily adapt to shifts or downturns in one market by redirecting outward flows to others, the report noted. In this regard, it said that recently, China rerouted exports to alternative markets amid tariff escalation with the United States, suggesting that market diversification can cushion the impact of sudden shifts in any individual market on revenues and production. It also said that regional initiatives can help diversify productive structures and prevent excessive reliance on particular products – as well as any individual export destination market – while providing a potential bridge to global trade integration based on higher value-added goods. Multilateral institutions are crucial in mitigating the potentially negative spillover effects of policy decisions in one country on others. More generally, multilateral cooperation and coordinated policies are needed now more than ever to avert economic fragmentation, revitalize and sustain long-term growth, and tackle global challenges, the report concluded. +
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