Global Economic Outlook For 2015
US Economy almost out of the woods
At the outset the 2015 global economic outlook would indicate to some stability with growth expected pick up to 3-3.3% in the next two years, up from 2.6% in 2014. This would occur amidst continuing depressed commodity prices, coupled with improving international trade prospects. The expected forecasted continuing soft crude oil prices would mean that there would be economic structural re-adjustments between oil exporting and importing countries. Since the post-crisis rebound, rate of economic growth has been at a pace slower than the first decade of the 2000’s. A simplistic global outlook would entail consideration of the impact of eventual hiking of monetary policy rate in United States which would lead to capital flight between disparate economies. Lastly, differential global recovery rates will have a varied constituent impact on economically linked and interdependent economies.
With United States gradual acceleration of economic recovery under way, and the instillation of life via QE in a stagnating Eurozone and possible receding headwinds in Japan, current crude oil prices should stimulate consumption albeit the prevalently latent aggregate demand. At a time when steady recovery is required, capital flight, an upshot of market volatility could lead to derailment of recovery effort. Therefore it is imperative that high income countries of Eurozone and Japan, institute fiscal policy reforms, both mid and long term, leading to tangible growth prospects. Accordingly, this is also an opportune time for some developing economies, benefiting from a lower oil import bill, to establish fiscal space, which could provide the necessary buffer to use when countercyclical fiscal policy inactions may be needed. With a receding oil import bill and accordingly production cost, issue of high unemployment should be swiftly addressed.
United Kingdom’s and U.S. economies have displayed similar recovery patterns. In both economies housing markets have improved and declining oil prices has propped disposable income increasing aggregate demand with an output nearing its potential. However, there is a sense of uncertainty as both brood impending interest rate hikes in the foreseeable future that may help wage rates, but can manifest in an increasing output gap via curtailment at the behest of potential rising production cost, aided via soft crude oil price. Reciprocally a soft demand in Eurozone bodes of a foreseeable weak export economic environment and, this bend, which entails addressing debt and financial recovery with its global economics implication, must be manoeuvred carefully.
Global Economic Challenges: Is QE/Monetary Easing Just a Placebo?
The slackness of the Euro Area needs no overstatement. With a directive to control stagflation, bank recapitalization and deleveraging may seem to run contrary to the ECB’s 1.1 trillion “Quantitative Easing” plan, but this addresses the issue of financial fragmentation within the EU, which should bolster investor confidence. With the institution of Asset Quality Review, aimed at improving broader operations, the compressing interest rate differentials with peripheral EU nations should be a leash of life for smaller EU economies, which should expedite economic recovery. With pick-up in Ireland and Spain underway, and fragmentation being addressed via uniformed policy implementation, the challenges of high unemployment and structural rigidities will resist prospects of growth recovery. A prolonged period of whining inflation and slow growth rates are on the horizon, with a modest growth figure of 1.1% for 2015 expected in the region. This situation is akin to the prevalent economic conditions of Japan, where a high savings rate, is detracting from investment even though soft oil prices should support recovery with contained cost of energy. With real wage rates below optimum, labor participation rate is subpar global financial crisis level and this needs addressing. The sales tax increase of 2014, a necessary fiscal reform and running counter to the logic of developing aggregate demand and its associated investment opportunity, is partially being balanced by an accommodative monetary policy with the Central Bank aiming to expand its balance sheet to 70% of GDP.
In the backdrop of soft commodity prices through 2015-2017, low oil prices would have transformational impact on the economies of exporting and importing countries, with the consequence of undermining fiscal balances and current account surpluses of already fragile oil exporting economies in the Middle East, Europe, Central Asia and Latin America. This scenario can also impact well buffered developed countries like Canada who have a major dependence on crude oil export value. Therefore, prolonged depressed oil prices can result in sharp currency depreciations of oil dependent economies, as we have seen for Nigeria’s naira and Russian ruble, brought about by financial stress which would have to be countered by accommodative monetary policy and a mounting international debt. Corporates and banks already have reasonable debt on their balance sheet, and with falling commodity prices a depreciated currency poses risk to further exasperate financial conditions. This could make way to drying of liquidity, a financial deterioration which sets the precedent for capital flight. This leads to sharp downward asset price revaluations and exchange rate movements. Also its marginal impact on country-specific headwinds, including weak confidence may encourage households and corporate to save rather than invest even with monetary easing. This already complex situation may be compounded by the fact that further monetary policy rates of some major central banks are near zero and thus the goal of stimulating recovery via inflation expectations is limited, voiding the need to implement Eurozone wide QE.
China in the driver’s Seat
China has adopted measures to address financial vulnerabilities, unwinding excess capacity in an effort to stem slowdown brought about by the effects of global economy. Credit tightening has decreased the momentum of the sizeable real estate market and scope of investment dampening growth prospects. Total debt stands at 250% of GDP and this has been the main source of growth since the global financial crisis. Well in excess of levels in Japan and Korea in the 1990’s by 2014 investment was a staggering 45% of GDP. However, the widening gap between debt accumulation and GDP growth rate is suggestive of diminishing returns with a forecast growth slowdown going under 7% by 2017. But there is ample room for maneuvering as public debt 60% of GDP, much lower than other counterpart industrialized nations, provides a necessary fiscal buffer if there is economic slowdown. Also with most sovereign debt domestically held, capital controls will prevent sharp outflows. Further a burgeoning $4 trillion foreign exchange buffer poses no threat to the moving-peg exchange rate strategy mobilized by the central bank favoring the country’s export drive. All inclusively the Chinese economy is still very well insulated from international shocks and the soft oil prices are expected to boost activity in 2015 barring any need for policy stimulus.
Declining International Trade Volumes
Since the global financial crisis global trade volumes have slowed significantly and the momentum has gotten off-track from its trajectory. Primarily the waning recovery of Eurozone, which accounts for a quarter of global international trade, has halted this steady growth trend. However, modest economic demand in the US economy now is facilitating global recovery, notwithstanding potential of fragility in as an aftermath of monetary tightening. Consequently this has impacted the GDP of countries reliant on these markets, affecting their own aggregate demand via international trade. Therefore, strengthening demand from high-income countries will have disparate impact on global recovery, linked to the recovery of relevant trading partners.
Clarity, a need of the day
As the U.S. Federal Reserve Bank approaches its interest rate hike in 2015, clear guidance would be imperative to reduce volatility of the financial landscape. The Euro has reached a decade low against the US$ and a technical analysis of Dollar Index points to a further strengthening of the $ at the expense of Euro. Macroeconomic recovery measures should address excessive speculation in the credit market, while a comprehensive long term roadmap for fiscal stability with emphasis on quality public spending will be a further aid. Educational improvement reforms would have a far reaching impact. A similar track has to be strategized by United Kingdom, which would address vulnerabilities of disposable income to fiscal reforms. ECB on the other hand requires an extended period of policy harmony even though this may mean a further weakening of the Euro. But still Mario Draghi’s, who after overcoming opposition, unveiling of the 1.1 trillion Euro’s government bond purchase program should certainly have far reaching consequences if Single Supervisory Mechanism gains traction by addressing structural reforms of job creation, financial system integration, aggregate demand development and private investment. On a similar note the sales tax imposition did place a potential drag on Japanese economic growth, fiscal measures are nonetheless necessary for the government to address growing public debt and the banking sector exposure to sovereign debt.
Theoretically the relationship between global economic growth and exchange rate movements is unclear as both Mundell-Fleming framework and Monetary models have opposing views. While the former suggests a negative correlation, with exchange rate expected to weaken as growth accelerates, brought through the impact of an income shock that deteriorates the current account balance. Contrastingly Monetary Models exhibit a positive correlation with stronger growth increasing demand for money and causing appreciation. Empirically confidence should be placed on the notion that , a strong currency helps in capital inflows, as this is ratified by data over the last three decades displaying a positive correlation between cyclical component of GDP and that of exchange rate movements. Factual data shows that past episodes of monetary tightening in the US have resulted with declines or reversals in capital flows to emerging markets. So how does this bode for developing countries growth prospects in a global perspective? Due to larger buffers brought about via stronger institutional development, and a strengthened monetary policy framework potential for financial tightening in developed countries is expected to be handled with greater ease by their governments. This could provide additional room for policy manoeuvring to support growth. More clearly, many developing countries have had adequate policy response to address inflationary issues and additionally increasing reserves and net foreign currency positions have improved, allowing room to withstand constraints being brought about by restrictive monetary policies in developing nations.
The potential turmoil market volatility can breed into the financial system will certainly be a challenge for oil net producing countries, as some developing countries may not have the relevant financial buffers to withstand this monetary shock. But this impact of volatility is not only limited to developing countries as the rapid appreciation of the US$ against many major currencies is a manifest reality. As discussed a fundamental analysis of the global market the 2014 asset tapering of Fed has led to the steady erosion of the Euro and the Yen, yet even with this both economies aggregate demand has remained slack and investment growth non-existent. Now with the anticipated FED interest rate hike that will lead to a tighter monetary policy and also the antecedent EU QE program has already bred tremendous reverberation in currency movements and the mid-term future for the Eurozone still appears bleak and global volatility skewed, an issue of paramount importance.