The quest for robust and synchronised growth

Maurice Obstfeld

In this column, the IMF's new Economic Counsellor and Director of Research presents the latest World Economic Outlook, which shows how the world economy is at the intersection of at least three powerful forces. First is China’s economic transformation away from export- and investment-led growth and manufacturing, in favour of a greater focus on consumption and services; second is the fall in commodity prices; and third is the impending normalisation of monetary policy in the US.

The IMF’s new World Economic Outlook (IMF 2015) points out that the world economy is at the intersection of at least three powerful forces.

First, China’s economic transformation – away from export- and investment-led growth and manufacturing, in favour of a greater focus on consumption and services.

This process, however necessary and healthy in the longer term, has near-term implications for China’s growth and its relations with its trade partners.

Second, and related, the fall in commodity prices.

Years of high global demand drove prices upward and spurred investment in commodity sectors. But as China began to slow earlier during the present decade, many commodity prices turned downward, starting in the second half of 2011, and their fall has accelerated recently.

Third, there is the impending normalisation of monetary policy in the US.

Relatively favourable output and price performance in the US could soon justify an interest rate increase, but the possible global repercussions, especially in emerging and developing economies, add to current uncertainties.

Amid these developments, we project that in the near term global growth will remain moderate and uneven, with higher downside risks than were apparent at our July 2015 update. The ‘holy grail’ of robust and synchronised global expansion remains elusive.

Disparate fortunes

What do the numbers say? Broadly speaking, these reflect a reduction from our forecasts of last July. Global real GDP grew at 3.4% last year, but will grow at only 3.1% this year. For 2016, we project a rebound to 3.6% growth. We have reduced both of these numbers by 0.2 percentage points compared with our last projections three months ago.

The aggregate numbers reflect disparate fortunes between the advanced and the emerging market and developing economies.

In advanced economies we project a moderate growth pick-up this year relative to last, notably in the US and Eurozone. Unfortunately, Japanese growth seems to be faltering after a strong first quarter. Advanced economies grew at a 1.8% rate last year but we see a modest increase at 2.0% this year, then accelerating to 2.2% in 2016.

As always, the figures for advanced economies in general mask diverse prospects across individual countries.

Major commodity producers, notably Canada but also Australia and Norway, are experiencing slowdowns. Along with the fall in real incomes due to poorer terms of trade, there are also negative investment effects in the commodity-producing sectors, which have proved a significant headwind to growth even in the US.

But the downward trend in commodity prices, which, as I have noted, has accelerated recently, is having its most dramatic effects in the emerging and developing commodity exporters. For this group of countries – that now represents well over half of world GDP and will still generate the lion’s share of world growth – 2015 growth is projected to fall to 4.0% from its 2014 level of 4.6%. This rate of growth is much lower than what we saw in the recovery from the Global Crisis, and represents the fifth straight year of falling GDP growth for emerging and developing economies.

Of course, while commodities are a big part of the story, they are not the whole story: in some cases, political instability could be a bigger factor, or an overhang of debt after capital inflows and over-investment earlier this decade.

We project a rebound for next year, with 4.5% growth in emerging and developing economies, and a further pickup in subsequent years. This rebound mostly reflects an expected gradual normalisation of conditions in countries experiencing especially deep recessions this year – such as Brazil and Russia – as well as in some other economies that are currently growing much below trend, including in Latin America.

Future risks to emerging and low-income countries

To be sure, many emerging markets have increased their resilience to external shocks with increased exchange rate flexibility, higher foreign exchange reserves, increased reliance on foreign direct investment flows and domestic-currency external financing, and generally stronger policy frameworks.

That being said, we have recently become more worried about potential downside risks that may threaten this recovery – all the more so because some countries have limited policy space to respond. The new releases of the Global Financial Stability Report and the Fiscal Monitor cover financial and fiscal risks in detail. But some obvious concerns stand out.

A notable risk is a rapid decompression of bond risk premiums, leading to spikes in longer-term interest rates.

Indeed, we have already seen some of this increase for some emerging and developing economies, especially commodity exporters.

Exchange rate depreciation has generally been a helpful buffer for emerging and developing countries experiencing growth slowdowns – and has already been substantial – but could cause adverse balance-sheet effects where there is foreign currency borrowing. Some countries have proactively tightened monetary policy to keep inflation expectations well anchored.

Needed: Proactive policy management

No single set of policy prescriptions is suitable for every country seeking to improve growth performance or build resilience. But some familiar general principles still apply.

Emerging market and developing economies need to be ready for monetary policy normalisation by the US.

Enhanced surveillance over financial vulnerabilities, as well as a further shift away from debt finance, especially foreign currency financing, will be helpful preparations.

Targeted capital flow measures could also play a useful role.

Fiscal frameworks should be strengthened, with due attention to the needs to safeguard growth and to preserve social safety nets for the most vulnerable.

Advanced economies must continue to deal with crisis legacies, including non-performing loans, where they persist.

At the same time, monetary accommodation should continue where output gaps are negative, supplemented by fiscal measures where fiscal space permits. Deflation pressures remain in several regions.

In many economies, whether advanced or not, the case for infrastructure investment seems compelling at a time of very low long-term real interest rates and concerns about low global demand.

Higher investment is one way to enhance potential output growth, but targeted structural reforms can also play an important positive role. Such reforms help not only to enhance future growth, but to increase the resilience of growth.

Reference

IMF (2015), World Economic Outlook: Adjusting to Lower Commodity Prices, Washington, DC.