by Ned Pagliarulo
State of the World Economy
In the October 2013 edition of the World Economic Outlook, a biannual report on the state of the world economy, the International Monetary Fund presents a somewhat downbeat assessment, trimming down its global growth forecast from 3.2% to 2.9% for this year. However, according to IMF estimates, as advanced economies pick up going into next year, growth will expand to 3.6%.
A number of factors came together to shape this outlook. While the US economy has shown some strength, particularly in the housing market, the signaled adjustment in US monetary policy will prompt some volatility around the world. There have been some signs of life in the Eurozone economies meanwhile, but the IMF is quick to note that “this is the result not of recent major policy changes but of a change in mood.” Advanced economies should contribute more to global growth next year than they have in the past (especially Europe), but there are many notes of caution in the IMF report.
Elsewhere, emerging market economies, previously a source of strength in the global economy, have been revised down as a group by 0.5% to 4.5% growth in 2013. The forecasts for Russia and India are both down as well, as the IMF predicted Russia at 1.5% (down 1% from the spring estimate) and India at 3.8% (down 1.8%). While China still looks relatively robust at 7.6%, its drop from double-digit growth will “affect the rest of the world through lower import demand and lower commodity prices.”
Emerging markets face the twin challenge of adjusting to lower levels of growth at the same time as their financial conditions tighten. In the eyes of the IMF, “China and a growing number of emerging markets are coming off cyclical peaks.” As they do so, “policy spillovers may pose greater concern,” particularly the upcoming decision by the US Federal Reserve to slow the pace of asset purchases. The market speculation on this decision has contributed to capital outflows from those markets, leading to equity market losses and depreciating currencies, for instance in India. The IMF repeatedly recommends in the report that emerging market governments pursue a strategy of allowing exchange rates to adjust while strengthening macro-prudential measures against financial instability.
In the report, the IMF identified the United States as the main “impulse to global growth.” The sharp deficit reduction that had been undertaken in the US — through tax policy and the sequester — led to a fiscal tightening of an estimated 2.5% of GDP in 2013. But, in 2014, this damper on growth will shrink to .75%. Fiscal policy has counterbalanced improvements in several economic fundamentals in the US. As this check on growth ebbs, positive trends in the fundamentals could propel the US economy forward.
According to IMF graphs, surveys of bank lending conditions have indicated more respondents felt that standards are easing “considerably or somewhat.” The US household debt-to-income ratio has shrunk from near 130% to a little over 100%, while housing prices have risen. Hopefully, rising household wealth and an easier borrowing environment will lead to more activity by US consumers heading into next year. Yet, all of this depends on the government shutdown resolution and a smooth increase in the debt ceiling. The IMF warns that a long shutdown would be “quite harmful”, while a US default “could seriously damage the global economy.” Although the deal struck by Congress has averted a continued shutdown and a default, for the time being, these risks remain on the horizon.
The IMF assumes that US governance problems will be resolved and that there will not be a default. However, outside of that unlikely possibility, the report does sketch out a scenario in which the global economy sees a number of disappointments and falls short of expectations. The strongest impact occurs in China and emerging Asia as the transition to domestic consumption in China fails to proceed smoothly. In this scenario, China sees growth below 6%, which would lead to a 1% decrease in growth in Asia. If China gets its transition to a more stable domestic expansion right, then the effect on the globe should be positive.
For the US, the downside scenario pictures a larger hike in interest rates from the Fed’s upcoming policy decision as well as tighter financial conditions overall. A well-managed shift in potential growth in China with a clearly communicated and understood Federal Reserve decision on monetary policy could go far in keeping global markets stable and boosting growth worldwide.