Global growth – Down but not out

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While equity and commodity markets have recovered, it is an almost consensus view that already tepid global economic growth in H2 2015 likely weakened furthered in Q3 and shows few signs of recovering near-term,

Governments, lacking in both leadership and fiscal-reflation headroom, have passed the buck to central banks struggling to hit multiple growth, inflation and financial stability targets.

However, talk of global recession let alone economic collapse is somewhat overdone and I reiterate my long-held view that the global growth story is a cause for concern, not panic (17 December 2014).

Global GDP growth has been mediocre but pretty stable in the past three years at around 2.4 and 3.2%, according to respectively World Bank and IMF estimates, so perhaps it is the expectation of a return to pre-2008 growth rates which is unfounded.

International institutions have revised down their global GDP growth forecasts for 2015 but history suggests that the IMF’s 2015 forecast of 3.1% growth may prove a tad too pessimistic.

The focus on China’s ill-defined “hard-landing” and “true” growth rate has obscured the fact that growth in US, still the world’s largest economy, is back to its long-term average. 

Finally, while policy-makers are running out of tools to spur their economies, a number of emerging market central banks, including in China and India, still have room to cut policy rates further.

First the bad news

Governments in the US, Eurozone and Japan are struggling to deliver on the structural reforms necessary to address challenging demographics and low productivity growth and are either unwilling or unable to fiscally reflate their indebted economies.

Lower global commodity prices have eroded global spending and investment as net energy importers’ propensity to spend this commodity-price windfall is smaller than net commodity exporters’ propensity to spend the spoils from high prices.

Emerging markets are facing the potentially self-reinforcing triple whammy of collapsing international trade, capital outflows and a stronger US dollar. Where central banks’ real policy rates are already low and currencies are under duress (South Africa, Russia, Mexico), policy-makers are likely to remain in a bind. China’s transition from over-investment to higher value-added exports and consumption driven growth has stalled, with markets struggling to quantify the damage to Chinese corporates and banks.

A lack of leadership lies at the heart of the problem:

  • In the US President Obama is nearing the end of an often impotent presidency, with politicians increasingly focussed on elections and the rag-tag list of presidential candidates.
  • Eurozone leaders, bogged down by the reputation-sapping Greece fiasco, are now in disunity over how to get to grips with the mounting emigration and refugee crisis. German Chancellor Merkel, regarded as the eurozone’s “safe pair of hands”, is facing up to falling popular support, splits within her coalition government, tepid German growth and a growing list of corporate scandals.
  • In the UK, Prime Minister Cameron, fresh out of national elections, is engaged in a bruising domestic and European battle to reform the EU ahead of a possible UK in-out referendum in 2017 while the media obsesses with the recent election of Jeremy Corbyn as opposition leader.
  • In China the plethora of policies introduced to stabilise falling economic growth and volatile capital markets has struggled to gain traction or backfired in the case of the token renminbi devaluation.
  • In Russia, the collapse in oil prices and Crimea’s annexation have severely weakened the economy and President Putin’s credibility.
  • In a number of large emerging markets, including Brazil and Malaysia, allegations of financial impropriety are rocking leaderships.
  • In Australia, the fifth prime minister in five years was recently appointed – hardly the pre-condition for sound long-term economic planning.

Governments have resorted to passing the buck to central banks which are ill-suited to hitting multiple targets of inflation, growth and financial stability and quickly running out of hard-hitting policy ammunition.

  • This policy dilemma is particularly acute at the US Federal Reserve, with mixed US data (including weak September non-farm payrolls) nullifying Chairperson Yellen’s call for a pre year-end rate hike.
  • Bank of England Governor Carney was forced into a number of u-turns last year following unexpectedly strong labour market data.
  • Eurozone inflation and employment are still stuck in the doldrums and the question is seemingly less whether but when the European Central Bank (ECB) will expand and/or extend its current QE program. My concern that the ECB’s quantitative easing was a little late to the party is unfortunately proving justified.

 Growth – The new normal?

Nevertheless, talk of global recession let alone economic collapse is somewhat overdone. Figure 1 shows that for the past three years global GDP growth has actually pretty stable.

  • According to the World Bank, which uses market exchange rates to estimate countries’ relative weights in global GDP, global real GDP growth has hovered around 2.4%, only marginally below the prior 15-year average of 2.9%. Admittedly GDP growth in H1 2015 of 2.5% year-on-year was 0.7 percentage points lower than the average growth recorded between 1997 and 2008.
  • According to the IMF, which uses Purchasing Power Parity (PPP) to estimate countries’ relative weights in global GDP, real GDP growth has hovered around 3.2%, one percentage point below the prior 15-year average. The IMF does not publish quarterly global growth numbers, which I therefore estimate using IMF PPP weights and country GDP growth rates.
  • The gap between the World Bank and IMF measures of global GDP growth is mainly due to the higher weight that the IMF ascribes to China which was growing very quickly. Conversely, the recent slowdown in China’s growth has had a bigger (negative) impact on the IMF’s measure of global growth. As a result the gap between the World Bank and IMF measures of global growth has narrowed in recent years.

It is the expectation that policy-makers somehow can and should engineer growth back to the pre financial crisis levels that is perhaps misguided. Put differently, global growth around 2.5-3.0% may well be the new normal, rather than the long-term 3.5% average let alone the heady 4-6% growth occasionally recorded in the late 1990s and mid-2000s.

olivier desbarres

Growth outlook not rosy but short of calamitous

While most Q3 GDP data will not be released for a few more weeks (see Figure 8), the list of indicators pointing to a slowdown in growth from Q2 is long and distinguished. In particular, the global manufacturing Purchasing Managers Index (PMI), which correlates reasonably well with global GDP growth, suggests that the World Bank’s measure of GDP growth slowed to around 2.4% yoy in Q3 (see Figure 3) while the IMF’s measure of growth slowed to 3.0% yoy (see Figure 4).

global growth fig 3&4

Unsurprisingly, the IMF and other financial institutions have had to further revise downwards their once-again overly optimistic annual forecasts (see Figure 5). Specifically, in its October World Economic Outlook, the IMF revised its global GDP growth forecasts for 2015 and 2016 to 3.1% and 3.6%, respectively, from the 3.3% and 3.8% forecasts made in its July World Economic Outlook. The OECD made similar downward revisions in its September Economic Outlook, as did the National Institute of Economic and Social Research in August and the World Bank in June.

Note, however, that in the previous five years the IMF’s World Economic Outlook October forecasts for global GDP growth that year have systematically under-estimated actual growth by on average 0.3 percentage points (see Figure 6). For example, the IMF in its October 2010 Economic Outlook forecast global GDP growth of 4.8% in 2010, compared to actual growth of 5.4%. If this pattern is replicated, the IMF’s 2015 growth forecast of 3.1% may prove a tad too pessimistic, with actual growth closer to the 2012-2014 average of just under 3.4%.

global growth fig 5&6

Chinese “hard-landing” – Over-used and ill-defined hyperbole

A Google search of “China hard landing” throws up 5.8 million results and yet a clear definition of what constitutes a Chinese hard landing or how to measure it remains elusive. That is not to deny that Chinese growth has slowed sharply in recent years but it is odd that so few, if any, attempts have been made to define the parameters of a hard landing and therefore whether Chinese policy responses are appropriate.

Ultimately it is a subjective assessment. Australian mining companies would clearly qualify China’s growth slowdown and associated collapse in the price of commodities such as coal and iron ore as a hard landing. But other export-driven economies such as Germany have fared far better, with German exports rising on average 0.3% per month in the four years to July 2015 (see Figure 7). If the 5% collapse in the euro-value of exports in August proves not to be a one-off, this could be evidence that China’s hard landing is being more widely felt.

Pace of change matters more than “true” Chinese growth rate

Furthermore, there has been much debate about the “true” rate of Chinese growth being closer to 4-5%. But to the extent that the Chinese economy is at the heart of the global economy, growth in the rest of the world and commodity prices – which presumably are accurately reported – already reflect weak Chinese growth.

Put differently, global growth and commodity prices are good indirect measures of Chinese growth and would be stronger if China really was growing at 7%. What is arguably more relevant is the pace of the Chinese growth slowdown, rather than the actual level of Chinese growth.

global growth fig 7&8

China and US (almost) equal partners in growth

The understandable fascination with slowing Chinese growth has perhaps distracted attention from the US economy’s recovery and its growing contribution to global growth.

US GDP growth over the past five quarters has averaged 3.1% quarter-on-quarter annualised, in line with the average growth rate in the twelve years preceding the great financial crisis (see Figure 2). With the US accounting for about 23% of the world’s (nominal) GDP based on market exchange rates, US real GDP growth since mid-2014 has accounted for about 28% of global growth (see Figure 9). This is still below China’s contribution of 37% but in the preceding three years, the Chinese and US contributions to global growth were, respectively, 48% and 14% (see Figure 10).

global growth fig 9&10

Scope for monetary easing

In emerging markets, there is scope for further central bank policy rate cuts (More EM central banks to join rate cutting party, 30 September 2015). Where real policy rates are still quite high (e.g. India, Philippines) and in particular where central bank FX reserves are sufficient to provide currency stability near-term (e.g. China), central banks have both the incentive and room to further loosen monetary policy in a bid to support economic growth (see Figure 11).

global growth fig 11

 

Olivier Desbarres currently works as an independent commentator on G10 and Emerging Markets. He has over 15 years’ experience with two of the world’s largest investment banks as an emerging markets economist, rates and currency strategist.

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