Much cause for chagrin on global growth outlook

If the world economy is set to grow faster this year, then why are economists wearing such long faces? There are several reasons.

Europe’s growth rebound is one of the main contributors to the global recovery, but it is nowhere near high enough to pull the euro zone out of trouble, nor to mask the dysfunctional nature of its economics and politics.

The drop in the currency’s value has been one of the main developments in the past three months, creating uncertainty and dividing observers.

Quantitative easing by the European Central Bank at a time when the Federal Reserve is expected to hike interest rates in the US has certainly played a part in the euro’s weakness.

Optimists believe that monetary easing will boost demand and imports in the euro area, meaning Europe’s increased competitiveness from a weaker currency will not be detrimental to other economies.

We are not too sure.

The euro zone was already running a €236 billion (Dh944.34bn) current-account surplus last year. And with the euro falling so sharply now, the surplus could widen further as European exports become cheaper and imports more expensive.

If the world had only two countries, the current-account surplus of one country would be mirrored by an identical deficit in the other – and such a deficit detracts from growth. The surplus has to be balanced by something, so we could end up in a situation where the euro zone’s gain could be someone else’s loss.

How emerging markets respond to this scenario will be key to their growth prospects this year.

Countries could shield growth rates from external shocks by cutting interest rates, especially if inflation is low and interest rates are not close to zero per cent, as they are in the United States, Japan and the euro zone.

In fact, this is already happening. Twenty-four countries have eased monetary policy so far this year, and there is room for further easing, especially in China and South East Asia.

However, things could get more complicated. The monetary policy of small, open economies is not completely independent from that of much larger economies such as the US.

For example, if the Fed hiked interest rates aggressively and an emerging economy cut rates, the latter’s currency would likely weaken significantly against the US dollar. This could lead to problems, especially for countries with high levels of dollar-denominated liabilities.

What the Fed does will therefore be crucial. The market’s focus is on the timing of the first interest rate hike, but we think the speed of rate hikes and the anticipated peak of US interest rates are more important. And we expect the Fed’s hiking cycle to peak at 2 per cent, below the market consensus and Fed projections.

If we are correct, then the uncomfortable scenario for emerging markets, in which the Fed hikes while the euro zone’s current-account surplus widens further, might just be avoided.

Risks aside, there are also some positive developments in key emerging markets, such as India and China, that are worth noting.

According to our estimates, India is running a small current-account surplus, making it much more resilient to shocks in market sentiment. Our view is that India’s growth could be one of the positive surprises this year.

India’s growth has been mainly consumption-driven, and its infrastructure requires improvement. This year we expect investment to outpace consumption. China, on the other hand, needs – and is trying – to do the reverse.

The world is full of negative China stories, and the economy is slowing. Rebalancing such a large and complex economy is not easy, but despite the challenges we note two positive developments:

First, our data suggests that the housing market is bottoming. Although calling a rebound seems premature, our survey has detected an improved sentiment in the sector.

Second, China’s debt-to-GDP is levelling off at 251%. Although still high, this is good news, as it means credit growth is no longer faster than GDP growth, which is crucial for China’s rebalancing.

Our main case is for the world economy to improve this year, with India looking particularly attractive and China making progress on its rebalancing. This will be a long and challenging process, but it will lead to more sustainable growth.

European growth is picking up despite the mess in the euro zone and the US looks stronger. But yes, it’s complicated, and there is plenty out there for the worriers among us.

What we worry the most about is the risk of a policy mistake.

Marios Maratheftis is global head of macro research at Standard Chartered


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