Expect the world to grow by 2.5 per cent in 2016, lower than the 3 per cent of 2015. Why? Because we live in a world where growth is sluggish, and because we expect two of the world economy’s major drivers, the US and the euro area, to stagnate this year.
This is disappointing.
The world is suffering from weak demand. Policy makers in most countries are relying on monetary policy to boost growth. Low (and in some cases negative) interest rates and rounds of quantitative easing have failed to galvanise growth. Monetary policy increasingly looks impotent. Pushing interest rates further into negative territory is unlikely to boost demand, and might do more harm than good by hurting the banking system.
A sense of urgency is lacking
If the private sector is not borrowing to consume or invest despite the low-interest-rate environment, there is a need for governments to borrow and spend on key projects themselves. In the absence of a recession or a crisis, this is unlikely to happen. A sense of urgency is lacking.
Boost to Asian economies
China, however, is an exception, as the authorities seem determined to use fiscal policy to keep growth above 6.5 per cent. Indonesia and Thailand also look ready to implement infrastructure projects this year, which should boost their economies. Amid weak global growth, domestic policy in individual countries will play an increasingly important role.
Recent negativity on emerging markets has been driven by expectations of Federal Reserve (Fed) interest rate hikes, concerns about China and the collapse in oil prices. However, we think these three factors will be less of a concern in the next few months.
No more US rate hikes
For starters, we expect no more Fed hikes. We have held below-consensus views on the US economy for six years now, and continue to do so. Our growth forecast is below the Bloomberg consensus of 2.1 per cent, and below the 2.4 per cent actual growth recorded in both 2014 and 2015.
Fed is unlikely to hike interest rates again, which should be good news for emerging markets
Our below-consensus US view stems from the fact that financial conditions are tight, particularly with rising high-yield bond spreads and tighter bank lending conditions. Low oil prices are also leading to reduced energy-sector investment, which will have negative ramifications for manufacturing and local economies. Finally, we think the inventory cycle has peaked, and an inventory correction could drive growth lower.
In this environment, we think the Fed is unlikely to hike interest rates again, which should be good news for emerging markets.
The truth about China
We also think that negativity in China is overdone and that the world’s second-largest economy will grow by a solid 6.8 per cent this year.
But growth alone will not be enough to change negative sentiment towards China. After all, negative sentiment towards emerging markets – and China in particular – was widespread in 2015, though China’s growth remained a very high 6.9 per cent. Delivering growth will be essential, but not sufficient to improve sentiment.
If our growth forecasts are correct, China will grow almost seven times faster than the US economy
Two other factors will be important drivers of sentiment among international investors. The first is the way China communicates its policy. Uncertainty regarding China’s currency policy and equity-market intervention has been a negative factor. But since the Lunar New Year holiday, messages from the authorities have become clearer.
Second, how China manages its currency and capital outflows should boost investor sentiment and the economy. The market perception is that the Chinese yuan is overvalued and needs to weaken. We disagree. China runs a large current account surplus, which is not a sign of an overvalued currency. Although growth is decelerating, if our growth forecasts are correct, China will grow at more than double the pace of the world economy this year, and almost seven times faster than the US economy.
Stabilising the currency and capital outflows will be key in determining sentiment towards China, and emerging markets in general.
Expect oil prices to rise
The other big topic so far this year is oil prices, which are stabilising and have risen from their lows earlier this year. We expect prices to rise further, simply because we think that supply and production cannot be sustained otherwise. A supply crunch can rapidly push prices higher.
Momentum in the world economy is likely to remain sluggish, but sentiment should improve as markets readjust their expectations on the Fed, China and oil.