Global economy in the midst of fear

At the IMF and World Bank Annual Meetings in Lima (Peru) on October 9-10, the finance ministers of 188 member-countries are grappling with a weakened world economy. Some of the other concerns include the fall in trade volumes, volatile financial markets and China’s sharp slowdown and currency devaluation with serious global repercussions.

They faced a combination of negative factors threatening to worsen the current slowdown to 3.1 percent in 2015, even six years after the financial meltdown of 2008. These countries have called for nothing less than a strong, coordinated action to reinvigorate growth and lessen the current global uncertainties. A set of “right policies, strong leadership and global cooperation” is urgently needed, IMF Managing Director M. Christine Lagarde pointed out at the outset. She has urged all nations to upgrade their policy recipe to restore stability to the world economy. Three major factors contributing to global slowdown are the prospect of rising US interest rates, China’s painful readjustment to lower, sustainable growth, and rapid drop in commodity prices.  With the right policies, a crisis-like situation could be managed, she said.

IMF’s Regional Outlook for Asia and the Pacific, released as part of these annual meetings, draws attention to the loss of growth momentum in Asia, particularly in its emerging economies. According to the report, these emerging economies, a group of 7 nations, include China and India, as well as other developing countries in the region. Emerging Asian economies are faced with more challenging times over the next two years with their growth rate declining at an average from 6.8 percent in 2014 to a projected 6.5 in 2015 and 6.3 in 2016. Such a scenario essentially reflects the uncertain pace of China’s growth slowdown with global repercussions and financial market volatility that remains high. Asia as a whole, still the global growth leader, will also remain stuck at 5.4 percent in 2015-16.

The International Monetary Fund (IMF) has lowered India’s growth forecast for FY16 to 7.3 percent from its July forecast of 7.5 percent. Growth is expected to bounce back to 7.5 percent in 2016-17 on the back of reforms, a pick-up in investment and lower commodity prices, it said in its latest World Economic Outlook (WEO). This reduction, IMF officials pointed out, was given the more difficult external environment in general. Although India is also an open economy, it is not as open as China, and so when external demand weakens, Indian exports suffer. That has also pushed down the growth forecast for India.

On the positive side, the more favourable external development is the decline in commodity prices which, for an importing country like India, has helped to bring down inflation. While the export outlook is less rosy, the domestic demand component of growth looks “resilient and strong,” IMF spokesman noted. According to the Regional Outlook, Asia’s growth rests on relatively strong labor markets and a disposable income rise along with the ongoing gradual recovery in major advanced economies. For most major Asian economies, lower commodity prices should help consumption.

But negative risks to growth dominate, especially the possibility of a sharper slowdown in China or larger spillovers from the changing composition of China’s demand. In addition, further U.S. dollar strength accompanied by a sudden tightening of global financial conditions in the wake of a rate hike by US Fed before the end of the year poses risks of capital outflows from emerging market economies. In this challenging environment, the IMF Outlook calls  for “ carefully calibrated macroeconomic policies and a renewed impetus for structural reforms”  in emerging Asia to facilitate investment and improve economic efficiency, bolstering economic resilience, and potential growth.

For India, lower global oil prices have boosted ongoing economic activity and underpinned a further improvement in the current account and fiscal position and a sharp decline in inflation. Exports have dropped sharply, partly reflecting subdued global demand while the current recovery is sustained by domestic demand.

An incipient recovery of investment is expected to contribute more to India’s growth going forward, But in addition to policy actions taken recently, IMF says, further steps in relaxing longstanding supply bottlenecks, especially in the energy, mining, and power sectors, as well as labour and product market reforms, and improving the business climate are “crucial to achieving faster and more inclusive growth”. Reform agenda remains the holy grail of Modi Government though it has so far been unable to put through some of the major reforms like GST, apart from talking up the economy and reiterating resolve to contain revenue and fiscal deficits.  It has had to reassure Government leaders abroad of its determination to push ahead with its reforms soon. IMF says higher public infrastructure investment and initiatives to unclog raw material linkages and support the lending capacity of Indian banks should help crowd-in private investment. However, exports have weakened, with a continuous fall for nine consecutive months, depriving the economy of a growth impulse. The high corporate leverage and headwinds from weaknesses in India’s corporate and bank balance sheets will also weigh on the economy. On medium-term growth prospects, with Government’s keenness to hit 8 percent at the minimum, IMF says structural reforms should remain a priority for this growth by facilitating investment and job creation, which would also help lower vulnerabilities in the near term.

Asia has also experienced large capital outflows, and regional currencies have depreciated, according the Outlook. India which has also witnessed modest outflows in 2015 so far  and is highly dependent on external flows to finance infrastructure would be affected, going by the forecast by the International Institute of Finance that net capital flows to emerging markets this year would be negative for the first time since l988.

In this kind of scenario, as global financial conditions tighten, rise in long-term US rates after lift-off of the policy rate from its present near-zero level could lead to a spike in global risk aversion. If further capital outflows from Asia are triggered, IMF sees higher domestic borrowing costs and another bout of weakening of Asian currencies. It would pose balance sheet risks for corporates and households with foreign exchange exposure. The extent of deterioration of the global environment is substantially linked to the management of dominant risks for China’s growth while the economy is being rebalanced toward domestic consumption and services away from a credit-led investment. China has claimed that it grew by 7 percent in the first half of 2015, and the latest IMF projection is 6 .8 percent in 2015 and 6.3 percent in 2016.