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Under the prolonged grip of Brexit

Under the prolonged grip of Brexit
The world economy, India included, has relatively smoothly absorbed the initial shocks from UK referendum of June 23 to exit the European Union – other than a weakening pound. In part, this was helped by readiness of major central banks to intervene with needed liquidity, which has supported confidence in market resilience, according to IMF.

Going forward, policy-makers in the United Kingdom and the European Union have a key role to play in helping reduce uncertainty. Of primary importance is a smooth and predictable transition to a new set of post-exit trading and financial relationships that as much as possible preserves gains from trade between the United Kingdom and the European Union.

In its World Economic Outlook (WEO) July Update, IMF, however, cautions that a longer period of uncertainty lies ahead until UK-EU renegotiate trade and financial relationships avoiding large increase in economic barriers that would not disrupt financial markets afresh.

IMF officials said the U.K. vote, which surprised global financial markets, came like “throwing a spanner in the works” at a time of hope of global outlook improving with a better-than-expected performance in early 2016. This deterioration reflects the expected macroeconomic consequences of a sizable increase in economic, political, and institutional uncertainty.

Still, making benign assumptions, IMF has marginally downgraded global and certain other growth projections, in a scenario of limited political fallout from the referendum, though it does not rule out more negative macroeconomic consequences, especially in advanced European economies. And with the event still unfolding, it is very difficult to quantify its potential repercussions.

Post-referendum asset price and exchange rate movements in emerging markets have been generally contained, it notes. Some revival in world trade is expected growing 2.9 percent in 2016 and 3.9 percent in 2017. That should offer some hope for exporting nations.

Global growth forecasts for 2016 and 2017 have both been marked down by 0.1 percentage points relative to the April WEO, to 3.1 percent and 3.4 percent, respectively. The outlook worsens for advanced economies (down by 0.1 and 0.2 percentage points in 2016 and 2017) – chiefly the United Kingdom.

The referendum-hit country will slow down from an earlier estimated 1.9 percent to 1.7 percent in 2016 and from 2.2 to 1.3 percent in 2017. This implies the larger build-up of uncertainty till 2017 as the new UK Government under Madam Theresa May, grapples with the “exit” complications and engages in tough negotiations with EU.

The impact of Brexit is projected to be muted for the United States, as lower long-term interest rates and a more gradual path of monetary policy normalisation are expected to broadly offset larger corporate spreads, a stronger U.S. dollar, and some decline in confidence.

While projections remain broadly unchanged for emerging market and developing economies in general, strangely, our India, the world’s “bright spot” and “fastest-growing economy”, is an exception with growth revised down from the 7.6 percent in 2015 to 7.4 percent for both fiscal 2017 and 2018 (as against the earlier IMF estimate of 7.5 percent for these two years.

In IMF language, “ In India, economic activity remains buoyant, but the growth forecast for 2016-17 (two fiscal years) was trimmed slightly, reflecting a more sluggish investment recovery”. Now, we must await the next October WEO to see whether monsoon and investment make a difference to the current Update.

So, that in a way reinforces what the outgoing RBI Governor Dr Raghuram Rajan has said this week that “we are in the midst of recovery”, despite shocks from global economy and Brexit, but that he would not thump the table to put a number on GDP growth. RBI’s last projection for fiscal 2017 was 7.6 percent, and as the monsoon develops and global factors play out, “there would be changes in the number.”

Maybe Dr Rajan may throw more some light when he makes the next and last bi-monthly review of monetary policy on August 9. He does expect the economy with “quite creditable performance”, amid global shocks, to move forward, but he would not get “overly fixated” with a particular growth rate. CPI inflation surge to 5.77 percent seems to rule out a rate cut, as a parting gift by him.

Manila-based Asian Development Bank in its update retains March estimates for India at 7.4 percent in 2016 and a higher 7.8 percent in 2017 with “expected support from brisk consumer spending and uptick in rural economy”.

Among countries of BRICS, fast-growing India apart, IMF expects Brazil and Russia, both oil and commodity exporters, to see a softening in their 2015 recession levels to -3.3 and 1.2 percent respectively in 2016 before growth turning positive for them in 2017. South Africa’s economy will remain flat in 2016.

On China, the world’s second-largest economy, IMF projection is 6.6 and 6.2 percent for the two years 2016/17. With policy support, fiscal and monetary, the near-term outlook has improved. Continued reliance on credit as a growth driver is heightening the risk of an eventual disruptive adjustment in China. The direct impact of the U.K. referendum will likely be limited, IMF notes, in light of China’s low trade and financial exposure to the United Kingdom. However, should growth in the European Union be affected significantly, the adverse effect on China could be material.

IMF update brings out other interesting trends. “The Brexit shock occurs amid unresolved legacy issues in the European banking system, in particular in Italian and Portuguese banks”. Hence, it calls for emerging market economies more broadly to remain alert to financial stability risks.

Risks of non-economic origin also remain salient. (Political divisions within advanced economies, refugee problem, geopolitical tensions and terrorism as also climate-related factors like drought in Africa and diseases in Latin America and Caribbean region).

More interestingly, with spreading discontent against neo-liberal economic policies, even across advanced nations, IMF Update acknowledges worsening of social tensions in a slow-growth environment with wage stagnation, structural economic change, and threats to entitlement programmes.

It is for policymakers (even more, political leaders) to counter developments that blame all ills on globally-oriented markets, it adds. But the counter-narrative must also offer the hope of policy actions that would ensure benefits of economic growth can be more fairly shared”. It is critical to deploy all policy levers efficiently—growth-friendly fiscal policies, well-sequenced structural policies, and monetary policy support for anchored inflation expectations.  

(The views expressed are strictly personal.)
S Sethuraman

S Sethuraman

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