Why 2017 is Not 2012-16

The last five years are un­likely to be a good guide for what will un­fold next in the global econ­omy

The Economic Times - - The Edit Page - Chetan Ahya

Over the last five years, the global econ­omy has been through a num­ber of wob­bles. Ini­tially, de­vel­oped mar­kets (DMs) faced un­prece­dented delever­ag­ing head­winds. Sub­se­quently, China and other emerg­ing mar­kets (EMs) un­der­went a pe­riod of deep ad­just­ment.

The out­come was a global ex­pan­sion that was un-syn­chronous and heav­ily de­pen­dent on pol­icy stim­u­lus, which has been re­flected in years of be­low-par growth. From 2012 to 2016, global GDP growth has av­er­aged just 3.3% a year and, more re­cently, since 2014 Q2, global GDP growth has av­er­aged just 3.2% a year, well be­low the long-term av­er­age of 3.5%.

Fast for­ward to to­day, global growth is track­ing at its fastest pace since 2014 Q2. The growth has been broad­based, with up­side sur­prises in Europe and China. While some mod­er­a­tion in growth in the sec­ond half of 2017 is ex­pected, full-year global GDP growth is es­ti­mated at 3.6%, which would be the strong­est rate of growth since 2011. More­over, global growth is track­ing bet­ter than what we have built in for the full year (2017), prin­ci­pally due to a stronger-than-ex­pected out-turn in Q2.

There are a num­ber of fac­tors that dif­fer­en­ti­ate this year. First, both DM and EM growths are ac­cel­er­at­ing for the first time since 2010. Within that, the re­cov­ery has been broad-based across in­di­vid­ual economies too. Sec­ond, global trade in value and vol­ume terms is at its strong­est since 2011.

Third, the global in­vest­ment cy­cle has im­proved mean­ing­fully, as global ex-China gross fixed cap­i­tal for­ma­tion grew at the fastest pace in 2017 Q1 since 2015 Q1 in an­nual per­cent­age terms and in a broad-based fash­ion.

Fi­nally, while the strength of the re­cov­ery is sim­i­lar to that of 2010-11, the re­cov­ery was, to a large ex­tent, driven by base ef­fects and was, there­fore, some­what sta­tis­ti­cal in na­ture as it re­flected a re­cov­ery from a deep re­ces­sion, that re­cov­ery driven by ag­gres­sive mon­e­tary and fis­cal ex­pan­sion in both DMs and EMs. When eval­u­ated against this con­text, global growth is cur­rently track­ing at the best rate since the 2003-06 cy­cle.

Sharp Slow­down Ahead?

De­spite the re­cent strength in global growth, there is still a fair bit of scep­ti­cism. The three key de­bates are:

Will tight­en­ing by DM cen­tral banks cause a sharp slow­down? In­vestors con­tend that the re­cent sub­dued in­fla­tion prints are point­ing to­wards some weak­ness in ag­gre­gate de­mand, and the planned re­moval of mon­e­tary ac­com­mo­da­tion by DM cen­tral banks will hurt the re­cov­ery.

How­ever, pri­vate sec­tor risk at­ti­tudes are nor­mal­is­ing, as delever­ag­ing pres­sures are now be­hind us. In­deed, within G4, the non-fi­nan­cial pri­vate sec­tor has been lever­ag­ing up for the last four quar­ters. Fis­cal pol­icy is not tight­en­ing, as it was be­tween 2011and 2015. As the pri­vate sec­tor takes on a greater role in driv­ing growth, mon­e­tary­ac­com­mo­da­tion­can­be­grad­u­ally rolled back with­out caus­ing a sharp slow­down in growth.

Will a weak­en­ing of credit im­pulse in China weigh heav­ily on growth? In­vestors are con­cerned that with pol­i­cy­mak­ers now di­alling back the stim­u­lus, growth would de­cel­er­ate sharply, as it did dur­ing 2013-15.

There are three off­sets to this pol­icy tight­en­ing. First, ex­ter­nal de­mand is re­cov­er­ing and the con­tri­bu­tion of net ex­ports to growth has turned pos­i­tive. Pol­i­cy­mak­ers in China — who tend to run a coun­ter­cycli­cal growth model — are re­ly­ing less on debt-fu­elled pub­lic in­vest­ment de­mand, which is re­sult­ing in a par­ing back of ag­gre­gate credit growth.

More­over, pri­vate sec­tor in­vest­ment and pri­vate con­sump­tion are im­prov­ing, which is lend­ing sup­port to the on­go­ing re­cov­ery. In the prop­erty mar­ket, in­ven­tory lev­els have been de­clin­ing rapidly. Even though prop­erty pur­chase re­stric­tions have been tight­ened, the prop­erty mar­ket is un­likely to re­quire, or ex­pe­ri­ence, that depth of ad­just­ment it ex­pe­ri­enced dur­ing 2013-15.

Is re­cov­ery in emerg­ing mar­kets ex-China (EMXC) just about com­mod­ity price im­prove­ment and China? As China with­draws its stim­u­lus and com­mod­ity prices re­v­erse, growth in EMXC will de­cel­er­ate. But the re­cov­ery un­der­way in EMXC is not just about com­mod­ity prices. In­deed, both com­mod­ity ex­porters and im­porters have had a re­cov­ery in growth. More fun­da­men­tally, the ma­jor­ity of EMXC have had to un­dergo a pe­riod of ad­just­ment (pay­back), as they had pur­sued un­pro­duc­tive ex­pan­sion­ary poli­cies post-2009, which re­sulted in el­e­vated macro sta­bil­ity risks. This ad­just­ment is now com­pleted in most of th­ese EMs. Hence, a grad­ual re­cov­ery is now un­der­way.

Risks to Growth

To be sure, there are still risks to global growth, par­tic­u­larly in DMs as they are more ad­vanced in the busi­ness cy­cle. If DM cen­tral banks were to tighten even more ag­gres­sively than we are build­ing in, it could weigh on growth. In China, we are watch­ing risks to growth that could emerge if pol­i­cy­mak­ers take up more ag­gres­sive tight­en­ing from 2017 Q4 post the 19th Party Congress.

Our base case is that global growth will mod­er­ate some­what in the com­ing quar­ters from the cur­rent high run rate, but will set­tle on av­er­age at above trend for both 2017 and 2018. In other words, the ex­pe­ri­ence of the last five years is un­likely to be a good guide for what will un­fold next in the global econ­omy.

The writer is global co-head of eco­nom­ics, Mor­gan Stan­ley

It’s got cloudy

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