By guest author Maury Obstfeld, IMF Economic Counsellor and Director, Research Department:
The Global Expansion: Still Strong but Less Even, More Fragile, Under Threat
Amid rising tensions over international trade, the broad global expansion that began roughly two years ago has plateaued and become less balanced. We continue to project global growth rates of just about 3.9 percent for both this year and next, but judge that the risk of worse outcomes has increased, even for the near term.
Growth remains generally strong in advanced economies, but it has slowed in many of them, including countries in the euro area, Japan, and the United Kingdom. In contrast, GDP continues to grow faster than potential and job creation is still robust in the United States, driven in large part by recent tax cuts and increased government spending. Even U.S. growth is projected to decelerate over the next few years, however, as the long cyclical recovery runs its course and the effects of temporary fiscal stimulus wane. For the advanced economies, we project 2018 growth of 2.4 %, down 0.1 percentage point from our April World Economic Outlook projection. We maintain an unchanged forecast of 2.2 % growth in those economies for 2019.
For emerging market and developing economies as a group, we still project growth rates of 4.9 % for 2018 and 5.1 % for 2019. These aggregate numbers, however, conceal diverse changes in individual country assessments.
China continues to grow in line with our earlier projections. In some large economies in Latin America, emerging Europe, and Asia, we now project growth rates below our April forecasts. Supply disruptions and geopolitical tensions have helped raise oil prices, benefiting emerging oil exporters (for example, Russia and Middle Eastern suppliers) but harming importers (for example, India). For the aggregate of emerging market economies, the upward and downward revisions largely offset each other.
Overall growth in sub-Saharan Africa will exceed that of population over the next couple of years, allowing per capita incomes to rise in many countries; but despite some recovery in commodity prices, growth will still fall short of the levels seen during the commodity boom of the 2000s. Adverse developments in Africa—civil strife or weather-related shocks, for example—could intensify outward migration pressures, especially toward Europe.
As always, Federal Reserve policy is central to global financial developments. Given strong U.S. employment and firming inflation, the Fed is on track to continue raising interest rates over the next two years, tightening its monetary policy compared with other advanced economies and strengthening the U.S. dollar. The dollar has already appreciated broadly since April, and financial conditions facing emerging and frontier economies have become somewhat more restrictive. These financial conditions remain relatively benign in historical context despite that tightening, however. Markets—so far—continue to differentiate among borrowers, and capital account pressures have been most intense for those with evident weaknesses (for example, political uncertainty or macroeconomic imbalances). Were the Fed to tighten faster than is currently expected, however, a broader range of countries could feel more intense pressures.
But, the risk that current trade tensions escalate further—with adverse effects on confidence, asset prices, and investment—is the greatest near-term threat to global growth. Global current account imbalances are set to widen owing to the United States’ relatively high demand growth, possibly exacerbating frictions. The United States has initiated trade actions affecting a broad group of countries, and faces retaliation or retaliatory threats from China, the European Union, its NAFTA partners, and Japan, among others. Our modeling suggests that if current trade policy threats are realized and business confidence falls as a result, global output could be about 0.5 percent below current projections by 2020. As the focus of global retaliation, the United States finds a relatively high share of its exports taxed in global markets in such a broader trade conflict, and it is therefore especially vulnerable.
Other risks have become more prominent since our April assessment. Political uncertainty has risen in Europe, where the European Union faces fundamental political challenges regarding migration policy, fiscal governance, norms concerning the rule of law, and the euro area institutional architecture. The terms of Brexit remain unsettled despite months of negotiation. Prospective political transitions in Latin America over coming months add to the uncertainty. Finally, although some geopolitical dangers may appear to be in remission, their underlying drivers in many cases are still at work.
Financial markets seem broadly complacent in the face of these contingencies, with elevated valuations and compressed spreads in many countries. At the same time, however, high levels of public and private debt create widespread vulnerability. Asset prices are no doubt buoyed, not only by easy financial conditions, but by the generally still satisfactory global growth picture. They therefore are susceptible to sudden re-pricing if growth and expected corporate profits stall. Supporting growth into the medium term—where trend growth rates are forecast to be lower for advanced economies and many commodity exporters—requires that policymakers act now to raise growth potential and resilience through reforms, while re- building fiscal buffers and guiding monetary policy carefully to keep inflation expectations well anchored on targets.
Governments must also pay more attention to economic equity among citizens, and especially protecting the poorest. The widespread political malaise driving many current policy risks, including on the trade front, has roots in several countries’ experiences of non- inclusive growth and structural transformation, heightened by the financial crisis of 2007-09 and the difficulties that followed. It is urgent to address the underlying trends through equity- and growth-friendly policies, while assuring that macroeconomic tools are available to fight the next economic slowdown. Otherwise, the political future will only darken.
While rising to these challenges, countries must resist inward-looking thinking and remember that on a range of problems of common interest, multilateral cooperation is vital. Issues of common concern—where national action is not enough—include strengthening the multilateral trading system, reducing excess global imbalances, financial stability policy, international tax policy, cyber and other terrorist threats, disease control, and global warming. A truly global effort is also needed to curtail corruption, which undermines faith in government in so many countries. Finally, recurrent surges in international migration pressures, which have proven so politically destabilizing recently, cannot be avoided without cooperative action to improve international security, support the Sustainable Development Goals, and resist climate change and its effects.”
Here is the full IMF update:
Less Even Expansion, Rising Trade Tensions
- Global growth is projected to reach 3.9 % in 2018 and 2019, in line with the forecast of the April 2018 World Economic Outlook (WEO), but the expansion is becoming less even, and risks to the outlook are mounting. The rate of expansion appears to have peaked in some major economies and growth has become less synchronized. In the United States, near-term momentum is strengthening
in line with the April WEO forecast, and the US dollar has appreciated by around 5 % in recent weeks. Growth projections have been revised down for the euro area, Japan, and the United Kingdom, reflecting negative surprises to activity in early 2018. Among emerging market and developing economies, growth prospects are also becoming more uneven, amid rising oil prices, higher yields in the United States, escalating trade tensions, and market pressures on the currencies of some economies with weaker fundamentals. Growth projections have been revised down for Argentina, Brazil, and India, while the outlook for some oil exporters has strengthened.
- The balance of risks has shifted further to the downside, including in the short term. The recently announced and anticipated tariff increases by the United States and retaliatory measures by trading partners have increased the likelihood of escalating and sustained trade actions. These could derail the recovery and depress medium-term growth prospects, both through their direct impact on resource allocation and productivity and by raising uncertainty and taking a toll on investment. Financial market conditions remain accommodative for advanced economies—with compressed spreads, stretched valuations in some markets, and low volatility—but this could change rapidly. Possible triggers include rising trade tensions and conflicts, geopolitical concerns, and mounting political uncertainty. Higher inflation readings in the United States, where unemployment is below 4 % but markets are pricing in a much shallower path of interest rate increases than the one in the projections of the Federal Open Market Committee, could also lead to a sudden reassessment of fundamentals and risks by investors. Tighter financial conditions could potentially cause disruptive portfolio adjustments, sharp exchange rate movements, and further reductions in capital inflows to emerging markets, particularly those with weaker fundamentals or higher political risks.
- Avoiding protectionist measures and finding a cooperative solution that promotes continued growth in goods and services trade remain essential to preserve the global expansion. Policies and reforms should aim at sustaining activity, raising medium-term growth, and enhancing its inclusiveness. But with reduced slack and downside risks mounting, many countries need to rebuild fiscal buffers to create policy space for the next downturn and strengthen financial resilience to an environment of possibly higher market volatility.
Expansion Continues at a Less Even Pace
As the global cyclical upswing approaches its two-year mark, the pace of expansion in some economies appears to have peaked and growth has become less synchronized across countries. Among advanced economies, growth divergences between the United States on one side, and Europe and Japan on the other, are widening. Growth is also becoming more uneven among emerging market and developing economies, reflecting the combined influences of rising oil prices, higher yields in the United States, sentiment shifts following escalating trade tensions, and domestic political and policy uncertainty. While financial conditions remain generally benign, these factors have resulted in capital inflow reductions, higher financing costs, and exchange rate pressures, more acute in countries with weaker fundamentals or higher political risks. High-frequency data present a mixed picture of near-term global activity.
Retail sales volumes appear to have picked up in the second quarter, and survey data of purchasing managers for the service sector remain generally strong. Industrial production, however, appears to have softened, and survey data of purchasing managers in manufacturing indicate a weakening of new export orders.
Commodity prices and inflation. Largely reflecting supply shortfalls, global oil prices increased 16 % between February 2018 (the reference period for the April 2018 WEO) and early June 2018 (the reference period for the July 2018 WEO Update). In June, the Organization of Petroleum Exporting Countries (OPEC) and non-OPEC oil producers agreed to raise oil production by about 1 million barrels per day from current levels, correcting the recent undershooting of the November 2016 group target. Market expectations suggest that declining capacity in Venezuela and US sanctions on Iran may pose difficulties for the group to deliver the agreed upon production increase consistently. Futures markets, however, indicate prices are likely to decline over the next 4–5 years (in part due to increased US shale production)—as of end-June, medium-term futures prices are about USD 59 per barrel (20 % below current levels). The increase in fuel prices has lifted headline inflation in advanced and emerging market economies. Core inflation has strengthened in the United States as the labour market has tightened further, and inched up in the euro area. Core inflation in emerging markets has also increased, reflecting pass-through effects from currency depreciation in some cases and second-round effects of higher fuel prices in others. Prices of agricultural commodities have increased marginally, reflecting diminishing excess supply.
Financial conditions in advanced economies. With firmer readings on inflation and strong job creation, the US Federal Reserve continued the course of gradual policy normalization. It raised the target range for the Federal Funds rate by 25 basis points in June, while signalling two additional rate hikes in 2018 and three in 2019—a steeper schedule than indicated in March. The ECB announced that it will taper its monthly asset purchases from the current EUR 30 billion to EUR 15 billion in October, with an anticipated end to the program on December 31. It also indicated it will maintain policy rates at their current levels at least through the summer of 2019, a somewhat more accommodative forward guidance than anticipated by markets. US Treasury 10-year yields, at around 2.85 % as of early July, have risen modestly since February, while yields on German 10-year bunds, at around 30 basis points, have declined over the same period. Among other advanced economies, in late May Italian sovereign spreads widened by their largest amount since 2012, following difficulties around the formation of a new government. They have since declined but remain around 240 basis points as of early July on concerns about future policies. Spillovers to other advanced economies’ bond markets were mostly contained, with other euro area spreads remaining compressed. Equity prices in advanced economies are generally higher than their February-March levels. After the February spike, volatility has subsided and risk appetite has been strong. Consequently, financial conditions in advanced economies remain generally accommodative.
Financial conditions in emerging markets. Central banks in key emerging market economies —including Argentina, India, Indonesia, Mexico, and Turkey—have raised policy rates, responding to inflation and exchange rate pressures (coupled with capital flow reversals in some cases). Long-term yields have also increased in recent months, and spreads have generally widened. Most emerging market equity indices have declined modestly, reflecting, in some cases, concerns about imbalances (e.g., Argentina and Turkey), and, more generally, rising downside risks to the outlook.
Exchange rates and capital flows. As of early July 2018, the US dollar has strengthened by over 5 % in real effective terms since February (the reference period for the April 2018 WEO), while the euro, Japanese yen, and British pound sterling are broadly unchanged. In contrast, some emerging market currencies have depreciated sharply. The Argentine peso has weakened by over 20 % and the Turkish Lira by around 10 %, due to concerns about financial and macroeconomic imbalances. The Brazilian real has depreciated by over 10 % on a weaker-than-expected recovery and political uncertainty. Weaker-than-anticipated macroeconomic data for South Africa contributed to the 7 % depreciation of the South African Rand, unwinding part of the sharp appreciation that had occurred in late 2017 and early 2018. The currencies of the largest emerging market economies in Asia have remained broadly in line with their levels in February, with the Chinese renminbi depreciating modestly. Reflecting signs of financial stress in some more vulnerable countries and growing trade tensions, capital flows to emerging economies weakened in the second quarter (through May) after a strong start to the year, with a pickup in non-resident sales of portfolio debt securities.
Global Growth Forecast
Global growth for 2018 and 2019 is projected at 3.9 %, as forecast in the April 2018 WEO. While headline numbers suggest a broadly unchanged global outlook relative to the April WEO, underlying revisions point to differing prospects across economies. The baseline forecast assumes gradually tightening but still favourable financial conditions, with localized pressures based on differences in fundamentals. Monetary policy normalization in advanced economies is assumed to proceed in a well- communicated, steady manner. Domestic demand growth (notably investment, which has been an important part of the global recovery) is expected to continue at a strong pace, even as overall output growth slows in some cases where it has been above trend for several quarters. In the baseline forecast, the direct contractionary effects of recently announced and anticipated trade measures1 are expected to be small, as these measures affect only a very small share of global trade so far. The baseline forecast also assumes limited spillovers to market sentiment, even if escalating trade tensions are an important downside risk.
Advanced economy growth is expected to remain above trend at 2.4 % in 2018— similar to 2017—before easing to 2.2 % in 2019. The forecast for 2018 is lower by 0.1 percentage point compared to the April WEO, largely reflecting greater-than-expected growth moderations in the euro area and Japan after several quarters of above-potential growth.
- In the United States, near-term momentum in the economy is expected to strengthen temporarily in line with the April WEO forecast, with growth projected at 2.9 % in 2018 and 2.7 % in 2019. Substantial fiscal stimulus together with already-robust private final demand will lift output further above potential and lower the unemployment rate below levels last registered 50 years ago, creating additional inflationary pressures. Imports are set to pick up with stronger domestic demand, increasing the US current account deficit and widening excess global imbalances.
- Growth in the euro area economy is projected to slow gradually from 2.4 % in 2017 to 2.2 % in 2018 and to 1.9 % in 2019 (a downward revision of 0.2 percentage point for 2018 and 0.1 percentage point for 2019 compared with the April WEO). Forecasts for 2018 growth have been revised down for Germany and France after activity softened more than expected in the first quarter, and in Italy, where wider sovereign spreads and tighter financial conditions in the wake of recent political uncertainty are expected to weigh on domestic demand.
- The growth forecast for Japan has been marked down to 1.0 % for 2018 (0.2 percentage point below the April WEO projection) following a contraction in the first quarter, owing to weak private consumption and investment. The economy is expected to strengthen over the remainder of the year and into 2019, aided by stronger private consumption, external demand, and investment.
Emerging market and developing economies have experienced powerful crosswinds in recent months: rising oil prices, higher yields in the United States, dollar appreciation, trade tensions, and geopolitical conflict. The outlook for regions and individual economies thus varies depending on how these global forces interact with domestic idiosyncratic factors. Financial conditions remain generally supportive of growth, though there has been differentiation across countries based on economic fundamentals and political uncertainty. With the updraft on oil exporters from higher oil prices largely offset by the combined drag on other economies from the forces described above, the group’s overall 2018 and 2019 growth forecasts remain unchanged from the April WEO at 4.9 and 5.1 %, respectively.
1 These include the increase in US tariffs on imported solar panels, washing machines, steel, aluminium, and a range of Chinese products, and the announced retaliatory measures by trading partners as of July 6. The effect of the broader trade actions announced by the United States on July 10 is not incorporated in the baseline.
- Emerging and Developing Asia is expected to maintain its robust performance, growing at 6.5 % in 2018–19. Growth in China is projected to moderate from 6.9 % in 2017 to 6.6 % in 2018 and 6.4 % in 2019, as regulatory tightening of the financial sector takes hold and external demand softens. India’s growth rate is expected to rise from 6.7 % in 2017 to 7.3 % in 2018 and 7.5 % in 2019, as drags from the currency exchange initiative and the introduction of the goods and services tax fade. The projection is 0.1 and 0.3 %age point lower for 2018 and 2019, respectively, than in the April WEO, reflecting negative effects of higher oil prices on domestic demand and faster- than-anticipated monetary policy tightening due to higher expected inflation. Growth in the ASEAN-5 group of economies is expected to stabilize at around 5.3 % as domestic demand remains healthy and exports continue to recover.
- In Emerging and Developing Europe, growth is projected to moderate from 5.9 % in 2017 to 4.3 % in 2018 and further to 3.6 % in 2019 (0.1 percentage point lower than in the April WEO for 2019). Financial conditions have tightened for some economies with large external deficits— notably Turkey, where growth is set to soften from 7.4 % in 2017 to 4.2 % this year.
- Growth in Latin America is projected to increase modestly from 1.3 % in 2017 to 1.6 % in 2018, and further to 2.6 % in 2019 (0.4 and 0.2 percentage point lower than projected in the April WEO). While higher commodity prices continue to provide support for commodity exporters in the region, the subdued outlook compared with April reflects more difficult prospects for key economies, owing to tighter financial conditions and needed policy adjustment (Argentina); lingering effects of strikes and political uncertainty (Brazil); and trade tensions and prolonged uncertainty surrounding the NAFTA renegotiation and the policy agenda of the new government (Mexico). The outlook for Venezuela, which is experiencing a dramatic collapse in activity and a humanitarian crisis, was revised down further, despite the pickup in oil prices, as oil production has declined sharply.
- Oil exporters in the Middle East, North Africa, Afghanistan, and Pakistan region have benefited from the improved outlook for oil prices, but the outlook for oil importing countries remains fragile. Several economies still face large fiscal consolidation needs and the threat of intensifying geopolitical conflict continues to weigh on growth in the region. Growth is projected to strengthen from 2.2 % in 2017 to 3.5 % in 2018 and further to 3.9 % in 2019—0.2 percentage point higher than in the April WEO for 2019.
- The recovery in Sub-Saharan Africa is set to continue, supported by the rise in commodity prices. For the region, growth is expected to increase from 2.8 % in 2017 to 3.4 % this year, rising further to 3.8 % in 2019 (0.1 percentage point higher for 2019 than forecast in the April WEO). The upgraded forecast reflects improved prospects for Nigeria’s economy. Its growth is set to increase from 0.8 % in 2017 to 2.1 % in 2018 and 2.3 % in 2019 (0.4 percentage point higher than in the April WEO for 2019) on the back of an improved outlook for oil prices. Despite the weaker-than-expected first quarter outturn in South Africa (in part due to temporary factors), the economy is expected to recover somewhat over the remainder of 2018 and into 2019 as confidence improvements associated with the new leadership are gradually reflected in strengthening private investment.
- Growth in the Commonwealth of Independent States is projected to stabilize at around 2.3 % in 2018–19, with an upward revision of
0.1 percentage point for each year compared with the April WEO. The outlook for the Russian economy is similar to the April projection, with the positive effects of higher oil prices counterbalanced by the impact of sanctions, while the outlook for Kazakhstan has improved on stronger oil prices.
Risks Tilted to the Downside
While the baseline forecast for global growth is roughly unchanged, the balance of risks has shifted to the downside in the near term and, as in the April 2018 WEO, remains skewed to the downside in the medium term. The possibility for more buoyant growth than forecast has faded somewhat in light of the weak outturns in the first quarter in several large economies, the moderation in high-frequency economic indicators, and tighter financial conditions in some vulnerable economies. Downside risks, on the other hand, have become more salient, most notably the possibilities of escalating and sustained trade actions, and of tighter global financial conditions.
- Financial tensions. Recent bouts of volatility highlight the possibility of abrupt shifts in global financial conditions due to markets’ reassessment of fundamentals and risks, including changing expectations about monetary policy or the effects of rising trade tensions, sudden increases in risk- or term premia, and increasing political uncertainty. As discussed in the April 2018 WEO and Global Financial Stability Report, signs of firmer-than- expected inflation in the United States could lead to a shift in market expectations of US interest rate hikes, which are currently well below those in the WEO baseline forecast. A sudden deterioration of risk appetite could trigger disruptive portfolio adjustments, accelerate and broaden the reversal of capital flows from emerging markets, and lead to further US dollar appreciation, straining economies with high leverage, fixed exchange rates or balance sheet mismatches. In some euro area countries, policy inaction and political shocks at the national level could lead to sovereign spread decompression, worsening public debt dynamics and weakening bank balance sheets. In China, where the authorities are taking welcome steps to slow credit growth, uncoordinated financial and local government regulatory action could have unintended consequences that trigger disorderly repricing of financial assets, increase rollover risks, and lead to stronger-than-forecast negative effects on activity.
- Trade tensions. The outlook is also clouded by ongoing trade tensions and waning support for global economic integration in some advanced economies. In the past few months, the United States has imposed tariffs on a variety of imports, prompting retaliatory measures from trading partners. At the same time, NAFTA and the economic arrangements between the United Kingdom and the rest of the European Union are under renegotiation. An escalation of trade tensions could undermine business and financial market sentiment, denting investment and trade. Beyond its immediate toll on market sentiment, the proliferation of trade measures could increase the uncertainty about the potential breadth of trade actions, thus hindering investment, while higher trade barriers would make tradable goods less affordable, disrupt global supply chains, and slow the spread of new technologies, thus lowering productivity.
- Noneconomic factors. By raising the possibility of slower reform implementation or significant changes in policy objectives, political uncertainty, including in the context of upcoming elections or their immediate aftermaths in several countries, could deter private investment and weaken economic activity. In Europe, the late May sell-off in Italian bonds has once again turned the spotlight on deep structural challenges and thin buffers at the national level, posing significant risks to the outlook. Geopolitical risks and domestic strife are weighing on the outlook in several economies, especially in the Middle East and sub-Saharan Africa. Furthermore, many countries remain vulnerable to the economic and humanitarian costs of extreme weather events and other natural disasters, with potentially significant cross-border ramifications through migration flows.
While the baseline forecast for the global economy points to continued, if less even expansion in 2018–19, the potential for disappointments has increased. Against this backdrop, there is an even greater urgency to advance policies and reforms that extend the current expansion and strengthen resilience to reduce the possibility of a disruptive unwinding. Moreover, medium-term per capita growth projections remain below past averages in many economies. Without comprehensive measures to raise potential output and ensure the benefits are shared by all, disenchantment with existing economic arrangements could well fuel further support for growth-detracting inward-looking policies. Multilateral cooperation within an open, rule-based trade system has a vital role to play in preserving the global expansion and strengthening medium-term prospects. Given the diversity of cyclical positions, structural constraints, and available policy space, policy priorities differ across countries.
- In advanced economies, the macroeconomic stance should be tailored to the maturing cyclical position. Where inflation is converging to targets, a gradual, well-communicated, data-dependent monetary normalization can ensure a smooth adjustment. With debt levels near record highs in many countries, fiscal policies should start rebuilding buffers where needed. The pace should be calibrated to avoid sharp drags on growth, with appropriate measures to enhance economic inclusion. Procyclical fiscal stimulus should be avoided and rolled back (e.g., United States), while further steps should be taken by countries with fiscal space and excess external surpluses to boost domestic growth potential and address global imbalances (e.g., Germany). To strengthen medium term prospects, countries should prioritize supply-side measures that raise potential output and productivity, including investing in physical and digital infrastructure, boosting labor force participation where aging threatens future labour supply, and enhancing workforce skills. Repairing remaining pockets of vulnerability in the financial sector is essential in some advanced economies in the euro area, including through continued balance sheet clean-up, promoting consolidation in overbanked jurisdictions, and boosting bank profitability. More broadly, avoiding an indiscriminate rollback of post-crisis regulatory reforms would help maintain resilience in a potentially more volatile financial environment.
- Many emerging market and developing economies need to enhance resilience through an appropriate mix of fiscal, monetary, exchange rate, and prudential policies to reduce vulnerability to tightening global financial conditions, sharp currency movements, and capital flow reversals. Long-standing advice on the importance of reining in excess credit growth where needed, supporting healthy bank balance sheets, containing maturity and currency mismatches, and maintaining orderly market conditions has become even more relevant in the face of renewed market volatility. In general, allowing for exchange rate flexibility will be an important means for cushioning the impact of adverse external shocks, although the effects of exchange rate depreciations on private and public sector balance sheets and on domestic inflation expectations need to be closely monitored. With debt levels rising rapidly in both emerging and low- income economies over the past decade, fiscal policy should focus on preserving and rebuilding buffers where needed, through growth-friendly measures that protect the most vulnerable. To raise potential growth and enhance its inclusiveness, structural reforms remain essential to alleviate infrastructure bottlenecks, strengthen the business environment, upgrade human capital, and ensure access to opportunities for all segments of society.
- Multilateral cooperation remains vital to address challenges that transcend countries’ borders. Global economic integration under an open, rule-based multilateral trade system has raised living standards, helped lift productivity, and spread innovation throughout the world. To preserve and broaden these gains, countries should work together to reduce trade costs further and resolve disagreements without raising tariff and non-tariff barriers. Cooperative global efforts are essential across a range of other areas, such as completing the financial regulatory reform agenda, preventing further build-up of excess global imbalances, strengthening international taxation, and mitigating and coping with climate change.