Outlook Overview – Back to the Future: Economic developments around the world over the past two months have confirmed the short-term prognoses and directional changes spotted by earlier this year. Baldly stated in the most simple terms, economic recovery has firmed up in the advanced economies, (notably the US and Japan) improving their growth prospects while the slowdown in emerging markets is being compounded by pullback of external capital. The latter is caused both by the prospects of “tapering” of global easy money as well as reappraisal (and repricing of risk) of fundamentals, especially structural weaknesses and external vulnerabilities. Going forward, the engine for generating growth momentum for the global economy over the coming year is once again the United States, much as the proverbial American consumer kept the global economy afloat in previous periods of stress. Back to the future, it is!
In quantitative terms, the aggregate growth of world GDP in 2013 is now likely to be somewhat below the pace in 2012. Besides the slower growth in emerging economies (2½ percentage points below 2010 per the IMF, much of it accounted for by Brazil, China and India), the revised estimates paradoxically reflect a markdown in US growth estimates for Q1 this year (and a significant upward correction for 2012Q4). Notwithstanding the weak first half of 2013, there are unmistakable signs of strengthening in the US economy with manufacturing and construction expanding in addition to the already evident positive indications from the labor and housing markets, consumer spending including vehicle sales, as well as corporate capex intentions and increased lending by banks. Moreover, the fiscal situation is expected to ease somewhat next year.
In Japan the first two “arrows of Abenomics” have continued to deliver positive results with economic growth steadily broadening across sectors beyond the immediate benefits of the significantly weaker yen (20% in real terms) and export expansion. The results of elections to the Upper House in July now augur well for the third “arrow” viz structural reform.
In the United Kingdom as well, economic momentum is broadening albeit in the opposite direction from consumers and housing to investment and exports. Not only is more balanced growth key to sustainability of the recovery, but also improvement in business confidence and corporate investment, especially in service sectors, has self-evident implications for Indian IT/ITeS industry.
Finally, among our key markets, the Eurozone economy appears to have emerged out of recession, growing 0.3% in Q2 after six quarters of successive falls. This is sooner than was expected even as recently as a few months back, and probably reflects some one-time factors. Nonetheless it can be considered a vindication of the “whatever it takes” approach exemplified by Mario Draghi (ECB President). While business indicators show improvement and the fiscal drag is likely to be lower in 2014, economic growth in the Eurozone is expected to remain below 1% p.a. and several economic challenges still remain to be addressed decisively including private sector deleveraging, financial fragmentation, high unemployment and labor markets, as well as growing divergence within the Eurozone.
The travails of Emerging Markets have dominated economic news over the past month, and not just in India. While the precise circumstances (e.g. business cycle, trade balances, financial vulnerability) vary across countries, there are clearly some commonalities among the drivers of the problems. The pre-eminent factor, evident in the profound reaction to Ben Bernanke’s remarks on Fed “tapering”, is the prospect of the unwinding of unconventional monetary policies (UMP) pursued by the major central banks. This has triggered severe external financing pressures, sharp increase in volatility in various markets and drops in stock markets as well as currencies of these nations. There are both push and pull dimensions: on the one hand higher nominal yields in developed economies attract capital to stay there. On the other, the ebbing tide has revealed structural weaknesses and vulnerabilities of individual countries that have led to deeper reassessment of growth prospects and repricing of risks.
Accordingly, the pressures are highest for economies confronting high inflation, balance of payments deficits, and excessive credit growth. Most of the major emerging market economies are concerned and the issue of an orderly exit from UMP is an economic focus of the G-20 Summit in St. Petersburg. While the Indian currency is the worst affected among major emerging markets (Table 2), Brazil has also seen non-trivial reduction in GDP growth estimates.
China, with its massive reserves, is in a different league of its own. Financial stability has emerged as a critical risk in the past year in light of rapid credit growth and any turmoil would have international implications. Efforts to rebalance the economy have seen limited results to date; the government appears comfortable with a slower growth rate (still over 7% p.a.) but that is likely to adversely affect many developing economies, not least among them being the commodity producers.
There has been no respite for the Indian economy which continues to slow down; new data releases (e.g. quarterly GDP, PMI) indicated a worse situation than expected. The decline in sentiment is captured well in the attached chart showing the steady deterioration over the past year-and-a-half in successive monthly forecasts of GDP growth and inflation (CPI). Attention, however, has focused overwhelmingly on the currency as the rupee plunged to unprecedented levels, 67 per US$ at the end of August. That is the subject of a companion note entitled “Rupee Story Unfolds Further”.