The global economy at present appears to be gloomier than anticipated. Markets across the globe continue to exhibit significant volatility resulting in increased financial stress. Simultaneously, monetary authorities across the major economies have taken recourse to aggressive policy measures striving to revive growth prospects. Sluggish pace/ pickup in economic activities in developed as well as developing markets has raised concerns about emergent recessionary risks. The article aims to throw light on the current economic scenario across emerging and major developed economies; and the challenges that lie ahead.
Increasing vulnerabilities in China and other emerging economies….
At present emerging markets are undergoing significant changes. In particular, China the second largest economy is transitioning from an investment and export led to a consumption and services oriented economy at a time when the economy is slowing down to 6% from its double digit growth of three years ago. As a result, the country is facing major policy challenges.
Vulnerabilities in financial and corporate sectors have been rising substantially as indicated by the increasing credit to the corporate sector; which rose from 124% of GDP in 2011 to 163% of GDP in 2015. This is also reflected in the ballooning Chinese bank assets (US$30 trillion). The current economic slowdown will pressure the profitability of these corporations, making debt deleveraging difficult. Moreover, the country also has massive local government debt; and rapidly dwindling forex reserves. Its overall debt to GDP is up by 100 percent points since 2007. These factors consideration, are instrumental in raising concern-levels about a further slowdown and its probable slide into recession.
Another important development is the downward movement in commodity prices, which has had severe implications across all the emerging economies. Corporates in emerging markets raised large quantum of debt during the periods of high commodity prices and adequate liquidity conditions. Hence, the banks and corporates are burdened with high debt. Now, given that oil and commodity prices have witnessed a sharp decline of over 70% and 45% respectively; emerging economies are increasingly susceptible to financial stress, economic slowdown and capital outflows.
From the financial stability angle, a significant portion of debt in emerging economies is raised by oil and mining sectors, particularly in the MENA region; which is the worst hit by the recent oil rout. As a result, these exporting countries have witnessed a considerable decline in corporate revenues and also experienced increased fiscal imbalances; raising concerns about their credibility. Subsequently, in the recent months, many of these countries have witnessed a rating downgrade.
Furthermore, the normalization of interest rates in U.S. and strengthening of the dollar has tightened access to external liquidity, raising the cost of dollar denominated debt. Consequently, emerging economies are struggling to adjust to lower inflows or even outflows in some cases. In addition, the domestic conditions also have begun to tighten owing to rising NPLs and risks to banks emerging from corporate exposure.
Issues inherited by advanced economies…..
At the moment, developed economies continue to strive to overcome issues they inherited from the crisis. The recovery in these economies continues to be weak and uneven.
Among the advanced economies, U.S. remains a better performing economy, with relatively higher growth. It has witnessed improvement with respect to housing debt, thereby restoring capital in its banks. In addition, the U.S. Fed has taken successful recourse to interest rate normalization. However, here too, financial vulnerabilities have emerged during the period of monetary stimulus.
Spreads had become overly compressed. The high yield markets boomed with supply of funds from retail investors. Credit risks have currently increased and are particularly concentrated in the high-leverage Energy sector. It raises concerns over the sustainability of economic growth, as the economy witnessed a sharp slowdown in the 4th quarter to 0.7%; after registering a significant growth for two consecutive quarters at 3.9% and 2% respectively. Also, both the PMI manufacturing (53.70 vs 55.93) and services indices (57.10 vs 55.92) have been consistently sliding, indicating absence of pick up in industrial activity.
Apart from U.S., Euro zone has also seen some progress. In an attempt to boost growth and prevent the downside of inflation, monetary easing has come to the region’s rescue. The economic growth has exhibited a degree of sustainability and stands at around 1.5-1.6% for the past three quarters. This is also marginally reflected in the PMI manufacturing and services index, which has indicated marginal improvement over the past few quarters. On the downside, it is way below (just 0.01% in 2015) achieving its inflationary targets of 2%. Hence, the Euro zone has yet to tackle the vulnerabilities prevailing in sovereign and banking segment, which remains to be very critical. The NPLs of banks though improved, remain very high, at above 5.5% of banking assets.
Going ahead…
Presently, high levels of debt and low interest rates continue to prevail, in advanced economies. As a result, financial markets are vulnerable to developments in emerging economies and the global markets. This is evident from the recent volatility in Equity markets. This has also been mirrored in the recent widening of credit spreads and the flattening of yield curves. Besides, the macro fundamentals do not indicate a strong recovery in the advanced economies; while emerging economies struggle to show signs of improved growth prospects. To some extent these developments do indicate a path towards a gradual economic slowdown and potential recessionary risk.
However, the measures taken by the monetary and fiscal authorities to address these concerns across the major economies are expected to provide some support to the overall global economy; thereby partly offsetting recessionary risk. Similarly, IMF suggests that recovery is on the way; albeit modest and uneven. The global growth projection has been revised downwards as the growth is expected to be gradual. For 2016 the growth is expected to reach 3.4%; up from 3.1% in 2015. However, in order to ensure and attain global financial stability policy makers need to tackle a host of challenges emerging from increasing vulnerabilities in EME’s, persistent legacies from the crisis in advanced economies and weak liquidity conditions; which have been the major contributors to volatility across global markets.
