This article first appeared in Forum, The Edge Malaysia Weekly, on February 8 - 14, 2016.
THERE is growing pessimism about growth prospects for the world economy. The extreme volatility in financial markets around the world in January has alarmed many observers. In addition to deepening concerns over China’s slowdown, pessimists can point to the slowdown in earnings growth in key equity markets, the widening of credit spreads, the travails of the high-yield securities market, and the tighter financial conditions that resulted from the market turmoil as evidence of growing risks to growth.
The stream of data out of the US has not helped either; its manufacturing sector is clearly struggling and construction spending lost momentum in December. Gross domestic product growth appears to have dropped below 1% in the final quarter of last year and the initial data for January suggests that this weakness is persisting into this quarter. With the American economy — perceived to be just about the only game in town — decelerating, fears abound that global growth will buckle under as well. In fact, the Organisation for Economic Cooperation and Development’s composite lead indicator has been edging down, as if to confirm these concerns.
While there certainly are headwinds hurting global growth and some real risks, such as China’s worsening economy, we would still hold that the global outlook is better than these downbeat signals indicate. Our more optimistic view is built on several factors: We see the American economy likely to revive again after a weak start to the year, the fragile recoveries in the eurozone and Japan gaining a little more momentum and the benefits of lower oil prices.
The G3 economies are likely to gain momentum in 2016
The basic processes that have underpinned economic recovery in the US remain intact — the slowly compounding effects of small improvements in the labour market, housing market and bank lending to parts of the economy that have been credit-constrained, such as small and medium-sized businesses, each feeding off the other and producing a stronger base for growth. Taken as a whole, the recent data from the economy is reasonably good.
• The services sector continues to grow, with the purchasing manager survey showing that employment and new orders continued to rise.
• Employment conditions continued to improve through December, with the unemployment rate now down to 5%, very close to full employment. Even the so-called U6 measure, which employs a much broader definition of what constitutes unemployment, had fallen to 9.9% in December compared with 11.2% in December 2014. Significantly, we are seeing more evidence of localised labour shortages, a pattern that precedes a pickup in wages. Indeed, Walmart has already announced that it will be raising wages for its 1.2 million employees in February, something that will spur further wage increases, given the influence Walmart has.
• Consequently, measures of consumer confidence have been improving since last year and even the bad news from the stock market falls in January do not appear to have dented this confidence very much.
• Small businesses, in particular, are becoming more confident about prospects, as seen in the sentiment index of the National Federation of Independent Businesses. This is important because these smaller businesses employ the bulk of the workforce.
• The housing market remains firmly on a recovery track. The data in recent weeks shows home prices rising faster and new home sales surging.
Still, the American economy is facing some challenges. The stronger dollar appears to be hurting export competitiveness and so, dragging down the manufacturing sector. American manufacturers have not been helped by the oil sector slashing capital spending in response to the sharp fall in oil prices. That has hurt demand for capital equipment. There are also incipient signs of financial stress, but these are mostly localised in particular sectors such as smaller operators of shale oil wells. Overall, it is reasonable to expect the strengths of the US economy to offset these potential headwinds. Growth in 2016 should be a tad higher than in 2015.
In essence, the eurozone and Japan are benefiting from low oil prices, more competitive currencies and generally loose monetary conditions. The eurozone is seeing clearer signs of a revival in growth. The lead indicator for the eurozone is signalling that the region’s economic growth will continue to edge up. Unemployment is falling, albeit slowly and the first signs are emerging that banks are easing up on lending standards. The latter is a critical turning point because it is when credit-constrained parts of the economy become more confident about securing credit that one gets a stronger economic recovery.
As for Japan, the data shows the economy losing some momentum of late. However, the labour market is still tight and surveys suggest some pickup in capital spending. This, together with the Bank of Japan’s aggressive shift to negative interest rates last week, will help further support the economy.
The economies of the US, the eurozone and Japan which, we argue, are gaining momentum, account for just below half of the world economy compared with just 13% for China, which is decelerating: The world is not falling apart.
Oil prices should help the world economy this year
There is almost a perverse view in financial markets that low oil prices are a bad sign for the world economy. This does not make sense. Put a little simplistically, there are vastly more consumers of oil than there are producers — the net gain from lower oil prices is huge.
So, why is it lower oil prices do not seem to have produced a big fillip for global growth? It would appear that there is a longer lag than normal and there are good reasons for this, reasons which we believe are likely to fade away in the course of 2016:
• First, the world economy is just coming out of one of its worst periods since the 1930s depression. Not only was there the global financial crisis of 2007/08, but we have also had the eurozone sovereign debt crisis that only began to ease in 2015. The downturn in China is something that businesses find hard to read, given that it is only recently that China emerged as such a large influence on the global economy and its data is suspect. There have also been major political challenges — the collapse of major states in the Middle East and the concomitant rise in terrorism, the migration crisis in Europe as well as the rise of populist political parties and personalities in both the US and Europe. It is not surprising, then, that businesses remain hesitant to commit to large-scale expansion of capacity.
• Moreover, households in most rich countries saw the value of their retirement portfolios fall sharply because of the impact of the global financial crisis on real estate and
equity values. Consequently, many consumers are saving a part of the windfall from lower oil prices. For example, in the US, the household savings rate rose from 5.3% in November to 5.5% in December.
• Finally, the initial impact of the collapse in oil prices was negative because the losers, such as higher-cost producers of oil and oil-exporting countries, slashed capital and other spending almost immediately. However, the winners from oil prices were more cautious — they wanted to see whether the lower prices were here to stay first, before splurging. Energy-dependent businesses chose to wait a while before taking advantage of the opportunities presented. And consumers, as we argued above, chose to save some part of their gains. We believe the moment has been reached when these businesses and consumers will start spending more confidently — and we should, therefore, see higher spending out of the gains from lower oil prices.
What about Southeast Asia?
There are several factors that will determine the direction of economies in the region.
• The first is how much uplift each economy gains from the recovery in G3 demand that we are projecting and from lower oil prices versus the drag from a slower China. We believe that all of Southeast Asia will gain more from the positive drivers than lose from a downturn in China.
• Second is whether the domestic cycles in these economies are gathering strength, whatever is happening in the global economy. Simply because 2014 and 2015 have been rough years for the region, the simple absence of negatives such as
further fuel-subsidy cuts and the revving up of government spending could help
support these economies.
• Third, whether there are vulnerabilities in the financial structures or external accounts that could be worsened by sudden currency depreciation or abrupt capital outflows. There are certainly areas of unease. For example, foreign ownership of bonds and equities remains high in Malaysia and Indonesia and household debt in Malaysia, Singapore and Thailand has
risen a tad too fast since 2008. Nevertheless, there is no evidence that these vulnerabilities are severe enough to detract from financial stability.
• Finally, how effective policy, in particular central bank policy, is in providing resilience to external shocks, particularly the extreme financial volatility that continues to buffet all our economies. Here, too, we would argue that things are looking reasonably good. Note the circumstances in which Bank Indonesia cut rates recently — just as a major terrorist attack was unfolding on the streets of Jakarta and global financial markets were sliding. Yet, the rupiah held steady and most investors were satisfied that BI knew what it was doing: Central bank credibility is a strength in most of this region.
In short, despite all the worries that are rocking financial markets, the world economy is likely to perform at least a little
better this year than in the last. And Southeast Asian economies are in fairly good shape to weather the shocks and maintain good growth rates.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy
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