This article first appeared in Forum, The Edge Malaysia Weekly, on November 16 - 22, 2015.
The Organisation for Economic Cooperation and Development has just downgraded its forecasts for global growth next year. Instead of a 3.6% expansion, the OECD now expects a more modest 3.3%, up slightly from 2.9% in 2015. Like several other agencies that have recently cut their forecasts, the OECD’s analysts are concerned that world trade volumes have been languishing, growing at a pace normally seen only during global recessions. Moreover, the OECD’s lead indicator for the world economic growth is signalling below-trend growth, which seems to support their pessimistic view.
We have a different take on global prospects. First, recent indicators suggest that economic momentum is actually picking up, not fading away. Second, the underlying processes driving global activity are mostly positive, suggesting that things are likely to get better, not worse. The main risks to global growth are still the headwinds from a slowing China, remaining deflationary pressures and the risk that global imbalances will widen again.
Recent indicators are pointing up in the developed world
The past week has produced a rash of economic data that describes a more positive picture for the world economy:
• Global services are rising. The purchasing manager index (PMI) for global services activity points to accelerating services production in October from already robust levels earlier. Since services account for the bulk of economic output in developed economies as well as middle-income emerging economies, this is significant;
• Manufacturing has been shaky but is beginning to rebound. At the same time, the global manufacturing PMI has also risen in October despite weakness in large emerging economies such as China. In particular, there are signs that the overhang of inventories that hurt manufacturing activity is beginning to ease, particularly in the US. Overall, the PMI data suggests that global economic activity is gaining, not losing, momentum;
• Most confident consumers in nine years. Niel-sen’s index of global consumer confidence increased three points to 99 in the third quarter, and is now at its highest since 2006; and
• Technology turnaround? Global semiconductor sales expanded 1.9% m-o-m in September, after rising in August as well, the first back-to-back monthly expansions since late 2014. Many analysts are expecting new product launches to boost tech spending.
China remains a risk
Nevertheless, there remain causes for concern, principally in the dismal performance of world trade. There seems to be no end to the desultory growth rates in import volumes. China, which takes up about 12% of global economic output and about 9% of world imports, has been slowing, and this has dragged growth down across emerging economies, which export natural resources, as well as advanced economies, which sell resources as well as capital goods to China.
Indeed, the Chinese economy in October displayed decidedly mixed signs. Fixed asset investment growth fell to its slowest pace in 15 years while industrial production grew at its weakest rate in five years. The worsening problems in China’s industrial sector are, however, being offset to some extent by strong consumer spending. Retail sales surged 11% in October, boosted by booming car sales resulting from the government’s stimulus policies.
Given signs that the key real estate sector is beginning to find its feet, and the government’s expanding stimulus efforts, we expect a modest stabilisation in China’s economy in 4Q2015. Still, it is right to worry about whether this stabilisation will last, given the immense imbalances in the Chinese economy. Thus, it is important to ascertain whether the headwinds created by a Chinese slowdown can be offset by positive factors elsewhere in the world.
Fortunately, the processes underpinning world economic trends are mostly positive
If we look beyond the m-o-m data and focus instead on underlying trends, there are some clear positives — as well as a few warning signs.
First, economic conditions are normalising in the crisis-hit major economies:
• The normalisation process is most advanced in the US. Credit conditions, for example, are easing, especially for the credit-constrained smaller firms. The Small Business Lending Index was up 11% y-o-y in September, with businesses in a wide range of sectors enjoying improved access to banks loans. Labour market conditions have also basically returned to normal, with an October unemployment rate of 5%, which is just a hair’s breadth away from the 4.9% considered as full employment. The housing market is also reviving, with construction spending now back to pre-crisis levels;
• But even the eurozone is beginning to see light at the end of the tunnel. Surveys of bank officers in the eurozone point to lending standards being eased as well, a sign that the worst of the financial crisis is now over. Eurozone purchasing manager indices for both manufacturing and services are depicting an economy that is not only growing but accelerating modestly. There are signs that even Greece is beginning to bottom out; and
• Similarly, the UK economy is reviving as well, with the manufacturing sector growing at its fastest pace in 16 months and the rise in October ranking as the largest surge in 24 years. Even in Japan, despite some remaining pockets of weakness, we are seeing the manufacturing sector accelerating to its strongest position in 12 months, while there are signs that household incomes are expanding more rapidly, a good sign for consumer spending in 2016.
Since the US, UK and the eurozone account for about 40% of world output, this normalisation is a significant boost to global prospects.
Second, the continued fall in the price of oil and other commodities will be a bigger positive as time goes on:
• Initially, the fall in low oil prices caused oil-related industries to cut back spending while oil-exporting countries suffered an immediate fall in incomes and spending. However, the beneficiaries of low oil prices took a while to accept that the fall in prices was long-lasting and are now stepping up their spending. Consequently, the positives of low oil prices are now offsetting the initial negatives; and
• Similarly, the fall in commodity prices ex-energy has been seen as a negative because it has hurt economic growth in countries as different as Australia, Brazil, Indonesia and many countries in Africa and Latin America. It is true that natural resource exporters who failed to diversify their economies will suffer, but they do not represent the majority of the world economy — consumers of raw materials are the majority and their costs are going down, which will boost global economic activity. Even among the natural resource exporters that are suffering lower incomes, widening fiscal deficits and deteriorating external accounts, there is a silver lining — these adverse conditions will compel them to adjust policies and overcome the constraints that have prevented them from diversifying their economies. The net effect over time will be higher-quality growth that is more sustainable.
Third, contrary to the beliefs of those who worry about the impending end of ultra-low US rates as the Federal Reserve begins to raise rates, we see it as a positive. When the Fed raises rates, the signal it is sending to businesses across the country is that the US economy is now sound. The signals the Fed has been sending in the past 12 months have been confusing, seeming to suggest that the US economy is so fragile that it could be hurt by problems in emerging economies, for instance. As US businesses see the Fed raising rates cautiously from ultra-low levels, they will feel more confident about business prospects while still enjoying a relatively low cost of capital since rates will still remain very low by historical standards for a long time. We believe that this could spur US companies to step up capital spending, as they become more confident about demand prospects.
Fourth, the headwinds created by policy rectification in developing economies should recede in 2016. The last two years saw emerging economies cut back on wasteful fuel and other subsidies while also deploying macro-prudential controls to rein in excessive credit growth. We saw much of these policy rectification measures in Malaysia and Indonesia, for example. All these policies were necessary for the long-term good: What is happening now is that the near-term headwinds created are beginning to fade.
Fifth, there are nevertheless two worrying trends that are also emerging:
• Deflationary forces are spreading from raw material prices to industrial goods prices. China’s massive excess capacity is resulting in a rise in exports of industrial goods at lower prices. This has already been evident in steel. However, there is more evidence that Chinese exporters are cutting prices in a range of other goods, including appliances, in order to mop up their excess production. With manufactured goods prices already falling, this deflationary force could intensify. Another consequence could be rising protectionism — we have seen a rash of anti-dumping complaints against China, accompanied by penalties being imposed on Chinese exporters; and
• Global imbalances are widening and could create more headaches for global economic management. China is seeing its investment rate fall, while its savings rate is not falling as quickly — this must mean a major expansion of its current account surplus. That, too, could lead to more resentment against China and, potentially, more protectionism as well.
So, what is the bottom line?
We would argue that the net effect over 2016 and 2017 is largely positive. The acceleration and normalisation of the big developed economies (accounting for nearly half of world output and more than half of global imports) is likely to continue, while the effects of low oil and commodity prices will almost certainly become more pronounced. These should be enough to offset the drag from a slowing China and possible ructions in other emerging economies — as long as policymakers do not cave in to protectionist pressures that result from fears of deflation and global imbalances.
Manu Bhaskaran is a partner and head of economic research at Centennial Group Inc, an economics consultancy