The State Of The World Economy


Photo: NASA

The World Bank recently released its semi-annual Global Economic Prospects report, which takes a look at the global growth situation, breaks out growth forecasts for different regional economies, and examines trends between high-income and developing countries.The world economy initially accelerated at the beginning of the first quarter of 2012, but then  decelerated from there as the effects of European stimulus efforts (e.g. the LTRO) began to fade and tensions flared up once more in financial markets.

Although the developing world is poised to significantly outpace high-income economies in the coming years, the upshot is that the woes of  the developed world will have a serious impact on emerging markets. The global outlook is, therefore, somewhat grim from the World Bank’s perspective.

The euro crisis is crushing sentiment

The World Bank says that the financial turmoil in the eurozone has 'caused the price of risk to spike upwards globally.' Rates on credit default swaps are up all over the world, albeit less in most parts of the world than in Europe.

By the beginning of June, stock market returns in the developed world were nearly flat year-to-date after rising around 10 per cent at their peak in the first quarter of the year. The U.S. dollar appreciated against 'virtually all' emerging market currencies, and industrial commodities plunged.

Source: The World Bank

Financial stress is holding back growth

The World Bank says that financial woes will cause a 0.2 per cent contraction in the Euro Area in 2012, while global GDP will rise 2.5 per cent -- high income GDP is expected to rise 1.4 per cent and GDP in developing countries will rise 5.3 per cent.

In 2013 and 2014, the World Bank projects global GDP growth of 3.0 and 3.3 per cent respectively -- high income countries growing 1.9 and 2.3 per cent while developing countries will grow 5.9 and 6.0 per cent.

On developing countries, the World Bank says that several 'may even require a slowing in activity in order to prevent overheating over the medium run.'

Source: The World Bank

Developing countries will get hurt if the developed world continues to stumble

The World Bank warns that 'developing countries could be expected to take a large hit' if the situation in developed markets deteriorates sharply, a scenario which 'cannot be ruled out.' In this case, it says developing countries could come in 4 per cent lower than expected.

The World Bank suggests that developing countries should 'return to more neutral macroeconomic policies' in order to protect themselves from an external shock arising from tensions in the developed world. Specifically, developing countries could focus on improving surpluses, paying down short-term debt, and building financial buffers.

Source: The World Bank

Developing countries must find a new growth strategy

The World Bank points out that the developed world looks set to continue fostering a low-rate environment as central banks persist with loose monetary policy and debt and deficits are addressed, the 'external environment for developing economies is likely to remain characterised by volatile capital flows and volatile business sentiment.'

However, instead of instituting policies reactive to this external economic picture, the developing world should focus on 'medium-term domestic considerations,' according to the World Bank. It argues that many developing economies have almost full recovered from the financial crisis of 2008 and that macroeconomic policy in those countries needs to begin to reflect this.

Source: The World Bank

Progress in Europe initially calmed markets in 2012

Look at all the good things that have been accomplished in Europe so far this year, according to the World Bank:

Market concerns about fiscal sustainability in Europe, although still present, declined in the first quarter of 2012, in the wake of major policy initiatives, including: cross-party agreement to fiscal consolidation plans; the passage of far- reaching structural policy reforms; the successful restructuring of Greek debt; agreement of pan- European fiscal rules and firewalls, and a significant easing of borrowing conditions by the European Central Bank (ECB) in the context of its Long-Term Refinancing Operations (LTROs).

The World Bank says these developments caused 'risk premia required of high-spread economies' to decline in the first quarter.

Source: The World Bank

But European bank deleveraging is having a global impact

Economies are suffering from ongoing deleveraging in the European banking system. In the first quarter, Euro Area loans declined at a 2.3 per cent annualized rate. This resulted in a decline in syndicated bank lending, and developing countries also saw a 'sharp decline in new equity offerings,' the effects of which were not offset by increased debt issuance in emerging markets.

Furthermore, weakening exchange rates versus the U.S. dollar, stock market losses, falling commodity prices, and the increase in the price of credit default insurance in May all point toward tighter financial conditions going forward for developing countries.

Source: The World Bank

Global industrial production strengthened in 2012 before falling off again

The World Bank notes that global industrial production picked up in the first quarter after a very soft 2011, expanding in a broad-based manner (across regions) at an annualized rate of 9.4 per cent. However, it began to decline again toward the end of the quarter, led by a strong dip in the Euro Area.

The World Bank explains the industrial production picture in the Euro Area:

Area-wide, GDP was stagnant, reflecting relatively robust growth in Germany and Greece (respectively 2 and 2.9 per cent saar), and less robust growth in Belgium and France. These expansions were offset by continued contraction elsewhere, including in Italy, the Netherlands, and Spain.

Source: The World Bank

Developing countries led this initial surge in industrial activity

Developing countries led the upward thrust in global economic activity in the first quarter. A sharp rise in import demand from emerging markets more than offset the decline in Euro Area import demand, thus driving global industrial production higher.

Specifically, developing countries imported a lot of capital goods in the first quarter, which according to the World Bank were 'expanding at an annualized rate of 35.6 per cent (3m/3m, saar) during the three months ending January 2012.' This represents business investment, and the World Bank says this 'augurs well for future activity' in developing economies.

Source: The World Bank

Lower food prices have brought inflation down

Emerging market inflation dropped on the back of declining food price inflation in developing countries. First quarter headline inflation was 5.4 per cent annualized whereas food price inflation is around 5 per cent.

The World Bank says food prices will still weigh on those in developing countries:

Despite the welcome normalization of domestic food price inflation, domestic food prices in developing countries remain 25 per cent higher relative to non-food consumer prices than they were at the beginning of 2005. While incomes in developing countries have continued to rise, the sharp increase in food prices will have limited gains for many households, such as the urban poor, where food often represents more than one half of their total expenditures.

Source: The World Bank

Global imbalances have decreased

The World Bank says that the 'aggregate absolute value of current account balances' decreased from 5.7 per cent of global GDP in 2006 to near 4 per cent in 2011, as shown in the chart. They say that the decline has largely been driven by a narrowing U.S. trade deficit and a narrowing China trade surplus in the wake of the 2008 financial crisis.

Going forward, the World Bank does not expect much change in imbalances from these levels:

Declining surpluses among oil exporters, where windfall oil revenues are projected to continue fueling import demand growth in excess of export growth for several years (a modest projected decline in global oil prices will also play a role) are projected to be offset by an increase in deficits among high- income countries. As domestic demand recovers, their current account deficits are expected to expand through 2014 (to 3.6 per cent in the case of the United States). China's surplus is projected to rise to about 3.6 per cent of its GDP as efforts to reduce its current reliance on investment spending reorient demand toward less import-intensive consumer goods.

Source: The World Bank

The developed world will slow as it addresses monumental debt and deficits

As governments in the developed world attempt to pay down debts and reduce structural deficits, lower levels of government spending will translate to lower growth, according to the World Bank. While they see this effect slowing in the Euro Area in 2013 and 2014 as countries get closer to their fiscal targets.

The U.S. and Japan, on the other hand, will see a greater fiscal drag ahead. Japan took a hit from a tsunami and nuclear accident in 2011 which increased government spending and thus deficits. In the United States, meaningful progress has yet to be made on fiscal consolidation, and the fiscal cliff looms ahead.

Source: The World Bank

Emerging economies are in danger of overheating

The World Bank says that around half of global growth has been driven by developing countries since the 2008 financial crisis. However, they note that many of the leading emerging market countries are 'close to or above potential (figure 14), which suggests that they will not be able to provide as much an impetus to global growth as before.'

The World Bank says these capacity constraints are causing problems internally for developing countries as well:

In some of these countries, capacity constraints are generating inflationary pressures in either goods or asset markets, or raising current account imbalances. In some, fiscal and or monetary policy remains very loose, raising the possibility that financial tensions will intensify and suggesting that opportunities to rebalance policy and regenerate policy buffers that were consumed by the crisis are not being exploited.

Source: The World Bank

Emerging economies now lack a buffer against shocks

The World Bank warns that 'on average developing country government deficits are 2.5 per cent of GDP higher than in 2007-- suggesting they will be less able to respond to a downturn with fiscal stimulus.'

Current account deficits have also increased by an average of 2.7 per cent of GDP, according to the World Bank. In the event of another major financial crisis, these larger deficits and worsened fiscal positions will likely force these countries to implement harsh austerity measures, the likes of which are adding to the current economic woes in Europe at the moment.

Source: The World Bank

Geopolitical tensions are still a risk

The World Bank says their global outlook is predicated on stabilised oil prices around current levels. In the even that international tensions arise once again, perhaps with Iran, for example, higher oil prices would be detrimental to global growth.

Such a scenario, as described by the World Bank, could go like this:

In particular, a prolonged blockage of the Strait of Hormuz, although a low probability event, could send oil prices soaring. Some 17 mb/d of crude and products transit the strait (an average 14 crude tankers daily, with another 14 returning empty). Although alternative routes for some Middle-East oil could be found and any disruption is likely to be temporary (see Commodity Annex for more details), a net 13 mb/d or 15 per cent of global demand could be disrupted for several months and would likely be only partially offset by release of strategic reserves.

An elevated level of oil prices $50 higher than the World Bank's baseline forecast for an extended period of time 'could reduce global GDP by around 1.3 per cent in oil- importing countries,' the World Bank says.

Source: The World Bank

Lower commodity prices will be good for importers but bad for exporters

The World Bank cautions that 'if commodity prices were to come off their current highs there could be potentially serious consequences for the external and internal imbalances of commodity exporting economies.'

A 20 per cent fall in oil prices could reduce GDP in oil-exporting emerging markets by 0.4 per cent while increasing GDP in oil-importing emerging markets by 1.5 per cent, for an overall impact of a 0.9 per cent rise in emerging market GDP, according to World Bank estimates.

Also, the World Bank estimates that a 20 per cent fall in non-oil commodity prices would lead to a 0.2 per cent reduction in GDP for oil-exporting emerging markets and a 0.3 per cent increase in GDP for oil-importing emerging markets -- resulting in a 0.1 per cent rise in emerging market GDP.

Source: The World Bank

Emerging markets will face tougher financing constraints

Deleveraging in high-income countries 'should yield a more robust global financial environment,' says the World Bank. However, stability comes at a cost, and the relative lack of liquidity that will result as opposed to the pre-2008 crisis period will have 'important real-side implications for developing countries.'

According to simulations ran by the World Bank, growth could take a knock as a result of less liquidity:

If these tighter conditions result in an increase in developing country capital costs of between 30 and 310 basis points, potential growth rates in developing countries could be reduced by between 0.2 and 0.7 percentage points for an extended period of between 5 and 7 years.

Source: The World Bank

Now take a look at which countries the World Bank projects will grow the fastest over the next two years

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