- Global growth will accelerate modestly in 2014 as fiscal austerity eases in developed countries.
- Emerging countries will see growth decelerate to about 5% in Asia and a little below 4% in Latin America.
- Developed economies will grow faster if not thwarted by political shocks.
The pace of global growth will quicken in 2014 if the U.S. recovery is not derailed by more brinkmanship around the federal budget and debt ceiling. Japan's recent growth has exceeded expectations, and the euro zone is on the road to a slow but credible recovery.
Monetary policy easing reversed China's slowdown in the first half of the year, providing temporary relief to commodity exporters in Asia, South America and Africa. Additionally, policy-driven spending on infrastructure and a weaker currency will support Brazil's rebound. Following a growth pause in 2012, Latin America is projected to grow somewhat faster this year and next, supported by stronger external demand and less upward pressure on the region's currencies.
Less fiscal drag in 2014
Developed countries are expected to ease fiscal policy in 2014, lifting an important constraint on the recovery. Japan leads the way. To jump-start its long-stagnant economy, the Abe government this year is front-loading fiscal stimulus equal to about 2% of GDP. Sweden also has an expansionary fiscal stance in 2013 as its structural deficit is estimated to rise to 0.5% of GDP.
In the U.S., fiscal policy has been a significant constraint on the economy. The fiscal drag is estimated to equal 2.3% of GDP in 2013, but is expected to decline to 0.7% of GDP in 2014. In the euro zone, fiscal drag will moderate to 0.3% of GDP in 2014 from 1.1% of GDP in 2013. Also, European policymakers have slightly altered their stance toward fiscal policy and are more willing to allow automatic stabilizers to play a role in cushioning shocks.
The euro zone’s business and consumer confidence index rose in October to its highest level in more than two years, auguring an eventual rise in consumer spending. Further, the euro zone’s ZEW indicator of investor confidence also rose in October to its highest level in more than four years.
The October Markit flash estimate of the euro zone purchasing managers’ index indicates growth in private sector activity. It was the fourth consecutive month that the PMI has signaled expansion, although the October reading was weaker than September's. As the PMI is highly correlated with GDP, the flash reading suggests the euro zone recession has ended, but that growth in the fourth quarter remains sluggish.
Monetary policy still broken
The European Central Bank’s monetary policy continues to be accommodative. Nevertheless, insufficient progress in reducing financial market fragmentation is to blame for the uneven pace of growth. The transmission mechanism for ECB monetary policy remains broken, unable to push borrowing costs lower in the southern euro area.
Borrowing rates to economically viable firms in Italy, Spain, Portugal and Greece are still 100 to 350 basis points higher than for their counterparts in Germany. Core countries in the euro area enjoy abundant liquidity and low borrowing costs, while credit is scarcer and more costly in the peripheral countries.
The ECB also must be wary of euro appreciation, which increases the risk of deflation and could upend Europe’s recovery by making exports less competitive. In recent years, the export sector has been the euro area’s main growth driver, but a stronger currency could change this.
The euro has risen 10% on a trade-weighted basis since July 2012. In the past month, despite a narrowing spread between U.S. and European interest rates, the euro climbed to its highest level vis-à-vis the U.S. dollar. This is partly because of the euro zone’s improved safe-haven status relative to the U.S.—confrontations over the U.S. federal budget and debt ceiling have made U.S. government debt more risky—and partly because of the euro zone's improved economic outlook.
The ECB's unexpected decision to cut its benchmark refinancing rate to 0.25%, announced Thursday, shows it is quite concerned about deflation. Record high unemployment, weak domestic demand, and the stronger euro are behind the estimated 0.7% annual inflation rate in October, compared with a rate of 2.5% a year earlier. Euro area annual inflation is not only well below the ECB’s medium-term 2% target, but it is on a clear downward trend.
Central bankers in Europe believe inflation will remain subdued over the medium term because of broad-based weakness in the real economy. This outlook for inflation and recent price trends would tend to reinforce deflation expectations and influence spending behavior in ways that further shrink domestic demand.
One channel is through the negative wealth effect: Deflation increases the real debt burden of households, making it harder for them to spend. Deflation also dampens business activity as price declines squeeze company profits. Further, when deflation expectations take hold, firms anticipate weak demand and grow less willing to hire and invest.
Abenomics is on track
Prime Minister Shinzo Abe's economic plan to end deflation and jump-start the economy is progressing well. The monetary and fiscal components of Abenomics are producing the desired results.
Aggressive monetary easing encouraged investors to shift away from cash and Japanese government bonds. The move into equities, real estate, and higher-yielding foreign assets led to a 60% y/y rise in the equity market and a 22% depreciation of the yen.
Thanks to the wealth effect and weaker yen, consumption and net exports both rose, supporting a 4.1% GDP rise (SAAR) in the first quarter, followed by a 3.8% increase in the second quarter. The best news is that the upward revision in second quarter GDP comes from stronger capital spending. Support for a more sanguine outlook comes from the most recent Tankan survey, indicating a significant rise in capex intentions.
China bounces back
Third quarter GDP growth in China accelerated to 7.8% y/y from 7.5%, as the government, fearing a deep downturn, reversed its credit-tightening policy and launched a mini-stimulus of tax cuts for small businesses, easier financing rules for exporters, and plans for more railway investment. Much of China's third quarter growth was driven by investment in fixed assets that include railways and housing construction.
China's economy is expected to grow 7.6% this year and 7.5% in 2014. However, over the medium term, GDP growth will decelerate to around 6% by 2020 as the aging of the population slows labor force growth, returns from adding capital to labor diminish, and policy reforms shift the economy's growth toward private consumption.
Recovery strengthens in Latin America
Policy stimulus and accelerating investment in infrastructure to meet deadlines for the 2014 World Cup will lift GDP growth in Brazil to 4.3% next year from an estimated 2.8% in 2013. Mexico had weaker growth in the first half of the year because of temporary factors such as slower public spending during the political transition, weaker foreign demand, and a slowdown in construction, but growth is expected to pick up in 2014, rising nearly 4% from an estimated 1.3% this year.
Growth in Chile, Peru, Uruguay and Colombia is expected to moderate closer to trend levels, supported by domestic demand in 2013. Stronger external demand in 2014 will help boost these economies. Growth in the region is expected to accelerate to about 3.9% in 2014 from 3.3% this year.
Tu Packard is a Senior Economist at Moody's Analytics.
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