Global economy: What the future holds

The diverging policies in Europe and the United States will solidify a trend that has been underway for many months: The euro will weaken further and the dollar is likely to grow ever stronger

With the beginning of the New Year, it is a perfect time to reflect on how the global economy fared in 2015 and on what’s in store for 2016. The global economy had a bumpy 2015.
The diverging policies in Europe and the United States will solidify a trend that has been underway for many months: The euro will weaken further and the dollar will grow ever stronger. What’s more, the rising dollar over the last year has already had profound effects. It has helped account for the drop in commodity values, which are commonly priced in dollars and has punished many commodity-producing nations, like Brazil, Russia, Saudi Arabia and Canada.
At the same time, the dollar has helped put a lid on inflation in the United States while hurting the competitiveness of American exporters and contributing to weakening global economic demand. A strong U.S. dollar has continued to weigh on earnings, particularly for companies with significant international exposure and is likely to do so in 2016. Those effects are widely expected to strengthen, not weaken, in the months ahead.
China: The big question for Chinese authorities is how they will trade off near-term growth against longer term sustainability. On this, China’s latest Five Year Plan implies an average target for economic growth of 6.5 per cent through to 2020. That is a step down from the 7-8 per cent pace over the past four years. Markets are concerned about a sharper deceleration, with the focus of attention on weakness in the manufacturing sector. But, while the “old world” economy slows, activity within the new world has quietly forged ahead. Service sector activity is almost 50 per cent of overall output, up from 40 per cent just eight years ago.
The Chinese government has also drawn a line on what is a tolerable for economic growth, injecting fiscal stimulus to shore up momentum when it underperforms expectations. We expect efforts to continue on this front. However, a slowing China will continue to weigh on other emerging market economies, particularly those with significant trade linkages, like Taiwan, Malaysia, South Korea, Singapore and Thailand.  Emerging markets (EM) were hit by three inter-related shocks in 2015: a collapse in commodity prices, which hurt those reliant on commodity exports; slower growth in China, which especially hurt its Asian trading partners; and rising capital outflows, which led to sizeable depreciations in many EM currencies. The downward slide created by these colliding influences will lessen in 2016, but the economic landscape for EMs will remain a challenging one.
After the 2008 Great Recession, it took EM commodity-exporters one year to surpass their prior peak in real GDP. This time around, we expect it to take two years. All eyes have been on China in recent months as it went from being a financial market ugly duckling, to becoming an IMF swan. Markets balked when China unexpectedly revalued its currency in August, and intervened in the stock market to stem a disorderly decline.
By late-fall, calmer heads prevailed, reinforced by the IMF who admitted the Chinese yuan as the fifth world reserve currency within their basket in December. This was a crucial step to help legitimize the yuan on the global stage, and also encourage ongoing financial reform. But, beyond that, the move should have a limited near-term influence.
Adding to the challenge, China is on a slower economic growth trajectory with many structural changes afoot that don’t exactly exude the confidence needed for reserve managers to shift their holdings to the yuan. Policy missteps – like the August yuan revaluation – will inevitably occur and China has occasionally backpedaled on reforms when growth appears to slow too far.
Global financial markets in 2015 were pulled between two opposing forces: The first was the Federal Reserve’s determination to raise interest rates as the U.S. job market strengthened. The second was pressure for lower interest rates in much of the rest of the world as China’s economic growth slowed and commodity prices sank. The results of the tug of war were a soaring dollar, crumbling junk bonds, stubbornly low Treasury yields and a stock market that ended the year roughly where it started.
Those tensions will continue into 2016. The likely result: a global economy that escapes recession but leaves stocks battered and investors’ nerves frayed.
Advanced nations continue to make steady progress, but the balance of risks has shifted to EMs. They will continue to be challenged by low commodity prices and weaker exchange rates. There is also the lingering risk that the US Federal Reserve’s tightening cycle may impart another round of pressure on EM capital flows, increasing volatility within their financial markets. However, as many of the adjustments have already been made, the pay-off should be more stable growth in the years ahead. As advanced economy growth solidifies, and pain in EMs eases, global growth should accelerate modestly in 2016.

The writer is Director General, Bangladesh Foundation for Development Research

Global economy: What the future holds

The diverging policies in Europe and the United States will solidify a trend that has been underway for many months: The euro will weaken further and the dollar is likely to grow ever stronger

With the beginning of the New Year, it is a perfect time to reflect on how the global economy fared in 2015 and on whats in store for 2016. The global economy had a bumpy 2015. The diverging policies in Europe and the United States will solidify a trend that has been underway for many months: The euro will weaken further and the dollar will grow ever stronger. Whats more, the rising dollar over the last year has already had profound effects. It has helped account for the drop in commodity values, which are commonly priced in dollars and has punished many commodity-producing nations, like Brazil, Russia, Saudi Arabia and Canada. At the same time, the dollar has helped put a lid on inflation in the United States while hurting the competitiveness of American exporters and contributing to weakening global economic demand. A strong U.S. dollar has continued to weigh on earnings, particularly for companies with significant international exposure and is likely to do so in 2016. Those effects are widely expected to strengthen, not weaken, in the months ahead. China: The big question for Chinese authorities is how they will trade off near-term growth against longer term sustainability. On this, Chinas latest Five Year Plan implies an average target for economic growth of 6.5 per cent through to 2020. That is a step down from the 7-8 per cent pace over the past four years. Markets are concerned about a sharper deceleration, with the focus of attention on weakness in the manufacturing sector. But, while the old world economy slows, activity within the new world has quietly forged ahead. Service sector activity is almost 50 per cent of overall output, up from 40 per cent just eight years ago. The Chinese government has also drawn a line on what is a tolerable for economic growth, injecting fiscal stimulus to shore up momentum when it underperforms expectations. We expect efforts to continue on this front. However, a slowing China will continue to weigh on other emerging market economies, particularly those with significant trade linkages, like Taiwan, Malaysia, South Korea, Singapore and Thailand. Emerging markets (EM) were hit by three inter-related shocks in 2015: a collapse in commodity prices, which hurt those reliant on commodity exports; slower growth in China, which especially hurt its Asian trading partners; and rising capital outflows, which led to sizeable depreciations in many EM currencies. The downward slide created by these colliding influences will lessen in 2016, but the economic landscape for EMs will remain a challenging one. After the 2008 Great Recession, it took EM commodity-exporters one year to surpass their prior peak in real GDP. This time around, we expect it to take two years. All eyes have been on China in recent months as it went from being a financial market ugly duckling, to becoming an IMF swan. Markets balked when China unexpectedly revalued its currency in August, and intervened in the stock market to stem a disorderly decline. By late-fall, calmer heads prevailed, reinforced by the IMF who admitted the Chinese yuan as the fifth world reserve currency within their basket in December. This was a crucial step to help legitimize the yuan on the global stage, and also encourage ongoing financial reform. But, beyond that, the move should have a limited near-term influence. Adding to the challenge, China is on a slower economic growth trajectory with many structural changes afoot that dont exactly exude the confidence needed for reserve managers to shift their holdings to the yuan. Policy missteps like the August yuan revaluation will inevitably occur and China has occasionally backpedaled on reforms when growth appears to slow too far. Global financial markets in 2015 were pulled between two opposing forces: The first was the Federal Reserves determination to raise interest rates as the U.S. job market strengthened. The second was pressure for lower interest rates in much of the rest of the world as Chinas economic growth slowed and commodity prices sank. The results of the tug of war were a soaring dollar, crumbling junk bonds, stubbornly low Treasury yields and a stock market that ended the year roughly where it started. Those tensions will continue into 2016. The likely result: a global economy that escapes recession but leaves stocks battered and investors nerves frayed. Advanced nations continue to make steady progress, but the balance of risks has shifted to EMs. They will continue to be challenged by low commodity prices and weaker exchange rates. There is also the lingering risk that the US Federal Reserves tightening cycle may impart another round of pressure on EM capital flows, increasing volatility within their financial markets. However, as many of the adjustments have already been made, the pay-off should be more stable growth in the years ahead. As advanced economy growth solidifies, and pain in EMs eases, global growth should accelerate modestly in 2016. The writer is Director General, Bangladesh Foundation for Development Research