Sunday, 1 January 2017

THE GLOBAL ECONOMY: WHAT'S IN STORE FOR 2017 by Giovanni Bartolotta, Head of Risk, FIMBank plc

The year that just passed, 2016, has been an eventful one. From the Brexit vote to Trump election - both unexpected and fueled by an increase in social inequality, mostly blamed on trade globalisation and immigration trends - rise in economic nationalism will inevitably shape the outlook for the year that just started. 2016 also saw the death of way too many rockstars, but that is the topic of my Rolling Stones article...

Overall, the global economy is expected to fare better in 2017, growing around 3% versus 2.5% in 2016. However, as in 2016, growth will diverge across geographies, with the US likely to benefit from the fiscal stimulus promised by president-elect Trump, large EM economies like Brazil and Russia emerging from the recession of the last two years and China achieving stabilisation of its economy, albeit at a reduced growth rate. The Eurozone remains the big question mark, with large economic imbalances between Germany and the Southern countries remaining, and anaemic overall growth. The UK, despite Brexit, will continue to grow at a higher rate than the continent, also because the expected negative effects of Brexit will not begin to manifest themselves before 2-3 years. Emerging markets as an asset class will also exhibit higher growth rates than in 2016 (expected at 4.8% versus 4% in 2016), as commodity prices have steadied and economic reform of the past ten years bears fruit, however a significant downside risk is given by the continued strength of the dollar and rising interest rates, which might deter capital and investments from these countries.

You are not alone

An important policy shift in 2016, which will be a key theme for 2017, is the fact that macroeconomic policy is not left to central banks alone and to their setting of ultralow (sometimes negative) interest rates, in the hope that this strategy alone would revive economic growth. Political pressure and rising populism (although a negative trend in itself) are contributing to an easing of fiscal policy in the advanced economies. Increased public spending, a somewhat more tolerant attitude to achieving deficit targets in the EU, promised tax cuts in the US (the magnitude of which will however need to be toned down) are all bringing back political responsibility to center stage, easing pressure off central bankers. This is also because ultralow-rate monetary policies have been largely ineffective in countering weak growth, on the contrary contributing to rising social inequality (by inflating asset prices and punishing savers). This is not to say that in 2017 aggressive monetary policies will be suddenly abandoned, however a progressive reduction of the asset purchase programme by the European Central Bank (reducing bond buying to EUR60 billion per month) and a gradual rise in US Fed rates (possibly 75bps over the year) will contribute to normalise the interest rate environment. This is also likely to put pressure on global bond prices, however price adjustments should be gradual and not disrupt financial markets.

Globalisation is not the enemy

Globalisation has been mentioned as the cause for weak growth in household income and rising inequality witnessed in many advanced economies in recent years. Offshoring, rising imports from emerging markets and immigration have, according to this argument, held down wages and contributed to a loss of manufacturing jobs. However, the pace of trade opening has actually slowed in the US and Europe in the last few years, while the decline in the share of manufacturing jobs long predates NAFTA or China's accession to WTO. Sluggish growth in advanced economies has been more a reflection of private sector deleveraging, fiscal consolidation and weak external demand. Nonetheless economic nationalism is a feature which is destined to increase in 2017. In particular in Europe, a number of upcoming elections risk to bring anti-EU parties into power, therefore reducing openness to trade. This would harm the global economy by limiting the gains from specialisation. Trade restrictions would only benefit some producers with low reliance on global supply chains, but this would be generally at the expense of the consumer. It is undeniable that globalisation has made possible for each one of us to carry a supercomputer in our pockets (our smartphone) at a very low cost. Immigration restrictions would also be damaging for long-run growth. In Europe and the US, ageing populations have reduced labour force growth, which has however been significantly offset by net immigration of a generally younger labour force. In the UK alone - which voted against immigration with Brexit - the boost to labour supply, and ultimately to GDP growth, given by immigration has been close to 0.5% per year.

Emerging Markets: back to flavour of the month?

Emerging markets started seeing a slight reversal of fortunes towards the end of 2016, with Brazilian and Russian recessions bottoming out, commodity prices recovering and stabilising, and China seeing the benefits of its stabilisation policies. India, on the other hand, closed the year putting into place one of the bravest social experiments of all times (the demonetisation of its economy, by declaring illegal tender 85% of its banknotes in circulation). While this caused a shock to the economy in the short term, the long term effects should be beneficial, by reducing corruption and bringing most monetary transactions inside the banking system. Turkey, on the other hand, has seen unabated political tensions over the year - from the coup in March to the terror attacks of 31st December - which have weakened its investment environment and its currency, damaging the economy at large. At the moment, the outlook for Turkey in 2017 is the less benign of all major emerging markets.

Oil prices (a significant variable in the performance of emerging economies) has remained stable around 50 US dollars per barrel, also sustained by the recent production cuts agreed at OPEC level. Prices are expected to remain stable or slightly increase in 2017, as the OPEC agreement takes hold and inventories are used up by increased industrial production. Other hard commodity prices (iron ore, coal, steel, copper) have all rallied in recent months, in response to optimism about US infrastructure spending and sharp cuts in coal production in China.

To summarise, 2017 should be a year of normalisation for the global economy, however downside risks are not to be taken lightly. My top three risks are: 1) a political shock in the EU, undermining the European project, 2) a flair in inflation, causing interest rates to be lifted too fast, hence harming emerging markets and EU recovery and 3) Trump presidency turning more populist than necessary - due to his inexperience in government, harming global trade.

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