World Economic Outlook

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1 World Economic Outlook Transitions and Tensions Rupa Duttagupta Deputy Division Chief Research Department, IMF United Nations, Project LINK Meetings, October 21, 213 1

2 Global growth dynamics are in transition Two new developments: Markets anticipated a change in U.S. monetary policy Lower growth in emerging market economies, notably China 2

3 Despite still ample slack in U.S. labor markets and downward revisions to real GDP growth, monetary conditions have tightened since May. 1 Unemployment Rate (percent) 5 Government Bond Yields and GDP Growth From Consensus Forecast (percent May 22, Unemployment rate (left scale) Employment as percent of population GDP growth in 213 GDP growth in year government bond yields Sources: Bloomberg, L.P., Consensus Forecast; and IMF staff estimates Jan. 213 Mar. 13 May 13 Jul. 13 Sep. 13 3

4 Tighter U.S. monetary conditions have spilled over into the euro area and, to a lesser extent, Japan Policy Rate Expectations 1/ (percent; months on x axis; dashed lines are from the April 213 WEO) United States Europe Key Interest Rates 2/ (percent) U.S. average 3 year fixed rate mortgage Germany Japan United States t t+12 t+24 t Sep. Source: Bloomberg, L.P. 13 1/ Expectations are based on the federal funds rate for the United States, the sterling overnight interbank average rate for the United Kingdom, and the euro interbank offered forward rate for Europe; updated September 24, / Interest rates are 1 year government bond yields unless noted otherwise.

5 EMEs slowing and AEs picking up 58 Manufacturing PMI (index; >5=expansion; sa) Real GDP Growth 1/ (percent; quarter on quarter annualized; sa) Advanced economies Emerging market economies Q2 Advanced economies 5 Emerging market and developing economies Aug Sources: IMF, World Economic Outlook; and IMF, Global Data Source. 1/ Lighter shades indicate Hodrick Prescott smoothed lines. 5

6 EM growth has declined for cyclical and structural reasons Decomposing the Slowdown 1/ (percentage points) Long term Expectations: Up and Down 2/ (medium term growth forecast; change from April 24 WEO) Potential Cyclical Change in real growth Brazil South Africa China Russia India Brazil India China South Africa Russia Source: IMF, World Economic Outlook. 1/ Cyclical component of growth calculated as the difference between real and potential growth. Potential growth estimated using multivariate filter (see Box 1.2 of the October 213 WEO for details). 6 2/ 5 year ahead growth forecasts used as a proxy for longer term growth expectations. India s figures for the July 213 update are in fiscal year terms.

7 Tighter U.S. monetary conditions interacted with EM domestic weaknesses and led to tighter EM funding conditions Net Capital Flows to Emerging Markets Breakdown (billions of U.S. dollars; monthly flows) VXY 1/ Interest Rate Spreads (basis points) Sovereign 2/ United States BB Corporate 3/ May 22, Greek crisis Irish crisis Equity Bond 1 st ECB LTROs June 29, 212 May 22, :H1 1:H2 11:H1 11:H2 12:H1 12:H2 Sep. 13 Sources: Bloomberg, L.P.; EPFR Global/Haver Analytics; and IMF staff calculations. Note: ECB = European Central Bank; LTROs = longer term refinancing operations / JPMorgan emerging market volatility index. 2/ JPMorgan EMBI Global Index spread. 3/ JPMorgan CEMBI Broad Index spread. Sep

8 Key EMs are under pressure but exchange rates have acted as a buffer and reduced or reversed previous overvaluations. Real Effective Exchange Rates (percent change from January 21 to August 213) 2 Percent change from April 213 to Aug Sur. Def. Aln. Sources: Haver Analytics; IMF, World Economic Outlook, April 213 and IMF staff calculations. Note: Aln. = aligned emerging market economies, including India, Mexico, Poland, Russia, Saudi Arabia; Def. = deficit emerging market economies, including Brazil, Indonesia, South Africa, Turkey; Sur. = surplus emerging market economies, including China, Malaysia, Thailand. 8 15

9 Exchange rate depreciation, however, will not forestall lower growth extent of slowing depends on policy room. 2.5 Market Interest Rates (percentage point deviation) Equity Prices (percent deviation) TUR IDN BRA CHN IND RUS MEX TUR IDN BRA CHN IND RUS MEX Bilateral Exchange Rate (against the U.S. dollar; percent deviation; positive = appreciation) TUR IDN BRA CHN IND RUS MEX Source: IMF staff estimates. Note: BRA = Brazil; CHN = China; IDN = Indonesia; IND = India; MEX = Mexico; RUS = Russia; TUR = Turkey. Real GDP (percent deviation) TUR IDN BRA CHN IND RUS MEX

10 Assumptions underlying the forecast AE monetary policy: U.S. tapers gradually, keeps rates on hold until 216; euro area and Japan stay very accommodative AE Fiscal policy: Less tightening in U.S. & euro area; more in Japan. EM: tightening of external financing conditions is largely a one off 1 1

11 The WEO forecast has been revised down, mainly on account of emerging economies. WEO Real GDP Growth Projections (percent change from a year earlier) 213 (Oct. 213) 213 (Jul. 213) World U.S. Euro Area Japan Brazil Russia India China (Oct. 213) 214 (Jul. 213) Source: IMF, World Economic Outlook. 11 8

12 Global growth impulses to be increasingly driven by advanced economies Contributors to Global Growth and Changes in Global Growth (Percent) United States Japan Euro Area Other Advanced Economies Developing Asia Latin America Other EMDEs Global Growth Global Growth 213 Change in Global Growth 214 Global Growth 214 Change in Global Growth Source: IMF staff estimates. Note: EMDEs = Emerging Market and Developing Economies. 12 1

13 Near term risks remain on the downside. Market risk indicators do not point to a large change in risks. Prospects for World GDP Growth (percent change) Downside risks: US budget/debt ceiling Emerging economies US interest rates Euro area US & Japan MT fiscal Monetary policy Geopolitical percent confidence interval 9 percent confidence interval (April 213 WEO) Baseline Source: Consensus Forecasts; and IMF staff estimates.

14 Risks from higher interest rates in advanced economies for emerging economies Why rates in AEs would be higher matters: Higher than expected growth good for the world Tighter policy stance not good for the world Higher than expected infla on bad for the world Worse fiscal posi ons ugly for the world Other? Depends. 14

15 EM growth and capital flows do not necessarily fall much when U.S. policy rates rise because of stronger U.S. growth. Februrary 1994 June 1999 June Latin America and the Caribbean: GDP Growth (year over year percent change, SA; deviations from t=) Latin America and the Caribbean: Gross Capital Inflows (percent of GDP; deviations from t=) Source: IMF staff estimates. Emerging Asia: GDP Growth (year over year percent change, SA; deviations from t=) Emerging Asia: Gross Capital Inflows (percent of GDP; deviations from t=)

16 EMs are now more resilient than in However, vulnerabilities have built up in some. (initial conditions) Key EMs Under Pressure Today vs Asian Financial Crisis EMs (percent) Crisis EMs 2/ Selected large EMs with capital outflows Short term external debt (% of GDP) Short term external debt (% of GDP) Right Scale Fixed ER regime (% of total) External debt (% of GDP) Reserves (% of short term external debt) Source: IMF, World Economic Outlook, April / Brazil, Indonesia, India, Turkey, and South Africa. Data shown for / Indonesia, Korea, Thailand, Malaysia, and Philippines. Data shown for

17 Over the medium term, a plausible downside scenario is one of several, limited disappointments and much lower global growth. Tighter external funding conditions for EM Less potential growth in EM, notably China Lower commodities prices Euro area investment stalls, notably in periphery Japan policy implementation is incomplete US potential growth disappoints US monetary conditions tighten more than assumed in the WEO forecast Fiscal accidents in AEs 17 17

18 In the plausible downside scenario, U.S. policy rates stay close to the zero bound for many years Real GDP Growth (percent) GDP Growth (percent) Source: IMF staff estimates. United States Market Interest Rate (percentage points) Japan Market Interest Rate (percentage points)

19 EM are hit particularly hard and global growth averages 3 percent, rather than 4 percent Emerging Asia: Real GDP Growth (percent) Latin America: Real GDP Growth (percentage points) World: Real GDP Growth (percent) World: Oil Price (U.S. dollars a barrel) Source: IMF staff estimates

20 Policies Euro area: banking union; financial sector, structural, entitlement reforms; fiscal adjustment Japan: work on all 3 arrows of Abenomics US: address ST fiscal challenges; easy monetary policy; careful calibration and effective communication on timing of exit from asset purchases; MT fiscal adjustment & entitlement reforms China: advance rebalancing and reform shadow banking India: improve fiscal policy and remove structural bottlenecks Brazil: raise domestic saving and foster private invetsment Russia: rebuild fiscal buffers and improve the investment climate EMDC: (i) exchange rate buffer; (ii) monetary policy to keep inflation well anchored; cut rates if room exists; (iii) fiscal policy to be geared to MT objectives; stimulate only if major slowdown threatens; (iv) preserve financial stability; (v) structural reforms 2 2

21 Thank you 21

22 But inflation pressures are very low. Thus, our WEO assumes that monetary policy stays very accommodative in advanced economies. Global aggregates: Headline Inflation (year over year percent change; dashed lines are the six to ten year inflation expectations) Emerging Market and Developing Economies Euro area Japan United States : Q4 Sources: Consensus Forecast; and IMF staff estimates

23 AE fiscal policy will be less tight in 214, except in Japan. Fiscal Impulse (Change in structural balance as percent of GDP) Euro area United States Japan April 213 WEO Source: IMF staff estimates

24 Spillovers: (effects of a US monetary policy shock) 1/. Econometric Evidence (peak effect of 1 basis point increase in U.S. policy interest rate; percent) United States LAC Asia Europe Source: IMF staff calculations. 1/ U.S. monetary policy shock defined as a surprise change in monetary policy rates that is not a response to inflation or economic conditions, and is taken from Romer and Romer (24). See October 213 WEO Chapter 3 for details. 24

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