Global recovery strengthening amid emerging risks: Fitch

Fitch expects monetary policy in major advanced economies to remain data driven and consistent with central banks' forward guidance

March 14, 2014 11:25 IST | India Infoline News Service
Fitch Ratings says in its latest Global Economic Outlook (GEO) that global growth will accelerate in 2014 and 2015, driven by a strengthening recovery in major advanced economies (MAE), while growth rates will remain broadly flat in Emerging Markets (EMs).

Its latest forecasts for world GDP growth (weighted at market exchange rates) are 2.9% in 2014 and 3.2% in 2015, up from 2.4% in 2013, unchanged from the December GEO.

Favourable economic trends are continuing in MAEs with GDP growth accelerating in the US and the eurozone in 4Q13 and already strong growth becoming more balanced in the UK. In contrast, in EMs, tighter funding conditions, lower non-energy commodity prices, structural weaknesses and heightened political risks added to downside revisions and risks to growth.

A deflation risk has emerged in the eurozone. "Inflation is unexpectedly low, at 0.8% in February, despite the cyclical upturn and loose monetary conditions. Monetary policy options are more constrained than in other MAEs and low inflation adds to the costs of periphery rebalancing and potentially poses the risk of a debt deflation spiral," says Gergely Kiss, Director in Fitch's Sovereign team. "Deflation is not our base case, but we forecast eurozone inflation at just 1.2% in 2014 and 1.4% in 2015, persistently below the ECB's target."

The US economy gained momentum in 2H13, and Fitch forecasts real GDP growth to accelerate from 1.9% in 2013 to 2.8% in 2014 and 3.1% in 2015, the strongest among MAEs. Improving household incomes, strong corporate profitability, an easing in fiscal drag and accommodative monetary policy will continue to support growth. Fitch forecasts an unemployment rate of 6.4% in 2014 and 6.0% in 2015, while inflation will remain subdued.

Fitch expects the gradual recovery in the eurozone to continue, with GDP growth of 1.1% in 2014 and 1.4% in 2015 after contracting 0.4% in 2013, reflecting cyclical improvement in both the core and the periphery. Growth will be supported by an easing of the degree of fiscal consolidation, normalisation of financing conditions and improvement in economic sentiment. However, high unemployment will persist, with the peak not expected until 2H14.

Fitch forecasts EM growth to flatline at 4.5% in 2014 and improve only marginally to 4.8% in 2015, well below the 6.1% average of 2010-2012. To varying extents, major EM economies face headwinds from tighter global funding conditions, idiosyncratic structural weaknesses, including heightened political risks, and lower non-energy commodity prices. While growth in EMs will continue to exceed MAEs, the differential between the two groups will decline to 2.5pp in 2014-15, the lowest since 2002.

In China, the National People's Congress announced a growth target of 7.5% for 2014, leading Fitch to revise up its growth forecast to 7.3% from 7.0%. The unchanged macro targets are despite wide-ranging reform ambitions and a desire to rebalance the country's growth model. The People's Bank has tightened domestic monetary conditions, allowed some two-way exchange rate volatility and injected greater credit discipline by allowing corporate debt defaults. Fitch believes these measures are intended to address perceived risks to financial stability while engineering a continued soft landing for the economy.

Growth remained strong in 4Q13 in the UK at 0.7% qoq and its composition became more balanced as consumption growth slowed and business investment accelerated. Better balanced growth led Fitch to revise up its GDP growth forecast to 2.5% in 2014 and 2015. However, on-going fiscal consolidation and the limited scope to increase household indebtedness will constrain growth over the medium term.

Japan will benefit from the combination of stronger MAE growth and a weaker exchange rate, through stronger net trade. Fitch does not expect the impact of the April consumption tax hike to derail the economy. GDP growth will pick up from 1.5% in 2013 to 1.7% in 2014, before moderating to 1.2% in 2015.

Fitch expects monetary policy in MAEs to remain data driven and consistent with central banks' forward guidance. The Fed will continue the gradual tapering of its asset purchases and start increasing the policy rate in mid-2015, the first among MAE central banks. The ECB will keep interest rates at their current historical lows at least until end-2015, although it could loosen policy settings if deflation risks intensify.

In this GEO's alternative scenario we analyse the impact of a slowdown of EMs triggered by a 400bps EM-wide risk premium shock. The impact on individual countries depends primarily on their dependence on foreign financing and monetary policy response to the shock. Fitch's simulation results show India would suffer a cumulative fall in the level of GDP of 3pp in 2014-15, Brazil 2.3pp, Russia 1.8pp and China just 0.8pp. By contrast, the impact in MAEs would be low, at only 0.2pp in Germany and Japan and less elsewhere.

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