IMF report hints at soft landing, but divergences increasing

31 Oct 2023 , 09:44 AM

IMF WEO OCTOBER REPORT IMPROVES OVER JULY

The latest IMF World Economic Outlook (WEO) is slightly different from the previous report in July. Back in July, the reported had pointed to several risks to the global growth story in the form of higher inflation, impact of inflation on growth etc. This time around, the focus has shifted to a higher degree of confidence that a hard landing may have been avoided and a soft landing of the global economy looks most likely. However, there are two concerns that the IMF WEO report has highlighted. The first concern pertains to the fact that the growth in the coming 3 years would still be among the slowest in decades. That is going to have long term repercussion on job creation and spending. Secondly, the IMF report has also pointed out that the divergences among economies are gradually increasing.

QUICK WORD ON GDP GROWTH PROJECTIONS

Here are some quick takeaways from the growth projections made by the IMF WEO, October 2023 edition pertaining to some of the key economies withing the advanced economies and the emerging markets.

1. The IMF WEO estimates that world GDP will grow at 3.0% in 2023 and at 2.9% in 2024; after growing at 3.5% in 2022. The world’s largest economy, the United States is likely to grow at 2.1% in 2023 and 1.5% in 2024; after growing at 2.1% in 2022. Clearly, despite the recent positive cues on GDP growth, US growth is likely to falter over the next couple of years.

    

2. The Euro Area overall is likely to grow at a lower rate of 0.7% in 2023 and 1.2% in 2023; after growing at a relatively healthy 3.3% in 2022. In the Euro region, the largest economy of Germany is expected to contract in 2023 before bounce back to positive in 2024. Even economies like Spain and Italy that grew at 5.8% and 3.7% respectively in 2022, are likely to falter to under 2% average growth in next two years.

    

3. Among the other two major advanced economies, Japan is likely to grow at 2.0% in 2023 and 1.0% in 2024 after growing at 1.0% in 2022. On the other hand, UK growth will taper to 0.5% and 0.6% in the next 2 years after growing at a healthy clip of 4.1% in 2022. Clearly, the momentum is tapering in many of the advanced economies.

    

4. Let us turn to the largest emerging market economy, China. The Chinese economy is expected to grow at 5.0% and 4.2% in the next two hears after growing at 3.0% in 2022. Clearly, China is likely to see positive momentum. Russia, which had contracted by -2.1% in 2022 amidst the Ukraine war is likely to grow at 2.2% and 1.1% in the next two years. 

    

5. In 2022, India was the second fastest growing economy after Saudi Arabia, which grew at 8.7% on the back of a sharp rally in oil prices. However, in 2023 and 2024, India is expected to be the fastest growing economy at 6.3% in both the years. This is against 7.2% growth recorded by India in 2022. 

Overall, the emerging markets are likely to see much better traction in the coming two years compared to the advanced economies. This is a clear shift from the trend we saw between 2011 and 2019.

WHY IMF FEELS THE GLOBAL ECONOMY IS LIMPING ALONG?

The biggest concern for IMF is that global growth in the coming 2 years would be at multi-decadal lows. The world economic growth is projected to slow from 3.5% in 2022 to 3.0% in 2023 and 2.9% in 2024. Of course, further downsides cannot be ruled out and even at current levels, they remain much below the historical averages. The good news, according to the IMF WEO, is that the impact of hawkishness on inflation is now clearly visible. For instance, the average inflation is expected to fall from 9.2% in 2022 to 5.9% in 2023 and to 4.8% in 2024. Core inflation (excluding food and energy) is also expected to taper gradually to 4.5% by 2024. However, the IMF has also warned that countries will get closer to inflation targets only by 2025 and now by 2024 as anticipated earlier.

The gist of these numbers is that, despite less than average growth, the risk of a hard landing may have been obviated and now a soft landing not only looks possible but also very likely. The US is likely to see a rise in unemployment from the current level of 3.6% to 3.9% by 2025, which should be consistent with inflation control goals and still very close to the definition of full employment at 3.5%. However, divergences are visible. For instance, the slowdown is more pronounced in advanced economies than in emerging markets or even in developing nations. The surprising part of the story has been that emerging markets also proved unexpectedly resilient, although China continues to struggle under a mountain of real estate problems. But that is a different story altogether.

SOME KEY RISK FACTORS TO WATCH OUT FOR

According to the IMF WEO, there are a number of key risk factors to watch out for, which may manifest in the coming months and quarters. Here are a few of them.

• A largely part of the recovery in global growth was driven by services. In the aftermath of the COVID pandemic, the services sector had been the worst hit, especially the contact intensive sectors. From that point, the recovery in services is almost complete and the strong demand that supported services is now softening. Hence, growth stories could be more halting in the coming quarters.

   

• In some markets, credit tightened due to higher rates. In the US mid-segment, the tightening of credit markets is due to the banking crisis, especially the smaller banks. Tighter credit conditions are weighing on housing markets and investment; especially in countries with a higher share of adjustable-rate mortgages. It is also hitting consumption in specific markets where consumers are less willing or capable of dipping into their savings

   

• One big question is how much more can inflation soften. In the last one year, the commodity rally unwound itself leading to a sharp fall in commodity prices. This resulted in a sharp fall in commodity prices across the board. However, the recent geopolitical risks and the ongoing war in Russia underline that these advantages may not sustain and hence a new perspective on inflation may be required.

   

• The Chinese real estate market remains the bigger macro and business risk for the world markets. If you go by the Evergrande example, then the Chinese real-estate crisis could intensify, posing a complex policy challenge. Realty contributes nearly 20-25% of Chinese economic growth and the spillover effects on economic activity and banking health is huge. Restoring confidence requires restructuring struggling property developers and preserving financial stability. These are tough, especially considering that growth is slowing in China.

   

• Inflation expectations have come down sharply in the last one year. That is encouraging but it may not have much of room to improve from here. In the last 18 months, the central banks have been aggressive in hiking rates to tame inflation. Most economies are well above their neutral rates and very close to targeted terminal rates. The scope to aggressively hike rates from here is limited. Hence, the impact is likely to be cautious and inflation expectations spiral once again if they find that central bank efficacy in containing inflation is gradually waning. That remains a major policy risk since it is inflation expectations that eventually drives inflation.

   

• Many countries, in the last few years, have seen their fiscal buffers eroding to a point where their ability to meaningfully influence fiscal stimuli points become limited. There are a number of reasons like the elevated debt levels, rising funding costs, slowing growth, and a gradually increasing mismatch between the growing demands on the state and available fiscal resources. Most countries have spent more than they could during the pandemic and that is coming back to roost. This leaves many countries more vulnerable to crises and demands a renewed focus on managing fiscal risks.

   

• One of the biggest risks for many emerging markets is the possibility of a sharp repricing of risk. This is likely to be at the cost of emerging markets and benefit the advanced economies. The danger is of a sharp repricing of risk for emerging markets is that it would further strengthen the US dollar and trigger capital outflows. The dollar index is already at a level it has breached only 3 times in the last 40 years.

To sum up, risks are still aplenty and a lot of subtle risks are getting built in. 

HOW SHOULD NATIONS PRIORITIZE THEIR MACRO THEMES?

The year 2024 is likely to be a year of flux when major macro changes can be expected. Here are some macro themes for the coming year and how policy perspectives need to be prioritized.

• According to the IMF WEO, inflation will continue to recede as central banks maintain a tight stance and avoid easing prematurely. Tightening may not be via rate hikes but by longer pauses and delayed cuts. Only after the disinflation process is firmly established, with decreasing near-term inflation expectations and inflation targets in sight, will the central banks attempt to cut rates. That is likely to be the theme across economies.

   

• Fiscal policy may have lost its teeth due to limited buffers so the focus would be to rebuild buffers. This could include removal of energy subsidies, which will also help in disinflation. Last year, fiscal and monetary policies were substantially aligned as the pandemic emergency fiscal measures were unwound. However, that alignment has reduced now and the divergence cracks are appearing. For example, the United States has seen a substantial widening of fiscal deficit. 

   

• This would be the time ideal for structural reforms for the economy and India will be no exception to this rule. With lower growth, higher interest rates and reduced fiscal space, structural reforms could be the only answer. Higher long-term growth can be achieved with a calibrated sequencing of reforms, starting with a focus on governance, business regulation and the external sector. These first-generation reforms help unlock growth and they also pave the way for subsequent reforms to the credit markets, or for the green transition. It makes these efforts more efficient and valuable.

   

• It is also the time for greater, not less, multilateral cooperation. In the last few years, there has been a tendency towards isolationism. That has to change for economies to achieve greater growth. Countries must necessarily avoid implementing policies that contravene WTO rules and distort international commerce. Of course, some amount of protection of national interests inevitable and even essential, but that cannot become the norm.

   

The rule based global economy has to come back. Today there is too much fragmenting with several powerful and influential economies like the US, Russia, China, and India trying to have a larger say. That is good; bit it cannot be at the cost of fragmentation that impedes progress toward shared prosperity goal. The world must make a serious start towards a more rules-based multilateral framework that enhance transparency and policy certainty. That would be half the job of global challenges addressed.