IMF upgrades global growth in its latest WEO update

7 Feb 2024 , 10:57 AM

IMF PAINTS A ROSY PICTURE OF GLOBAL ECONOMY

The International Monetary Fund (IMF) has just put out the January 2024 issue of the World Economic Outlook (WEO), coving data up to the end of December. The broad message appears to be positive. The IMF has affirmed that the global economy had already seen the worst and should be on the path to a higher growth plane. For 2024, the IMF has upgraded growth estimates for the world economy as well as for some of the key economies like the US, China, and India. The global growth estimates put out by IMF in the January 2024 WEO is a full 20 bps higher than the growth estimate in the previous October 2023 outlook. According to the IMF, growth levers have moved faster than expected, economies have shown much more than the traditional resilience, and inflation has fallen much faster than expected. That is the background in which the IMF has updated its WEO for January 2024.

MODERATING INFLATION TRIGGERS HOPES OF SOFT LANDING

Just about a year back, analysts and economists had almost predicted an inevitable recession. This was likely to be an outcome of persistent hawkishness and the speed at which the rates were raised. The reality was something entirely different, as economies managed a soft landing, despite higher interest rates. Here is how.

• The IMF has projected global GDP growth at 3.1% in 2024 and at 3.2% in 2025. The 2025 forecast is static but the 2024 forecast is 20 bps higher than the last update in October 2023. The reasons are not far to seek. Global economies have displayed amazing resilience to central bank action across developed economies and emerging markets. Also, inflation has fallen faster than expected while China is finally showing green shoots of a sharp recovery in growth. However, it must be remembered that the 3.2% forecast of global growth for 2025 is still 60 bps below the average of 3.8% growth that the world economy displayed between the years 2000 and 2019. One big trigger has been the expectation that global headline inflation will fall to 5.8% in 2024 and to 4.4% in 2025.

   

• The better than expected growth has been magnified by disinflation. This is the opposite of inflation and has ensured that the prospects of hard landing are eliminated. The good news is that rapid disinflation could lead to further easing of financial conditions. This will also help loosen fiscal policy which should be growth accretive for global economies. However, there are also risks to inflation. The Red Sea standoff is resulting in ships being directed through the Horn of Africa. That is adding substantially to the cost of freight and the insurance costs, making economies like India vulnerable to imported inflation. The one big risk is the rather volatile property sector in China, which is still in crisis due to the huge gap in value of loans and value of underlying assets. 

   

• While a soft landing looks likely, it is yet to be achieved. For that, the policymakers have to adroitly mange the final descent of inflation to target. For instance, in the US PCE inflation is currently at 2.60%, just 60 bps from its target, whereas in India, the inflation is about 170 bps away from the target of 4%. Another positive feature that IMF has pointed in its WEO update is that with better economic conditions, countries are also opting for fiscal consolidation. For instance, India has shown fiscal prudence by cutting its fiscal deficit target to 5.1% for FY25, against the street expectation of 5.3%-5.5%.

Clearly, the IMF in its latest WEO update for January 2024 is a lot more positive about the world economy, including some of the high value economies. Let us turn to the forces that are shaping this renewed outlook for global markets.

WHAT IS BEHIND THE IMF OPTIMISM ON GLOBAL GROWTH?

The post-pandemic recovery has been much faster than expected. Despite the disruption caused by the Russia Ukraine war and the impact on crude prices, the world is in much better fettle today, that it was prior to the contagion. While demand recovery was never the issue, the real challenge in the last 3 years has been the supply side constraints as companies struggled to meet the surge in demand. That appears to have stabilized. Here are the key drivers for the IMF optimism.

Global economies are more resilient than expected

GDP growth in the second half of calendar 2023 is estimated to have been much stronger than expected. This is true of the US economy, as well as several major emerging market and developing economies; including China and India. For the US, the Federal Reserve has already put a hold on rate hikes and started talking about rate cuts. But, the big story has been the resilience shown by US GDP growth. For Q4, the first advance estimate has come in nearly 120 bps better than expected at 3.3%. Similarly, the Atlanta Fed GDP estimate for Q1 2024 is also 120 bps higher at 4.2%. In most of the economies, it is not just government and private spending that has contributed to the upswing. There has also been support coming from a spike in real disposable income and a higher propensity to consume. More importantly, the labour market continues to be robust with the US unemployment still at levels of 3.7%. This has kept wages higher. While that is making inflation stickier than expected, it has also kept growth and consumption resilient in tough times. 

Inflation falls quicker than expected

The inflation in the post-pandemic period was largely driven by the supply chain crisis. Chian was at the centre of the supply chain and they decided to call a halt to global supplies amidst the pandemic. That upset the applecart. Since then, companies have diversified beyond China, even as Chinese economy is gradually getting back on track. This has ensured that supply chain bottlenecks are largely addressed. In addition, the subdued prices of commodities and oil prices falling sharply in the last one year have also led to inflation falling much faster than expected. For instance, the estimate of global inflation in the January 2024 WEO update is a full 30 bps lower than the October 2023 update. An interesting trend visible globally has been the sharp fall in core inflation, which is the structural non-food, non-fuel inflation in the overall basket.

There is a positive side to high borrowing costs

In the last 2 years, most of the central banks resorted to aggressive interest rate hikes to reduce inflation. This had a negative impact in the sense that it increased the borrowing costs for businesses and for individuals. However, that also had a positive side to it. Higher cost of funds automatically put a lid on borrowing even as banks also became more cautious about consumer loans. The combined impact was to reduce spending and also inflation. This was one of the major reasons contributing to lower inflation expectations, which has been the trigger for central banks to start thinking in term of a rate cut. The immediate impact of this phenomenon has been the reduction in longer-term interest rates and rising equity markets. Also, central banks are not exactly converging on rate action. For instance, while the US and Europe continue to be hawkish; Japan, China and India have given up hawkishness quite some time back. 

Even fiscal policy has played a role

Governments in most of the advanced economies have already eased fiscal policy in the year 2023. The fiscal stance has been relatively more neutral in the case of emerging markets. One factor contributing to an improving fisc is that the oil prices have fallen by over 16% on an average yoy. It is true that the Red Sea crisis does post a threat to the oil inflation story. However, the positive side of the story is that many emerging and even developing countries are using this fiscal leeway to work on fiscal consolidation. The surge in fiscal deficit during the pandemic period, is now being cut rapidly and that is likely to improve the fiscal robustness of most economies by next year.

IMF GROWTH OUTLOOK FOR 2024 AND 2025

The IMF in its latest WEO report has updated its growth projections for 2024 and 2025 across emerging and advanced economies. Here are some key takeaways.

• World GDP growth is pegged at 3.1% for 2024 and 3.2% for 2025. While the 2024 GDP growth estimate is a 20 bps upgrade, the 2025 growth estimates are static.

   

• US GDP growth is pegged at 2.1% for 2024 and 1.7% for 2025. While the 2024 GDP growth estimate is an upgrade of 60 bps, 2025 is a downgrade of -10 bps

   

• Euro Area GDP growth is pegged at 0.9% for 2024 and 1.7% for 2025. While the 2024 GDP growth estimate is -30 bps downgrade, the 2025 growth estimates is -10 bps lower.

   

• Japan GDP growth is pegged at 0.9% for 2024 and 0.8% for 2025. While the 2024 GDP growth estimate is -10 bps downgrade, the 2025 growth peg is a 20 bps upgrade.

   

• China GDP growth is pegged at 4.6% for 2024 and 4.1% for 2025. While the 2024 GDP growth estimate is 40 bps upgrade, the 2025 growth peg is flat compared to October.

   

• India GDP growth is pegged at 6.5% for 2024 and 6.5% for 2025. While the 2024 GDP growth estimate is 20 bps upgrade, the 2025 growth peg is also a 20 bps upgrade.

   

• World Trade Volume growth is pegged at 2.6% for 2024 and 2.7% for 2025. While the 2024 GDP world trade growth estimate is 20 bps upgrade, the 2025 growth peg is flat. ASEAN and EM trade is likely to growth much faster than advanced economies.

   

• Global Inflation is pegged at 5.8% for 2024 and 4.4% for 2025. While the 2024 GDP growth estimate is flat, the 2025 inflation is -20 bps lower than October estimate.

Let us finally turn to the downside risks to this recovery highlighted by the IMF in its January 2024 WEO report.

DOWNSIDE RISKS TO GLOBAL GROWTH STORY

It is said that in economics your conclusions are as good or as bad as your assumptions. Here are some of the implicit risk assumptions in the global growth story, as highlighted by the IMF in its January 2024 update to the WEO report.

• The Red Sea crisis amidst the ongoing conflict in West Asia has renewed the risk that commodity prices could spike once again. Commodity price spikes could happen amid geopolitical and weather shocks. The Middle East and West Asia put together produces about 35% of the world’s oil exports and 14% of its gas exports. Nearly 11% of global trade goes through the Red Sea and that is the point of contention. Any shocks could effectively result in spikes in food, energy, and transportation costs. Container shipping costs have already increased sharply, and the situation in the Middle East remains volatile. El Nino continues to be an unpredictable factor in global growth.

   

• For now, core inflation is subdued, but it has not vanished. Persistence of core inflation may require a tighter monetary policy stance. Typically, the core inflation could turn sticky due to factors like labour market tightness and renewed tensions in supply chains. Such developments could trigger flight-to-safety capital flows, and strengthen the dollar.

   

• China is central to any global recovery as it still contributes maximum to dollar GDP growth each year. In the absence of a comprehensive rehabilitation package for the real estate sector, China could see its growth momentum faltering. 

   

• One of the negative outcomes of the pandemic was the sharp rise in fiscal deficit. Many countries also saw a sharp rise in debt levels. Now that the fisc is improving, several nations (India included) are resorting to fiscal prudence and consolidation. However, not all countries may adopt the prudence route and that remains a major risk and could cause serious fiscal spillovers. Also, any macroeconomic shock could pressure some of the indebted countries to face risk of debt distress; especially among emerging markets.

To sum up, there is good news on the growth front, but the risks are not fully out of the way.