The world economy
Weather report
The euro crisis casts a chill over a sunnier economic picture
Apr 21st 2012
WASHINGTON, DC
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UNTIL recently, the spring meetings of the International Monetary Fund (IMF) and World Bank, due to be held this weekend in Washington, DC, looked set to coincide with blossoming optimism about the world economy. But the euro crisis is again casting an unseasonal chill.
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Things look brighter than they did even a few months ago. America’s fragile recovery continues. After a disastrous 2011, Japan is on track for 2% growth in 2012, thanks in part to a boost from reconstruction spending. And the European Central Bank’s interventions in the banking system in December and February have pulled the euro area back from the brink. The IMF’s newest World Economic Outlook nudges up expected global growth in 2012 to 3.5%, from 3.3% in January. In September last year, the IMF reckoned there was a 10% chance of global growth dipping below 2% in 2012. Now the chance is just 1%, it says.
Inflationary pressures that buffeted emerging economies have been dampened by the global slowdown from 2011, allowing more room for monetary easing. The Reserve Bank of India surprised markets on April 17th by cutting its benchmark interest rate by 50 basis points, despite an IMF inflation forecast of 8.2% in 2012. And a well-managed slowdown appears to be in progress in China. The fund has raised its forecast of Chinese output growth to 8.2% in 2012.
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How China does is of critical importance to emerging markets. A recent paper by the Inter-American Development Bank, for instance, estimated that the impact of Chinese output variations on Latin American economies has tripled since the mid-1990s, while the effect of American economic wobbles has halved. America nonetheless remains crucial: it is still Latin America’s largest trading partner, and the fund reckons a strengthening US recovery will help growth in Mexico, Central America and the Caribbean to outstrip that in Brazil this year.
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But the sky is anything but clear. Although the IMF reckons the prospects for a broad and destabilising commodity-price spike are falling because a decade of rising food and metals prices has bolstered production, oil remains a dangerous exception (see left-hand chart). Although oil prices eased this week after talks about Iran’s nuclear ambitions, a supply shock which caused oil prices to spike to 50% above the baseline forecast (of about $115 a barrel) could reduce global output over the next two years by 1.25%.
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.
Inevitably, Europe is the biggest cloud on the horizon. The hopes generated when the ECB provided over €1 trillion ($1.3 trillion) in three-year liquidity to banks have faded. The yield on ten-year Spanish debt is flirting with unsustainable levels once again. Just as the IMF’s wintry January forecasts came too late to take the ECB’s actions into account, the fund’s new numbers may reflect the optimism of March and be too sunny as a result.
.
Much depends, of course, on how bad things get. That, in turn, depends on how well Europe uses the time bought by the ECB. The IMF sketches out three possibilities. On current policy, euro-area credit is expected to fall by 1.7% by the end of 2013, producing a shallow recession this year and a return to growth in 2013. Given better-than-anticipated progress on strengthening the euro zone’s rescue fund and governance, credit would shrink by just 0.6% in 2012 and the euro area could grow this year.
Alternatively, if recent fiscal agreements unravel, credit could tumble by 4% or more, touching off a deeper euro-zone recession. Recent Spanish difficulties, including slower growth and disappointing progress on fiscal goals, suggest that this ugly scenario is becoming more likely.
The fund reckons that growth in America, Japan and emerging Asia could be reduced by more than a percentage point in 2012 and 2013 if the ugly scenario did indeed occur. If the euro zone implodes, the fallout will settle most heavily on its own backyard.
.
Central and eastern Europe are most exposed to euro-zone bank deleveraging, and the huge importance of the euro area in the region’s trade will deal it a further blow (see right-hand chart). Some of the additional money that the IMF is seeking to raise could well end up being directed here. Financial linkages are less important in CIS countries and in the Middle East and north Africa, but a deeper euro-area recession will batter export industries there, too.
The conventional wisdom, nonetheless, is that the world economy could just about cope with stagnation or a shallow recession in Europe. But there is another, stormier possibility: that of renewed market turmoil caused by the risk of sovereign default or a euro-zone break-up. The ECB’s efforts have greatly reduced the possibility of a Lehman-like shock, but policymakers elsewhere still fret about the ability of the Europeans to fend off the direst outcomes, not least because they seem unable to come up with any remedies besides fiscal austerity. The global economy is in bud, but it is far too soon to plan for summer.
.
UNTIL recently, the spring meetings of the International Monetary Fund (IMF) and World Bank, due to be held this weekend in Washington, DC, looked set to coincide with blossoming optimism about the world economy. But the euro crisis is again casting an unseasonal chill.
.
Things look brighter than they did even a few months ago. America’s fragile recovery continues. After a disastrous 2011, Japan is on track for 2% growth in 2012, thanks in part to a boost from reconstruction spending. And the European Central Bank’s interventions in the banking system in December and February have pulled the euro area back from the brink. The IMF’s newest World Economic Outlook nudges up expected global growth in 2012 to 3.5%, from 3.3% in January. In September last year, the IMF reckoned there was a 10% chance of global growth dipping below 2% in 2012. Now the chance is just 1%, it says.
Inflationary pressures that buffeted emerging economies have been dampened by the global slowdown from 2011, allowing more room for monetary easing. The Reserve Bank of India surprised markets on April 17th by cutting its benchmark interest rate by 50 basis points, despite an IMF inflation forecast of 8.2% in 2012. And a well-managed slowdown appears to be in progress in China. The fund has raised its forecast of Chinese output growth to 8.2% in 2012.
.
How China does is of critical importance to emerging markets. A recent paper by the Inter-American Development Bank, for instance, estimated that the impact of Chinese output variations on Latin American economies has tripled since the mid-1990s, while the effect of American economic wobbles has halved. America nonetheless remains crucial: it is still Latin America’s largest trading partner, and the fund reckons a strengthening US recovery will help growth in Mexico, Central America and the Caribbean to outstrip that in Brazil this year.
.
But the sky is anything but clear. Although the IMF reckons the prospects for a broad and destabilising commodity-price spike are falling because a decade of rising food and metals prices has bolstered production, oil remains a dangerous exception (see left-hand chart). Although oil prices eased this week after talks about Iran’s nuclear ambitions, a supply shock which caused oil prices to spike to 50% above the baseline forecast (of about $115 a barrel) could reduce global output over the next two years by 1.25%.
.
.
Inevitably, Europe is the biggest cloud on the horizon. The hopes generated when the ECB provided over €1 trillion ($1.3 trillion) in three-year liquidity to banks have faded. The yield on ten-year Spanish debt is flirting with unsustainable levels once again. Just as the IMF’s wintry January forecasts came too late to take the ECB’s actions into account, the fund’s new numbers may reflect the optimism of March and be too sunny as a result.
.
Much depends, of course, on how bad things get. That, in turn, depends on how well Europe uses the time bought by the ECB. The IMF sketches out three possibilities. On current policy, euro-area credit is expected to fall by 1.7% by the end of 2013, producing a shallow recession this year and a return to growth in 2013. Given better-than-anticipated progress on strengthening the euro zone’s rescue fund and governance, credit would shrink by just 0.6% in 2012 and the euro area could grow this year.
Alternatively, if recent fiscal agreements unravel, credit could tumble by 4% or more, touching off a deeper euro-zone recession. Recent Spanish difficulties, including slower growth and disappointing progress on fiscal goals, suggest that this ugly scenario is becoming more likely.
The fund reckons that growth in America, Japan and emerging Asia could be reduced by more than a percentage point in 2012 and 2013 if the ugly scenario did indeed occur. If the euro zone implodes, the fallout will settle most heavily on its own backyard.
.
Central and eastern Europe are most exposed to euro-zone bank deleveraging, and the huge importance of the euro area in the region’s trade will deal it a further blow (see right-hand chart). Some of the additional money that the IMF is seeking to raise could well end up being directed here. Financial linkages are less important in CIS countries and in the Middle East and north Africa, but a deeper euro-area recession will batter export industries there, too.
The conventional wisdom, nonetheless, is that the world economy could just about cope with stagnation or a shallow recession in Europe. But there is another, stormier possibility: that of renewed market turmoil caused by the risk of sovereign default or a euro-zone break-up. The ECB’s efforts have greatly reduced the possibility of a Lehman-like shock, but policymakers elsewhere still fret about the ability of the Europeans to fend off the direst outcomes, not least because they seem unable to come up with any remedies besides fiscal austerity. The global economy is in bud, but it is far too soon to plan for summer.
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