By Olivier Blanchard
Yesterday we released our update of the World Economic Outlook.
The world economy remains in 3-speed mode. Emerging markets are still growing rapidly. The U.S. recovery is steady. And much of Europe continues to struggle.
However, there is a twist to the story. Growth almost everywhere is a bit weaker than we forecast in April, and the downward revision is particularly noticeable in emerging markets. After years of strong growth, the BRICS, in particular, are beginning to run into speed bumps. This means that the focus of policies will increasingly need to turn to boosting potential output growth or, in the case of China, to achieving more sustainable and balanced growth.
What the Numbers Show
Growth in emerging market and developing economies is forecast to be 5.0% in 2013. This is 0.3% less than in our April forecast. It is forecast to increase to 5.4% in 2014, but this is also a 0.3% downward revision relative to what we said in April.
Looking specifically at the major emerging market economies: Growth in China is forecast to be 7.8% in 2013, a downward revision of 0.3%; growth in India is forecast to be 5.6%, down 0.2%; growth in Brazil is forecast to be 2.5%, down 0.5%; growth in Russia is forecast to be 2.5%, down 0.9%. In all four cases, we have also revised down our earlier forecasts for 2014, by similar or even larger amounts.
Turning to advanced countries, growth in the United States is forecast to be 1.7% in 2013, a downward revision of 0.2%. But growth is expected to increase back to 2.7% in 2014. We continue to predict negative growth in the Euro in 2013, at -0.6%, again a downward revision of 0.2%. This reflects not only large negative growth in Spain and Italy, but also low growth in the core countries. Growth in the Euro should turn positive in 2014, but will remain very low.
The odd country out continues to be Japan. We forecast 2.0% growth for 2013, an upward revision of 0.5%, but only 1.2% for 2014, a downward revision of 0.3%.
The Story Behind these Numbers
The slowdown in the major emerging market economies appears to have both cyclical and, more importantly, structural components:
On the demand side, the slowdown in exports coming from low growth in advanced countries is playing a role, but in each case, domestic demand, be it consumption or investment, is also contributing to the slowdown. On the supply side, the slowdown hasn't been accompanied by much of a decrease in inflation. This, and other evidence, suggests that potential output has moved more or less in line with actual output. This has an important implication: Growth in emerging market economies will remain high, but may be substantially lower than it was before the crisis.
The slowdown in the United States is not particularly worrisome, and hides a robust recovery in private demand. Stronger than expected - as well as stronger than desirable - fiscal consolidation has been only partly offset by a stronger housing market, and this explains our downward revision. If fiscal consolidation had been weaker, growth in the U.S. would be substantially stronger.
Europe, and in particular the eurozone, is still struggling. In the southern Euro periphery, improvements in relative costs are leading to increases in export shares, but this is not enough to offset a very weak internal demand. High interest rates and fiscal consolidation are clearly playing a role. And unemployment levels remain unacceptably high.
Even in the core countries, forecasts have been revised down. Lower exports, and induced low investment, are playing a major role in Germany. A large fiscal consolidation is playing a big role in France. But there seems to be more at work here - a general lack of confidence in the future, which, if it does not turn around, may turn out to be partly self fulfilling.
One could say Japan falls in the three-and-a-half speed. While it is too early to tell how much of it reflects Abenomics, growth this year has been stronger than expected, and confidence appears to be building.
Old Risks Remain; New Risks Arise
Turning to risks: Old risks are still present, the main ones related to Europe. We see also three main new risks:
The first is risks to growth in China. After a very large increase in investment since the beginning of the crisis - an increase largely financed through the shadow banking system - Chinese policy makers face a difficult choice: Either letting investment remain high, at the risk of increasingly unproductive investment and building credit risks; or tightening credit and slowing investment and risking a decrease in growth, since consumption is unlikely to increase fast enough to compensate. Thus, we see downside risks to growth in China.
The second is Japan's Abenomics, namely the "three arrows" of fiscal stimulus, aggressive monetary easing, and structural reforms. Unless the second arrow is soon complemented by a credible medium run fiscal plan, and the third arrow reflects substantial structural reforms, the risk is that investors become worried about debt sustainability, and ask for a higher interest rate. This would make it difficult for Japan to maintain debt sustainability.
The third is risks associated with the exit from quantitative easing in the United States. We attribute the high volatility of financial markets in the recent past to the sudden realization by investors that quantitative easing would eventually come to an end. As they tried simultaneously to rebalance portfolios, both in the U.S. and abroad, the result was some overshooting, isolated dislocations, and high volatility. Going forward, we expect volatility to decrease, but one cannot rule out further attacks of nerves along the way.
In the emerging market economies, the focus should be on boosting potential growth, while dealing with the capital outflows that may follow from U.S. QE exit.
In both the United States and Japan, a credible medium-term fiscal plan is of the essence. And in Europe, measures must nurse the timid recovery. These include gradual fiscal adjustment, the assessment and repair of bank balance sheets, and progress on the banking union.