At the presentation of the World Economic Outlook, World Bank economist, Olivier Blanchard, Economic Counsellor and Director of the Research Department, gave insight into trends in world economy. Here are some of the insights
Excerpt:
What is your view on the world economy?
I am going to do the usual quick tour of the world economy. I am going to start with the U.S. In the U.S., private demand continues to be strong. On the assumption that fiscal accidents are avoided, which is the underlying assumption of our forecast, recovery should strengthen. Growth will be higher next year than it is this year. It is, therefore, time to make plans for exit from both quantitative easing and zero policy rates, although it is not time yet to implement these plans.
While there is no major technical issue involved in doing so, the communication problems facing the Fed are new and delicate. Therefore, it is reasonable, looking forward, to think that there will be some volatility in long rates for some time to come.
Moving on to Japan, the recovery in Japan continues. Whether it can be sustained depends very much on Abenomics, as it is called, meeting two major challenges. The first, reflected in the debate, about the increase in the consumption tax is the right pace of fiscal consolidation. It has to be neither too slow to compromise credibility nor too fast to kill growth, and that is always a delicate balancing exercise. The second is a credible set of structural reforms to transform what is now a cyclical recovery into sustained growth.
Let me turn to core Europe. Core Europe is at last showing some signs of recovery. This is not due to major recent policy changes but partly to a change in mood, I would say, which could be self-fulfilling or at least partly self-fulfilling. Now, I have talked here about core Europe. South and periphery countries are still struggling. Definite progress on competitiveness and exports is not yet strong enough to offset depressed internal demand. In both the core and the periphery, uncertainty about bank balance sheets remains an issue, which the promised so-called Asset Quality Review should help reduce. Taking the longer view, just as in Japan, underlying growth is low and, therefore, structural reforms are badly needed.
Now, the major news, as I said at the start of this press conference, comes from emerging markets, where growth has declined often more than we had forecast in July. So, the obvious question is whether this reflects a cyclical slowdown or a decrease in potential growth. That is a very hard question to answer and we will know the answer only in time. Based on what we know today, the answer is both.
Unusually favorable world conditions, be it strong commodity prices or global financial conditions, led to higher potential growth in the 2000s, with, in a number of countries, a cyclical component on top. Now, as commodity prices are stabilizing and financial conditions are tightening, potential growth, looking forward, is likely to be lower. In some cases, this has been compounded by a fairly sharp cyclical adjustment.
So, confronted with these changes, governments in emerging market economies face two challenges. The first is to adjust to lower potential growth and, where needed, deal with the cyclical adjustment that some of them confront.
On the first, while some decrease in growth relative to the 2000s is probably inevitable, structural reforms can help and are now becoming more urgent. The list is familiar, you have heard it before, from rebalancing toward consumption in China to removing barriers to investment in India or Brazil.
On the second challenge, which is the cyclical adjustment, then standard advice also applies. Countries with large fiscal deficits, of which there are a few, should consolidate; countries with inflation running persistently above target should tighten; and more importantly than what they do to interest rates, they should put in place a credible monetary framework, which some countries still do not have.
Now, the increase in U.S. long rates makes the advice even more relevant than it was, say, six months ago. Normalization of interest rates in advanced economies is likely to lead to a partial reversal of the earlier capital flows, and this is where the tensions come in. As investors repatriate funds, countries with weaker fiscal positions or high inflation are particularly exposed. The right response for emerging market economies faced with these issues must be twofold.
First, where needed, they have to put their macro house in order to clarify the Monetary Policy Framework to maintain fiscal sustainability. Second, in response to the capital outflows of a slowdown in capital inflows, they should let the exchange rate depreciate in response to these flows. Foreign currency exposure, which led to the adverse effects of depreciation in the past, is more limited today and emerging market economies should be able to adjust to the changed environment without major difficulties.
Just to finish the world tour, I have not focused on low-income countries. The good news here is that they continue, in general, to be quite resilient and achieve fairly high growth. Nevertheless, looking forward, they will also face a tougher, more challenging environment.
Let me summarize. The recovery from the crisis continues, I think that is an important fact, but too slowly. While the focus this time is more on emerging market economies, other legacies of the crisis are still very much present. Advanced economies are not out of the woods; public debt and, in some cases, private debt remain very high. Fiscal sustainability is not a given. The architecture of the financial system is still evolving and its future shape and solidity are still unclear, a theme which will be developed in the presentation of the GFSR tomorrow. Unemployment remains very high and will remain high for a long time. So, these challenges remain and I think they will be the major challenges we face in the years to come. Thank you.
Looking at these numbers, 2.9 percent global growth in 2013, that is the lowest number in four years. Is the world economy in danger of slipping back into recession?
… Why, after all this stimulus in the advanced economies, is this recovery so sluggish? We know about the reasons that you often give: Eurozone austerity, fiscal consolidation in the States. But overall, why is it so much lower than you had predicted earlier?
These are very good questions. Is the world economy likely to slip back into recession? We do not have a number under which this happens, but I think there are reasons to be relatively optimistic.
As you noticed, I have avoided giving you the growth number for the world as a whole, because I think that in some ways it is a meaningless number. I think if you look, what you have are these two evolutions. You have the recovery of advanced economies, and these are the economies which were sick and, therefore, it is very important that recovery is, looking forward, is going to be a bit stronger.
Then you have a slowdown in emerging market countries, but it is still the case that they are growing fairly fast. If they do some of the structural reforms that they intend to do, they should be able to continue. So, on that, although the global growth number is not impressive, I think that the news on that is rather good. Those countries which were sick are less sick than they were, and the others are slowing down, but I would not call this sickness. So, I think that is the answer to the first part of your question.
The second is, why is it that growth is still so low in a way and, say, lower than in 2010? I think what happened in 2010 was the recovery from an acute illness. Many things could be repaired relatively easily. When you go down the lot, it is easier to go up fast. Then there are some brakes which are easy to identify that can be removed. I think that is what we saw.
We are now in a different situation in which what needs to be done is more complex. These are more complex reforms of the financial system, more complex fiscal reforms. So, there is no easy gain and I think that is what is being reflected. There is also probably a bit of adjustment fatigue which is leading to maybe less reforms than would be desirable.
On the U.S., has the current World Economic Outlook forecast taken the impact of the short-term and long-term consequences of the government shutdown, and what if the debt ceiling cannot be raised in time?
On China, given Chinese Premier Li Keqiang’s 7-percent growth bottom line, what made the IMF believe that the Chinese policymakers have refrained from further stimulating growth?
I will take the question on the U.S. You know, what would happen in the bad scenario is difficult to tell. If the debt ceiling is not lifted, then there is a direct effect on spending, government spending, which would have to be cut quite dramatically. So, just the mechanical effects of that, if it lasted for some time, would be very, very large.
In addition, it would probably lead to a lot of financial turmoil, and there it is very difficult to know exactly what will happen, what mechanical problems it will create, what psychological problems it will create, what investors will do, and where will they go. Here, we are exploring various scenarios, but it is very hard to give a number. I think what can be said is if there was a problem lifting the debt ceiling, it could well be that what is now a recovery would turn into a recession or even worse.
On China, Our forecast for growth for China for this year is about 7.6 percent, moderating slightly to 7.3 percent next year. The main reason we think that this is broadly the appropriate pace of growth is because, so far, growth has been driven by investment and the economy has become a bit too reliant on social financing credit-driven investment. As a result of this, the attendant sort of risks have increased, especially on the financial sector, in terms of financial sector asset quality, and also because a lot of the recent increase in growth was driven outside of the budget through the local government platforms. The off-balance sheet risks have also increased, as a result of which there is less of a willingness by the authorities to continue in this growth model. The IMF thinks that this is the right approach. The next step, of course, would be to move more toward a consumption-based growth model, for which a number of reforms would still be needed, including expanding the social safety net, moving to more market-determined interest rates, and rely more on risk-based financing, and so on and so forth.
On the U.S., you said that it was time to plan but not implement those plans on monetary policy. What is your working expectation of when you feel tapering is going to start? Secondly, what is your modeling on the effect just of the shutdown, assuming the debt ceiling is settled but the shutdown continues.
…Do you see this as a linear focus, X percent of GDP per week of shutdown, or do you see more of a … it is not bad and then it is bad and, if so, at what point do you feel it becomes bad?
On what the Fed will do, I will not second-guess the Fed. I think they have been very clear about the fact that the approach would be dependent, to use the expression, and, as a result, they will start when they think they have to start. Our working assumption at least on the policy rate is the policy rate will not be increased before 2016.
On the shutdown, I think it is linear for some weeks until it becomes nonlinear and then it has effects on expectations. Some of the people not paid become liquidity-constrained; financial markets worry. But I think it is linear at least for some time, for a number of weeks. I do not know and you do not know.
The WEO has cut the growth forecast for India very steeply. Where is this coming from and what measures do you think policymakers have failed to take, which has resulted in such a steep cut, or what should they be doing?
For India, our forecast for FY2013 is for growth to average around 3.8 percent, and this is in market prices, and it will gradually pick up to 5.1 percent next year. You are right; growth has slowed down quite sharply. A number of domestic factors have played an important role in this regard.
On the structural side, we still see investment recovery to be very slow. A lot of supply-side bottlenecks, say constraints in the mining sector, in the power sector, as well as, in general, investment sentiment has been very weak in terms of slow project approvals. These things have played a role in keeping investment still pretty subdued. Also, given much tighter monetary conditions, given the higher inflation, higher interest rates have played a role in keeping consumption demand pretty subdued.
But having said that, more recently the exchange rate has depreciated significantly in real effective terms, and agricultural production is also undergoing a strong rebound. So, built on these factors and high-frequency indicators show that even investment growth is picking up, we expect growth to pick up next year.
Six months ago you warned, you singled out the U.K. as a country which was not necessarily carrying out the right kind of fiscal policies, and said it might need to reconsider its course. You warned that the Chancellor’s kind of policies were the economic equivalent of playing with fire. Today there is not a criticism of the U.K.’s fiscal policies within the WEO. You have upgraded the U.K.’s economic forecast as well by more than any other G7 country. Is it not the case that the IMF itself here is the one who has had its fingers burned?
Six months ago we worried about growth in the U.K. not coming back and we have been pleasantly surprised by the fact that it was stronger. I do not think this settles any of the debates that took place six months ago, or earlier. It does not tell us whether the pace of fiscal consolidation was the right one or not. It does not tell us whether growth could have come back earlier with a different fiscal framework. It is our job to warn about risks. When we see a risk, we warn. If a risk is avoided, all the better. I think that is what happened.
On the structural reforms that the emerging markets need to take in order to grow better, what will be the pitfalls that you would avoid in the case of Brazil, the main dangers?
On Brazil’s pitfalls, I am not sure there are pitfalls strictly in terms of structural reforms. What seems clear is that there are bottlenecks in a number of areas. They have been identified; in particular, in terms of infrastructure. There is a complementarity between public investment infrastructure and private investment. So, to extent that this is addressed, I think there will be no pitfall.
Well, Brazil has had a very strong bounce-back after the crisis. It has had a slowdown. Since then, it has been a difficult environment to navigate. On the one hand, I think the central bank in 2011, recognizing that the economy was overheating, was tightening its monetary policy stance. At the same time, the euro area crisis was unfolding. You had a less favorable external environment. Markets took a different turn. So, it was a difficult environment to have the macro policy stance right. Maybe this slowing in 2011 was a bit too tight, given what happened externally.
Now, recently, Brazil has been hit by the turbulence in global financial markets, but again, the ingredients have been there. As Olivier Blanchard mentioned, a good response to volatility in capital inflows is to let the exchange rate adjust, as clearly happened in Brazil. Brazil has also, by tightening monetary policy in an environment where inflation was moving to the upper end of the bound, shown its determination to stick with the Monetary Policy Framework and re-establish or establish the fact that this framework is standing and is credible. So, again, this falls on what Olivier Blanchard meant. Keep your house in order. That was also confirmed. So, in that sense it has not been exactly smooth sailing, but the ingredients to move on and keep the economy as stable as it can are there.
What are the biggest risks to GDP growth in Poland and the other new EU members from CEE?
First, the good news is that growth in the Central and European economies has picked up. This year already there are almost no economies that are any longer contracting in that part of the world and that growth will be slightly higher next year, around close to 2 1/2 percent, with again no economy contracting anymore. So, this is the good news.
But there are a number of risks. The most immediate one, of course, stems here from the United States and the debate about the budget and the debt ceiling. There are also risks still emanating from Europe. A lot of banks in Europe are still under pressure to deleverage and will have to continue to deleverage and that this will continue to affect the economies in Central and Eastern Europe. Obviously, these economies will also be affected if growth in the emerging economies was lower than what we project.
Finally, some of the Central and Eastern European economies still have noticeable macroeconomic imbalances, relatively large current account deficits and fiscal deficits, and these pose risks in the context of a relatively more volatile global environment such as we are in.
For Russia, you project 1.5 percent growth this year, and the Russian authorities have taken the unusual step of publicly disputing the projection. They believe that growth should be in the range of 1.8 to 2 percent. What makes you more pessimistic, and do you see a scenario where growth might turn negative?
We see two issues in Russia. There is a cyclical issue and there is a structural issue. The structural issue relates to low potential growth and a business climate that has not been very supportive of investment, and this has been weighing on activity. The first half of this year was not good in Russia. We expect that the second half will see a modest recovery partly helped by stronger demand from abroad. As we move into 2014, growth will be back up around 3 percent. That explains basically the structural problems, plus the subdued start to the year, why we see growth only at 1 1/2 percent.
You seem less worried about the Eurozone whereas it is once again the only region in recession in the world. Could you explain that optimism and could you also explain why you revised upward your forecast for France?
So, the optimism comes from problems mending on a number of fronts very gradually. Good progress has been made with respect to fiscal adjustment and this means that for this year we have much less budgetary consolidation than we had in 2012, and next year we would have even less consolidation necessary except in some of the periphery countries that are under pressure. This should be boosting activity. We have already seen positive growth in the second quarter. Growth was indeed higher than what we had expected. That is what has led us to revise up this year. Same thing for France. As we move into next year, we finally see even the periphery also coming out of recession and the area as a whole growing by 1 percent. Now, while we made this progress on the activity front, there is still a long way to go to reduce the very high unemployment rates. That is why we keep pushing for more measures to reduce the financial fragmentation in the euro area, including through a strong banking union. We believe that this is absolutely critical. At the same time, member countries need to persist with their efforts to reform their economies to improve the competitiveness in the periphery through measures that open up markets to more competition and that foster more job-friendly wage-setting. If all this comes together, then we can talk about a sustained recovery for the euro area that can then also make a bigger dent into the still very high unemployment rate in that region.
In the report, it shows there are two new challenges that will shape the global economy. One is the Federal Reserve’s monetary policy and the second is China’s economy. So my question is, as we have seen, the Fed has not started the tapering yet and China is on the way to doing structure. Can you explain to us how these two countries’ policy change will pose challenges to other countries going forward?
In both cases, there is more to come, because for the Fed, for the moment, as we know, there has been no actual change in action. There has been the announcement of actions in the future. So, this still has to come. However, markets look forward and, therefore, long rates have already reacted to what will come later. So I think you can say the Fed has not started moving but in fact the markets have anticipated its future move. So this is already having an effect on capital flows, on exchange rates on the rest of the world.
In the case of China, I think the long-announced and the long hoped-for reallocation from investment to consumption has barely started. What we have seen in the slowdown is largely a decrease in investment but not yet an increase in consumption. I think this is going to take, and everybody understands why, it is going to take many years, but it is again something which is just starting. The interaction of the two will take different forms now, in six months, in two years and so on.
I want to ask about emerging markets, especially Latin America. All the region has been debilitated after the last projections end of June. One of the countries that were surprising was Mexico; you put in the World Economic Outlook that it surprisingly decreased its trend of growth. Which are the main problems of putting on the road structural reforms, like fiscal or energy, while you have a debilitated economy?
It is the same for emerging markets, I think. If you look at Mexico, we have revised downward the projections for 2013 quite sharply. If you look at the underlying reasons, they are partly related to the neighbor, the United States, where demand has been weaker this year than we anticipated earlier, but more importantly also for domestic reasons. There were some problems in the construction sector, with large financial problems in large construction firms. There was lower than expected public spending. But to some extent, we think this will be temporary and for the future we predict quite a noticeable recovery back to growth rates in the order of 3 to 4 percent.
You asked about structural reforms. Mexico has implemented welcome structural reforms. More is to come. A number of important bills are with parliament, including for the oil and gas sector. Going forward, there is the hope that these reforms will be implemented and that they will support growth going forward.
You seemed to ask about structural reforms and crises. Mexico is one of the cases where a number of structural reforms were promoted by a sense of problems; for example, in the energy sector, I think the limits to raising or maintaining production in the current framework sort of turned out to be well-known and it was clear that in the current framework there was little hope that the problem could be addressed. So, I think now there is hope that the necessary steps will be taken.
Can you elaborate a little bit more about the Balkan countries, actually Southeast of Europe from Slovenia to Macedonia? Because the whole region was in recession, do you think they are still in recession?
Croatia and Slovenia are members of the EU. Do you see those countries like some kind of financial burden for rest of the European Union?
The region was affected by the slow growth in Europe over the past few years and then some specific factors such as a drought that hit in the last summer and then a very good and harsh winter. As a result, growth in many of these countries was fairly subdued. Looking forward, we see a broad-based pickup in the area. So, in many countries, growth will be around 1 1/2 to 2 percent or even somewhat more in 2014.
The area still faces some significant challenges. There is still work in a number of countries with respect to repairing or improving the financial sectors. There is also still work to be done in terms of completing the old transition agenda, which is about liberalizing product and labor markets to some extent.
Joining the EU, as Croatia has done, has traditionally given countries like a boost on the reform front and should then pay off in terms of higher growth over the medium term.
