Emerging market outlook stabilizes, while political risks take center stage

Moody's Global Macro Outlook 2016-17

Over the last year, many of the risks to global growth that we had identified in our previous outlooks have materialized, with Brexit being the latest, said Mood's in Global Macro Outlook 2016-17. The global economy experienced steep reductions in commodity prices associated with a slowdown in China's economy and severe terms of trade shocks to commodity-exporting countries. Global financial market volatility intensified in late 2015 and early this year on concerns regarding China's growth trajectory, as well as the pace of US monetary policy normalization. Going forward, these challenges remain and financial markets volatility can easily re-emerge.

Looking ahead, growth in emerging market economies will stabilize, although there is substantial differentiation between countries

 

We have revised our growth forecast for G20 emerging markets up by 0.2 percentage points, to 4.4% for 2016 and 5.0% for 2017. The revisions are mainly driven by faster easing of the contractions in Russia and Brazil, against lower growth in Turkey and South Africa and somewhat higher growth in China. We now expect China's economy to grow at the rate of 6.6% and 6.3% in 2016 and 2017 respectively, compared to 6.3% and 6.1% previously, driven by significant fiscal and monetary policy support. Medium-term downside risks to China's growth outlook persist, especially if the reduced efficacy of policy support over time becomes apparent. We don't expect material implications for other countries, as China's imports continue to fall. Headwinds to emerging markets have moderated, driven by the economic stabilization in China, the modest recovery in commodity prices, and the return of capital flows; however, we expect the US Federal Reserve to resume its interest rate tightening cycle at the end of this year.

Growth in advanced economies will remain stable at low levels

We expect G20 advanced economies to grow at 1.6% for 2016 and 1.9% for 2017, compared to 1.9% in 2015. We have revised up Japan's growth forecast to 0.7% and 0.9% in 2016 and 2017, from 0.4% previously for both years, to incorporate the impact of the recent fiscal stimulus and expectations of further monetary policy easing. We have revised our GDP growth estimate for the US down to 1.7%, from 2.0%, for 2016 to reflect the lower advanced estimates of second quarter growth. Our 2017 US growth forecast remains unchanged at 2.3%. In our July post-Brexit update, we already revised our forecasts for the UK, the euro area, Germany, France and Italy.1 Our baseline real GDP growth expectation for the UK is 1.5% in 2016 and 1.2% in 2017. We expect limited Brexit-related spillovers to the euro area but some deterioration due to country-specific developments and maintain our euro area forecast at 1.5% and 1.3% for 2016 and 2017.

There are a number of downside risks to the global economic outlook, the most immediate being associated with the US presidential election in November. A change in US policy stance that contributes to a weakening of the current global trade and security architecture could have a detrimental impact on global confidence and growth, and would prompt us to revise our forecasts. EU political contagion represents the greatest risk to otherwise muted global impact from Brexit. Uncertainty surrounding China's growth path, the future path of US interest rates, the sustainability of the recent inflows of capital to emerging markets, the rise in emerging market corporate sector leverage, and other political risks remains. Constrained monetary and fiscal policy space limit the ability of policymakers to provide support if downside risks were to materialize.

Global Synthesis

There are six main themes that inform our outlook for the remainder of 2016 and 2017.

1. Advanced economies are growing close to historically low potential growth rates due to a mix of demand and supply factors, including public and private deleveraging, deficient demand, slow productivity gains and aging populations. Persistently low inflation rates and inflation expectations continue to defy central bank objectives. Limited effective policy space constrains policymakers from stimulating nominal demand.

2. Economic growth in the euro area as a whole remains stable, although structural factors deter improvements in some of the countries, especially France and Italy. While monetary policy is expected to remain supportive, its effectiveness is limited due to the structural constraints.

3. Given the stability and strength of the US economy, the normalization of monetary policy is expected to resume at the end of this year. However, we expect the tightening cycle to be gradual in keeping with the cautious approach demonstrated by the members of the FOMC so far.

4. With China's economy significantly supported by fiscal and monetary policy, slowdown and rebalancing is likely to be gradual. Thus we do not expect China to exert a significant drag on global growth prospects over the rest of 2016 and 2017.

5. Stabilization of commodity prices, especially non-oil commodities, from the lows reached in January has provided relief to commodity-exporting economies. However, we expect limited upside to commodity prices from here.

6. External conditions have become more favorable for emerging market countries since March given the expectation of stable growth in China, more stable commodity prices and the delay in the normalization of US interest rates. But there is substantial differentiation in the fundamentals of individual emerging market economies. Their ability to weather external headwinds during the early phase of the Federal Reserve's interest rate tightening cycle in 2017 is material to the assessment of their economic outlooks. Our growth expectations for India, Indonesia, Korea and Saudi Arabia are unchanged from our previous outlook publication in May.

There are a number of downside risks to the baseline outlook. These include:

The risk to the global financial sector from heightened volatility and possibly synchronous re-pricing of assets including equities, bonds and currencies when US interest rate normalization process resumes.

Downside risks to growth from strong reversals of capital flows in emerging market countries that have external imbalances and open capital markets. This could be triggered for instance when US interest rates begin to rise. Countries carrying foreign currency denominated debt on public or private sector balance sheets are especially vulnerable in case of a sharp currency depreciation.

Medium-term risk of a marked deterioration related to the Chinese economy and its financial sector, given the evidence that the most recent rounds of policy stimulus have become less effective.

The political and geopolitical risks of a rise in nationalist and protectionist pressures. The most immediate risk in this context is an outcome in the upcoming US presidential elections that ushers in an administration that would renegotiate global trade pacts and security alliances. We believe that such a development would harm confidence and global growth. In Europe, with a busy election calendar over the coming two years, we see a potential risk that the European Union fragments further, with global consequences. Geopolitical risks, especially from a potential diplomatic or military flare-up over the sovereignty over the South China sea, or renewed tensions in the Korean peninsula could have a regional impact in Asia, as well as globally.

Our Global Macro Outlook underpins our universe of ratings, providing a consistent benchmark for analysts and investors. This report is an update to our May 2016 Global Macro Outlook. It reviews recent key developments, provides an update on our central forecasts for 2016-17, and discusses the main risks around our forecasts. We present our central scenario in Exhibit 1 and highlight the following factors:

We express our forecasts for annual GDP growth and unemployment as a range of one percentage point (ppt) to avoid spurious precision and to focus on significant changes that could potentially influence rating decisions.

We indicate the level of uncertainty for our central forecasts, presenting ranges from the forecasts that we survey and compare to the historical standard deviation of real GDP growth.

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