World Economy: After a Tumultuous 2016, a Slight Improvement in 2017
By Coface, the international trade credit insurance company
According to Coface’s estimates, global growth weakened for the second consecutive year in 2016, at 2.5%. Marginally higher growth of +2.7% is expected in 2017, especially with the upturn in activity in emerging economies (+4.1% in 2017, up from +3.7% in 2016) and the economic recovery in Brazil and Russia which will offset China’s gradual economic deceleration.
GDP growth in advanced economies will hold steady at 1.6%, with the slowdown in the United Kingdom being compensated by the resilience of the Eurozone and the slight improvement in US economic activity.
The factors that have sustained developed economies in recent years, such as low oil prices, relaxed monetary policies and low levels of inflation, are set to become less favourable this year. Raw material prices, which began falling in mid-2014, reaching a low point in 2016 and helped boost economic activity1, are slightly higher.
The IMF global raw materials index is expected to increase by 11% in 2017, compared to a 10% fall in 2016. The recent agreement reached by OPEC at the end of November was undoubtedly responsible for the upward surge of US$10 in the price of Brent, seen in December 2016.
Nevertheless, Coface does not expect oil prices to increase significantly this year due to a number of factors such as: (i) There is no guarantee of compliance with production targets for the 1st half of 2017; (ii) The long-term commitments by OPEC countries are still to be honoured, while Russia has only made a relatively limited effort; (iii) The risk of the release into the market of US shale oil if prices rise further and reach the marginal cost of shale oil of around 60 dollars.
Any potential rebalancing of the world market is only likely to happen slowly. Macroeconomic uncertainty remains significant, as in 2016. There were peaks of volatility during 2016 following the UK referendum and the US elections, with increases in the VIX volatility indicator.
The current uncertain environment could once again be accentuated by peaks of volatility in raw material prices - although, according to an analysis by the Banque de France, this is not guaranteed. Price uncertainty appear to be more closely linked to the issue of predictability than volatility2.
Another global factor is the current performance of world trade which is at an historical low and not expected to rebound quickly, given the depressed state of economic growth. The relationship between trade and economic activity has weakened with reduced elasticity.
This new “normality” (the reasons for which lie in structural factors such as slower growth in the world value chain3) will lead to continuing disappointing performances in international trade in coming years, even if there is an upsurge in activity4. This lack of trade vitality is an even greater concern given the mounting fears of a resurgence of protectionism, heightened by the victory of Donald Trump.
The outcome of the elections did not, however, prevent the Fed from raising rates, as expected. There was limited reaction from the financial markets to this first (and long awaited) sign of a reduction in the abundant levels of liquidity in the markets.
The US Federal Reserve is concerned about the re-emergence of inflation and is expected, at the very least, to raise rates once again in 2017 (following increases in December 2015 and 2016). In this context, the dollar should continue strengthening against other currencies during the first half of 2017.
The euro reached a low point in December 2016, at USD 1.054. Capital flows to emerging economies are also likely to be limited by the reduction in the relative gap between national key lending rates and US rates – unless countries decide to align with this rate increase as Mexico has done with a +250 bp increase in 2016.
In addition, the growing uncertainty in developed economies is likely to inhibit the flow of investment into emerging economies, which triggers a “flight to quality” (as shown in an analysis by the Banque de France5). Shocks originating in Europe normally tend to have a more limited impact on flows than those from the United States.
China will remain subject to the same issues in 2017. As the Chinese government is not yet ready to trim its level of support for the economy, it would seem that reducing the country’s imbalances is not a priority. This has been demonstrated by the increase in the private non-financial debt/GDP ratio of +20 GDP pts between June 2015 and June 2016, according to the Bank of International Settlements.
The restrictive measures aimed at investors6 are not indicative of financial deregulation, despite the gradual changes in exchange rate policy such as recent changes to the basket of currencies aimed at achieving a better representation of the relative weights of the various trading partners.
The question is: Should a change in the paradigm be expected in terms of inflation? Inflation in developed countries remained particularly low last year (below 1% in the Eurozone). Compounding the relatively poor level of domestic demand, the fall in raw material prices from mid-2014 to 2016 has accentuated the downward trend, leading to negative inflation rates in some cases such as in Spain in the first-half of the year. Inflation is expected to begin rising again in 2017, if only as a basic mechanical reaction to raw material prices having reached their a low in 2016.
A sudden leap in inflation is unlikely, due to weak internal demand, in the context of a still-widening output gap, particularly in the Eurozone. According to the latest Eurostat flash estimates, Eurozone inflation rose 1.1% in December against +0.6% in November, due to sharp rises in energy and food prices. One noteworthy factor is that energy will be making an upward contribution to inflation for the first time since July 2014.
Inflation in the United States is not expected to increase rapidly either, with the core index remaining below the 2% threshold according to an IMF analysis, provided that the dollar does not depreciate and the unemployment rate does not fall below its structural level7. Growing political uncertainty in the US is also likely to limit the rise in inflation8.
1/ IMF, WP/16/210, “Oil price and the global economy: is it different this time around?”, November 2016
2/ Banque de France, Working Document 607 “Does the volatility of commodity prices reflect macroeconomic uncertainty”, November 2016
3/ Coface Country Risk Assessment 3rd quarter 2016 “The price of oil, the emerging economy thermometer, once again a key concern”, October 2016
4/ VoxEu Article “The great normalisation of global trade”, October 2016
5/ Banque de France, Rue de la Banque n°34, “Economic policy uncertainties in industrialised countries and shift of portfolio investments towards emerging economies”, November 2016
6/ Adopted at the end of November, these measures are intended to limit outgoing capital movements (namely by means of increased controls on acquisitions abroad by companies based in China and increased controls on financial flows in yuan or currencies leaving the country) and implementing greater controls on investments made in other countries.
7/ IMF, WP/16/124, “What is keeping US inflation low: insights from a bottom-up approach”, July 2016
8/ Banque de France, Rue de la Banque n°33, “Uncertainty in economic policy and inflation expectations”, November 2016
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