Globalization & Monetary Policy Institute
International Economic Update
Global Growth Prospects Downgraded as China Loses Momentum
June 21, 2013 · Update in PDF
The global outlook has weakened. The Organization for Economic Cooperation and Development’s May Economic Outlook posted a downward revision to global growth for 2013—from 3.4 to 3.1 percent—and 2014—from 4.2 to 4.0 percent. This is in response to a slowdown in many emerging economies, particularly China, and a prolonged recovery in the euro area. In first quarter 2013, the euro-area contraction was more severe than anticipated, which offset higher-than-expected growth in Japan. Slowed growth and low commodity prices have given way to disinflationary pressures, allowing monetary easing across the board, with the exception of Brazil and Indonesia.
China Redirects Growth Strategy
China’s real gross domestic product (GDP) growth fell short of expectations in first quarter 2013. The economy expanded 7.7 percent from year-ago levels, compared with Consensus Economics’ March forecast of 8 percent. Some of the slowdown can be attributed to policy reforms aimed at promoting sustainable economic development, transitioning away from previous strategies concentrated on fast-paced growth. Much of the economy’s previous growth acceleration was the result of government expenditure financed by rapid credit expansion. In 2009, loans denominated in domestic currency grew 31 percent. Though official bank lending has slowed, broader measures of domestic credit continue to rise. Increasing house prices amid slowed economic growth are a sign of unstable credit expansion (Chart 1). If left unchecked, an increase in lending can lead to a reduction in loan quality, putting the financial sector at risk of counterparty default. As the market becomes saturated with loans, the cost of funding should increase, causing the interbank lending rate to rise. The three-month Shanghai Interbank Offered Rate jumped 1.5 percentage points in June, after remaining nearly constant since January 2013. The inaction of the People’s Bank of China to counteract this sudden rate increase through liquidity injection signals a desire to rein in rapid expansion of credit and avoid credit-fueled growth.
Euro Area Shows Signs of Improvement …
Though real GDP declined further than anticipated in first quarter 2013, subsequent data releases have been more optimistic. The euro-area manufacturing Purchasing Managers Index (PMI) showed signs that output has begun to stabilize. The PMI rose from 46.7 in April to 48.3 in May, moving closer to the expansionary threshold of 50. Exports have led the recovery for many of the periphery economies. Net exports have provided the only positive contribution to GDP growth since 2011 for Italy, Spain and Portugal. The boost in export growth amid fiscal consolidation and weak domestic demand has corrected some of the external imbalances among the euro-area economies (Chart 2).
… But a Long Road Lies Ahead
Domestic demand must be repaired in order to achieve sustainable growth across the euro area. This will require a reduction in the unemployment rate. With fiscal consolidation limiting government expenditure, positive growth contributions must stem from the private sector. Labor market reforms will be necessary to remove the mobility barriers preventing an adjustment in the unemployment rate. Unemployment in the peripheral economies has reached record highs, while unemployment in Germany remains at record lows (Chart 3).
Inflationary Pressures Concentrated in Select Economies
Slowed growth and low commodity prices have given way to disinflationary pressures. A low inflationary environment allows central banks to stimulate economic growth through monetary accommodation. Many central banks have recently dropped policy rates to record lows. Though the Brazilian economy has slowed, high inflationary pressures warranted monetary tightening. On May 30, Banco Central do Brasil raised its policy rate to 8 percent after an initial increase to 7.5 percent on April 18. Inflation remains at the cusp of the upper tolerance band, hovering around 6.5 percent in April and May (Chart 4). Contributing to inflationary pressure is the fact that Brazil’s domestic economy is operating at nearly full capacity: The unemployment rate has fallen to historic lows. On June 13, the central bank of Indonesia increased its policy rate from 5.75 to 6 percent.
Growth Improvement Requires Prudent Policy Measures
The global outlook remains hinged on sustainable growth among the emerging economies and a stable recovery in the euro area. China must continue to focus on curtailing excess credit to avoid the consequences of widespread default. The euro area must endure additional fiscal consolidation and labor market reforms. With monetary policy becoming more accommodative in most economies, emerging markets must remain vigilant toward inflationary pressures while becoming less reliant on external demand.
About the Author
Mack is a research analyst in the Globalization and Monetary Policy Institute at the Federal Reserve Bank of Dallas.