Emerging Oil Slick Shifts Growth to Developed Markets
While many economists are worried about deflationary shocks, a recent Credit Suisse report sees no evidence of a global slowdown, but finds the balance of growth shifting from emerging to developed markets.
Entitled "Lost in Transition," the recently published Global Economics Quarterly report from Credit Suisse Economics Research reports that the global economy is "in the midst of a transition in the balance of growth towards developed markets from emerging markets, with the lower oil price as a key mechanism of that change."
Oil as a Trigger
While the impact of lower oil is still being digested, growth in many emerging markets is already slowing. This will make the environment more challenging for emerging markets and "should support solid growth in developed markets this year."
The shift is expected to have the biggest impact on oil exporting countries such as Russia and Venezuela. Regionally, Latin America looks "especially vulnerable" because of weak growth, high inflation and fiscal deficits, most notably in Brazil. Other regional oil exporters such as Colombia, Ecuador and Mexico, may also be challenged. Growth is slowing in Asia as well, but the report indicates that some Asian economies are better positioned to handle a growth slowdown than others.
At the same time, lower oil prices are now boosting real household and corporate incomes in developing economies. Over time, the report predicts "that should lead to an acceleration in demand and GDP growth" and an easing of deflationary concerns.
Although this adjustment may be welcome, the report notes that shifts in the mix of global growth are rarely orderly. The current episode is no different. "And although markets will focus on the processes and pains of such a transition, it is important they do not lose track of the bigger picture," the report states. "Higher market volatility looks here to stay, as markets oscillate wildly between digesting the consequences of stronger growth in the G3 and fears of deflation."
A key risk is that some emerging economies will deliver a financial or economic accident "sufficient for the convergence of emerging markets and developing market growth rates to overshoot and keep deflation fears alive."
Even with the decline in oil prices, a top-down view of global growth suggests little recent volatility compared with much of the past decade. The global economy grew 2.6 percent in 2014. Having slowed at the end of last year, growth momentum is currently just shy of that. But the report forecasts modest acceleration, to above 3 percent GDP growth, in the second half of the year. In short, global growth should continue to fluctuate modestly around its long-run average rate.
Deflation Fears Will Abate
At the same time, fears of deflation in developed markets are expected to abate as evidence of the stimulus from lower oil prices to growth in many developed economies accumulates, and headline inflation rates climb back to well above zero.
A country by country review shows deflation on the run in most major developed markets worldwide:
In Japan, the economy has started to gather momentum again after demand slowed following last April's consumption tax increase. Until recently, net trade was the main driver of the improvement, but the report notes growing evidence that domestic demand, having lagged, is coming on board. In particular, corporate spending should recover on the back of a pick-up in profitability. Monetary policy expansion is set to continue, and the risks are that policy eases further this year, possibly through the adoption of a negative rate for loans to private sector banks.
While growth in the Euro area was disappointing last year, the report sees growing evidence that domestic demand is accelerating in response to policy loosening and a drop in energy prices. Retail and auto sales have strengthened and corporate investment plans have recovered from a mid-year swoon following uncertainty over Russia and the Ukraine.
"Although it is questionable how much the ECB's aggressive QE programme will deliver further upside to domestic demand, the drop in the euro has been sufficiently sharp to support external demand," the report states. "As such, we believe there is good reason to think GDP and domestic demand growth can surprise to the upside this year."
Shaking Off the Chills
In the U.S., exceptionally cold weather is expected to deliver a speed-bump to growth for the start of this year, and industrial production looks to be cooling after a red-hot end to 2014.
"But demand fundamentals look remarkably strong: jobs growth is rapid, meaning that along with lower energy prices, real labor incomes could grow faster than 5 percent," the report states. "The start of monetary policy normalization in the U.S. may deliver a powerful corrective to rates markets concerned about deflation. It should also lend support and substance to the theme of policy divergence, making it reality, not forecast."
Some emerging economies, the report adds, are better positioned to manage those challenges than others. The fundamentals of many Asian economies look promising as inflation has been falling and demand has already slowed (in part thanks to tighter fiscal policy), allowing for some loosening of monetary policy. Improving current account positions, stronger growth in Europe as well as trade-weighted currency strength suggest that this region has some flexibility in responding to Fed tightening and dollar strength.
The downside risks to Chinese growth would clearly impact the broader region. Although Credit Suisse's forecasts for growth this year (6.8 percent) are already downbeat, the ongoing anti-corruption campaign looks set to continue to bear down on investment and consumption growth.