A moment of relief

Moody’s Investors Service’s latest assessment of the global economy reveals a more stable future for emerging market economies, due to a combination of a modest recovery in commodity prices, better capital flows and a better near-term outlook for growth in China.

Moody’s now expects China’s economy to grow at a rate of 6.6% and 6.3% in 2016 and 2017 respectively, compared with its previous forecast of 6.3% and 6.1%, with the higher growth rate being driven by significant fiscal and monetary policy support.

“China’s real GDP grew at 6.7% year-over year in the second quarter of 2016,” says Moody’s. “The economy appears to be stabilising at a robust rate with the help of significant fiscal and monetary policy stimulus measures. We have, therefore, revised our growth expectation for the Chinese economy.”

Other than the stabilisation of commodity prices, Moody’s adds that the modest revisions have had minimal impact on its forecasts for the rest of the world, however, as imports to China continue to fall.

Furthermore, it says, while near term downside risks to China’s growth have receded for now, the delay in the inevitable rebalancing and deleveraging also increases medium to long term risks. “The sheer scale of leverage in the economy – with corporate debt at 166% of GDP – exposes the economy to the risk of a rapid deterioration in the event of a negative shock.

“A significant deceleration in China’s real GDP growth could have significant spillovers for the global economy through trade and financial channels. Commodity exporters and countries that are linked to China’s supply chain, especially in the Asia Pacific region, remain most vulnerable to the adverse trade-related external demand shock,” says Moody’s.

It adds that a wider transmission of such a shock through heightened global risk aversion, increased financial market stress and worsening of sentiment could have a material negative impact on already low global growth expectations.

Global growth nexus

External conditions have become more favourable for emerging market countries since March, due mostly to the expectation of stable growth in China, more stable commodity prices and the delay in the normalisation of US interest rates. However, there is a substantial differentiation in the fundamentals of individual emerging market economies, says Moody’s.

“The expectation of lower potential growth in most advanced and emerging market countries over the next few years is widely entrenched, and is reflected in the growth forecasts of international institutions and policy makers,” it says.

“A concerning aspect of this current environment is that the lack of fiscal buffers, combined with the limited scope for effective monetary accommodation, has reduced the ability of authorities in many economies to support economic activity in the event of future systemic and idiosyncratic shocks.

“Underlying the view that growth rates will remain low is the muted growth in global trade, investment and productivity. Even in the US and Japan, where investment has grown faster than GDP in recent years, investment as a share of GDP remains historically low. We agree with the consensus that growth prospects remain subdued for the next few years.”

At the same time, however, “we recognize that country specific policies to address structural impediments to growth, if undertaken, and productivity enhancing technological advancements could meaningfully reverse this trend in the future,” says Moody’s.

Signs of stabilisation

Although the stabilisation of commodity prices from the lows reached in January has provided relief to commodity-exporting economies, Moody’s predicts limited upside to commodity prices from here on in.

Moody’s adds that external conditions turned supportive in March, and are expected to remain so until the US Federal Reserve resumes the interest rate tightening cycle. Further, emerging market currencies have strengthened as capital flows have returned to all regions. Also, inflation in many countries has resumed a downward trend, allowing some policy makers to ease monetary policy.

“The developments are translating into signs of recovery among some the weakest emerging market countries,” says Moody’s. “We have reduced our growth forecasts for Turkey and South Africa.” Expecting real GDP growth in Turkey to moderate somewhat on account of the detrimental impact of heightened political risks on investment, Moody’s has revised its growth forecast for Turkey to 3.2% in 2016 and 2.9% in 2017.

In the case of South Africa, a downward revision of the 2017 growth forecast to 1.1% from 1.5% previously reflects Moody’s view that the recovery will be subdued as infrastructure issues, structural challenges, fiscal consolidation efforts and external challenges limit the pace of headline growth in the near term.

Moody’s growth expectations for India, Indonesia, Korea and Saudi Arabia are unchanged from its previous outlook publication in May.  Moody’s has, however, revised up its forecasts for China, Russia and Brazil. “In the case of Russia, we expect economy to emerge from the current recession in the second half of this year,” it says. “Much of the adjustment to lower oil and gas prices has occurred through the fall in real GDP and a sharp depreciation.

“Improvement is reflected in some of the high frequency indicators, such as industrial production, which increased by 1.7% year-on-year in June as a result of stronger growth in manufacturing. Manufacturing has benefited from import substitution in a number of industries, including agriculture and chemicals. The upward revision to the growth forecasts of Russia reflects these developments and the assessment that the economic adjustment has been faster than we previously anticipated,” concludes Moody’s.