Politics, populism and the global economy

Global growth is expected to pick up in 2017 as US investment recovers, fiscal policy is eased, and recessions come to an end in Brazil and Russia, says international ratings agency Fitch Ratings in its latest Global Economic Outlook (GEO).

It seems that China’s stabilisation policies have been successful and, while policy is now becoming less accommodative, the slowdown in 2017 will be “gradual”, adds Fitch.

Fitch also expects emerging market growth to pick up in 2017, but says that some new downside risks to both the near and medium-term growth have appeared. These include a rise in populism, US-China trade tensions and higher US interest rates.

While these risks could lead to policy choices that reduce long-run growth potential, Fitch adds that they are also prompting more fiscal easing.

An important implication of the shift towards fiscal easing, it says, is that central banks are no longer alone in providing macro policy stimulus, and there is increasing confidence that the normalisation of US monetary policy will progress at a faster pace than it has over the last year.

Politics at play

A myriad of political developments has started to have a significant impact on the global economic outlook, and will continue to push structural policies in the direction of economic nationalism, leading to a reduction in trade openness and international labour migration. At the same time, leaders in advanced economies are being pushed to embrace easier fiscal policies by electoral expressions of discontent.

In the long-term, Fitch says there is little doubt that increased trade protectionism and weaker migration flows will dampen growth in advanced economies. In the short-term, however, it is likely that the shift towards fiscal reflation will be the dominant factor.

“Our latest global growth forecasts for 2017 have been revised upwards as the US is now expected to see a significant fiscal boost, albeit far smaller than set out in President-elect Donald Trump’s campaign proposals,” it says.

China’s stabilisation policies also added to better-than-expected GDP growth in the third quarter of 2016 and, as a result, Fitch has revised its global growth forecasts up by 0.1 percentage point in both 2016 and 2017.

For emerging markets, the upgrade to China is more than offset by a weaker outlook for Mexico and India, reveals Fitch. The ratings agency has, therefore, revised down its emerging market growth in 2017 by 0.1 percentage points  to 4.8%.

The shift towards fiscal easing brings with it the implication that central banks are no longer alone in providing macro policy stimulus. Although Fitch has not changed its central view that the US Federal Reserve will hike interest rates in December 2016 and follow up with two further hikes in 2017, this increases confidence that the normalisation of US monetary policy will progress at a faster pace than over the last year.

No safe harbour

Meanwhile, the emerging market macro picture brightened over the course of 2016 as recessions in Russia and Brazil started to bottom out, commodity prices recovered and China’s growth stabilisation policies took effect. 

In 2017, Fitch expects emerging market growth to pick up to 4.8%. Nevertheless, it says, some new downside risks to the near-term emerging market growth have appeared.

The surge in populism and anti-establishment sentiment, for instance, could exacerbate fragmentary tensions within the Eurozone and thus reduce private sector investment growth, set back progress on strengthening the institutional framework of the currency bloc and potentially spark serious global market volatility. Also, in the event of the US imposing punitive trade restrictions in China, retaliatory actions could see a trade or currency war develop, while China’s growing corporate sector debt continues to pose “a significant threat” to growth over the medium term.

What’s more, Fitch says that downward pressure on activity in both Brazil and Russia is easing as massive import compression boosts net trade, higher commodity prices help corporate income and falling inflation has allowed central banks to start cutting interest rates.

“Improved confidence in the outlook for fiscal reforms in Brazil following the change of political leadership has helped business sentiment,” it says. “Incoming data since the September GEO confirm the likelihood of a return to moderately positive growth of just over 1% in both countries next year.”

While oil prices have remained in the $45 to $50 range in the last couple of months, other hard commodity prices have rallied in recent months due mostly to optimism about US infrastructure spending and sharp cuts in coal production in China.

“China’s stimulus policies have stabilised industrial production growth and prompted a recent pick up in fixed asset investment growth. Growth in 2016 is now likely to exceed the official target at 6.7%, an upward revision of 0.2 percentage points since the last GEO,” says Fitch.

“Policy is now starting to turn slightly less accommodative, and we no longer anticipate a further interest rate cut this year. A modest slowdown in growth is likely in 2017, albeit to a slightly higher rate than forecast in the last GEO at 6.4%.”

Meanwhile, Fitch predicts Mr Trump’s victory will harm investor confidence in Mexico. Coupled with a recent further tightening in monetary policy and a weaker peso pushing up inflation and reducing real incomes, growth is likely to fall below 2% in 2017.

Indian growth has also been revised down to reflect temporary disruptions to activity related to the Reserve Bank of India’s surprise demonetisation of large-denomination bank notes.

“Our overall emerging market growth forecast has been revised down only marginally since September, but the possibility of US-China trade tensions, renewed dollar strength and higher US interest rates have increased downside risks,” concludes Fitch.