Yet more global stagnation?

Forgoing a year of global growth is not a prospect that will enthuse already suffering ship operators. Yet, if policymakers around the world do not create a more balanced and potent mix of policies, this is the stark reality facing the global economy, according to the International Monetary Fund’s latest Global Financial Stability Report.

“Market turmoil could recur and intensify, and could create a pernicious feedback loop of fragile confidence, weaker growth, tighter financial conditions and rising debt burdens. This could tip the global economy into economic and financial stagnation,” it said. In such a scenario, world output could be almost as much as 4% lower than the baseline over the next five years, roughly equivalent to skipping one year of global growth.

The IMF also reported an increased number of global financial stability risks over the last six months, due to higher economic risks and uncertainty, falling commodity prices and concerns about China’s economy.

“Financial markets reacted negatively to these changes. Global equities plummeted; volatility rose sharply; talk of recession in advanced economies increased; and bank equity prices came under renewed pressure,” it added. “These developments reflected increased concerns about the ability of policies to offset the impact of higher economic and political risks.”

At the same time, the IMF noted that the situation in the financial market appears to have significantly improved since February, following some better news on the economic front as well as intensified policy actions by the European Central Bank and a more cautious stance toward raising rates by the US Federal Reserve. China has also stepped up its efforts to strengthen its policy framework to bolster growth and stabilise the exchange rate, it said.

The key question then, is whether the turmoil over the past few months is now safely behind us, or a warning signal that more needs to be done. José Viñals, financial counsellor and head of the IMF’s monetary and capital markets department, believes it is the latter. “More needs to be done to secure global stability,” he says.

Supporting Mr Viñals’ words, influential think tank Foundation for Economic and Industrial Research, or IOBE, has meanwhile expressed particular concern for the future of Greece’s economy in its most recent quarterly report. The country’s economy contracted about 0.5% last year, less than previously expected, but will likely stay in recession for the duration of 2016 without a strong surge in investment, it said.

Trouble in Greece

IOBE predicts that Greece’s economy will shrink by 1% this year, with the recession expected to deepen after a 0.3% contraction in 2015.

“There is a rational expectation that there will be growth in the second half, but this will not be enough to erase the recession, which will turn out deeper than last year,” IOBE chief Nikos Vettas said. “The longer the Greek economy stays unreformed, the more distant the end of the crisis becomes.”

He added that the expected rebound in the second half could set the stage for more growth momentum in 2017, provided a crucial bailout review is concluded soon. As it stands, Athens and its official creditors have yet to conclude a first review of compliance with reforms prescribed in the country’s third bailout which, in turn, will pave the way for debt relief talks.

The review of Greece’s progress on the terms of its bailout deal reached last July has dragged on for months due to differences among its lenders over the country’s economic progress as well as resistance in Athens to unpopular measures.

In its report, IOBE said that new fiscal measures to meet bailout targets will impact private consumption and employment in several sectors, leading to a decline in gross domestic product, despite an expected rise in tourism.

While lower disposable income as a result of similar measures will remain a deflationary factor, new indirect taxes will have a countervailing impact. This will lead to zero inflation or slight deflation this year, the think tank said.

A recovery in investment, which remains a weak component of Greece’s gross domestic product, is necessary for the country’s economy to fare better next year, stressed IOBE. “The weak link in the national output equation, once again, will be investment,” it said. “Growth cannot come before conditions are created for a strong investment wave.”

Handling global pressure

To avoid this downside scenario in Greece, as well as the threat of 4% lower than baseline global output, the IMF said that policymakers need to remember that while monetary policy remains crucial, it cannot be the only game in town.

“Policymakers must tackle a triad of pre-existing challenges: crisis legacy issues still unaddressed in advanced economies, elevated vulnerabilities in emerging markets, and systemic market liquidity risks,” it added. “By tackling these challenges, world output could instead be as much as 1.7% above the baseline by 2018.”

First, the IMF said that policymakers in advanced economies need to tackle crisis legacies as they play a key role in financing the economy, particularly banks. Banks also face important structural challenges in adapting to the new post-crisis realities that continue to depress their profitability, added the IMF.

“Banks urgently need to tackle elevated non-performing loans using a comprehensive strategy,” the IMF said in its report. “Over time, they will need to address overcapacity in some banking sectors. Europe must also complete the banking union and establish a common deposit guarantee scheme.”

Second, policymakers in emerging markets need to bolster their resilience to global headwinds, suggested the IMF. “The sharp fall in commodity prices has exacerbated both corporate and sovereign vulnerabilities, keeping economic and financial risks elevated. After years of growing indebtedness, emerging economies face a difficult combination of slower growth, tighter credit conditions, and volatile capital flows.

“So far, many emerging market economies have shown remarkable resilience to this difficult environment, thanks to the judicious use of buffers accumulated during the boom years. But buffers are depleting, with some countries running out of room to manoeuvre.”

Finally, as the health of the corporate sector deteriorates, refinancing pressures may become more acute. According to the IMF, this can generate spillovers to the state, as many weaker corporates are state owned.

“Bank buffers are generally adequate in many emerging markets but may be tested by increased non-performing loans. These interlinkages underscore the importance of close monitoring of corporate vulnerability, swift and transparent recognition and management of nonperforming assets, as well as strengthening the resilience of banks,” it said.