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Emerging Market Slowdown Adds to Global Economy Pains

IMF Survey online

July 9, 2013

  • IMF projects global growth in 2013 unchanged from 2012 at just over 3 percent
  • Weakness in emerging market economies will dampen global growth prospects
  • Risks to growth remain low in advanced economies but are more worrying in emerging markets

The global economy is growing more slowly than expected, with risks to that growth increasing especially in emerging markets, says the IMF in an update to its World Economic Outlook (WEO). Global growth is now projected at 3.1 for 2013 and 3.8 percent for 2014, a downward revision of percentage point each year compared with the forecasts in the April 2013 WEO.

Global growth increased only slightly in the first quarter of 2013, instead of accelerating further as expected at the time of the April 2013 WEO. The underperformance was due to continuing growth disappointments in major emerging market economies, a deeper recession in the euro area, and a slower U.S. expansion than expected. By contrast, growth was stronger than expected in Japan.

Looking ahead, the IMF expects the brakes behind the recent underperformance to ease, but only gradually. Growth in the United States is forecast to rise to rise from 1 percent in 2013 to 2 percent in 2014, as fiscal consolidation slows and private demand remains solid. In Japan, growth in 2013 is now expected to be 2 percent, up percent from the last WEO, reflecting the boost to confidence and private demand from recent accommodative policies. The euro area is forecast to remain in recession in 2013 before growing again in 2014. Activity in the region continues to suffer from the combined effects of low demand, depressed confidence, financial market fragmentation, weak balance sheets, and fiscal consolidation.

Growth in emerging market and developing economies is expected to moderate to 5 percent in 2013 and about 5 percent in 2014, some percentage point lower than projected in the April 2013 WEO. The weaker prospects reflect, to varying degrees, infrastructure bottlenecks and other capacity constraints, lower export growth, lower commodity prices, financial stability concerns, and, in some cases, weaker monetary policy support. In China, growth will average 7 percent in 201314, and percentage point lower in 2013 and 2014, respectively, than in the April 2013 forecast.

Risks, old and new, still on the downside

Financial market volatility increased globally in May and June after a period of calm since last summer. Emerging market economies have generally been hit hardest. Recent increases in advanced economy interest rates and asset price volatility combined with weakness in emerging market domestic activity led to some capital outflows, equity price declines, rising local yields, and currency depreciation in the latter.

The WEO forecast assumes that the rise in volatility and yields will partly reverse, as it largely reflects a one-time reassessment of risks by investors based on the weaker growth outlook for these economies and temporary uncertainty about the U.S. exit from monetary policy stimulus. But if the underlying vulnerabilities persist and financial market volatility remains high, this could increase capital outflows and lower growth in emerging market economies.

More generally, downside risks, old and new, still dominate the outlook. The WEO Update highlights increased risks of a longer growth slowdown in emerging market economies. These risks reflect the possibility of capital flow reversals and the possibility of more protracted effects of domestic capacity constraints, slowing credit growth, and weak external conditions.

Policies to generate strong growth

Weaker growth prospects in emerging markets and new risks worldwide are challenging global growth, employment, and rebalancing. The report underscores the need for policymakers everywhere to increase efforts to address these challenges and restore robust growth.

The policy priorities for the major advanced economies that were outlined in the April WEO report remain relevant. These economies should continue to pursue a policy mix that supports near-term growth, anchored by measures to put their public debt levels on a sustainable path over the medium term. Clear communication on the eventual exit from accommodative monetary policies will help reduce volatility in global financial markets.

In the euro area, a bank asset review should identify problem assets and quantify capital needs, supported by direct recapitalization by the European Stability Mechanism where appropriate. Building on recent agreements, policymakers should also make progress toward a fuller banking union, including through a strong Single Resolution Mechanism.

Although current conditions and vulnerabilities vary across emerging market and developing economies, weaker growth and risks of capital outflows have raised new policy challenges. There is a risk that the growth slowdowns in some of these economies could reflect lower-than-expected potential output. So these economies may have less budgetary room than previously estimated.

In general, monetary policy easing should thus be the first line of defense against downside risks. But real policy rates are low already, and capital outflows and the effects of further exchange rate depreciation on inflation may constrain further rate cuts. And many economies also face some financial stability risks given threats to asset quality from weaker growth and earlier rapid credit expansion. Given these challenges, it may be necessary to upgrade regulatory and supervisory frameworks.

Finally, there is a need for structural reforms across all major economies, to lift global growth and support global rebalancing. As in the past, this means steps to raise domestic demand in economies with large current account surpluses (such as China and Germany) and measures that improve competitiveness in economies with large current account deficits.