Latest IMF Forecasts: No Longer Waiting for Godot?

January 21, 2014

After some improvement in the global economy in 2013, today’s release from the International Monetary Fund (IMF) suggests that more progress will be made in the year to come. The recovery in advanced economies is gaining traction, but with the accumulation of government debt and slow balance sheet adjustments, the IMF indicates that it is not yet time to tighten monetary policy. Emerging economies are expected to maintain their strength as many of them return to potential output from their cyclical peaks.

Against this backdrop, the IMF has inched their world output growth forecast upward for 2014 in the latest World Economic Outlook (WEO) update to 3.7 percent, up from 3 percent growth in 2013. Stronger growth in 2014 is supported by the anticipation of a more robust recovery in advanced economies, whose growth for the current year is projected at 2.2 percent, a significant improvement from 1.3 percent growth in 2013. As a result, advanced economies will account for about a third of world growth, a leap from the 22 percent they contributed last year. Most notably, the recovery path is gaining steam in both the United States and Japan as their growth forecasts have been revised upward by 0.2 and 0.4 percentage points from the October edition of the IMF’s WEO, respectively.

Emerging markets and developing economies continue to support world growth, but forecasts for many of them have been revised downward slightly, to reflect a return to potential output from their cyclical peaks. China will, however, continue to make the largest contribution to global growth in 2014 as the government begins implementing reforms under its plan to transition to a more market-based, consumption-driven economy.

Advanced Economies: Two Steps Forward, One Step Back

The United States glided along as expected in 2013, growing by approximately 1.9 percent, reflecting increasing resiliency of private demand. The IMF is now projecting even faster growth in 2014 at 2.8 percent. Confidence in the American economy is being driven by the stability brought forth from a congressional budget agreement approved by President Obama. Furthermore, the limited impact of the government shutdown on the economy suggests that it has regained resilience and is better able to handle shocks as the path toward recovery solidifies.

The outlook for the euro zone is also improving: growth is forecast at 1.0 percent in 2014, which would bring it out of the recession that began in 2011. The recovery, however, remains highly uneven and vulnerable, while its sustainability is not without question. Germany is projected to emerge strongly from the euro-area recession, with its growth forecast revised upward by 0.2 percentage points to 1.6 percent. In France, despite President Hollande’s recent surprise announcement for economic reforms that will cut government spending and reduce taxes on businesses, the growth forecast for France has remained unchanged at 0.9 percent. It may show that the IMF did not find his plans particularly groundbreaking.

In Southern Europe, Italy and Spain are forecast to emerge from recession in 2014 at the same rate of 0.6 percent growth. Although the IMF’s forecasts put Spain and Italy on a similar growth path in 2014, their economies are currently facing very different dynamics. Spain has seen signs of improvement in 2013 sparked by export-driven demand that is creating strength in production. In recognition of this recovery, the big three credit rating agencies all revised their outlooks for Spain from negative to stable toward the end of last year. Italy, on the other hand, remains fragile with little sign of recovery, leaving the credit rating agencies to maintain Italy’s outlook at negative. These divergent trends in Southern euro-zone recovery are apparent in the WEO update: Italy’s growth forecast was revised downward by 0.1 and Spain’s was revised upward by an astonishing 0.4 percentage points.

Perhaps the most significant risks to the IMF’s new projections stem from the still unstable euro zone. Its recovery hinges on relevant improvements in financial markets. Specifically, the IMF indicates that the European Central Bank (ECB) needs to consider additional monetary stimulus through unconventional policies that aim at “targeted lending” — a coded word in “Fundese” for outright purchases of private sector securities, which the ECB has resisted. Furthermore, improving financial market fragmentation will rest crucially on the implementation of the banking union, which the IMF indicates should unify “both supervision and crisis resolution.”

Thus, unlike the United States, the European authorities may not be on the same page as the IMF for the future course of macroeconomic policies. Since the introduction of the Outright Monetary Transactions program in September 2012, the ECB has resisted calls for further unconventional easing — despite recent subdued inflation data. And while efforts to recapitalize banks are underway and the banking union is expected to be implemented in 2014, there is no plan for unified crisis resolution. Using its coded language, the IMF report suggests that, without granting appropriate authority to European policy makers to act decisively in periods of crisis or prolonged distress, consumer and business confidence will remain low, and fragmented growth and recovery patterns will persist.

While the euro zone has struggled to stay afloat in 2013, Japan is probably one of the biggest success stories of the advanced economies in 2013. The Japanese economy expanded by 1.7 percent in 2013, 0.5 percentage points higher than expected in the IMF’s January 2013 WEO update. It has also seen its forecast revised upward in the most recent update by 0.4 percentage points to 1.7 percent in 2014. As the IMF data appears to confirm, the Japanese macroeconomic stimulus plan implemented in 2013, also called “Abenomics,” has spurred growth and appears to have overcome persistent deflation, at least in the shorter run.

Emerging Economies: Growth Engine Despite Transition Challenges

Despite the potential volatility associated with reforms and the transition to advanced economy status, emerging markets will continue to be the big engine that drives global growth. Developing Asia is again expected to be the economic powerhouse, with growth rates up to three times larger than that of advanced economies. China and India, in particular, have both seen an upward revision to their growth forecasts to 7.5 percent and 5.4 percent, respectively. Prospects for growth in India remain strong, as structural policies are expected to strengthen investment. In China, the government’s commitment to create a stronger role for the market, and to transition from an investment-driven to a consumption-driven economy should create a stable foundation for future growth. The transition might not be as smooth as the IMF expects, however, as the People’s Bank of China (PBoC) has recently shown a commitment to tighten monetary policy while encouraging deleveraging. It is expected that, if the PBoC’s policy constrains growth below the government’s 7.5 percent target, the government will step in with additional stimulus or restrict further tightening of monetary policy.

In sum, the world economy is expected to grow faster and be more resilient by the end of the 2014, but significant risks remain that could carry potentially harmful spillover effects. The United States will likely keep cautiously unwinding its unconventional monetary policy to support continued fiscal consolidation and bank recapitalization. China will continue to be the largest single-handed contributor to world growth, but could face significant volatility as monetary conditions tighten and investment growth wanes.

The final global actor to watch out for will be, of course, the euro zone. Let’s hope that 2014 is the year that will turn the euro-zone recovery for the better. For this to materialize, however, the European authorities will need to do more than just hope.