Friday, April 19, 2013

World Economic Outlook is not in Spring

Joint note with Prof. Charan Singh, IIM B

The world economy in 2013 is projected to grow by 3.3 percent, a shade lower than 3.5 percent estimated in January 2013 and marginally higher than 3.2 percent in 2012, according to the World Economic Outlook released by the IMF on April 16 at Washington DC. The world is recording a three speed recovery with strong growth in emerging markets, slow growth in the US and negative growth in the euro area. The projections for all major countries except Germany and Japan have been revised downwards. India’s projected growth is now pegged at 5.7 percent, lower by 0.2 percent from the IMF estimates released in January 2013.

The IMF hails the positive trend in growth in 2013 over 2012 and observes that though global prospects have improved, the road to recovery in advanced countries will remain bumpy. The economic activity has already picked up steam in emerging markets and is expected to accelerate gradually in advanced countries in 2013. Interestingly, IMF observes that economic activity in many economies is held back by continued fiscal adjustment (even in the US), competitiveness problems and balance sheet weaknesses.  According to the IMF, two great threats to economy recovery – break-up of Euro area and sharp fiscal contraction in the US - have been defused. But risks still remain in the short and medium term. In the short term risks are mainly from the euro area while in the medium term, the key risks are insufficient institutional reforms, weak balance sheets, broken credit channels and prolonged stagnation in the euro area; and high deficits and debt in the US and Japan. In the medium term, emerging markets need to tighten their monetary policies and strengthen prudential measures for the financial sector in face of sustained rapid growth of credit and high asset prices, if necessary.

The emerging markets have done well on the fiscal front and are expected to continue with neutral fiscal policy in medium term. The WEO observes that the growth in emerging markets may be strong but is less than projected during the last few years. These forecast disappointments are symptomatic of deeper structural problems heralding cutbacks in investments or capital outflows and need to be seriously considered by the policy makers.

The improvement in global economy could again result in substantial capital flows to the emerging economies which would require adjustments in the policy mix. IMF guides that when the capital inflows threaten to destabilize the economy, then the country can adopt capital flow management measures to avoid the buildup of major internal imbalances. Merely tightening of monetary policy could reinforce capital inflows and therefore countries with current account deficits need to consider macro-prudential measures, fiscal tightening and avoiding exchange rate appreciation.

To reduce global imbalances, China needs to have higher consumption and Germany more investment while the US needs to boost national savings through fiscal consolidation. Other deficit economies need to undertake structural reforms to rebuild competitiveness, according to the IMF.

The prices of main commodity groups, including food and oil, are projected to decline in 2013 with improving supply prospects and harvest. However, metal prices are projected to trend upwards, consistent with global recovery.

The WEO contains very interesting discussion in two specific box items. First, the discussion in Box 3.1 under the title Does Inflation Targeting still make sense with a flatter Phillips Curve is certain to gladden the heart of two past Governors of the RBI, amongst many policy makers in India. The researchers in the IMF are now beginning to realize that touting inflation targeting to all countries and in all circumstances was probably not the best policy advice. In Box 1.1, titled The Great Divergence of Policies, an unusual path of global recovery when compared with the three global recoveries is discussed. The ongoing recovery path after the great recession exhibits two types of divergences. First, recovery has been the weakest for advanced countries and strongest for emerging markets in contrast to earlier recoveries where advanced countries were the engines of global recoveries. Second, and more interestingly, monetary and fiscal policies, mainly in advanced countries, have marched in opposite directions in this recovery whereas in the previous episodes, the two policies were always aligned.

For India, a number of concerns emerge. First, the recovery in euro area and the US economy continues to be sluggish which could impact India’s exports. Second, according to the projections by the IMF, India’s CAD is projected to be 4.9 percent in 2013 and 4.6 percent in 2014 and consumer prices nearly 11 percent for both the years. While the real GDP for India is projected to rise from 5.7 percent in 2013 to 7.0 percent in 2018 that of China is projected to rise from 8.0 percent to 8.5 percent, respectively.

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