2018: FADING MOMENTUM IN WORLD ECONOMIC GROWTH

YAO ZHIZHONG

Deputy Director and Researcher,Institute of World Economics and Politics,Chinese Academy of Social Sciences

In 2018, the world GDP grew by around 3.7% measured at purchasing power parity (PPP) and 3.2% if measured using market exchange rate,growing steadily at the same pace as the previous year. The world GDP growth rate rose rapidly from 3.3% in 2016 to 3.7% in 2017, with an increase of 0.4 percentage point. However, this trend of rapid increase in GDP growth rate failed to sustain in 2018. As the world economic growth is losing momentum,world economic growth is likely to shift further to the downside in the future.

WORLD ECONOMIC SITUATION

I. Signs of slower economic growth emerge

In 2018, world economic growth didn't continue the strong and synchronized rebound experienced by many countries in 2017. Only the United States and a few economies enjoyed faster growth rate and most other economies suffered slower growth. The International Monetary Fund (IMF) forecast showed that the world GDP growth rate in 2018 maintained basically the same as that of 2017. However, the aggregate data employed by the IMF hid the fact of economic slowdown in most economies and might overestimate the real growth rate of world GDP in 2018. Among advanced economies, growth divergences between the United States, which was riding high,and the others including the Euro zone and Japan, which sped down. Emerging markets and developing economies, as a whole, experienced stronger growth in 2017, but divergences have been spotted since 2018. Except for a handful of countries such as India and Vietnam,the economic growth of other major emerging Asian economies has slowed down to a certain extent. The economic growth of emerging markets and developing economies in Europe declined dramatically in 2018. Economic turmoil spread across several countries in Latin America and the Caribbean. Among them, Argentina and Venezuela suffered negative GDP growth. The Middle East and North Africa region and Russia saw a certain degree of recovery, but Iranian economy was thrown into deteriorating conditions by another round of US sanctions.

II. Unemployment rate remains low

Despite the signs of downturn in the world economy, global unemployment rate generally remains at a low level,except for only a few emerging markets whose economies are in worsening shape. This situation indicates the signs of world economy falling back from the peak of recent booms. The US unemployment rate keeps declining. In November 2018, the rate stood at 3.7%, 0.5 percentage point lower than the same period of one year before and approaching the lowest level since the 2008 financial crisis. The overall unemployment rate in the EU fell from 7.4%in October 2017 to 6.7% in October 2018.The seasonally-adjusted unemployment rate in Japan was 2.4% in October 2018, reaching lows since entering the 21st century. Except for a few emerging countries suffering deteriorating economic conditions, the majority of countries in this grouping have also seen their unemployment rate dropping.

The longest cycle of interest rate hikes in the US history is three years, meaning that after such a period of consecutive interest rate increase, the economy may decline. This round of interest hikes started in December 2015, reaching three years till December 2018.The pace of the hikes indicates that it won't take long for the US economic growth to slow down. The picture shows US President Donald Trump harshly criticizing the Federal Reserve interest rate regime ahead of a rally in Pennsylvania.

III. In flation rate rises slightly

The year-on-year growth rate of the US seasonally-adjusted CPI rose from a recent low of 1.6% in June 2017 to 2.9%in July 2018, and then fell back to 2.2%in November 2018. Triggered mainly by fuel and food prices hikes, the overall commodity prices in Europe have picked up slightly, but its core inflation rate remains broadly stable while declining slightly. The EU's harmonized index of consumer prices (HICP) grew by 2.0% year on year in November 2018, showing a slight increase from the same period last year. But the core HICP, which excludes fuel and seasonal foods, did not follow the same trend, rising only 1.2% in October 2018. In Japan,the commodity prices continued to prop up. Its CPI grew by 0.5% in 2017 and its monthly year-on-year growth rate from January to November 2018 fluctuated around 1.0%. Major emerging market economies saw their inflation rates increasing by a small margin and several individual countries in this grouping suffered huge rounds of inflation.Strongly impacted by drastic currency depreciation, Argentina and Turkey saw their CPI skyrocketing by 48.5% and 21.6% respectively on year-on-year basis in November 2018.

IV. Slowdown in international trade growth

In the first three quarters of 2018,global commodity exports grew by 14.3%, 12.7% and 8.4% respectively, with growth rate gradually declining. When price factors are excluded, the real total exports of goods increased by 3.7%,3.1% and 2.7%, respectively down by 1.1,0.8 and 2.3 percentage points compared with the previous year. By region, Asia experienced the most dramatic drop in the growth rate of international trade.In the first and second quarters of 2018,the seasonally-adjusted volume of commodity exports in Asia grew by 4.7%and 3.8% respectively, down by 3.6 and 2.9 percentage points compared with the previous year. The growth rate of international trade declined to certain degrees across Europe. The seasonallyadjusted growth rate of commodity exports in Europe was 2.8% both in the first and second quarters of 2018, respectively down by 0.2 and 0.3 percentage points from a year earlier. With rapidly declining export growth rate in Central and South America, the real export volume of the region grew negatively by-1.8% in the second quarter of 2018.

V. Sluggish international direct investment

Global FDI inflows amounted to US$1.43 trillion in 2017, 23% lower than the previous year. This decline was mainly the result of less inward foreign direct investment attracted by developed economies. FDI inflows to developed economies were merely US$712 billion in 2017, down by 37% compared with the previous year. FDI inflows to developing economies remained broadly stable. Among the 126 investment policies formulated by economies around the world in 2017, 93 policies touches upon investment liberalization and facilitation measures; 18 policies adds new investment restrictions and regulations;and the rest 15 policies remain neutral.The share of restrictive and regulatory policies increased, reaching 21% in 2017.Global investment policies show that developing countries tend to promote investment, while developed countries tend to restrict investment. 2018 didn't see the accelerated growth of the world economy or any sign of substantial growth in international direct investment. The United Nations Conference on Trade and Development (UNCTAD)estimated a less than 10% increase of global FDI inflows in 2018. In view of the downward trend of world economy in 2019 and the uncertainties triggered by changes in the international trade and investment system, international direct investment may dip again in 2019.

VI. Turbulence in financial markets

Global financial markets present two main features in 2018: one is the turbulence in the global stock markets; and the other is the continued appreciation of the US dollar and at the meantime,varying levels of the depreciation of other currencies. As of December 21st,2018, global stock indexes had plummeted 13.3% since the year started, as measured by the MSCI index, a measurement created by the Morgan Stanley Capital International. The MSCI emerging markets index plunged 17.4% and the MSCI developed world index fell 12.8%. Global stock prices have fluctuated wildly to reflect the potential risks in the world economy. The US Federal Reserve (Fed) launched four rounds of interest rate hikes in 2018, while the European Central Bank and the Bank of Japan still adopted negative interest rates. The US dollar thus appreciated markedly. In November 2018, the nominal US dollar index appreciated by 7% and the real US dollar index appreciated by 6.5% compared with the end of the previous year. While the US dollar continues to appreciate, other major currencies depreciate against the US dollar to varying degrees. From the beginning of 2018 to December 14th,euro depreciated by 5.8% against the US dollar and the Japanese yen by 0.6%.The currencies of emerging economies depreciated more sharply, with the Chinese yuan renminbi down by 5%,the Brazilian real tumbling by 15%, the Indian rupee falling by 11.3%, the South African rand plunging by 13.9% and the Russian ruble devaluing by 13%. In addition, the Turkish lira and the Argentine peso respectively depreciated by 28.9%and 50.8%.

KEY FACTORS AFFECTING THE WORLD ECONOMY

I. Prospect of downturns in the US economy

In 2018, only the United States and a couple of countries sustained robust growth, while the majority of countries slowed down the pace of growth. The US economic development trajectory in 2019 will substantially impact the world economy. The US quarter-on-quarter GDP growth rate, which stood at 1.3% in the second quarter of 2016 and reached 3.0% in the third quarter of 2018, has been climbing for nine consecutive quarters. The US economy will remain pretty sound in the short term.

In October 2018, the IMF projected that global growth would remain steady over 2018-19 at last year's rate of 3.7%, measured at PPP. Other international organizations predict that the world economic situation will remain basically in the same shape in 2019. The picture shows the IMF Managing Director Christine Lagarde attending the closing ceremony of the 2018 Annual Meetings of the International Monetary Fund and the World Bank in Bali Nusa Dua, Indonesia on October 14th, 2018.

But there are signs of US economic boom approaching its peak. Firstly, The unemployment rate is already at its lowest level since the 1970s, indicating that the labor force has been sufficiently employed. The uptick in wages, higher than consumer price hikes, squeezes the profits of firms. Secondly, the US stock market has started to fall from a recent peak, posing an increased risk of the burst of a stock market bubble.The end of the US rate hike cycle will drive the economic growth on another strong downward trajectory. The Fed predicts that the federal funds rate will stay at 3% for a long period, still 0.5 percentage point higher than the current policy rate of 2.5%, but this gap can be filled after another one or two rounds of interest rate increase. In view of the pace of rate hikes, the downturn in US economic growth is in sight.

The IMF forecasts the US GDP to expand at 2.9% in 2019, down from 2.5% in 2018; and the Fed predicts the 2019 GDP growth will slow to 2.5%, down from the projected 3.1% in 2018.

II. Impacts of turbulence in financial markets

The world economy is now faced with three factors that may trigger financial crises.

The first is the US Fed's further rate hikes and “balance sheet contraction”,which may result in currency depreciation and currency crises in other countries, particularly across emerging market economies. There is a good chance that the Fed will continue to raise interest rates and “reduce balance sheet”, resulting in reflux of capital to the US and further appreciation of the US dollar. Emerging market economies will thus be at a higher risk of currency crises.

The second is the heavily-indebted countries, which face the risks of debt defaults and even debt crises. The rapidly mounting government debts in some heavily-indebted emerging market economies and low-income countries may trigger sovereign debt defaults and crises. The Fed's rate hikes push up interest rates globally and thus impose heavier burdens on debtor countries.Besides, advanced economies, which will suffer weakening solvency due to economic growth slowdown, may also face debt crises.

The third is the slower growth of the US real economy, which may cause collapse in its asset prices and further pass through to other countries. US stock market has been bullish since 2009, with the market capitalization rising from US$11 trillion in 2008 to US$40 trillion in 2018. If the US stock prices tumble and trigger a synchronized plunge in other economies, the world economy will be hit by another grave financial crisis.

These three risk factors may separately emerge in individual countries,but may also exert knock-on effects in a number of countries and create more tremendous impacts. If combined, these three risk factors may spark off acute crises across a large area and have an enormous and negative impact on the world economy as a whole and the Chinese economy as well.

III. Policy space to combat the next recession

If the world economy enters the next recession, major countries, especially the advanced economies, will not have so broad space to carry out stimulus policies as they did ten years ago, be it monetary policies,fiscal policies or international macro policy coordination.

With the US federation funds rate standing at a slim 2.5%, even if the US economic downturn starts after two more rounds of rate hikes, the country has limited room of 3% to further cut interest rates. The Bank of England currently maintains a policy rate of 0.75%, leaving the country only 1% to further lower interest rates.And the European Central Bank and the Bank of Japan still adopt a negative interest rate monetary policy, depriving the countries of any room for reducing interest rates. Surely, central banks can continue to launch quantitative easing programs, which act to stimulate consumption and investment by lowering long-term interest rates. However, the current yield on 10-year treasury bonds in the United States and Japan is around 3% and 0.1%, respectively, and the euro zone's 10-year bond yield is around 0.4%,giving quite limited room for cutting long-term interest rates.

Since the US financial crisis, the debt burdens on governments around the world haven't eased significantly, but increased instead. For advanced economies, the average government debt-to-GDP ratio rose from 74.5% in 2007 to 103.8% in 2018. For emerging market economies, the ratio was up from 35.5%in 2017 to 48.7% in 2018. Countries, especially the EU members, are bound by the immense debt when pursuing expansionary fiscal policies. Moreover, the international environment for policy coordination is not as favorable as it was ten years ago. The United States, the world's largest economy, bolsters the“America First” policy and international policy coordination is not a priority policy option for the country. The G20 Summit, a mechanism born after the financial crisis, fails to satisfyingly play its role in global macro-policy coordination. If policy coordination and constraint are absent in the next economic recession, “beggar-thy-neighbour”policies may be followed by individual countries and gradually spread to multiple countries.

IV. Evolution of trade war and antiglobalization movement

The negative impacts of trade war on the world economy are gradually emerging. On September 27th, 2018,the WTO revised down the real growth forecast for global merchandise trade from 4.4% to 3.9% as well as its forecast for global growth in 2019 to 3.7%.

The trade war has disturbed the sound and predictable trade environment created by the WTO, caused instability in international business and undermined the confidence of investors. The trade tensions initiated by the US also hamper the intermediate trade by raising tariffs and the origin criteria,thereby impeding the expansion of the international division of labor and the increase in global productivity, which will exercise long-term adverse effects on the world economy. The trade war may lead to the resetting of global economic rules or evolve into financial conflicts, political and military clashes.If the latter scenario becomes reality,the world economy will be hit catastrophically.

There is possibility that the United States reaches a deal with China to end the trade war and enter into agreements with major trading partners on tariffs on steel, aluminum and cars, which will have a positive impact on international trade and the world economy. However, for the United States to end the tariff battles with China or other major trading partners, arduous negotiations need to be conducted and compromises need to be hammered out. This future process will be full of uncertainties.

In October 2018, the IMF projected that global growth would remain steady over 2018-19 at last year's rate of 3.7%, measured at PPP. Other international organizations predict that the world economic situation will remain basically in the same shape in 2019. The World Economic Situation in 2019: Analysis and Forecast published by the Institute of World Economics and Politics of the Chinese Academy of Social Sciences predicts that the world economy will grow by about 3.5% in PPP terms in 2019, lower than the forecasts of the IMF and other international organizations. This lower forecast mainly reflects concerns about downside risks facing the US economy, financial market turmoil, limited room for policy maneuver to counter recession and the impact of trade tensions.