New Delhi: Britain’s vote to exit from the European Union has cast a shadow on the global growth prospects. The International Monetary Fund on Tuesday lowered the world output growth by 0.1 percentage point each to 3.1 per cent in 2016 and 3.4 per cent in 2017 as compared with 3.1 per cent in 2015. The IMF’s World Economic Outlook update also lowered growth forecast for major emerging
nations including India. “In India, economic activity remains buoyant, but the growth forecast for 2016-17 was trimmed slightly, reflecting a more sluggish investment recovery,” the report said while forecasting GDP growth of 7.4 per cent in each of 2016 and 2017, as compared with7.6 per cent in 2015. India GDP growth will still be fastest among major EMEs with China expected to grow by 6.6 per cent in 2016 and 6.2 per cent in 2017 while Brazil and Russia are likely to contract and South Africa expansion may remain flat.
BREXIT FALLOUT
Before the June 23 vote in the UK in favour of leaving the EU, economic data and financial market developments suggested that the global economy was evolving broadly. “The outcome of the U.K. vote, which surprised global financial markets, implies the materialization of an important downside risk for the world economy,” IMF said.
As a result, the global outlook for 2016-17 has worsened, despite the better-than-expected performance in early 2016. This deterioration reflects the expected macroeconomic consequences of a sizable increase in uncertainty, including on the political front.
“This uncertainty is projected to take a toll on confidence and investment, including through its repercussions on financial conditions and market sentiment more generally. The initial financial market reaction was severe but generally orderly. As of mid-July, the pound has weakened by about 10 per cent, despite some rebound, equity prices are lower in some sectors, especially for European banks; and yields on safe assets have declined.”
Brexit-related revisions are concentrated in advanced European economies, with a relatively muted impact elsewhere, including in the United States and China. Pending further clarity on the exit process, this baseline reflects the benign assumption of a gradual reduction in uncertainty going forward, with arrangements between the European Union and the United Kingdom avoiding a large increase in economic barriers, no major financial market disruption, and limited political fallout from the referendum. “But more negative outcomes are a distinct possibility,” IMF warned.
WORST IS YET TO COME FOR UK
IMF flagged concerns over the less probable severe scenario envisages an intensification of financial stress, especially in advanced Europe, leading to a sharper tightening of financial conditions and larger confidence effects, in line with the “adverse scenario”.
If negotiations between the United Kingdom and the European Union do not proceed smoothly and trade arrangements eventually revert to WTO rules.
“A larger portion of U.K. financial services is assumed to relocate to the euro area. This would reduce consumption and investment more markedly relative to the baseline and lead to a recession in the United Kingdom.”
Trade and financial spillovers are more significant than under the moderate scenario. As a result, the global economy would experience a more significant slowdown for the remainder of 2016 and 2017 that would be more pronounced in advanced economies.
SLOWING GROWTH PROSPECTS
Among advanced economies, the United Kingdom experienced the largest downward revision in forecasted growth. While growth in the first part of 2016 appears to have been slightly stronger than expected in April, the increase in uncertainty following the referendum is projected to significantly weaken domestic demand relative to previous forecasts, with growth revised down by about 0.2 percentage points to 1.7 per cent for 2016 and by close to 1 percentage point to 1.3 per cent in 2017.
In the United States, first-quarter growth was weaker than expected, triggering a downward revision of 0.2 percentage points to the 2016 growth forecast. High-frequency indicators point to a pick up in the second quarter and for the remainder of the year, consistent with fading headwinds from a strong U.S. dollar and lower energy sector investment. The impact of Brexit is projected to be muted for the United States, as lower long-term interest rates and a more gradual path of monetary policy normalization are expected to broadly offset larger corporate spreads, a stronger U.S. dollar, and some decline in confidence.
In the euro area, growth was higher than expected at 2.2 percent in the first quarter, reflecting strong domestic demand—including some rebound in investment. While high-frequency indicators point to some moderation ahead, the growth outlook would have been revised up slightly relative to April for both 2016 and 2017 were it not for the fallout from the U.K. referendum. In light of the potential impact of increased uncertainty on consumer and business confidence (and potential bank stresses), 2017 growth was revised down by 0.2 percentage points relative to April, while 2016 growth is still projected to be slightly higher, given outcomes in the first half of the year. Delays in tackling legacy issues in the banking sector, however, continue to pose downside risks to the forecast.
First-quarter activity in Japan came in slightly better than expected—even though the underlying momentum in domestic demand remains weak and inflation has dropped. With the announced delay in the April 2017 consumption tax hike to October 2019, the growth forecast for 2017 would have been raised by some 0.4 percentage points next year. However, the further appreciation of the yen in recent months is expected to take a toll on growth in both 2016 and 2017: as a result, the growth forecast for 2016 has been reduced by about 0.2 percentage points, and the upward revision to growth in 2017 is now projected to be only 0.2 percentage points. Japan’s growth in 2017 could be higher if, as expected, a supplementary budget for fiscal year 2016 is passed, providing more fiscal support.
RISKS ARE RISING
As noted earlier, with Brexit still very much unfolding, the extent of economic and political uncertainty has risen, and the likelihood of outcomes more negative than the one in the baseline has increased. Brexit may lead to a “more acute tightening of global financial conditions and larger confidence”.
Other risks have become more salient. The Brexit shock occurs amid unresolved legacy issues in the European banking system, in particular in Italian and Portuguese banks. Protracted financial market turbulence and rising global risk aversion could have severe macroeconomic repercussions, including through the intensification of bank distress, particularly in vulnerable economies.
Continued reliance on credit as a growth driver is heightening the risk of an eventual disruptive adjustment in China.
Many commodity exporters still confront the need for sizable fiscal adjustments, and emerging market economies more broadly need to be alert to financial stability risks. Risks of non-economic origin also remain salient. Political divisions within advanced economies may hamper efforts to tackle long-standing structural challenges and the refugee problem; and a shift toward protectionist policies is a distinct threat.
Geopolitical tensions, domestic armed strife, and terrorism are also taking a heavy toll on the outlook in several economies, especially in the Middle East, with further cross-border ramifications. Other ongoing concerns include climate-related factors– e.g., the drought in East and Southern Africa—and diseases such as the Zika virus afflicting the Latin America and Caribbean region.
POLICY IMPLICATIONS
IMF said central banks were prepared for possible effects from the referendum and responded quickly to its outcome.
“In particular, major central banks stood ready to provide domestic currency liquidity and also to alleviate shortages of foreign exchange liquidity through swap lines. Their preparedness has supported confidence in market resilience.”
Going forward, policy makers in the United Kingdom and the European Union have a key role to play in helping to reduce uncertainty. Of primary importance is a smooth and predictable transition to a new set of post-exit trading and financial relationships that as much as possible preserves gains from trade between the United Kingdom and the European Union.
Most advanced economies continue to confront significant economic slack and a weak inflation outlook, with further downside risks in this more uncertain environment. To address these challenges, a combination of near-term demand support and structural reforms to reinvigorate medium term growth remains essential under the baseline—all the more so given the increasingly fragile and uncertain environment.
The effectiveness of policy support would be enhanced by exploiting synergies among a range of policy tools, without leaving the entire stabilization burden on the shoulders of central banks. And greater reliance on measures to support domestic demand, especially in creditor countries with policy space, would help reduce global imbalances while contributing to stronger world growth.
“The effectiveness of structural reforms can be enhanced by careful sequencing and appropriate macroeconomic support, including from more growth-friendly fiscal policy,” IMF said.
Remaining financial sector vulnerabilities, especially those in Europe’s banking sector—legacies of the global financial crisis and its aftermath—must be tackled quickly and decisively to ensure a financial system resilient to the protracted periods of uncertainty and turbulence that may lie ahead, it said.
Policy challenges are more diverse across emerging market and developing economies, but in most cases they also include a need to bolster medium-term growth prospects through structural reforms. The scope for short-run demand support varies across countries, but may be limited in periods of heightened global risk aversion. Policymakers should strengthen defenses against protracted periods of global financial turbulence and tighter external financial conditions.
Priorities include reining in excess credit growth where needed, supporting healthy bank balance sheets, containing maturity and currency mismatches, and maintaining orderly market conditions.
And policymakers need to stand ready to act more aggressively and cooperatively should the impact of financial market turbulence and higher uncertainty threaten to materially weaken the global outlook.
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