03 Outlook 2015 Tues 0900 1030 AYHAN KOSE
Thank you for inviting me. It's great to be here in Canberra. I was thinking how to motivate this
talk about the global economy, and I think that the question we had been asking since 2009 has
not changed. In the trough of the crisis, we were asking the shape of the recovery for the global
economy, and that question is still the same.
So what I am going to do today, I'm trying to answer this question. Before I do that, I need to
advertise these two important publications. One of them is the Global Economic Prospects we
release January and June every year that looks at the global economy, provides detailed forecast.
And the other one is the Commodity Markets Outlook. We release this publication four times a
year. World Bank forecasts all commodities until 2025. It's I think quite relevant, especially for
this audience.
Now, the talk is about disappointment, divergences, and expectations. What do I mean by that?
When we look at the global economy, we see a slow-moving recovery. And disappointments are
there mostly about the growth. There are important drivers of the global outlook. Three of them
are there.
The first one, low commodity prices, it's all positive. The second one, easy financial conditions,
has been around. It's also positive. But the third one, the big global trade that's dampening the
growth. When we look at the country groups, what we see, divergences. Divergences we see in
the context of advanced economies, divergences we see in the context of emerging markets.
And now new divergences appear in terms of oil exporters, oil importers, or commodity
exporters, commodity importers. Now, what I'm going to do, I'm going to ask three questions
today. What is the state of global recovery? What are the main risks? And what are the main
policy issues?
Now, let me start with the first question. What is the state of global recovery? Global economy is
simply limping along. What does that mean? When we look at the global growth since 2010-this is the blue line here, the bars-- what you see is that every year, the global growth was smaller
than the previous year or was almost flat.
From 2014 to '15, that's not changing much. The growth is going to accelerate from 2.6% to 3%,
but overall global growth is going to remain weak. Now, for high-income countries or their mass
economies, what we see is a sluggishness going forward. For the developing countries, though,
the good news is that growth slow from 2013-14. That was bad news. But now from '14 to '15,
growth is going to pick up.
Just some numbers. These are always boring but good to look at. Growth is going to pick up for
the world economy, as I mentioned. For high-income countries, we see a pick up as well, mostly
because of the US economy. For developing countries, as I mentioned, growth went down from
4.9 to 4.4 from 2013 to '14, but we think that it's going to pick up in 2015. East Asia Pacific is
going to slow down very gradually, but it's still the fastest growing region in the world.
Now, I talked about disappointments. Let me explain what I mean by that. These two lines tell
you about the global growth average prior to the crisis, 2003 to 2008, and after the crisis, 2010 to
2013. After the crisis, growth was rather bigger. You hope that you will basically eventually
accelerate and get to the pre-crisis growth rate.
Now, how did we see the world economy in January 2014? We thought that growth is going to
accelerate when we come to 2015, and maybe 2016 we will get to the growth rate average we
had prior to the crisis. Now, we came to June 2014. We reduced our growth forecast for 2014.
And then we came to January 2015. We reduced our forecast for 2014 and '15 as well. So there
were multiple disappointments. Now, the question is that why did we revise our forecast
downwards in 2014 and '15? The answer is very clear. Some parts of the world have been
performing much weaker than what we thought.
In the context of advanced economies, those parts are Euro Area and Japan. In the context of
emerging markets, those parts are Brazil and Russia. So most of the forecast's revisions were due
to those four economies. One economy surprised on the upside, and that was the United States.
Now, the drivers of global outlook, as I mentioned, three factors. One, low commodity prices,
mostly oil. The second one is the financial conditions. These two are supporting global growth.
And the third one is weak global trade. That's basically dampening global growth.
Now, what about low oil prices? So that has been an unusually sharp drop since June 2014,
mostly driven by supply factors, but a little bit of weaker demand as well. The decline in oil
prices has been larger than the declines we observed in other commodities since their peaks in
2011. We think that the prices are going to remain weak in 2015 and '16.
Low oil prices is good news for the global economy. If price decline is around 45% on an annual
basis from '14 to '15, we think that that adds global GDP around 0.7% to 0.8%. Having said that,
there are multiple mitigating factors that will affect the beneficial impact of oil price decline on
global growth.
We still live in an environment of weak confidence, the legacies of crisis, especially high debt,
still there. In the past, when oil prices went down, central bankers responded by basically
reducing interest rates. Now that's quite difficult, especially in the context of large central banks.
So there is also a monetary policy constraint.
Of course the relationship between oil and activity has been changing. The intensity of oil use in
production has been being declining. There's reduced investment in new oil exploration. That's a
negative. And there is in general weak demand.
Now, what do we see when we think about oil prices and the prices of other commodities? Other
commodity prices, agriculture and metals and minerals, have been going down after reaching
their peaks in 2011. On the other hand, oil price till last year's June picked up, mostly because of
geopolitical tensions. Those tensions disappeared. There was acceleration of expansion in supply
from unconventional producers.
The major cartel OPEC responded to that by announcing they are not going to basically
intervene. They are going to let the market to determine the price that translated into a free fall in
oil price. Now, what do we think is going to happen to oil price? We think that from 2014 to '15
oil price is going to go down around 45% and will remain weak for 2016 as well.
What about commodity prices? In the latest Commodity Markets Outlook, we basically
forecasted that in all commodity price indices you look at, prices are going to go down in 2015.
There will be a small recovery in 2016. Now, if the financing conditions have been with us for a
while and will be with us for the foreseeable future.
Here, the major players are the Euro Area and Japan. And this graph is very interesting because
it tells you something very interesting. Market participants expect that in the context of Euro
Area and Japan, policy rates are going to be close to zero as far as the eye can see till 2018.
They think that in the US, interest rates are going to increase sometime this year. But they are
going to increase very gradually, and actually they are now thinking that the increase in interest
rate's going to be even smaller than what they thought last year in May. Irrespective of all of
these developments, when you look at 10-year bond yields, they are still at all-time record lows.
What about global trade? Prior to the global financial crisis, trade was growing at around 7% per
year. In 2012 to '14, that number went down to 4%. There are both cyclical and structural
reasons behind this important development that affects all small open economies, including
Australia.
Now, on the one side, the cyclical reason is rather obvious, weak demand. On the other side, we
have this structural change between activity and trade. In other words, when global GDP
increases, the response in trade has been smaller than what it used to be. One reason for this is
that we used to see rapid expansion of these global supply chains, especially relevant in East
Asia Pacific region.
That rapid expansion has been maturing. With that, we see a smaller response of trade to changes
in activity. The question is how long this change will be with us. We think that for the
foreseeable future, global trade is going to remain weak and is going to have a negative impact
on growth.
Now, 2015 is going to be a year we will ask this question multiple times. Can advanced
economies support global growth? When we think about advanced economies, actually the one
we are thinking about is the bright spot, the United States. United States can support global
growth up to a point but not more than that.
UK is also accelerating. That's also good news. But on the other side, you have Euro Area and
Japan. This is the great divergence we see within the context of advanced economies. What is
going on is that you see a little bit of acceleration, both in Euro Area and Japan. But growth is
still going to be around 1%, 1.2% in both of these large economies.
Corresponding to that, you see a great divergence of monetary policies as well. And that will
have implications in terms of financial market volatility. What about developing countries?
There as well we have a mixed outlook and new divergences emerging. In the case of China, we
foresee an orderly slowdown. For commodity producers, exporters, times are going to be
challenging.
Brazil, Russia, and South Africa will miss the days they used to have much higher growth rates.
Brazil will have a tough time in 2015. Russia will probably have an even more difficult time.
There are some reformist governments. One of then is India. We think that India's growth will
accelerate and in 2016 will reach to 7%. Mexico as well, we'll see a higher growth in the coming
years, thanks to structural reforms the government has been undertaking.
Now, what about the risks? It's clear with this outlook, downsides will still dominate. What are
those risks? Volatility in financial and commodity markets, normalisation and divergence of
monetary policies, secular stagnation in the Euro Area, geopolitical tensions, disorderly
slowdown in China, and medium-term slowdown in developing countries.
Given interest, I'm going to talk a little bit about the case of China. What's the big problem in
China? These two figures tell you that problem. On the one side, you have a very large debt
stuck accumulated in a very short time period. Prior to the crisis, total debt was around 160%.
Now it's around 260%. While debt is accumulating, growth has been slowing down. That's the
figure on the right side.
This is an explosive combination in any economy, in a short time period observing a dramatic
slowdown in its growth but at the same time a dramatic increase in its debt. In the case of China,
we think that it has ample buffers to mitigate a slowdown. Now, let me briefly talk about those
buffers.
First, as much as debt is large, in the case of China, public debt is still rather small. We say
around 60%. So if China wants to undertake fiscal stimulus, it can do that. If China wants to bail
out certain entities, financial, non-financial, it can do that. It has the ammunition.
Second, China has ample institutional buffers. Sovereign debt, predominantly domestic, financial
system mostly state-owned, and capital controls preventing sharp capital outflows. Third, China
has very large foreign exchange reserves. So, in summary, it's difficult to envision a scenario.
China is having an outright debt crisis, the types of debt crisis we have seen in emerging market
economies.
It's difficult to envision a scenario. China is having a subtle stop, the types of subtle stops we
have seen in emerging markets. And ultimately it is difficult to envision a scenario. China is
having a currency crisis, the types of currency crisis we have seen in emerging market
economies.
Briefly, let me turn to the third question. What are the main policy issues? There are multiple
policy challenges, but at the same time these challenges provide windows of opportunity.
Monetary policy is something we talk about a lot. Here, it's going to be a challenge for central
banks to think about growth, inflation, and current stabilisation.
This is going to be a tough balancing act, and the bank, Reserve Bank of Australia, is having that
challenge as well. Help from low oil prices in net importing countries provides an opportunity
though, at least temporarily. I'm going to talk about fiscal policy and importance of having fiscal
space to run effective counter-cyclical fiscal policy.
The speed of expanding fiscal space of course depends on country circumstances, and that
provides an opportunity in this challenging environment. As always, structural policy is
important, and we think that low commodity prices provides a window of opportunity to
undertake timely subsidy reforms.
Now, let me talk about a little bit emerging markets and frontier markets and the fiscal
challenges they have given the interest of the audience. Now, when we look at these emerging
and frontier market economies, the first thing we see, deficits are now larger than they used to be
prior to the crisis.
But at the same time, if you look at government debt, government debt actually is rather stable.
In an environment when you have larger deficits but somewhat stable government debt, what's
going on? These countries implemented expansionary fiscal policies during the crisis effectively.
They were able to stimulate their economies.
But since then, they haven't built up their fiscal buffers to be able to counteract if they have a
growth slowdown. As much as government debt is stable in emerging and frontier market
economies, the big problem is that private debt has risen. Private debt has risen dramatically,
especially in some of those countries. They enjoyed credit booms because of the easy financing
conditions.
Now, when financing conditions are easy, it is good to basically undertake the expansions, credit
expansions. But financing conditions can change dramatically, and it did in the past. Russian
crisis is an example, global financial crisis an example. During these periods, private debt can
overnight become public debt, and it will be very difficult to counteract this type of change. And
as we have seen in Indonesia, Thailand, Ireland, and Latvia, countries have very difficult
circumstances.
I'm going to tell you one more thing about the fiscal policy. It's very important for countries to
have fiscal space to undertake effective counter-cyclical fiscal policy. In other words, when you
have lower deficits and lower debt stocks, it is easy to see a larger return when government
expends an additional dollar. In other words, fiscal multipliers are larger when you have more
fiscal space.
Structural reforms always a long list, but we think that it's important to undertake subsidy
reforms in this period. I ask three questions. One, what is the state of global recovery? The
simple answer is that global economy is limping along helped by commodity prices and easy
financing conditions but held back with global trade Divergences and disappointments are
important words in different country groups.
What about the risks? Downside risks dominate the outlook. What are the main policy issues?
There are many challenges but also windows of opportunity. Now, let me turn to what I ask at
the beginning. From 2009 to 2015, every year we started the year asking the question, what will
be the shape of the recovery?
We are still asking this question, and I think that I did my best to answer it. Probably I did not
answer it, but that gives me an opportunity to come back to Australia next year. Thank you.