Global Economy Faces Strong and Complex Cross Currents

IMF Blog, January 19, 2015

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The world economy is experiencing strong and complex cross currents: major economies benefit from the decline in the price of oil, while lower long run prospects in many regions are weakening demand.
World Economic Outlook Update (released in Beijing) projects:
- Global growth in 2015 is 3.5%, 0.3% higher than global growth in 2014, but 0.3% less than the forecast in October.
- Global growth in 2016 is forecast at 3.7%, a downward revision from the last World Economic Outlook.

Recent price movement:
- The price of oil declined from about 100 dollars a barrel in June to less than 50 dollars today.
- The decline appears largely due to an unexpected change in OPEC strategy: maintaining OPEC supply despite increasing non OPEC supply and weakening global demand.
- Expectation: much but not all of the price decline to be persistent.
Effects on oil importers:
- Price decline increases real income and decreases firms' production costs, leading to more spending.
- Numerical illustration: if oil consumption equals 3% of GDP, a 50% drop reflects an increase in real income of 1.5%.
- Lower inflation resulting from the decline is a concern in an environment of too low inflation and central banks’ policy rates close to zero.
- Net assessment: for oil importers the effect is strongly positive.
Effects on oil exporters and energy firms:
- Persistent price decreases imply oil exporters will need to reduce government spending.
- Those with substantial buffers or flexible exchange rates can adjust more slowly; others may need more dramatic adjustments.
- Adverse effects on Russia and Nigeria are likely to be very large.
- Some energy firms may face financial risks; systemic risks from country or corporate defaults appear limited.

Since August:
- The dollar has appreciated in real terms by 7%.
- The euro has depreciated by 3%.
- The yen has depreciated by 10%.
Implications:
- Dollar appreciation may slow the US recovery but is seen as a welcome adjustment.
- Appreciation should boost demand in the euro area and Japan and may help them out of slump.

Divergence among advanced economies for 2015:
- United States growth revised up to 3.6%.
- Euro area growth revised down to 1.2%.
- Japan growth revised down to 0.6%.
Emerging markets and regions:
- Large downward revisions in Sub-Saharan Africa, the economies of the Commonwealth of Independent States (CIS), and Latin America.
- Smaller downward revisions in Emerging Asia, where growth remains very high, particularly in leading economies like India and China.
Country-specific notes:
- Japan: 2014 disappointment; sustained growth requires more private demand in the short run and higher potential growth in the medium run; structural reform impetus remains too weak.
- Russia: suffering from uncertainty, poor investment climate, sanctions, and lower oil prices.
- China: gradual decrease in growth to below 7% in 2015 reflects a deliberate reorientation toward consumption and away from real estate and shadow banking; this lower growth affects the rest of Asia.
- Effects of commodity price declines since 2011 are lowering growth prospects in Latin America and sub-Saharan Africa.

Downside risks:
- Stagnation in the Euro area and in Japan is the most obvious downside risk.
- Risks of turmoil from increases in short rates in the United States are present but limited.
- Some corporates in emerging markets indebted in dollars could be vulnerable to a strong dollar and weak earnings from low commodity prices.
Policy priorities:
- For advanced economies at risk of stagnation (Euro area, Japan): use the "three arrows"—monetary policy, fiscal policy, and structural policies.
- For oil exporters: reduce spending if price declines persist; pace depends on buffers and exchange rate flexibility.
- For oil importers: benefits from lower oil prices can act like a significant fiscal expansion, but low inflation near zero policy rates requires monitoring.
Systemic risk assessment:
- While some corporate and country financial strains are expected, systemic risks from defaults appear limited.

The forecast is slightly pessimistic relative to potential upside from the oil price decline:
- The decline in oil prices may provide a stronger “shot in the arm” than is implicit in current forecasts.
- Possibility: forecasts may prove too pessimistic when reassessed in the spring.

Source: Olivier Blanchard, "Global Economy Faces Strong and Complex Cross Currents", January 19, 2015.