Perspectives for economic growth in 2016: a mixed bag…
In 2015 economic growth extended the weak and halting trend in place since the global financial crisis. The consensus forecast for US economic growth was revised down from 3% at the start of the year to 2.5% in October 2015. Growth forecasts for the eurozone were revised higher, but not enough to compensate for the weaker growth in the US and in emerging economies. Some of the factors weighing on growth in 2015 were idiosyncratic (e.g. the cold winter in the US, geopolitical issues), others more structural in nature. Inevitably, the continued absence of a robust and synchronised global economic expansion raises questions about the underlying reasons for the feeble recovery. I advance below our analysis of the structural factors we see as weighing on growth.
For 2016, our central scenario is for a desynchronised pattern of economic growth across the globe. The US economy looks stable and we expect domestic demand in the US to compensate somewhat for headwinds from overseas. In the eurozone we anticipate an extension of the cyclical recovery. However, in emerging markets we foresee relatively less favourable conditions, due to the slowdown in China, low commodity prices, a stronger US dollar and high levels of leverage in a number of countries. We expect inflation to stay low and central banks to keep monetary policy accommodative.
Exhibit 1: Divergence in the global economy – the composite Purchasing Managers’ Indices suggest a parting of the ways; (Composite PMI index, weighted by GDP)
Source: Markit, BNP Paribas Asset Management
Deleveraging: the process has barely begun
High and rapid increases in debt levels led to the global financial crisis in 2008/09. During the recession that followed, the underwriting, in the US and eurozone, of the financial system led to burgeoning government debt burdens. Sovereign debt problems mushroomed in the eurozone. As the availability of bank credit tightened, an era of deleveraging was supposed to start. Yet on a global scale deleveraging has still barely begun.
At the end of 2007, before the global financial crisis, global debt stood at USD 78.4 trillion. At the end of 2009 it had increased to USD 90 trillion. It peaked at USD 120 trillion at the end of the second quarter of 2014, 53% higher than at the onset of the global financial crisis.
Admittedly, the debt burden has declined since mid-2014, but only marginally. Relative to GDP, the reduction in debt has been somewhat more pronounced, as nominal GDP has been growing. This relative form of deleveraging has been most pronounced among US households, due to debt repayments and the writing-off of mortgage debt. Private sector debt in Denmark, Germany, Ireland, Japan, Portugal, Spain and the UK has also fallen, relative to GDP.
Among sovereigns, deleveraging has progressed only (and only very recently) in Germany, India, Norway, Saudi Arabia and Turkey. These countries are the exceptions. In general, the debt ratios of many sovereign borrowers are high and continuing to rise.
Exhibit 2: Debt – the bugbear of the global economy; (Total non-financial debt as a percentage of GDP in the principal regions of the global economy)
Source: BIS, BNP Paribas Asset Management
While sovereign debt ratios have risen sharply in developed economies, private sector debt has ballooned in emerging economies. Low interest rates have kept the burden of servicing debt manageable in most countries, but Brazil, China, Hong Kong and Russia stand out on account of the deterioration in their debt service ratios.
In our opinion, high levels of debt are definitely having a negative impact on global growth. Accommodative monetary policy in the form of extremely low interest rates has less of a stimulative impact when borrowers are already heavily indebted. It also leaves countries vulnerable to changes in investor sentiment, as was shown by the ‘tantrums’ financial markets threw in May 2013 (when the US Fed started talking about winding down the pace of its asset purchases), and again in the summer of 2015 (when the Fed seemed on course to hike rates before the end of the year). And, just as borrowing can accelerate consumer spending and business investment, so deleveraging can have the opposite effect.
Another feature of the global economy is low labour productivity and a dearth of investment. According to OECD data, the rate of growth in US labour productivity averaged 2.4% year- on-year between the 1960s and the first oil crisis in the mid-1970s. Between 1977 and 2005 this slowed to 1.5%. Since 2005 US productivity growth has averaged only 1.0%, despite a cyclical surge right after the global financial crisis.
The downshift in productivity in Japan in the mid-1970s was even more pronounced; until then, productivity had grown by 7.4% year-on-year but then slowed to an average of 2.7% year-on-year during the period up to 1995. Since 1995 it has grown at 0.9% year-on-year.
Data for the eurozone is not available over such a long period, but productivity growth has averaged a meagre 0.3% year-on-year since 2001. In the 1990s it averaged 1.5% year- on-year. This slowdown in productivity has been accompanied by a slowdown in business investment.
Exhibit 3: A downward trend in labour productivity growth – unbroken since 1960 (Year-on-year % change in labour productivity, as measured by the OECD, 1960-2015)
Source: Datastream, BNP Paribas Asset Management
Business investment in the US after depreciation has recovered from a cyclical low in 2009, but remains low relative to GDP. In fact, after moving sideways between 1960 and 1990, the peaks and troughs in the cycle of net business investment in the US have since trended lower. The current peak is lower than the troughs in the 1960 to 1990 period.
In the eurozone, where we have data since 1995, the gross investment-to-GDP ratio is close to a record low. The low level of investment is surprising, in particular in the US, given low interest rates and high corporate profitability.
We think structural factors — high debt burdens, low investment and low productivity — largely explain the lacklustre economic recovery since the global financial crisis. Although we foresee an extension, and even some improvement to global economic growth in 2016, we don’t believe there will be a strong cyclical upturn.
A desynchronised pattern to economic growth across the globe in 2016
Low productivity growth and a slowdown in population growth have dragged down the potential GDP growth rate in the US to around 2.25%, according to the Congressional Budget Office. For 2016 our view is that the economy can exceed that growth rate. We expect a growth rate of around 2.5%, driven primarily by domestic factors. Employment growth, income growth and further improvements in the housing market should support consumption. The tailwind of lower oil prices should fade, but so should the headwinds of dollar appreciation. Nevertheless, with the US economy growing faster than those of its main trading partners, foreign trade is likely to be a drag on growth. The overall growth rate will be supported by a favourable base effect in the first quarter, unless we get another severe winter.
The eurozone will in our view continue its cyclical recovery, leading to GDP growth above the potential rate. Support from improving housing markets should kick in in Germany, Spain, the Netherlands and Ireland. Improving momentum in the credit cycle should also help. The economic environment at the start of 2016 will be favourable, with some support from a weaker euro and low oil prices, although this will probably fade during the course of the year. However, business investment could benefit from improving corporate profitability.
In Japan, the jury is still out on whether ‘Abenomics’ is working. On the plus side, the Bank of Japan has done its part with a massive programme of quantitative easing. This has resulted in an increase in the rate of inflation, mainly through a weaker yen. However, apart from improvements in corporate governance, the structural reform process has been slow. Although the Trans-Pacific Partnership (TPP) trade deal should favour structural growth, delays in its ratification and a gradual phasing-in process mean it does not provide a strong investment case for 2016. On the other hand, the labour market and household incomes have improved. Income growth is now slightly positive. Inflation has been volatile due to oil price movements, yen depreciation and a hike in the consumption tax. Recently, a higher rate of inflation has partly undone the positive effects of increases in wages. The Bank of Japan thinks more wage rises are essential and Prime Minister Shinzo Abe has pushed business leaders to deliver, despite Japan being likely to suffer from the growth slowdown in China and the rest of Asia. We foresee only a modest rate of economic growth for Japan in 2016, but still better than the sluggish pace in 2015.
In our view, the Chinese economy will slow further in 2016. The economy should continue to rebalance away from credit and investment-led economic growth toward a more sustainable growth model based on consumption and services. The way this is playing out currently is that consumption is holding up, but not completely compensating for slowing investment. Monetary and fiscal stimulus should be supportive as should the shift in the financing of local government from shadow banking to municipal bonds. The housing market is stabilising, with notable improvements in sales and price developments. However, this is all happening against the background of still high and rising levels of leverage. So the cost of the near-term stabilisation in housing may be a higher risk of a credit bubble or a prolonged period of weak economic growth.
The weakness in many emerging economies is not just related to China. Commodity exporters are of course suffering from lower prices, which are due to ample supply and limited growth in demand. We do not foresee strong gains in commodity prices in 2016, but the negative impact of the drop in commodity prices should fade. However, there are also issues with high and rising debt burdens, as mentioned above, and a lack of structural reforms. Nonetheless, recent declines in emerging currencies will, in our view, have a positive impact on exports.
Inflation to distinguish by its absence in 2016; cautious central banks
The focus of financial markets in the latter part of 2015 has been very much on whether or not the US Fed would start hiking rates. This discussion obscures the fact that we are still in a global easing cycle. In the 12 months prior to September 2015, 23 of the 42 central banks in our global sample cut interest rates or purchased assets. This is due to the absence of inflationary pressures.
In August 2015 global GDP-weighted inflation was running at 1.8%; 0.2% in developed economies and 4.6% in emerging economies. This headline rate of inflation is still low due to the drop in oil prices in late 2014. If oil prices were to stabilise, headline inflation would soon gravitate towards the level of core inflation.
Core inflation increased to 1.9% in the US in September 2015, but was hovering below 1% in the eurozone and Japan. So far, even in economies like the US and Japan where conditions in labour markets have tightened, it has been a challenge for central banks to create inflation. That may gradually change over 2016, although globally, structural disinflationary forces will, in our view, persist.
We expect inflation to bottom out in the eurozone, while in the US we expect inflation to rise gradually. The strong US dollar will limit that pick-up, though. Overcapacity in China and other emerging economies will lead to subdued inflation in those countries.
This environment will keep central banks cautious. At the time of writing the discussion focuses on the timing of the Fed’s first rate hike but more important is the path of hikes in 2016. We have pencilled in a hike each quarter. That may look aggressive compared to market expectations of two hikes in total up to the end of 2016, but on a historical basis it would still be a very gradual path. We think an even slower pace would imply something going wrong in the US economy, for example a negative market reaction to Fed rate hikes.
With inflation sticky below the ECB’s target and downside risks from abroad, we think the ECB will continue its asset purchases beyond September 2016. Increasing the pace of purchases above EUR 60 billion per month and broadening the range of assets the ECB acquires is also likely and even a cut in the deposit rate further into negative territory is possible. However, we do not think the outlook for economic growth and inflation in the eurozone warrants overly aggressive measures.
If inflation in Japan stays far below the Bank of Japan’s 2% target, the BoJ could also step up the pace of its asset purchases, but we give this a limited probability. Weakening the yen has a negative impact on the spending power of Japanese consumers and there is less pressure for this from the government. For the three arrows of ‘Abenomics’, the BoJ has done its part, but the structural reforms process has stalled and fiscal consolidation is far from complete. So the central bank may be less willing to act. However, with inflation set to stay low, an increase in the pace of asset purchases is likely in early 2016.
Lower inflation in emerging markets gives central banks scope to cut policy rates further. There is scope for further easing of monetary policy in China, although trying to stimulate such a debt-laden economy further with lower interest rates may only increase risks further down the road.
Finally, those countries where rates of inflation are propped up by the effects of currency depreciation, such as Russia, Brazil and Turkey, may find some room to cut policy rates over the course of the year.