So far, 2014 has been action packed, as emerging markets have come under renewed pressure, prompted in part by concerns about the sustainability of their financial positions against the backdrop of US central bank ‘tapering’.
Several EMs have experienced significant currency depreciations and interest rates have been raised by central banks in Turkey, India, South Africa and Brazil. Despite the increases in nominal interest rates, high rates of inflation mean that real rates remain low; further central bank action is therefore likely. More ‘normal’ real interest rates and weaker currencies are a necessary part of the adjustment to a sustainable post-crisis growth path for the EMs, but the process may be painful at times and the prospect of further policy tightening has prompted a series of modest downgrades to our EM growth forecasts.
China – beware a credit bubble
For China, by far the largest of the EMs, interest-rate increases have been more about domestic factors. Concerns about possible financial instability, especially linked to shadow banking, have risen recently. In the absence of clearer information about the health of the financial system, the prevailing consensus remains that the authorities will ultimately retain broad control of the situation. Faster consumption growth should, in our view, help offset slower investment growth this year, allowing the economy to expand by 7.3%. But the country’s banking system needs to adjust to a slower rate of credit growth to avoid potentially destabilising future bubbles. This process may be bumpy and we are therefore slightly below consensus on China’s 2015 growth outlook.
Extreme pessimism would not be justified at this point; periods of EM volatility are not unusual, and most pass without lasting global economic damage. Weaker EM growth could constrain activity in the developed markets via trade, financial and market sentiment impacts, but this remains a risk scenario at present, rather than the most likely outcome.
Modest eurozone expansion and a stronger performance from the US, UK and Japan – together accounting for around 55% of global economic activity – should allow the global recovery to remain broadly on track. Recent US data have been on the soft side, prompting some concerns about the robustness of the recovery. The weakening-off of the data is, in our view, partly related to severe weather, and partly to high stock levels weighing on firms’ activity after an exceptional build-up in inventories in 2013 H2. The recent softness is therefore most likely temporary, with job gains, pay growth, housing activity and recent positive fiscal developments supporting our modestly above-consensus view on the US economy for 2014-15.
As such, the US central bank asset-purchase tapering looks set to be completed this year, but interest rates are likely to remain on hold until mid-2015. The UK economy, now in ‘phase 2’ of forward guidance, appears to be on a similar time path for interest rates. Further monetary stimulus remains possible for both Japan and the eurozone, however – in the former case, to offset the impact of April’s consumption tax increase alongside recent data disappointments and, in the latter, in the event that deflation risks grow.
