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World Economy Health Check: Mixed Bag of Prospects in 2012

Posted on the February 21st, 2012 under Research & Views by

By Chandana Karunaratne, Research Assistant – IPS

The world economy is in for a tumultuous 2012. The euro zone is going through a turbulent period as it seeks a sustainable solution to its sovereign debt crisis, and analysts forecast a rather dismal GDP growth rate of 1.8% for the USA in 2012.1 The decline of these two economic powerhouses is likely to send shockwaves around the world. Recent revisions in the global economic outlook for 2012, conducted by the International Monetary Fund (IMF), have placed world output ¾ percentage point lower than what they predicted in September of last year.2

Crisis in the Euro Zone


Unless bold decisions are made among policy makers in the European Union (EU), bank defaults and strict capital controls will grip the region. Analysts predict a global recession worse than that which took place in 2008-2009 if the euro zone is allowed to collapse.3 Borrowing costs for Spain’s government have more than doubled within a month, France and several other EU nations have lost their AAA credit rating which has seen their borrowing costs rise, and Germany recently had a dismal auction for its government bonds. Financial panic is spreading across the region, with banks growing increasingly reluctant to issue loans and investors pulling their deposits.

However, the bold decision-making necessary to avoid economic catastrophe is not forthcoming from the EU’s key policy makers. The European Central Bank (ECB) is reluctant to become the region’s lender of last resort, fearing moral hazard will grip the region’s administrations and seduce its leaders with the assurance that their economies will be bailed out if needed. This would reduce the pressure for governments to implement tough financial reform and strict austerity measures, both of which are essential for avoiding a euro zone collapse. However, without the ECB’s support in decreasing short-term borrowing rates and engaging in large-scale purchasing of government bonds, it is unlikely financial stability will return to the region.

Another key policy maker, Germany, also refuses to step in. Its administration is concerned that, if a significant chunk of euro zone debt is to be mutualized, as has been suggested by some experts, Germany would have to help sustain its weaker economic neighbors for years to come. Unless Germany and other EU leaders make key policy changes to help restore investor confidence and financial stability, the euro zone may show signs of collapse.

Bipartisan bickering in US

Among the economies most likely to feel this impact is that of the USA. However, the country has its own domestic issues that it is struggling to manage. In November of last year, a congressional team of Democrats and Republicans was expected to reach a decision on ways to address the country’s budget deficit. The Democrats refused to stand down on reforms related to the major welfare programmes, including Medicare, Medicaid, and Social Security. The Republicans rejected any policy changes that would see an increase in tax rates. After three months of discussions, the team failed to reach a consensus. The implications of this failure are twofold. It shows that the main political parties are inept at cooperating with each other, an obstacle which must be overcome if Congress is to eventually resolve the budget deficit. It also means that fiscal tightening is on the horizon. This does not bode well for the American economy, which is expected to experience sluggish growth in the next two years. The IMF made a downward revision in its forecast for the economy for 2013, moving it by -0.3 percentage points in output from its September 2011 outlook. However, with Presidential elections coming up later this year, it is unlikely that President Barack Obama will enact any bold policy reforms in the coming months.

Figure 1: Recorded and Expected Real GDP Growth for Selected Economies, 2007 – 2016
India tied up in red tape

Linked closely to the American economy is that of India. The USA is India’s second largest export market and accounted for over 10% of all Indian exports in 2011.4 As the American economy slows down in the next few years, so too will the Indian economy, the IMF predicts. Forecasts show a downward revision of 0.8 percentage points to 7.3% in GDP growth for 2013 compared to the IMF’s September 2011 prediction.5 But it is not only the USA that will slow down India’s economic development. Domestic issues are plaguing the country’s growth, ranging from corruption scandals, in which two ministers in the telecoms sector resigned, to excessive state influence in the electricity market. Entrepreneurs and others in the business community are complaining of licensing processes entangled in red tape that are severely impeding growth in the business environment. A decrease in capital inflows played a part in the country’s declining industrial output, recorded to have dropped by 2.9% in October 2011.6 Nonetheless, the potential for the country’s consumer base in the coming decades is formidable. Its middle class is predicted to grow to over 250 million within four years and to over 600 million by 2030. If India is to reap the full potential of its dynamic economy, it must enact bold policy reforms that tackle the bureaucratic red tape and corruption that are hampering the development of its private sector.

A changing of the guard in China

There does remain another Asian giant, one which holds more substantial sway over the course of the global economy. China has developed at a phenomenal rate over the last decade and is currently among the largest economies in the world. The country may not hold the panacea for the ailing economies of the West, but it does possess substantial economic clout which may be needed to avoid a global recession.

However, it appears that this giant is losing momentum, and many analysts fear a hard landing for the goliath. The IMF revised its GDP growth forecasts for China downward by 0.8 and 0.7 percentage points for 2012 and 2013, respectively.7 One reason for concern is the large-scale credit stimulus that helped the economy through the global financial crisis in 2008 – 2009. Such a stimulus raises questions about the strength of the banking sector. Analysts worry that if exports took a dive or infrastructure investments performed more poorly than expected, the industrial sector would suffer and there could be a rise in non-performing loans. This could then lead to severely limited access to the amount of credit available to banks, curbing their investments and increasing the cost of borrowing. A fall in investment would hurt GDP growth and would likely push down on consumption, affecting the country’s demand for imports and inevitably affecting global trade linkages and financial markets.8 

Any bold policy changes to help counteract this scenario is unlikely. This year will be one of transition for China, and the country looks keen to pass on the reigns of its leadership with as little turbulence as possible. This change at the helm takes place only once a decade. It is doubtful the country’s current leaders, President Hu Jintao and Premier Wen Jiabao, will make any controversial policy changes before passing the baton in order to ensure a smooth transition. However, if the euro zone slips into a recession or if China’s growth slows considerably, the Communist Party may need its current and aspiring leaders to make bold decisions. Rather, it appears the Party will adopt an inward-looking attitude to avoid “hostile international forces [from] strengthening their efforts to Westernize and divide us,” as quoted by President Hu Jintao in an article published in the Communist Party magazine.9

Nonetheless, China is not closing herself off completely. The country is exploring its options abroad and has invested extensively in Africa over the last decade. Investments in infrastructure, mining, and telecommunications projects have generated large revenues for the Asian giant. Huawei Technologies (the Chinese mobile telecoms manufacturer), for example, began business on the continent in 1998 and has since generated annual revenue of US$ 2 billion while growing at a rate of 12-15% per year.10

A New Age for Africa

Despite expected slowdown in emerging economies, growth is expected to remain fairly robust in developing Asia and Africa. Africa has entered a new age of development and is home to six of the ten fastest-growing economies in the last decade. Over the course of this year, the IMF forecasts the continent’s growth to reach almost 6%.11 This progress is partially due to the vast natural resources lying below the ground. Africa holds half the world’s gold deposits, a third of its diamond reserves, and substantial amounts of oil. The Economist estimates that, between 2000 and 2008, a quarter of the continent’s growth was led by its considerable wealth in natural resources.12

Yet the commodity markets are not the only significant factor behind Africa’s push for development. The manufacturing and services sectors have played important roles in the region’s growth. Entrepreneurs, like Nigeria’s Aliko Dangote, among the richest people in the world, are making billion-dollar fortunes through investments in manufacturing industries like sugar, logistics, and construction projects. It is not only the upper crust that is benefitting from the continent’s growth. The middle income class is expanding rapidly. It is estimated that by 2015, Africa will be home to 100 million households generating over US $3,000 in annual income, a surge from the current figure of 60 million.13

Political stability is also improving in some parts of the continent. Around two-thirds of all nations in the region hold elections now, and despite evidence of corruption and electoral fraud in some cases, it is still an improvement from what was the case a generation ago. Regulatory reforms have made markets more accessible, without which the likes of Huawei Technologies would not have been able to penetrate the telecommunications sector to such a degree. State influence in the economy is diminishing in several countries through the numerous privatizations that are taking place. Nigeria alone has made over 100 privatizations, ranging from the banking industry to petroleum corporations. The privatization scheme in the electricity sector that was proposed last year is expected to increase power supply by 13 times over the next decade.14

It is these developments that are encouraging outside investors to place their faith in Africa’s future. Foreign direct investment (FDI) is five times what it was ten years ago, with over US$ 55 billion flowing into the continent in 2010 alone. Nonetheless, even Africa will experience a slowdown in economic growth in the near future, albeit less pronounced than most other regions. Its GDP growth over the next two years was revised downward by 0.3 and 0.2 percentage points, respectively, partially due to an expected decrease in demand for commodities in China. However, the region is projected to maintain growth above 5% in 2012 and 2013.15

Commodity-driven Development in Latin America

Another region of emerging economies that is predicted to experience healthy growth is Latin America. It is forecasted to enjoy an expansion in real GDP ranging from 3.5% to 4.3% in the next five years.16 Much of the growth in the region is due to high commodity prices, with Mexico, Brazil, and Venezuela among the top 15 oil producers in the world.17 However, the region is also expected to face decelerating growth due to a slowdown in high-income countries like the USA and key importers of the region’s commodities, like China. Latin America will also face an increase in borrowing costs and more limited access to international capital due to the credit crunch in Western markets, and this will likely hamper investment and private consumption in the region. 18

Emerging Scenario

Despite the potential of emerging markets around the world, it is clear that the slowdown in the West will have a significant impact. Developing countries are clearly not insulated against the shockwaves that will ripple out as advanced economies slip into recession. However, many of the emerging economies are robust and dynamic and may weather the storm that lies ahead. Perhaps it will be these very markets that provide the life raft of economic recovery for the West in years to come.

Citations:
1World economy: EIU’s global forecast – Upgrading the US, downgrading emerging markets, Economist Intelligence Unit, 18th January 2012; 2World Economic Outlook Update, International Monetary Fund, 24th January 2012; 3“Is This Really the End?” The Economist. November 26th-December 2nd 2011; 4Export Import Data Bank, Department of Commerce, Government of India; 5World Economic Outlook Update, International Monetary Fund, 24th January 2012; 6Ibid.; 7Ibid.; 8Global Scenario Service, Oxford Economics, December 2011; 9“2012 – China’s Year of Change.” BBC News. 3rd January 2012; 10“Into Africa.” Economist Intelligence Unit. 3rd January 2012; 11“Africa Rising.” The Economist. December 3rd-9th 2011; 12Ibid; 13“The Sun Shines Bright.” The Economist. December 3rd-9th 2011; 14“Let There Be Light.” The Economist. October 21st 2010; 15World Economic Outlook Update, International Monetary Fund, 24th January 2012; 16World economy: EIU’s global forecast – Upgrading the US, downgrading emerging markets, Economist Intelligence Unit, 18th January 2012; 17Top World Oil Producers, 2010, U.S. Energy Information Administration; 18World Economic Outlook Update, International Monetary Fund, 24th January 2012

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World Economy Health Check: Mixed Bag of Prospects in 2012

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