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2018 Forecast: State Of The Global Economy And Its Outlook

How will the economy be in 2018? A look at the current global condition and forecasting for 2018

Global Economy (2017) - broad based economic recovery and strong growth momentum

After the global economy grew by only 3.1% in 2016 (according to IMF), it has been witnessing synchronized, broad based and strengthening economic expansion over this year - with many developed economies (US, Eurozone and Japan) growing above trend, growth momentum picking up in most emerging economies - duly supported by accommodative monetary policy - (with many economies in Asia (ex-Japan) settling into a more stable economic growth trend - notably, Malaysia, Taiwan and South Korea) and four largest emerging economies (China, India, Brazil and Russia) growing simultaneously. According to the IMF’s World Economic Outlook (October 2017), the global economy is projected to grow by 3.6% in 2017.

Factors supporting global growth, corporate profits and global stock markets

Supporting this global economic expansion has been the dynamic of strengthening domestic demand, accompanied by strong global trade, rise in commodity prices and subdued inflation in  most economies. Complementing strengthening consumption demand has been the pick up in business investment across a broad range of economies over this year. Major stock markets (such as S&P 500, Nasdaq, Dow) have touched record levels this year, global stock markets are continuing to benefit from a combination of broad-based global growth and accommodative  monetary policies (as reflected in MSCI All Country World Index) - with emerging markets leading the way (MSCI Emerging Markets Index posting stellar returns) and global economic expansion, subdued inflation and excessively loose monetary policy have provided a very positive backdrop for strong corporate earnings growth in major developed economies (such as the US, Japan and Eurozone). Further, latest flash (November) PMI readings for Eurozone, Japan and the US indicate that growth continues to pick up in these economies - which should improve export (and investment) prospects for emerging economics in the following months of 2018.  

Global Economy (2018) - likely to grow sustainably and moderately higher

The global economy is likely to grow sustainably and moderately higher in 2018 (though sub-trend and well below 4%), relative to 2017 (despite several downside risks - geopolitical, economic and financial).

Most developed and many emerging economies in 2018 are expected to witness synchronized upswing in economic activity (even as China is likely to slowdown gradually in the coming quarters - as it attempts to reduce excess capacity, restrain unsustainably high corporate debt and maintain financial market stability) - with corporate investment becoming a more prominent growth driver in 2018 due to more optimistic growth outlook, higher business confidence, favorable financing conditions (despite less accommodative monetary policy), rising corporate profitability, increasing capacity constraints, rise in credit growth, positive outlook for global trade, strengthening consumption demand and expectations of benign (yet moderately higher) inflation in most economies (despite firming oil and commodity prices (reduction in China’s excess industrial capacity, among several other factors, is underpinning commodity prices)).

 

Oil Prices - will remain firm, yet range bound

I expect oil prices to range between US$55-60 in 2018, as OPEC’s efforts to restrict global oil supply (OPEC and non-OPEC producers led by Russia have agreed to extend oil output reductions until the end of 2018) is likely to have a limited upside impact on oil prices due to US shale production, continued growth of US crude oil production in the coming months (as per EIA forecasts) and moderation of global demand for oil (if oil prices rises beyond a point).

Monetary Policy - major central banks likely to tighten policy only very gradually in 2018

Turning to monetary policy, fortunately for global financial markets and emerging economies’ financial markets, capital inflows, currencies, economic growth and corporate balance sheets, major central banks - such as the Federal Reserve and ECB - (baring the Bank of Japan, which is likely to continue with its significant monetary stimulus in 2018) are expected to proceed very gradually with reference to removal of policy accommodation/trimming of bloated balance sheets in 2018. This is because inflation remains well-below target in major developed economies (except in the UK), there is considerable uncertainty around the inflation outlook, wages in the US, UK, eurozone, Japan and Canada are struggling to gain momentum and are likely to only gradually firm up in the following quarters, fear of inversion of the US yield curve and central banks’ would want to avoid destabilizing volatility in global equity, bond and currency markets and prevent disruption of the ongoing global economic expansion.

With reference to the US, the Federal Reserve is likely to hike rates by 25 bps this month (December). Thereafter, I envisage two more rate hikes of 25 bps each in 2018. Further, due to several factors, I don’t expect any meaningful (i.e. only a moderate) rise in long term bond yields in the US (or in other developed markets) in 2018 (which in turn should keep mortgage rates in check). Consequently, the US yield curve is expected to be quite flat ahead in 2018.

Proposed US Tax Reforms -  unlikely to spur growth in any significant manner in 2018

With reference to Trump’s administration’s tax reform legislation, even if the Congress approves them in whatever form in the coming months, growth is unlikely to be spurred in any significant manner in 2018 (though such reforms might have some gradual upside impact on wage growth and give a boost to the US dollar). This is because the US business cycle is at a mature stage, the economy is already growing above trend and there is the combination of high federal debt (which means higher interest payments for the government, which in turn is likely to lead to higher inflation and interest rates - discouraging investment, consumption and slowing the housing market) and a tight labor market (with unemployment at a 17-year low). Further, the US economy is increasingly shifting towards services. Moreover, the Federal Reserve can always tighten policy further to rein in any fiscal stimulus and prevent overheating of the US economy.

US Economic Outlook  - sustained economic expansion expected

The US economy has been growing above trend this year (yet underlying price pressures remain subdued) - with consumers continuing to be the primary driver of growth along with marked pick up in business investment and recovery in exports. According to  Commerce Department, the US economy grew by 3.3% annualized rate in the third quarter (as a result of stronger business investment). Strong economic momentum continues in the fourth quarter - duly reflected in latest (October) economic data (ISM manufacturing index, consumer confidence, existing home sales, business spending on equipment, industrial production, retail sales, car sales, unemployment rate (which fell to a 17 year low of 4.1% in October) and housing starts). On an annual basis, I expect the US economy to grow by 2.2 % in 2017.

Turning to 2018, my projection for US annual growth is 2.6%. Growth will largely be driven by strong domestic demand. Moderately firming wage growth (slack in labour market and subdued  productivity growth are likely to continue to prevent wage growth from rising more rapidly), uptrend in house and stock prices, healthier household balance sheets and elevated consumer confidence are likely to support continued consumer spending growth in 2018. However, due to income growth lagging behind and likely moderate uptick in inflation over the coming months, I expect growth in consumer spending to ease slightly in 2018, relative to 2017. Business investment will be higher (as a result of stronger global growth, higher business confidence and a competitive US dollar). Uptick in manufacturing will be supported by stronger global growth, competitive dollar and firm commodity prices. Exports are likely to grow more rapidly in 2018.

 

Eurozone Economic Outlook  - growth to continue, but likely to moderate slightly

Eurozone has been witnessing continuing and broad based economic recovery this year and is growing above trend. Germany has been powering this region’s economic recovery (propelled by buoyant exports and rising business investment) and France (supported by domestic demand and exports), Netherlands (supported by household consumption, investment and exports), Spain and Italy are all on the growth path. The eurozone, according to Eurostat, grew at an annualized rate of 2.5% in 2017Q3  High frequency economic data (such as the Economic Sentiment Indicator (a high quality leading indicator which reached a near 17-year high in October), composite (manufacturing and services) PMI, consumer confidence, Germany’s ZEW economic sentiment indicator and IFO Business Climate Index) suggest that economic momentum in the eurozone continues to be strong in the fourth quarter. My eurozone GDP forecast for 2017 is 2.2%.

Turning to 2018, though the broad-based and self-sustaining economic momentum should continue (with German economic outlook particularly favorable due to record-high employment, rising real wages and very low interest rates), yet growth is likely to moderate slightly in the following quarters due to weak productivity growth, insufficient pace of structural reforms, political uncertainty, aging populations, weak bank balance sheets (hindering strong credit growth) and deleveraging pushing growth back to more sustainable levels. Consumption is likely to grow at a similar pace in 2018, as low productivity growth and remaining slack in the labour market constrain wage growth and due to muted growth of real disposable income; business investment will pick up further in 2018 (due to higher business confidence, improvement in bank lending to firms, rising corporate profitability, ECB’s prolonged period of monetary stimulus, favorable financing conditions, stronger external demand and higher capacity utilization); and, export growth is likely to be lower, relative to 2017, given the likelihood of a gradual slowdown of the Chinese economy, moderation in global trade growth and continued growth supporting the euro (making eurozone exports less competitive). My GDP growth projection for 2018 is 2%.

Chinese Economic Outlook - growth likely to slowdown only gradually

The Chinese economy grew by 6.9% year-on-year in the first half of 2017. Thereafter, growth eased slightly in the third quarter to 6.8% year-on-year — according to official data. Growth this year has been driven primarily by domestic demand (supported by lagged impact of substantial monetary and fiscal stimulus in 2016, real estate activity, infrastructure spending and consumer spending). A spate of slightly weaker economic data (PMI manufacturing, retail sales, lending, industrial production, fixed asset investment, property sales, new construction starts and imports) in October suggests further moderation of growth momentum in the fourth quarter. Weakness in real estate and construction have started to act as a drag on economic growth. However, I expect China to grow above target (by 6.8%) in 2017- fueled by a further rise in the debt ratio.

Going forward, I expect the Chinese economy to slow down only gradually (to around 6.3% - 6.5%) in 2018, rather than precipitously, as policy makers would be highly reluctant to cause unemployment to rise sharply - given its detrimental effect on social stability. Deleveraging, tackling corporate debt and excess industrial capacity, less supportive fiscal policy, further modest reining in of credit growth (yet credit growth is likely to higher than nominal GDP growth in 2018), probability of  deceleration in infrastructure spending, rising costs of financing, slowing real estate and construction sectors and slight easing of export growth (though continued global expansion and expected moderate depreciation of the yuan will support export growth) are the main factors that are likely to gradually slowdown growth in 2018. The key driver and supporter of growth in 2018 will be private consumption - which will underpin domestic demand - and strong services sector growth (given the underlying strength of private consumption). However, private consumption growth is likely to moderate slightly next year, relative to 2017, due to expected moderation in real wage growth and property market slowdown.

UK Economic Outlook - growth likely to decelerate further (uncertain outlook)

The UK economy witnessed lackluster growth in the first three quarters of 2017 (even though growth was higher than expected in the third quarter (0.4% quarter-on-quarter and 1.5% year-on- - according to ONS). Essentially, the severe squeeze on spending power of households, as a result of rising inflation (due to the pass-through of last year’s depreciation of GBP and rise in energy prices) and muted wage growth during this year (real wage growth continues to be negative), has played a major part in UK’s economic slowdown, relative to 2016. Further, even though PMI manufacturing, services and construction sector readings were reflective of upturn in business activity in October, the unemployment rate is at multi-decade lows and house prices in UK (which picked up in October), as reported by Halifax and Nationwide, point to a more buoyant picture of the housing market, yet the UK economy remains in a quite a fragile state. For 2017, the Office for Budget Responsibility (OBR) forecasts a growth of only 1.5%.

Turning to 2018, growth is likely to slowdown further in the coming quarters. According to OBR’s forecast, the UK economy is projected to grow by only 1.4% in 2018. With continuing negative real wage growth (at a time of low household savings and high consumer borrowing), likelihood of continued muted wage growth (given slowdown in productivity growth), uncertain political and economic outlook (though UK and EU are possibly edging towards a Brexit deal), subdued outlook for housing market activity, further borrowing hard to sustain (as interest rates have edged up), prospects of a softer labour market, lower consumer confidence and house prices likely to grow more slowly in 2018, I expect consumer spending (which accounts for around 65% of UK GDP) to grow more slowly in the coming quarters of 2018 (even though inflation is likely to slowly return back towards 2% inflation target in the forthcoming quarters, as the effects of the marked depreciation of the pound fades away). Further, business investment will be subdued (as a result of Brexit related uncertainty, lower business confidence and weaker outlook for productivity growth). Export growth too is likely to ease a bit in 2018, as a result of a recovering pound (GBP). Moreover, even though fiscal austerity has been eased modestly (refer to UK’s Autumn Budget, 2017), public spending cuts will weigh on UK economic growth.

Japanese Economic Outlook - growth to continue, yet some moderation is expected

The Japanese economy is growing above trend (with strong exports continuing to play a pivotal role in driving growth and fiscal stimulus too) and expanded for the seventh consecutive quarter in 2017Q3. However, growth moderated to 1.4% annualized rate - according to Japan’s Cabinet Office - (due to contraction in private consumption and subdued business investment growth) from 2.6% in the second quarter. Several economic indicators (industrial output, Bank of Japan’s Tankan Survey, unemployment rate, exports and trade surplus) for October, elevated consumer confidence (at a four year high in October) and manufacturing PMI (November) suggest that economic recovery is on track in the fourth quarter (even though retail sales fell for the first time in October in a year - a temporary blip). My GDP growth forecast for fiscal 2017-2018  is 1.6%.

Moderate economic expansion should continue in fiscal 2018-2019. However, growth is likely to be lower (1.3%), as the Japanese economy will confront capacity constraints (given the extend period of growth above trend, shrinking workforce and structural factors restraining growth), fiscal consolidation and lack of strong domestic demand drivers. Further, though elevated levels of consumer confidence, high stock prices, rise in households’ average financial assets and a strong labour market provide optimism about private consumption growth (which accounts for around 60% of GDP) in the following quarters, yet I expect the same to decelerate moderately (relative to fiscal 2017-2018) as wage growth remains subdued (real wages fell 0.1% year-on-year and nominal wages rose 0.9% year-on-year in September) and are unlikely to rise much (firms remain reluctant to translate record corporate earnings into higher wages).

Business investment should pick up modestly (due to strong corporate profits, higher business confidence, tight labour markets, capacity shortages and construction related to 2020 Tokyo Olympic Games) and though export growth is likely to be supported by a weaker yen and strong external demand, yet growth in the same should decelerate a bit, relative to fiscal 2017-2018, due to moderating Chinese import demand. Monetary policy will continue to support growth.

Indian Economic Outlook - growth prospects looking up; 8% growth not before 2019-2020

After the Indian economy grew at its slowest pace in three years (5.7% year-on-year - according to CSO) in the April-June quarter (fiscal 2017-2018) - as a result of destocking ahead of implementation of GST, lingering effect of demonetisation and a slowdown in exports - it is again gaining momentum with GDP growing by 6.3 % year-on-year (according to CSO) in the July-September quarter. But subdued two wheeler and car sales, lower manufacturing PMI and decline in exports in October indicate that economic recovery remains tentative. However, several indicators suggest that private consumption is rising and along with a slow expansion of the manufacturing sector, improving services sector and agricultural growth, GDP growth should pick up further in the third and fourth quarter of fiscal 2017-2018. However, GST related issues, rising inflation, rupee appreciation, slowing government spending and low capacity utilization are likely to constrain growth. I expect the Indian economy to grow by 6.7% in fiscal 2017-2018.

Next, with respect to fiscal 2018-2019, economic growth in India is likely to gather pace as a result of further rise in private consumption, stabilization of export growth (with the subsiding of GST related distortions) and most importantly due to gradual recovery in private investment strengthening growth (due to a spate of reforms undertaken by the government - such as the massive bank recapitalization plan for public sector banks, infrastructure push, GST, demonetization, initiatives regarding resolution of NPA’s in the banking sector etc. - and Moody’s upgrading India’s sovereign rating that has boosted confidence in India’s medium and long term economic outlook). My projected GDP growth for the aforesaid fiscal year is 7.5%. 

Emerging Economies (as a whole - excluding China) Economic Outlook - bright prospects

These economies in the aggregate are likely to grow moderately higher in 2018, relative to 2017 (with commodity exporting EM’s contributing very significantly to overall EM growth), despite likelihood of the Chinese economy slowing down gradually (leading to lower import demand). Low volatility, low interest rates in developed economies and weakness in the US dollar have contributed significantly in creating a favourable economic environment for these economies.

Key drivers of overall EM growth in 2018 are likely to be synchronized pick up in global growth, buoyant global trade, higher private investment (as result of continued momentum in global trade), strengthening private consumption (due to likelihood of inflation remaining benign in most EM economies) and firmer oil prices (boosting growth in commodity exporting EMs,). Expected relative stability of the yuan (I expect only a slight depreciation of the yuan over 2018) should also benefit emerging markets. Moreover, emerging Asia is likely to be the most important contributor to overall EM (excluding China) growth in 2018 - with EM’s in ASEAN poised to grow prominently as a result of sustained global growth and resilient domestic demand.

Growth in MENA will possibly rebound in 2018 (particularly in the UAE, as a result of higher oil prices and business investment, easing of fiscal consolidation, improved banking sector liquidity and strong non-oil sector growth) and pick up pace in Latin America in 2018 - but growth will still be low (Brazil will probably witness an uptick in growth in 2018, as a result of an improving labour market, subdued inflation, favourable export outlook and monetary easing. However fiscal stress and political uncertainty will pose a threat to growth. With reference to Mexico, uncertainty regarding forthcoming elections and NAFTA related negotiations is clouding its economic outlook). Russia too is on a recovery path after a lengthy recession, with higher oil prices and monetary and fiscal stability indicating steady growth ahead in 2018.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


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Sher Mehta

The author is CEO and Chief Economist Macroeconomic Monitoring Unit (MMU) Macroeconomics School London, UK and New Delhi

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