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International outlook for 2020: No room for mistakes

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Associate Professor of Finance, Kelley School of Business, Indiana University

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Clinical Assistant Professor of Business Economics and Public Policy, Kelley School of Business, Indiana University Bloomington

Introduction

As we are approaching the end of 2019, the International Monetary Fund (IMF) is estimating that this year’s global GDP growth is unlikely to exceed 3 percent. This constitutes its lowest growth since the financial crisis of 2009. This global slowdown is largely due to the uncertainties created by several trade disputes (see Figure 1). For example, a lot of uncertainty has been driven by continued Brexit concerns and the ongoing trade war between the U.S. and China. Similarly, frictions created by U.S.-European Union trade disputes, Japan-South Korea trade disputes, and an unratified United States-Mexico-Canada trade agreement have contributed to uncertainty and an overall global economic slowdown.

Figure 1: Trade uncertainty and global growth

Line graph from 2015-2019 showing trade policy uncertainty increasing dramatically and global GDP growth dropping slightly.

Source: The Trade Policy Uncertainty Measure is the annual average of monthly values from Baker, Bloom and Davis’ Economic Policy Uncertainty Index: Categorial Index: Trade Policy; Real GDP growth is taken from the International Monetary Fund’s October 2019 World Economic Outlook, Table A1: “Summary of World Output”

Advanced economies are already suffering from weak productivity growth and an aging population, and the increased tariffs followed by decreased business confidence have added to the structural strains on their growth potential. The group of countries formed by the U.S., Japan and Europe is expected to be a drag on global growth (see Figure 2 and Figure 3).

Figure 2: World real GDP growth

Column chart from 2018-2020 showing global growth, advanced economy growth and emerging/developing economy growth.

Note: (p) indicates projections.
Source: International Monetary Fund

Figure 3: Advanced economies’ real GDP growth

Column chart from 2018-2020 showing growth for the U.S., Euro Area, Japan, Canada, U.K. and South Korea.

Note: (p) indicates projections.
Source: International Monetary Fund

The anticipated recovery of economic activity in the emerging markets (see Figure 4) will drive the 2020 global growth estimate of 3.4 percent.

Figure 4: Emerging and developing economies’ real GDP growth

Column chart from 2018-2020 showing growth for Brazil, Mexico, Russia, South Africa, India and China.

Note: (p) indicates projections.
Source: International Monetary Fund

The accommodative monetary policy of the U.S., as well as in other advanced and emerging economies, has helped offset the adverse effects of the trade frictions. Without the interest rate cuts from many central banks, the global growth forecast would have been around 0.5 points lower in both 2019 and 2020. However, central banks’ policies have reached their limit, and it will become increasingly difficult to appease downside risks if economic conditions further degrade.

United States

The current U.S. economic expansion, which started in June 2009, celebrated its 10th anniversary and became the longest period of uninterrupted economic growth on record. Most economists forecast decelerating growth in the United States. However, we anticipate this slowed growth of 2.1 percent to be the strongest out of the advanced economies in 2020.

Downside risks to this forecast are substantial. The trade frictions are starting to negatively impact manufacturing activity and business sentiment. The latest data from the Institute for Supply Management reported that the U.S. manufacturing index, which monitors changes in production levels from month to month, fell to its lowest level since June 2009. Fortunately, in 2019, slowed business investment continued to be offset by stronger household consumption.

In 2020, consumer spending and low unemployment are expected to continue to support the U.S. economy. As long as consumers retain their income flows (i.e., remain employed) and are willing to spend, the economy will expand.

The Federal Reserve System’s “insurance” rate cuts, which Fed Chair Jerome Powell described as “intended to ensure against downside risks from weak global growth and trade tensions,” have contributed to the improved outlook for residential investment. The housing market indicators, including home sales and housing starts, are showing positive signs. Similarly, data on the U.S. financial accounts continues to indicate increased household wealth that will further support domestic consumption.

Europe

Eurozone economies are flirting with recession, as they are continuing to be hit by Brexit concerns, as well as the uncertainties associated with the World Trade Organization’s newly authorized tariff retaliations from the United States.

The Eurozone’s real GDP growth is projected to grow by 1.4 percent next year pending two important assumptions:

  • That the U.K. ratification of an EU withdrawal agreement is reached by its third extension of January 31, 2020.
  • That the U.S. will not implement its tariff retaliations.

In 2019, Europe’s usual engine of growth, Germany, grew by only 0.5 percent. General trade uncertainty has adversely affected business investment, and Germany’s critical manufacturing sector was battered by the decrease in demand for German exports. Furthermore, the political resistance toward abandoning the country’s rigid balanced-budget policy has been exacerbating the economic slowdown, due to the lack of injected fiscal policy stimulus.

The European Central Bank’s new round of quantitative easing and rate cuts have resulted in taking the interest rates deeper into negative territory. Having negative rates means that deposits incur a charge for staying in a bank and encourage firms and households to borrow. In the short term, it is clear that the encouraged borrowing has supported household consumption and business spending, ultimately helping to ease trade frictions. However, the buildup in public and private debt could eventually harm the economy by simply transferring burden and inflationary pressures to future generations.

Britain’s economy has slowed since the June 2016 vote to leave the EU. Specifically, annual growth rates have dropped from more than 2 percent before the referendum, to a projected 1.4 percent in 2020. However, Brexit has become immensely more complicated, and the path to a no-deal Brexit is increasingly likely. A possible no-deal Brexit will lead to a sharp depreciation in the British pound and immediate contraction in economic activities. Given the third extension of Brexit has pushed the exit date to January 31, the start of the year is expected to set the tone for a slow growth period if no deal is struck upon exit.

In 2020, growth in Europe will be driven by the peripheral countries, notably Poland and Hungary where strong domestic demand and rising wages are expected to support economic activities.

Japan and South Korea

For Japan and South Korea, growth is anticipated at 0.5 percent and 2.2 percent, respectively.

A political dispute between Japan and South Korea, which originated from colonial events of the first part of the 20th century, has started to spill over to their economic activities by contributing to falling exports in both countries. Specifically, under the escalating political dispute, Japan dropped South Korea as a preferred trading partner, which negatively affected trade volumes and disrupted the global supply chain for smartphones and electronic devices. Firms like Samsung Electronics, whose revenue comprises 14 percent of South Korean GDP, are expected to be adversely affected by these growing trade tensions.

With no obvious way out of this political crisis, the 2020 growth forecasts for both countries are subject to significant downward risks. Namely, the trade tensions are adding to the expectations that the Bank of Japan will cut rates deeper into the negative territory in 2020. This negative-interest-rate policy in Japan is more negative than the policy in the Eurozone, and if it continues to trend even more negative, it can ultimately lead to credit rationing—where banks stop lending. Under credit rationing, the risk is that private spending will dry up and hinder growth in economic activity.

Canada

In 2019, Canadian economic growth has been resilient thanks to its robust labor market with low unemployment, growing wages and inflation right on the central bank’s target. The 2020 projection is that Canada will experience growth of 1.8 percent.

However, the forecast shows three areas of concern. First, high household debt in Canada is holding down consumption spending. Second, the potential contraction of the American economy would negatively affect Canada, given that the U.S. is its first trading partner. Third, given Canada’s general reliance on international trade, the lingering North American trade-related uncertainties remain the biggest risk in this forecast.

Specifically, the U.S. Congress has yet to ratify the United States-Mexico-Canada trade agreement (USMCA). American politicians are concerned that USMCA does not sufficiently reform NAFTA. In particular, U.S. policymakers have not come to agreement on the terms of labor, environmental and intellectual property protections. This trade policy uncertainty has been holding down Canadian exports and investment since 2018.

Mexico

Economic growth in the United States’ second-largest trading partner is expected to be positive, though limited by reduced investment spending and continued global trade policy uncertainty in 2020. After growing by 2 percent in 2018, Mexico’s real GDP growth rate fell sharply to only 0.4 percent in 2019, as the new government’s sudden decision to cut infrastructure spending combined with U.S. tariff risks to adversely impact investment spending and business confidence. Yet, consumer sentiment has remained high, and robust consumer spending should help raise growth to 1.3 percent in 2020. Recent data showing growth in Mexico’s manufacturing purchasing orders could help reinforce the positive trend. Given Mexico’s dependence upon exports for nearly 40 percent of its GDP, downside risks will dominate if approval of USMCA languishes and if trade policy disputes intensify.

China

For the first time in nearly 30 years, China’s GDP growth rate is forecast to fall below 6 percent in 2020. Although a slowing of growth has been expected, a slowing of demand by the world’s second-largest economy and importer of the world’s goods will certainly have repercussions on global growth. The decrease in growth from its 2019 level of 6.1 percent reflects in part the continued rebalancing of China’s economy away from its dependence on manufactured exports and investment spending to one driven by services and consumer spending. The aging of China’s workforce is also consistent with lower long-term growth.

Trade policy uncertainty, however, has exacerbated the decline in growth. Threats of higher tariffs and an expansion of the amount of imports covered by these tariffs reduced Chinese manufacturing orders, industrial production and business confidence. By October 2019, the U.S. had imposed 25 percent tariffs on $250 billion of Chinese imports. China retaliated with tariffs on $75 billion of U.S. products. The Chinese government’s imposition of stronger lending standards on banks to lower debt burdens further reduced spending. The effects of China’s slowdown, the trade war and policy uncertainty spilled over into the broader Asian region. Growth in the Asean-5 (Indonesia, Malaysia, Philippines, Thailand and Vietnam), for example, fell from 5.2 percent in 2018 to 4.8 percent in 2019 as demand from China fell.  

Monetary policy stimulus by China’s central bank and hopes for a de-escalation of trade tensions are expected to limit the fall in China’s growth rate to 5.8 percent in 2020. Recent data from China’s Caixin Composite PMI Survey showing an expansion of business activity and higher domestic and export orders provides hope that a sharper-than-expected drop in China’s economic growth rate will be avoided.

Brazil, Russia, South Africa and India

In contrast to China, the remaining “BRICS” (Brazil, Russia, India, China and South Africa) countries are expected to see increases in real GDP growth in 2020, albeit at different rates. Brazil’s economy, the largest in Latin America, is expected to expand by 2.0 percent in 2020, up from 0.9 percent in 2019. Growth in 2019 was negatively impacted by the mining disaster and resulting supply disruptions, as well as by weak or negative growth in Brazil’s major Latin American trading partners. Indeed, the economies of neighboring Argentina and Venezuela contracted by 3.1 percent and 35 percent, respectively, in 2019. Absent an acceleration of global trade tensions or new political risks, Brazil’s economy should achieve a moderate pace of growth as activity recovers. Brazil’s economy should also benefit from a recent vote to overhaul its pension system—a change which will help reduce both its budget deficit and its public debt burden. A currency depreciation has increased domestic inflation, but inflation is expected to remain below 5 percent.

A fall in oil prices along with a contraction in demand for manufactured goods contributed to sharp slowing of Russia’s economic growth in 2019. Economic growth is expected to recover somewhat to just under 2 percent in 2020. However, risks from the impact of economic sanctions, continued low oil prices, and geopolitical and trade policy risks will create challenging domestic and foreign demand conditions to support that growth.

South Africa’s economy has been experiencing positive—but very low—growth over the past five years. The economy suffers from an unemployment rate of nearly 30 percent, reduced business confidence, and regulatory constraints limiting investment. In 2019, economic growth slowed further as a result of weak commodity prices, a drop in trade and labor strikes in mining. Although South Africa’s economy is expected to expand at a slightly faster rate in 2020, the high costs of doing business, inflexible labor markets, low population growth and trade policy uncertainty are expected to keep growth just over 1 percent.

India’s economic growth rate will continue to exceed the “emerging and developing country” average. Though a slowdown in manufacturing, lower credit growth and tighter lending standards, and trade tensions in 2019 caused India’s growth rate to drop to 6.1 percent, economic growth is projected to rise to a robust 7 percent in 2020. Measures supporting this high rate of growth include a more accommodative monetary policy, a reduction in corporate tax rates, regulatory reforms directed toward encouraging foreign and domestic investment and improving the business environment, as well as efforts to encourage growth in rural areas. India continues to rise in the rankings of the World Bank’s Ease of Doing Business survey, and the adoption of business-friendly reforms along with India’s young and growing workforce could help India become one of the growth success stories of 2020. Yet, Moody’s recent downgrade of India’s debt serves as a reminder that this recovery in growth remains fragile.

Conclusion

The latest warning from the International Monetary Fund is clear: “At 3 percent growth, there is no room for policy mistakes” (2019). This is the reason why our 2020 forecast needs to be taken with caution as they rely on the efforts of policymakers to agree to decrease the trade frictions (Brexit, U.S.-China, U.S.-EU, Japan-South Korea, and USMCA frictions) before they irrevocably affect confidence, job creation and growth potential.

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