The External Economic And Financial Environment: What Is The New Normal Ahead?

Is the global economy finally shaking off the hangover from the global financial crisis and moving back into a Goldilocks scenario or is there a different new normal ahead?

Andreas Bauer
 
So far in 2017, global financing conditions have been benign for India and emerging market economies more generally. Moreover, global growth and trade are picking up, and financial market valuations have risen. Monetary policies in major advanced economies are normalising, with the US Fed hiking rates and the European central bank also mulling a gradual tightening. 
 
Let us start just looking how the world looks like? Where are we? Have we reached a new normal, an equilibrium, a good state or are we still in transition? You’ll see that that depends a little bit on the view that you take and how you look at this whole construct of the global economy.
 
The first good news is, of course, the global economy is picking up. We have been struggling; the IMF has been hoping for recovery every year and then had to downgrade its forecast. This is the first year this has not happened and we all, of course, are very happy with that. This recovery is also a broad-based recovery. It is not a recovery driven just by a few countries. Finally, Europe has turned a corner. Japan is growing well. China is growing. So I would say across all country groups, we look at emerging markets, lower income countries and advanced economies, we see a pick up in growth and that is certainly good news. 
 
At the same time, inflation is contained across the globe as well. There has been a little bit of reflation in advanced economies but the latest data points that we have show that after the slight increase in inflation now again price pressures in advanced economies have come down to the fact that the discussion today among economists is, we have missing inflation. Where is inflation going? But generally, the fact that prices are not rising very fast is good news and the same is also happening in emerging markets, partly driven by lower oil prices as well, and by the weakness of the dollar.
 
From the perspective of emerging market economies, the financing conditions are extremely favourable. 
 
Now what’s holding back growth? The biggest culprit holding back growth is poor productivity and especially total factor productivity which we can understand as the ability to produce more goods and services with the same type of inputs or if you look at it the other way to be able to save some inputs to produce the same amount and put them to better use somewhere else. 
 
India cannot really expect a lot of push from the out­side. There will not be big demand push, people running to markets, or companies running to buy Indian prod­ucts. In fact, what we forecast to happen in next five years is that the expected average is considerably below of what we had seen earlier at the beginning of the last decade.
 
Risks are also there – risks to the outlook, risks to the global outlook. One of them, I want to talk about is China. China is an extremely important economy for the world. We’ve mentioned some data on the GDP and what they make of the GDP. Growth in China matters for the world economy. China has been growing very fast for a long time but the growth has become unbalanced. The economy has to rebalance; it has to rebalance the growth drivers and has to also slow down to a level that is more sustainable over time. A lot of this has happened already but a lot more has to happen as well. One of the big shifts that China needs to undertake is to move from the manufacturing sector to services.
 
The current key issues are – are major central banks giving up on predictability? Is the investor to just turn this little box and be scared all the time that Jack is suddenly coming, jumping out, and surprising him or her. Well I think, we’re far off from a world in which we return to the times of what was called mumbling with great incoherence. 
 
But basically 30–40 years ago, the central banks thought that if you leave everybody in the dark and then surprise the market, then centrally the transmission of your policy can be much faster because economic actors will react much more strongly, maybe even overreact and so we can adjust much faster.
 
Talking about the Fed communications policy, the normalisation of Fed policy has worked reasonably well. It looks like the market is understanding what the reaction function is of the Fed. We even had an election with a surprising outcome that generated just a little adjustment in inflation expectations and in rates but didn’t really lead to a major adjustment of portfolios.
 
For India, the decline – the low level and plus, even further decline is a big issue. I do think that actually there is quite a bit of human capital formation that gets lost in the process. You do have investment in education of these girls and young women. Many of them, ultimately, will not bring this education to bear so there is also – when I think about India – I think about an economy that is essentially quite a bit underneath its production possibility frontier. It could produce a lot more with the same impulse it has. Raising labour force participation is clearly in my mind – an instrument to also help keep productivity growth up in this economy. 
 
The final point is, with a rather subdued external outlook, I strongly believe that India’s growth prospects depend on what happens inside. 
 
About the author:
Andreas Bauer is IMF’s Senior Resident Representative for India, Nepal and Bhutan. Prior to this, he was an Assistant Director in the Strategy, Policy and Review Department, where he headed a unit in charge of institutional strategy & international monetary issues.

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