September 25th, 2014
from the Dallas Fed
Global growth in the second quarter picked up in the emerging economies but slumped in the advanced countries. Growth in the emerging economies was mainly driven by a 2.73 percent year-over-year boost in Mexican GDP. The Organization for Economic Cooperation and Development revised down its euro-area GDP growth outlook from 1.2 percent in May to 0.8 percent in September and suggested urgent and ambitious reform in the region. The outlook for the global economy remains cloudy, and three risks loom: weak growth in the euro area, the emerging effects of the Russian sanctions and growing concerns about rising Chinese debt.
ECB Next to Implement Quantitative Easing
The European Central Bank (ECB) is about to start the next round of monetary policy easing. In addition to lowering the deposit and refinancing rates to historic lows of –0.2 percent and 0.05 percent, respectively, ECB President Mario Draghi announced at the ECB’s meeting in September that the ECB will partake in a form of quantitative easing that includes purchasing asset-backed securities and covered bonds. These policy actions are targeted at alleviating the euro-area crisis that has been a growing burden since 2011. Inflation rates in the euro area are at a five-year low of 0.4 percent year over year (Chart 1). Unemployment is in the double digits in France, Greece, Italy, Spain, Portugal, Latvia and Ireland. The efficacy of these changes in monetary policy remains unclear, however. If the quantitative easing that Draghi is attempting fails, the euro area may have to look to fiscal policy changes to strengthen the region’s economy. Furthermore, sanctions imposed against Russia may be impacting growth in the euro area, which may further hamper the region’s economy.
Sanctions Are Slow to Show Effects
The sanctions imposed against Russia are slow to show an effect on the Russian economy, while indications that the sanctions are impacting the euro area are becoming more apparent. Russia runs a trade surplus, meaning it exports more than it imports; therefore, it is better able to sustain itself than other economies that rely more on other countries to fulfill their demand. Russia also has a large amount of assets in foreign banks, which exposes these countries to Russia. The manufacturing Purchasing Managers Index (PMI) indicates that Russian output has been improving despite sanctions being imposed in March 2014 (Chart 2). In addition to its trade (oil and gas) surplus, perhaps another reason why Russia has been seemingly immune to the sanctions is the recent greater sense of Russian nationalism. Russian businesses are hiring more workers, and more domestic goods are being purchased.
Conversely, the PMIs in Italy and Germany, two of Russia’s largest trading partners, have declined; the PMI for Italy indicates that the Italian economy is contracting. About 3 percent of German exports and about 2.5 percent of Italian exports go to Russia (Chart 3). Of the euro-area countries, Germany and Italy are most exposed to the sanctions against Russia. Whether the decline in the German and Italian PMIs is a result of the Russian sanctions or the crisis in Europe is unclear; however, in either case, the global economic outlook may be at risk.
Credit Boom Could Hurt China
The credit boom in China also poses a risk to the global growth. China’s nonfinancial private credit-to-GDP ratio is approaching 2-to-1, with first quarter 2014 coming in at about 1.9-to-1 (Chart 4). In addition to a high credit-to-GDP ratio, house prices fell 0.59 percent in August. With house prices falling, people may now owe more on their house than its actual worth. Since much of the investment in housing was financed by credit, if people start defaulting, China may experience a housing bust. The fear of a collapse is not unwarranted; however, China saves about 51 percent of its income, which is the key difference between China’s credit growth and the euro zone’s. In the event of a crisis, China may fare better than the euro zone because investors will be less likely to leave. Domestic savings may be enough to sustain the boom, which builds confidence in the investors. Furthermore, second quarter GDP for China came in at 7.47 percent—0.04 percent above first-quarter growth. This is in line with the Chinese GDP target of 7.5 percent growth.
Geopolitical Events Complicate Outlook
Monetary policy changes in the euro area may lead to a positive turn in the economy; however, effects of the recent sanctions imposed against Russia have dampened the outlook. Data suggest that the euro area, specifically Italy and Germany, is taking a larger dent in its economies than expected. Furthermore, the shadow-banking situation in China presents a headwind to the global economic outlook. Credit allocation in China nearly mirrors what happened in the euro area in 2011, but perhaps China has enough domestic savings to prevent another global crisis.
About the Author
Graves is a research assistant in the Globalization and Monetary Policy Institute at the Federal Reserve Bank of Dallas.