Trade tensions, policy uncertainty weakening global growth

The global growth outlook has weakened amid unresolved trade tensions and elevated international policy uncertainty, with growth projections for 2019 downgraded across both developed and developing countries, says a United Nations report.

Kanaga Raja

IN its World Economic Situation and Prospects (WESP) mid-2019 report, the UN said while looser monetary conditions have contributed to some stabilisation in global financial markets and capital flows, the world economy continues to face considerable downside risks arising from persistent trade tensions, the build-up of financial imbalances, and intensifying climate change.

Against this backdrop, it said, world gross product growth is now expected to moderate from 3.0% in 2018 to 2.7% in 2019 and 2.9% in 2020, reflecting a downward revision from its forecasts released this January.

The WESP mid-2019 report, which updates its earlier report released in January 2019, said in the face of these multifaceted challenges, tackling the current growth slowdown and placing the world economy on a robust path towards the 2030 Agenda for Sustainable Development require more comprehensive and well-targeted policy responses. This should include a combination of monetary, fiscal and development-oriented measures, said the report.

‘It is increasingly clear that policies to promote sustainable development will need to look beyond GDP growth and identify new and more robust measures of economic performance that appropriately reflect the costs of inequality, insecurity and climate change,’ said Elliot Harris, UN Chief Economist and UN Assistant Secretary-General for Economic Development.

According to the WESP report, the weaker growth outlook across most regions is attributable to a confluence of external and domestic factors.

On the external front, persistent trade tensions and higher tariffs have weighed on the trade performance of many developed and developing countries. Rising barriers to trade have not only directly impacted global trade flows but have also increased uncertainty, affecting business and consumer confidence. As a result, global merchandise trade volume growth has slowed more sharply than expected, particularly in late 2018 and early 2019.

Data from the United States Census Bureau showed that bilateral merchandise trade between the United States and China has declined by more than 15% since September 2018, when the second round of tariffs came into effect. This has also impacted global value chains in East Asia and other trading partners, said the report.

Elevated trade-related headwinds have been compounded by continued volatility in global commodity prices, it added. Oil prices have recovered from the recent lows in December 2018, with the Brent spot price reaching $75 per barrel in April 2019. The UN said that the assumptions underlying the economic forecasts in its report are for Brent spot prices to average $65.5 in 2019 and $65 in 2020. However, these assumptions are subject to high uncertainty. With global oil demand expected to decelerate and United States crude oil production growing, an effective extension of the OPEC-led production agreement is a key determinant of crude oil prices in 2019. Significant supply disruptions and a spike in oil prices due to geopolitical factors remain possible, given the situation in Iran, Libya and Venezuela.

Among other commodities, agricultural commodity prices are generally expected to remain weak in the near term. However, localised spikes of food prices in parts of Western Asia and Africa due to weather-related shocks and conflicts cannot be ruled out, said the report.

Growth projections for 2019

According to the WESP report, growth projections for 2019 have been revised downward in all major developed economies.

In the United States, the growth momentum is projected to moderate as headwinds from trade policy are compounded by the waning effects of fiscal stimulus. Economic sentiment indicators in the United States deteriorated in early 2019, as tangible impacts from tariff hikes and trade tensions materialised, and consumer confidence was buffeted by the longest federal government shutdown in history. The Congressional Budget Office estimates that the five-week shutdown, which impacted 800,000 federal employees, reduced the level of GDP in the first quarter of 2019 by 0.2%, although much of this will be recovered later in the year.

The United States’ GDP is projected to grow by 2.3% in 2019 – down from 2.9% in 2018 and a projection of 2.5% (in the forecast released in January) – as the effects of fiscal stimulus measures wane and export growth is hampered by ongoing trade disputes. In 2020, GDP growth in the United States is expected to moderate further to 2.1%.

In Europe, while the effects of auto production disruptions are expected to dissipate, economic activity will be dampened by weaker confidence, softer external demand and prolonged uncertainty surrounding the Brexit developments.

The EU is projected to expand by 1.5% in 2019 and 1.8% in 2020. This constitutes a downward revision compared with the previous forecast, as the trade-related downside risks attached to the last baseline forecast have started to materialise. By contrast, private consumption remains relatively robust. Solid labour market conditions underpin upward wage pressure, which together with subdued inflation rates supports household purchasing power and private consumption spending.

The report said that the postponement of the United Kingdom’s exit from the EU without clarification as to the way forward has increased the risk of a disorderly separation. This could have severe negative consequences in the form of a disruption or even breakdown in trade flows to and from the United Kingdom.

In Japan, weak external demand has weighed on investment in the manufacturing sector, while household consumption remains sluggish. Japan’s growth forecast for 2019 has been revised down from 1.4% to 0.8%, with the revision reflecting weakening external demand.

For the economies of the Commonwealth of Independent States (CIS), external conditions, including demand from major economies and prices of non-oil commodities, are less supportive in 2019. Growth is expected to moderate, especially as fiscal policies are largely growth-neutral and several countries have tightened monetary policy. The aggregate GDP of the CIS and Georgia is expected to increase by 1.9% in 2019 and 2.3% in 2020.

The growth outlook for many developing economies has also weakened, said the report.

Southern Africa, Western Asia and Latin America and the Caribbean have seen particularly large downward revisions for growth in 2019.

The economic outlook for Africa remains challenging. While growth is estimated to pick up, the region faces difficulties in embarking on a robust and sustained growth trajectory, amid a global slowdown, tepid commodity prices and protracted fragilities in many commodity exporters. Aggregate GDP growth for the region is projected at 3.2% in 2019 and 3.7% in 2020, after an estimated expansion of only 2.7% in 2018.

The weaker prospects for Southern Africa are attributable to the devastation caused by Cyclone Idai, coupled with a subdued outlook for South Africa’s economy, which is severely hampered by power shortages.

In Western Asia, growth in Saudi Arabia is projected to slow amid oil production cuts, while Turkey will only gradually emerge from recession following a sharp contraction in domestic demand in the second half of 2018.

The downward revision of the outlook for Latin America and the Caribbean reflects weaker-than-expected activity in the region’s largest economies – Argentina, Brazil and Mexico – and a further severe contraction in Venezuela. GDP for the region is projected to expand by only 1.1% in 2019 and 2.0% in 2020, following growth of 0.9% in 2018.

In contrast, growth prospects remain favourable in other developing regions, most notably East Africa and East Asia.

In China, recent policy stimulus measures will largely offset the adverse effects from trade tensions. Growth in China is projected to moderate gradually from 6.6% in 2018 to 6.3% in 2019 and 6.2% in 2020. Recent monetary and fiscal stimulus measures are expected to bolster domestic demand, partially offsetting the adverse impact of trade tariffs on overall growth. Nevertheless, these measures could also exacerbate domestic financial imbalances, raising the risk of a disorderly deleveraging process in the future.

Despite downward revisions, growth in India remains strong amid robust domestic demand. The Indian economy expanded by 7.2% in 2018. Strong domestic consumption and investment will continue to support growth, which is projected at 7.0% in 2019 and 7.1% in 2020.

According to the report, in the second half of 2018, gross fixed capital formation growth moderated, including in several large developing and transition countries.

The prolonged period of high uncertainty in the global policy environment has hampered business sentiments and weighed on capital spending, particularly in trade-oriented sectors.

‘A sharper and more protracted downturn in international trade activity could significantly impact the medium-term growth outlook of trade-dependent economies,’ said the report.

In many developing countries, investor confidence has also been adversely affected by elevated domestic policy uncertainties, amid persistent structural challenges.

In several large economies, such as Brazil, Mexico and South Africa, the inability to achieve a sustained revival in investment could weigh on already weak long-term productivity growth, further impeding their sustainable development prospects.

Economic projections for the least-developed countries (LDCs) have also been downgraded (from the forecasts released in January). After expanding by 4.8% in 2018, GDP growth in LDCs is projected to decline slightly to 4.6% in 2019, before improving to 5.8% in 2020. Thus, Sustainable Development Goal 8.1 (at least 7% annual GDP growth in the LDCs) remains distant, said the report.

In the near term, living conditions in countries such as Afghanistan, Angola, Burundi, Haiti and Lesotho are expected to improve only slightly. In addition, Cyclone Idai has caused a humanitarian crisis in Mozambique, a country that already faces extremely difficult economic conditions, amid a prolonged debt crisis and political instability. Against this backdrop, there are concerns over the capacity to manage mounting public health and food security challenges, and to mobilise financial resources for reconstruction.

Monetary and fiscal policy stances

According to the report, the slowdown in global economic activity has triggered a shift towards easier monetary policy stances across many developed and developing economies. This shift is taking place in an environment of subdued global inflation, amid weakening demand and a moderate outlook for global commodity prices.

Among the developed economies, headline inflation generally remains below central bank targets. Across the developing regions, including Africa and Latin America, inflationary pressures have also eased, in part reflecting more stable exchange rates and improved agricultural production.

In March, the United States Federal Reserve (Fed) lowered its expectations from two rate hikes to none in 2019, while maintaining the target range for the federal funds rate at 2.25-2.50%. The Fed will also begin to slow the pace of its balance sheet normalisation.

In efforts to boost credit growth, the European Central Bank (ECB) recently launched a new series of targeted longer-term refinancing operations and delayed any increase in interest rates until at least 2020.

Meanwhile, the People’s Bank of China further lowered the reserve requirement ratios for banks in early 2019 to improve domestic liquidity conditions.

Given increased uncertainty over growth prospects, a few large developing economies, including Egypt, India and Nigeria, have also reduced their key policy rates.

Recent monetary policy shifts have helped stabilise global financial conditions and pushed up asset prices. After significant financial pressures in the second half of 2018, capital flows to emerging economies recovered in early 2019, with a modest increase projected for the rest of the year. However, financial markets remain prone to abrupt shifts in investor sentiments and risk assessments. Furthermore, emerging economies continue to face the challenge of translating capital inflows into productive domestic investments.

‘The easing of monetary policy may have reduced some short-term risks, but is unlikely to significantly boost domestic demand in countries with highly leveraged household and corporate sectors,’ said the report.

Moreover, high policy uncertainty, particularly surrounding unresolved trade disputes and the Brexit process, may also limit the effectiveness of monetary policy.

For many economies, said the report, a more protracted period of monetary accommodation could exacerbate financial imbalances, thus raising medium-term risks to financial stability.

As monetary policy space remains limited, more countries worldwide are adopting easier fiscal policy stances to bolster growth, said the report. For many economies, however, their ability to introduce large-scale fiscal stimulus measures is limited, given persistent fiscal deficits and elevated public debt levels. For commodity-dependent economies, fiscal space remains constrained as commodity prices are still well below levels seen before 2014.

The report said the extended period of low global interest rates fuelled increasing borrowing by governments. Many countries have seen a significant rise in interest burdens, undermining governments’ capacities to utilise fiscal policy to pursue development objectives. In 2018, interest payments alone exceeded 20% of government revenue in several countries in Africa, Latin America and South Asia. These countries are also particularly vulnerable to shifts in financial conditions, via a rise in borrowing costs, currency depreciations or commodity price shocks. Of particular concern is the rising number of low-income countries that are either already facing difficulties in servicing their debt or at a high risk of debt distress.

Given increasing downside risks to growth and limited fiscal resources, policymakers in many countries face the challenge of simultaneously supporting short-term economic activity and preserving fiscal sustainability. In this environment, said the report, there is a risk that policymakers would delay structural reform measures necessary to address sustainable development challenges, including eradicating poverty, tackling rising inequality and enhancing climate change resilience.

For most countries, there is a need to improve the efficiency of fiscal spending, channelling expenditure towards measures that will promote more inclusive and sustainable growth prospects. In addition, measures to improve fiscal management are also important to strengthen public finances and preserve confidence. These measures include improving the allocation of expenditure, expanding the tax base and ensuring that public borrowing is channelled towards productive investment, said the report.

Major downside risks

According to the WESP report, the baseline scenario rests on the assumption that current economic and financial conditions will not deteriorate further. However, with major downside risks prevailing, there is a significant possibility of a sharper slowdown or more prolonged weakness in the global economy that could impact development progress, it cautioned.

A further escalation of trade disputes among the world’s largest economies poses a significant risk for both short- and medium-term global growth prospects. Alongside unresolved trade tensions with China, the United States recently signalled its intention to impose additional tariffs on the European Union, primarily targeted at the aircraft and food industries. This is in addition to the imposition of steel and aluminium tariffs that are already in place.

‘The impact of a spiral of additional tariffs and retaliations would not only dampen growth of these large economies, but also have severe spillover effects on the developing economies, particularly those with high export exposure to the impacted economies,’ the report warned.

The report also cautioned that in addition to rising global trade tensions, the effectiveness of the present rules-based multilateral trading system is under threat. The World Trade Organisation (WTO)’s dispute settlement process may become constrained by member states’ failure to fill the vacancies of the Appellate Body (AB) which makes the final binding decisions on appeal cases. As of 1 April 2019, only three AB members remained, the minimum number for a quorum to review a case. Since two serving members’ terms end on 10 December, failure to secure new appointments to the AB would leave the WTO without an appeal function by the end of 2019. ‘Paralysis in the Appellate Body would critically weaken the rules-based multilateral trading system, at a time when the number of active trade disputes has risen significantly.’

The report also said that recent shifts towards more accommodative policies may have lifted investors’ sentiment in the short term. However, the impact on asset prices and risk-taking behaviour could increase financial risks in the medium term. Prolonged loose financial and lending conditions – including lower expectations over the federal funds rate in the medium term – will fuel search-for-yield behaviour, contributing to a further build-up of debt.

The high level of indebtedness has become a prominent feature of the global economy. The global stock of debt is nearly one-third higher than in 2008 and more than three times the global GDP. Elevated levels of debt are not only a financial risk in themselves, but also a source of vulnerability in case of an economic downturn. If the slowdown in the global economy becomes more acute, firms and households may struggle to roll over debt, triggering a disorderly deleveraging process, large corrections in asset prices and spikes in risk aversion.

In this context, a particular risk stems from the recent upsurge of leveraged loans in the corporate sector in some developed countries. The global leveraged loan market has grown to about $1.3 trillion, more than double its size a decade ago. In the United States, it now exceeds the size of the high-yield corporate bond market. Rising investor demand, coupled with firms’ willingness to take on more debt, has led to a deterioration in underwriting standards and credit quality of these loans.

The report noted that in 2018, the average global temperature was the fourth highest since 1880. The 20 warmest years on record have occurred in the past 22 years amid continuously rising carbon dioxide levels. The degree of warming during the past five years has been remarkable, both on land and in the ocean. The last five years now hold the record for the hottest period since modern measurements started. The year 2019 might prove to be warmer still, given forecasted El Nino conditions.

In 2019, the level of carbon dioxide in the atmosphere is projected to witness one of the largest ever increases in 62 years of measurements. A large proportion will remain in the atmosphere for thousands of years, said the report.

The Atlantic hurricane season this year is predicted to be slightly below average, but the impacts of long-term global warming are increasingly present. Last year’s season was the third in a series of above-average seasons, causing damages of about $51 billion. There were also devastating floods in India and a major typhoon in the Philippines. The 2018 wildfire season included California’s largest and deadliest wildfire yet and an extremely rare event when wildfires broke out north of the Arctic Circle in Scandinavia. These and other severe costly events made 2018 the fourth-costliest year in terms of insured losses since 1980. Three insurance and reinsurance firms (Aon, Munich Re and Swiss Re) estimate the economic cost of natural disasters in 2018 at $155-225 billion, with only $79-90 billion insured.

The report also said that the number of conflict-related forcefully displaced persons, including refugees and internally displaced people, is estimated to have continued to rise in 2018. According to the United Nations High Commissioner for Refugees, the number of refugees under its mandate exceeded 20 million in June 2018, while the conflict-related internally displaced population stood at 39.7 million. Existing political instabilities and social tensions could lead to a further increase in forcefully displaced people in 2019.

About 95% of conflict-related forcefully displaced persons are hosted in developing countries, pressuring fiscal balances. Despite financial support from the international community, many host countries divert substantial financial resources from already-strained budgets to support forcefully displaced residents. This may impinge on other social provisions as well as on the policy space available to react to external shocks, said the report.                                  

Kanaga Raja is Editor of the South-North Development Monitor (SUNS) published by the Third World Network. This article was first published in SUNS (No. 8913, 23 May 2019).

*Third World Resurgence No. 339/340, 2019, pp 10-13