At the start the of the new year, the global economic and financial market conditions deteriorated drastically, and were dominated by a series of events such as a renewed fall in oil prices, fresh turmoil in China’s financial market, a looming European banking crisis, and policy variations by some of the world’s key monetary authorities. Some of these events, which could have boosted sentiments significantly, actually failed to do so. Cheaper energy and commodity prices, which enhance consumers’ disposable income and lower companies’ input costs, are hurting energy companies’ profits and now seen as a threat to lender banks.1 The International Monetary Fund (IMF) notes that though a decline in oil prices driven by higher oil supply should have supported global demand given a higher propensity to spend in oil importers relative to oil exporters, several factors have dampened the positive impact of lower oil prices.2 Given the lack of structured fiscal consolidation policies that are consistent with growth, private investment and consumption have stagnated in many parts of the globe. Risk perceptions have also changed with the gloomy growth prospects. The US Federal Reserve (Fed) decided to raise its key policy rate in mid-December, in what was considered to be a watershed moment for the global economic revival. However, the consequent intensification of capital flow reversal and rise in the US dollar is deepening problems of several emerging market economies (EMEs) that were already slowing at this juncture. On the other hand, the monetary authorities in Europe and recently in Japan have taken recourse to negative interest rates to avoid deflation. While the lack of monetary policy action at this juncture could further slow domestic demand, lower interest rates have begun to hurt global financial market sentiments. Banks in Europe are under pressure to clean up their balance sheets ridden with non-performing loans since the 2007-08 crisis, and policy induced negative interest rates are hurting banks’ profitability and asset quality, as demand has failed to pick up commensurately. Financial instability risks have again come to the fore with banking sector and emerging market vulnerabilities rising, and have led to sudden strong market reactions as seen by the declines in equity and bond prices worldwide at the start of 2016.
The global economic outlook has been made worse by productivity slowdown, policy gridlock, a widening geopolitical rift and increasing leverage in EMEs with tighter liquidity conditions. Downside risks have intensified again amid heightened uncertainty about EME growth prospects, further fallouts of China’s rebalancing, volatility in financial and commodity markets, and a rise in geopolitical tensions. Projections for global growth have been revised even lower in 2016.3 The severe financial market turbulence in the first six weeks of 2016, intensified by the fears about a sharper and prolonged slowdown in the world economy, has led to calls for changes in the policy environment from different quarters. Moody's Investors Service has warned that investors may start to price in the possibility of lower economic growth and returns, which could become partly self-fulfilling via negative wealth effects and tighter financing conditions. The impact on the global economy would be amplified if losses on trading portfolios and financial assets more generally led banks to tighten credit standards. The OECD points out that sole reliance on monetary policy has proven insufficient to boost demand and produce satisfactory growth, while fiscal policy is contractionary in several major economies and structural reform momentum has slowed. An increasing number of economic analysts are now calling for a stronger fiscal policy response, as a commitment to raising public investment would boost demand and help support future growth. The OECD has noted that with governments in many countries currently able to borrow for long periods at very low interest rates, there is room for fiscal expansion to strengthen demand in a manner consistent with fiscal sustainability.
The price of oil, which was trending lower in the last few months of 2015, dropped below US$30 a barrel in January; the markets are oversupplied at a time when demand is faltering because of the slowdown in key importers such as China, as well as exploration of alternate energy sources in some countries.
Fiscal strain in many oil exporters has reduced their ability to smooth the shock, leading to a sizable reduction in their domestic demand. The oil price decline has had a notable impact on investment and employment in oil and gas extraction, also subtracting from global aggregate demand. Finally, the pickup in consumption in oil importers has so far been somewhat weaker than evidenced from past episodes of oil price declines. The impact of the fall in commodity prices has not only hit oil producers in emerging economies but also US shale producers, with firms borrowing heavily from both banks and markets against oil reserves and projected revenue.
The IMF in January had already lowered its earlier projections for 2016, for global and US growth by 0.2 per cent to 3.4 and 2.6 per cent, respectively, for emerging Asia by 0.1 per cent to 6.3 per cent, and for Latin America by 1.1 per cent to -0.3 per cent as Brazil’s outlook was lowered by a sharp 2.5 per cent to -3.5 per cent. The IMF forecasts the Russian economy will shrink 1 per cent this year, after contracting 3.7 per cent in 2015. The Organisation for Economic Co-operation and Development (OECD) has in February lowered forecasts for 2016 global growth further, as well as for individual economies, with the largest impacts expected in the US, the euro area and major economies reliant on commodity exports, like Brazil. Growth in the US is expected to decelerate to 2 per cent in 2016 from 2.5 per cent last year, with the dollar’s strength weighing on exports and manufacturing activity and lower oil prices curtailing investment in mining and related industries. The euro area is projected to grow at 1.4 per cent, with German growth at 1.3 per cent, both lower than 1.5 per cent in 2015. While China is expected to continue to grow at 6.5 per cent, India is expected record a robust grow of 7.4 per cent. Brazil’s economy, which is experiencing a deep recession, is expected to shrink by 4 per cent this year.