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Special Topic: World economic outlook and implications for New Zealand

The outlook for the world economy continues to be revised up as the recovery gathers momentum. Consensus forecasts have been revised up since their trough a year ago and the International Monetary Fund (IMF) has recently revised up its forecast for world economic growth.[1]

This article looks at the recent performance of our main trading partners and the revised outlook for growth. It then considers the implications of those changes for the New Zealand economy and the main risks associated with the revised outlook.

Economic performance picks up …

All of our major trading partners[2] have now recorded positive growth on a quarterly basis since the downturn in 2008-2009, but the significant disparity in the growth rates of the major developed and developing economies is expected to continue (Figure 8).

Figure 8 – IMF world growth forecasts
Figure 8 - IMF world growth forecasts.
Source: International Monetary Fund

Usually in the recovery from a downturn the countries which experienced the greatest fall in output experience the fastest recovery. That is not the case so far this time as the developed economies remain sluggish, weighed down by debt and imbalances, whereas the developing economies, especially in Asia, have rebounded quickly thanks to large fiscal and monetary stimulus in China and stock rebuilding in emerging Asia. The countries closely integrated with them have also recovered quickly, especially Australia which benefitted from its own fiscal and monetary stimulus, in addition to faster population growth. This is having flow-on benefits for New Zealand.
… and forecasts revised up
Trading partner growth (TPG) in 2009 was better than we expected a year ago in Budget 2009. The fall in output was less than expected, and so forecasts for the recovery have also been revised up. Consensus forecasts for 2009 and 2010 have been revised up in each month since their trough in May 2009 and the latest figures translate into trading partner growth for New Zealand of 3.7% in 2010 and 3.5% in 2011 (Table 2).

Table 2 – NZ trading partner growth forecasts (%)
  2009 2010 2011
Budget 2009 -2.5 1.0 2.2
Half Year Update -1.5 2.9 3.2
Consensus (April ‘10) -0.9 3.7 3.5

Source: NZ Treasury, Consensus Economics

The IMF has also revised up its forecasts in its latest World Economic Outlook. A year ago, they were projecting world output to contract by 1.3% in 2009 and expand by only 1.9% in 2010. Their latest estimate is that world output declined by 0.6% in 2009 and that it will expand by 4.2% in 2010 and 4.3% in 2011 (Figure 8).

The faster than expected recovery in the world economy has been chiefly the result of the massive fiscal and monetary stimulus in the major economies, the stabilisation of financial conditions and credit markets, a rapid rebound in output as stocks were replenished following their sharp rundown in the early stages of the crisis, and the subsequent recovery in world trade. Business and consumer confidence in the major developed economies have also recovered from their lows as asset prices have stabilised (in the case of housing) or increased (in the case of equities).

World commodity prices have recovered …

The more rapid recovery in the world economy has also been reflected in commodity markets. Prices for many commodities have increased sharply over the past year: oil prices have more than doubled from their low of less than US$40 per barrel in early 2009 and prices for industrial raw materials (including metals) have also more than doubled from their low in early 2009; food prices have increased by much less from their early-2009 low, but US dollar prices for New Zealand-specific commodities have increased by more than half from their low point over a year ago and stand just below their mid-2008 peaks (see Figure 9).

Figure 9 – Commodity prices in US dollars
Figure 9 - Commodity prices in US dollars.
Sources:  The Economist, ANZ Bank, DataStream

… driven up by demand from China …

The rapid recovery in output in emerging Asia, and associated rebuilding of inventories, has made a significant contribution to the bounce-back in commodity prices from their early-2009 lows. China’s industrial production was up 18% in March from a year ago and India’s was up 17% in January. The stronger recovery in the developing economies, which are resource-intensive, is a major factor in the increase in commodity prices.

Some non-commodity factors may also be driving prices up: the ample monetary stimulus pumped in by central banks has created an environment of low interest rates and ample liquidity, reducing stock-holding costs; investors are eager to find higher returns and commodities whose prices are rising may provide that. The weakness of the US dollar may also be boosting prices denominated in that currency. Other factors may also be at play in the case of dairy prices: fears of the impact of the current drought on New Zealand’s production may be driving prices up; Australian dairy production was down 6% in the year to February, also as a result of dry conditions, and it was feared that European production would be held back by the severe winter.

… but are they sustainable?

The rapid rise in commodity prices has raised concerns about their sustainability. In large part this depends on the recovery in the emerging economies. Higher commodity prices will lead to higher consumer price inflation, especially in developing countries where food accounts for a larger share of household expenditure, putting the recovery at risk. There are also concerns about asset price bubbles and over-investment in China as a result of lax credit growth. Furthermore, a tightening of monetary policy in the developed economies might bring a correction in commodity prices as holding costs increase.

Implications for New Zealand

Higher commodity prices are expected to translate into a higher terms of trade for New Zealand as export prices are more affected by commodity price movements than import prices. There is also now a partial offset to higher oil import prices as oil exports accounted for approximately one third of the value of oil imports in 2008 and 2009. However, there may simply be a lag in the impact of higher commodity prices on import prices as higher input costs filter through to higher prices for imported investment and consumer goods.

Sovereign debt a major risk to the outlook …

Although the world economy has recovered more strongly than expected, there are several risks associated with the outlook, both up and down.

The greatest risk to the continuation of the world recovery at present is the sovereign debt crisis in Greece. Greece has applied to the IMF and European Union for a €45 billion loan (around 20% of their GDP) to allow them to meet the current year’s fiscal deficit and roll over maturing debt. The fiscal deficit was around 14% of GDP last year and public debt is estimated at 115% of GDP. The government has announced a number of austerity measures aimed at reducing the fiscal deficit and stabilising debt levels.

However, even with these steps, debt is likely to continue to increase as the fiscal measures and the adjustment required to make the Greek economy competitive again will result in slower economic growth (if not outright declines), further reducing tax revenues and exacerbating the debt position. As the extent of the problem has unfolded, interest rates on Greek debt have soared, especially for shorter-dated bonds (2-year bonds briefly reached 25% on 28 April). Moody’s and Standard & Poor’s (S&P) have both downgraded Greece’s credit rating, in S&P’s case to below investment grade. Greek debt markets steadied towards the end of April on news that a larger bailout package may be available and that agreement will be reached soon.

The main threat from the Greek debt crisis is that it will spread to other highly-indebted European nations, in particular Portugal, Spain, Ireland and Italy. S&P downgraded both Portugal and Spain in the last week of April and further downgrades could follow. If the crisis spreads, it would have wider consequences as those countries sought to regain control of their fiscal positions and make their economies more competitive. Initially, there might be an increase in safe-haven demand for government bonds, with rates falling in less indebted nations. However, if the crisis escalated there might be fears about the sustainability of the fiscal positions of the heavily-indebted major developed economies such as Japan, the US and UK. Japan’s net government debt is around 160% of annual GDP and both the US and UK are running budget deficits in excess of 10% of GDP. If the crisis spread to these countries, there could be a generalised movement of risk aversion away from government debt, resulting in higher bond rates around the world. New Zealand’s relatively low fiscal deficit and debt level would reduce the risks it would face in such a case.

… as is the withdrawal of stimulus

The second major risk associated with the outlook for the world economy is the transition from the fiscal and monetary stimulus provided by governments and central banks to a genuine strengthening in private demand. Monetary policy remains very stimulatory in all the major economies, with the exception of Australia which has started to tighten; most economies have not started to withdraw fiscal stimulus yet. Premature withdrawal of that stimulus or a failure on the part of firms and households to replace it could result in a faltering in the recovery path.

There are several other threats to the recovery in the global economy. A more rapid economic rebalancing, while desirable, would result in lower growth overall as the trade-surplus, excess-savings economies (e.g. China) would be unable to fully replace the final demand of the trade-deficit, excess-spending economies (e.g. the US). There is also concern about the strength of growth once the current stock-rebuilding phase ends.

Furthermore, although financial conditions have stabilised, credit growth in the major developed economies remains subdued and there is a risk that the recovery could be constrained if credit creation is limited. Regulation of financial markets and of international trade may also impede the pace of the recovery as governments aim to prevent a similar crisis developing again or seek to protect domestic interests. Continuing weak housing and labour markets might also act as a brake on final household demand.

There are upside risks as well …

The chances of an even stronger recovery relate to a more generalised cluster of outcomes rather than specific event risks, as in the case of the downside. There is a higher probability of a stronger recovery, bit its impact would not be as great as any one of the major downside risks. A stronger recovery may occur if emerging economies, especially in Asia, maintain monetary policy settings linked to the developed economies by keeping interest rates low and not revaluing their currencies to assist global rebalancing.

Faster progress in restoring financial sector strength and rebuilding firm and household balance sheets, as asset prices recover, would also lead to a quicker pace of recovery, assisted by faster credit growth. These risks would have positive dynamics, with higher credit growth and higher asset prices, in turn bolstering business and consumer confidence, and supporting investment and consumption.

… with an impact on New Zealand economy

A stronger-performing world economy would have flow-on benefits for New Zealand. With stronger global demand, the terms of trade would be higher, but easier availability of credit, positive wealth effects and increased confidence would support domestic demand in the New Zealand economy as well.

Depending on the event which triggered a slower recovery in the world, the transmission to New Zealand might be more direct. A sovereign debt crisis would reduce demand for our exports, but might also result in a lower exchange rate (reducing purchasing power) and higher bond rates to reflect risk factors. A faltering in the recovery, whether because it atrophies once stock rebuilding is complete or because private demand fails to replace public stimulus, would chiefly result in a lower terms of trade.

 

Notes

  • [1]http://www.imf.org/external/pubs/ft/weo/2010/01/index.htm.
  • [2]Our top 12 trading partners (measured by value of exports) are Australia, United States, Euro Area, Japan, China, United Kingdom, Korea, Singapore, Taiwan, Malaysia, Hong Kong and Canada.


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