Written Statement to the IMFC by Angel Gurría
13 October 2018 - Bali, Indonesia
The Global Economic Outlook
1. The global expansion may now have peaked. Global GDP growth remained solid in the first half of 2018, at around 3¾ per cent, but differences across countries and sectors have begun to emerge, in contrast to the broad-based expansion seen in 2017. Confidence has eased and trade growth has slowed, amidst rising trade tensions and heightened trade policy uncertainty. Strong job growth has continued, with the OECD-wide unemployment rate finally falling below the pre-crisis level, but wage and income growth remain moderate, particularly for low-income households. In the September OECD Interim Economic Outlook, global GDP growth is projected to settle at 3.7% in both 2018 and 2019, falling short of pre-crisis norms, with outcomes diverging across the major economies. This divergence would be amplified if mounting downside risks from rising trade tensions and financial market pressures were to intensify.
2. These developments pose considerable challenges for policymakers. An immediate priority is to reduce policy-related uncertainty by arresting the slide towards protectionism and reinforcing the global rules based international trade system through multilateral dialogue. A prolonged retreat from open markets will only harm long-term growth prospects. Macroeconomic policy requirements differ across countries, but should increasingly reflect the need to ensure sufficient scope for policy support in the event of a future downturn. Other policy priorities include enhancing resilience against risks, particularly continued financial vulnerabilities from high debt levels, reducing inequalities, and strengthening prospects for sustainable and more inclusive medium-term growth that provides opportunities for all.
3. Strong job growth and fiscal and monetary policy support should continue to help underpin domestic demand in the advanced economies in the near term. However, rising trade tensions, softer confidence and heightened uncertainty are likely to temper trade and investment outcomes, with adverse effects on medium-term growth prospects.
- GDP growth is projected to be close to 3% in 2018 in the United States, before easing to around 2¾ per cent in 2019. Gradual monetary policy normalisation is set to continue, but tax reductions and higher government expenditure are providing a substantial short-term boost to domestic demand, adding to the impetus from solid job creation, strong asset prices and record levels of oil production. Higher tariffs are, however, likely to add to costs for businesses and temper investment growth.
- Output growth in the euro area has eased, particularly in industrial sectors faced with softer external demand, but is set to remain close to 2% over 2018-19. Accommodative monetary policy, mildly expansionary fiscal policy, strong job growth and favourable financing conditions are all helping to underpin domestic demand. GDP growth is set to remain solid in Germany and France, but softer outcomes are likely in Italy, amidst considerable uncertainty about policy choices.
- GDP growth in Japan is set to be close to 1¼ per cent in 2018 and 2019, despite mild fiscal headwinds. Business investment remains strong, buoyed by high corporate profits and severe labour shortages. Private consumption growth remains moderate, although there are finally signs of an upturn in wage growth.
- GDP growth in the United Kingdom is projected to remain modest, at around 1¼ per cent on average over 2018-19. Household consumption is constrained by the subdued pace of real income growth, despite tight labour markets, and business investment is held back continued uncertainty about the future relationship between the United Kingdom and the European Union.
4. Developments in the major emerging market economies (EMEs) are also becoming more dispersed. The growth outlook has weakened in those economies facing substantial financial market pressures and uncertainty about the future pace of reforms.
- GDP growth in China is projected to ease slowly to below 6½ per cent in 2019. Infrastructure investment and credit growth have both moderated and the working age population is declining. Headwinds from trade tensions remain modest, with the currency depreciation helping to counteract the impact of higher tariffs, but could intensify. Recent policy measures have improved financial conditions, and scope remains to expand fiscal spending if required. Such measures could, however, delay the necessary deleveraging of the corporate sector and aggravate risks to financial stability.
- GDP growth is set to remain robust in India, at around 7½ per cent in both FY 2018 and FY 2019. Higher oil prices and tighter financial conditions could weigh on household spending, but past reforms will continue to foster investment and export growth.
- In Brazil, the recovery has slowed amid uncertainty about future policies and strike related disruptions. Restarting reforms, particularly pension reform, would help to improve confidence and private sector spending, allowing GDP growth to pick up from 1¼ per cent this year to around 2½ per cent in 2019.
- Near-term growth prospects in Turkey and Argentina have weakened considerably in the aftermath of strong financial market pressures in 2018, with the policy measures required to restore stability likely to involve significant and challenging declines in domestic demand. GDP growth in Turkey could ease to less than 1% in 2019, from close to 7½ per cent in 2017. Output in Argentina is projected to decline by around 2% this year and stagnate in 2019. Failure to restore confidence could result in even weaker outcomes.
A further intensification of trade restrictions would have significant costs
5. Increased trade tensions and uncertainty about trade policies remain a significant source of downside risk to global investment, jobs and living standards. Trade tensions are already starting to bite. Restrictive policy measures are having clearly visible adverse effects on trade flows and prices in targeted sectors, raising costs for consumers and for businesses. Policy announcements have also adversely affected business sentiment and investment plans. This has contributed to the disappointing slowdown in global trade volume growth, from 5% in 2017, to around 3% in the first half of 2018.
6. A broader rise in trade tensions, such as a wider imposition of tariffs in the sectors where trade disputes typically occur, would have significant adverse effects on trade and hit production and household incomes in the economies imposing restrictive measures. Global value chains mean that few countries can escape the costs of stronger trade restrictions on widely-traded products such as cars, trucks and auto parts. Weaker trade outcomes would also harm medium-term growth prospects by impeding future productivity gains and lowering competition. In contrast, steps to lower tariffs in a coordinated manner could bring widespread gains.
Financial vulnerabilities could intensify further in the emerging-market economies
7. Financial conditions have tightened in the emerging-market economies this year. Rising interest rates in the United States, the associated appreciation of the US dollar, and a shift in risk sentiment have contributed to sizeable currency depreciations in many economies. Countries with large external deficits or high foreign-currency denominated debt have been particularly exposed, most notably Argentina and Turkey. Higher oil prices have added to challenges in oil-importing economies. Policy interest rates have risen in several countries, with currency depreciations adding to inflationary pressures. Bond spreads and risk premia have also increased, albeit from relatively low levels, and equity prices have declined.
8. Broader contagion across all emerging-market economies, as seen during the crises in the late 1990s, has so far been avoided. Many economies are now less vulnerable than at that time, with improved domestic macroeconomic fundamentals, strengthened institutions, more flexible exchange rate arrangements and higher foreign exchange reserves. Nonetheless, risks remain of a more widespread downturn in investor sentiment. A faster-than-expected normalisation of monetary policy in advanced economies or a deepening of trade tensions could each trigger a further round of capital outflows and asset repricing in EMEs’ financial markets, with adverse effects on growth prospects.
New vulnerabilities have built up during the protracted recovery from the crisis
9. The prolonged period of very accommodative monetary policy required to recover from the global financial crisis has resulted in new financial vulnerabilities. Asset valuations are elevated in some markets, including housing, and levels of public and private debt are higher than prior to the crisis in many economies. Credit provision has expanded in the shadow banking system and in bond markets, shifting risks from the banking system to other financial institutions and credit intermediaries. Risks remain that a faster-than-expected normalisation of interest rates could give rise to financial instability, including challenges in meeting debt-service burdens.
10. Internationally coordinated reforms since the financial crisis should help to mitigate these risks, at least in part. Improved prudential regulation, including higher capital requirements and new macro-prudential tools, and enhanced credit quality have strengthened the ability of banks to withstand adverse shocks. Non-performing loans are also on a downward trend in advanced economies, although less so in some EMEs. However, the capacity of many non-bank financial intermediaries to absorb large shocks remains untested.
11. In this context, the main policy priorities are to reduce uncertainty and enhance resilience, productivity and inclusiveness. Macroeconomic policy requirements differ across economies, reflecting the diverging challenges they face. In all economies, enhanced deployment of macro-prudential policies would help to strengthen financial resilience and lower the risks from high debt. Ambitious policy reforms are also needed to make growth more sustainable and inclusive over time, including efforts to help those most exposed to the impact of global integration transition to new jobs and acquire new skills, as well as to have prompt access to digital technologies and innovation.
Macroeconomic Policy Requirements in Advanced Economies
12. A gradual normalisation of monetary policy is required in the major advanced economies, but at a varying pace due to diverging growth and inflation prospects. In the United States, monetary policy normalisation should be continued given strong near-term growth, and the likelihood of medium-term pressures on inflation from low unemployment even after fiscal easing diminishes. In the euro area, the ECB is set to cease asset purchases by end-2018, and start phasing out the negative interest rate policy in late 2019. Heightened uncertainty and more moderate growth prospects may, however, require a more gradual pace of normalisation than otherwise. In Japan, where inflation remains very low, stimulus measures must be continued.
13. Fiscal policies need to focus on medium-term challenges. The fiscal stance is pro cyclical at present in the majority of countries and additional easing is likely in some countries in 2019. At the same time, government debt and deficits remain high, and in many countries larger than prior to the global financial crisis, limiting room for manoeuvre in the event of a future downturn. Policy choices should thus avoid excessive pro-cyclicality and focus on measures that improve the prospects for solid and more inclusive growth in the medium term. Scope remains for well-targeted spending and tax policy measures that enhance incentives to invest and participate in the labour market, and ensure that increases in incomes and living standards are shared more widely.
Macroeconomic Policy Requirements in the Emerging-Market Economies
14. Macroeconomic policy requirements differ across the major emerging-market economies, but careful choices are required in all countries to maintain policy credibility and avoid harm to medium-term growth prospects. In China, scope remains to ease monetary policy and enhance public investment if there are risks that near-term growth might slow abruptly. At the same time, such measures need to be designed in ways that limit a further build-up of indebtedness in the medium term. In other emerging-market economies faced with capital outflows and external funding pressures, the appropriate policy response depends on the magnitude of the shift in investor attitudes, the extent to which vulnerabilities have built up, and the policy space available to mitigate these pressures.
15. Further policy actions may need to be only modest in emerging-market countries with a credible macroeconomic policy framework and flexible exchange rate, provided any exchange rate change does not cause significant difficulties for domestic borrowers with foreign currency debt. Additional monetary tightening is likely to be required to prevent exchange rate depreciation from adding to inflation, but economies with solid fiscal positions can ease policy if necessary to support demand. There is less scope for such support in economies where there are concerns about fiscal sustainability. The priority in these economies should instead be further reforms, particularly to pensions and medium-term budgetary frameworks. Structural reforms with a low fiscal cost, such as measures to improve the ease of doing business, would also support growth and boost sentiment.
Greater structural policy ambition is needed to make growth more inclusive and improve opportunities for all
16. Structural reform efforts have generally slowed, or paused, in both advanced and emerging-market economies in the past two years. More ambitious and coherent reform efforts to foster business dynamism, enable fast and deep technology diffusion, and make labour markets more inclusive would help to improve living standards for all, as recommended by the OECD Framework for Policy Action on Inclusive Growth. This would also significantly strengthen medium-term prospects for investment, productivity, and the creation of good jobs for the greatest number, allowing the benefits of growth to be distributed more widely. A stronger push to implement reforms in EMEs, together with trade and investment frameworks that are conducive to inclusive growth, would also help to foster confidence in countries currently facing significant short-term challenges from financial market pressures.
17. Current cyclical conditions, with strong job growth, provide an opportune moment to rekindle reform efforts in a manner that combines growth and inclusiveness. Such conditions help to maximise the benefits of reforms. Around the world, stronger reforms are needed to promote business dynamism and the diffusion of new ideas and technologies, enhance skill acquisition and innovation capacity and help workers benefit from fast-changing labour markets. Improved redistribution through tax and transfer policies also needs to be an integral part of well-designed policy packages, to make work pay, provide support for vulnerable groups, and help strengthen real income growth amongst poorer households.
18. Alongside steps to safeguard the rules-based international trading system, more needs to be done to mitigate the impact of stronger global integration on vulnerable workers and regions. In particular, reforms are needed to improve opportunities for workers to transition to new jobs and acquire new skills. Targeted measures to improve skill acquisition and training for low-skilled workers would lower the risks of prolonged joblessness or of being trapped in low-paid, poor quality jobs. Further enhancement of childcare provision, an area where reform progress is already comparatively advanced, and steps to help migrants participate fully in labour markets would also enhance participation in labour markets. Other areas for action include expanding vocational training and apprenticeships and facilitating life long learning to help workers acquire the skills necessary to succeed in the digital economy. In many emerging and developing economies, a key challenge is to raise enrolment and educational attainment, improving the prospects for living standards to catch-up with those in higher-income countries in the longer term.