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Global economic growth to remain modest in 2013, despite lower risk of a global downside event and improved financial market conditions

Andrew Burns's picture

As 2013 gets underway, a review of global economic trends over the past six months reveals a mix of positive and negative developments, punctuated by the influence of policy conditions in high-income countries.

The most visible upside change in recent months has been a dramatic easing of conditions in financial markets. Credit default swap rates for high-spread Euro Area economies, for example, are now down to levels last seen in the third quarter of 2010. Key reasons behind the better conditions are improvements in fiscal sustainability in a number of EU countries and the European Central Bank’s commitment to further efforts to defend the euro.

A strengthening of financial markets can also be observed in developing countries, where bond spreads (as measured by the EMBIG) are more than 280 basis points below their average 2000–10 level and stock market indices are up by 12.6 percent since June. The improved market sentiment helped translate into a rapid increase in gross capital flows to developing countries, which at $170 billion approached record levels in the final quarter of 2012.

Despite the encouraging signals on the financial side of the global economy, real-side conditions remain largely lackluster. Business confidence indicators remain low after only limited improvement in late 2012, and order books for capital goods have declined in recent months. Furthermore, prevailing conditions in high-income countries during the course of 2012—fiscal policy uncertainty in the United States and weak demand in Europe and Japan—served to constrain growth in developing countries.

The latest edition of the World Bank’s Global Economic Prospects (GEP) reflects the still-difficult current environment in its modest GDP growth forecasts:

  • The global economy is now expected to expand by 2.4 percent in 2013, down from the 3 percent projected in the June 2012 GEP, before accelerating to 3.1 percent in 2014 and 3.3 percent in 2015.

  • For high-income economies, growth is forecast to come in at 1.3 percent in 2013, unchanged from 2012, and to rise to 2 percent and 2.3 percent in 2014 and 2015, respectively.

  • Developing economies are expected to grow by 5.5 percent in 2013, up from a 10-year low of 5.1 percent in 2012, rising to 5.7 percent in 2014 and 5.8 percent in 2015.

 

And although the likelihood and potential severity of a globally-felt downside event materializing in 2013 has declined versus mid-2012, several major risks remain.

A deterioration of conditions in the Euro Area could result in a freezing out of vulnerable countries from international capital markets, for instance, which would have negative implications for the global outlook, as would failure by U.S. policy makers to reach timely agreement on ongoing fiscal policy and debt ceiling negotiations, an abrupt decline in high investment rates in China, an interruption in global oil supply, or a resurgence of food commodity prices.
A surge in food or fuel prices would have especially tough consequences for the world’s poor.

In light of the risks, the GEP argues that developing countries would benefit from rebuilding the fiscal and social policy buffers that were depleted in the course of responding to the global financial crisis several years ago, so that the extra space could be leveraged in the case of a growth downturn. Simulations presented in the report indicate that developing countries with adequate fiscal positions would face GDP contraction of 30 percent less than in fiscally-constrained countries in the case of a GDP shock in high-income countries.

Developing countries would also do well to focus on structural factors, such as productivity enhancements and investments in infrastructure, human capital and governance, rather than demand stimulus in seeking to revert to faster growth rates in the years ahead.

For observers of the global economy, the light at the end of a long tunnel of volatility and weak growth is that headwinds resulting from restructuring and fiscal consolidation in high-income countries will diminish over the coming years, making way for noticeably higher growth rates in 2014 and 2015.