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Global growth to pick-up again, but with downside risk

Theo Janse van Rensburg's picture

The World Bank’s Global Economic Prospects (GEP) – "Managing Growth in a Volatile World" was released earlier today. In this blog posting, I highlight some of the interesting baseline forecasts numbers as well as some alternative plausible outcomes emanating from a Euro zone crisis. 

Growth is expected to slow in 2012, before picking up slowly ...

In our January edition of the GEP, we foresaw a fragile and weak outlook for the Euro Area. The lack of change in the Euro Area growth forecast for 2012 from the January GEP reflects the recognition that growth through April was stronger than anticipated earlier (which would have had us upgrade the forecast by 0.2 percentage points), and that the uptick in uncertainty will cut into growth – coincidentally offsetting the influence of the earlier strength.

Taking account of the recent increase in tensions, our baseline forecast suggests that:

  • GDP in developing countries is projected to expand 5.3 percent in 2012. Weak high-income demand, high oil prices, weak capital flows, rising capital costs and capacity constraints in several large middle-income countries will conspire to keep growth from exceeding 6 percent in each of 2013 and 2014.
  • High-income GDP is expected to expand only 1.4 percent this year, weighed down by market jitters, banking-sector deleveraging and ongoing fiscal consolidation. As these pressures ease, growth is projected to firm to what will be a still modest 1.9 and 2.3 percent pace in each of 2013 and 2014. The Euro zone is projected to contract by 0.3 percent this year, returning to positive territory with a weak 0.7 percent growth in 2013 and 1.4 percent in 2014.
  • Overall, global GDP is projected to increase 2.5 percent in 2012 (from 2.7 percent in 2011), with growth accelerating to 3.0 and 3.3 percent in 2013 and 2014.


Downside scenarios concerning Euro Area

Current conditions in the Euro Area are worrisome. Bond yields on the debt of several countries have reached levels that, in the past, have been associated with interventions by international agencies. At the same time, deposits withdrawals from banks speak to a weakening of domestic confidence in the financial systems of some countries.

As discussed in the January 2012 edition of GEP, if conditions in high-income Europe deteriorate sharply such that one or more countries found themselves frozen out of financial markets, global economic consequences could be severe. However, scenarios depicted below are not meant to be predictive, but rather illustrative of the magnitude of impacts that might be envisaged if the situation in high-income Europe were to deteriorate sharply. They are presented, in the spirit of recent stress-tests of banking systems, as a tool that could help policymakers in developing countries prepare for the worst, and they are presented with full recognition of the limitations of the tools that underpin them. If a downside scenario actually materializes, its precise nature, triggers, and impacts will doubtless be very different from these illustrations

In the first scenario it is assumed that one or two small Euro Area economies face a serious credit squeeze.

An inability to access finance that extends to the private sectors of these economies causes GDP in the directly affected countries to fall (broadly consistent with what has been observed when other high-income economies that have faced financial crises — see Abiad and others, 2011). It is assumed in this scenario that although borrowing costs in other European economies rise and banks tighten lending conditions due to losses in the directly affected economies and uncertainty, the banking-sector stress in Europe is contained and does not spread to the rest of the high-income world. However, uncertainty and concerns about further credit squeezes induces increased precautionary savings among both firms and households worldwide. While this scenario does not envisage an exit of the countries from the Euro Area, it is felt that the modeled effects would capture the bulk of impacts for developing countries should such an event occur.

Overall, GDP in the Euro Area falls by 1.6 percent relative to baseline, and by 1.1 percent in the rest of the high-income world. Developing countries are also hit. Direct trade and tighter global financial conditions plus increases in domestic savings by firms and households as a result of the increased global uncertainty contribute to a 1.3 percent decline in middle-income GDP relative to baseline in 2012. The decline among low-income countries (0.6 percent) is less pronounced reflecting weaker financial and trade integration. Weaker global growth contributes to an 8.3 percent decline in oil prices and a 1.6 percent drop in internationally-traded food commodity prices.

In the second scenario, the freezing up of credit is assumed to spread to two larger Euro Area economies (equal to around 30 percent of Euro Area GDP), generating similar declines in the GDP and imports of those economies.

Repercussions to the Euro Area, global financial systems and precautionary savings are much larger because the shock is about 8 times larger.2 Euro Area GDP falls by 8.5 percent relative to the baseline in 2013, and because confidence effects are bigger. GDP impacts for other high-income countries (-3.3 percent of GDP) and developing countries (-4.0 percent) are less severe but still enough to push them into a deep recession. Overall, global trade falls by 10 percent (relative to baseline) and oil prices by 25 percent (5 percent for food).

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