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Prospects Weekly: A broadly-based recovery remains elusive, Monetary policy in developing countries has continued to ease, Low interest rates have contributed to rapid accumulation of household debt

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A broadly-based recovery remains elusive. While orders for capital goods are picking up in the Euro Area, they have slowed in the United States, reflecting fiscal and monetary policy uncertainties, and are declining for developing countries considered as a whole. With a few exceptions, monetary policy in developing countries has continued to ease. Low interest rates in recent years have contributed to rapid accumulation of household debt, especially in the East Asia and Pacific region, subjecting them to risks from future tightening of financial conditions.

Diverging trends in demand for investment goods argue against a broadly-based recovery. Orders for capital goods, an indicator of future business investment plans, are experiencing diverging trends across regions. A nascent recovery in the Euro Area economy is fueling demand for German machinery and equipment. Orders for Japanese investment goods rose at an annualized 18 percent pace in the third quarter, but slowing of GDP growth (to an annualized 1.9% in Q3 from 3.8% in Q2) has raised concerns of potential headwinds. In the US, although GDP growth picked up to annualized 2.8 percent pace, investment goods orders contracted in two out of the three months in the third quarter, mainly reflecting fiscal and monetary policy uncertainties. Developing-country investment orders are still contracting, but the pace of deterioration has eased led by rising orders in China. These heterogeneous trends in investment orders are consistent with a still hesitant recovery in global growth.

Monetary policy in developing countries has been on an easing path since late 2011, despite non-receding inflation. Since November 2011, the number of rate cuts by developing-country central banks has outnumbered rate increases by a ratio of 4. This ratio did not substantially change during the summer when several middle-income economies (Brazil, Indonesia, India) increased rates in an effort to support currencies under stress from the reversal in capital flows associated with higher US treasury rates. Weak growth coupled with low inflation prompted rate cuts in Hungary, Mexico, and Romania. Notwithstanding elevated inflation, policy rates have also been cut in other economies (Armenia, Egypt) experiencing weak growth. Policy rates in Asian countries have been mostly on hold (China, Thailand, Malaysia) since June or tightening (Indonesia) as they start to deal with domestic imbalances.

Easy international and domestic monetary conditions have contributed to increased households indebtedness in several countries, exposing them to downside risks. Low interest rates in the post-crisis period have translated into very fast increases in credit and household debt particularly in East Asia. In China, Malaysia and Thailand, household debt as a proportion of GDP has increased by more than 20 percentage points since 2007, with credit-to-GDP ratios reaching 80 percent of GDP in Malaysia and 68 percent in Thailand. Credit-to-GDP ratios in Brazil and Turkey rose by more than 10 percentage points in this period. This trend partly reflects deepening of financial markets – which is broadly healthy. However, a too rapid accumulation of debt by new borrowers in an environment of low interest rates may be increasing the likelihood of a crisis in some countries. When monetary policy normalizes and global and local interest rates rise, borrowers may have trouble servicing debt that is rolled over at new higher rates – potentially sparking an uptick in non-performing loans and the risk of banking sector crises.

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