The global economy has entered the late phase of this expansion. Here, we examine the underlying outlook for slower growth—not necessarily in 2019, but reasonably soon. A common feature of late-cycle economic performance is that cheap excess capacity has been used up and growth becomes harder. We are at that point, as global growth has slowed since 2017. A number of economies are producing at or above their potential output level, which is strong reason to expect further slowing ahead. Here, we sketch some of the features of economies that have run past their longer-term sustainable pace, including the risk of recession and some of the special features of this cycle that need to be watched.
Slowing growth and substantial imbalances make economies less resilient to shock, so a helping hand from central banks is more likely to be needed via slow normalization. Foremost among imbalances in this cycle is a large debt overhang. The good news in this regard is that DM banks are holding lots of capital and fairly high-quality assets. Those banks are likely to be able to continue lending on a normal basis in a slowdown or recession, even though they will have to tighten credit standards. The bad news is that non-banks have become a large source of credit to the economy and are exposed to fairly low-quality assets. Asset quality in some large EM banking systems is also worrying. A large component of lending to riskier credits has been outside the more highly- capitalized DM banking system, so the risk of sudden credit stops have not disappeared with increased macro-prudential banking regulation.
Policy makers may face difficulty in resorting to fiscal stimulus in the face of a slowdown. In extreme cases, this is more a necessity than a preference. EMs running substantial deficits now will be hard pressed to finance larger ones if growth slows.
Slowing Growth and Fed Normalization Could Worsen Debt Ratios
Debt-to-GDP ratios have risen during the post-great fi crisis (GFC) recovery, facilitated by low nominal and real interest rates, as countries endeavour to sustain growth. DM central bank normalization—and its spill over effects on EMs— mean that debt financing (both bonds and loans) is getting more difficult. Indeed, economies are facing a wall of debt.
EM hard currency loans and debt securities have been in the spotlight in 2018. This is largely due to Argentina’s government debt and Turkey’s corporate debt, both of which are amplified by being hard currency debt (mainly USD- denominated) rather than local currency. With rising Fed interest rates plus an elevated USD, these problems could spread to other EM borrowers during 2019. Refinancing will likely also be more difficult amid higher interest rate regimes. USD debt repayments in select EM borrowers (such as Indonesia and Malaysia) could be problematic, but tighter monetary policy can also cause debt-servicing problems for local currency debt (such as in Brazil). The need to ensure financing of this debt wall could mean that policy is set tighter than on purely domestic grounds, causing adverse feedback problems for the economy. An increasing proportion of weak EM corporates are subject to rising default risks, due to both the overspill of Fed tightening and mediocre profitability. With low ratios of profits to interest coverage, this could cause select corporate distress.
In the EM space, we have two concerns. First, EM hard currency debt and loans will remain in the spotlight in 2019, given our forecast of 2019 Fed tightening and a persistently elevated USD. Second, China’s local currency debt has reached high levels relative to GDP and has grown rapidly since the GFC. Its debt cycle is now maturing.
After a period of manageable sovereign debt in Africa, debt is on the rise, where the median debt-to-GDP ratio in the region is slightly over 50%. Africa’s growing public debt has sparked debate about debt sustainability in the continent, where creditors are mostly commercial entities or state financial organisations, unlike in previous debt crisis where the IMF or World Bank played a leading role. The relationship between China and some African nations is seen as one of the main problems, as large infrastructure projects financed by China, are burdening the host countries with high debt levels which will be hard to repay. Around 20% of African government external debt is owed to China, making China the largest single creditor nation for African countries.
Currently, Angola, Congo, Gambia, Ghana, Mozambique, Cape Verde, Mauritania, Sao Tome, Nigeria, Togo, Zambia, Zimbabwe and Sudan are the countries with the highest debt burdens.
Populism: On The Rise
It is an open question whether economic stresses opened the way for the recent rise of populism in western democracies. The diversity of political movements that have been labelled “populist” makes it unlikely that all have similar roots. There seems a significant risk, though, that populism in many of its manifestations will grow stronger as employment growth slows. Inflation, either for asset price or basic necessities, could add fuel to populism.