IMF 2014-2015 Outlook: Weaker Growth as Europe Drags its Feet

In October, the IMF released its much-awaited World Economic Outlook (WEO) forecasts for 2014-2015. As expected, the Fund has continued to cut back its estimates for the global economic activity, in line with its forecasts published six months ago. And the gloom is getting gloomier: while growth in H2 2014 and through 2015 is expected to continue and accelerate on H1 2014, the recovery is getting weaker.

The Fund is now projecting global economic expansion of just 3.3 percent for 2014. This is 0.3 percentage points lower than 2014 forecasts produced by the IMF a year ago and ca 0.4 percentage points below the April 2014 WEO number. Similar scaling down of forecasts applies to 2015. In today's release, the IMF is projecting 2015 global growth at 3.8 percent, which is almost 0.2 percentage points lower than its October 2013 forecast and 0.1 percentage points below April 2014 outlook.

Ditto for virtually all major advanced economies. As chart below shows, the new forecasts are projecting significantly lower growth over 2014-2015 for Italy and France, Germany and the whole of the euro area. Out of the major Western Economies, only the UK and Spain have managed to squeeze an upgrade in their growth outlooks and in the case of Spain that upgrade is simply reflecting the dire state of the economy emerging from a horrific crash.

Title: Cumulative 2014-2015 Growth Downgrades
October 2014 World Economic Outlook Forecasts compared to April 2014 (Real GDP, percent)
Source: Author's own calculations based on IMF WEO data.

In simple terms, the IMF notes that the crisis legacy is continuing to weigh heavily on Europe's capacity to expand output, generate new employment and lift up investment, consumption and wages. Thus, in addition to projecting a generally weaker outlook for growth for 2014-2015, today's forecasts also highlight an uneven pace of recovery across various countries. Chart 2 below illustrates.

Title: Real GDP Growth Rates relative to Advanced Economies Average Growth Rate Percentage points
Source: Author's own calculations based on IMF WEO data.

For all the IMF optimism about the expected onset of the recovery in 2015, the euro area is expected to under perform other advanced economies in terms of growth this year and next. The euro area Big 4 economies (Germany, France, Italy and Spain) are likely to trail behind not only the US and the UK, but also the overall advanced economies' average. In short, the US and the UK are expected to be the drivers of the positive momentum in global growth. Euro area, meanwhile, will be dragging the world down. All of the monetary policy accommodation, easing of austerity, historically low cost of Government debt funding and record low interest rates amount to the euro area still stuck at the rates of growth that are two-and-a-half times lower than those in the US.

All of the above assumes a rather benign risk environment. Yet, as IMF notes, "downside risks have increased compared with the spring [forecasts]. The main reason is the increase in geopolitical risks..." But the IMF also notes the rising risks in the Western financial markets, where both booming investors' optimism and erratic asset prices volatility have now hit pre-crisis conditions. Longer-term yields on government and corporate debt have fallen below pre-crisis lows. All of this suggests that the markets are now primed for a major correction. Adding an insult to the injury, despite all the ECB unorthodox easing, investment remains stagnant.

And euro area also brings along its own risk - not present elsewhere. The chief amongst these is the prospect of possible deflation which signals a risk of what the IMF calls "secular stagnation" or a period of protracted near-zero growth that permanently pushes euro area away from the path of recovering from the Great Recession. Chart 3 below illustrates these recessionary and deflationary risks.

Title: Recession and Deflation Risks
Source: IMF, WEO October 2014, Chapter 1, Figure 1.12.

As the IMF concludes, "one-year-ahead recession risks have increased [in October forecasts] compared with the April 2014 [WEO forecasts] in the euro area, Japan, Latin America, and the Rest of the World group. The increase is largely due to [the fact] that a smaller negative shock is more likely to trigger a recession, everything else equal. " In short, risks of shocks are up, vulnerabilities to shocks are up and growth slowdown is ongoing. Hardly time for start celebrating the recovery.

Dr Constantin Gurdgiev is the Adjunct Assistant Professor of Finance with Trinity College, Dublin

IMF WEO Chapter 1 - http://www.imf.org/external/pubs/ft/weo/2014/02/pdf/c1.pdf

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