High Inflation and Interest Rates Likely to Weigh on Growth in Emerging Markets

High inflation and interest rates as well as a deceleration in exports are likely to curtail growth in emerging markets this year and next, says Moody's Investors Service in a report.

Moody's also highlights that a sharper slowdown in China than currently expected would affect the global economy not only via trade linkages but probably also via negative confidence effects for real and financial investors.

In contrast, growth in advanced economies should pick up in 2015 driven by higher business investment, though ongoing deleveraging in the euro area and a preference for holding large cash reserves by companies in the US and the UK will curtail the pace of the recovery.

Moody's notes that the improvement in global growth is only likely to be visible in 2015, with 2014 expected to be another below-average year.

For the G20 economies, GDP growth is forecast at around 2.8% in 2014 (broadly unchanged from 2013) before rising to 3.2% in 2015. Moody's forecasts higher growth in the US in 2015, at 3%, after only 2% in 2014.

However, there is a material risk the economy's medium-term potential is overestimated given the lacklustre growth the US economy has recorded during the past five years, despite favourable conditions being in place for some time.

Medium-term growth that comes in somewhat below expectations would likely trigger a gradual reassessment by investors of potential returns on US assets, but would be unlikely to lead to a global growth-destabilising correction in financial markets.

"In Europe, the contrast between robust growth in the UK over the past year and very low growth in the euro area is stark and will be sustained throughout this year and next," says Marie Diron, a Senior Vice President in Moody's Macro Financial Analysis unit.

While Moody's has revised its UK forecast upwards, the euro area's growth forecast is broadly unchanged at around 1% in 2014 and 1.5% in 2015.

Prolonged low growth in the euro area poses a risk that low inflation could become entrenched, with deleveraging increasingly economically and politically painful.

By contrast, Moody's has again revised downwards its growth forecasts for a number of emerging markets. In these countries, central banks have raised interest rates earlier this year in response to high inflation, which will weigh on growth.

Moreover, export growth will probably be relatively low for some time given that demand from China, a key export destination for many emerging markets, is unlikely to bounce back in the near future, inflation is expected to remain high and production bottlenecks are only slowly being addressed.

"High inflation and subdued export growth have replaced a possible sharp slowdown in capital inflows as the main source of concern for emerging markets," continues Diron.

While there are downside risks to Moody's forecast for specific countries, there are relatively few sources of risk that would significantly affect the global outlook.

A simultaneous correction in a number of financial markets that would trigger negative wealth effects and raise the cost of finance globally is an additional source of risk to the global economy.

However, only a sharp, prolonged and widespread market correction, with sizeable losses for banks, would have a significant impact on global growth, says Moody's.

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