The slowdown in China’s economy, the world’s second-largest, is weighing on global growth, according to
The Economist Intelligence Unit’s latest Global Outlook Report. In line with Economist Intelligence Unit expectations, China’s economy grew by 7.5% in the second quarter of 2013.
The new government’s unwillingness, so far, to provide stimulus marks a change from past practice, and suggests that a desire to curb excessive credit growth, channelled through the shadow banking system, is taking precedence over economic growth.
Financial markets remain focused on the US Federal Reserve, which has unsettled investors by proposing to ease its massive bond-buying programme. Financial assets, which sold off sharply in May/June, partially recovered as Fed officials reassured markets that interest rates would not rise in the foreseeable future. Yet many emerging-market currencies, including India’s, have been weakened by capital outflows, raising inflation concerns at a time when demand is generally soft.
Interest rates have climbed sharply in the US in the last month, following the Fed’s decision to consider a slowdown in bond purchases. Although rates have retreated slightly from their June highs, US consumers and businesses will face higher borrowing costs. With employment rising and consumer and business confidence at relatively strong levels, the recovery should remain broadly on track.
Central bank communication will be important
Central banks have an inglorious history of deepening recessions, or choking off recoveries, with tighter monetary policy. In the early 1930s the Fed did just that. The Fed's chairman, Ben Bernanke, a student of the Great Depression, is unlikely to make this mistake. But unwinding the Fed’s liquidity surge has to begin at some point, and with the US economy now creating more than 200,000 net new jobs a month, this is a reasonable time to begin the discussion.
However, the transition could be difficult for many emerging markets. The prospect of tighter US monetary conditions has strengthened the dollar and weakened many developing-country currencies. This in turn will push up the cost of imports and raise consumer prices in countries like India. In light of the disruption to India from the recent sell-off in international capital markets, The Economist Intelligence Unit is this month lowering its 2013/14 GDP growth forecast for India to 5.8% (from 6.2%).
Uncertainty for upcoming months
There is an extraordinary level of uncertainty in the two major engines of the global economy – and, by extension, in every other country. Despite the fact that the decisions made by the Chinese and US governments are, for the most part, prudent, necessary and likely to support growth in the longer term, this does not diminish the risks that they pose to the global economy in the coming months.