Chinese Tariffs Slowing Global Economy

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Just in time for the annual meeting of the high and the mighty at the World Economic Forum in Davos, Switzerland, the International Monetary Fund (IMF) has issued the January update to its World Economic Outlook (WEO). To say that the outlook is muted may be an understatement.

For the year just passed, the WEO has maintained its previous forecast of global growth at 3.7% but cautioned that a slowdown in the last half of the year will carry over “into coming quarters” with global growth for 2019 forecast at 3.5% and at 3.6% for 2020, both lower than the prior WEO estimate.

Growth in advanced economies is projected to drop from 2.3% in 2018 to 2.0% in 2019 and 1.7% in 2020, primarily due to downward revisions in the eurozone. Brexit remains a major concern and recent developments have done nothing to rein in uncertainty.

U.S. growth in 2018 was revised downward to 2.3% and projected to dip to 2.5% in 2019 and dip further to 1.7% in 2020 as the unwinding of fiscal stimulus continues and the Federal Reserve’s funds rate “temporarily overshoots the neutral rate of interest.” Ironically, perhaps, domestic U.S. demand is expected to remain strong, contributing to higher levels of imports and a wider U.S. current account deficit.

Economic growth in developing Asian countries ticks down to 6.5% in 2018 and is projected to dip to 6.3% in 2019 before recovering a bit to 6.4% in 2020. Trade tensions between China and the United States coupled with continued financial tightening in China are estimated to result in 6.6% economic growth in 2018, down from 6.9% in 2017. The WEO notes that worries about China’s economy have, and may again, lead to sell-offs in the financial and commodity markets that add pressure to the country’s trading partners, commodity exporters and other emerging markets.

A key risk to the global economy going forward is tension over trade. The tariff war between China and the United States is currently on hold, but the WEO comments that “the possibility of tensions resurfacing in the spring casts a shadow over global economic prospects.”

Regarding commodities, the WEO expects crude oil prices to remain “broadly” at around $55 a barrel for West Texas Intermediate (WTI) for the next four to five years. A slowing global economy weakens demand for crude oil and uncertainty remains tied to supply increases and U.S. policy on Iranian oil exports.

Inflation has been mostly restrained except in the United States, where the WEO notes that “above-trend growth continues.” Among emerging economies, lower oil prices are relaxing inflationary worries in most countries.

The principal risks to the global outlook are trade negotiations and financial conditions. If trade issues are not resolved and more tariffs are imposed, costs will rise on intermediate goods and, ultimately, for consumers. Additionally, uncertainty over trade issues lowers business investment, disrupts supply chains and slows productivity growth.

Financial sentiment nosedived in the last few months of 2018, dragging equity prices down sharply. The WEO noted other financial issues that could derail projections for growth in 2019 and 2020: interest rate spreads on Italian debt, a no-deal Brexit and a deeper-than-expected slowdown in China.

The WEO suggests that policy priorities need to focus on “preventing additional deceleration and strengthening resilience.” To that end, addressing dissatisfaction with the world’s rules-based trading system need to be addressed cooperatively in an effort to reduce trade costs and resolve differences without imposing tariffs.

On the domestic front, developed nations are encouraged to emphasize policies that boost productivity, raise labor force participation (particularly of women) and ensure adequate social insurance, “including for those vulnerable to structural transformation.”

Emerging economies face a wider range of problems, largely because they don’t have much room for error. High private debt burdens along with balance sheet and bond maturity mismatches need to be sorted out. Fiscal policy should ensure that debt ratios remain sustainable under increasingly difficult external financial conditions. Targeted subsidies and recurring expenses should “help preserve capital outlays needed to boost potential growth and social spending to enhance inclusion.”

The following table offers an overview of WEO global growth projections along with additional projections on trade volume, commodity prices, consumer prices, and the Libor rate.