IMF sees EMs presenting greatest risks to global recovery

By bne IntelliNews April 8, 2014

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The global economic recovery will continue to gain traction, the International Monetary Fund (IMF) predicts in its latest World Economic Outlook released on April 8. However, it sees growth becoming more uneven, with emerging markets presenting the greatest risks.

During the second half of 2013, growth in advanced economies rebounded by 1.3 percentage points, a trend that should strengthen further in 2014-15, the IMF forecasts. That will help global growth rise from 3.0% in 2013 to 3.6% in 2014 and 3.9% in 2015, which is broadly unchanged from the October 2013 outlook. 

"The recovery… in advanced economies is becoming broader," the report opens. "Fiscal consolidation is slowing, and investors are less worried about debt sustainability. Banks are gradually becoming stronger. Although we are far short of a full recovery, the normalization of monetary policy - both conventional and unconventional is now on the agenda."

However, emerging markets look set for a tougher ride. "These dynamics imply a changing environment for emerging market and developing economies," the IMF analysts continue. "Stronger growth in advanced economies implies increased demand for their exports. The normalization of monetary policy, however, implies tighter financial conditions and a tougher financial environment. Investors will be less forgiving, and macroeconomic weaknesses will become more costly."

That puts the onus on structural reform for many emerging markets, the international lender insists. 

Although the report admits that "appropriate policy measures" differ across emerging economies, it maintains that the priorities are constant: free floating currencies; tight monetary policy; lowered budget deficits; and reform of infrastructure and market entry.

All of which suggests a split between the new members of the EU, whose open economies are set to benefit most from increased export demand from advanced markets - particularly the Eurozone - and the other emerging markets in the Commonwealth of Independent States (CIS). 

Growth across the EU is seen at 1.6% this year, which is a slight rise on the last IMF forecast, with CEE states doing the most to boost the number. The largest upgrade in the bloc was handed to Slovenia, while Hungary and Poland are also among those at the top when it comes to improved outlooks. 

By way of contrast, the near-term prospects in Russia and many other CIS economies have been downgraded, with growth set to be hampered by the fallout from the crisis in Ukraine and the related geopolitical risks. 

"Investment had already been weak, reflecting in part policy uncertainty," the report states. "In emerging and developing Europe, growth is expected to decelerate in 2014 before recovering moderately in 2015 despite the demand recovery in western Europe, largely reflecting changing external financial conditions and recent policy tightening in Turkey."

Central Europe setting the pace

Already leading the recovery thanks to increased export demand and robust fiscal management, Central Europe's relatively open economies are set to accelerate the most on the back of the brighter prospects in the Eurozone. Growth in Hungary and Poland is forecast to strengthen in 2014 to 2.0% and 3.1% respectively, from 1.1% and 1.6% in 2013. 

"In both economies the strengthening is being driven by a pickup in domestic demand, supported by monetary easing, improvements in the labor market, and higher EU funds, which are expected to boost public investment," the report says. 

However, in line with the concerns expressed by investors over the landslide re-election of Hungarian Prime Minister Viktor Orban on April 6, the IMF cautions that Hungary's still-high external vulnerabilities, although declining, could weigh on growth, particularly as the region's recovery progresses. By 2015, Hungary is set to see the slowest growth in Visegrad, with Romania and Bulgaria set to overtake it. 

Constrained in Southeast Europe

In Southeast Europe, the IMF says the pickup in growth in 2014 will remain moderate like in 2013, at about 1.9%. Most of that will be attributable to improving external demand, though domestic demand in a few countries will benefit from EU spending. "However, demand will remain constrained because of slow progress in resolving nonperforming loans, persistent unemployment, and the need for fiscal consolidation in some countries," it adds.
The IMF expects inflation to decline or remain moderate in most countries of the region. Core inflation, it notes, has been decreasing in Bulgaria, Croatia and Romania, reflecting a still-negative output gap, depressed domestic demand, weak bank credit and negative external price developments. "Deflation risks, however, are low for emerging Europe as domestic demand takes hold and the effects of one-off factors dissipate," it says.
The Eurozone remains the main source of potential shock to the region's growth story, given the strong trade and financial links with the single currency area. Those links have seen large declines in portfolio investment, and capital inflows to Southeast Europe turned sharply negative in the third quarter of 2013 - especially for Turkey, which is embroiled in a political crisis. Accelerated outflows become a risk, the IMF says, if financial market volatility spikes again, "with negative consequences for financing still-sizable fiscal deficits in many countries and external deficits in some."
Although Slovenia received the largest boost to its 2014 growth outlook in the EU - moving from a 1.1% contraction forecast in January to 0.3% growth - the uncertainties there are greatest due to its ongoing financial sector and corporate restructuring. Question marks also hang over Serbia, where the new government needs to start imposing the necessary fiscal discipline.

Reform vital in Eurasia

The rising geopolitical tension over Ukraine is the greatest threat to growth prospects for the Caucasus and Central Asia (CCA), the IMF suggests. Should Russia's economy suffer from the standoff with the West, it would affect CCA through both real sector and financial channels, particularly if energy supply is disrupted and oil and gas prices rise. 

In addition, the economies of CCA oil importers would also weaken if growth prospects in Russia fall, with adverse effects on trade, remittances and project funding, especially considering limited external and fiscal buffers, the report says. Meanwhile, the analysts also worry that weaker commodity prices could delay recovery in the region's hydrocarbon exporters, although it notes that countries with large foreign asset buffers would be less affected. 

Still, there are brighter spots, the Washington-based lender notes. "Strengthening external demand, as well as recovery of domestic demand in Armenia and Georgia owing to fiscal easing and increased hydrocarbon exports from Turkmenistan on past expansions in productive capacity, will support economic activity in the CCA," the report says, "despite a temporary weakening of oil output growth in Kazakhstan and flat gold exports from the Kyrgyz Republic."

However, the risks mean reform is needed more than ever. Policies should focus on implementing structural reform and increasing investment to raise growth potential, the report says. For some countries, correcting serious imbalances is also seen as a priority. 

"Structural reforms to improve the business environment, diversify the economy, and enhance external competitiveness are also needed across the region for strong growth to last and become more inclusive in the years ahead," it concludes.

Meanwhile, inflation will continue to stalk the region, the IMF cautions, although it should generally remain within central banks' targets. Kazakhstan's devaluation in February will contribute to the pressure on prices this year, it notes, while "in Uzbekistan, inflation will continue to linger in the double digits because of increases in administered prices, currency depreciation, and strong credit growth."

Subdued prospects in EE

The IMF turned more pessimistic on Russia, forecasting 0.6 percentage point lower growth than previously thought, putting this year's Russian GDP increase to around 1% instead of around 2%. 

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