Rafael Pampillón. Professor. IE Business School
28 March 2016
Recent growth forecasts do not justify the panic that we are seeing in world markets, and still less in the Spanish market.
Coinciding with moments of enormous uncertainty and volatility in the financial markets, last January the International Monetary Fund (IMF) published its forecasts for economic growth in 2016 and 2017. The IMF spoke clearly, shedding a little light on the future of the world economy. The growth forecasts do not justify market panic. As a result, the markets are calming down, and the IBEX, for example, saw its biggest rises since last July. The IMF says that the world economy will see higher rates of growth over the next two years - 3.4% in 2016 (compared to 3.1% last year) and 3.6% in 2017. These forecasts are lower than those made in October, but that doesn’t mean we are seeing a brusque slowdown of the world economy.
The main root of the cause of the deterioration of the world economy lies with China and its struggle to transform its economic model. For years now, the communist party has been trying to encourage consumption among Chinese citizens by importing more and exporting less so that citizens would have a greater quantity of goods and services that improved their standard of living. This is something that was considered, and is still considered, as very necessary to better satisfy the needs of a booming middle class. But this change is encountering difficulties, given that consumption and the services sector are not, for the moment, sufficiently powerful to take up the slack from fewer exports and investment. The result is less economic growth in China.
It’s true that the rate of growth of the Asian giant fell in 2015 to 6.9%, its lowest level in the last 25 years, but this is the rate that the government had fixed as an objective some time ago. However, the quality and transparency of economic information coming out of China has always given rise to uncertainty among analysts, which means that the rate of growth, or the quality of its banking system’s credit portfolio could be far greater (or less) than that published. What is certain is that if China “sneezes” the rest of the world is going to get a major dose of flu given the big impact on trade and finance in such a globalized economy. Nevertheless, the Chinese authorities are applying structural and fiscal monetary policies to prevent the world’s second largest engine from “catching a cold.”
Price of raw materials
As China is the biggest buyer of raw materials in the world, the slowdown in its rate of growth is causing a brutal drop in its imports and, consequently, a fall in the price of raw materials worldwide. Since April of 2011, the price of raw materials has fallen by 60%. This benefits importing countries like Spain, but weakens growth potential in exporting countries, which is the case of most countries in Latin America. Hence, this year Latin America and the Caribbean region will continue in recession (-0,3%), as a consequence of the fall in prices of raw materials, the drop in exports to China, flight of capital to the US, and finally, the major contraction of the Venezuelan and Brazilian economies.
In fact, the forecast for the Brazilian economy, the largest in Latin America, is a regression of 3.5% in 2016 and economic stagnation (0%) for 2017. Brazil is suffering from serious economic and political problems which, unfortunately, have been getting worse in recent months. Export levels are dropping due to the economic slowdown of its main trading partners, along with the fall in the price of raw materials. Moreover, foreign investment has also dropped because of the loss of confidence in the country caused by the Petrobras corruption scandal. This Thursday Standard & Poor’s (S&P) reduced its rating outlook of Brazil’s public debt from stable to negative, making it a BBB. Thus S&P are following in the steps of Fitch, which reduced its rating of the solvency of Brazilian public debt in October of last year, leaving just about one rung above the category of junk bond.
US: signs of exhaustion
The IMF also revised its forecast for growth in the US downward for 2016 and 2017. This drop was due on the one hand to more expensive loans for companies and families as a result of a more restrictive monetary policy applied by the Federal Reserve, and on the other, the negative effect the strong dollar is having on US exports. Another factor is the smaller industrial sector due to the fall in investment in the oil sector.
Unfortunately, only the European Union can be a “black swan” in 2016. Nobody dares to say it very loudly, but the markets are taking it for granted that a recession is coming to the US economy. One reason is that the US is seeing the fourth longest period of economic expansion in its history and is already showing signs of maturity and decline. And although figures for job creation, consumer confidence, and real estate construction are still good, the stock market is bracing itself for the burnout that comes with an expansive phase.
Europe and Spain are on the up
For the Eurozone, on the other hand, the IMF is far more optimistic and has revised its forecast for growth in 2016 (leaving it finally at 1.7%). Good forecasts for Germany and Spain make up for low rates forecast for France. Hence, Spain is once again one of the more favored economies in the new IMF forecasts. Estimated GDP now stands at 2.7% for 2019 and 2.3% for 2017, both higher than forecasts published last October. IMF forecasts for this year coincide with those of the OECD and FUNCAS, which also point to a growth rate of 2.7%.
Nevertheless, trying to predict the future behavior of the Spanish Economy is no easy task. There are too many uncertainties of different types. We don’t know who will be in power in Spain, what their tax policy will be, or their public spending, minimum wage and market unit policies. Nor do we know how oil prices will evolve throughout the year, or real estate prices, or exchange rates of the euro compared to the dollar. All these internal and external insecurities can impact the confidence of entrepreneurs and consumers and, therefore, will affect economic activity and employment.
This is why in these days of unease and uncertainty it should be noted that Spain is better prepared than in 2008, when the crisis began. The level of economic activity in Spain reaping the benefits of the reforms applied in recent years, for which the IMF is full of praise. Spain has a solvent finance system, a smaller public deficit, and many more companies that are exporting on a regular basis (those that export for minimum four consecutive years).
Spain’s new government is going to receive a far healthier economy than the previous government inherited, and one that is more open to the exterior. This starting point will enable Spain to continue with reforms that could position it at the forefront of the world’s industrialized countries.