IMF slashes emerging market growth forecasts
The International Monetary Fund is the latest high-profile organisation to cut its EM growth outlook for 2012, but stopped short of a recession warning.
Yet another high-profile emerging market growth downgrade, this time from the IMF.
In its latest World Economic Outlook Update (WEO), the Fund lowered its growth forecasts for emerging and developing economies to 5.4% in 2012, 0.7 percentage points lower than its previous projection in its September 2011 WEO, reflecting both a deterioration in the external environment (read: eurozone), as well as a slowdown in domestic demand in key emerging economies. It revised down its global growth forecast to 3.3% in 2012, from its previous projection of 4.0% growth.
Predictably, the Fund warned that Central and Eastern Europe (CEE) is the region most at risk due to its direct trade and financial linkages to the eurozone, with the IMF lowering its growth outlook for the region by 1.6 percentage points to 1.1% in 2012 a more sizable growth forecast downgrade than that offered by the European Bank for Reconstruction and Development earlier in the day.
However, in contrast to the stark recession warning from the World Bank last week, the IMF insisted that the impact of the slowdown in developed markets on other emerging market regions was likely to relatively mild, suggesting that macroeconomic policy easing is expected to largely offset the effects of slowing demand from advanced economies and rising global risk aversion.
Consequently, while it revised down its growth forecasts for all emerging market regions, the revisions were much smaller for other regions (see table):
And its downside scenario projections were also less pronounced than those of the World Bank or, for that matter, the EBRD.
In the event of an intensification of adverse feedback loops between sovereign and bank funding pressures in the eurozone resulting in larger and more protracted bank deleveraging and contractions in credit and output, a scenario that the Fund sees as the most immediate risk to the growth outlook, it projects that euro area output would be reduced by 4 percentage points relative to the WEO forecast implying a deep recession in the single currency bloc. But the global economy as a whole would avoid recession, with the growth outlook under such a downside scenario 2 percentage points lower than the WEO projection.
Deleveraging risks not confined to CEE
Nevertheless, the Fund stressed the severity of the risks posed by the threat of European bank deleveraging, not just to CEE, but to emerging market regions as a whole, highlighting potential spillover effects for trade finance and local asset markets in EM regions beyond CEE in its accompanying Global Financial Stability Report Update:
|First, credit channels could become impaired as pressures on European banks result in a pullback of cross-border lending, notably trade finance activities, and a loss of parent bank support for local lending. For example, euro area banks provide roughly 30 percent of trade and project finance in the Asian region, even though their balance sheets account for only about 5 percent of bank assets. The impact depends on the extent to which local banks can step in and fill the financing gap: even though some banks may have the balance sheet capacity to do so, there are significant operational challenges in some areas of trade finance. New entrants will also have to raise substantial dollar funding in stressed market conditions. Constraints on long-term funding could severely limit banks capacity in such areas as shipping and aviation trade finance, as well as project and infrastructure finance.
Second, local asset markets (foreign exchange, fixed income, and equity markets) could come under renewed strains through outflows, deteriorating liquidity, and a repricing that could have a knock-on impact on local financing conditions. Emerging markets that are heavily reliant on external portfolio flows could be especially susceptible.
Domestic hard landing risks
Aside from eurozone and deleveraging risks, the Funds WEO also highlighted heightened risks of a hard landing in key emerging economies triggered by an unwinding of domestic real estate and credit markets:
|Should the dynamics of real estate and credit markets unwindtriggered by losses in confidence and a paring back of expectations at home or by falling demand from abroadthe impact on economic activity could be very damaging.|
Faced with these challenges, the IMF was keen to stress that there is no one-size-fits-all policy fix for emerging markets.
However, it broadly divided EM nations into three different categories, prescribing different policy responses for each, as follows:
|Economies where inflation is under control, public debt is not high, and external surpluses are appreciable (including China and selected emerging economies in Asia) can afford to deploy additional social spending to support poorer households in the face of weakening external demand.
Economies with diminishing inflation pressure but weaker fiscal fundamentals (including various economies in Latin America) can afford to stop tightening or to ease monetary policy, provided they manage to control lending to overheating sectors (such as real estate) through macroprudential measures.
Those that suffer from both relatively high inflation and public debt (including India and various economies in the Middle East) may need to take a more cautious stance on any policy easing.
All in all, yet another dire warning to add to the gloom that has enveloped markets ... oh, wait. Perhaps the bad news really is priced in, after all.