The headlines are filled with debt, deleveraging and default. The World Bank has slashed its global growth forecast for 2012 to 2.5% from 3.6%. But given that recoveries after financial crises tend to be slow, drawn-out affairs, that's not too surprising—and 2.5% is not a disaster. The global economy still has some sources of resiliency, particularly in emerging markets. Still, growth will be very uneven and there is a higher risk of a worse outcome than a pleasant economic surprise.
The euro-zone crisis remains the key risk to the global economy. A combination of fiscal austerity and bank deleveraging means the euro zone economy will contract in 2012; UBS forecasts a full-year decline of 0.7%. But a European recession won't sink the global economy: Europe is a fairly closed economy, and so less of a drag on world exports. But the crisis could go global through the financial system, and Greece remains the flashpoint. A loss of confidence in European banks, spurring fresh contagion, could have huge repercussions. Helpfully, the European Central Bank's move to provide three-year loans has significantly reduced systemic risk.
Elsewhere, the outlook is perhaps brighter—if only because the fallout from the euro-zone crisis, which has been building for two years now, is proving limited. The JP Morgan Global Purchasing Managers Index ended 2011 at 53, a nine-month high and above the 50 line that divides contraction from expansion. U.S. growth appears to have stabilized. While the Chinese economy is slowing, growing at 8.9% in the fourth quarter on a year earlier, many believe that the political transition to a new leadership will ensure the authorities seek to support growth. Many emerging-market economies have room to loosen monetary policy.
But debt reduction in the world's developed economies, which has hardly started, will hang over growth. While 2.5% global growth isn't far off the 30-year average of about 3.3%, that underplays the meteoric rise of China in the last 10-15 years: the world's potential growth rate should be higher. With China alone to generate one-third of 2012's economic growth, according to Citigroup, the result is a subpar recovery elsewhere—and one that remains vulnerable.