Uneven global growth driving divergent policy agenda – 2016 Outlook


Monday, January 11, 2016 5:53 PM / ARM Research

Over the next few weeks, we will feature excerpts from ARM’s core strategy document – The Nigeria Strategy Report.

The report communicates their understanding on key happenings in global and domestic financial markets in 2015 and provides insight on what they believe will be the major themes underpinning investor sentiment for 2016.

Extending recent trends, global growth continued to negatively surprise as continued growth deceleration across EM continued to outweigh a modest economic recovery in advanced economies. Progress on the latter group reflects improving macro-economic conditions in the US, which underpinned the first rate hike in nearly a decade whilst protracted slowdown in China, fall-out from commodity price rout on several EM and political turmoil wreaked havoc on growth in the former. In line with the prevailing economic headwinds and continued over-supply picture, the bear run deepened further across commodities, with the exception of a few, where weather shocks from a strengthening El Nino drove price recovery. Caught between the nexus of EM and commodity exporting countries, Nigerian equities floundered for the second consecutive year as uncertainty over policy direction exacerbated concern over softening fundamental picture. On the other hand, local debt rallied following onset of accommodative monetary policy in Q4 15.

Going into 2016, growth levers remain unchanged from 2015 with dividends from lower oil prices and economic recovery in EM buoying optimism. On the flipside, the deadbeat commodity price outlook, and tightening global financial conditions, poses sustained headwinds  to commodity exporters like Nigeria where a Keynesian fiscal quest to boost aggregate demand and continued accommodative monetary policy are being deployed to fight out growth deceleration. The extent to which these economic policies address the shocks to the Nigerian economy should weigh on investor sentiment across domestic financial markets in 2016.

We begin the series with a look at the major themes that dominated the global economic and financial landscape over 2015 with our outlook on same for 2016.


DM economic recovery slows in tandem with global demand

Over the course of the year, the IMF revised its 2015 global growth thrice, eventually settling at 3.1% YoY —lowest since the 2009 financial crisis. The subdued pace of growth reflects deceleration of economic activities in EM countries which weighed on import demand as well as slow recovery in DM countries.

Focusing on DM countries, US economic growth slowed in Q3 15 with an annualized quarterly growth of 2.1% YoY (Q2 15: +3.9% YoY) partly reflecting lower private inventory, non-residential fixed investment and exports—impacted by softening external demand. Notwithstanding the deceleration in output, the US economy is perceived to be resilient as consumer spending continues to rise (+1.4% YoY in November 2015) on sturdy labour market data with unemployment rate of 5% being the lowest since April 2008.


Whilst this positive picture induced the US Federal Reserve to hike interest rates in December 2015 (+25bps to 0.5%), for the first time since 2006, it was not enough to offset concerns of declining global growth especially from China, ultimately weighing on US equities. Nonetheless, the relative strength of the US economy underpinned the outperformance of the US dollar (+9.3%) against a basket of other major currencies in 2015.


Figure 1: Performance of US equity indices



Across the Atlantic, economic recovery in the Euro-zone lost momentum in Q3 15 as weaker-than-expected growth from Germany (+0.3% QoQ) and Italy (+0.2% QoQ), fresh contractions in Greece (-0.9% QoQ), Finland (-0.6% QoQ) and Estonia (-0.5% QoQ) as well as stagnation in Netherlands and Portugal more than offset improved economic activities in France (+0.3% QoQ). While lower exports underpinned the weakness in Germany and Italy, contraction in Greece is unsurprising following the bailout drama which saw banks shuttered and capital controls imposed in the country’s financial system.


The tepid economic growth as well as persistently low inflation (0.2% YoY in December 2015) necessitated the ECB’s inclusion of regional and local Euro Area debt in its €60 billion per month bond buying program which, also, the bank extended to at least March 2017. In addition, the central bank announced the reinvestment of principal payments on securities purchased as well as reducing its deposit rate further by a further 10bps to -0.3%. The negative sentiment which arose from the ECB measures, as it fell short of investors’ expectations, combined with concerns from the Paris attacks, which weighed on travel shares, to drag European bourses lower in H2 15.


Though the United Kingdom continues to outperform many of its European peers, its economy floundered in Q3 15 (QoQ: +0.4%) as renewed recession in its manufacturing sector (-0.4% QoQ) and slump in construction sector (-1.9% QoQ) muted impact of improved services sector (+0.6% QoQ). With CPI figures still hovering around zero (Nov 15: 0.1% YoY) the Bank of England voted to leave both interest rate of 0.5% and 375-billion-pound asset-purchase program unchanged. Nonetheless, in tandem with slumping commodity prices (GSCI:-22.01%), towards which the British equity market is heavily weighted, the FTSE 100 posted a negative performance.



Figure 2: Performance of European Equity Indices


Japan’s economy avoided a technical recession as stronger domestic demand and improved business investment (+0.6% YoY) underpinned an upward review of its annualised Q3 15 GDP to 1% YoY (previous estimate: -0.8% YoY). Despite an upbeat growth number and a decline in jobless rate to 3.1% in October—lowest in two decades—depressed oil prices induced three consecutive months of negative core inflation. The deflationary trend, which last occurred in 2013, when BoJ announced its asset purchase program, had underpinned expectations for expansion of the QE program. Whilst the BoJ left the asset purchase program unchanged, it extended the duration of the Government bonds bought from 10 to 12 years as well as set up a 300-billion-Yen fund to buy exchange-traded funds (ETFs) that specifically target firms actively spending on capital expenditure and wages.


The latter decision was taken to prod more companies into raising wages and increasing new investment. To further stimulate private consumption, the Japanese Prime Minister ordered his cabinet to compile an extra budget for the fiscal year ending March 2016 which, among other things, would include cash payouts to low-income groups. These expansionary policies were enough to sustain the Nikkei’s positive momentum (+9.1% YTD), whilst managing to keep Japanese Yen largely flat (-0.4%), notwithstanding the roiling of Asian markets in H2 15 by successive

devaluation of the Chinese Yuan.


Figure 3: Performance of Japanese Equity and Exchange Rate



Discordant growth picture across EM

Notwithstanding a wide range of stimulus measures including cutting interest rates (-25bps) and reserve requirements (-50bps), as well as 3% devaluation of the Yuan adopted by the Chinese authorities in the third quarter to boost demand, Q3 15 GDP growth of 6.9% YoY is the country’s slowest growth since the global financial crisis of 2009. In a bid to stabilize economic growth, the PBoC consequently reduced interest rate further (1 year lending rate: -25bps to 4.35%, 1 year deposit rate: -25bps to 1.5%, SLF: -175bps to 2.75%, 7-day bank loan rate: -225bps to 3.25%), lowered reserve requirements of banks (-50bps to 17.5%). In addition, the central bank lessened the Reserve Requirement Ratio (-50bps) of banks which lend to agricultural firms and small companies while scrapping the cap on deposit rates for China's commercial lenders and rural cooperatives. Furthermore, amid strengthening dollar—in anticipation of US Fed rate hike—the PBoC loosened its grip on the Yuan by allowing it to weaken for 10 consecutive days (longest weakening streak on record) to 6.4837yuan to $1 on 17th of December 2015 (2015: -4.6%). Notwithstanding the aforementioned policies, sustained contraction in China’s manufacturing sector with the PMI hitting a three-year low of 49.6 in November 15 as well as negative sentiment from the currency depreciation led the Shanghai index (YTD:+9.4%, H1 15: +32.2%) to erode most of the gains recorded in H1 15.


Economic activities continue to deteriorate in Brazil as its 4.5 % YoY (-1.7% QoQ) GDP contraction in Q3 15 is the steepest decline since the beginning of the current data series in 1996. Pressure points included investment which fell for its ninth consecutive quarter (-4% QoQ) while output from services (-1% QoQ) and industrial sectors (-1.3% QoQ) contracted sequentially for the fourth1 and sixth1-straight quarters. Further shattering consumer and business confidence is the surging inflation figures which rose to a 12 year high of 10% YoY in November (target inflation: 4.5%) notwithstanding a 50bps hike in the Selic rate to 14.25% (highest since October 2006). The spike in inflation as well as deteriorating jobs data, with unemployment rate of 7.9% in October 15 being the highest in six years, weighed on Household consumption (-5.6% YoY). The floundering economy, deteriorating fiscal2 conditions together with ongoing political crisis, threatening to unseat President Dilma Rousseff, all combined to effect ratings downgrade by major ratings agencies 3to junk in H2 15, and underpinned the weakness of the Brazilian Real (-49%) as well as its equities (-13.3%).


Similar to Brazil, economic weakness in Russia persisted into the third quarter as Q3 15 GDP contracted 4.1% YoY in line with similar contractions since the beginning of this year (Q2 15:-4.6% YoY, Q1 15: -2.2% YoY). Western imposed sanctions and sustained plunge in oil prices (50% of government’s revenue) weighed on output and induced a 25.9% QoQ decline in seasonally adjusted current account surplus to $13.7 billion in Q3 15. The weakened trade balance underpinned weakness in the Ruble (2015:-19.4%). Largely reflecting pass-through from currency depreciation, elevated inflation figures (November 2015: 15%) continue to constrain consumer spending (October real disposable income: -5.6% YoY, November 2015 real wages: -10.1% YoY). Notwithstanding the blurred economic picture, the Russia Micex ASI rallied to a 2015 high of 1,868 following agreements between Russia and US to join forces in the fight against ISIS in November—which is perceived to herald easing of western imposed sanctions on Russia—consequently nudging the index returns over 2015 to 26.1% (H2 15: +6.5%).


In contrast to the rest of EM countries, India’s economy grew 7.4% YoY, outpacing China as the fastest growing economy in the world. The sanguine economic picture benefitted from sustained monetary easing of the Reserve Bank of India which undertook its fourth interest rate cut in 2015 to 6.75% in September 2015—lowest since April 2011. As a result, India’s manufacturing (+9.3% YoY) sector and investment (6.8% YoY) both improved, overshadowing a 13 month high inflation of 5.41% YoY in November 2015. Nonetheless, concerns about US interest rate hike underpinned renewed portfolio outflows (November: -10.8 billion Rupees, December4: -7.5 billion Rupees)—after a brief respite in October (22.4 billion Rupees) —dragged the Indian currency to the lowest on record at 67.1037 rupees to $1 on the 14th of December 2015. (2015 performance: -4.9%). The capital flight over H2 15 (FPI outflow from equities: -23.3 billion rupees) also weighed on the Sensex index (2015 performance: -4.9%).


Figure 4: Performance of EM Equity Indices



EM economic recovery and bearish energy prices to drive global growth higher

Global economic growth is projected to pickup in 2016 with IMF estimating a 50bps YoY expansion to 3.6% largely underpinned by lower oil prices (2016 IMF forecast: -18% YoY to $42/bbl). Across the DM countries, US economic growth (+20bps to 2.8% YoY) is expected to be driven by improved domestic consumption on projections of lower energy prices as well as stronger jobs data with US Fed forecasting unemployment rate to fall to 4.7% in 2016.


The bearish outlook for oil prices is also expected to support ongoing monetary easing by both the ECB and BoJ to drive economic growth in the Euro Area (+10bps to 1.6% YoY) and Japan (+40bps to 1% YoY) respectively. On a contrary note, the IMF forecasts a 30bps deceleration in UK’s growth to 2.2% YoY amid challenging outlook for exports and declining business confidence.


As for the EM countries, India is expected to strengthen further (+20bps to 7.5% YoY), benefitting from recent policy reforms, including liberalization of FDI in 15 sectors, which should boost investment as well as from lower commodity prices.


Furthermore, expected hike (23%) in government salaries should further boost domestic consumption. The foregoing, together with slower pace of contraction in Russia (+320bps to -0.6% YoY) and Brazil (+200bps to -1% YoY), is expected to neuter growth deceleration in China (-50bps to 6.3% YoY). As a result, the IMF forecast a 50bps expansion in EMs GDP to 4.5% YoY in 2016.


The uneven pace of economic recovery posits sustained divergence in global monetary policies as the BoE, ECB and BoJ prolong easing monetary policies while the US Fed is looking to further raise interest rate (2016: +100bps). The impact of the foregoing is in twofold. Firstly, the divergent monetary policy is expected to drive a broad based strengthening of the US currency, compounding the already bearish outlook for commodity prices and consequently exacerbating fiscal vulnerabilities of commodity exporting countries. Secondly, it would lead to tightening of global financing conditions as monetary authorities of EM countries will be forced to offer higher yields to attract the more expensive US funds.


In sum, capital flows will increasingly discriminate based on country prospects and vulnerabilities with the resultant readjustment of capital flow causing volatility across financial markets. Further risks exist to financial market performance as investors react to outcome of Britain’s referendum on EU membership. With the EU referendum likely to hold in 2016, an exit could trigger various economic negotiations leaving foreign companies to question the wisdom of investing in the U.K. The resultant effect will be weaker trade and investment, a situation which would have repercussion on the pound and gilts.


Overall, global growth is expected to improve from its multi-year lows, while divergent monetary policies will drive most currencies weaker and impact on capital flows.



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