Last week the IMF downgraded its global growth forecast for 2016 to 3.4%. Among the developed economies, only the US and the UK show encouraging signs, with forecast growth of around 2.4% for this year. Growth remains limited despite abnormally low interest rates and a debt stock only seen in a WW2 context which low inflation cannot clear. Such a sequence of bad news could trigger only one question: is the ‘crisis’ back?
The commodity price drop witnessed at the beginning of the year has taken its toll on the lending and bond side. 46 corporate borrowers have already defaulted on a total of $50bn of debt so far this year. According to the Financial Times, more than 80% of investors expect the default rate on junk-rated companies to reach at least 5% by year-end. This has already caused the liquidity on the bond markets to dry up, practically barring the weakest companies from accessing fresh capital inflows. Private equity sponsors, which are well known for making highly-leveraged acquisitions, have seen the default rate for their leveraged loans go from 0.88% on 31 January to 1.46% as of 31 March. Again, this tightness happens at a time of very affordable debt, which can make us fear the time when Central Banks will sketch a move back towards positive interest rates territory. At a country level, lending from the World Bank has reached its highest level since the aftermath of the 2008 financial crisis. “It is our highest lending in a non-crisis period ever” added the World Bank’s president. If we are not in a crisis then where are we?
What is certain is that the root causes have been identified for months: “sluggish capital investment, falling industrial production and declining business confidence” which partly feed themselves from geopolitical uncertainties (Brexit currently topping the agenda) and a lack of politically supported structural reforms – on the latter, we cannot blame politicians for favouring electorate-friendly measures over high-risk initiatives one year before reelection time.
To solve these issues, all only have one word to say: ‘GROWTH’. The IMF estimates that one additional point of growth would enable the advanced economies to bring their indebtedness ratio to pre-crisis levels. But experts strongly diverge on practical ways to get hold of this extra growth.
Although many lights are red-flashing on the world economy dashboard, I agree with IMF’s Jose Vinals and I do not believe we are heading towards a ‘sudden’ crisis of the type we faced in 2007-2008. I nonetheless think that we are entering a world where low growth and low inflation will become the new norm –
former IMF Chief Economist Olivier Blanchard writes about a ‘weak recovery‘ situation. Once decision makers and Central Banks will have realised that achieving 2% of inflation annually is not realistic in a world where innovation builds on limited capital accumulation, where disruption takes place through not only better features but also lower prices and therefore drag inflation down (take the example of Airbnb or Uber) and where 5 out of 10 America’s fastest growing jobs pay less than $25k a year, the money tap will stop running, there will undoubtedly be a few winners but many more clear losers. And the interest rise wall can be closer than we think: in the video below, US Federal Reserve Chair Janet Yellen justified the December 2015 rate increase by the fact that labour statistics were positive – still the case as the US is experiencing its longest-ever streak of private sector job growth ever – and that “the Federal Reserve was feeling reasonably confident in the fact that inflation would move up over the medium-term back to 2%” – i.e. there is no need for inflation to reach 2% for rates to go up again.
The big question is now if the paradigm shift happens, how will it do so, and which target will Central Banks will be asked to go for. A brand new uncharted territory for the economic theory to discover.