2016 Economic Outlook

What does it mean for the world economy now that low oil prices are here to stay for the foreseeable future?

By Simon Baptist, Chief Economist, The Economist Intelligence Unit

 

When I looked at global financial markets at the start of 2016, I felt a familiar sensation. What was going on looked like a reprise of the worst moments of 2015. China’s overvalued stock markets were tumbling, their falls exacerbated by misguided government intervention. The oil price had fallen almost as quickly, thanks to soaring stocks and plentiful supply. Confidence had been lost around the world, stripping US$4 trillion from the value of stocks. I fully expect that financial markets will calm down this year — indeed, they may well be less volatile by the time you read this — but the shifts in the global economy mean that further periods of instability are likely throughout the year.

 

There are reasons not to be alarmed about falling Chinese stockmarkets. Chinese stock holders tend to move in herds, which makes prices rise higher and fall lower. The link between equities and the real economy is also tenuous. The economy continued to grow at a similar rate in 2014 (when stock prices rose precipitously) and in 2015 (when they fell sharply). Nevertheless, the government’s decision to shut down trading showed it to be less trusting of market forces than I had hoped.

 

I am more worried about the currency, which has weakened a lot against the dollar. In December alone, the Chinese central bank spent more than US$108 billion to prevent a steeper decline. A weaker renminbi reflects capital leaving the country in search of better — or less risky — returns elsewhere. It may also induce China’s exporting rivals in Asia to devalue their own currencies so as to maintain their export competitiveness. A currency war would be bad news for the global economy.

 

Together with China, the resumption of falling oil prices contributed to the gloomy start to 2016. I think that cheap oil, of less than US$70/barrel, is here to stay. Although some US shale producers will be forced out of business over the coming year because of the low price, there will be new sources of supply from Iraq, Iran and Libya that will keep oil plentiful and cheap for the next five years at least. Despite lots of stories in the media about slowing demand from China, I think the low oil price is essentially a supply story. The development of the US shale industry has permanently weakened the ability of OPEC to set a high oil price.

 

It is harder than it used to be to assess what cheap oil means for the global economy. An old rule-of-thumb said that for every US$10 fall in the price of a barrel of oil over a year, global growth would rise by 0.1 percent. This is because the economies of oil importers — like the US, China and Japan — are bigger than those of oil exporters such as Saudi Arabia and Nigeria. Yet this was not visible in 2015, despite oil falling from US$100/ barrel to US$50/barrel. I think this is because producers account for a larger share of the global economy than they have previously, because the impact on the US is now more nuanced given that its own oil companies suffer when the price falls and because other developed countries, such as Canada and Australia, have focused their economies on exporting commodities, many of which rise and fall in tandem with oil.

 

In 2016, even cheaper oil (and other commodities) will make conditions difficult for many emerging markets. Added to this is the fact that the US has started raising interest rates, which will make borrowing more expensive. I am expecting a second consecutive year of recession in Brazil and Russia, while there will be only slow growth in Indonesia, South Africa and Turkey. I think that the days of emerging markets propping up the global economy are over — although there are some brighter spots in India and Vietnam.

 

Among developed economies, the biggest theme of the year will be the behaviour of central banks. In the US, the Federal Reserve will increase interest rates two or three times, but will be wary of slowing the economy too much. The force behind the US economy is the strengthening job market. More Americans in work means that household spending — which accounts for 70 percent of the economy — will continue to grow. More spending on goods and services means more investment by businesses, which means more job growth. The US is enjoying this virtuous circle at present. Only the energy sector and exporters are finding the going tough, thanks to the strong dollar.

 

But in Europe and Japan, central banks are continuing to run quantitative easing programmes to support their economies. Partly because of the low oil price, inflation is proving tricky to generate. I don’t think that government policies are optimal in either the euro area or Japan. If governments were to increase spending — and take advantage of the incredibly cheap borrowing costs — inflation would rise and the central banks would be able to end their money printing programmes more quickly. However, as always, politics looks set to get in the way and this means that 2016 will be a lot bumpier than it needs to be.

 

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