Over the past year, the global economy has struggled to gain traction. Unfortunately this has been an all too familiar theme in the aftermath of the global financial crisis. According to the IMF, world growth for 2015 is expected to have slowed to 3.1 per cent, from 3.4 per cent in 2014, reflecting a weaker than anticipated recovery in advanced economies and, more significantly, broad-based weakness in emerging market economies. The IMF expects growth to pick up in the coming year, to 3.6 per cent with downside risks continuing to dominate.¹ A further slowdown in China and other emerging markets (EMs), tightening financial conditions and lower commodity prices could provide significant headwinds to growth going forward. The volatility in financial markets in the first week of 2016, influenced to a large extent by ongoing concerns about Chinese growth and uncertainties about the policy response of authorities, served as a reminder that many investors remain very nervous about the road ahead. Then there is the issue of geopolitical risks, which unfortunately have also shown signs of escalating of late.

Global growth in 2015 was driven by the advanced economies and in particular by the sustained recoveries in the United States and United Kingdom. The US experienced higher-than-expected growth in the third quarter, which, together with robust domestic private demand and job creation, allowed the Fed last month to finally embark on its much anticipated lift-off as part of policy normalisation. Market participants viewed the Fed's statement following the December FOMC meeting as somewhat dovish, reinforcing the gradual prospective path of normalisation. Furthermore, as demonstrated by the FOMC's "dot plots" over the last few FOMC meetings, the range of the projected target federal funds rate has narrowed, signifying a more clearer and coherent path of normalisation. Such perceived moderation of the Fed's expectations, together with ample advance notice through its communication strategy, no doubt helped markets digest the dreaded "first hike in the cycle" (the first increase in the Fed funds target in almost ten years) without major price swings.

In Japan and the euro area, however, growth remains weak and fragile. The euro area expanded by an annualised 1.2 per cent in the third quarter, and indicators ranging from business confidence to credit growth are showing increasing signs of upward normalization. However, concerns over a lack of pricing pressures² prompted the ECB to lower its deposit rate and extend its QE programme last month. On the other hand, even as Japan avoided a technical recession in the third quarter, inflation remains well below its 2 per cent target level. Going forward, it is anticipated that growth in advanced economies will strengthen on the back of supportive fiscal and accommodative monetary policies and lower commodity prices. However, weaker growth in emerging markets and resultant feedback loops, harbour downside risks.

Emerging market growth continued to disappoint in 2015, with the slowdown in China, recessions in Brazil and Russia and weak commodity prices dominating the outlook going forward. China continues to rebalance its economy, and according to the IMF is expected to have grown by 6.8 per cent in 2015, and achieve growth of 6.3 per cent in 2016.³ Monetary policy continues to support the economy, with the People's Bank of China reducing the policy rate by 165 basis points in 2015, and new fiscal measures announced in 2015 should help shore up demand and avoid a hard landing. Meanwhile the Chinese financial markets have gained in prominence in the past few years, which is why the turbulence over last week warrants particular attention. The Chinese authorities' decision to implement and then remove the 7 per cent "circuit breaker", which was triggered twice in the week, was a significant development and may suggest that financial market volatility may well be something that we have to live with for the time being.

On a more positive note, India's strong growth momentum continues. The IMF expects India to grow faster than China for the first time since 1999, forecasting GDP growth of 7.3 per cent in 2015 and 7.5 per cent in 2016. Indeed, India's economy grew by 7.4 per cent, year on year, in the third quarter, making it the world's fastest growing major economy for that quarter. In Russia, third quarter data suggests that the pace of contraction, and the impact of declining oil prices and political sanctions may be slowing. Prospects for Brazil, however, remain challenging, with the economy contracting by 4.5 per cent, year on year, in the third quarter. Meanwhile the 10.7 per cent year on year increase in consumer prices recorded in December confirmed that Brazil missed their inflation target for the first time in more than a decade. Political challenges have weighed heavily on consumer and business confidence, while cutbacks in public investment and government spending will impinge on the growth prospects in the near-term.

Closer to home, the growth momentum is slowing in sub-Saharan Africa (SSA). Since achieving growth of 5.0 per cent in 2014, the region is forecast to grow by 3.8 per cent in 2015, and 4.3 per cent over the coming year.⁴ As you are aware, the region is dependent on commodity exports and as such has been hard-hit by the decline in commodity prices and the slowdown in global trade. Oil exporters, such as Nigeria and Angola, have been severely affected, with growth for this group of countries expected to drop from 5.9 per cent in 2014, to 3.6 and 4.2 per cent for 2015 and 2016 respectively. The further unexpected decline in oil prices that we have witnessed since the beginning of the year does not bode well for growth prospects and may result in actual outcomes being worse than current forecasts. Yet even for oil-importers, reduced demand for raw materials has meant that the benefits of cheaper energy imports have been offset by the general decline in commodity prices, which have decreased by approximately 40 to 60 per cent between January 2013 and August 2015. In several African countries, the decline in prices of commodity exports has also led to a deterioration in both external and government balances, which had already been stretched by ambitious public infrastructure programmes and some relaxation of government spending discipline. In an environment of higher US interest rates, international diversification of investments is less forthcoming with a result that many countries in the region have found that external financing has become more difficult, or at least more costly.

This has been the case of middle-income countries on the African continent, such as Ghana and Zambia, where tighter financing conditions as well as supply constraints are expected to weigh down on growth. Other countries, however, face fewer of the aforementioned constraints, such as Kenya and Senegal, and are expected to see an acceleration in economic activity, supported by public investment and private sector activity, respectively. For low-income countries in the region, the outlook is more favourable, mainly as a result of robust infrastructure investment and private consumption driving growth. On average, this group of countries is expected to grow by 6.0 per cent in 2015, which while impressive, is still roughly three quarters of a percent lower than was forecast by the IMF in October 2014. This downward revision highlights the challenging headwinds facing the region. In the context of persistently low commodity prices, less favourable financial conditions, currency pressures, and external and fiscal vulnerabilities, risks to the outlook for sub-Saharan Africa remain on the downside.

On the inflation front, global inflationary pressures are subdued. In advanced economies, lower commodity prices and weak growth have led to lower inflation, and even deflation in some cases. Core inflation is expected to remain soft in advanced economies over the next two years,5 reflecting persistent slack and lower import, particularly energy prices. In emerging markets the picture is more mixed. In Latin America, countries such as Chile, Colombia, Peru and Brazil have raised interest rates, as currency depreciation has led to a rise in inflation, and inflation expectations in some cases. However, in other emerging markets, particularly in Asia, policy rates have been eased in order to support growth. Overall, despite significant currency depreciations faced by emerging markets, inflation pressures in general remain fairly contained mainly as a result of weak demand.

Moving to the economic outlook for 2016, one issue that is likely to dominate the policy landscape is the tightening of international financial conditions and the impact that this may have on emerging markets. In the aftermath of the financial crisis, extraordinarily accommodative monetary policies in the advanced economies and the search for yield, combined with the relative strong growth performance of many emerging markets, drove strong capital inflows into emerging markets.

However, as you are aware, there has been a turning of the tide. This is in response to both the beginning of monetary policy normalisation in the US, as well as the weakening fundamentals in many EMs. For example, the IIF expects non-resident inflows to emerging markets to have reached US$ 548 billion in 2015, below the levels recorded in 2008/2009, and for net capital flows to EMs in 2015 to have been negative. As a share of emerging market GDP, capital inflows are estimated to have fallen from a high of 8 per cent in 2007 to 2 per cent for 2015.⁶ China accounts for a large proportion of these outflows, with the IIF estimating capital outflows of over $500 billion from the country in 2015. The market turbulence experienced in September and October 2015, as well as in the past week, also highlight the manner in which developments in China, and fears of a crisis in emerging markets, will influence financial market conditions. Whilst the announcement of the initial Fed rate hike removed one source of uncertainty, other potentially more disruptive risks persist.

Despite the weakness and uncertainties that exist in the outlook for advanced economies, developments in emerging markets are likely to prove crucial for the global economy in 2016. Between the 1980s and present, emerging markets and developing countries' share of global GDP growth (in PPP terms) has doubled to over 70 per cent.⁷ The growing importance of emerging markets to the global economy implies that a faster slowdown in China, or a protracted slowdown in EMs in general, could threaten the fragile global recovery. Recent research by the World Bank indicated that on average, a one percentage point decline in growth in BRICS countries could lead to a reduction of global growth of 0.4 per cent over the next two years.⁸ At the same time, EMs face significant headwinds in the form of monetary policy divergence in the advanced economies, weaker commodity prices, dwindling policy buffers and a weak global growth and trade outlook. Further dollar appreciation and an increased sensitivity of EM yields to US rates not only pose risks to growth and inflation in many emerging markets, but also to financial stability, through balance sheet exposures.

Policy makers globally need to commit to policies aimed at boosting both actual and potential output, in order to support a strong, sustainable and balanced global recovery. Looking to the near-term, demand management measures also have a role to play in supporting growth outcomes globally. In many advanced economies, negative output gaps and low inflation trends allow for a continuation of accommodative monetary policies, and in some instances for more expansionary fiscal policies. In many emerging markets, however, the scope for both monetary and fiscal easing has narrowed, as policy makers look to manage rising vulnerabilities. In many cases cyclical policies need to move in sync with structural reform measures aimed at boosting potential growth in the medium-to-long term.

Globalisation and interconnectedness are key features of the world economy. Thus, exogenous influences are an integral part of policymaking today. This includes, inter alia, the spillover risks generated by policy decisions in large key economies such as the US or China. To further support global growth, there is therefore a need for continued global cooperation, and well calibrated communication, in order to mitigate the negative spillovers national policies may generate.

By Mr Daniel Mminele,

Deputy Governor of the South African Reserve Bank

References

1 World Economic Outlook, IMF, October 2015.
2 Inflation in the euro area stands at only 0.2% y/y in both November and December 2015.
3 World Economic Outlook, IMF, October 2015.
4 All data on sub-Saharan Africa from the Regional Economic Outlook for sub-Saharan Africa, IMF, October 2015.
5 Economic Outlook, OECD, November 2015.
6 Capital Flows to Emerging Markets, IIF, October 2015.
7 IMF WEO database.
8 Global Economic Prospects, World Bank, January 2016.