In the second post of the mini-series on predictions for 2014, Morgan Stanley noted that developed markets would be crucial to boosting global growth this year. However, for that prediction to come true, the world has to undergo five major transitions successfully this year.
Those economic transitions make up the third and final post for the Prediction 2014 series and are taken from Morgan Stanley’s 2014 Global Macro Outlook released in early December.
According to the financial firm, the five key transitions refer to ongoing developments in five key globally important countries/regions:
In the US, Federal Reserve Chairwoman-in-waiting Janet Yellen will need to ensure a smooth transition from quantitative easing (bond purchases) to credible forward-looking guidance on interest rates.
As part of that process, Morgan Stanley believes the unemployment level expected to trigger an interest rate hike, currently 6.5%, will be lowered to 6% and the first interest rate hike in the US will come along only in early 2016.
Japan will need to transition from deflation to moderate inflation. However, Japan will face significant challenges in doing so, cautions Morgan Stanley. It believes that planned corporate tax cuts will be unable to offset the negative effects of a consumption tax hike expected to come into force in April.
Structural reforms are also unlikely to make enough progress to boost growth in the short term.
Nevertheless, the report predicts additional monetary easing measures, such as asset purchases and potentially a US-style guidance on interest rates, by the Bank of Japan, which should help the economy move from deflation to moderate inflation over time.
The eurozone will have to shift from financial fragmentation to a more credible banking union for a more sustainable economic recovery. The region’s GDP is predicted to expand by 0.5% in 2014.
The balance sheet review of banks in the 17-member currency union before the European Central Bank (ECB) takes over as the region’s regulatory supervisor towards the end of 2014 is likely to reduce financial fragmentation, and promote a more sustainable recovery in 2015.
The ECB is also expected to cut its benchmark policy (refi) rate one more time, possibly in the first quarter of 2014.
China will have to move from state-owned enterprise-driven and leveraged (debt-laden) growth to reform-driven growth. The challenges are however, substantial.
Recent measures to liberalise financial markets are likely to improve resource allocation within the economy, and is better than just simply shepherding the economy towards consumption-led growth.
“If financial liberalisation rather than the social reforms (land ownership, further relaxation of one-child policies, hukou reforms) is pushed through earlier, the movement of market prices towards their fundamental levels (which could be higher from here for interest rates) could interact with the process of deleveraging (reducing debt) to create downside risks to growth in the near term,” notes Morgan Stanley.
The investment house expects Chinese GDP to expand 7.2% in 2014 and 7.4% in 2015.
5. Emerging Markets
Emerging markets have to implement structural reforms. “Yet, so far, Emerging markets have either backed away from implementing much-needed reforms (India is a good example), are on the wrong track (Brazil, Russia) or face near-term challenges (China, Mexico),” notes Morgan Stanley.
The investment house believes the role of central banks will continue to be important for emerging markets in 2014. Thirteen emerging market central banks are expected to raise rates in 2014, although they will be from relatively smaller economies, such as Poland, Hungary, Turkey, Israel, Taiwan and Indonesia.
India and Brazil are in the midst of a cycle of increasing interest rates, but are likely to see their rates decline by the last quarter of 2014.
The tapering of the US Federal Reserve’s monetary stimulus could also prove to be a big problem for emerging markets. “We doubt that vulnerable emerging market economies have taken enough steps to protect themselves against a future bout of uncertainty in the US, and therefore they remain hostage to a successful transition at the Fed,” the report warns.
As a bonus, here’s what Morgan Stanley believes could be in store for three key emerging economies:
The investment company has revised upwards its GDP estimate for India to 5.1% for 2014 on the back of better-than-expected farm output, short-term policy fixes by the central bank that have improved the management of foreign exchange risks and improved export growth.
“We believe that the key will be to lift real GDP with policy reforms and addressing issues related to the business environment to improve productivity. In this context, the general election outcome in 2014 will be critical,” it notes.
A strong government at the centre could lift GDP growth further to 5.8% in 2014, while an unstable government could slow the reforms process and drag growth lower to 4.1%.
Korea’s GDP is forecast to increase 3.5% in 2014. Driving growth will be an improvement in private consumption, continued fiscal support from the government, improving export growth and larger fixed investments.
The Bank of Korea is also expected to raise the policy rate once in the last quarter of 2014, according to Morgan Stanley.
Structural changes will continue to hurt Brazil’s GDP growth, which is estimated at 1.9% for 2014, lower than the 2.3% growth estimated for 2013. A strong currency continues to hurt the country’s export competitiveness, especially in the industrial sector.
Slower growth and slowing inflation (to below 6%) will restrain the central bank from hiking the policy interest rate aggressively next year. In fact, it is expected to stop raising the rate by February.
To sum up, assuming the five key transitions are made successfully (and Morgan Stanley believes they will be), the world will see higher economic growth in 2014.
And on that note, wallofmoney would like to wish everyone a very happy X’mas! Keep the festive cheer going.