Developed nations will drive global growth in 2014. But what are the key risks?

Morgan Stanley made the prediction late last year. No doubt, some other experts made the forecast as well (although I can’t seem to find much evidence). Now, the World Bank is chiming in with the same idea.

According to the international economic institution, global economic growth is expected to improve in 2014 on the back of an accelerating recovery in developed economies. The US, in particular, looks likely to replace emerging markets as the engine driving global growth.

“For the first time in five years, there are indications that a self-sustaining recovery has begun among high-income countries, suggesting that they may now join developing countries as a second engine of growth in the global economy,” World Bank chief economist Kaushik Basu said in the report titled “Global Economic Prospects 2014”.

Global GDP growth is projected to firm from 2.4 percent in 2013 to 3.2 percent this year, stabilising at 3.4 percent and 3.5 percent in 2015 and 2016, respectively, with much of the initial acceleration reflecting stronger growth in high-income economies,” the bank report notes.

The US economy is forecast to expand 2.8% in 2014, faster than last year’s 1.8% expansion, while the eurozone is forecast to expand 1.1% this year, ending two years of recession. The World Bank had earlier expected GDP in the 18-nation single currency bloc to grow by 0.9% this year.

The report also forecasts growth in developing countries to at 5.3 percent this year (lower than expected) from 4.8 percent in 2013.

Of course, this relatively buoyant outlook for the world economy remains sensitive to the US Federal Reserve’s tapering of its monetary stimulus.

What I found interesting (apart from the Bank’s estimate of the impact that tapering will have on emerging markets in three different scenarios) were the potential threats to the ongoing recovery in developed economies, which are, after all, predicted to drive global growth in 2014.

Here is what the World Bank had to say on those risks:

United States

Any mis-steps by the Federal Reserve as it gradually exits from its super-easy monetary stimulus measures could undermine the ongoing recovery, the report says.

Political negotiations in February over raising the debt ceiling ( a long-standing problem) could also cause undermine financial market confidence.

The unemployment rate, while having slipped to 7% (the lowest level since 2008) remains a problem because employment rates remain well below pre-crisis levels, partly because “of the withdrawal of retirees from the labour force and also because of the large numbers of part-time workers,” the report notes.

Europe

While the labour market is showing signs of stabilising, long term and youth employment remains pressure points, spreading concerns about the potentially permanent ’employability effects’ of extended joblessness, according to the report.

With low economic activity, significant spare capacity among producers has become significant. That has led to a sharp slide in core inflation (low demand leads to low production and falling prices) and fears that a debt-deflation cycle could begin.

European banks continue to hold a rising share of sovereign debt in troubled economies and continue to face deleveraging (a process of reducing debt by selling off assets) pressures ahead of asset quality reviews due in 2014.

Any delays in the development of a credible banking union risks a new bout of financial market turmoil or further market asset sell-off pressures if adequate backstops for the banking sector are not found.

Japan

Structural reforms unveiled by the government, arguably the most important of the three arrows of ‘Abenomics’, have disappointed so far, raising doubts about whether the recent improvement in economic performance can be sustained over the medium to longer term, the report notes.

“Aggressive fiscal and monetary easing have sparked a strong cyclical recovery, but this recovery is unlikely to be sustained in the absence of structural reforms that boost productivity growth and wages, particularly in the relatively low-productivity domestic service sector.”

Fiscal tightening (in the form of a tax hike) is also expected to weigh on growth in 2014, although monetary policy is expected to stay super-loose.

(For the entire World Bank report, click here.)

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