2014: a balance between global optimism and latent risks

political risk storm

The World economy is on the mend, but recovery will not happen everywhere at the same pace. Here are some of the risks that will play a large role in determining the success of economic recovery in 2014.

Advanced economies, such as the UK and the US already stand out from the crowd. There, the economy is growing again; investment is strong, employment and industries are boosted by full order books. Elsewhere, although 2014 could mark the end of the 2008 financial crisis, major risks remain latent owing to fragile recovery, easily reversible gains and insufficient global trade resumption.

The spectrum of a Japanese relapse

The verdict on Abenomics is still out” recently said Holger Schmieding, chief economist of the German Bank Berenberg, referring to Japanese Prime Minister Shinzo Abe’s economic and monetary policies.

Last November, the Bank of Japan pledged to maintain its ultra-easy monetary policy to sustain growth and shake off fifteen years of stubborn deflation by hitting the 2% inflation target within 2 years.

On the way to recovery at a moderate pace, the Japanese economy has mostly benefited from the so-called ‘wealth effect’, thanks to an increase of 30 percent in home values and 50 percent in NIKKEI index throughout 2013. However, as Patrick Artus, chief economist at Natixis admitted, there are no real growth prospects for 2014 and wages are likely to continue to fall. Everything relies on the country’s ability to absorb a 3 percentage point increase in consumption tax rate (from 5 to 8 percent) scheduled for next April.

This sales-tax increase could prove a success for economic revitalization and fiscal rehabilitation if the mentioned 3 points are taken from savings. If they are from taken consumption, this could jeopardize the gains made from Abenomics and Japan could end up in recession. Economic recovery will also depend on the government’s ability to intend and implement needed economic reforms, such as allowing better competition in the energy sector.

A new growth model for emerging countries

Major developing countries such as China, Brazil, India and Indonesia could experience further financial turbulence and defiance from investors if they do not tackle serious structural problems.

Since the Fed signalled its intention to taper its stimulus program, countries with large current account deficits and high inflation rates have proved increasingly subject to devaluation pressures. Worried about a potential lack of liquidity in the markets, investors have been flying risks, entailing a slowdown of foreign investment and economic activity in those emerging economies.

China’s current situation as the worst performing stock market in Asia reminds us how a one-time worldwide economic leader can prove disappointing. The country’s debt has dramatically increased: public debt has reached 53 percent of Gross Domestic Product (GDP) and the local government’s debt the tremendous ratio of 30 percent of GDP.

China, like many other emerging countries has to come up with an alternative growth model and do so quickly. The accelerated phase of urbanisation calls for a restructuring and a general upgrading of the Chinese economy, away from the coastal export-oriented model towards a more balanced and sustainable pattern, encouraging inland development.

The Fed’s monetary policy: the major unknown of 2014

For Europeans as well as the rest of the world, the repercussions from the tapering of monetary stimulus in the US will prove determinant for the evolution of bond and stock markets and the economy as a whole. Since the crash of 2008, the American institution has played a central role in the global economic recovery through quantitative easing, printing several trillions of dollars to buy Treasury and mortgage-backed bonds.

Risks will depend on which type of the above-mentioned bonds the Fed will predominantly taper and at which pace. Such an exercise is delicate and requires certain virtuosity not to hinder the ongoing phase of economic recovery in the US.

The Eurozone remains fragile

Due to increased EU exports of high value-added products such as cars and luxury goods to the reviving US, many investors have proved optimistic about the development in Eurozone indices.

The European economy is stabilizing, but its recovery is fragile and not yet job-rich. Unemployment is stubbornly high, and growth is weak, too weak to finance European social models that require full employment. Lending to consumers and businesses has contracted by 2.3 percent in November, the biggest annual drop over more than two decades.

Many investors remain worried about the potential resurgence of a banking and sovereign debt crisis in Europe as well as about latent risks of deflation that could destroy corporate profits and hamper job creation. Last October, the Eurozone inflation rate dropped to 0.7 percent, far from the 2 percent target, increasing real interest rates and consequently  the debt burden of governments, banks and private households.

The key challenge for national governments in the EU is to re-create the conditions for strong and sustainable investment. And even if the ECB seems more constrained than its US or Japanese counterparts (the only Central Bank in advanced countries not to have used quantitative easing programs so far), the EU institution remains highly proactive thanks to far-reaching intervention instruments such as its new Long Term Refinancing Operations (LTROs) and negative deposit rate.

Rise of populist and anti-EU parties

Suffering from high abstention rates and far from national challenges, the European elections are often considered as “second order” elections, especially when national elections are due to be held in the same period as is the case in France, Belgium, Hungary and Romania.

This disinterest in taking part in politics combined with a growing social discontent are likely to disqualify traditional parties and spur the rise of populist ones. After years of unpopular austerity measures “imposed” by Brussels, the anti-EU discourse has now gained in visibility and argumentation.

Aware of their potential in hard-times, extreme right parties have decided to cooperate to increase their weight in the European Parliament for the next elections due in May. Last November, the French Front National and Dutch PVV laid the ground for a future Eurosceptic alliance that could hinder or even block EU policy-making.

Increasing social unrest

According to the Economist Intelligence Unit, 65 countries, among which appear Ukraine, Bulgaria, Tunisia, Egypt, Turkey, will be at a high or very high risk of social unrest in 2014. This is 19 more than 5 years ago. Even places traditionally considered as muted, such as Japan and Singapore, have seen demonstrators in the streets and are projected to experience further protests in the year ahead.

Although austerity measures, increasing social inequalities and economic distress have played a crucial role in the outbreak of the crises, root causes may be deeper, revealing a more general distrust in government and political institutions.

Although the world economy is recovering, risks remain. Optimism is a necessary ingredient to achieve full recovery. But policymakers and economists must bear in mind not to slip into smugness, a pernicious risk that could push interest rates up and government’s inclination for tough but necessary reforms down.

Advertisements

Tags: , , , , , , , , , , ,

Categories: Economics, International

Author:Louise Meloy

Louise Meloy is a recent MSc Graduate in Political Economy of Europe from the London School of Economics and Political Science. Her MSc Dissertation provided a comparative analysis of the impact of political conditions (government effectiveness, state capacity, rule of law, level of perceived corruption…) on Foreign Direct Investment in Slovakia and Bulgaria, demonstrating the importance of good institutional bases in generating positive spillovers for host countries. She also holds a MSc in European Studies with Distinction from the Université Libre de Bruxelles and previously achieved her BA in Political Science and Sociology at Paris Dauphine University. Her areas of specific interest include the analysis of Political and Economic transitions in Western, Central and Eastern Countries as well as the study of Interest Groups and Economic Policy Making in the EU. Currently, she is working as an Intelligence intern at AKE Group, providing political and security risk research and analysis on European and Former Soviet Union Economies.

Connect

Subscribe to our RSS feed and social profiles to receive updates.

No comments yet.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s

%d bloggers like this: