Economic Outlook 2018: Fly me to the moon

5 min
Stéphane Colliac
Stéphane Colliac Senior Economist for France and Africa
  • World GDP growth should remain at +3.2% as in 2017 – the best performance since 2011
  • Investment in Advanced Economies will be a key driver

Let the beat goes on

Everything comes to those who wait. Ten years after the worst financial crisis since 1929, growth has finally recovered in 2017. This year should see similar growth and comparable drivers.

So what’s the difference? At the beginning of 2018, we all know (corporates, households, governments) that this year will be about good growth, again the best perfromance since 2011 to +3.2%.

This is a key change from one year ago when the news was all about policy nudges and the glass ceiling limiting growth levels.

Why such a recovery? A pessimist would say this is because we experienced no global shocks over the last two years despite the risky accumulation of debt over the last decade – when economic performance was overall mediocre.

In some ways this is true. Insolvencies, for example, have risen among big corporates which benefitted the most from Central Banks asset purchases (see page 7 for a special focus on insolvencies).

An optimist could claim that things are radically different from 2016. Growth is above trend in three key ways: trade, investment and a growing number of Emerging Markets are now overachievers.

But, as the risk appetite is mopping up in the real economy and policy is pushing to go one bridge further, beware that things do not go one bridge too far.

Trade and growth live together

Trade growth was back in 2017, with many one-off aspects driven by a price recovery fueled by the oil price rebound, but also some volume growth acceleration.This virtuous circle had positive spillovers on GDP growth in the most open economies in Asia as well as in Eastern Europe.In 2018, world trade is set to grow faster than GDP for a second consecutive year, a return to a pattern unseen since 2011. In volume terms, trade should rise by +3.9% compared to +3.2% for GDP growth.

Why the comeback? Troublemakers turned into cycle makers again. This is particularly true for China, since growth increased in 2017 to +6.9% (from +6.7% in 2016), the first such acceleration since 2010. What about imports? These grew by +7.2% in volume terms. This added demand for other Asian economies, as well as commodity exporters in the region, in Latin America and in Africa. As a result, highly open economies were among the best growth performers.

This momentum might ease in 2018. But open economies will keep their lead vis-a-vis countries with comparable income levels. South Korea is forecast to grow by +3% while France should advance by +1.9%. Poland should post +3.7% while Russia is estimated to expand by +1.9%. And Spain with +2.4% should perform better than Italy with a mere +1.3%.

Investment in Advanced Economies: Let’s go party

The Eurozone and Japan got back to higher growth in 2017, much like the US and China had done earlier. That was one (small) step for them, one giant leap for the World Economy. Growth across all key economies means fewer issues of slack - a measure of the quantity of unemployed resources - or high inventories.

This is because there are no remaining major weaknesses when it comes to demand drivers. Definitely, the risk of deflation is over.The usual (missing) link between unemployment and wage inflation should make a comeback, but not in the immediate future.

This means that corporates are benefiting from growing turnovers (+4.4% y/y in Italy in Q3) without one per one pass-through to wages. Goodbye balance sheet recession, hello balance sheet reflation, and supportive low credit costs.

As a result, after a long period of underinvestment, 2018 will be the second year in a row to see above trend investment growth. Corporate investment, for example, will grow by +4.7% in the US. A catch-up effect is a pervasive driver. This is particularly true in France where the “lost decade” of corporate investment means a EUR 40 bn gap that will be hard to close.

Yet booming growth can help to lower or eliminate slack. Capacity utilization rates returned to pre-crisis levels (87.2% in Germany and 85.4% in France during Q4). As household investment is also facing a good year in 2018 (e.g. +3.6% in Germany), the story holds for private investment as a whole and is supportive for related sectors (particularly capital goods and metals).

Table 1 Growth forecasts

 

Sources: National sources, Euler Hermes, Allianz Research

Emerging Markets: Let me play among the stars

2017 was a year of recovery in Emerging Markets (EM), after recessions in Brazil, Russia, South Africa and Nigeria. 2018 should demonstrate growth in a wider range of EMs.

External conditions eased substantially.  Commodity prices increased and still-low interest rates in advanced economies pushed capital flows to high yielders. Net capital flows to EMs rose to USD 300 bn in 2017, the best level since 2012 (before the Fed tapering).

This figure excludes China, but even it saw a reversal to inflows during the year.Optimistic expectations still hold for 2018, since domestic credit conditions recently further improved as a result of lowering interest rates. Moreover, this recovery is not only about financial conditions. Our EM aggregate manufacturing PMI rose to 52.2 in December 2017, the highest figure since April 2012.

What about the EM consumer? He is also back in a wide range of economies, from Brazil to Russia, and from Poland to South Africa, adding to positive figures in countries where they never weakened (e.g. in Vietnam or in China). On aggregate, Emerging Markets’ growth (excl. China) will accelerate in 2018 to +3.7% from +3.3% in 2017 (and +2.5% in 2016).

Chart 1  Corporate investment growth

Sources: National sources, Euler Hermes, Allianz Research

Upside down: Are we about to stock new imbalances?

The duration of the current growth cycle is a key question. It’s true that the level of spared capacities decreased, but the main economies are not already overheating, thus growth can continue in 2018 without a major risk of overproduction.

Yet some existing factors may trigger excesses in this early phase of the cycle. The first is the kind of financing that fuels growth. The credit intensity of growth is strong or has increased in key economies. In China, 3 units of debt are needed to generate one unit of GDP (twice the 2011 level). In France, 4.3 units of debt are now needed (instead of 3.4), with a bias toward big corporates.

Great expectations may also trigger overoptimistic valuations. The US stock market capitalization has reached a new high in 2017, above 140% of nominal GDP. As the fiscal package was finally adopted, we revise our growth forecast up to +2.6% in 2018.

But in a late phase of the US growth cycle such a fiscal stimulus may trigger more inflation acceleration than currently expected. This could precipitate more Fed tightening and a growth impact in 2019/20: not exactly what is in current market valuations.