Oil and emerging markets resilient as world economy slows

From the UK's vote to leave the EU to Donald Trump’s championing of 'America First', there is increasing pressure to deal with one’s economy than to gather globally in search of seemingly accommodating solutions.

The British prime minister Theresa May’s recent hard-line shift on immigration is bound to have an effect on the UK economy. Matt Cardy / Getty Images

Much has been said recently about the future of globalisation. From Britain’s vote to leave the European Union to Donald Trump’s championing of “America First”, increasingly there is pressure to deal with one’s economy than to gather globally in search of seemingly accommodating solutions. The calls for less integration and more protectionism threaten to depress a world economy that the IMF says is already “weak and fragile”.

In its latest World Economic Outlook released last week, the fund highlighted a subdued global expansion. After growth of 3.2 per cent last year, the world economy’s expansion will slow to 3.1 per cent this year before rebounding to 3.4 per cent next year, according to the report. The forecast for US growth was cut to 1.6 per cent this year and 2.2 per cent next year.

For the IMF, the reduced forecast for the global economy reflects a more subdued outlook for advanced economies following the UK vote in June in favour of leaving the EU, and weaker-than-expected growth in the US. These developments have put further downward pressure on global interest rates, as monetary policy is now expected to remain accommodative for longer. And of great interest is that despite zero interest rates, anaemic growth in advanced economies continues to prevail.

Although the market reaction to the Brexit shock was reassuringly orderly, the ultimate effect remains unclear, as the fate of institutional and trade arrangements between the UK and the EU is uncertain. There are those who believe that the differences between the UK and the EU will not be resolved amicably, and some even expect the pound to be worth just one euro by the end of next year – it was trading at €1.11 on Monday. Moreover, markets are trying to digest the likely consequence of prime minister Theresa May’s recent shift to a harder anti-immigration line on the UK economy. Initial economic data since the vote has displayed resilience, helped in part by a weaker pound. Factories had their best month in more than two years last month, as export customers took advantage of lower prices. In the weeks to come, the pound could fall further than what we witnessed on Friday, when it briefly fell 6 per cent, then recovered to close 1.7 per cent down against the dollar.

As for the rest of the world, the IMF’s view is that market sentiment toward emerging market economies has improved with expectations of lower interest rates in advanced economies, reduced concern about China’s near-term prospects following policy support to growth, and some firming of commodity prices. China appears to have recovered from the acute anxiety at the start of the year. The economy’s transition away from reliance on investment, industry and exports in favour of greater dependence on consumption and services could become bumpier than expected at times, with important implications for commodity and machinery exporters, as well as for countries indirectly exposed to China through financial contagion channels. At 6.5 per cent for the second quarter this year, China’s growth remains higher than the average for emerging markets and developing economies.

Appetite for emerging market assets will be determined by the direction central banks will provide, especially the Federal Reserve, in the coming weeks. Growth prospects differ sharply across countries and regions, with emerging Asia in general and India in particular showing robust growth, and sub-Saharan Africa experiencing a sharp slowdown. While growth in Asia and India continues to be resilient, the largest economies in sub-Saharan Africa – Nigeria, South Africa and Angola – are experiencing sharp slowdowns or recessions as lower commodity prices interact with difficult domestic political and economic conditions. Brazil and Russia continue to face challenging macroeconomic conditions.

On oil, the IMF says two things worth noting. Oil futures contracts point to rising prices – I would agree with that. The IMF's conservative assumptions for average petroleum spot prices, based on futures prices, suggest average annual prices of US$43 a barrel this year – a decline of 15 per cent from the average price last year – and $50.60 a barrel next year.

The second point is that the IMF sees high inventory and a rapid response from US shale producers as a lever that would mitigate a sharp rise in oil prices in the near future. In the medium term, the oil market is expected to remain quite tight in light of supply constraints, considering that the decline in oil prices has dramatically reduced investment in extraction, unless shale production can be boosted or global demand falters. The reaction of shale producers in the event of rising prices is an important determinant for the future direction of oil prices.

John Sfakianakis is the director of economic research at the Gulf Research Centre in Riyadh.

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