Author: Marek Pielach

Journalist at Obserwator Finansowy

IMF: Many obstacles to growth in Europe

Weaker demand for European products, high energy prices and the approaching end of the business cycle will weaken the GDP growth in Europe in the short term, predicts the International Monetary Fund (IMF).

The long list of downside risks has led the IMF to lower the growth forecasts for Europe. 2017’s growth rate of 2.8 per cent is no longer attainable. GDP growth is projected to reach 2.3 per cent at the end of 2018, and only 1.9 per cent in 2019. GDP in the Eurozone will also increase by 1.9 per cent in 2019. The growth rate in the countries of emerging Europe is supposed to amount to 2 per cent. However, this result has been dragged down by Turkey’s problems. If we were to exclude Turkey, the growth forecast for this group of countries would amount to a decent rate of 2.5 per cent. The IMF expects GDP growth in Poland to reach 4.4 per cent in 2018, 3.5 per cent in 2019 and 3 per cent in 2020.

Economists at the IMF emphasize that growth in Europe is still above potential growth and that we are still living in fairly good times, at least for the time being, because dark clouds are already gathering on the horizon. “On the back of supportive macroeconomic policies, economic activity continued to expand in the first half of 2018, driven by domestic demand. However, there are signs of softening in Romania, Turkey, and the United Kingdom. Also, in the Eurozone, GDP growth cooled further to 0.2 percent in the Q3’18 (q/q, annual rate), from 0.4 percent in each of the first two quarters. The deceleration was mainly due to weaker external demand (especially for goods), special factors (inclement weather, car production), and base effects in the Q1’18. In most Central and Southeast European (CSE) countries, the expansion remained robust thanks to a higher absorption of EU funds and strong private consumption growth on the back of increasingly tight labor markets,” the IMF wrote in its November 2018 report.

According to the IMF Europe should fear the most a trade war with the United States. Especially in the scenario where customs tariffs are introduced on the imports of European cars. Sylwia Nowak, a senior economist at the IMF’s European Department, said that in the scenario of trade tensions assumed by the Fund, GDP growth in the Eurozone would be reduced by almost 0.2 percentage points in 2018, by over 0.3 percentage points in 2019 and by almost 0.5 percentage points in 2020.

“It is a myth that European economies are only trading with themselves and are not as open to the global market as, for example, the Asian countries. Trade is very important for Europe and its potential disruption could have serious consequences by disrupting global production chains,” explained Ms. Nowak.

Escalating trade tensions could impact global economic activity through a negative combination of higher trade costs, increased uncertainty for businesses, weaker private sector investment, and tighter financial conditions.

The IMF also estimated how much Europe will lose on Brexit compared to a hypothetical scenario where it does not occur. The United Kingdom itself will lose the most in the long-term — approx. 4 per cent of GDP (Ireland will lose almost as much). The Netherlands and Denmark will each lose over 1 per cent. In this respect Poland falls somewhere in the middle of the ranking with a loss of about 0.4 per cent of GDP.

Economic growth will be further dampened by the increases in energy prices. Prices of commodities have increased by 7 per cent since the spring of 2018, and in September 2018 crude oil cost almost USD80 per barrel. The IMF has calculated that as a result of these changes real disposable incomes have fallen by an average of 0.5 percentage points of GDP. There are two exceptions: Russia and Norway, i.e. the only oil producers in the region.

There is yet another important long-term factor. The current phase of economic expansion in Europe has been the longest in two decades. In the cycle which has lasted since September 2016, the number of months in which PMI indices (measuring the optimism of managers responsible for purchases) stayed above their long-term averages is the highest ever. The very nature of economic cycles means that trend changes are increasingly more likely as the business cycle matures.

“In the short term, escalating trade tensions and a sharp tightening in global financial conditions could undermine investment and weigh on growth. In the medium term, risks stem from delayed fiscal adjustment and structural reforms, demographic challenges, rising inequality, and declining trust in mainstream policies. Also, a “no-deal” Brexit would lead to high trade and non-trade barriers between the United Kingdom and the rest of the European Union with negative consequences for growth,” the IMF wrote.

For many years the IMF has been offering the same unchanged set of recommendations for dealing with such challenges: the policymakers should implement structural reforms and rebuild room for fiscal policy in order to be able to cope with future shocks. In contrast, the countries that already have ample fiscal space should increase their public investment (Germany and the Netherlands have been singled out in this regard).

The IMF also advocates far-reaching reforms of the Eurozone. “Completing the banking union, with common rules and backstops, and advancing the capital markets union would support private cross-border risk diversification. Equally important is the pressing need for fiscal institutional reforms. A central fiscal capacity that supports macroeconomic stabilization, and that embeds strong safeguards against permanent transfers and moral hazard, should be developed in conjunction with a revamping of fiscal rules to make them simpler and easier to enforce,” advises the IMF.

The monetary policy recommendations vary depending on a part of Europe. In general, however, the IMF recommends that in emerging Europe, where inflation pressure is generally building, central banks should gradually normalize monetary policy in a well-communicated manner to ensure a smooth adjustment. Meanwhile, in, “advanced European economies, where underlying inflation pressures are generally subdued, monetary policy should remain supportive to ensure durable increases in inflation toward targets.”

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