Review of Developments in The World Economy

The global economy gained momentum in the second quarter after a relatively weak start to the year. The main impetus behind this pick-up in activity has come from the OECD economies, with a healthy performance in the US and the Euro-zone returning to growth after eighteen months of recession. Emerging and developing economies are likely to follow, led by China and Brazil is expected to gain further traction in the second half. However, India and Russia are likely to continue to be impacted by declining investments. Growth in both countries is expected to remain below potential, with Russia in a better position to withstand the current challenges. The improving situation in the developed economies can be seen in the most recent Purchasing Manager’s Indices (PMIs) for the manufacturing sector. Despite recent improvements, the forecast for global economic growth in 2013 remains at 2.9%, the lowest level since 2010, due to the low growth at the start of the year. However, the pick-up is expected to continue into the coming year, with global growth forecast at 3.5%.

A more positive performance for the world economy could materialize on developments such as any progress made on US fiscal issues; a stronger-than-expected recovery in the Euro-zone; more effective stimulus measures in Japan; further progress in structural reforms in emerging economies; and an improvement in international trade. Among the downside risks are the upcoming budget and debt ceiling negotiations in the US, the continued weakness in the Euro-zone’s banking system, and fiscal consolidation in Japan. Further downside risks include the impact on emerging and developing economies of efforts to scale back monetary stimulus in the US; the potential re-emergence of challenges to China’s financial system; and reduced foreign and domestic investments in India and Russia.

Looking at the OECD in more detail, the Euro-zone’s return to growth in the second quarter has been a significant driver for the improvement in the global economy. In recent years, its severe sovereign debt crisis and the impact that this has had on the financial sector, as well as the decline in output due to austerity measures had a significant negative effect on the global economy. The latest data appears to show a broader-based yet gradual improvement in the Euro-zone. In the US, strong growth in the second quarter in combination with the expansion of its manufacturing sector has been supportive to the global economy. Elsewhere, Japan is benefitting from the recovery in its main trading partners in the OECD and China, and seems to be on track with its stimulus measures. However, the need to make fiscal adjustments will likely drag on the country’s growth next year.

In the emerging and developing economies, expectations that the US central bank will reduce monetary stimulus in the coming months has proved a challenge, particularly for economies with large current account deficits. India, in particular, has seen a significant depreciation in the value of its currency, as well as declining investments in recent months. These factors are likely to dampen economic growth in the second half. Russia is also experiencing declining investments, which could impact growth over the coming quarters. Brazil has experienced a welcomed increase in investments in the first half, which should lead to an improvement in economic growth in the second half. China’s output numbers have improved recently and lead-indicators point to better momentum in the second half. More broadly speaking, the current recovery in the developed economies could be expected to filter through to the emerging and developing economies in the coming months.

The recent positive developments in the OECD economies have already resulted in a gradual improvement in oil demand. This, along with some supply outages, has resulted in a decline in OECD crude inventories, adding to the upward pressure on crude oil prices in recent weeks. However, a look at days of forward cover – which provides a good measure of market needs – shows that OECD inventories stand at a comfortable level of 58.5 days. This figure is above the historical norm and provides confirmation that the market at present remains well supplied. Looking ahead, crude stocks should gradually begin to build as refiners head into maintenance at the end of the third quarter and summer demand winds down. At the same time, the on-going rise in non-OECD inventories should also provide a further cushion to the market, complementing existing – and expanding – crude oil production capacity.