End of Coordination?

We argued last month that Eastern European equity markets to a large extent are driven by the global development but that it is difficult to find a clear trend for the world economy, which causes a lot of uncertainty on the financial markets. This is still the case, but one important implication of the diverging trends is that the strongly coordinated global economic policy action that we have got used to during the past two years is losing momentum. The G20 meeting in April 2009 was probably the high point, but the EU/IMF bailout package this spring was also an important achievement, although it may be argued that it came too late. It is not that there is no need for coordination on important issues or a lack of proposals, but the political will is arguably not as strong today as it used to be. The issues are more complex though, and the sense of urgency has decreased. The talks of a currency war – the debate about the strength of currencies that has intensified lately – is worrying, and the main players seem more inclined to blame one another than find solutions. In particular, the focus is on China and the need to revalue the yuan, a discussion that so far has yielded little progress.

The underlying problem is that different regions of the world are at different stages in the recovery and it is tempting for the policy-makers to look after their own house first. The emerging world is struggling to keep its currencies from appreciating too strongly, the Americans and Japanese seem to have decided to continue with stimuli (and thus most likely exacerbate the EM currency pressure), and the Europeans seem to have no choice but to start tightening. Put differently, it is a struggle between monetary stimulus, fiscal tightening and doing nothing. These diverging policy choices mean that it will be difficult to reach any meaningful joint decisions at the IMF and G20 meetings during the autumn.

The positive side of the story is that the global economy is in radically better shape today than it was at the height of economic policy coordination. The IMF increased the growth forecast for the world this year – from 4.5% to 4.8% – in the recently- released World Economic Outlook, but lowered it slightly, to 4.2%, for next year. Another recent survey, the Brookings- FT Tiger Index, reaches a similar conclusion, arguing that the “global economic recovery is losing momentum”. These surveys seem to support our conviction that we are not going towards a double dip but rather a slowdown in the recovery. But there is no room for complacency, as there are substantial challenges remaining in the system. The IMF repeats the mantra that the “recovery remains fragile and uneven” and that the main policy challenge is “to effect a smooth transition from public to private sector-led growth in many advanced economies, and from external to domestically driven growth in key emerging economies.” It is this smooth transition that is so difficult to achieve given the radically different policy options available.

The outlook for the key economies in Eastern Europe remains rather good. The IMF argues that “growth in economies that experienced the mildest downturns (Poland), and in others that faced the crisis with relatively strong household and bank balance sheets (Turkey), is projected to continue gaining strength, helped by the normalization of global trade and capital flows.” The forecast for Turkey for this year was revised up from 6.1% to 7.8%. The IMF did revise down the growth outlook for Russia a little this year, to 4%, but adjusted it upwards for next year, to 4.3%. But the main positives in these economies are that the growth is driven increasingly by domestic demand, exactly what the IMF is asking for, and the exchange rates are increasingly flexible, which is what the rest of the world wants to see from emerging markets.