October 2015

21 October 2015

Impressions and main takeaways from the IMF Annual Meetings in Lima 9-11 October

Emerging markets: The Meetings were overshadowed by adverse sentiment towards emerging markets. The now dominant narrative is based on a combination of a slowdown in China, falling commodity prices and an expected interest rate hike by the Federal Reserve that has depressed the outlook for emerging markets and investor appetite. In meetings with senior policy makers, the tone was very cautious and several do not expect sentiment to turn in the short-term often stating that risks are tilted further towards the downside.

The adverse China effect is often stated as the main source but rarely quantified. The decline in commodity prices has had a mixed effect as the sharp decline in oil prices brought some terms of trade gains for non-oil commodity exporters. China’s imports through September 2015 have declined by about 15 percent year-to-date year-on-year amid a rapid decline in import growth from January 2015. Several emerging markets have also been subject to self-inflicted damage with Brazil and for different reasons Russia are two key examples that have contributed contaminating sentiment overall.

The discussions about emerging markets appear reminiscent of the 1990s when emerging markets were strictly seen as a function of investor risk appetite set by market conditions in the advanced economies. This seems puzzling given the fact that China and emerging markets now represent about 45 percent of world GDP at market prices and have since 2000 contributed about 60 percent of world nominal GDP growth in dollar terms. While all countries remain dependent on global economic trends to a larger or lesser extent, the perception of emerging markets seems inconsistent with recent advances on economic policies, existing policy buffers and economic developments being made. It does seem to validate concerns that many emerging markets still fail to guide investor sentiment sufficiently probably due to the fact that economic policy communication remains broadly inadequate.

One commentator emphasised that the vulnerability of emerging markets to adverse spillovers are exaggerated as fundamentals remain key. For Latin America, the combination of negative growth in Brazil, negative terms of trade shocks for many Latin American countries and low productivity growth will unavoidably lead to a weaker outlook for the region. Emerging markets suffer their worst year in 2015 in terms of net capital inflows over the past few years one commentator mentioned.

Emerging markets are merely subject to broader adverse trends stressing that emerging markets are not in a crisis on aggregate but merely slowing one commentator added. The commentator stressed that while emerging markets corporate debt has increased there are no major solvency issues especially as repayment profiles have remained supportive.

China: The Chinese authorities were not represented during the Meetings at Governor level. PBoC Governor Xiaochuan Zhou was not at the International Monetary and Financial Committee (IMFC), the IMF’s main advisory body, meeting in Lima, suggesting that China either does not consider important the Meetings as a forum for its policies or is not willing to face the scrutiny and questioning in particular by private sector representatives the Meetings would certainly have attracted or is simply indifferent to international concerns.

The downside risks from China featured prominently as a major source of world economy drag (at the International Institute of Finance (IIF) about 50 percent of polled respondents ranked it the no.1 concern.

One commentator highlighted that the soon to be announced new instalment of China’s Five-Year Plan, representing China’s central government framework for China’s longer-term economic and social policy objectives, is expected to help clarify China’s current policy direction. On 26-29 October, the Central Committee of the Communist Party of China is scheduled to hold its fifth “plenary session” (of the 18th CPC Central Committee 2012-17) and hold discussions on the plan. In March 2016, the plan is due to be released following the National People’s Congress meetings. The plan is seen to have a broad impact on the business and commercial environment in particular also for foreign companies and investors. China’s current mixed signals regarding its liberalisation efforts raises the importance of the plan. The plan is expected to offer broad-based guidance on domestic financial liberalisation, the role of state-owned enterprises and the lifting of most capital controls (balance of payments) possibly including further shifts in China’s monetary policy and exchange rate regime.

The Five-Year Plan is expected to set a target for a continued increase in GDP per capita. Different numbers have circulated ranging from an increase from US$7,500 (2014) to US$12,500 (2020) to a doubling of GDP per capita from 2010 levels (China per capita already doubled under the 12th Five-Year Plan from US$4,437 in 2010 to US$8,154 in 2015). The interesting challenge will be if China can convincingly implement a strategy to escape the “middle income trap” holding down many other emerging markets countries when approaching high middle-income levels of income.

One commentator underlined that while China’s traditional sectors were slowing, the services sector is growing fast. Lack of sufficient knowledge about China’s service sector may impair an adequate assessment of China’s economic outlook.

One commentator stressed that if China wants to redirect its economic model towards domestic consumption, it needs to shift attention towards the proper functioning of its domestic banks while renminbi internationalisation is exactly the wrong approach.

The risks of a hard landing in China or precipitous slowdown have been mostly discarded in discussions.

Effect of quantitative easing: The real effect of quantitative easing was again a noticeable topic. One commentator indicated that lowering the real interest rate by some percentage points or fraction thereof is unlikely to make much of a difference underscoring that few believe that small changes in intertemporal prices have a huge impact on economic activity. The important factor is access to finance as few companies can borrow anywhere near prevailing low market rates. The commentator argued that borrowing by small and medium sized companies in the U.S. is still today below their 2007 level (though naturally the 2007 level is unlikely an appropriate benchmark). The Federal Reserve should therefore have focused more on small regional banks rather than the big banks to restore conditions for lending to small firms.

Inequality and economic growth: The effect of rising inequality on economic growth was highlighted by several commentators. The failure to integrate explicitly equity concerns into economic policy frameworks risks removing from policy formulation possibly an important determinant of economic growth. Excessive reliance on price targets as implicit in inflation targeting framework may therefore unduly reject additional needed policy instruments to achieve desired policy outcomes. One commentator stressed that as policies in advanced economies have led to shifting revenue to the wealthy who save more, the problems articulated around the notion of savings glut have actually worsened contributing to an investment slump and hence inhibiting productivity growth.

Monetary policy frameworks: The effectiveness of prevailing monetary policy frameworks was called into question repeatedly. One commentator underscored that central banks are trying to fix long-term structural problems with cyclical policies stressing that existing deflationary pressures are structural calling for inflation targeting frameworks to be replaced. The commentator felt that a continuation of existing policies by advanced economies’ central banks is likely to cause more harm and criticises that central banks are being increasingly driven by markets and policies determined by liquidity concerns rather than fundamentals. It was also emphasised that an overwhelming proportion of the causes of inflation are global in nature such as the effect of falling oil prices and China and that there is little central banks can do about it.

Climate change: The Meetings debates featured prominently climate change related issues in particular in preparation of the Paris Climate Summit. The IMF highlighted adverse incentives and distortions induced by excessive fossil fuel subsidies and recommends introduction of comprehensive carbon taxation or pricing. The World Bank advocated that finding sufficient financing to combat climate change should be the objective of the Meetings. It was underscored that countries that have historically caused high emission have a moral duty to help the poorer countries.

It was noted that many countries have already presented their national climate change plans. Critics stressed that while there is mounting awareness of the issues at hand, policy makers do not seem to have internalised fully what it takes in measures to meet the 2°C global warming limit. One critic highlighted that the next 20 years will be decisive in determining of whether warming advances too fast or will be contained. The importance of climate change contrasted with the lack of concrete economic policy responses. There remains a fundamental deficiency of integrating climate related targets into existing economic policy frameworks.

The IMF highlighted the importance of carbon pricing but dismissed the importance of green GDP accounting. However, green GDP, by which environmental damage will be deducted from GDP and not as currently added (plus remedial environmental measures), could provide critical incentives to change economic behaviour. Carbon pricing in contrast, by inflating the price of carbon-intensive technologies, would in the short-term at least lead to an increase in GDP thus possibly unduly offering comfort conveyed by rising nominal GDP. Carbon pricing may therefore unintentionally mollify policy makers’ resolve to take important measures to combat climate change.

IMF SDR: The SDR has not featured commonly but in one presentation about China, most questions from investors were directed at the SDR regarding the inclusion of the renminbi. One commentator indicated that the IMF will decide by year-end on the composition of the basket. There were rumours during the Meetings that the U.S. now de facto supports the renminbi for the SDR all but securing the renminbi’s basket inclusion. Operational difficulties were mentioned that may pose a possible obstacle in particular around the freely available selection criterion in transactions with the IMF. Some of those concerns seem more of a matter of principle as most countries in IMF transactions normally request to transact in dollars or euros only.

IMF governance: The IMF reiterated its frustration about the U.S. Congress failing to support the pending IMF governance reform and hinted that alternative measures may need now be taken to allow quota adjustments to take place including one that may imply a significant dilution of the U.S.’ quota share (such protests have now been voiced for a number of years). The IMF still awaits ratification by the U.S. Congress and other countries to allow its 2010 governance reform that provides for a significant shift in quota shares towards emerging markets and a doubling of quota resources, to go into effect.

The IMF is right to be frustrated. The IMF quota reform was initially pushed by the U.S. started in 2006 and has now seemingly fell victim of Congress’ recalcitrance. However, to seek remedial measures which may eventually significantly diminish the U.S.’ role at the IMF would be wrongheaded. It seems fair to say that not sufficient efforts including especially by the U.S. government to persuade Congress to support the IMF quota reform have occurred. The IMF needs itself to make a stronger case that as an international forum it remains highly relevant for the U.S. and as a multilateral institution the natural environment for economic policy engagement amid the virtual absence of meaningful alternatives. This rests on the assumption that a G2 between U.S. and China is neither desirable for the U.S. and China nor certainly for the rest of the world.

Social peace: The decline in productivity growth was mentioned throughout the Meetings as one of the greatest economic policy challenges. One commentator indicated than lower productivity may not allow to sustain standards of living and could lead to a rise of more populist policies and possibly social unrest.

International migration crisis: The international migration crisis especially in Europe had not featured noticeably at the Meetings. This seems surprising amid the implicit fiscal and other economic consequences the large migration flows represent for Europe but in particular for the countries of the immediate vicinity of the crisis countries.

Policy normalisation: The Meetings repeatedly made reference to the need for policy normalisation. While reference is normally made to monetary policy by advanced economies’ central banks, commentator rarely seem to adhere to a common notion of normalisation. Few seem to believe that a return to the status quo ante is indeed desirable let alone feasible. The question then of normalisation naturally begs the question of normalisation of what. Policy makers seem still to be struggling that the current economic, social and financial environment seems more conducive towards moving into an entirely different direction than going backwards.