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World economic growth through the eyes of the IMF

07 May 12          

Paul Stewart of Plexus Asset Management writes that in the current global economic climate solid growth is a rare phenomenon. And where growth does exist, it tends to be more prevalent in emerging market economies. The accommodative monetary conditions in the developed world should result in G3 nations’ currency depreciation over time and lend support to global growth. However, it may be a while before the economic scale becomes more balanced between the developed and developing world.

In the IMF World Economic Report published on Tuesday this week the IMF raised its 2012 global economic growth forecast (see accompanying Graph A) to 3,5% from the previous 3,3%, stressing however that the recent recovery is “very fragile” and that the eurozone debt crisis, as well as the increase in oil prices, poses a significant threat to the economy. The IMF also cautioned the EU against excessive austerity, which might hurt growth. It urged the ECB to restart its bond purchase programme, carry on with its non-standard measures and cut the refinance rate.

With regard to Spain, which many see as the next probable big headache in the eurozone, the IMF said the country’s fiscal adjustment balance is correct and praised its labour reform and bank recapitalisation plans.

Nevertheless it expects the Spanish economy to shrink by 1,8% this year. Regarding the possibility of a country undergoing a disorderly default in the eurozone, the IMF said it would be difficult to predict the outcome of such a situation and did not rule out the possibility that “if such an event occurs, it is possible that other euro area economies perceived to have similar risk characteristics would come under severe pressure as well, with a full-blown panic in financial markets and depositor flight from several banking systems”.

The probability of negative output growth in 2012 is about 55 per cent for  the euro area, 15 per cent for the United States, 14 per cent for Japan, and less than five per cent for Latin America. According to the IMF report, new shocks or policy mistakes could push one of the major advanced economies into prolonged deflation.

Deflationary pressures are prominent in periphery economies of the eurozone, like Ireland, Greece, Portugal and Spain. The probability for various global economies that might experience deflation by Q4 of 2013 is shown in the accompanying Graph B. Meanwhile, the European Commission released a statement on Tuesday stating that the Troika does not see the need for more funds for Greece. They mentioned that the country should now concentrate all its efforts on implementing the plans for reform in order to reach the debt target in 2013/2014.

While Spain remains a concern, we continue to believe policy-makers in the eurozone have the political and fiscal will to prevent a catastrophe and to pull the eurozone out of its current predicament, albeit at a slow and painful pace. And while China’s growth has begun to slow, we believe with the transition from export-led growth to consumption-led growth that is currently under way, China will not experience a hard-landing scenario.

In summary, while asset prices in general are not cheap (or overly expensive), as long as interest rates remain low the Plexus investment team believes investors should continue to hold equities on a close-to-benchmark position in favour of the alternatives, i.e. cash or bonds. We are, however, still very cognisant of the fact that the world remains a risky place for investors.

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