Stronger footing masks multiple risks
Although the global economic environment has improved after a rocky start to 2016, volatility will persist. This is in large part due to global monetary policy divergence and fears about an inevitable reckoning in China's highly leveraged financial system. The developed world will remain dependent on central bank stimulus, with deflationary pressure an ongoing concern. Performance in emerging markets will be held back by soft demand in the West and China, widespread policy mismanagement, heightened geopolitical risk and depressed terms of trade for commodity producers.


The global economy has found a firmer footing after a rocky start to 2016. The opening weeks of the year were notable for sharp falls in global stockmarkets, a renewed downward lurch in oil prices and remarkable declines in developed-market sovereign bond yields. The downturn in sentiment was caused by concerns about the strength of Chinese demand, volatility stemming from the start of a US monetary tightening cycle and fears about deflation.


Sentiment has since improved, although the reasons for this are not unambiguously positive. The US economy had a poor first quarter, growing at an annualised rate of only 0.5%. This, together with fears of a renewed sell-off of asset markets, has led the Federal Reserve (Fed, the US central bank) to adopt a more dovish tone and markets to price in an even more gradual cycle of monetary tightening. The dollar rally has stalled as a result, providing relief to emerging-market currencies and easing fears of an emerging-market debt crisis. In China, the focus of much of the worry, growth appears to have stabilised. This, together with the weakening of the dollar, has contributed to a partial recovery across the commodity complex. However, Chinese growth is coming at the cost of a further build-up of leverage in the financial system.


The Economist Intelligence Unit expects volatility to remain the dominant theme of 2016, driven by global monetary policy divergence and concerns that the Chinese government's efforts to stimulate the economy will only delay and worsen the inevitable reckoning in its financial system. The developed world will remain dependent on central bank stimulus. The outlook for emerging markets remains poor, given soft demand in the West and China, widespread policy mismanagement, heightened geopolitical risk and depressed terms of trade for commodity producers. Overall, we expect global GDP growth to moderate from 2.4% in 2015 to 2.2% this year. Growth will accelerate to an average of 2.7% in 2017‑18 as the outlook for emerging markets gradually improves. The global economy will then slow once more, to 2.2% in 2019, when we expect the end of the US business cycle to result in a mild recession, before recovering to 2.6% in 2020.


Developed world


Among the most fundamental problems facing the global economy is the inability of the developed world to stimulate domestic demand. There are several long-term factors responsible for this failure: the build-up of debt in the 2000s that has required a long and painful deleveraging cycle in many countries; the related inability of central banks to steer economies away from low inflation and outright deflation in some cases; a reluctance to use fiscal policy to generate demand despite historically low borrowing costs; and weakening demographics.


The financial crisis acted as a structural break in the functioning of these economies, but the new rules of the game are still being learned. Trend levels of economic growth, inflation, interest rates and trade are all materially lower than in the pre-crisis period. The policy response has been to engage in unprecedented levels of monetary easing. We are pessimistic about the ability of the UK, Europe and Japan to lift their main policy interest rates from rock bottom in our forecast period (2016‑20), and we expect the pace of Fed monetary tightening to be pedestrian compared with previous cycles.


Of the four, the US economy is in the best position. This year is likely to be a soft one—with growth of around 2%, held down by contracting business investment in the energy sector and the strong dollar, which will dampen exports—but we expect growth to rise in 2017‑18, supported by stronger investment. Inflation will accelerate as the labour market tightens and commodity prices recover. The business cycle will turn in 2019 as higher interest rates curb private consumption, resulting in a short recession. Weaker US import demand will weigh on global growth in 2019, but we expect a swift recovery in 2020.


In Europe the European Central Bank (ECB) remains in the loosening phase of its cycle. In March it reduced its deposit rate from ‑0.3% to ‑0.4%; increased the size of its quantitative easing (QE) payments by 20bn euros (22bn dollars) a month; added investment grade non-bank corporate debt to the QE programme; cut its policy rate to zero; and introduced more measures to encourage banks to lend. This was an aggressive package, but the euro failed to weaken against the dollar in response. A persistently strong euro will hamper the ECB's efforts to deliver inflation of 2%. Confidence in the euro zone will be undermined by wider existential questions about its future, the rise of national opt-outs from region-wide policy and its ability to resolve the migrant crisis. Furthermore, the issue of Greece has not gone away: disagreements over reforms between the government and creditors will keep the risk of "Grexit" alive.


The fate of Japan is what European governments are keen to avoid. Growth is lacklustre, pulled down by a shrinking workforce, a rising old-age dependency ratio and tight immigration controls. The Bank of Japan (BOJ, the central bank) is pursuing unconventional measures, most recently a levy on some commercial bank reserves. The BOJ's QE programme probably has another year to run at its current volume, before the central bank gradually reduces the size of its purchases over another 12‑month period.


Emerging markets


A heightened sense of instability surrounding the Chinese economy in the past year, with the government unwisely intervening in stock and currency markets, is a sign that the authorities are finding the ongoing process of delivering a consumption- and services-driven economy hard to manage. The economy is growing at two speeds: the manufacturing sector, plagued by overcapacity and inefficiency, is struggling to expand at all, but the consumer-driven services sector is growing strongly. As the engine of growth shifts from manufacturing to services, further periods of volatility are certain. We put the risk of China experiencing a hard landing at some point in the next five years at 40%. (We define a hard landing as a drop of 2 percentage points or more in average annual economic growth compared with the previous year.) There are many routes to such an outcome, but we are particularly concerned by the rapid build-up of debt in the economy. At an estimated 240% of GDP, the private debt stock is at levels that have coincided with crises in other economies, such as Japan in the early 1990s and the US in 2007. The implicit sovereign support for the (largely state-owned) banking sector and deposit guarantees should reduce the risk of bank runs. But the level of non-performing loans is likely to be far higher than officially reported and will rise further because of the current attempt to stimulate growth through credit expansion. The migration of a large amount of financing to China's unregulated shadow banking system poses other, unquantifiable, risks.


In the light of the stimulus measures and the stabilisation in activity, we have edged up our 2016 growth forecast to 6.7% (6.5% previously). But we forecast a slowdown to 6% in 2017 and to 4.3% by 2020. This view assumes that the government recognises that credit growth has become unsustainable and takes steps to curb it by late 2016.


In India lower oil prices have eased structural problems with high inflation and enabled looser monetary policy. Growth should remain steady, averaging 7.3% a year in 2016‑20, but the measures that could see it reach double digits again—land acquisition reforms and a nationwide goods and services tax—will prove hard to legislate without an upper house majority.


The malaise affecting Latin America will continue for a third year in 2016. The underperformance is being driven by Brazil, where GDP is forecast to fall by 3.7% in 2016, following a similar contraction in 2015. As expected, the Brazilian president, Dilma Rousseff, of the left-wing Workers Party, faces impeachment and has been forced to stand down from office for 180 days (most probably permanently). The vice-president, Michel Temer, of a centre-right party, has assumed the presidency. This will pave the way for more orthodox policies, but given the scale of the political and policy challenges, Mr Temer will struggle to drive through the changes needed to restore confidence and lift the economy out of its worst recession since the 1930s. Other than Brazil, even the better-performing countries, such as Peru and Colombia, are struggling with a downturn in the credit cycle. Venezuela faces a high risk of default. We assume a political transition that will see the president, Nicolás Maduro, leave office early, probably in 2017.


Cheap oil means that oil producers in the Middle East and North Africa are cutting spending to contain budget deficits while also seeking to diversify economic activity and revenue away from oil. Saudi Arabia has released an ambitious new strategy that aims to end the country's "addiction to oil", although it does not address the kingdom's unpredictable and opaque business climate—arguably the biggest single complaint of companies operating in Saudi Arabia. Non-oil economies have received a boost from cheaper oil and, combined with a stronger Iran, will enable regional GDP growth to accelerate from 2% in 2016 to 3.5% a year on average in 2018‑20.


Sluggish growth in South Africa, Nigeria and Angola will continue to depress Sub-Saharan African growth. At 2.3%, GDP growth this year will be the slowest pace of expansion seen since 1999. A less supportive external environment, including generally weak commodity prices, slower growth in China and much reduced international liquidity amid rising interest rates in the US, will continue to expose the structural flaws that plague many African economies. Growth will remain below 4% in the forecast period, a rate considered mediocre during periods of high commodity prices. By 2020 GDP per head at purchasing power parity exchange rates will have barely improved from its 2015 levels.


Exchange rates


The past few weeks have seen a partial reversal of the trend of broad-based dollar weakness, a trend that started in late January as investors priced in expectations of a slower pace of monetary tightening by the Fed. The weakening of the US dollar in the period from February to April coincided with a rebound in commodity prices, which supported commodity currencies and emerging-market currencies more widely. It is too early to say whether the dollar's recent rally marks a possible turning-point or is merely a prelude to another bout of dollar weakness. Even if the dollar fails to build on the gains of the past fortnight, following a 20% surge in the trade-weighted dollar index since mid‑2014, it will remain strong against most currencies. Given the relative strength of the US economy, we expect the dollar to remain well supported in the short term, before a cycle of sustained dollar weakness sets in in the second half of the forecast period.


Commodities


Oil prices have rallied in recent weeks, driven by stronger economic data from China, robust gasoline demand in the US, falling US output and a spate of supply disruptions, most recently in Canada and Nigeria. The broad recovery in wider financial markets, coupled with a modest weakening of the US dollar, has also boosted sentiment.


Although recent price developments have tilted risks to the upside, we continue to forecast that dated Brent Blend, the global benchmark, will average 40 dollars/barrel in 2016. Global demand growth will moderate owing to falling usage of heating oil, slowing global economic expansion and the diminishing oil intensity of China's economy. The fall in US shale supply is largely offset by rising output from OPEC and Russia. Following the failed Doha meeting in April, Saudi Arabia and Russia will keep pumping at record levels, and Iran will continue to rebuild its production.