Global economy recovery is on track in 2014: RBI

The Macroeconomic and Monetary Developments 2014-15 update is released by Reserve Bank of India along with its first bi-monthly monetary policy statement for 2014-15. As per the macroeconomic update, the recovery of the global economy is on track in 2014, though tightening financial conditions and the divergence in inflation pose risks. Since the January 2014 monetary policy statement, global growth outlook remains broadly unchanged though weaker initial data to some extent cloud optimism. Global economic activity had strengthened in H2 of 2013. On the current reckoning, global growth is likely to be in the vicinity of 3½ per cent in 2014, about ½ a percentage point higher than in 2013. The expansion in global output is expected to be led by advanced economies (AEs), especially the US. However, downside risks to growth trajectory arise from ongoing tapering of quantitative easing (QE) in the US, continuing deflation concerns and weak balance sheets in the euro area and, inflationary pressures in the emerging market and developing economies (EMDEs). Weakening growth and fi nancial fragilities in China that have arisen from rapid credit in recent years pose a large risk to global trade and growth.

Growth also picked up in the EMDEs during H2 of 2013, but the momentum looks weaker than in the AEs and it faces new risks.
Improved EMDE growth emanated largely from external demand on the back of currency depreciation in these countries. Going forward, drag on its sustainability may emerge from tightening monetary and fi nancial conditions that can intensify further in case of a faster than-anticipated withdrawal of monetary accommodation by the AEs. Recent sovereign rating downgrade for Brazil and downward revision in rating outlook for Russia has also added to the growth risks for EMDEs.

Global inflation remains benign with activity levels staying below potential in the AEs as well as in some large EMDEs and a
softer bias for global commodity prices continuing into 2014. However, infl ation in many EMDEs remains high, though actions in tightening monetary policy and slack in output are expected to help generate some disinflationary momentum. The divergent
trends in infl ation between AEs and EMDEs pose an added risk to global growth.

After the unexpected shock from the May 2013 tapering indication by the US Fed, global financial markets have weathered the initial dose of actual tapering of the quantitative easing (QE) quite well. However, the global interest rate cycle has just begun to turn. Moreover, a large part of the withdrawal of monetary accommodation by AEs remains to play out. Consequently, capital fl ows to EMDEs could remain volatile, even if they do not retrench. Also, with corporate leverage rising in many EMDEs, capital flow volatility could translate into liquidity shocks impacting asset prices.