MACROECONOMIC & MARKET OUTLOOK Q3 / 2016 Seedwell Hove and Jeremy Wakeford
Macroeconomic and Market Outlook 1 Third Quarter, 2016 Highlights Despite the calming of conditions after a difficult start to 2016, global markets faced another wave of volatility in June, sparked by the Brexit vote. The global economy is expected to remain tepid, amid downside risks affecting high income and emerging markets which could keep global growth below the projected 2.4 percent in 2016. High income economies growth momentum will be dampened by the Brexit shock. Developing and emerging countries are facing headwinds from several factors, including: persistent low oil and other commodity prices; weak global trade amid the slowdown and rebalancing in China; tightening of financial conditions; and the Brexit vote. Growth in Sub-Saharan Africa in 2016 is now projected to be less robust than initially envisaged, under the weight of both external and domestic challenges. Oil and other commodity prices have picked up in the second quarter, after a slump at the beginning of the year. Oil prices are forecast to average $43/bbl in 2016 and $52/bbl in 2017, an upward revision from the previous forecasts in April. The macroeconomic outlook is overshadowed by downside risks emanating from the slowdown in large emerging market economies, notably in China amid that economy s rebalancing, lower commodity prices and prospects of financial tightening and possible disorderly unwinding of Brexit negotiations. African countries are also subject to risks related to political uncertainties, security threats and drought. 1 Prepared by Seedwell Hove and Jeremy Wakeford Quantum Global Research Lab AG Bahnhofstrasse 2 6300 Zug Switzerland Phone +41 41 560 29 00 Fax +41 41 710 63 00 www.quantumglobal.ch
Global Macroeconomic Outlook After a turbulent start to 2016, global markets calmed down during the second quarter. This was marked by a pick-up in oil prices and improved sentiment, but the world economy remains tepid. Market volatility returned after the unexpected result of Brexit, when Britain voted to leave the EU on June 23. The World Bank has revised down its global growth projections for 2016 to 2.4 percent, amid slower than expected growth in high income countries and the continued slowdown in developing and emerging market economies. Given the Brexit outcome and inherent risks in emerging market economies, we believe that global growth could remain subdued and well below the projected 2.4 percent in 2016. However, global growth could pick up marginally in 2017 as some of the headwinds subside, but this will largely depend on how Britain s exit from the EU is handled and possible ripple effects it may cause. Despite a boost from lower energy prices and improvements in labour markets, growth in advanced economies could be less than expected 1.7 percent in 2016 2. The US economy is forecast to grow at 2.4 percent in 2016. While lower oil prices, an improving housing market consumer spending, and reduced fiscal drag continue to support economic activity, the challenges in the oil sector and manufacturing sectors are tempering US economic growth 3. The US Fed left interest rates unchanged at its June meeting amid weak jobs data and concerns about the global economy. We expect the Fed to remain on its glacial normalisation path. Further tightening of monetary policy is unlikely in 2016, given the uncertainty surrounding the process of the UK s exit from the EU and its implications for the global economy. Economic activity in the Euro Area was modest in the first quarter, supported by accommodative monetary policy, low oil prices, and some expansionary fiscal policies, but the Brexit vote will put the recovery at risk. The Brexit is likely to weaken Europe s economic growth prospects, and possibly drag it into recession. A disorderly unwinding of Brexit could disrupt economic activity and trade, strain financial systems and further complicate the migrant crisis. Market sentiment has been fragile and volatile in the immediate aftermath of the referendum. The Euro Area is much more important for the global economy than the UK, as it accounts for about 16 percent of the global economy. Hence its slowdown could weigh on global growth prospects. Although the ECB recently provided some stimulus to the zone, additional policy support could be needed to safeguard confidence and avert global contagion effects. The Brexit shock has happened when the world economy is still grappling with weak commodity prices and subdued global trade. As such, growth momentum may be weakened. The medium term prospects for Europe largely depend on how and when the UK will leave the EU and how the Brexit process will unfold, amid contentious issues of trade and access to the EU s single market, investment and migration. The UK economy s growth rate decelerated to 0.4 percent in Q1 as exports contracted, domestic demand stalled and uncertainty continued to dampen investment. The Brexit shock could further slowdown the economy and even push it into recession, amid uncertainty in the negotiation process. The EU is the destination for more than 50 percent of UK merchandise 2 World Bank, Global Economic Prospects, June 2016 3 Federal Reserve Bank data, 2016. 2
exports. While the impact of the shock could be significant for the UK economy, the direct impact on the global economy could be limited, given the relatively small contribution of the UK to the global economy (3.7 percent) 4. However, the contagion risks could be substantial because of significant trade and financial sector linkages. A deleveraging cycle may create strains for the UK banking system which, although considered too big to fail, can also be too big to bail. The Bank of England and the UK treasury have indicated their readiness to intervene to mitigate the fallout. However, the latitude for monetary and fiscal policy seems limited as interest rates are already low, while the fiscal deficit and public debt are still large. The outcome also raises the threat of political discontent within the UK. Scotland and Northern Ireland, where a majority of voters in the referendum voted to remain in the EU, could call for independence, a process that could heighten uncertainty and further diminish confidence. Japan s growth (projected at 0.5 percent in 2016) is held back by the strong yen and weak private consumption, despite accommodative monetary policy and lower oil prices. Prime minister Shinzo Abe has delayed the increase in consumption tax from 8 to 10 percent that was scheduled for April 2017 until 2019, in order not to depress aggregate demand. Although Japan s trade linkages with the UK are limited, Brexit has led to further appreciation of the yen, and could weaken demand for Japan s exports, which are the traditional engine of its economy. Actual and expected inflation in high income countries remain largely below policy objectives. In the Euro area, inflation returned to negative territory in April, with prices falling 0.2 percent on an annual basis, and now lingering in the danger zone (below 1 percent). Monetary policy in developed countries remains largely accommodative, but the scope for further interest rate cuts is limited. Global merchandise trade remains subdued, reflecting weaker demand from commodity exporters and rebalancing in China. Global trade is expected to remain subdued in 2016 because of weak global investment, a muted global economic outlook and the Brexit shock. Emerging market and developing economies are still facing headwinds from persistently low commodity prices, tightening financial conditions, subdued capital flows and lacklustre global trade. Growth in 2016 could be well below the projected 3.5 percent 5 as the initial headwinds are further compounded by the Brexit shock. Current account deficits and fiscal deficits are widening in a number of countries. As emerging market and developing economies account for over 70 percent of global growth, their slowdown will continue to drag down global growth in 2016. Commodity exporting countries are struggling to adjust to the low levels of commodity prices, but net importers are showing some resilience. Major emerging market economies are facing challenges, with the synchronous slowdown of Brazil, Russia, China and South Africa continuing to raising concerns. The Brexit shock is likely to dampen their prospects further, as external demand could soften and commodity prices remain depressed. 4 MRB report, June 2016 5 World Bank, Global Economic Prospects, June 2016. 3
Figure 1: Global Growth and Projections 10.0 8.0 6.0 4.0 2.0 - -2.0 2009 2010 2011 2012 2013 2014 2015 2016 2017 World -4.0 Euro area Sub-Saharan Africa -6.0 Source: IMF and World Bank Advanced economies Emerging market and developing economies China continues its gradual economic rebalancing with a weakening of industrial activity, amid continued unwinding of excess capacity in the manufacturing and real estate sectors. Growth in the services sector, however, is robust. The economy is projected to slow down to 6.5 percent in 2016 and further to 6.2 percent in 2017. The slowdown of the Chinese economy remains the driving force behind low commodity prices, as it is a trading partner of more than 100 economies that account for about 80 percent of world GDP. China s credit growth has been steadily rising this year, amid policy stimulus, while fixed asset investment growth is bottoming out in the rebalancing process. The property market has been booming in recent months, with price increases experienced in several cities 6. We do not expect a hard landing of the Chinese economy as authorities continue to use their policy levers to avoid such an outcome. Brazil is still in recession, with output expected to contract by 4 percent in 2016. The economy contracted by about 5 percent in the first quarter, the fifth straight quarterly slump, amid a myriad of challenges: low commodity prices, rising inflation, depressed investor confidence and the political crisis 7. The escalation of political tensions saw President Dilma Rousseff being suspended in May, pending an impeachment trial within 6 months on allegations of fiscal mismanagement and corruption. The government of interim president Michel Temer is proposing drastic fiscal reforms to reduce a massive budget deficit (more than 10 percent of GDP). Recent economic data however reveals the tough road ahead: retail sales contracted in March, while the manufacturing PMI fell to the lowest level in over seven years in April on the back of weak domestic demand, tightening credit conditions and fiscal tightening. The new central Bank governor Goldfajn is expected to focus on fighting inflation to restore the policy credibility and investor confidence. This implies that monetary policy is likely to remain tight. 6 MRB Report, 12 May 2016 7 Brazil Central Bank, Economic Indicators 4
Russia is struggling to keep its head above the water, with the economy projected to contract by 1.2 percent in 2016 8. As the economy continues to adjust to lower oil prices and international sanctions, it contracted by 1.2 in the first quarter. The fiscal deficit widened in April, prompting the government to withdraw some part of the Reserve Fund. However, recent data on industrial production and exports shows budding signs of economic recovery. Inflation decelerated to 7.3 percent in May, prompting the central bank to cut its policy rates by 50 basis points to 10.5 percent 9. Economic activity in other commodity-exporting EMEs such as Mexico, Malaysia, Venezuela, Chile and South Africa continue to be buffeted by the persistently low commodity prices. However, constraints are easing in some net oil importing countries such as India, Indonesia, Malaysia, Hungary and Kenya, which are benefiting from lower oil prices. India is projected to grow at a robust pace of 7.6 percent in 2016, supported by strong investor confidence, capital inflows, low oil prices and expectations of good monsoonal rains which are forecast to be the strongest in 22 years. The outlook for emerging and developing countries for 2017, is subject to a number of factors: the rebalancing process in China, Brexit negations and the resultant adjustment process, policy responses to the current headwinds and commodity prices. Macroeconomic Outlook for Africa In Sub-Saharan Africa (SSA) growth is projected to be more moderate than previously envisaged, due to external and domestic constraints. As the severe external shocks persist, average growth for the region is projected at 3 percent in 2016 10 (Table 1). Lower oil and commodity prices, the slowdown in China, tightening global financing conditions and a possible slowdown in Europe following the Brexit will continue to weigh on the region s outlook (For detailed analysis, see the paper: Potential Implications of Brexit for African Economies). Commodity prices are expected to remain below their 2015 levels in 2016, and may not rise to super cycle levels any time soon. The situation is more challenging for oil exporters (such as Angola, Nigeria and Equatorial Guinea) and non oil commodity exporters (Ghana, South Africa, Zambia and Zimbabwe), as their exports and fiscal revenues are reduced, exerting pressure on fiscal balances, external accounts and exchange rates. Global financial conditions are tightening, reflecting volatile financial markets especially after the Brexit in June. This will increase the financing costs for SSA borrowers and affect infrastructure financing. The difficult economic conditions are exerting pressure on fiscal balances, external accounts and exchange rates. 8 IMF, World Economic Outlook, April 2016 9 The Central Bank of the Russian Federation, Inflation Report June 2016 10 IMF, World Economic Outlook, April 2016. 5
Table 1: Macroeconomic Indicators for Sub-Saharan Africa 2010 2011 2012 2013 2014 2015 2016 2017 Real GDP Growth (percent) 6.9 5.1 4.1 4.1 4.6 3.4 3.0 4.0 Nominal GDP (USD Billion) 1275 1428 1526.3 1607 1670 1560 1478 1620 Inflation (percent, yoy ave.) 8.2 9.5 9.4 6.6 6.4 6.9 9.0 8.3 Oil production (mbpd) 5.4 5.4 5.6 5.2 5.3 5.1 5.0 5.4 Net FDI (percent of GDP) 2.7 2.1 2.0 1.3 1.3 2.1 2.2 2.4 Fiscal Balance -37.4-1.1-1.8-3.1-3.5-4.3-4.6-4.1 Total Public Debt (percent of GDP) 27.7 28.3 28 29 29.9 30.7 37.2 36.8 CA Balance -0.9-0.7-1.9-2.4-4.1-5.7-6.2-5.5 Reserves (Months of imports) 4.2 4.6 5.3 5.0 5.6 5.1 4.2 3.9 Sources: AFDB, IMF, World Bank, IEA Most oil importers are generally faring better, with growth in excess of 5 percent and even higher in countries such as Côte d Ivoire, Kenya, and Senegal. In these countries, strong growth is supported by infrastructure investments, agriculture and strong private consumption buttressed by lower oil prices. Figure 2: Growth estimates and forecasts for selected African countries, 2016 and 2017 10 8 6 4 2 0-2 -4-6 -8 2016 2017-10 Source: IMF and World Bank On the domestic front, drought, political instability and security threats, and electricity shortages are further hampering economic activity. The El Nino driven drought is undermining economic activity in several Eastern and Southern African countries in 2016. About 40-50 million people will experience food insecurity in 2016. Budgets and external positions are strained, while a lot of pressure is exerted on exchange rates and inflation. A number of central 6
banks have responded by tightening monetary policy (Angola, Ghana, Mozambique, South Africa, Uganda, Zambia). Political instability in South Sudan, and security threats linked to Boko Haram in Nigeria, Cameroon and Chad continue to negatively affect economic activity, forcing governments to divert resources from development goals towards security. In South Africa, Zambia and Zimbabwe, electricity shortages also continue to constrain economic activity. Fiscal positions are expected to weaken in most oil exporting and commodity exporting countries, amid decrease in fiscal revenues driven by low commodity prices (Congo Republic, Angola, Cameroon, Equatorial Guinea and Zambia (Figure 3). Current account deficits will also widen in these countries. This is inducing currency depreciations, cutting back foreign exchange reserves and increasing external debt. Investments in exploration and extraction are being curtailed or delayed in some cases (e.g. in Mozambique, Tanzania and Uganda). Private consumption growth will remain weak in oil exporters as revenues decline and as subsidies are removed in some countries, while depreciation-induced inflation will weigh on consumers purchasing power. Government debt ratios have continued to rise, especially in oil producing countries and frontier economies which have recently accessed funds from international financial markets. Private sector debt is also rising in some countries, manifesting in significant increases in nonperforming loans in some oil exporters (Angola, Equatorial Guinea) and small and fragile states (Gambia, Malawi, Sierra Leone, Zimbabwe). 11 With deteriorating economic conditions, sovereign debt ratings have been recently downgraded in Mozambique, Republic of Congo, and Zambia. Figure 3: Fiscal Balances in selected African countries (percent of GDP) -14-12 -10-8 -6-4 -2 0 2 4 Source: IMF 2015 2016 Angola Bostwana Cameron Chad Congo Republic Cote D Ivoire DRC Equatorial Gunea Ethiopia Gabon Ghana Guinea Kenya Mozambique Nigeria Senegal Sierra Leone South Africa Tanzania Zambia Zimbabwe 11 IMF, Regional Economic Outlook, SSA, April 2016 7
Capital flows to the region are expected to slow further in 2016, especially cross-border bank lending and bond issuances, as global financial conditions tighten. Bond spreads have however reversed their upward trends, but remain higher than global averages (Figure 5). Because of high borrowing costs, some countries are negotiating favourable credit facilities with the World Bank and IMF (e.g. Angola, Zambia and Ghana). Increased external pressures were met with reserves drawdowns and currency depreciations in many countries, raising public debt denominated in foreign currency, as well as inflation rates. The South African rand depreciated by more than 23 percent since January, with new lows experienced after the Brexit in June. The Angolan kwanza lost 23 percent of its value in the first half of 2016, while the Zambian kwacha fell 14 percent in the second quarter. The Nigerian naira depreciated by 42 percent following the liberalisation of the foreign exchange market on June 20, while the Mozambique metical plunged 14 percent in May and further 8 percent in June to a record low against the US$. In Angola, Mozambique, Nigeria and Zambia, inflation has increased sharply, reaching doubledigit figures of 29.2 percent, 18 percent, 15.6 percent and 21.3 percent, respectively, and exceeding the central banks targets. In our view, 2016 will be difficult for many SSA countries and economic activity will remain subdued as the external environment remains less favourable. The outlook largely depends on the pace of rebalancing of the Chinese economy, how the Brexit negotiations unfold and how the world economy will respond, and developments in the commodity and financial markets. Commodity prices are expected to remain low, while external financing conditions might tighten further. Although oil prices have improved somewhat in the second quarter, we believe that they will remain at levels around US$50/barrel, not enough to lift up growth prospects for oil exporting countries in 2016. SSA growth could inch up marginally to about 4 percent in 2017, as commodity prices stabilise and policy interventions responding to Brexit begin to take effect. The prospects for individual countries is uneven. Nigeria s growth is projected to slow down to 2.3 percent in 2016, from 3 percent in 2015, amid persistent low oil prices, foreign exchange shortages and oil production 12 disruptions by the Niger Delta Avengers militant group. GDP contracted by 0.4 percent in the first quarter of 2016, dragging the economy into recession for the first time in 12 years. 13 In the non-oil sector, activity is weighed down by declines in manufacturing, financial services and real estate, despite strong growth in agriculture and telecommunication services. The escalating economic challenges are manifesting in rising unemployment (12 percent in the Q1 from 10.4 percent in Q4 of 2015). Security concerns from Boko Haram militants and infrastructure and electricity deficits also continue to hamper economic activity. The Nigerian naira depreciated by about 42 percent on June 20 when the central bank liberalised its foreign exchange market, ending the 16-month peg to the US dollar and raising import prices. This is likely to push up inflation, which has already notched up a six-year high of 15.6 percent in May. The central bank might be forced to tighten monetary policy. Capital flows slowed in first quarter of 2016, which could further complicate the implementation of the new exchange rate mechanism. Nigeria is planning a Eurobond sale later 12 The oil sector contributes about 10.29 percent to GDP 13 National Bureau of Statistics, Nigeria, GDP Report, Quarter1, 2016 8
in 2016. On the outlook, Nigeria s growth could marginally pick up in 2017 as activity in nonoil sectors improves, and the new government implements structural reforms and normalizes oil production. Angola s growth prospects are blighted by low oil prices. Growth is forecast at 2.5 percent in 2016, but could inch up marginally to 3.8 percent in 2017 if oil prices stabilize. 14 Fiscal revenue shortfalls will persist and the budget deficit is expected to widen to 7.1 percent of GDP in 2016 from 4 percent of GDP in 2015. The government is implementing expenditure measures, including removing fuel subsidies and freezing public sector hiring, as it adjusts to a new normal of lower oil prices. Foreign exchange shortages remain acute and the exchange rate gap between the official exchange rate and the parallel exchange rate continues to widen. As the central bank continues to manage the exchange rate, foreign exchange reserves have fallen by 1.5 percent to $24.4 billion in May from April. Inflation accelerated to 29.2 percent in May, the highest level in 10 years, fuelled by the depreciation of the kwanza (23 percent this year), removal of fuel subsidies, and loose monetary conditions. 15 This prompted the central bank to raise its benchmark interest rate in June by 200 basis points to 16 percent. The imbalances in the foreign exchange market calls for gradually phasing out of the administrative restrictions on access to foreign exchange at the official rate. The outlook for 2016 remains difficult, despite some increase in oil prices in May/June. However, a modest recovery could materialize in 2017, if Angola s terms-of-trade improve and shortages of foreign exchange are addressed. In South Africa, growth in 2016 is projected to inch below 0.6 percent, dampened by low commodity prices, a severe drought, the slowdown of China, and low investor confidence. The economy shrank by 0.4 percent in the first quarter, amid an 18-month slide in the mining sector resulting from persistent weak commodity prices. The mining sector (8 percent of GDP) contracted by 18.1 percent, while the agriculture sector (2.2 percent of GDP) slumped by 6.5 percent in the first quarter. The government is struggling to restore investor confidence in the wake of deteriorating economic conditions and corruption scandals surrounding President Zuma. Unemployment increased to a staggering 26.7 percent in Q1. Inflation inched down from 6.3 percent in March to 6.2 percent in April, but still remains above the inflation target range of 3-6 percent. Monetary policy is likely to remain tight until inflation is within the target range. High unemployment and tight monetary policy will limit private consumption. South Africa narrowly escaped a credit rating downgrade in May, but could succumb later in 2016 as external conditions worsen, especially after the Brexit shock. The outlook for 2017 points to a slight recovery, with real GDP growth forecast at 1.1 percent, as electricity supply improves and commodity prices stabilize. Economic activity is expected to pick up moderately in Ghana in 2016, helped by improving investor sentiment, increased oil production in new oilfields, and the improvement in electricity supplies. However, low oil prices could keep growth from leaping beyond the projected 4.5 percent in 2016. The fiscal consolidation has largely remained on track, with some notable improvement in the overall fiscal deficit, expected at -3.9 percent in 2016. The government s major challenge is to avoid slippage from the fiscal consolidation program in light of the 14 World Bank, Global Economic Prospects, January 2016 15 IMF Statement, June 2016. 9
upcoming general elections in late 2016. Inflation edged up to 18.9 percent in May from 18.7 percent in April. In Zambia, Africa s second biggest producer of copper, headwinds from depressed copper prices, electricity shortages, high interest rates and drought continue to sap growth. 16 Zambia s credit rating was downgraded by Moody s in April on a bulging budget deficit (over 7 percent of GDP) and rising government debt ahead of elections in August 2016. In some frontier economies such as Kenya, Cote d Ivoire and Senegal, growth is robust. Kenya s growth is projected at 6 percent in 2016, supported by strong growth in agriculture, accommodative monetary policy and a stable exchange rate. Inflation declined to 5.0 per cent in May, on the back of a stable exchange rate and lower food and oil prices, allowing the central bank to lower interest rates. However, the likely slowdown in the UK and Europe following Brexit is likely to affect Kenya s horticultural exports. Cote d Ivoire is anticipated to grow at 8.5 percent in 2016, buoyed by higher cocoa prices, good agricultural production and reforms from a progressive government. Fiscal discipline is also helping to sustain Cote D Ivoire s external debt and fiscal deficit. Senegal s strong growth of 6.6 percent in 2016 is bolstered by improving agricultural productivity and a dynamic private sector. In some low income countries (Mozambique, Rwanda and Tanzania) strong growth is supported by infrastructure development, mining expansion and consumer spending. These countries are anticipated to grow at 6 percent or more in 2016 and 2017. 17 Mozambique s prospects however are dented by negative effects of a financial scandal (undisclosed borrowing that exceeds US$1 billion) which has led to the suspension of financial assistance by the IMF. The country s debt and looming risk of default has prompted a credit rating downgrade in March. Delayed investment into the liquefied natural gas sector, rising inflation, and low investor confidence will weaken Mozambique s medium term prospects. In Ethiopia, Zambia, Malawi and Zimbabwe, economic activity is affected by a severe drought, which is holding back agricultural production. The Ebola affected countries - Guinea, Liberia, and Sierra Leoneare gradually recovering as the effects of Ebola wane. Commodity Markets Commodity prices recovered from the January lows but remain low on the back of abundant supply and weak demand. Brent crude oil prices increased to about $47/b in May from about $42/b in April, marking the fourth consecutive monthly increase since recording a 12-year low of $31/b in January. Oil prices rebound was supported by supply disruptions in Canada, Nigeria, Libya and Venezuela and a decline in shale oil production in the United States (For detailed analysis of the oil market, see QGRL Oil Market Outlook,3rd Quarter, 2016). The UK referendum outcome to leave the European Union immediately triggered a 6 percent decline in the dollar price of oil as the dollar strengthened and concerns about future global economic growth grew more pessimistic. Continued volatility in the financial markets after the Brexit and a strong U.S. dollar will continue to put downward pressure on oil prices in the short term. Brent crude oil prices are forecast to average $43/b in 2016 and $52/b in 2017. 18 As oil 16 Copper accounts for 75 percent of exports in Zambia. 17 World Bank, Global Economic Prospects, June 2016 18 Energy Information Administration (EIA) Short-Term Energy Outlook, June 2016. 10
inventory accumulation is expected to remain elevated in 2017, a sustained price recovery is unlikely before the latter part of next year. In light of the structural changes in the global oil industry (especially new fracking techniques in the US) it unlikely that we will see a significant price recovery in the medium term. Metal prices have also rallied after January lows, on expectations of stronger demand, and ongoing supply rebalancing from production cuts and lower investment in new capacity (Figure 4). The rebound was largely driven by the uptick in iron ore and metal prices. After the Brexit vote, gold surged as much as 8.1 percent to $ 1 358 per ounce, reflecting its safe haven appeal. However, prices of other metals (copper, iron ore, nickel) fell, reflecting concerns about the implications of the shock for the global economy as well as the appreciation of the US dollar (metals are usually quoted in US$). Metal prices are projected to decline by 14 percent in 2016 and to rise moderately in the medium term as the expansion of capacity slows. 19 Prices of agricultural commodities also rebounded somewhat since February as the effects of the El Nino effects in South America, East Asia and Africa offset the pass-through effects from lower energy prices. Commodity prices are expected to remain low amid sluggish global economy compounded by the Brexit shock. Reduced concerns about the near term Chinese growth prospects and an improvement in risk sentiment are likely to support recovery in commodity prices in 2017. Figure 4: Commodity Price Indices 300.00 250.00 200.00 150.00 100.00 50.00 0.00 All Commodity Price Metals Price Index Agricultural Raw Materials Index Crude Oil (petroleum) Price index, Source: IMF Primary Commodity System. Note: Index (2005=100) 19 IMF, Commodity Market Developments and Forecasts, April 2016 11
The lower commodity prices in 2016 will stifle economic of activity in the SSA region where a large share of commodities in exports: fuels, ore, and metals account for more than 60 percent of the region s exports compared with 16 percent for manufactured goods and 10 percent for agricultural products. Financial Markets Global financial market conditions calmed down somewhat in the second quarter, after the turbulent start to 2016. However, volatility returned after the Brexit referendum, as the market was not expecting the leave outcome. Global stocks tumbled significantly on the Brexit outcome, marking the most severe return of market volatility since the beginning of the year. The FTSE 100 Index plunged as much as 8.7 percent, the largest loss since 2008, while European stocks slid 7 percent in their worst day since 2008. The MSCI s global stock index lost 4.8 percent in the biggest slide since August 2011. The Johannesburg Stock Exchange lost 3.5 percent while gold jumped by more than 8.1 percent to reach $1 358 per ounce. The British pound sterling lost as much as 11 percent of its value, as investors searched for safer assets. The euro was down 2.5 percent raising fears about its future, while the South African rand depreciated by 4.9 percent to reach a cumulative loss of 21 percent so far in 2016 20. Crude oil retreated as much as 6.8 percent to reach $46.70 a barrel following the shock, raising further concerns for the prospects of oil exporting countries. While many of the stock indices recovered somewhat in the ensuing days after the referendum, market sentiment will likely remain weak and volatile until there is greater clarity about how the Brexit will unfold. Capital flows to emerging and developing economies remain vulnerable to sudden reversals. As volatility increase in the market after the UK referendum, economic uncertainty could slow down or reverse capital flows (especially cross border lending and bond issuances) to emerging market, as global financial conditions tighten. Foreign direct investment flows to developing countries, e.g Africa could be reduced as the global economy slows. The strengthening of the US dollar after the vote will raise the cost of servicing external debt, especially in frontier economies (e.g. Ghana, Cote d Ivoire, Angola and Zambia) which accessed Eurobonds in recent years. Also, as risk averse investors seek safe havens, the risk of capital flight from African emerging market economies such as South Africa, Nigeria and Kenya is possible. Bond yields have declined at the beginning of the year, following an escalation of stimulus policies from some large central banks (ECB, Bank of Japan and the European Central Bank) and further after the Brexit vote. Although bond spreads widened markedly in 2015, the trend reversed, with somewhat narrowing since beginning of 2016. However, the spreads for most African countries remains at high levels (Zambia, Ghana) and well above the averages for the world and Africa, reflecting weak market confidence (Figure 5). 20 http://www.bloomberg.com/news/articles/2016-06-24/u-k-referendum-roils-global-currencies-from-australiato-mexico. 12
2014-01-02 2014-02-02 2014-03-02 2014-04-02 2014-05-02 2014-06-02 2014-07-02 2014-08-02 2014-09-02 2014-10-02 2014-11-02 2014-12-02 2015-01-02 2015-02-02 2015-03-02 2015-04-02 2015-05-02 2015-06-02 2015-07-02 2015-08-02 2015-09-02 2015-10-02 2015-11-02 2015-12-02 2016-01-02 2016-02-02 2016-03-02 2016-04-02 2016-05-02 2016-06-02 Figure 5: Sovereign Bond Spreads 1600 1400 1200 1000 800 600 400 200 0 Source: Bloomberg Global Africa Ghana Namibia Nigeria South Africa Zambia At its meeting in June, the US Federal Reserve Bank kept the target range for its benchmark interest rate unchanged at the 0.25 percent to 0.50 percent range. The Bank of England has also maintained interest rates at historic lows of 0.5 percent, but may be forced to cut interest rates to support the economy in the case of further economic slowdown following the Brexit outcome. Several high income central banks (e.g. Denmark, Sweden, Switzerland, the ECB and Japan) have continued to maintained negative interest rate policies. The ECB has kept interest rates unchanged since the -0.05 percent easing in March, aimed at stimulating demand and dealing with deflation. Elsewhere in some emerging markets, central banks in Brazil, Chile and Argentina have kept their policy rates unchanged since the last increases July 2015, December 2015 and August 2014 respectively. Facing inflationary pressures, Colombia, Namibia, Egypt and Mozambique have raised their policy interest rates. However, India, Russia, Hungary, Kenya, and Uganda have cut their interest rates in May/June to stimulate economic activity, as inflation expectations ease 21. Several central banks have announced that they are ready to act if their countries economic conditions deteriorate following Brexit. The outlook for global financial markets remains uncertain as investors are nervous about the sluggish global economy. In the context of low commodity prices and China s slowdown, high levels of sovereign, corporate and household debt in many countries continue to cast a shadow on the outlook. However, policy responses to the Brexit will largely determine the outlook for global financial markets in the short to medium term. 21 http://www.cbrates.com/ 13
Key risks to monitor The outlook is subject to downside risks. On the external front, key risks relate to uncertainty on the path of withdrawal of the UK from the EU, the rebalancing of the Chinese economy, lower commodity prices and prospects of financial tightening and weaker than expected growth in advanced markets. African countries are also facing risks emanating from political uncertainties and security issues, El-Nino-induced drought and policy uncertainties. The rebalancing of the Chinese economy is still an important downside risk to the outlook. While the rebalancing of the Chinese economy could be good for China in the long run, the sharper than expected slowdown could keep commodity prices low and further reduce exports and investment, especially in African economies. Although oil and other commodity prices have improved towards the end of the first quarter, such increases may not be sustained for a long time due to a number of dampening factors: continued slowdown in China, sluggish growth in Europe following the Brexit and continued oil supply glut. This will dampen growth prospects for many commodity exporting countries and widen fiscal and current account deficits and further weaken their currencies. While the persistent decline in commodity prices has strong effects on commodity exporters, the effects can easily spread to non-commodity countries and other sectors through trade and financial channels. The Brexit negotiations following the leave vote is an important risk factor to monitor. The outcome will likely have a significant influence on market stability, recovery of global trade and global economic prospects and commodity prices. Increased market volatility could tighten global financing conditions, resulting in higher borrowing costs and reduced sovereign bond access for many frontier economies. Weaker-than expected growth in the Euro Area and the UK following Brexit could further weaken external demand for developing countries exports, especially in Sub-Saharan Africa, and reduce investment and development aid. Investors need to continue to monitor UK/Europe links with the world economy, especially financial and trade contagion effects. Political and security uncertainties and drought will continue to put a drag on economic activity in a number of African countries in 2016. Planned elections to monitor in Africa in 2016 are in Cape Verde, DRC, Gabon, Gambia, Ghana, and Zambia. 22 Elections in Uganda were disputed, and there is a risk of contested elections in DRC amid tensions surrounding the extension of the third presidential term. Political and security uncertainties in Burundi, Burkina Faso, Mali and Egypt could also hold back economic activity. In Nigeria, while the fight of the Boko Haram insurgency is continuing, the recent attacks on the oil installations by the Niger Delta Avengers group is threatening oil production. On the global scene, an escalation of ongoing geopolitical tensions in Syria, Russia, Iraq and parts of Africa and terrorist attacks in Florida and Turkey in June, and Brussels in March, continues to raise concerns. These risks could stifle economic activity, disrupt trade and dampen investor confidence. 22 National Democratic Institute: https://www.ndi.org/electionscalendar 14
In Eastern and Southern Africa, drought is expected to intensify as the year progresses. As agricultural production is dampened, a large part of the population will face food shortages. Food imports could exert pressure on the budgets and external balances, while rising food prices could accentuate inflationary pressures in the affected countries. Policy implications The above-mentioned risks and challenges call for prudent policy responses. In many oil and commodity exporters, rapidly diminishing foreign reserves, weakening of currencies and the resultant inflationary pressures have forced them to tighten monetary policies. However, it is important for central banks to strike a balance between policy tightening when inflationary pressures are persisting and promotion of economic activity. Oil importers with easing constraints due to lower oil prices could cut interest rates to support economic activity. Allowing for exchange rate flexibility could also help in facilitating smoother adjustments to external shocks in emerging market and developing economies. To avoid distortions and constraints to economic activity, administrative controls on foreign exchange may need to be avoided. In light of the Brexit shock, policymakers may need to provide stimulus if global financial system stresses affect their economies. The commodity price shock has widened fiscal deficits in many developing countries. As such, finding an appropriate fiscal response to economic shocks remains an important challenge for many countries. Commodity exporting countries can reduce fiscal deficits through better prioritization of spending initiatives coupled with stronger revenue mobilization. As oil and commodity prices are expected to remain at low levels for some time, fiscal adjustment to the new normal of low commodity prices may be necessary to safeguard macroeconomic stability, especially in the region s oil-exporting countries. One of the biggest structural constraints to growth in Africa is infrastructure deficits. As such, addressing such deficits, especially power supply and transport bottlenecks, should be a policy priority. More focus could be given to investing in new power generation capacities, especially providing incentives to private investors to invest in energy. While macroeconomic policies can be deployed to the deal with the current challenges, it is also important to advance the economic diversification agenda for the long term. Conclusions Despite the calming of conditions after a difficult start to 2016, global markets market faced another wave of volatility sparked by the Brexit in June. Growth forecasts for the world economy have been downgraded on slower than expected growth in both high-income countries and emerging market economies. Financing conditions are tightening further, while capital flows to emerging markets are weakening. The slowdown in China is continuing at a measured pace, while the possible slowdown in Europe could dampen global trade and keep commodity prices low. Given the Brexit outcome and inherent risks in emerging market economies, global growth could remain subdued and well below the projected 2.4 percent in 2016. Although oil 15
prices have improved somewhat in the second quarter due supply disruptions in some oil producing countries, they are expected to average about $43 per barrel in 2016, as global demand remain tepid. Oil prices could edge up to average $52 per barrel in 2017 and other commodity prices are expected to remain depressed. Growth in Sub-Saharan Africa will remain less robust in 2016, as commodity prices remain subdued. The global economy could pick up marginally in 2017 as some headwinds subside amid policy responses and as commodity prices stabilise. The outlook is subject to downside risks emanating from the continuing slowdown in the Chinese economy, persistently lower oil and commodity prices, tightening financial conditions, uncertainty about the Brexit negotiation process after the June referendum, and geopolitical risks. For African countries, the outlook also depends on political uncertainties and security risks related to militant/terror insurgencies and drought. Various short-term and long-term policies will be needed to respond to the challenges. While most of the challenges could be addressed by short term policies, many African countries need to consider policies that can address the underlying structural issues in the long term, such economic diversification and investment in infrastructure. This will help to insulate economies from recurring commodity related shocks and lay the foundation for industrialization. Policy reforms that promote investment and reduce constraints to business remain critical. 16