2017 Global Economic Outlook

posted by Nikolai Tagarov on December 19, 2016 - 1:54pm

In 2017, China will manage to avert a banking crisis despite rising debt levels in both firms and households. China has started spinning off bad debts into separate asset management companies. This will help avoid a crisis but will come at the cost of slower growth than 2016. High RE prices in first-tier cities will also act as a factor for slower growth as they crowd out and make unprofitable the operation of many SMEs. However, since households are now overburdened with unprecedentedly high debt levels as well (a great proportion of which is due to existing mortgages), sales of new RE assets even in tier one cities will slow down – which may lead to stabilizing and even falling RE prices. At the same time, China will continue with its “going out” strategy of investing abroad, particularly along the New Silk Road. However, in order to avoid sharp depreciations of the currency, outflows will be tightly controlled and SOEs will benefit disproportionally as they receive more outward investment quotas. However, due to the slowing economy, in the second half of 2017 we will likely see some attempts to reform (e.g. allow to go bankrupt and privatize) loss-making SOEs.

By far the most important factor that will likely greatly influence the global economy next year is the Italian referendum, which PM Renzi just lost. It is very likely that the ensuing instability, whether a stable coalition of regionalist parties (Lega Nord) and the anti-establishment Five Star movement can be formed or not following elections, will lead to a banking crisis in Italy. Such a (more likely than not) scenario poses far more existential threats to the Euro and the EU than Brexit; the concurrence of the two may prove exceedingly dangerous.

The origins of the Italian crisis really lie in the fact that the Eurozone is not an “optimum currency area”; Italy has been losing competitiveness vis-à-vis Germany yet due to having the same currency cannot resolve this problem by devaluing its currency. Ultimately, there are only two ways that this can be resolved. Either Italy must leave the Eurozone to regain competitiveness, or the EU must move decisively in the direction of fiscal union. In the context of rising xenophobic sentiments in Europe, such solidarity even among Europeans will be highly unlikely. A drawn-out string of half-measures as in the case of Greece is probably not going to be an option to postpone effective decision-making for an economy as large and important for Europe as Italy.

Eastern Europe will probably continue on a path of divergence from “Old Europe” on a range of matters, and will be increasingly assertive with its claims that its voice should be heard, particularly via the use of semi-formal coalitions such as the Visegrad Group around specific issues such as immigration. However, buoyed by increasing levels of Chinese investments while (in most cases) being able to pursue relatively independent monetary policy, Eastern Europe will remain one of the regions with higher than average GDP growth.

Given the recent developments in Italy, the events to watch out most carefully are election results across Europe (both West and East). If anti-establishment parties come to the fore, this will make it very challenging to mitigate and deal with the negative effects of Brexit and the potential banking crisis and instability in Italy. As for the US, concerns about the contagion effects of the above will probably make it very difficult for President-Elect Trump to fulfill his promise to raise interest rates.