World's Economic Recovery: Prospect, Uncertainties and Challenges

In recent years,the world economy has been troubled by unilateralism. Due to the lack of new mechanisms and drives,and the impact of COVID-19,major economies are faced with unprecedented challenges. The year 2021 witnessed the turnaround points of the pandemic and inflation expectations,and the point of the world economy is also about to emerge. The recovery of the world economy is fraught with uncertainties: the pandemic,multilateral cooperation mechanisms,and relations between major powers. The recovery may also bring various shocks. Therefore,we need to take a prudent view on the world's economic recovery. At a roundtable discussion organized by China Forex,Shen Jianguang,chief economist of JD Digits,and Zhong Zhengsheng,chief econonomist of Ping An Securities,shared their opinions on the recovery of the world economy. The conversation,which follows in edited form,was moderated by Zhong Wei,China Forex deputy editor.

Zhong Wei: Welcome to our roundtable discussion. 2020 saw a global recession,with only China maintaining positive growth among major economies. Even so,China is still striving for a full and balanced recovery. In 2021,some countries launched mass vaccination,heralding the turnaround point of the epidemic. Western countries,especially the US,are returning to normal social and economic activities. It is expected that the world economy will usher in a strong recovery in the second half of 2021. But some fear that the difference in the prevention of the pandemic in many countries may bring about an uneven economic recovery. In your opinion,when will the turnaround point of the world economy occur? What will be the characteristics of the recovery?

Shen Jianguang: The year 2021 will see an accelerated world economy. But compared to those in previous economic crisis,this round of recovery will be characterized by unbalances. That is to say,developed countries will have a significantly faster recovery than that of emerging economies. The U.S. will put on the best performance.

The reasons lie in public health and financial relief policies. First,the United States will lead the world in vaccination. Countries  rely on vaccination to prevent and control the pandemic,and to resume work and production. To now,the U.S. is among the first countries to reach herd immunity. EU countries lag behind the U.S. and the U.K. in securing supply and the inoculation rate,despite  large procurement of vaccines. Emerging economies are even further behind the EU,facing potential new outbreaks and delayed economic recovery.

Second,the financial bail-out policies are obviously different. After President Biden signed the US$1.9 trillion coronavirus relief package,the fiscal stimulus for the pandemic registered over 15% of the national GDP,filling the output gap  promptly. The Federal Reserve and the OECD both predicted that the U.S. economy will be up to 6.5% this year. In contrast,European countries and Japan did not have large-scale follow-up stimulus plans. Emerging markets are subjected to restricted fiscal space,high-interest rates,and limited fiscal support. What’s worse,the fast recovery of the U.S. would trigger a sharp rise in U.S. bond rates,intensifying capital outflows from emerging markets.

In summary,the “darkest moment” of the pandemic will pass with accelerated vaccination. The recovery will be very strong,especially in the second half of 2021. But the recovery will be unbalanced,especially in emerging markets,which will face the pressure of controlling the pandemic and preventing large-scale capital outflows.

Zhong Zhengsheng: At the current sage,the world economic recovery has two characteristics. First,the recovery is more likely to be “Nike-shaped”,rather than “V-shaped”. In the face of the pandemic,a “natural disaster”,the economy will recover faster than in financial and economic crises. At the current stage,the disease is still hampering economic activities. Recently,a third rebound of the pandemic occurred in Europe. As a result,many countries intensified blockade measures. So the recovery of the economy will be lower than expected in the first quarter of this year. In addition,developing countries are having difficulties obtaining vaccines. Therefore,it is uncertain whether the recovery will be “V-shaped” in 2021. It is more likely to be “Nike-shaped”,meaning the recovery will be slow and prolonged.

Second,the U.S. economic recovery may be better than expected. The U.S. and European countries may not be in sync. With Biden in power,the U.S. tightened pandemic prevention and control,accelerated vaccination,and passed fiscal stimulus packages. The U.S.,therefore,speeded up its economic recovery. IMF and OECD have made great upward revisions to the forecasts of the U.S. economic growth. In contrast,the European economy is under the shadow of uncertainties. First,European countries fall far behind the U.S. and the U.K. in vaccination. Second,it is difficult to put their recovery plans in place because of poor coordination. Third,Germany,Italy,and other countries are still troubled by political instabilities. Therefore,the prospect of the European economic recovery is gloomy.

Zhong Wei: Inflation expectations are already a hot topic. A study showed that commodity prices have had a great growth as early as the second half of 2020,but it did not trigger strong inflation expectations. Since February 2021,the pandemic cooled down,which has brought about greater inflation expectations. Yields on Western sovereign debt,especially on 10-year U.S. bonds,continued to rise. Recently,the U.S. passed a US$1.9 trillion fiscal stimulus plan,adding to the worries about potential inflation that precedes the recovery. Do you think that a new round of persistent inflation is looming?

Shen Jianguang: Since the financial crisis,the central banks of developed countries have been using super-easy monetary policies,including zero interest rates,negative interest rates and quantitative easing; but the core inflation never went up. So inflation will not come this time either. I do not agree with this view. In the current round of response, developed countries,especially  the U.S.,almost abandon  fiscal restraints. Using large-scale stimulus is already monetizing the deficit,increasing the risk of inflation.

First,the U.S. economic stimulus far exceeds its output gap. The U.S. Congressional Budget Office estimates that the U.S. nominal output gap is US$ 420 billion in 2021. However,Biden’s latest stimulus plan far exceeds this number. So it will thus increase the risk of inflation.

Second,the demand in this recovery will push core inflation upward. In previous financial crises,although major central banks provided much liquidity to the market,the core inflation remained stable due to the lack of aggregate demand. But the current round of the U.S. stimulus scale far surpasses the output gap. It will increase domestic demand,leading to a higher core inflation index.

Third,rising commodity prices,U.S. Treasury yields,and asset prices all signal inflation. This year,the rise in commodity prices,especially crude oil,coupled with the recent 1.75% U.S. 10-year Treasury bond yield,has contributed to market concerns about inflation.

Zhong Zhengsheng: I’ll cover two aspects. Now I’ll talk about inflation in the U.S. In 2021,the U.S. may become the “source” of global inflation. First,the U.S. policy stimulus may be overkill. In 2020,we estimated that the U.S. fiscal stimulus accounted for 18.4% of its GDP,while OECD forecasted that the U.S. output gap made up for 6% of the GDP in that year. In 2021,the $1.9 trillion bill accounted for 9% of the U.S. GDP of 2020,while OECD predicted that the U.S. output gap would be 4.6% and 3% in 2021 and 2022. Second,the U.S. may face pressure from the fast recovery in consumption and fast-rising wages. At present,U.S. companies may have to raise wages in response to a slowly recovered job market. This will raise production costs and central prices,intensifying inflation. Third,the U.S. had a low base last year. Assuming that PCE grows at an even pace this year (with an average month-on-month ratio of 0.185%),the U.S. PCE will peak at 2.7%-2.8% month-on-month in April and May,and may also be slightly higher than 2.5% in November. These are likely to be new highs since 2012.

Next,let’s take a look at the commodity cycle. From a global perspective,the rise in commodity prices since the pandemic is an important factor of higher global inflation expectations. According to the data of U.S. Energy Information Administration,OPEC’s idle capacity is expected to remain at 7 million barrels per day in the first quarter of 2021,well above the historical high of 4 million barrels in 2009. In addition,global geopolitical games may also prompt oil-producing countries to increase strategic production. As a result,the risk of inflation caused by excessive commodity price increases may not be as severe as expected.

Zhong Wei: Many countries adopted very accommodative monetary policies during the pandemic,and the U.S. is no exception. Although inflation levels are still within the targets,and the Fed has not indicated that it will raise interest rates following a pickup in real interest rates. But people are anxious about the inflection point of interest rates that comes with inflation. In many countries,interest rates on sovereign debt have returned to or are even higher than the pre-covid level. What can be done to balance the recovery and inflation ? As inflation continues,when will the Fed increase interest rate? When is the inflection point of global interest rates?

Shen Jianguang: This year,the monetary policies of all countries will diverge. Emerging economies are the first to raise interest rates. On the one hand,they have to control the rising prices of food,fuel,and other goods; on the other hand,they want to have a rainy-day hedge against the capital outflows that may be triggered by the rise of the U.S. long-end interest rates. At the same time,countries such as India,which are highly dependent on energy imports,may also raise interest rates to quell imported inflationary pressures.

The developed economies,especially the U.S.,are a different story. Their monetary and fiscal rates or negative interest rates are set to last. First,the inflation targeting regime is under scrutiny. For example,the Fed switched to average inflation targeting regime last year,with a higher tolerance for PCE surpassing 2% year-on-year. Second,monetary policies in developed countries are more focused on economic growth and employment.

Zhong Zhengsheng: Indeed,a balance between inflation and economic recovery is something that the Fed and most central banks find extremely difficult to attain. We believe that ensuring economic recovery may be more important than preventing inflation from going higher. This can be understood in three ways. First,the current inflation is not likely to last long. We may have a phased supply-demand conflict of goods. The rising prices may naturally lead to a new balance between supply and demand. According to the Fed’s latest forecast,while the U.S. PCE inflation may exceed 2% in 2021,long-term inflation will remain around 2% in 2022,2023,and beyond. This suggests that the Fed believes inflation may not last long. Second,recovering the economy is more difficult than controlling inflation. The economic recession may repeat itself. If the U.S. prematurely tightens policies to curb inflation,then the country may go back to what it had been in the past decade: “low inflation and low growth”. In other words,the U.S. may fail to reach a target inflation rate. This is something that the Fed does not want to see. Third,although central banks are overstretched in pushing up inflation,they are full of tricks in suppressing inflation. As Powell said,the Fed has enough tools to deal with high inflation.

Dr. Shen said we need to pay attention to the pressure on emerging economies to raise interest rates. Recently,we saw that Turkey,Brazil,Russia,and other countries have been running at the forefront of raising interest rates. At present,the interest rate spreads between European,Japanese, Chinese bonds etc. and U.S. bonds have dropped to pre-pandemic levels. If the spread continues to narrow,a new round of Carry Trade may occur. This is also the making of the recent strengthening of the dollar.

Zhong Wei: A controlled pandemic and economic recovery is certainly a good thing,but it can also bring new shocks. For example,recently,the global stock market is even more volatile,especially in China. Many countries saw a heated property market. Higher U.S. bond rates and a rebound in the dollar index will also have an impact on the foreign exchange  market. What spillover effects will the external economic recovery have on the Chinese economy? Domestically,the “two sessions” were convened,which centered on the socio-economic development goals for 2021,the 14th Five-Year Plan,and Long-Range Objectives Through the Year 2035. Internationally,the world economic recovery takes on a veil of uncertainty. In such a context,what impacts will be exerted on China?

Shen Jianguang: The external economic recovery has a multifaceted impact on China’s economy. First,China’s exports are expected to grow steadily. Countries outside China have unbalanced economic recovery. Developed economies saw a fast-growing consumer demand,which could not be fulfilled by the “slow recovery” of emerging economies on the supply side. In this context,China will continue to excel in the diversity and resilience of its products in the first half of this year. China’s export businesses in vaccines,furniture, home appliances,and electronics will remain strong. In the second half of this year,when the pandemic is under control,the drive of China’s exports will gradually shift from overseas consumer goods supply to overseas investment expenditure,and from final goods to intermediate and capital goods. What’s more,as vaccination will help resume international travel and facilitate cross-border investment and financing,China will attract more foreign investment.

Second,we are concerned about imported inflation. As the world economy is recovering,international oil prices,copper prices,and other commodity prices are going back up. The new round of the U.S. fiscal stimulus will continue to boost global demand,which will support the upward trend of global commodity prices. It may affect the prices of some of China’s imported commodities,generating upward price pressure on PPI and other indicators.

Third,the financial market is more volatile.  Monetary policies should put emphasis onthe balance between internal and external environments. In 2020,China’s economic fundamentals remained well. Having a sound monetary policy and rising overseas spreads,China faced a large influx of capital into the stock and bond markets. The “anchor of global asset prices”,the 10-year U.S. bond yield has risen from 0.68% to 1.71% in the last six months,which triggered financial shocks and thus a correction in China’s capital markets after the Spring Festival. China and the U.S. are not at the same pace in policy-making . Therefore,China’s interest rates,exchange rates,and capital flows may experience inevitable impacts.  Monetary policies should be more targeted to reach a balance  internally and externally .

Zhong Zhengsheng: Let’s look at China’s exports this year. We believe that the pace and characteristics of the world economic recovery are good for China. First,the U.S. fiscal stimulus and real estate investment will significantly boost demand for at least 1-2 quarters. Second,European countries are still in lockdown,but they have a strong potential in demand. So even though their economic recoveries lag behind the U.S.,they are expected to recover in the second half of this year and drive China’s external demand successively.

Next,China needs to deal with the medium- and long-term external impact. First,we should use “regional cooperation” to empower the “double economic cycles”. Trade frictions between China and the U.S. and even among the world ,overlaid by the impact of COVID-19,bring challenges to globalization. The U.S. supports “closed” international cooperation. In other words,it uses allies to restore the U.S. leadership,and impede the development of China,Russia,and other competitors. This is an ebb in globalization,which we believe may last long. But it does not mean the end of international cooperation. The signing of RCEP,the progress made in the China-Japan-South Korea FTA,and the willingness of China,the U.S.,the U.K. to join CPTPP all suggest that regional cooperation will bring new opportunities for China and the world. This is good news for the “double economic cycles”. Second,we should strive for high-quality development. An old saying goes “coping with shifting events by sticking to a fundamental principle”. This holds true in today’s world of uncertainties. While learning from and cooperating with the outside world,China should always solve problems based on its own conditions. For better development,China should focus on the following things: give incentives to market players,pursue innovation-driven development,implement the rural revitalization strategy,improve the urbanization strategy,reform the capital market and stick to a higher level of opening up. The 14th Five-Year Plan is set sail,we hope that China can make new grounds in the high-quality economic development.

Zhong Wei: Thank you. You both showed concerns about the rise in inflation expectations,believing that the rise is driven by rising commodity prices and consumption. You are also optimistic about China’s exports in 2021. We need to pay attention to the financial turbulence and monetary policies in emerging countries. Facing internal and external challenges,and standing at the intersection of the “two centuries”,China needs to stand the test and find the drive to deliver high-quality development.