Paul Sheard

Biz@India

May 2016

Fall of Oil Boon or Bane?

Paul Sheard, EMD & Chief Global Economist Standard & Poor’s Ratings

The decline in oil prices has both losers and winners globally. To combat the geopolitical and federal risks everybody has to interrogate their economic forecasts, says Sheard.
 
How was the global economic situation in 2015 and how do you see it in 2016? What are the most worrying trends?
 
In terms of 2015, global growth actually slipped a little bit. Since its recovery in mid-2009 it has been running around 3.5 pc, last year it was around 3.1 pc. Some of the major emerging economies went into recession – Brazil and Russia in particular. China also slowed.
 
In 2016, the markets are obviously off to a very bad start. However, in terms of the economic outlook that we have at the moment, we think 2016 will be quite good in terms of economic outcomes, probably a little better than last year.
 
The first worry point is that there is such a divergence between the markets, the mood and the economic forecast. Everybody has to continue to interrogate their own forecasts. But we think markets are probably just reacting to some nervousness and China is on top of the list. There is some geopolitical risk along with some sort of federal risk that is coming into play. I think there’s some seasonal effect as well that markets didn’t do badly last year but coming back to this year, when everybody came back from the New Year holidays, there were news about federal rate hike and some disappointment with the ECB (European Central Bank). The Bank of Japan (BoJ) did some easing but it sort of confused the markets. It gave the impression that maybe BoJ was losing its nerve. Maybe the Kuroda Bazooka (referring to the trumpet used by the Governor of BoJ – Haruhiko Kuroda) was not going to be used as much. There is geopolitical risk with Saudi Arabia and Iran. There is worry about China, which is not really showing up in the Chinese data but many investors don’t really believe the data, the GDP (Gross Domestic Product) numbers in particular. I think these are all the worries that are weighing on the market.

If 2016 were to end quite badly in terms of growth, it would have to be because China had some kind of hard landing. The US, Europe and Japan looks okay. So it has to come from China, we really need to ask a question that how likely is a sharp falling growth in China. We think China’s growth will slow down before casting 6.3 pc, which is half a pc deceleration. But to go lower than that or to even get to that number, you need the economy to be on a downward trajectory sharply. But then the policymakers will react so you have to assume either they don’t react or the policy reaction doesn’t work, in other words the economy doesn’t react – but we don’t think that’s very likely. If the economy does weaken, the policymakers will keep an eye. They will respond, have responded already and will continue to respond. And we think the Chinese economy will respond to that and thus 6-6.5 pc growth is easily achievable in China this year.

Why is it so worrying for the market? Are markets totally disconnected from the reality?

You can never claim that markets are totally disconnected from reality. Another factor that is weighing on the market is the fall in the oil price. In close to about a year or a year and a half, oil price has gone from USD 110 to as low as USD 20. We know that spot oil price is determined by supply and demand. But we you don’t really know what is the right mix and I think there’s a lot of concern that may be the supply is more and the demand is falling as well. That fall in demand is coming from China – so it again comes back to China story and it puts a question mark over Chinese economic statistics. China declared its fourth quarter GDP which was at 6.8 pc, which gave a GDP of 6.9 pc for the full year. Many market participants when they look at what the oil price is doing, they don’t really believe these numbers. Also last year there was a loss of confidence in Chinese policymakers with the bursting of the equity market bubble. Interventions were seen as clumsy and ill advised – this is again a market perception. There was a lot of confusion around China’s exchange rate mechanism.

Actually China is moving the exchange rate mechanism in a good direction with more flexibility, more transparency but that’s not enough for the market. Markets are always very demanding, if you give them what they want, then they want more so there’s a lot of criticism of China that they are not transparent, they are confusing and not communicating well – all of that is kind of true but we shouldn’t lose the sight that China is engaging in one of the most dramatic reform of economy in the history of the world. And of course it’s going to be confusing sometimes – there will be multiple voices always that we will not understand. But if you look at what happened with Chinese exchange rate last year, moving to more flexibility, more transparency, clearly signalling that they will manage against the basket of currency and getting the Renminbi (Chinese currency) into the SDR (special drawing rights) – all these things are quite important developments. But they are all feeding in to this sense of the market that we don’t know what’s going on and may be something wrong is going on in China.

Does that mean that market has already painted China black and then it is trying to find everything to fit that picture?

I think in a certain sense the markets have got themselves into a slightly dyspeptic mood and they tend to take everything negatively – they are overshot. Markets reflect economic prospects and therefore as they become reality, markets come back. But They can also influence the future, so one of the risk factors is the negativity of the market and policymakers can lean against that. But it is rather a nervous time at the moment.

Do you see the Middle East falling off the edge because of oil?

At the global level, there are winners and losers with the fall of oil. The losers by large are the oil exporters and producers for example in the US, shale produces employment and capital. But there are a lot of winners, which is basically all the oil importers. That’s the reason why it’s hard to get negative about the global economy when 70 pc of the US GDP is consumption and more and more dollars are being put into the pockets of the US consumers. Japan, China and Europe too are importers. So for the global economy this re-adjustment in the oil market which to a large extent reflects the Shale revolution (revolution that stimulated the production of oil and natural gas in the US) that in itself is driven by technological innovation. Also, on the demand side the composition of GDP is becoming less energy intensive because we are moving into an informationbased economy. Technological innovation allows us to be much more efficient with the use of energy. All these factors when we come back to the Middle East, suggest that governments there are oil producers and exporters and many of them have been doing this in the past but they will have to refocus more on strengthening and diversifying their own economies and making them more resistant. They still have a lot of oil, even if the prices are low, they are exporting a lot of it and getting revenues also but they may have to adjust their economics and also in some cases social welfare systems to a different reality. Because oil at USD 30-40 is different from oil at USD 110-120.

Are they doing anything in that regard?

I am not an expert on the Middle East so I can’t comment on the country by country report but there are certainly examples. The UAE has been trying to diversify their economy for many years and some other gulf states too.