International Monetary Fund is expected to lower its global growth projections at its April spring meeting
When oil prices fell in 2014, it was widely expected that growth would get a boost globally. This was more likely for oil importing countries as purchasing power shifted from oil producers to consumers. Yet that scenario did not materialize: world output growth forecasts were successively downgraded in 2015; global trade languished. Moreover, 2016 appears to be heading that way, too. Once again, the International Monetary Fund (IMF) is expected to lower its global growth projections at its April spring meeting; this would follow a 20 basis points downward revision in January— to 3.4%.
Ahead of that, however, the organization offers a peep as to why lower energy prices may have failed to deliver the much anticipated kick to growth.
In a March 24 blogpost by Maurice Obstfeld, its chief economist, and co-authors Gian Maria Milesi-Ferretti and Rabah Arezki, the IMF notes that while consumption and investment have both weakened in oil exporting economies, the demand outturn in oil importers hasn’t been very different either. Certainly, the latter group hasn’t shown the kind of robustness one would expect from a 65% drop in oil prices.
This is counter-intuitive, prompting the question as to what might be obstructing a demand pickup in these countries. Note that cheaper oil was expected to yield net positive gains to global growth, notwithstanding the fall in producer incomes in oil exporter countries.
The IMF identifies some unique behavioural features of the global economy that might explain this. This is the extraordinary coincidence of falling oil prices and slow economic growth. To combat the latter, central banks have had to resort to unorthodox monetary policies. But nominal interest rates cannot fall below zero. Hence the extraordinary “...decline in inflation (actual and expected) owing to lower production costs...” (Oil prices) has raised the real rate of interest, which is “...compressing demand and very possibly stifling any increase in output and employment.” The Fund suspect something to this effect might be playing out in these countries.
The irony here is that inflation, or oil prices in this context, needs to rise for expansionary effects to be seen, simply because higher inflation would lower the real rate of interest. While the IMF’s World Economic Outlook will spell out the underlying details when released next month, the observations indicate that this time it is unusually different and the real rate of interest matters for investment, output and employment aggregates.
The Fund’s observations apply to India, an oil importer where lower production costs haven’t visibly translated into increased investments, jobs and so on, although gross domestic product growth remains strong and steady.
Overall terms of trade gains are estimated to be around 1-1.5 percentage points for India—a significant chunk of this has gone to the government, helping offset the fall in direct tax revenues and to enable higher capex spending to revive growth, while the cheap oil price-pass-through to consumers has been about 25%.
Yet aggregate industrial production growth is the same as last year’s levels, the slack in capacities is progressively higher, investment continues to decline and even the consumption revival does not show sustained strength. Producer prices have been in the negative zone for nearly a year and a half, while nominal interest rates are benchmarked to the much-higher retail price inflation.
Is it then a ridiculously high real interest rate that is inhibiting investments in India? Some have argued not, but the IMF’s research insight is that real interest rates matter considerably.
Renu Kohli is a New Delhi-based economist.
