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Economic analyses with Julian Voynov IBA Blog

Expected economic slowdown is a challenge for citizens and businesses

Part 1. The Global Business Environment

There is no doubt that the world economy has started to descend on the downward part of the business cycle curve. The world has long been a common economic space, thanks to global supply chains and the free movement of capital and economic problems in one part of it immediately affects the rest. Unfortunately, the current global economic downturn is due to economic policy and the trade wars started by US President Donald Trump.

The main reasons for the current negative economic development in the world can be summarized as follows:

– Reduction of individual tax rates, which benefits primarily the richest layers of American society

– Reduction of the corporate income tax from an average of 39% to an average of 25%

– Amnesty on repatriated US corporate earnings, generally held in tax-free offshore accounts

– Introduction of a corporate tax on an extraterritorial basis for US companies

– Imposition of customs duties on raw materials and goods imported by the US, such as steel, aluminum, certain consumer electronics, industrial chemicals, health and safety products, certain types of child safety furniture including high chairs and car seat, etc., dedicated mainly against China. The reason is the serious US trade deficit with China, which according to Trump can be reduced by higher duties on Chinese imports. In response, China has retaliated in regards to US imports, mostly agricultural products, affecting US farmers regarded as key voters and supporters of the US president but also stainless steel pipes and scrap aluminum.

The consequences of this economic policy are the following:

– Increased consumption and investment: Tax relieves and profit repatriation have led to increased consumption and higher investment activity, which ultimately caused the US economy to overheat and in the second quarter of 2018 economic growth reached 4.2%, the highest quarterly level in four years.

Inflation surge: Increased economic activity has led to an increase in US inflation and in the last three years between 2016 and 2018 it has doubled – from 1.27% to 2.54%.

FED’s hike of interest rates: The overheating US economy and rising inflation forced the Federal Reserve to start raising its key interest rates and from 0% in 2015 at the end of 2018 they reached 2% – 2.25%, the highest level for the past 10 years.

Debt service issues: The higher interest rates has affected the loans in dollars what hit many countries and particularly those with high foreign debt. In 2018 serious problems experienced Turkey, whose short-term debt in foreign currency exceeds 50% of GDP and Argentina, which has concluded an agreement with the IMF as well as several other emerging markets.

– Dollar strengthening pushed ”hot” money withdrawing: US dollar exchange rate rise further aggravated the debt repayments of some countries with high foreign currency liabilities, which in turn led to the withdrawal of ”hot” money from emerging markets – the cause of turbulence at capital markets in the summer of 2018.

Contrary to the expected effect of higher US tariffs: At the same time, the higher tariffs imposed on part of the Chinese imports not only did not reduce the trade deficit with China, but on the contrary. In 2018, China reported a record increase of its trade surplus with the US, which reached USD 323.32 billion, the highest level since 2006. China’s exports to the US increased by 11.3% annually in 2018 to USD 478.4 billion, while US imports to China reported an increase of 0.7%. This is clear evidence of the inadequacy of President Trump’s measures to address the US trade deficit with China.

Negative impact on US budget and business: On the other hand, Trump’s economic measures have led to two more negative outcomes for the United States: first, to an unprecedented level of budget deficit, which for the fiscal 2018 reached USD 779 billions, the highest level since 2012 and, secondly, to the very serious losses of US farmers who have suffered severely from China’s retaliation, especially on imports of American soybeans, which has prompted the US government to grant subsidies to these farmers for about USD 20 billions, given that farmers are among Trump’s main voters.

Daniil Peshkov_xl

The consequences listed above concern not only the United States. They have global implications and impact the entire global economy. China also suffered from the higher tariffs imposed on the Chinese exports:

– Depreciation of RNB. China’s capital account is closed, which means that there is no free capital movement and the country’s exchange rate is regulated by the central bank. To counter higher tariffs, the Chinese National Bank has devalued the yuan, which is tantamount to cancelling higher tariffs over Chinese exports. Trump, of course, has reacted and threatened to raise tariffs again, and only the agreement between him and Chinese President Ciang Jinpin at the G20 summit in Argentina for a commercial truce until the end of February has hindered the further escalation of trade wars.

Economic slowdown. Despite China’s attempts to neutralize the impact of the trade war with the United States, the negative effects on the Chinese economy have become visible and China’s economic growth in 2018 has slowed significantly. The Chinese government’s goal was economic growth of more than 6.5%, while the latest known plans are already targeting GDP growth in the range 6% – 6.5%. The main reason for the slowdown is the lower growth of the industry, as well as the beginning of the process of deleveraging.

Liquidity support to Chinese banks. Since China’s main tool to maintain high growth until recently was through credit growth, the economic slowdown has been taken very seriously by the Chinese authorities, and recently the Chinese National Bank has poured additional liquidity into the banking system, at an unprecedented level to date in a single day of USD 84 billion in order to boost the growth.

Given the enormous impact on the global economy of the situation in the two largest economies in the world, it is inevitable that the slowdown in their development will have a serious impact on the rest of the world. In terms of Europe and the EU, the main driver of the European economy, Germany, was affected simultaneously and the country did not enter into recession in the fourth quarter of 2018, thanks only to the fact that the last quarter of the year was one business day larger than the third one and the country has seen GDP growth of 0.1%. However, annual growth declined to 1.5%, which is 0.7 percentage points lower than the level recorded in 2017, namely 2.2% and the lowest score for the last 5 years.

The main reasons for Germany’s declining growth are as follows:

– The severe drop of 18% in exports of pharmaceuticals to Ireland (0.5% of GDP)

– The impact of the higher tariffs that the United States has on basic German export products (0.6% of GDP)

– Decreased demand from China (around 0.2% of GDP)

– The decline in industrial production of -1.7% on a quarterly basis

– Lower sales of new cars

It is clear that the interdependence between the economies has its price and the reduced economic development in some countries, especially when it comes to the US and China, leads to reduced economic activity of all others. According to the WB’s latest global outlook report, the world economy will slow down to 2.9% in 2019, a 0.1 percentage point decrease compared to the July forecast of the bank and an expected 3% in 2018. The US economy is expected to slow to 2.5% from 2.9% in 2018 and euro area economic growth will reach 1.6% from 1.9% last year.

On the basis of everything said so far, it is clear that the world is entering a downward economic cycle and whether it will turn into recession and how deep it will be will be detected very soon.

Bulgaria will inevitably follow the global economic trends, especially since its main trading partners are countries facing serious economic problems. We have already mentioned Germany, but in similar situation are Italy, Turkey, Romania, Greece and so on. It is almost impossible for Bulgaria to expect that its economy will grow by more than 3% in 2019 and the projected growth of 3.7% in the next year’s state budget looks like a chimera. The main driver of economic growth in 2019 will be consumer demand, but it will not grow at such a pace as in the previous year.

In this situation, it is important for citizens and businesses to review their budgets and strategies and prepare for a significantly weaker business year than in 2018. What these measures could be, this will be the subject of the next article!

By Julian Voynov

Highly skilled multilingual economic and financial analyst with more than 15 years professional experience in research centers, analytical think-thanks, and financial institutions, including governmental and supranational organizations, using econometric software, with many analytical publications

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