Fitch: Emerging Market Vulnerability Weighing on Global Growth Outlook

India takes over as the fastest growing BRIC this year with 7.5% GDP growth, accelerating to 8% in 2016

In its latest Global Economic Outlook (GEO) Fitch Ratings forecasts the global economy will grow by just 2.3% in 2015, the weakest since the global financial crisis in 2009, dragged down by a recession in Brazil and Russia and a structural slowdown in China and many emerging markets (EM). We forecast a pick-up to 2.7% in 2016 and 2017 as growth recovers somewhat in EM. Growth in major advanced economies (MAEs) is forecast to strengthen to 2% in 2016, the fastest since 2011.

Fitch's global growth forecast (which is weighted at market exchange rates) has weakened marginally (by 0.1pp for 2015, 0.2pp for 2016 and 0.1pp for 2017) since June's GEO, due entirely to EM revisions.

Although the Fed left its key interest rate unchanged at its September meeting we still expect the Fed to start the global monetary tightening cycle before end-2015, followed by the Bank of England. The pace and extent of the tightening will be subdued by historical norms. Fitch forecasts the key US policy interest rate to average 0.8% in 2016 and 1.6% in 2017. The ECB and the Bank of Japan will continue their QE programmes.

EMs are becoming an increasing source of global growth risks as the collapse in commodity prices and political shocks exacerbate a secular slowdown. Our baseline forecast for China is a gradual slowdown to 6.3% in 2016 and 5.5% in 2017, from 6.8% in 2015. Although investment is slowing sharply, growth continues to be supported by robust consumption and policy easing. However, there are downside risks from the real estate sector, capital flows, and policy settings.

India takes over as the fastest growing BRIC this year with 7.5% GDP growth, accelerating to 8% in 2016 driven by structural reforms and higher investment. The current deep recession in Russia and Brazil (-4% and -3% in 2015, respectively) will be followed by only a weak recovery starting in 2016 in Russia (0.5%) and only in 2017 in Brazil (1.2%).

The US economy bounced back in 2Q15, growing at its the fastest quarterly rate since mid-2014, driven by strong domestic demand. Fitch forecasts the US economy to grow by 2.5% in 2015 and 2016, followed by 2.3% in 2017 as the economy approaches full capacity. The labour market recovery is continuing, with unemployment down to 5.1%.

Fitch expects the eurozone recovery to continue. Our outlook is unchanged since the June GEO, with GDP growth forecast at 1.6% over 2015-2017. The gentle cyclical recovery is supported by a weaker effective exchange rate, low oil prices and easing financing conditions driven by the ECB's QE programme that is being increasingly transmitted to the real economy. Nevertheless unemployment will remain above 10% until 2017.

Headline inflation in the eurozone will pick up in 4Q15, mainly due to base effects, reflecting the steep fall of energy prices a year earlier. Fitch forecasts inflation will rise to 1.1% for 2016 and 1.5% in 2017, driven by the on-going economic recovery, improving labour market conditions and a forecast increase in oil prices. Nevertheless this remains below the ECB's target and deflation risks could re-intensify in case of adverse exogenous shocks, for example, triggered by EM turbulence.

The recovery in Japan is weaker than previously expected, despite benefiting from a weaker exchange rate and higher real wages. Growth will accelerate modestly to 1.2% in 2016 from 0.8% in 2015, before slowing on the assumption of the consumption tax's increase in April 2017. The UK economy has passed the peak of its growth cycle as spare capacity is gradually absorbed. Our GDP growth forecast is unchanged at 2.5% in 2015, 2.3% in 2016 and 2.1% in 2017.

This GEO's alternative scenario explores the potential global impact of a sharp slowdown in Chinese investment. The shock scenario is based on the combination of real and financial components and would lead to a contraction in investment in China such that the level of GDP would be 6pp below the baseline by 2017. Asian countries, including Japan, would be hit most severely by the shock (3-4pp), but MAEs' GDP would also be lower by around 1.5pp by 2017 and deflation risks would increase globally.

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