Ahead of the G20 meeting of finance ministers and central bank governors in Sydney on 22 and 23 February 2014, the International Monetary Fund (IMF) released a report titled "Global Prospects and Policy Challenges", which discusses recent global economic developments as well as an outlook for the near future. According to the report, global economic activity picked up in the second half of 2013, largely due to improved conditions in advanced economies, thus boosting exports in many emerging markets.
However, domestic demand in most emerging economies has weakened, reflecting in part tighter financial conditions in these markets: "Financial volatility affected emerging market economies as markets reassess their fundamentals. While the pressures were relatively broad-based, emerging economies with relatively high inflation and high current account deficits saw the largest asset price declines initially." In the case of Indonesia, speculation about the looming end of the Federal Reserve's quantitative easing program since late May 2013 resulted in severe capital outflows as the country recorded inflation of nearly 9 percent (year on year) in the second half of 2013 after the government had raised prices of subsidized fuels in June 2013. Moreover, amid robust domestic demand and weak exports, the country's current account deficit reached a record high of USD $9.9 billion in Q2-2013 (or, 4.4 percent of Indonesia's GDP, an unsustainable level).
Recently, markets are showing signs of financial stabilizing, albeit fragile, due to monetary and fiscal policy changes in several key emerging economies to boost confidence and strengthen their policy commitments. "However this episode underscores vulnerabilities as well as the challenging environment for many emerging markets. The rapid jump in global risk aversion had also driven down advanced economy equity prices."
The IMF has not significantly changed its outlook for global economic growth compared to the January report, as the institution assumes that the impact of recent financial volatility is short term only: "in advanced economies, less fiscal consolidation and relaxed financial conditions will support growth this year, while near-term prospects for emerging economies are broadly unchanged." The IMF expects the world economy to grow about 3.75 percent in 2014 (from 3.0 percent in 2013) and 3.9 percent in 2015. Regarding Indonesia, the forecast for economic expansion in 2014 is set at 5.3 percent and 5.8 percent in 2015.
Real GDP Growth Projections IMF (annual percent change):
Source: International Monetary Fund (IMF)
The IMF expressed its concern about capital outflows, higher interest rates, and sharp currency depreciation in emerging markets: "a persistent tightening of financial conditions could undercut investment and growth in some countries given corporate vulnerabilities."
Further action and cooperation are needed to promote financial stability and robust recovery. Particularly:
Advanced economies should avoid premature withdrawal of monetary accommodation as fiscal balances continue consolidating. Given still large output gaps, very low inflation, and ongoing fiscal consolidation, monetary policy should remain accommodative in advanced economies. There is scope for better cooperation on unwinding UMP, including through wider central bank discussions of exit plans. In the euro area, repairing bank balance sheets remains critical to monetary policy transmission. Finally, fiscal consolidation should proceed at a measured pace, while preserving the long-run growth potential of the economy.
In emerging market economies, credible macroeconomic policies and frameworks, alongside exchange rate flexibility, are critical to weather turbulence. Further monetary policy tightening in the context of strengthened policy frameworks is necessary where inflation is still relatively high or where policy credibility has come into question. Priority should also be given to shoring up fiscal policy credibility where it is lacking; subsequently buffers should be built to provide space for counter-cyclical policy action. Exchange rate flexibility should continue to facilitate external adjustment, particularly where currencies are overvalued, while FX intervention - where reserves are adequate - can be used to smooth excessive volatility or prevent financial disruption.
Further policy actions are needed to reduce unemployment and strengthen medium-term growth, while making it more balanced. Key policies to boost potential include competition-enhancing product market reforms, infrastructure investment, and labor participation reforms, while further action is needed to avoid a resurgence of global imbalances as the recovery proceeds and ensure sustainable medium-term growth.