24 October 2016
The Federal Reserve is expected to raise interest rates this month. Photo: Bloomberg
The Federal Reserve is expected to raise interest rates this month. Photo: Bloomberg

Three major risks in a world with divergent economies

The US Federal Reserve is set to raise interest rates soon, while Europe is poised to expand monetary easing to contain the deflationary risk.

Clearly, the United States and Europe are treading divergent paths, and the situation presents three major risks that could affect global economic growth.

First, the chance of a Fed liftoff this month has reached over 80 percent. Two of three conditions for a rate hike have already been met. The US non-farm payrolls rose by 271,000 in October, and the unemployment rate dropped to 5 percent.

Inflation is the only uncertainty. The core personal consumption expenditure rose by 1.3 percent in October, lower than the goal of 2 percent.

Second, the terrorist group Islamic State has become a major threat to European nations like France and Germany, which have been receiving huge tides of refugees from North Africa and the Middle East.

The Paris terror attacks have exposed weaknesses in France’s police and security capability. It’s estimated that France would need 20 billion to 30 billion euros (US$21.2 billion to US$32 billion) to adequately tackle security issues.

Meanwhile, Germany is also on a bumpy road. It has already received more than 800,000 refugees, and the number is likely to surpass a million by year-end. The refugee issue may affect the nation’s economic growth in coming years.

Frankly speaking, the entire Europe has been taken hostage by the refugee issue. The nations have to deploy more resources to help the refugees settle down.

And if, say, a dozen terrorists are able to enter Europe by pretending to be refugees, they could present a long-running threat to the security of these nations.

Third, friction between Russia and Turkey over the downing of a Russian warplane may result in military action.

So far the incident has had two results. Crude oil price surged to a two-week high on Nov. 24, while Brent soared to US$46.12 per barrel. Oil price has jumped 8 to 10 percent since the downing of the Russian fighter jet.

Oil price may rebound to US$60 if Russia and Turkey resort to military action against each other. Also, gold may bounce back.

By contrast, the euro could face more downward pressure due to diminishing competitiveness. The euro might weaken to below 1 against the US dollar next year.

In China, the risk of economic slowdown is largely “manageable”.

We have to separate China’s financial market from the real economy when assessing its performance.

The nation’s financial market has survived the worst after the market meltdown in July. It seems the destabilizing force has been placed under control.

Meanwhile, the divergence between the real economy and the financial market remains unresolved.

Some private companies, particularly small and medium-sized firms, continue to suffer from very limited access to funding.

How to break the monopoly held by state-owned banks, and efficiently connect capital suppliers with the demand side remains an issue.

Over the last six months or so, China has gone through a “Financial Great Leap Forward”.

Everyone was so eager to find a short cut using huge leverage. Many small private business owners put their money in the stock market in April, when the authorities were promoting a bull market.

However, as much as 3 trillion yuan (US$468.8 billion) vanished during the market crash in the summer.

In that case, China’s real economy is likely to struggle further in the next one or two years, as it takes time for private capital to recover along with structural changes under way.

This article appeared in the Hong Kong Economic Journal on Dec. 1.

Translation by Julie Zhu

[Chinese version中文版]

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adjunct professor in the Department of Finance at HKUST Business School

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