Global growth is expected to be resilient in 2017, with advanced economies’ confidence indicators posting multi-year highs and EMEs clocking improved performances aided by higher commodity prices, notes the Bank for International Settlements. In its 87th Annual Report, the BIS report points out that the feared sharp slowdown in China didn’t materialize, thanks to timely support provided by authorities to its economy, but there remains great risks amid the ongoing Chinese debt buildup.

BIS Report – Globalization comes under a protectionist threat

The BIS report notes that the global economy has gathered momentum, amidst reduced unemployment rates and inflation readings moving closer to central bank objectives.

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Strengthening global economy BIS Report

However, despite reaching the best near-term prospects in a long time, the report notes that globalization, as a powerful engine of world growth, has slowed and come under a protectionist threat. The BIS report touches upon four risks that could threaten the sustainability of global growth in the medium term: rising inflation, financial stress, weaker consumption and a rise in protectionism.

Describing the financial market sentiment as "remarkable," the BIS report highlights a shift in the main forces that are driving the markets. For instance, politics took over from central banks after the Brexit vote and the U.S. election. The report notes that instead of broad-based swings between “risk-on” and “risk-off” positions, investors started to differentiate more across sectors and countries.

The BIS report highlights that despite virtually all major economies expanding by early 2017, shrinking measures of economic slack indicated that the expansion was maturing. The BIS report notes that consumption-led growth is less durable amid a rise in credit especially a Chinese debt buildup, and a rise in protectionism could challenge the open global economic order.

Chinese debt buildup not only issue, As Tariff on U.S. imports from China would result in cost shock

The BIS report notes that international trade not only relies on but also generates financial links. The report points out that international trade and finance have enhanced competition, driving efficiency gains and aggregate productivity.

In an exclusive analysis, the BIS report highlights how sensitive U.S. production costs are to tariffs on imports from China and Mexico. By considering a hypothetical tariff of 10% on imports originating in China and Mexico, the report highlights the propagation of protectionist measures through global value chains. Touching upon the direct and indirect effects of such tariffs, the report points out that if a tariff increases the cost of oil imports from Mexico, U.S. production costs for goods that use oil as an input, such as plastics or chemicals, would also increase. The following graph captures the resulting cost shocks, as U.S. wages would have to be reduced to fully compensate for the increasing costs of imported inputs.

Tariff on US imports

The BIS report suggests that properly designed domestic policies could enhance the gains from globalization and mitigate the adjustment costs.

However, as always China is the wildcard as the BIS report notes about the Asian giant and in particular about the Chinese debt buildup:

Many EMEs experienced slowing financial booms and some outright downturns in 2016. In aggregate terms, both real house prices and credit relative to output flattened out. Excluding China, EMEs even experienced a small reduction in their credit-to-GDP ratio. This reflected, in particular, downturns in Brazil and Russia, with sustained house price and credit declines (Annex Tables A2 and A3). The corporate debt ratio fell by 3–5 percentage points in Brazil, India, Korea and Russia, but increased further in China. These changes followed rapidly rising corporate debt post-crisis in many EMEs. Between 2007 and 2016, the EME corporate debt ratio rose on average by 19 percentage points, most prominently in China (by 70 percentage points to 166% of GDP). Household debt ratios also rose in some EMEs over the past year, particularly in China and Korea, to 44% and 93% of GDP, respectively.

Chinese debt buildup bis report

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position in the financial cycle is considered (Chapter III). Standard metrics, such as credit-to-GDP gaps, signal financial stability risks in a number of EMEs, including China and other parts of emerging Asia.

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In particular, the feared sharp slowdown in China did not materialise, as the authorities stepped in once more to support the economy, albeit at the cost of a further expansion in debt.

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In some cases, such as China, the booms are continuing and maturing; in others, such as Brazil, they have already turned to bust and recessions have occurred, although without ushering in a full-blown financial crisis.

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In EMEs, a cause for concern has been the sharp increase in corporate debt in several economies, sometimes in foreign currency. Indeed, empirical evidence points to a link between US dollar appreciation and investment weakness in many EMEs (Chapter III). China stands out, given the combination of  unprecedented debt-financed investment rates and signs of excess capacity and unprofitable businesses. A sharp slowdown there could cause much broader ripples in EMEs, including through a slump in commodity prices.

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