Shiran Fernando highlights the global economic themes that could play out this year together with their impact

As much as local developments have an impact on the Sri Lankan economy, changes on the global front play a significant role in the outlook for domestic trade, forex and investment. In this month’s column on the economic outlook, we highlight potential themes that could play out in the global arena during 2018 as well as their impact on the local economy.

GROWTH Almost 10 years after the global financial crisis, the world’s growth outlook appears more promising than bleak. According to the OECD, all 45 economies that it tracks are growing for the first time in a decade.

With 34 of the 45 economies witnessing an acceleration in growth, this period has been aptly coined as one of ‘synchronised global growth.’

And when it comes to world trade, the signs also point to an acceleration. Global manufacturing activity (measured by the Purchasing Managers’ Index) reached a 78 month high in October 2017, highlighting an increase in the pace of orders and exports. There is also more optimism among global businesses with October’s IHS Markit Global Business Outlook survey reaching its highest level in three years.

These signs augur well for Sri Lanka as the countries where synchronised growth is being led are key export markets. The demand created through an improved global growth environment should help increase earnings from exports in 2018.

US TAXES In December, the US saw a key piece of tax legislation being passed; it reduced the corporate income tax rate from 35 percent to 22 percent. The worry in Asia is that the headquarters of global businesses will start relocating from the region to the US. Broadcom has already relocated its legal headquarters from Singapore back to the United States.

While there are factors beyond tax rates that affect investment decisions, this development is a wake-up call for the Asian region. It could potentially be a catalyst for countries in the region including Sri Lanka to improve their competitiveness and ease of doing business.

FED HIKES The US Federal Reserve’s cautious and communicative approach to interest rate increases helped emerging market currencies such as the Sri Lankan Rupee last year. Emerging market stocks and currencies enjoyed their best performance in over eight years.

The Fed stuck to three rate hikes in 2017 as communicated at the end of the previous year. A similar message of three more hikes in 2018 has been conveyed; and if such a case materialises, we can potentially see 2018 being a positive year for currencies and certain classes of assets in emerging Asia once again.

However, if the US economy improves more than forecasted and overheats as a result of the boost from lower tax rates, we could be in for more hikes than expected. In such a situation or if other central banks tighten monetary policy more than expected, it could have an adverse impact on emerging countries.

Once again, clear communication and forward guidance will reduce the prospect of volatility in markets resulting from such moves.

CHINA FOCUS Following the National Congress of the Communist Party in October, the policy signals indicate that the Chinese government is more focussed on the quality of growth rather than speed. This policy direction will help ease and control some of the financial risk that exists in the system.

However, the odd bout of volatility in China’s financial markets cannot be ruled out with reforms ongoing. The more interesting development to watch out for will be from the Chinese Belt and Road Initiative (BRI). This will present opportunities for the region to not only develop hard infrastructure but plug in more towards trade and investment.

GEOPOLITICS Tensions in the Korean Peninsula are likely to continue into 2018, which would not only affect countries such as Vietnam and South Korea but also result in periods of volatility in global markets.

Such periods of volatility can reduce the appetite for investor risk, and lead investment flows to safe haven assets such as gold and US treasuries. As such, Sri Lanka will need to time its reentry when raising bonds in international capital markets.

OIL PRICES Oil prices rose in 2017 on the back of OPEC’s policy decision to implement production limits amidst a rebalancing of excess supply in the market.

This year, the consensus according to a Reuter’s poll of analysts is for the rising trend in the price of oil to continue. This is based on the improving demand for oil, and commitments by OPEC and its allies to maintain production cuts until the end of 2018. A rise in oil prices will have an impact on Sri Lanka’s fuel import bill, which rose in 2017 alongside adverse weather conditions.

While other global themes could emerge, the local economy will need to weather such risks by strengthening external indicators like the country’s reserves.