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Recent trends in the global economy and near term outlook

Juris Kravalis

Head of International Relations andCommunication Department

13.11.2014

Global Economy

Where is the growth?

Source: IMF’s World Economic Outlook, October 2014

Global activity and trade in the first half of 2014 were weaker than expected

Source: IMF’s World Economic Outlook, October 2014

Growth in emerging market economies is slowing down

Source: IMF’s World Economic Outlook, October 2014

The U.S. economy is back on track

Source: IMF’s World Economic Outlook, October 2014

The shale energy boom has played an important role in the U.S. recovery

Recovery in the euro area is still fragile

GDP growth (annualized quarterly percentage change)

Source: IMF’s World Economic Outlook, October 2014

Sovereign bond spreads in the euro area have come down, butdifferences in lending conditions to SMEs are still substantial

Source: IMF’s World Economic Outlook, October 2014

Asset quality review by the ECB a significant steptowards getting lending in the euro zone going again

• The ECB is taking over supervision of the largest euro area banks from thenational regulators on 4 November 2014

• The asset quality review and stress tests carried out earlier this yearidentified capital shortfalls totalling EUR 25 billion at 25 euro area banks

• Banks with shortfalls to submit capital plans by 10 November 2014

• Banks with capital shortfalls will have 6 – 9 months to remedy thesituation

• Improved bank capitalization should contribute to recovery of the lendingmarket in euro area

European CIS countries are close to stagnation

Source: IMF’s World Economic Outlook, October 2014

Growth in Asia is holding up

Source: IMF’s World Economic Outlook, October 2014

Overview of the World Economic Outlook projections by the IMF

Overview of Euro area projections by the European Commission

Inflation in the euro area below that in the U.S. and themedium term target of close to but below 2%

Source: IMF’s World Economic Outlook, October 2014

Central Bank balance sheet paths to diverge going forward

• The U.S. Fed announced the endof Quantitative Easing on 29 October 2014

• The ECB announced additionalmonetary policy easing in Juneand September of 2014 andstarted purchases of asset backedsecurities (ABS) in October 2014

• Bank of Japan is continuingagressive monetary easing

U.S. Fed expected to start raising rates in 2015

Source: IMF’s World Economic Outlook, October 2014

Key near term risks going forward

• Geopolitical risks

• Risks from a financial market correction

• Volatility resulting from monetary policy normalization in the United States

• Protracted period of low inflation in the euro area

• Risk of stagnation and lower potential growth in a number ofadvanced economies

• Considerably slower growth in China

Policy recommendations

• Both continued support to demand and supply side policies needed

• Increased public investment in most current account surplus countries(other than China)

• (Continued) structural reforms in the (former) current account deficitcountries

• Macroprudential tools (such as loan-to-value, debt-service-to-incomeratios) to limit credit booms in a number of smaller advanced economies

Policy recommendations: Euro area

• Reestablish confidence in banks and improve financial intermediation inthe euro area

• Cost-effective active labor market policies, measures to lower the opportunity cost of employment, and better-targeted training programs

• Complete the single market in services, including a single digital market

• Make progress with free trade agreements

• More closely integrate energy platforms and policies

Fiscal Outlook

The fiscal outlook

• Immediate fiscal pressures have lowered (due to low interestrates)

• However, underlying fiscal vulnerabilities persist (as shownby high debt levels)

• Moreover, growth is weaker than expected and inflationremains low

Advanced economies: Proceeding with consolidationwhile supporting employment and growth

Emerging market economies: Consolidation postponed; It is time to rebuild fiscal buffers

Job creation is at the top of political agenda

• Global unemployment exceeds 200 million people

• In AEs: raising concerns about permanent skills and human capital erosion associated with long-term unemployment and inactivity

• In EMEs: informality remains high and job creation insufficient to absorb the large number of young people entering the labor market

Do lower taxes mean higher employment?

Impact of social security contribution (SSC) cuts

Targeted SSC cuts: Successful examples

Targeted SSC cuts: Not so successful examples

Financial Stability

Global financial stability assessment

• An increase in risk appetite has driven the search for yield and pushed up market and liquidity risks

• Credit risks have declined, reflecting favorable funding conditions and improved asset quality

Accommodative monetary policies have led to

• Increased economic risk taking

– Improving the outlook for capital expenditure(especially in Japan, the US, and the UK)

• And possibly too much financial risk taking, as reflected in

– Compressed credit spreads

– Low volatility

– Elevated and highly correlated asset prices

Banks have become stronger

But they also need to adjust business models

• Return-on-equity has fallen to a historically low level.

• Investors demand high returns from banks, with the cost of equity having risen since before the crisis

• As a result, banks accounting for 80% of total assets of the largest institutions currently have a so-called “return-on-equity gap”

Transition needs are large

What should banks do?

• Reprice current business lines

• Re-allocate capital away from low-risk assets

• Retrench from some activities

• Restructure weak banks

• Resolve unviable banks

• Move away from cross-subsidization

Shadow banking has increased

• Financial intermediaries or activities involved in credit intermediation outside the regular banking system, and thus lacking a formal safety net

It constitutes about one-fourth of total financial intermediation worldwide

Benefits and risks of shadow banking

• Can complement traditional banking by expanding access to credit or by supporting market liquidity, maturity transformation, and risk sharing

• The global financial crisis revealed that, absent adequate regulation, shadow banking can put the stability of the financial system at risk

• However, assessing risks associated with recent developments in shadow banking remains difficult, largely because of a lack of detailed data

Role of financial policy

• Support Economic Risk Taking

– Improve flow of credit to the economy

• Facilitate banks’ transition to new business models

• Encourage (safe) non-bank credit

• Address Excessive Financial Risk Taking

– Macroprudential policies as a first line of defense

– Address rising market liquidity risks in shadow banking

• Prevent market runs

• Prepare contingency measures

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Latvijas Banka

Latvijas Banka:• līdzdarbojas monetārās politikas

noteikšanā un īstenošanā;

• pārvalda rezerves aktīvus, t.sk. zelta rezerves;

• veicina maksājumu sistēmu raitu darbību;

• nodrošina starpbanku maksājumus;

• nodrošina raitu skaidras naudas apriti valstī;

• vāc, apkopo un publicē finanšu statistiku;

• pārstāv Latvijas intereses starptautiskās finanšu institūcijās.

To dara:• ekonomisti un ekonometristi;• grāmatveži;• finanšu tirgus analītiķi;• statistiķi;• maksājumu sistēmu eksperti;• finanšu ieguldījumu portfeļa vadītāji;• kases operāciju metodikas eksperti;• maksājumu un finanšu tirgus analītiķi.

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Studentu zinātniski pētniecisko darbu konkurss

Darbu iesniegšana:Bankā no 2015. gada 18. maija līdz 29. maijam.

Naudas balvas:I vieta – 2000 eiro;divas II vietas – 1 250 eiro katram;trīs III vietas – 700 eiro katram.

Konkursa mērķis: veicināt Latvijas tautsaimniecības makroekonomisko problēmu apzināšanu un analīzi un stimulēt augstāko mācību iestāžu studentu pētnieciskās domas attīstību.

Tēmas: piedāvāts plašs makroekonomisko tēmu loks, kas aplūkojamas Latvijas, Baltijas valstu vai eiro zonas tautsaimniecības kontekstā.

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