Global economy : 5 issues that Will make or break the world economy in 2015

T he world economy enters
2015 at a fork in the road.

One track leads to the self-
sustaining vigorous recovery that
policy makers have sought in vain
ever since the financial crisis
erupted in 2007. Lower oil prices
get consumers spending and
businesses investing. Memories of
the biggest recession since the
1930s are finally banished. The
rest of the world starts to look
like a revitalised US.
The other track leads back
towards recession. Problems that
have been stored up since 2008-09
can be contained no longer. A
financial crisis erupts in the
emerging markets. China has a
hard landing. Greece sparks off a
fresh phase to the eurozone’s
struggle for survival. Deflation
sets in. The rest of the world
starts to look like Japan. Here,
then, are five issues that will
define a make-or-break year.

Russia and the Ukraine

The Russian economy will go into
deep freeze in 2015. Even before
the dramatic plunge in the rouble
in the weeks running up to
Christmas, the central bank was
predicting a fall in output of
4.5%. Pushing up interest rates
from 10.5% to 17% in one move
may well help to stabilise the
rouble and prevent further capital
flight – but at a cost. Neil
Shearing of Capital Economics
says history is about to repeat
itself; just as after the debt
default of 1998, Russia is “staring
down the barrel of a deep
recession”. The depth of that
slump, Shearing says, will depend
on what happens to the price of
oil and whether the west lifts the
economic sanctions that it has
gradually been intensifying since
last spring.
Two other things are also unclear.
Firstly, how Vladimir Putin will
respond. The Russian president
offered the people a bargain:
accept a hard man in the Kremlin
in return for rising living
standards. That deal will be
broken in 2015, and there is no
guarantee that it will encourage
the Kremlin to take a softer line
over Ukraine. On the contrary, a
failing economy could spur Putin
into acts of nationalist defiance.
That would not just intensify the
recession; it would also have
knock-on effects for Russia’s
neighbours and for the eurozone.
The second unknown is whether
Russia will be a special case. The
fear is that it will set off a chain
reaction across other emerging
markets that have attracted the
copious amounts of footloose
capital generated by the
quantitative-easing (money-
creation) programmes of the
world’s central banks. Turkey and
Indonesia and are two big
countries to look out for.

Oil

In the summer of 2014, a barrel of
Brent crude was changing hands
at $115 a barrel. By Christmas it
could be obtained for barely half
that price. The big drop in the oil
price is positive for global growth:
it puts more spending power in
the hands of consumers and it
cuts costs for businesses. The link
between the cost of crude and the
world economy is well
established: the long booms of
1948-1973 and the 15-year period
that preceded the great recession
of 2008-09 were both built on
cheap oil. The four recessions of
the postwar era (1974-75, 1981-82,
1990-91 and 2008-09) have all
been associated with rising oil
prices. Trevor Greetham, director
of asset allocation at Fidelity
Solutions, says: “A low oil price is
a stimulus for consumers. Global
growth should pick up over 2015
and there are as yet few signs of
the kind of inflation that would
necessitate meaningful monetary
tightening.”
But there is a caveat. Greetham
says the plunging oil price could
prompt “credit stress”. This would
affect governments, such as
Russia, Venezuela and Iran, that
can only balance their books if
the oil price is at $100 a barrel or
more. And it would affect the
shale gas sector in the US, where
much of the investment has been
financed by high-yielding but
risky junk bonds. As the Bank of
England points out in its recent
Financial Stability Review : “As US
oil and gas exploration firms
account for 13% of outstanding
debt in US high-yield bond
markets, an increase in the
preceived or realised credit risk in
this sector could lead to sales by
investors and potentially illiquidity
in the broader high-yield market”.
In other words, shale could be the
next sub-prime.

China

China will be crucial to the
performance of the global
economy in 2015. Depending on
the yardstick used, it is now the
world’s biggest economy. It is
also, according to Kenneth Culkier
of the Economist magazine, a net
exporter of foreign direct
investment. China could soon join
the select club of countries with a
reserve currency.
But 2014 has been an uneasy
year, as Beijing has tried to mop
up the credit excesses left behind
after the growth-at-all-costs
approach adopted during the deep
downturn of late 2008. Policy
makers have been running a tight
ship and the constraints on credit
have started to bite. Growth will
be lower in 2015: the question is
how much lower.
A marked slowdown would affect
the rest of the world in two big
ways. First, exports to China
would weaken. This would affect
countries such as Germany, which
sell the machine tools needed for
China’s industrial expansion, and
those, such as Australia, that
provide China with its raw
materials. A sluggish Chinese
economy in 2015 will compound a
low oil price.
Second, China will export deflation
to the rest of the world. The
prices of goods leaving China are
already falling and that trend will
continue. The US and Europe will
be flooded with cheap Chinese
goods, driving down inflation. In
the case of the eurozone, it may
result in deflation. Central banks,
faced with inflation being well
below target, will be cautious
about raising interest rates even
if their economies are growing at
a healthy rate, risking the
recreation of the conditions that
led to the pre-2007 asset bubbles.

US

Next year will be hugely
significant for Janet Yellen and
her colleagues at the Federal
Reserve, and for global markets. A
focus for investors in the new
year will be the timing of the first
rise in interest rates. Rates have
been in a record low range of
between zero and 0.25% since
December 2008, but the economy
has been gaining momentum in
recent months. The Fed has
already called time on its $4.5tn
bond-buying programme,
completing its final purchases in
October. Winding the clock back
to May 2013, then chairman Ben
Bernanke triggered a so-called
“taper tantrum” when he
suggested the Fed might start
slowing the rate of its bond-
buying sooner than markets were
expecting. Investors – hooked on
ultra-loose monetary policy since
the crisis fully erupted in 2008 –
took fright and triggered a fresh
wave of volatility.
Given we’re talking about the
world’s largest economy,
speculation on the first rate rise
will have repercussions around
the world. Investors will
scrutinise Fed statements for any
change in tone that might indicate
when the first increase will come.
Until it does come, uncertainty –
despised by markets – will reign.
At its latest policy meeting in
December, the Fed dropped its
insistence that rates would be
kept on hold for a “considerable
period”, replacing it with the
message that it could be “patient”
about policy changes. Within
minutes of the statement, New
York’s Dow Jones Industrial
Average shot up 1.5%, as investors
interpreted it as a signal that
there would be no mad rush to
raise rates. However, if the
economic data in the coming
weeks and months continues to
reflect a strengthening US
economy , the Fed’s patience may
wear thin. Expect market
volatility when the central bank
drops its cautious tone as it paves
the way for the first rate rise
since the great recession.

Eurozone

The eurozone is the crisis that
keeps on giving, and there is
every reason to believe this will
remain the case in 2015. Mario
Draghi, the eloquent president of
the European Central Bank , lifted
the single currency bloc out of the
worst phase of the crisis in the
summer of 2012 simply by saying
that he would do “whatever it
takes” to save the euro. But he
now faces one of his biggest
challenges yet.
In 2014, the story in the eurozone
was one of a recovery that failed
to get off the ground and of the
mounting threat of deflation.
Neither of those problems has
gone away, with growth of just
0.2% in the third quarter of 2014
and an annual inflation rate of
0.3% at last count in November.
Greece and Spain are already
stuck in a deflationary rut and
there is concern that a dangerous
deflationary spiral will spread to
the rest of the region. The fear is
that as prices continue to fall,
businesses and consumers will
delay spending plans as they
expect prices to fall further. With
a backdrop of weak growth, low
oil prices and general lack of
inflationary pressures, the ECB’s
battle against deflation will
continue well into 2015.
Measures announced in 2014 –
including charging banks to park
cash with the central bank in a
bid to encourage more lending –
have failed to provide a silver
bullet. The bank has one weapon
left up its sleeve: full-blown
quantitative easing.
So far the eurozone’s
policymakers have failed to take
the plunge with QE, largely as a
result of forceful opposition from
Germany. But 2015 could be the
year to abandon the hints and
throw the kitchen sink at the
problem. More weak data from
the eurozone will make investors
nervy. Failure to press the QE
button in the face of weakness
could trigger outright panic.
The relevance for the UK is huge:
policymakers at the Bank of
England and within government
have repeatedly warned that
fragility in the eurozone is one of
the biggest threats to the UK
recovery, not least because it is
Britain’s biggest trading partner