Seth Carpenter: China’s Impact on Global Growth

As the economic growth spread between Asia and the rest of the world widens, China’s reopening is unlikely to spur growth that spills over globally.

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Welcome to Thoughts on the Market. I'm Seth Carpenter, Morgan Stanley's Global Chief Economist. Along with my colleagues, bringing you a variety of perspectives, today I'll be talking about the outlook for global economic growth. It's Tuesday, April 4th at 10 a.m. in New York.

How is the outlook evolving after one quarter of 2023? The key trends in our year ahead outlook remain, but they're changing. The spread between Asian growth and the rest of the world is actually a bit wider now. And within developed market economies, downgrades to the U.S. forecast largely on the back of banking sector developments and upgrades to the euro area, largely on the back of stronger incoming data, now have Europe growing faster than the U.S. in 2023. In China, the data continue to reinforce our bullish call for about 5.7% GDP growth this year, and if anything, there are risks to the upside, despite the official growth target from Beijing coming in at about 5%.

Had it not been for the banking sector dominating the market narrative, I suspect that China reopening would still be the most important story. But China's recovery has always had a critical caveat to it. We've always said that the rebound would be much more domestically focused than in the past and more weighted towards services than industry in the past. We don't think you can apply historical betas, that is the spillover from Chinese growth to the rest of the world, the way you could in the past.

I want to highlight a recent piece that quantifies how China's global spillovers are different this time. Two main points deserve attention. First, the industrial economy never contracted as much as the services economy in China did, and that means that the rebound will be much bigger in services than it could be in the industrial economy. And second, we do try to estimate those betas, as they're called for the spillover from China to the global economy, excluding China. And what we conclude is that the effect is smaller the more important the services economy in China is for growth. Put differently, the three percentage point acceleration from last year to this year will not carry the same punch for the rest of the world that a three percentage point acceleration would have done years ago.

The modest upgrade we've made to the euro area growth is not as a result supported by the China reopening, but instead is coming from stronger incoming data that we think reflect lower energy prices and more sustained fiscal impetus. The modestly stronger outlook, though, doesn't change the fact that the distribution of likely outcomes over the next year, it's skewed to the downside. Seven months from now Europe will be starting the beginning of another winter and with it the risk of exhausting gas inventories, and with core inflation in the euro area not yet at its peak, stronger real growth is simply a reason for more hiking from the ECB.

In contrast, we have nudged down our already soft forecast for the U.S. for 2023. Funding costs for banks are higher, the willingness to lend is almost surely lower than before, but that restriction in loan supply is coming at a time where we are already expecting material slowing in the U.S. economy and therefore falling demand for credit. So the net effect is negative, but banks willingness to lend matters a lot less if there are fewer borrowers around.

So where does this all leave us? The EM versus DM theme we have been highlighting continues and if anything it's a bit stronger. The China reopening story remains solid and the U.S. is softening. Within DM the stronger growth within Europe compared to the U.S. is notable both for its own sake, but also because it will mean that the ECB hiking will look closer to the Fed's hiking than we had thought just three months ago.

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