COLOMBO: The world economy appears to be booming – in its latest World Economic Outlook Update, published on January 22, the International Monetary Fund (IMF) estimated that global gross domestic product (GDP) grew by 3.7 percent last year, up from 3.2 percent in 2016, which is the fastest rate of expansion since 2011. What’s more, this pick up in the global economy has been unusually broad-based. GDP growth has strengthened across the developed world, driven by stronger export and investment growth, while the major emerging economies have also performed well.
This suggests that the world economy is finally shaking off the effects of the global financial crisis a decade ago. Indeed, the early signs indicate that last year’s strong momentum has carried over into 2018, with most forecasters expecting another solid year for global growth.
While this period of greater economic dynamism is to be welcomed, there are significant risks that should not be ignored, particularly in the case of a small open economy like Sri Lanka with significant external vulnerabilities. Chinese economy picked up in 2017, there are some signs that it started to slow in the final months of last year as the government tightened credit conditions. If this is right, we may see the resurgence of worries that the Chinese economy is heading for a so-called ‘hard-landing’, which rocked financial markets in late 2015 and early 2016. At the very least, this would lead to a tightening of global financial conditions that would weigh on demand in Sri Lanka’s key exports markets in Europe and the US. The pickup in global growth has not yet triggered a substantial rise in inflation and there are a few signs of upward pressure on wages. But as their economies strengthen, central banks in Europe, Japan and the US are increasingly turning their attention to tighter monetary policy.
The risk is that a sudden surge in inflation leads to policy interest rates being hiked much more quickly than financial markets currently expect, sparking a selloff in these markets and setting the stage for the next global economic downturn. This prospect appears most likely in the US, where President Trump has just delivered a fiscal stimulus to an economy that, by most measures, is already running at close to full capacity and so could trigger a sharp rise in inflation. The main risk for Sri Lanka here too is from tighter global financial conditions and weaker demand in its key markets.
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