European Union
Eurozone is under increased growth pressure, recent data shows.Reuters

Growth indicators have weakened in Eurozone and Japan after the release of the October World Economic Outlook (WEO) by the International Monetary Fund (IMF), the fund said in a paper published ahead of the G20 Summit scheduled for 15-16 November.

There is a risk of low potential growth in both advanced and emerging economies for the medium term, IMF said in its review of global economic scenario, titled "Global Prospects and Policy Challenges", released in the run up to the Brisbane meetings of G20 leaders.

"In addition to the implications of weaker potential growth, major advanced economies, especially the Eurozone and Japan, could face an extended period of low growth reflecting persistently weak private demand — especially investment — that could turn into stagnation, with a further adverse impact on potential growth."

"As for emerging economies, several years of slowing growth prospects brings to the forefront the risk that potential growth could disappoint further," the fund said.

Eurozone

IMF said in Eurozone, external demand was weak, reflecting in part the growth moderation in China, but domestic demand was also surprisingly weak, notably, in Germany.

"Recent data also shows disappointing industrial production, for example, in Germany and France, raising concerns over stalling growth in the euro area."

IMF said risks to activity from low inflation remain relevant, especially for the Eurozone. Inflation continues to remain below the ECB target, and longer-term inflation expectations have begun drifting downward.

"With policy rates at the zero bound, negative shocks can lower inflation or expectations further, raising real rates, hampering recovery and increasing debt burdens," according to IMF.

The recent comprehensive assessment of European banks found a manageable capital shortfall of €9.5bn (£7.4bn, $11.8bn) after taking into account capital raised this year, but also registered a large increase in the stock of non-performing loans, the fund noted.

According to IMF, swift action is now needed to deal with the few banks identified by the assessment as being in need of further capital, and to resolve non-performing assets.

"Overall, while tail risks have decreased and balance sheet repair has progressed, the recent increase in volatility is a reminder about the challenges ahead."

Japan

In Japan, recent indicators show that the recovery is weak but still ongoing. The Bank of Japan's (BoJ's) recent policy actions have helped lift inflation and inflation expectations.

On 31 October, the BoJ expanded its Quantitative and Qualitative Monetary Easing (QQE) framework by accelerating purchases of JGBs (and extending their maturity) and tripling the purchases of private assets, which should support domestic demand.

The IMF, however, warned that for those measures to succeed, they need to be supported by growth and fiscal reforms.

In addition, weakness in industrial production in India and consumer and investor confidence in Korea point to the sluggishness of the recovery, the fund said in its 12 November release.

Oil Prices

One major event in October was the sharp decline in oil prices, IMF said, and added that the slide will boost global growth. Oil prices have fallen by almost 20% since early September, dragged by lower demand as well as higher supply.

"Weaker than expected activity since the spring has weighed on oil demand, but its impact on prices has initially been muted by increased precautionary demand and the restocking cycle."

"Higher-than-expected production in non-OPEC countries, led by shale oil in the United States and recovering output in Libya, has also played a role," the IMF said.

According to the fund, in light of higher supply and the fact that some of the weakness in demand is already reflected in the WEO baseline, the decline in prices will—ceteris paribus—boost global growth.

"Weak oil prices will have a different impact across regions, easing the pressure on external position of net oil importers with current account deficits, while posing an additional downside risk for producers in emerging economies where which growth is already decelerating."

Geopolitical

IMF said geopolitical tensions have heightened and may increase further.

"Developments in Ukraine and Russia could trigger an escalation of sanctions and large spillovers in other parts of the world, including via confidence effects," the fund said.

Similarly, heightened geopolitical risks in the Middle East could lead to disruption in oil markets, it added.

US Scenario

Higher global risk aversion has led to an increase in risk premie and volatility in global financial markets, and the increased role of the shadow banking system and faster-than-expected normalisation of U.S. monetary policy are likely to result in liquidity shocks, IMF said.

"An increase in global risk aversion can be associated with further declines in U.S. long- term yields but still lead to a capital flow reversals and exchange rate pressures in emerging markets, as well as negative effects on equity prices."

IMF said uncertainty about the cyclical position in the U.S. can amplify risks associated with faster than expected tightening in monetary policy.

"Against the backdrop of the still low risk spreads and volatility indicators, such surprises could trigger financial market corrections," the fund said.