Shutdown Detracts from Much Bigger Global Risks

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By Katie Holliday

Bigger risks to the global economy have been overlooked in recent weeks amid intense focus on U.S. politics, U.K. based research house Capital Economics warned.

With the U.S. government shutdown set to enter its 10th day Thursday, speculation about the fallout from a potential debt default was center stage.

However, given the extremely low chances of a default and the fact that a default would likely turn out to be "less apocalyptic than many assume," Capital Economics said other risks to the global economy required greater scrutiny.

"With all eyes on the U.S. debt ceiling drama, the world's more intractable economic problems may get overlooked. The unresolved debt and competitiveness problems of the eurozone and the structural slowdown in emerging economies are more serious problems than those of the U.S.," said Andrew Kenningham, senior economist at Capital Economics.

Given its fundamental problems, the eurozone "still poses the biggest risk to the global recovery," Kenningham said.

The eurozone climbed out of a one-and-a-half year recession in the second quarter of this year, as better growth in Germany and France boosted the overall growth figures. However, growth in the peripheral countries remains lackluster, and it is this trend that has Capital Economics' Kenningham most worried.

"Peripheral countries are unlikely to achieve the growth rates needed to reduce their high rates of unemployment, and progress towards fiscal and banking union is likely to remain painfully slow," he said.

Kenningham added that investors have been so focused on what a default by the world's largest economy could mean for markets, they are ignoring the fact that the next sovereign default is far more likely to come from the eurozone than from the U.S.

And aside from the eurozone, structural issues faced by some of the major emerging economies were also a major concern for Capital Economics.

This week the International Monetary Fund revised down its growth projections for the emerging world to 4.5 percent this year, from its previous forecast of 5.5 percent in January, and to 5.1 percent for 2014, from 5.9 percent.

But Kenningham said the IMF has been slow to recognize worsening conditions in the region.

"These countries' key problems are structural and can only be addressed by politically difficult reforms," he said, specifying that China needed to boost household consumption and liberalize its financial system, while India, Russia and Brazil need to improve their investment climates.

"As progress on these structural reforms is likely to be sluggish at best, we expect the trend growth rate in emerging economies to remain well below its pre-crisis rate for the foreseeable future," he said.

Capital Economics also said that markets had overreacted to the prospect of the wind down of the Fed's flow of easy money. They expect the Fed's exit from quantitative easing to be gradual, keeping interest rates near zero for at least two more years.

"Even if monetary conditions tighten in the U.S., they need not necessarily do so in other advanced economies. Most emerging economies should also be able to cope with a shift in global capital flows," said Kenningham, adding the caveat that India, Turkey and South Africa could face further currency volatility.


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