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Industrialised countries
US
The US economy is still the more resilient of the major OECD economies despite the fact that it has witnessed some slow-down recently. The 1Q12 GDP growth number was confirmed at 1.9% compared to 3.0% in the 4Q11. There is an expectation of a slight improvement in quarterly growth for the remainder of the year, but not at a major margin. This is due to the still high unemployment rate, a slowdown of global trade and declining confidence levels. The upcoming presidential election in November and the fiscal issues that will have to be sorted out for the year after are also important factors to watch and to consider when providing the growth forecast for the next 18 months. The current expectation is that the fiscal issues will not largely be a drag on growth in the next year and that pending issues will be sorted out in a constructive manner by the US Congress. It should be noted, however, that it was a very late agreement that was reached last year for lifting the debt ceiling and that there is at least some likelihood that it will again be challenging to find an agreement on the necessary fiscal cuts.
The labour market continues its slight improvement. Although the unemployment rate remains at 8.2% in June, 80,000 jobs were reported to have been added in the nonfarm area in June, after 77,000 job additions in May, a number that was positively revised from 69,000. Long-term unemployment remains an issue but has improved in June. 41.9% of all unemployed have been without work for more than 27 weeks in June. This compares to 42.8% in May and to last year’s peak levels of more the 45%. It is still a large number and a major improvement is not expected anytime soon, but a decline of the current monthly share of around 1 percentage point should provide some support to the economy. The participation rate has stabilized at 63.8%, the same level as in May.
With only marginal improvements in the labour market, consumer confidence has declined. The consumer confidence index of the Conference Board was recorded at 62.0 in June, lower than the 64.4 in May and considerably below this year’s peak level from February of 71.6. The other consumer sentiment index of importance, the index of the University of Michigan, declined as well — and even more sharply — to 73.2 from 79.3 in May, which was the highest level since October 2007. Monthly retail sales numbers were falling in May by 0.17%, after a decline of 0.22% in April. On a yearly comparison, it is still a rise of more than 5%, but clearly it is slowing down. Industrial production continues expanding on a yearly base. It grew by 4.7% y-o-y in May, compared to 5.1 % y-o-y in April and compared to 3.6% in March. This translates to a meagre monthly decline of 0.1%. Manufacturing orders were also posting a positive yearly trend in May, when they grew by 3.0% y-o-y, after 3.4% in April. While the manufacturing orders point at a continued expansion, the latest ISM numbers were pointing down and highlighting the likelihood of a continued deceleration, particularly in the manufacturing area. The ISM number for the manufacturing sector in June stood at 49.7, below the growth indicating level of 50, after it recorded a solid number 53.5 in May. The ISM for the services sector also declined to 52.1 from 53.7 in May.
The very important housing sector exhibited a rise in some of its most important measures. After having fallen by 5.5% in April, pending home sales rose by 5.9% in May, according to the National Association of Realtors. Pending home sales are considered a leading indicator of progress in real estate because they track contract signings. Furthermore, the yearly change of the house pricing index of the Federal Housing Finance Agency (FHFA) has continued its rising trend with a monthly price rise of 3.0% in April, after 2.4% in March. Finally, existing home sales in March held up relatively well at 4.55 million in May, though still slightly below the May level of 4.62 million. So taking the above into consideration, as well as the expected challenges to reduce the fiscal deficit in the coming months, there will be some pressure on the spending abilities of the public household as well as private households. On the other hand, an improvement in the labour market as witnessed over the previous months could provide support to the economy. Finally, the Federal Reserve Bank (FED) has highlighted on many occasions that it is able and willing to support the economy further. This leads to a forecast of 2.0% for next year at almost the same level as this year’s growth expectation of 2.1%.
Japan
Japan’s economy has continued its recovery in the past weeks but remains dependent on stimulus efforts to revive the local economy and its exports, which are mainly manufacturing based, an area that depends on the development of the global economy and which is showing signs of a slow-down. While growth is one issue in the Japanese economy, the fiscal balance is another one. In comparison to other major OECD economies, Japan has so far not addressed this issue as aggressively as other economies, due certainly in part to the triple disaster of last year. In the meantime, the government has started to tackle the issue by planning to double the consumption tax; further measures are expected to follow in the future. With an ageing population, the highest debt burden of all major OECD economies and despite the needed recovery efforts after last year’s events by far, it is certainly a sensible area that needs to be sorted out as long as it possible to do so without the pressures from capital markets.
There is a plan to increase the consumption tax to 8% by 2014 and to 10% by 2015, from currently 5%. But even with the rise in consumption tax, the gross debt-to-GDP measure is forecast to stand at a stunning 292% in 2016, according to an estimate that has been undertaken by Credit Suisse. To find new sources of revenue, therefore, should be expected to be a key issue for the future. Additional sovereign funding needs will probably hold back next year’s expansion, after this year’s focus moves away from providing support for the economic recovery. The current global slowdown and demographic developments will potentially make it challenging to find the right balance. However, it should be noted that to raise the tax in the current environment might turn out to be a risky move. In 1997, the last time the tax was increased, it led to a recession and a slump in retail sales and to a steep decline in central government tax revenues.
Another sensitive area — and consequence of last year’s events — is the shut-down of the nuclear facilities in Japan, which have provided more than a third of electricity to the country. There is currently a popular mistrust of nuclear energy and it remains to be seen how this will develop. Only one reactor has been re-started recently, but this is considered to be an exception; no additional nuclear energy supply should be expected in the near future. Currently, the shortage of electricity is compensated via imports of fossil fuels for burning to generate electricity. This is not only more expensive, given that the nuclear infrastructure had been providing relatively cheap energy after the expensive installation costs had been absorbed, but it is also a burden to the economy, which has been facing a yearly trade deficit, a phenomenon not known for more than two decades. Trade surpluses had been an important source of funding for the economy and, hence, the trade deficit has become the source of its largest fiscal deficits. It is not expected that the country will return to its nuclear facilities anytime soon, which in the short-term will also have a negative impact on the economy.
The pattern of a monthly trade deficit promptly started in March of 2011, when the country was hit by the tragic events. The April 2011 gap was the highest at 697 billion yen, but the most recent May number was again at almost the same level at 657 billion yen. This comes despite a relative successful development in exports, which increased by 10.0% y-o-y in May on a non-seasonally adjusted base and by 8.0% in April. Industrial production is also holding up well, but the momentum seems to fade with a yearly rise of 3.4% in May compared to a 12.9% rise in April. Retail trade has slowed down slightly as well, from a 5.9% y-o-y rise in April to a 3.6% increase in May. The slowing momentum becomes even more evident when reviewing the recent manufacturing order numbers which declined by 7.1% in May, after a rise of 9.2% in April. This yearly comparison translates into a monthly change of an even greater magnitude of -14.8, compared to an increase of 5.7% in April.
Interestingly, it is domestic demand that has fallen sharply by 23.0% m-o-m, compared to foreign demand, which was at around the same level in May as it was in April at 0.3%. This will need further close monitoring as the latest Tankan survey signaled improving manufacturing data. The large manufacturer business conditions diffusion index improved from -4 in the March Tankan to -1. This is the first improvement in large manufacturer business conditions in three quarters. The outlook for large manufacturers is also for continued improvement to an index of 1; and despite some disparity between industries, manufacturing conditions are reported to be solid overall. The more positive momentum of the Tankan index is contrary to the lead indicator of the purchase manufacturing index (PMI), provided by Markit. The June composite PMI fell below 50 for the first time since November of last year to stand at 49.1. Both the manufacturing and the services sector are forecast to decline with an index level of 49.9 and 49.3, respectively.
The momentum in the 1H12 has been solid, especially when compared to the previous year. This higher than expected momentum has supported a lifting of this year’s growth forecast to 2.5% compared to last month’s forecast of 2.0%. However the slow-down in the global economy, combined with the need to tackle the fiscal situation and the expected slowdown in domestic demand, is expected to drag the expansion again to lower levels in the next year to around historical averages to stand at 1.2%.
Euro-zone
The Euro-zone debt situation remains a major issue impacting the global economy. After the elections in Greece have made a continuation of cooperation with the Troika (the EU Commission, the ECB and the IMF) possible, it remains to be seen if the country will be able to achieve the agreed upon cost cuts and hence receive the bailout funds needed. Ireland and Portugal have been reported to have made good progress and seem to be out of the danger zone for the time being, while Spain and Cyprus have moved into the spotlight and are now the centre of attention. Spain is certainly the most important part of the current European debt puzzle. In the most recent debt auctions, treasury bonds for Spain government bonds yielded more than 7%, a new record and an unsustainable level in the long-term for the economy to be able to move out of the debt spiral.
In the meantime, Spain’s government has agreed on a 100 billion euro support package for its ailing banking industry with Euro-zone leaders and in the most recent meeting of Euro-zone finance ministers, the details of this relatively large aid package was provided. By the end of July, the first 30 billion euros will be transferred and further stress tests will be pursued for the 14 largest financial institutions. The bank’s distressed assets will be managed afterwards by a specially designed “bad bank”. The entire plan aims at addressing the particular issues of the weakest segments of the Spanish banking industry and to avoid the spreading of a potential contagion to other sectors of the Spanish economy — or to other economies in the Euro-zone. Until the banks’ reviews are finished, the 30 billion euros will be held by the government as a \ contingency for urgent needs.
The whole emergency plan for the Spanish banking industry reflects a change of attitude among Euro-zone authorities as it will provide a direct injection of funds into a nation’s banking industry, while previously structures had been designed to avoid such direct funding. This direct funding will allow Spain — which has already established a sovereign fund at the national level for bailing out its banks some weeks ago — to transfer the accumulated debt burden for bailing out the banks from its sovereign balance sheet to the Euro-zone authorities. The support facilities that will be part of a refinancing of the European Stability Mechanism (ESM) that has been agreed upon just at the end of June at an EU summit will also potentially allow Ireland to transfer a large amount of its bail-out facilities — basically financed via sovereign debt — from the sovereign level to the accounting facilities of the Euro-zone.
A prerequisite for this support will be a Euro-zone wide supervision of banks, generally labeled as a “banking union”, which will move the authority of national supervision to a centrally installed supervisory institution of the Euro-zone. Details of this supervision have not been finalized yet, but the authority will most likely be within the sphere of the European Central Bank (ECB) and the European Banking Authority (EBA). Details about the final structure of the ESM will be discussed among Euro-zone finance ministers in September and be presented in October. In the meantime, the new facilities of the Euro-zone will still have to be approved by national legislatures in some Euro-zone member countries, which could pose some uncertainty as the past has shown on some occasions. The ECB has also acted to support the declining Euro-zone economy and has reduced its key interest rate from 1.0% to 0.75 % and its deposit rate to 0%, which could probably turn out to be the more important move as banks will no longer have a financial incentive to deposit money with the ECB and could be motivated to invest instead in the Euro-zone economy. Bank deposits with the ECB the day before the decision have been at almost 800 billion euros.
The decision could serve as an incentive for banks to instead park their funds in relatively safer assets, like treasury bonds of highly rated sovereigns, which would then further push down the yields of these economies and could further widen the wealth gap of the well-funded and the less well-funded economies. While the debt issues seem to be contained so far, the situation has become more critical again in the past months. The sums that are involved have become larger. The real economy continues to decline and the negative spin that has been observed in the first half will be carried over most probably into the second half. To some extent, it is expected to have an effect on growth in the next year. Industrial production has declined for five consecutive months, from the end of last year to April, while April has posted the sharpest drop of 2.4% y-o-y. Manufacturing orders do not point to an improvement but rather to a decline of 3.3% in April, leading to a continuation of this negative momentum. The same negative spin is provided by the latest purchase manufacturing index (PMI) numbers, published by Markit. The June composite PMI remains almost at the previous month’s level of 46.4 compared to 46.0 in May. It is currently mainly the manufacturing sector that seems to operate at very low levels with the PMI for the manufacturing sector at 45.1, at around the same level as it was in the previous month. This low industrial activity leads to an always rising unemployment rate, which is now at11.1% in May, again a record high. Consequently, retail trade has been negative for more than a year now for every month, with the latest number for May declining by 0.3%.
While it is forecast that the 2H12 will be impacted significantly by this negative momentum, it is expected that it will improve by the end of the year. This will depend largely on the ability of the Euro-zone to manage the sovereign debt crisis and to promote enough growth, while at the same time being able to contain the debt burden from increasing and, ideally, to reduce it. This assumption leads to an expected expansion of the economy by 0.1% in 2013, while the negative consequences of the current economic situation will be largely felt this year, which is forecast to decline by 0.4%.
Emerging markets
Uncertainty surrounding the strength and persistence of global economic growth, and the pace of expansion of economic activity in developed and emerging markets, has been the salient feature of the global economy since late 2011. In the 1H12, optimism over a smooth transition toward a robust, albeit uneven, expansion of economic activity in advanced and developing countries had all but faded following the deepening of the sovereign debt crisis in the Euro-zone, lackluster growth in North America and decelerating economic growth in emerging markets (notably in China, India and Brazil). Although recent developments imply that the Euro-zone is more likely to keep all of its member states on board with a shift in emphasis toward measures of growth in the short-run and a commitment by its member states to a ore consolidated fiscal stance in the medium- and long-term, the remote possibility of Greece leaving the monetary union has kept the risk of adverse economic impacts on the Euro-zone and the international economy significantly high.
Under the current scenario, it is expected that austerity plans will ease to some extent, with Spain and Italy continuing to meet their reform goals and the European rescue funds becoming available for short-run emergencies. In the longer-term, integration of the Euro-zone’s fiscal, debt and banking markets would move ahead, although at a slower pace than expected before. However, the fact that the departure of Greece from the Euro-zone, with a severe impact on the Euro-zone economy, still cannot be ruled out and remains a cause of concern. Such an action would provoke a massive capital outflow from the country and result in a default of its fiscal obligations, with a destabilizing effect on the Euro-zone and beyond. This points to the underlying vulnerability of the region’s economy to political shocks when its unemployment is already at record level. Besides the Euro-zone crisis, geopolitical tensions in the Middle East, the contraction of manufacturing in the US for the first time since 2010 and decelerating economic growth in emerging markets have been fuelling uncertainties regarding global economic growth, which has affected demand for commodity and oil in the 2H12. The US economic recovery remains on track, but a string of recent data releases has confirmed a softening of the pace in recent months. GDP growth in 2012 has been revised down slightly to 2.1% (at an annual rate).
It is expected that Asia and Australia (excluding Japan) will continue growing, albeit moderately, in 2012 and 2013. One factor affecting the region’s growth is a shrinking of their export markets due to a slowdown in the US and the economic crisis in the Euro-zone. We estimate that growth will ease to 4.7% in Asia (including Asia Pacific) this year. The growth rate is expected to remain\ around this figure for the next year as well, reflecting a slower expansion in the two regional giants, China and India. However, Asia will retain its status as the world's fastest-growing region. Asia's economic fundamentals are sound. The levels of debt (both government and private) are generally low compared with those in the West, and Asian banking sectors are mostly in good shape, having come through the global financial crisis without large losses (Economist Intelligence Unit (EIU), June 2012). The region will continue to benefit from China's emergence as an engine of regional growth, particularly as China's middle class expands and the government adopts policies to encourage growth in private consumption. In June, China's authorities announced a surprising cut in lending and deposit rates to take effect in July. China's economy has continued to slow, although economic figures for May were not as weak as expected.
This supports our long-standing view that China will avoid a hard landing. We estimate that Chinese GDP will expand by 8.1% in 2012 followed by an 8% growth rate in 2013. We have reduced our 2012 GDP growth forecasts for a number of emerging market economies, including Brazil and India. We estimate that Brazil’s economy to expand by only 2.5% this year and 3.3% in 2013. India’s GDP, in turn, is estimated to grow by 6.4% this year and by 6.6% in 2013. Both countries have been hurt by the broader slowdown in global growth, but each has also suffered from policy missteps, including allowing inflation to rise in 2011, which triggered damaging interest rate hikes that are only now being reversed. Policy easing should support growth in both economies later this year (EIU, June 2012).
Following a policy-induced rebound in 2010, growth in the Latin American region slowed to 4.4% in 2011. We forecast a further slowdown to 3.1% in 2012 and a moderate acceleration to 3.3% in 2013. The economic performance of the region is affected by the outright contraction in the Euro zone and sub-par growth in the US. Growth in South American countries will continue to be supported by China's demand for soft and hard commodities exports. Historically low OECD interest rates, coupled with an improving investor perception of the region's potential, will continue to benefit those Latin American economies that are well integrated into global financial markets.
The region's external balance sheet is sound, reducing the risk of debt servicing difficulties. External debt is much lower relative to GDP and foreign-exchange reserves are at record levels. Strong domestic demand has resulted in a current account deficit in many of the Latin American countries. This has increased the region’s vulnerability to shifts in market sentiment and has been reflected in renewed pressures on the region's currencies as investors have fled from risky assets amid the escalation of the Euro-zone crisis. Concerns about a slowdown in China's growth rate has also been a factor impacting commodity demand and prices (EIU, June 2012).
In Eastern European economies, the spillover from the Euro-zone crisis has blunted growth prospects. The 2012 recession expected in the Euro-zone will act as a brake on economic activity across Eastern Europe through weaker trade, investment and financing in the banking channels. The sovereign debt crisis in the Euro-zone, Eastern Europe’s key export market, has reduced growth prospects and raised doubts about the medium-term outlook. In the 1Q, export growth and industrial output weakened, while business and consumer sentiment in the region remained fragile. In addition to faltering external demand and a weak outlook for credit, domestic demand also remains weak, given high unemployment, excess capacity in some cases and the inability of governments with considerable budget deficits to respond with stimulus measures. External bank loans and foreign direct investment (FDI), both of which have helped to drive growth in the pre-crisis years, will be subdued in 2012.
Euro-zone plans to strengthen their banks' capital adequacy ratios in order to respond to the threat of sovereign bonds defaults will limit the lines of financing available to countries in Eastern Europe. Euro-zone banks are expected to increase their capital ratios through a mixture of fund raising, asset sales and reduced lending, which, according to the European Bank for Reconstruction and Development, would lead to "considerable deleveraging" in Central and Eastern Europe. The "Vienna 2.0" initiative of early 2012 is a positive development, however, although it does not go nearly as far as the 2009 Vienna Initiative that helped to prevent Western bank flight during the 2009 crisis (EIU, June 2012). We therefore expect a slowdown in economic activity in the region in 2012 with some countries such as Hungary expected to experience negative growth.
Economic growth in the Middle East and North Africa (MENA) region is expected to recover to some extent in 2012, despite the weak external environment, as a result of a rebound in some of the economies most affected by the civil unrest of 2011 and stillhigh global oil prices. We expect the region to grow by 3.5% in 2012 and then drop to 3.0% in 2013, as oil prices are likely to continue to slip lower towards their long-term path after peaking in the 1Q12. Geopolitical factors and continuing weakness of economic activity in Egypt are among the factors reducing economic growth in the MENA region. In the meantime, massive infrastructure and industrial development in Saudi Arabia, expansionary fiscal policy in oil-rich states of the region, and an expansion of Iraq’s construction and petroleum sectors support higher rates of economic growth.
Despite the overall weakness of the global economy, fundamentals have been improving in many emerging markets (EMs) in recent weeks. Nevertheless, policy mixes adopted in EMs to support economic growth differ significantly according to their individual economic circumstances. While in many emerging Central and Eastern European countries tight monetary policy to curb elevated inflation is still on the agenda, in Asia and Latin America a more accommodative monetary policy is being adopted on concerns over sluggish economic growth. Inflation in Latin America has been moving lower, allowing policymakers to turn to economic growth policies. The Central Bank of Brazil cut 50 basis points (bp) off its policy interest rate on 30 May on top of interest rate cuts earlier this year. A series of initiatives totaling 1.5% of GDP are also envisaged to shield Brazil’s domestic industry from external competition. India’s Central Bank (RBI), on the other hand, has also cut its policy rate by a surprising 50 bp at its last meeting of 17 April, double the expected 25 bp. India’s rupee is expected to remain under pressure due to a current account deficit as well as a government deficit. Meanwhile, China’s central bank has cut its policy interest rate for the second time in less than a month, reducing the prime lending interest rate to 6%. In Russia, private consumption and investment demand still remain firm and the manufacturing PMI had a surprise downside move in June. Although the labour market is tight and unemployment remains low, the accelerating inflation and the recent floods there might exert a negative impact on consumption growth.
Brazil
Brazil’s economic growth has been disappointing in the 1Q12 with GDP growth registering around 0.8 y-o-y. The agricultural sector contracted by a significant 8.5% on an annual basis while industry grew only by 0.1% y-o-year. The services sector performed better, expanding by 1.6% on an annual basis. On the expenditure side, aggregate demand has been driven by private consumption supported by low employment, as well as easy credit extension and high wages. In addition, government spending posted an increase in this period, although investments contracted in the 1Q. In light of the economy’s weak performance in the 1Q12, we have reduced our forecast of Brazil’s GDP growth for 2012 to 2.5%. This might even be seen as optimistic considering the weak prospects for industrial activities in the 2Q and its structural difficulties concerning a lack of competitiveness and relatively high wages. In an attempt to revive economic growth, the government launched in April 2012 a comprehensive package to boost domestic industrial activity to complement the country’s major plan published in August 2011. This package included measures to increase public and private investment, enhance competitiveness —particularly through special incentives to boost productivity and innovation — and reduce production costs.
Protection of industry by tax cuts, encourages banks to pass on lower borrowing costs consumers. The stimulus package consists of three main pillars: actions to curb exchange-rate appreciation, such as a financial transaction taxes on international flows (IOFs), which were recently extended to cover all loans maturing within the next five years; changes to the corporate tax structure; and measures to stimulate domestic production. With regard to the first pillar, the government has stated that all measures recently taken have a permanent character and are unlikely to be reversed. Although no new announcements on the exchange rate front were made under the new plan, the minister of finance, Guido Mantega, during a press conference following the announcement of the new measures, said the Selic rate — the monetary policy instrument of the Banco Central do Brasil (BCB, the Central Bank) — would be used as an indirect measure to counteract strong capital inflows. The government has also increased the amount of subsidized loans to companies. On the monetary policy front, the authorities have eased monetary expansion by a series of interest rate cuts since mid-2011, thereby reducing the policy rate from 12.5% in August of last year to a record low 8.5%. Many observers expect another BCB rate cut of 50 bp at its next meeting scheduled for 11 July as inflationary pressures are abating due to lackluster economic growth. The BCB and the government-owned CEF (Federal Savings Bank) have announced changes to their lending rates on some consumer and corporate credit lines in an effort to encourage private sector banks to follow suit in order to preserve market share. The public sector share of total banking credit in estimated to be around 44%. Private banks seem to be yielding to the president’s pressures by lowering rates on various credit lines and announcing their intention to lower fees on many of their services.
The public sector primary surplus for February has been above expectations at around US$ 5.7 bn. The primary surplus amounts to 3.3% of GDP over the last 12 months. This would reduce the nominal deficit for the overall public sector, which is obtained by subtracting interest expenditure from the primary surplus. Brazil’s nominal deficit of the public sector is estimated at 2.7% of GDP for 2012. Also, a government bill has been approved by the Senate which institutes a rigid ceiling on the share of government contributions for social security for newly hired federal employees with the remainder to be employee-funded. Annual inflation has now fallen much lower than expected to around 5.24%, below the BCB’s estimate.
China
The Chinese economy posted its weakest rate of growth in three years after 1Q real GDP growth moderated to 8.1%. China PMI for June was in line with expectations at 50.2 compared to 50.4 in May, as released by the National Bureau of Statistic (NBS). It seems that last month’s estimates of economic activity have underestimated the pace of the slowdown in industrial production. The government has stepped up efforts on monetary easing, reducing its policy interest rate by another 31 bp on 8 July on top of the 25 bp cut earlier on 7 June, thereby lowering the prime lending rate to 6%. The central bank also reduced deposit rates to 3% to mitigate the pressures on banks’ net interest margins. The main reason behind the recent interest rate cut is believed to be the easing of inflationary pressures which have currently lowered the inflation rate to 3.3%. The recent cut in the benchmark interest rate by the central bank has been interpreted as the government’s move to boost economic activity by lowering the cost of borrowing from the banking system in the face of a falling annual inflation rate.
The reserve requirement ratio (RRR) was also reduced by 50 bp effective 18 May. This has been the third reserve ratio cut in six months, in line with the central bank’s statement that targeted action would be taken to ensure stable credit growth. Pressure for an appreciation of the yuan against the US dollar is also expected to ease in 2012, given the downward trend in the country’s recent trade surplus. Looking into the 2H12, the risks associated with China’s economic growth have heightened significantly, mainly driven by the Euro-zone’s economic crisis. Data released for the month of April reveals a broad based slowdown across the economy as industrial production, fixed investment and retail all register weaker growth. With increasing signs of a deceleration of economic growth, the government has intensified its effort to address structural imbalances. Constrained credit demand has brought renewed calls for the government to provide a fiscal stimulus to the economy.
The Chinese government has already taken steps in this direction by increasing its spending by 26% on an annual basis in January-April, above the 12.5% increase in revenue. The government has also been trying to raise its investments in major infrastructure projects. Low unemployment and steady increase in real wages have reduced the imperative to make further interventions. Having brought down inflation in recent months, it might be seen imprudent for the government to overstimulate the economy and thereby risk a return of elevated inflation. Therefore, a dramatic msoftening of fiscal policy seems unlikely unless GDP growth appears to be falling below the government’s comfort zone of around 7-7.5%. We forecast an economic growth of 8.1% for 2012 and 8% for 2013. On the demand side, the fact that finished goods inventories have been rising recently implies weak domestic and external demand. Further declines in new orders — including exports orders — suggest that the Chinese economy still faced downside risk in the near term.
Aside from weak external demand, due mainly to sluggish OECD economic growth, domestic demand has also been growing at a less than expected pace. It appears that the government’s attempts to address the imbalances of high ratios of investment and low ratios of consumption-to GDP need more time to change these ratios to more desirable patterns. Other imbalances such as housing bubbles and externalities generated by high economic growth also have yet to be corrected. The unfavourable corporate environment has been another cause of concern, with corporate profits declining by 2.4% on annual basis in the first five months of the year.
India
The Reserve Bank of India (RBI) cut borrowing costs by a more than expected 50 bp in April after nearly three years, thereby reducing the benchmark borrowing rate to 8.0%. This was in response to worries about GDP growth expectations , which have sharply declined to around 6.4% compared to a higher than 7% level just two month earlier. Because of elevated inflation, further cuts are unlikely as this would increase the money supply and inflate prices above prudential mlevels. Inflation remains a major risk to India’s economic stability and on 18 May the government reported that the CPI had risen to 10.4% on an annual basis following an increase of 9.4% in March. The wholesale price index rose by 7.2% y-o-y in April, picking up about 6.7% a month earlier. Partly because of global factors, the rupee that had depreciated against the US dollar to a record level last month regained some of its losses and appreciated by 4% over the past couple of weeks. Meanwhile, improved domestic policies and the hope that India would return to policy reforms raised investors sentiments.
However, the recent appreciation of the rupee is believed to reflect positive developments in the international economy following the Euro-zone summit and the new hopes surrounding efforts to resolve the economic crisis in the region. The question is whether this appreciation could be sustained as the economy experiences its lowest expansion in almost a decade after real GDP growth in 1Q12 was estimated only to be 5.3% y-o-y. mThe weak economic performance was led by a 0.3% y-o-y contraction in manufacturing output while the agricultural sector expanded by a lackluster 1.7%. The government had estimated GDP growth would reach 6.9%; but because of the weak performance of the economy in the last several quarters, we estimate GDP to expand only around 6.4% this fiscal year. Many observers blame weak economic policies for the poor performance of the economy since last year. The coalition government that has been in office for the past three years has failed to introduce and implement any major reforms, which has undermined investors’ confidence in the economy. Furthermore, massive subsidies, particularly on energy and petroleum products, and welfare spending programs have fuelled inflation while preventing any effective fiscal stimulus for GDP growth.
Russia
The Russian economy expanded by 4.9% in the 1Q y-o-y, above its long-term trend. Although the manufacturing PMI had a surprise downside move in June to 51.0 from 53.2 a month earlier, the fact that the industrial sector is expanding despite unfavourable external demand driven by the Euro-zone crisis illustrates the resilience of the oil exporting economy. All key components weakened in June. Output PMI fell to 51.6 from 53.8, new orders fell to 52.1 from 54.9, employment fell to 49.6 from 52.2 (JP Morgan, 6 July 2012). On a more positive note, inventories were cut in June, indicating firm demand and leaving forward-looking orders to inventories unchanged. According to JP Morgan (6 July 2012), business confidence in Russia remained firm last month while electricity consumption accelerated to 1.8% compared to a year ago. A slowdown in economic activity in response to the global slowdown, as well as lower commodity prices and tighter domestic monetary policy are all possible; but a sharp decline in economic growth is not expected. We forecast 3.7% GDP growth in Russia in 2012 and 3.4% in 2013.
Domestic demand also helped the expansion of the economy as a whole as the government stepped up its spending prior to the March presidential election. The Russian central bank left interest rates unchanged at its policy meeting in May. As inflation has been accelerating in June, mainly on food price inflation, the move was seen as an effort to keep inflationary pressures under control while allowing the economy to grow near its potential level on the back of favourable oil and commodity prices. However, economic growth remains fragile as the industrial sector expanded by only 1.3% in April, below its trend and less than market expectations. The mild weather reduced demand for electricity by more than 14% in April compared with a month earlier. Retail sales also slowed in April, indicating that economic growth is facing difficulties and may start to flatten in the coming months.
The effective exchange rate of the rouble against the US dollar fell by 0.5% in April without any intervention from the central bank of Russia in foreign exchange markets. According to the EIU (June 2012) the Russian banks have now accumulated net foreign assets of US$ 62 bn, in contrast to US$ 100 bn net foreign liabilities in 2008. Leaving the interest rate unchanged amid a deprecating rouble might be, to some extent, a result of accelerating inflation, which in June made an upward surprise move reaching 4.3% on an annual basis after falling to a record low in April. Inflation is expected to rise further in the coming months as the indexation of regulated prices will lift core inflation. An expected increase in utility tariffs is also expected to affect consumer prices positively.
Developing Countries
The latest official data show that Argentina registered a current account deficit of US$ 552 m in the 1Q12. The trade surplus actually widened significantly in the period, from US$ 2.2 bn to US$ 3.6 bn, but the services and income deficits both continued to widen. For the ASEAN-4 countries (Indonesia, Malaysia, Philippines and Thailand), growth is projected to be buoyant this year, stepping up to 5% in 2012 with solid activity in Indonesia and a recovery in Thailand. Financial conditions in high-income Europe and higher oil prices would pose the largest risks to this outlook. A more rapid than expected slowdown in China poses an external risk for the rest of the region.
Prospects for the Sub-Saharan region remain robust, assuming no serious deterioration of the situation in Europe. Projected growth for the region depends on developments in the Euro-zone, as well as the extent of a slowdown in China. Uncertainty, volatility and significant social unrest continue to characterize conditions in the developing Middle East and North Africa region. Egypt is coming under increasing pressure to finance its burgeoning fiscal and current account deficits. Economic spillovers from Syria to Jordan and Lebanon are beginning to look serious. Egypt’s economy is projected to move up to 1.5% growth in 2012, rising by 1.5% in 2013. Growth is expected to pick up in Jordan and Lebanon, from 2.8% and 3.0%, respectively, in 2012 to near 2.0% in both cases in 2013.
OPEC Member Countries
Saudi Arabia's annual inflation eased to 4.9% in June, its lowest level since September of last year, despite a big rise in housing prices, according to recent official data. Data from the Central Department of Statistics showed previously that consumer prices slowed to 5.1% in May from 5.3% in the same month a year earlier, while monthly inflation remained unchanged from April at 0.2%. GDP is projected to slow down both this year and next, partly reflecting conscious policy choices. The main reason for the expected economic slowdown reflects the undeclared moratorium on gas output. According to the General Secretariat for Development Planning (GSDP), inflation-adjusted GDP growth should ease from 14% in 2011 to 6.2% in 2012, reaching 4.5% in 2013. Qatari authorities are exploring regional and international options to at achieve diversification and development of the country’s economy.
Oil prices, US dollar and inflation
As in the previous month, the value of the US dollar continued to increase. The monthly average from May to June saw it rise compared to all major currencies with the exception of the yen. The US dollar rose by 2.1% versus both the euro and the Swiss franc, while it gained 2.3% compared to the pound sterling. Only against the yen did it face a decline, falling by 0.5%. The level of the euro versus the US dollar seems to be still relatively well established around $1.25/€. But itmoved somewhat below this at the beginning of July, when it stood at around $1.23/€. The current process of finding a solution via further emergency funding in the Euro-zone to support the banking sector and the ailing peripheral economies might push the euro back as some confidence into the currency again could re-emerge.
In general, the near-term development will to some extent depend on the successful outcome of the newly implemented structure of the European Stability Mechanism (ESM) and the current bail-out of the Spanish banking sector. Similarly interesting is the recent development of the yen to US dollar relationship, which again fell below the critical ¥80/$ level and was trading above this for some days in the second half of June. It remains to be seen if the Bank of Japan (BoJ) will continue to support the yen’s weakening in the foreign exchange market, given that the yen has been trading at this relatively high level, which is hurtful to exports, since the beginning of May. In nominal terms, the OPEC Reference Basket continued falling sharply by $14.09/b or 13.0% from $108.07/b in May to $93.98/b in June. In real terms, after accounting for inflation and currency fluctuations, the Basket price fell by 11.9% or $7.92/b to $58.87/b from $66.79/b (base June 2001=100). Over the same period, the US dollar rose by 1.3% against the import-weighted modified Geneva I + US dollar basket while inflation fell by 0.1%.
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