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Industrialised countries
US
The US economy continues to grow below its growth potential but remains one of the more resilient developed economies. The most recent indicators point at a somewhat mixed recovery. The positive momentum in output, while having decelerated recently, seems to continue, although the unemployment rate has risen by a tiny margin. There have been, on the other side, some positive elements in the recent jobs report. Leading indicators point to balanced growth in the near future of around 2% annually. But this will also be influenced by the handling and management of the sovereign debt situation in the near future, particularly in 2013, after the presidential elections. The current expectation is that the fiscal issues will not largely drag growth down next year and that the open issues will be sorted out in a constructive manner. The Congressional Budget Office (CBO) however estimates that the combination of policies under current law will reduce the federal budget deficit by $607 billion, or 4.0% of GDP, between fiscal years 2012 and 2013.
According to this estimate, growth will be 0.5% in 2013, with the CBO expecting the economy to contract at an annual rate of 1.3% in the first half of the year and expand at an annual rate of 2.3% in the second half. This implies that no agreement will be found in Congress to avoid the so called “fiscal cliff”. The release of the GDP estimate for 2Q12 growth has highlighted a low but so far well supported growth trend. 2Q12 grew at 1.5% seasonally adjusted and annualized. This is lower than 1Q12 output, which was revised to 2.0%. Personal consumption contributed 1.1 percentage points to the growth of 1.5% in 2Q12, which is a continuation of a positive trend over the last several quarters and should be taken as a positive element. This release came together with the revision of GDP numbers back to 2009 and showed that the recession of 2009 was not as deep as initially thought, with an upward revision of 0.4 percentage points—from -3.5% to 3.1%—while the growth calculation for 2010 had to be revised down by 0.6 percentage points, from 3.0% to 2.4%. In terms of the accuracy of past numbers, it is important to say that the revisions did not reverse the direction of change in real GDP (whether increase or decrease) for any quarter; it only slightly changed the magnitude. These revisions were smaller than last year’s July revisions.
The labour market report for July was mixed. While job additions in the non-farm payroll area continued at a substantial magnitude of 163,000, with the private sector even having added 172,000, the unemployment rate moved from 8.2% to 8.3%. Furthermore, the share of long-term unemployment moved from 41.9% in June to 40.7% in July. This is the third consecutive month of improvement in this important area. 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 share of around a monthly level of 1 percentage point should provide some support to the economy. The participation rate is almost at the previous month’s level, standing at 63.7%.
The labour market, therefore, should be considered as still relatively weak. The improvements are slow but some build-up in momentum can be observed. In this environment it should not come as a surprise that consumer confidence is building up again slightly. But this depends on further improvements in the labour market, which could bounce further in the near future. The consumer confidence index of the Conference Board was recorded at 65.9 in July, compared to 62.7 in June and to this year’s peak level of 71.6 in February. The other consumer sentiment index of importance, the index of the University of Michigan, remained at almost the same level as in June. It stood at 72.3 in July, after 73.2 in the previous month and below May’s level of 79.3, which was the highest level since October 2007. Monthly retail sales numbers fell again in June by 0.5%, the third consecutive month of decline, after -0.2% in May and -0.5% in April. But with improvements in consumer sentiment, it should be expected to improve in the coming months.
Industrial production continues expanding on a yearly base. It grew by 4.7% y-o-y in June, compared to 4.4 % y-o-y in May and compared to 5.0% in April. Manufacturing orders seem to currently support the trend at a growth rate of 2.5% y-o-y, but the momentum seems to decelerate. This decelerating output growth is supported also by the latest ISM numbers for the manufacturing sector. The ISM number for the manufacturing sector in July stood at 49.8, barely higher than the June number of 49.7 and still below the growthindicating level of 50. The ISM for the services sector improved slightly to 52.6 from 52.1.
The very important housing sector continues improving but remains weak. After having fallen by 5.5% in April, pending home sales rose by 5.9% in May but recently declined again slightly by 1.9% in June, 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. The yearly change of the house pricing index of the Federal Housing Finance Agency (FHFA) has continued its rising trend at a monthly price rise of 3.7% in May, after 3.0% in April and 2.5% in March. So by taking the most recent revision of the previous year’s number into account, the growth forecast for 2012 was revised up to 2.2% from 2.1%. Considering the challenges for the economy ahead, the 2013 forecast remains unchanged at 2.0%.
Japan
Japan’s economy remains impacted by slowly growing domestic demand. Its recovery has been dominated by government-led stimulus in the past several months and by the global slowdown that has been rooted primarily in the Euro-zone. With industrial production and exports having slid recently, and with manufacturing orders and lead indicators pointing to a continued deceleration, the economy is facing a challenging second half of the year. It should be expected to grow at a lower rate next year as global trade is not expected to significantly rebound and the ability of the government to stimulate the economy is limited, especially considering that it is bearing the highest debt level of all major OECD economies. Growth is one issue in the Japanese economy, but the fiscal balance will certainly gain further attention as the debt issues so far have not been addressed as vigorously as in other developed economies. This widely known situation is expected to lead to an increase in taxation and social security contributions, and will therefore impact the spending ability of the economy’s private sector. Finding new sources of revenue, therefore, should be a key issue in the future. Additional sovereign funding needs will probably hold back next year’s expansion, after this year’s efforts to support the economy regardless of fiscal conditions. Furthermore, the economy remains burdened by the shut-down of all nuclear facilities with the exception of two, which is a major reason that the economy has recorded a trade deficit since last year’s triple disaster. The shortage of electricity has been compensated with imports of fossil fuels for burning to generate electricity.
This is not only more expensive, given that the nuclear infrastructure provided relatively cheap energy, but it is also a burden to the economy as it is resulting in a constant trade deficit. Trade surpluses had previously been an important source of funding for the economy. It is not expected that the country will return to its nuclear facilities anywhere soon, which in the short-term should have a negative impact on the economy. The pattern of a monthly trade deficit started in March 2011, when the country was hit by the tragic events. The April 2011 gap was the highest at 701 billion yen. After the most recent May 2012 number of 618 billion yen, the level eased to around 300 billion yen in June. Between January and June of this year, the trade deficit stood at 2.92 trillion yen, according to the finance ministry. This exceeded the 2.62 trillion yen deficit, which had been recorded in the first half of 1980, when the import bill was rising sharply due to an increase in oil prices. Nuclear facilities in Japan have typically provided more than a third of electricity to its highly industrialized economy. Still, after last year’s nuclear accident, there remains to be major public suspicion for nuclear energy in the country, it remains to be seen how this will develop and if nuclear power can again play a large role as an energy supplier. In the meantime, Japanese demonstrations against nuclear power have begun to generate serious concern.
The sudden rise in Japan’s import bill has been the immediate cause of a shift toward deficits, but exports have also been weakening. They declined 2.3% in June compared to last year. They recorded only 7 positive months out of the last 18 months, highlighting the decelerating effect on the economy. Export-dependent Japanese manufacturers have also struggled to contend with the effects of the yen’s sharp rise. The yen continued its strength, particularly against the US dollar, and traded mostly below the ¥80.0/$ level in the past weeks. If Japanese enterprises cannot cut costs in other ways, a strong yen will force companies that make goods in Japan to raise prices overseas or accept lower profit margins.
The current softening momentum is visible in various economic indicators as well. Retail trade fell by 2.1% m-o-m in June, the sharpest decline since March of last year. Industrial production was sliding for a third consecutive month in June on a monthly basis, while it improved slightly from the -3.4% in May to -0.1% in June. However, on a yearly comparison, the June number is 0.8% lower than last year’s June production, although this, like many yearly comparisons, is inflated by the higher expansion after the triple disaster of last year. The indications for future production are even more worrying with machinery orders, as a lead indicator for industrial output in the coming months, having declined by 14.8% on a monthly basis in May, the sharpest decline in more than a decade. The July composite Purchasing Managers Index (PMI) fell sharply again from 49.1 to 47.4, remaining below the growth-indicating level of 50. The PMI for the manufacturing sector is forecast to decline with an index level of 47.9, after 49.9 in June.
Despite the strained budgetary situation, expectations are building up that the government might again announce stimulus measures in a supplementary budget as it had done last year. For now, it is mainly the fiscal side that is expected to support the economy as the Bank of Japan (BoJ) is not being expected to ease its monetary policy in the near-term. However, the actions of the European Central Bank (ECB) and probably the Federal Reserve Board (FED) might trigger some action in order to avoid continued strengthening of the yen. The BoJ has kept extra monetary stimulus in reserve in July, underlining its commitment to keep interest rates low but dashing hopes of more powerful actions to check the rise of the yen. Backed largely by the momentum of the first half of the year, growth is expected at 2.5% in 2012, unchanged from the previous month’s forecast. However, the slowdown in the global economy combined with the need to tackle the fiscal situation and the expected continued declaration in domestic demand is forecast to drag the expansion to lower levels again in the next year, close to historical averages, to stand at an unchanged 1.2%.
Euro-zone
The Euro-zone’s debt problems remain an important issue for the current global economic slowdown. Many challenges remain and while the problems of Portugal and Ireland seem to have receded a bit into the background, the issue of Greece remains in the forefront. While the magnitude of these three economies is relatively minor, the challenges of Italy and Spain remain even more important. Recent comments by the European Central Bank (ECB) and European politicians have highlighted the aim of providing enough facilities to support ailing economies and avoid any further deterioration of the Euro-zone. But many uncertainties prevail. The constitutional court in Germany will decide upon the European Stability Mechanism (ESM) in September, when elections will be held in the Netherlands and the so-called Troika will report on current developments in Greece. It remains to be seen if the country will be able to achieve the agreed upon cost cuts and thus receive the bail-out funds needed. Ireland and Portugal, on the other hand, are reported to have made good progress and seem to be out of the danger zone for the time being.
After the ECB’s president recently highlighted the willingness of his institution to protect the Euro with further extraordinary measures, requesting additional help from Euro-zone leaders, confidence in the euro has increased. But the situation remains fragile as highlighted in the recent yield development of the peripheral economies, particularly for Spain. End of July 10-year yields stood at 6.61% for Spain and were again higher in August, trading at more than 6.7% but lower than the record level of 7% that has been sought by investors previously. For Italy, the situation was slightly better, with the 10-year sovereign debt trading at 6.08% at the end of July, while it moved to 5.9% in August. In Greece the Troika has reported some progress, but it still seems too early to assume that the economy is making enough progress to satisfy the requested austerity plan. Details of the structure of the enhanced support mechanism of the ESM will be discussed among Euro-zone finance ministers in September and be presented in October. In the meantime, the ECB has kept its key interest rate at 0.75% and its deposit rate at 0%. In recent statements from ECB officials, it has become clear that a lot of stress still exists in the European banking system and that the ECB’s broad support is vital for the functioning of the financial system. Hence, the banking system relies on the life-line provided by the ECB.
While the debt issues seem to be contained somehow, the overall economic situation has continued worsening. The real economy continues to decline and the negative trend that has been observed in the first half is expected to prevail in the second half. This dire situation is forecast to have an impact on growth in the next year. Industrial production has declined for six consecutive months, from the end of last year to May, while May has posted the sharpest drop of 2.5% y-o-y. Manufacturing orders do not point at an improvement yet at 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 Managers Index (PMI) numbers published by Markit. The July composite PMI remains at almost the previous month’s level of 46.5, compared to 46.4 in June. It is currently mainly the manufacturing sector that seems to operate at very low levels, with the PMI for the manufacturing sector at 44.0, again sharply lower than the 45.1 from June.
This low industrial activity leads to another record high unemployment rate of 11.2%, the same level as in May. The worst level has again been recorded in Spain at 24.8%, compared to Germany’s lowest level in recent years of 5.4% in June. This reflects the different strength of the economies within the Euro-zone. Youth unemployment for the Euro-zone was again high at depressing 22.4%, almost matching the record level of 22.5% in May and, again, the highest level has been in Spain with a stunning 52.7%. Consequently, retail trade has been negative for more than a year for every consecutive month, with the latest number for June declining by 1.2% y-o-y, again higher than the May level of -0.3%. While it is forecast that the second half of the year 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 of 0.1% in 2013, unchanged from the previous month, while the negative consequences of the current situation will be largely felt this year, which is forecast to decline by 0.4%.
Emerging markets
The effects of weaker economic growth in the US and the continuation of the Eurozone economic crisis are now being felt in emerging markets (EMs) stronger than before. The US economy, which seemed reasonably robust in January, has slowed in the last few months and in Europe it is not clear yet that European bank and sovereign deleveraging, which is reducing the amount of financing available to businesses and households, could even prevent the crisis from deepening. The impact of the global economic slowdown seems to be particularly acute in emerging Asia where economic growth has been closely linked with foreign trade and the expansion of the global economy. China and India recorded slower manufacturing growth for July and Taiwan’s economy also had been contracting in 2Q. It has becomes increasingly evident that the Euro zone debt crisis that has affected growth in Europe for more than a year now has started to translate into reduced demand for exports from Asia and other EMs. Sovereign and bank deleveraging policies in the Euro-zone have also affected the flow of investments to Eastern Europe.
The escalation of the Euro-zone crisis has dented immediate growth prospects for Eastern Europe’s key export market and added to uncertainties about the mediumterm outlook. External bank loans and foreign direct investment (FDI) is expected to be subdued in 2012. Western European banks are strengthening their capital adequacy ratio in order to withstand the impact of losses and potential losses and to meet the requirements of the EU banking regulator. Latin America’s economy is slowing down, led by the largest economy of the region, Brazil. In recent years the region has been, and will continue to be, supported by China’s demand for soft and hard commodities exports. However, a lack of competitiveness in manufacturing sectors, together with strong domestic demand, has caused a growing current account deficit in 2011 for the region compared to a surplus in 2007. This has increased Latin America’s vulnerability to shifts in market sentiment and has been reflected in pressures on the region’s currencies. In the MENA region, economic recovery has been constrained because of weaker EU demand and weakness in some countries that are still suffering from internal strife.
The fear is that emerging Asia, as exhibited by the recent data, will worsen further in second half of the year not only because of the poor economic performance of the OECD but also because of lacklustre growth in other emerging economies. This might reduce the prospect of global growth in 2012 even further. The slowdown in Latin America, a region with strong and growing trade ties with emerging Asia, for example, might dampen economic performance in emerging Asia in coming months. The largest economy of the region, Brazil, is now expected to grow only 2.1% in 2012. Although Brazil—and to some extent India—are feeling the effects of their own policy shortcomings, they are also suffering from reduced demand for their exports, weaker capital inflows and a general increase in investor risk aversion, all consequences of the ongoing Euro zone crisis. Ironically, the recent collapse of a major part of India’s power distribution grid, which affected economic activity in a large area from New Delhi in the north to Calcutta in the east, happened just hours after the Reserve Bank of India cut its forecast for India’s GDP growth this year to 6.5%, down from the 7.3% forecast made in April.
Against the short-run difficulties in EMs and the damage to sentiment stemming from the Euro zone debt crisis, the medium-term picture seems to be positive. This is because of the sound fundamentals of Asia’s economies, in general, with the exception of India. Levels of debt (both government and private) are generally low compared to those in the OECD. Also, the Asian banking sector is mostly in good shape, having passed through the global financial crisis without large losses. Emerging Asia will continue to benefit from China’s emergence as an engine of regional growth, as China’s middle class expands and as the government adopts policies to encourage growth in private consumption. In Latin America, particularly in Brazil, the policy initiatives adopted to boost economic activities are expected to begin affecting economic growth approaching to second half of 2013. This implies that GDP growth is most likely to remain subdued in the second half of 2012 and early 2013.
Commodity prices have been slipping since late March, reflecting a number of trends discussed above: financial instability, weaker than expected economic growth in the US, and distinct signs of a slowdown in a number of the large EMs. Policy mixes adopted in EMs to support economic growth differ significantly according to their economic circumstances. While in many EMs in Central and Eastern Europe tight monetary policy is still on the agenda to curb elevated inflation, 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 lower allowing policymakers to turn to economic growth policies. The Central Bank of Brazil cut 50 basis points off its policy interest rate on 11 July on top of its interest rate cuts earlier this year. It is expected that Brazil will further reduce its benchmark interest rate in August to stimulate demand for money and investment. A series of initiatives totalling 1.5% of GDP are also envisaged to shield domestic industries from external competition.
India’s Central Bank (RBI) is also cut its policy rate by surprised 50 basis points at its next meeting on 17 April, double the expected 25 basis points. However, due to accelerating inflation another interest rate cut in current year is unlikely and even the central bank might move to increase interest rate in early 2013 to curb inflation. India’s rupee is expected to remain under pressure due to the country’s current account deficit, as well as its 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%. Considering recent decelerations in manufacturing production in China, another cut in benchmark interest rate in China cannot be ruled out in the coming months. In Russia, private consumption and investment demand both remain firm, and the manufacturing PMI had an upward move in July. Although the labour market is tight and unemployment remains low, the accelerating inflation and the recent flood might exert a negative impact on consumption growth.
Brazil
Consensus on Brazil’s GDP growth has shifted downward following new data released by the country’s economic authority. Brazil’s economic growth has been disappointing in the first half of the year, given first quarter data and a continuous slump in Brazil’s manufacturing sector, where output has languished below the 2010 level. External factors have also been affecting Brazil’s economy in an unfavourable way. In addition to weaker than expected growth of OECD and Chinese economies, the hard landing in neighbouring Argentina, which is an important market for Brazil’s manufacturing (particularly its car industry), has reduced demand for Brazil’s exports. Although a 15% depreciation of the real, the country’s currency, since March has improved export conditions and may eventually relieve, to some extent, the industry from external competition, the impacts of the real’s depreciation on domestic private consumption and its inflationary impact have prompted the government to take measures like tax cuts, monetary easing and credit policy to boost domestic demand and support economic recovery. Fiscal policy is also now less restrictive compared to 2011, and public expenditure and lending by public banks has increased. Therefore, a stimulusdriven rebound is expected for the later months of the year; but this should be qualified, given the performance of the economy in first half of the year and current global economic conditions. The forecast for GDP growth in 2012 has been revised down in Brazil to 2.1% this month (from 2.5% last month), as denoted in Table 3.2 above, because the strength needed to increase the annualized GDP growth rate much above this figure cannot be underestimated.
The manufacturing sector is expected to underperform in the short- to medium-term but it will expand in the longer-term by a similar rate of economic growth. Manufacturing output is expected to be supported by growing domestic and regional demand despite structural competitiveness problems. Assuming a soft landing for the Chinese economy, commodity processing and extracting industries can be expanded further by external demand as well. Retail, financial services and construction are expected to outperform overall economic growth while agricultural performance will still depend on whether technological improvements and credit will support an expansion of activities. Bank credit has recovered in June with a pickup in new loans and an easing in credit standards. However, this has been mainly loans extended to households for car purchases. Therefore, while a rebound in economic activities is visible in recent months, there is no decisive indication yet of a substantial expansion in activity.
Inflation has eased to 4.9% in June and there is no sign of its possible acceleration given several interest rate cuts since last year. This would encourage the government to adopt a more aggressive monetary easing policy needed for stimulating the recovery. However, it is worth noting that the current rate of inflation is still higher than inflation central target of 4.4% for 2014 16. Sticky service wages and prices, high indexation and infrastructure bottlenecks are believed to be responsible for the relatively high inflation in Brazil as inflation remains vulnerable to food supply in the short-run. Since February, the real has depreciated from R1.7/$ to R2/$. The Euro-zone crisis and a tax on financial transactions and loans have eased this downward trend for the real. In spite of the recent depreciation of the real, the current account deficit is expected to rise as import growth outpaces export growth.
China
Given the recent deceleration in electricity output and considering the close relationship between economic growth and electricity use in China, where the industrial sector forms almost half of the economy, China’s economic data for the second quarter of 2012 seems to be somewhat inconsistent. Real GDP growth in 2Q is reported to be 7.6% (on an annualized basis) while electricity output grew only by 4.3% y-o-y. Considering the close correlation between electricity use and economic activities in China, the significant gap between rates of economic growth and electricity output has increased uncertainties regarding forecasting Chinese GDP growth in the second half of the year. According to JP Morgan, during the first half of 2012 industrial use accounted for 87.2% while residential use accounted for the remaining 12.8% of electricity output. On the other hand, the industrial sector has been 48.9% of total GDP in first half of 2012, with shares of services and agriculture in GDP at 43.5% and 8.6%, respectively. It seems that the annualized 8.3% growth rate of the industry and the 9.1% growth rate of services in the second quarter of 2012 are not consistent with the growth rate of electricity use for the period, unless the structure of the Chinese economy has been changing fast or electricity intensity has reduced significantly in 2012 compared to 2011.
Following a meeting in late July, the State Council of China (the chief administrative authority of the country) decided to expand the VAT reform in an attempt to lower the tax burden. It also called for support of economic growth in central China as a strategic base for agriculture production, energy and raw materials, manufacturing and high-tech industries. These decisions come after two interest rate cuts in June and July that reduced the benchmark interest rate to 6%. A further interest rate cut of 25 basis points is expected in the third quarter of the year that will bring the benchmark rate to 5.75%. The recent cuts 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 considering the fact that annual rate of inflation is now falling. The reserve requirement ration (RRR) was also reduced by 50 basis points effective from 18 May. This has been the third reserve ratio cut in six months in line with the Central Bank’s statement that targeted actions would be taken to ensure stable credit growth. Pressures for appreciation of yuan against US dollar are also expected to ease in 2012 considering the downward trend in the trade surplus of the country.
Looking to the second half of 2012, the risks associated with China’s economic growth remain mainly driven by the Euro-zone’s economic crisis and slowing growth in the US economy. Constrained credit demand has brought renewed calls for the government to provide a fiscal stimulus to the economy. The Chinese government has already stepped 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 a steady increase in real wages have reduced the imperative to intervene more. Having brought down inflation in recent months, it might be seen imprudent by the government to overstimulate the economy and thereby risk a return of elevated inflation. Therefore a dramatic softening of fiscal policy seems unlikely unless GDP growth appears to be falling below the government’s comfort zone of around 7-7.5%. The forecast for economic growth remains unchanged at 8.1% for 2012 and 8.0% for the next year. On the demand side, the fact that finished goods inventory has recently been rising implies weak domestic and external demand. Further declines in new orders including exports orders suggest that the Chinese economy still faces downside risk in the coming months.
India
Despite pressures for a further cut in interest rates following its April action, whereby the Reserve Bank of India (RBI) lowered the benchmark interest rate by 50 basis points after nearly three years and reduced borrowing cost to 8.0%, the RBI has decided to keep the benchmark interest rate on hold for the time being. This is due primarily to elevated inflation. Following the poor performance of the economy in the second quarter of the year, economic activists have called for a more accommodative monetary policy by the government in order to boost economic growth. Ironically, the recent collapse of a major part of India’s power distribution grid in late July, which affected the lives and economic activities of 650 million people in a large area from New Delhi in the north to Calcutta in the east, happened just hours after the RBI cut its forecast for India’s gross domestic product growth this year to 6.5%, down from the 7.3% forecast made in April. Although India, like Brazil, is feeling the effects of its own policy shortcomings, the country is also suffering from reduced external demand and foreign investment due to a slowdown of global economy.
Although the RBI has given no indication of its policy direction over the coming months, the chance for more monetary easing appears to have receded. On the other hand, monetary authorities have implied that a more consolidated fiscal stance would be needed for further monetary easing. Financing India’s huge budget deficit by the government has had a crowding out effect and has dampened private sector investment necessary for economic growth. So far, government attempts to reform public finance and improve the taxation system have been met with political opposition. Both wholesale and retail inflation have remained high in recent months. The wholesale price index over the first months of the year rose by an average rate of 7.5% on an annualized basis while the CPI grew by 10.1% on average in April-May, up from 7.2% in the first quarter of 2012. The weak rupee and the huge fiscal deficit are sources of inflationary pressure, although lower commodity prices in international markets have eased inflationary pressures to some extent. The widening trade and fiscal deficits have put downward pressure on the rupee. Last year, the rupee depreciated to a record low level under the influence of these factors and growing global risk aversion. It is expected that the rupee will remain weak in the coming months due to the ongoing Euro-zone crisis that has raised demand for the US dollar and triggered a fall in capital inflows to the Indian economy, which could depress GDP growth in second half of the year. Capital inflows have been financing India’s current account deficit, but the renewed escalation of the Euro-zone crisis is triggering a fresh rise in investor risk aversion (EIU, July 2012).
The current account deficit is expected to widen from an equivalent of 2.2% of GDP last year due to a sustained growth in imports and falling demand for India’s exports. It is expected that India’s imports will also decelerate in 2012. However, export growth will fall even more as the main markets of India’s exports in Europe and North America face continued economic slowdown. 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 investor confidence in the economy. The massive subsidies, particularly for energy and petroleum products, and expenditures on welfare programs, have fuelled inflation while preventing any effective fiscal stimulus to GDP growth.
Russia
The Russian economy expanded by 4.9% in first quarter y-o-y above its long-term trend. This has been supported by a 15% surge in gross fixed investment and a 7.2% rise in household consumption. Consumer confidence has also been firm. Unemployment fell to 5.4%, its lowest level since 1999, while industrial output picked up and grew 3.4% in May. The manufacturing PMI in July was almost 52 (51.99) compared to 50.97 in June, indicating an ongoing expansion of industrial activities in recent months. High oil prices have caused a surplus in the first half of 2012. Government revenues reached $203 bn yielding a surplus of $7.7 bn in this period. Currently the falling crude price has been offset by a weakening ruble, but lower commodity and oil prices could deteriorate the prospects for economic growth. Fiscal policy for the coming years will be based on new fiscal rules, which will limit budgetary spending in line with oil prices movements. Budget spending in 2013-15 will be based on an average of oil prices. The new rule allows planned spending to rise by 5% in 2013. This would not help to reduce the dependence of government expenditure on oil prices as it is projected that the non-oil deficit will shrink to 1% of GDP in 2014 from 11.3% in 2012.
Monetary policy, on the other hand, has been more prudent as the central bank has left the key refinancing interest rate unchanged at 8% at its latest meeting in July. Rising inflationary expectations have been the main reason for keeping interest rates on hold over the last six months. After higher than expected inflation in June and the increase in utilities tariffs in early July, the central bank is expected to wait for a clear indication of inflation before it considers changes to monetary policy. There is an official commitment to move towards a floating exchange rate with Russian Central Bank (RCB) intervention confined to preventing excessive currency volatility (EIU, July 2012).
Russian GDP growth in the second half of the year will be influenced by global commodity and oil prices. It is expected to decelerate as the global economy slows down. One channel of transmission of global financial turbulences to the Russian economy would be inflows of capital and direct investments in Russia. Although a slowdown in economic activity in response to a deceleration of global economic growth is possible, a sharp decline in economic growth is not expected. We forecast 3.7% GDP growth in Russia in 2012 and 3.4% in 2013. Inflation in Korea slid South Korean inflation in July slid far more than expected to a 12-year low as the economy cooled, reinforcing the market's growing view for a back-to-back interest rate cut next week. Indonesia, meanwhile, reported a slight pick-up in inflation for July due to a jump in food prices ahead of the Muslim fasting month, adding pressure on the central bank to keep its policy rate steady despite slumping exports. The Bank of Thailand revised down its forecasts for economic growth and inflation, and said downside risks and uncertainty emanating from the global economy are likely to increase this time.
The IMF now expects the MENA region to grow at a rate of 5.5% in 2012, on par with the average for emerging economies. This is up 1.3% after its April forecast of just 4.3%, and is by far the largest positive revision for any region or country. The IMF forecasts strong growth of around 6% for most GCC countries. The regional average was dragged down by oil importing countries, with growth rates forecast at around 2-3% for most countries, but with a contraction in Yemen and Syria.
FDI flows into Sub-Saharan Africa (SSA) shot to a record high of $35 billion in 2011 from $27.4 billion posted in 2010. West Africa received the bulk of this with 46%. Ghana, Nigeria and South Africa collectively attracted half of the 2011 FDI that flowed into the area. Ghana and Nigeria together made up 75% of the sub-region’s inflows, which were concentrated in the petroleum industry. The continent's powerhouse, South Africa, is among the slower performers, with growth estimates of 2.5%, with its more integrated economy vulnerable to global tremors.
OPEC Member Countries
Saudi Arabia’s real GDP is projected to slow down to around 5.0% in 2012 compared with 6.8% in 2011, but a surge in oil income will likely widen its fiscal surplus. Government spending will remain the main driver for the growth of the national economy. The Saudi economy is well prepared to adapt to the current global economic slowdown, even in case the debt crisis in the Euro-zone remains out of control. Oil revenues increased by 37.6% compared with last year due to the increase of production and oil prices. The increase, in terms of production and prices, has correlated to Saudi economic growth in three elements: The oil sector constitutes the major part of GDP; it is a major source of revenues for the state budget; and the country’s oil sector enjoys a competitive global advantage. The central bank of Iran has reported that the inflation rate has been rising since the beginning of the year. While the inflation rate was declining last year, it started to rise again this year, from 21.8% in the first month to 22.9% in the fourth month.
Oil prices, US dollar and inflation
As in the previous months, the US dollar continued its relative strength. On a monthly average from June to July, it rose significantly by 2% versus the euro and 2.1% compared to the Swiss franc, while versus the yen it fell by 0.4% and relative to the pound sterling it stayed almost flat at -0.2%. This support for the US dollar over the recent months highlights the relative strength of the US economy combined with its continued status as a safe haven, which has been accentuated by the weakness of the euro and the depth of US financial markets. Over the last six months (i.e. since February), it gained 7.2% versus the euro and the Swiss Franc, 1.3% compared to the pound sterling and 0.8% versus the yen.
The euro held up relatively well given ongoing issues in the economy, but the accelerating trend of the US dollar is obvious and it should be expected to continue as many unresolved issues in the Euro-zone prevail. It averaged $1.2274/€ in July, but depending on further developments in the Euro-zone’s sovereign debt crisis, it is likely that it will touch down to the $1.20/€ level, which is the next big support line. Of some interest is the recent development of the yen to the US dollar, which remained largely below the critical ¥80/$ level. The Bank of Japan seems not to have significantly intervened in the currency markets lately, although the yen has been trading at this relatively high level since already the beginning of May. In nominal terms, the OPEC Reference Basket rose by $5.6/b or 5.9% from this year’s bottom level in June of $93.98/b to $99.55/b. In real terms, after accounting for inflation and currency fluctuations, the Basket price rose by 6.8% or $3.99/b to $62.91/b from $58.93/b (base June 2001=100). Over the same period, the US dollar rose by 1.0% against the import-weighted modified Geneva I + US dollar basket, while inflation increased by 0.2%.
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