Sunday, December 19, 2010

The global economy - The times they are achanging

The upswing in the global economy continues at a moderate pace in the ‘old’ economies, while  growth in the emerging markets (EM), headed by  China and India, seems to be strong. It is expected  that EM will account for two thirds of global growth over the coming years.

In the 90’s and the early years of the new  millennium, the EM countries were known for their big debt problems while the old economies were at the top of the class. Today things have changed. The ‘new’ economies are in control of their debts and can afford fiscal stimuli so these economies have been jump-started.  Now things are almost moving too fast. And – on the contrary – the old economies are today struggling with high debts and the upswing is still moderate.

These differences between the old and the new economies have resulted in an inflow of capital to
EM. In the emerging markets, this has given rise to concerns about currency appreciation, asset
bubbles and overheating of the economies. There is a risk that such concerns may lead to increasing
protectionism to the detriment of the entire global  economy.

Upswing despite adversity 
The transition from a stimulus-driven upswing to a self-sustaining recovery put a damper on growth in mid-2010 and resulted in fears that the global economy was sliding into recession again (double dip). However, the recent months’ economic indicators have confirmed our expectations of a wider upswing, but there is often additional uncertainty associated with economic indicators during periods when economic trends are turning.

We have revised up our global growth estimates marginally to 4.6% for this year and to 3.9% for 2011. For 2012, we also expect 3.9% growth. It is to be expected that a number of circumstances will still put a damper on the recovery. These are the necessary consolidation of the public finances, but also the repercussions of
the crisis in the form of adjustments of household balance sheets as well as a fairly fragile labour market.

Even though the recovery is beginning to look more broadly founded, GDP is far the pre-crisis levels,
particularly in the euro zone and Japan. We expect that in the US the most recent top level will be
reached already this year. In the euro zone this is not expected to take place until the second half of
2012 and somewhat later in Japan. Things are totally different in the emerging markets. In Asia,
GDP never fell and only marginally in Latin America. However, the EM economies in Eastern
Europe are lagging somewhat behind the other EM regions.

Major political challenges 
Over the coming years, most countries will meet challenges such as having to tighten public finances. Inevitably this will have a short-term negative effect on demand. This effect can, however, be reduced if the tightening takes place in connection with a credible fiscal tightening programme.

The monetary authorities are facing the difficult task of having to withdraw the expansive monetary
policy so that it will match the economic recovery. We still expect that the two large central banks,
the Fed and the ECB, will raise their interest rates the first time in September and December 2011,

Continued uncertainty  
Economic growth is still facing a number of risks. We assess that the risks are almost in balance, yet that they are still a bit larger on the downside than on the upside.  Lower growth may be caused by turmoil in the
financial markets, continued more extensive adjustment of the debt balances of the households and the public sector, the sudden increase in government bond yields, the banking sector and the lack of credit as well as capital inflows into EM.

On the upside, investment growth may turn out to be stronger than expected as the investment ratio is very low at the moment and also corporate earnings have increased. But also normalisation of the situation in the financial sector and the pentup demand may lead to positive surprises in economic growth.

Economies out of step 
Concerns about growth and deflation, debt problems and relaxed monetary policy are on the agenda in the old economies. Inflation in the US and the euro zone – particularly core inflation – is very low. This gave rise to concerns about risk of deflation. However, the inflation development is typically very slow when the inflation rate reaches very low levels, and we do not expect to see deflation.

In the emerging markets, tightening of the fiscal and monetary policy is on the agenda, as the excess capacity in the economy is about to be depleted and fear of inflation is surfacing. The differences between the new and the old economies have resulted in a strong inflow of capital into the emerging markets with the risk of asset bubbles, currency appreciation and overheating of the economy. On the whole, this means that the central banks are increasingly forced to work less towards a weak currency and more towards tighter monetary policy resulting in lower export growth, higher export prices and more modest domestic growth. Several emergingmarket countries have slowly begun to raise interest rates and tighten fiscal policies.

Past experience indicates that emerging-market countries will not just tighten their monetary policies. Rather, they will actively choose to intervene in the FX market, introduce various capital controls and other growth-dampening initiatives such as tighter reserve requirements of the banks, etc.

There is a risk that the protectionist initiatives will escalate among the countries as they will protect their own interests. This will be counteractive to the necessary movement to establish a more balanced global economy that will also support higher inflation in the old economies.
Full report: The global economy - The times they are achanging 

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