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Global Economic Outlook - August 2012


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  • 1. Global Economic Outlookby Cecilia Hermansson 21 August 2012 The crisis in the euro zone is slowing the global economy and leaving it more vulnerable The global economy received a temporary boost in the first quarter after the major central banks expanded their quantitative easing, but during the second quarter growth slowed once again. The euro zone is on the brink of recession, the US recovery is sluggish and emerging markets are feeling the impact of weaker demand from developed countries as well as the effects of their own economic austerity in order to mitigate signs of overheating. The crisis in the euro zone and uncertainty about US fiscal policy will slow the global economy going forward. We have revised GDP growth downward to 3.0% and 3.1% for 2012 and 2013, from 3.1% and 3.4%, at the same time that the expected rise to 3.4% in 2014 assumes that the crisis is handled well and produces stronger institutions and closer integration in the euro zone. We give this muddling-through scenario a probability of 60%. Uncertainty about the euro zone crisis also affects the accuracy of our forecasts. We have assigned the scenario with slower development a probability of 35%, but only a 5% probability that the economy will outperform expectations. Economic policy here at home has to address the crisis in our most important export market, which affects exports and investment. Moreover, strategies have to be developed to best deal with the prospect of a closer integration in the euro zone, when countries on the outside will risk falling behind. We expect that any anything-but-straight path to a banking union, fiscal policy union, economic policy union and political union will eventually be chosen, since the alternative is a crumbling currency union that will produce huge economic, social and (geo)political costs. It is in our interest that the euro survives and that Europe’s inner market continues to develop. Cecilia HermanssonContents: Page:1. Imbalances are reducing global growth 22. Downside risks outweigh upside risks 63. Crisis in the euro zone 84. Our assumptions about the commodity and financial markets 145. Emerging economies are driving growth 23 - USA 24 - China 26 - Japan 28 - India 29 - Brazil 31 - Euro zone 33 - UK 36 - Nordic countries 386. Conclusions for our home markets 39 Ekonomiska sekretariatet, Swedbank AB (publ), 105 34 Stockholm, tfn 08-5859 7740 E-post: Internet: Ansvarig ugivare: Cecilia Hermansson, 08-5859 7720 Magnus Alvesson, 08-5859 1031,Jörgen Kennemar, 08-5859 7730, ISSN 1103-4897
  • 2. 1. Imbalances are reducing global growthAt the beginning of 2012 the global economy strengthened more Growth in early 2012than expected, especially in Germany and Japan. Liquidity was stronger thaninjections from central banks probably helped to hide actual expected …conditions and delay the slowdown that arrived in the secondquarter. Now there are clear signs of recession in parts of theeuro zone and the UK, at the same time that the economies inthe US, Germany, Japan, China, India and Brazil have cooled off.We have revised our global GDP growth estimates downward for2012 and 2013 to 3.0% and 3.1%, respectively, from 3.1% and3.4% in the April forecast. Not until 2014 – and with considerableuncertainty – do we expect GDP growth to reach 3.4%, which isstill weaker than in 2011.Global GDP forecast August Forecast April ForecastGDP growth (%) 2011 2012 2013 2014 2011 2012 2013US 1,8 2,1 1,7 2,3 1,7 2,1 2,3Euro zone: 1,5 -0,4 0,1 0,8 1,4 -0,5 0,4of which: Germany 3,1 1,1 1,1 1,6 3,1 0,5 1,3 France 1,7 0,3 0,5 1,1 1,7 0,3 0,6 Italy 0,4 -2,2 -1,0 0,2 0,4 -1,8 -0,3 Spain 0,7 -2,0 -1,2 0,3 0,7 -2,0 -0,8 Finland 2,8 0,7 1,4 1,8 2,9 0,8 1,7UK 0,7 0,2 1,0 1,7 0,7 0,5 1,0Denmark 0,8 0,8 1,2 1,3 1,0 0,5 1,0Norway 1,5 3,3 1,6 2,2 1,7 2,0 2,5Japan -0,7 2,2 1,3 1,2 -0,7 1,5 1,2China 9,2 7,9 7,8 7,6 9,2 8,1 8,0India 7,2 6,2 6,5 6,8 7,2 6,7 7,3Brazil 2,7 2,0 3,9 4,1 2,7 3,1 3,5Russia 4,3 3,8 3,9 4,3 4,3 4,1 3,9Global GDP in PPP 3,5 3,0 3,1 3,4 3,5 3,1 3,4Global GDP in US dollars 2,6 2,2 2,3 2,7 2,5 2,2 2,6Source: National statistics and Swedbank’s forecasts.Note: The countries represent around 70% of the global economy. To gaugetotal GDP growth, add around 0.3-0.4 percentage points.Due to the strong results early in 2012, current-year growth … because of whichestimates for certain countries have been revised upward. This GDP growth estimatesmainly applies to Japan and Germany. As a result, weaker for some countries havedevelopment in the euro zone’s crisis countries ended up being been revised upwardmore than compensated by stronger gains in Germany. In theUS, the positive effect of lower gas prices on private consumptionwas offset by increased concerns about growth-inhibitingausterity measures set to take effect at the end of the year. Whilethe US forecast for 2012 is unchanged, the euro zone’s has beenrevised upward slightly. At the same time growth has slowed2 Swedbank’s Global Economic Outlook • 21 August 2012
  • 3. more than expected in the BRIC countries (China, India, Braziland Russia), which necessitated a downward revision.Our outlook for 2013 has been revised downward even more. On the other hand, theAlthough US quarterly growth will rise in our forecast, the annual US and Europe willrate in 2013 will fall due to the weak start to 2012. The slow continue to weaken inimprovement in the labour market, troubled small businesses 2013…and, no less importantly, the negative effects of budget austerity,which will have to happen in some form, will choke off therecovery. In the euro zone, the recession in two crisis countries,Italy and Spain, is worsening, while the core countries are alsoseeing a slowdown due to the region’s weaker demand andgrowing instability in the financial market.While we expect stimulus measures and economic reforms to … and emergingstrengthen growth in India and Brazil in the years ahead, China’s markets will also growgrowth is headed in the opposite direction, though this is more slowlydesirable in some respects. The shift in focus from investmentsand exports to private consumption will mean a slightly lowergrowth rate. This process entails big risks, and experience showsthat a “fine-tuning” is hard to accomplish, even for politicians thatare used to steering the economy centrally – and should be hardin an economy as large as China’s.Actual growth in a number of countries 15,0 China 12,5 10,0 7,5 India 5,0 Percent Brazil 2,5 0,0 -2,5 US Eurozone -5,0 -7,5 Japan -10,0 05 06 07 08 09 10 11 Source: Reuters EcoW inWhether global GDP growth of 3.4% in 2014 will be reached A muddling-throughlargely depends on crisis management in the euro zone and the scenario is important tospeed of the debt restructuring of the public sector in the majority growth in 2014of developed countries. We expect the euro zone to continue tomuddle through. Even if the institutional framework isstrengthened, many problems will still exist, especially with debtlevels being high, the crisis countries struggling competitively andreform needs so great. Growth will be weak or practicallynonexistent during the forecast period.Swedbank’s Global Economic Outlook • 21 August 2012 3
  • 4. Another important question is how strong potential growth really How high is potentialis in developed and emerging markets given the economic global growth at thisclimate since the financial crisis. By potential production and point?growth we mean the production and growth that are possiblewithout creating serious imbalances in the economy: theproduction level at which supply meets demand and actual andprojected inflation are in line with the central bank’s explicit orimplicit targets.Debt restructuring in the developed countries is likely to chokeinvestment in every part of the world, which will impactproductivity growth. In addition, potential growth could be held incheck by increased structural unemployment, which is anotherreason why the skills that companies need are not available. Thiscould be the case in both the US and Europe.For emerging markets, the crisis in the euro zone and slow USrecovery mean weaker export demand, but also a lower appetitefor investment. As a result, there is a risk that investment andcapital flows will dry up, adversely affecting productivity growth.We have previously estimated potential global GDP growth at Without scientific4.2%, but this assumes that the US rises by 3.3%, the euro zone precision, we estimateby 2.3% and Japan, China, India by 1.5%, 8% and 7%, that potential growth hasrespectively. Now it seems more likely that potential GDP growth shrunk from 4.2% towill be less than 4%, and probably closer to 3.8%. Regardless of 3.8%the debate on potential growth, there is reason to fear that anumber of deficiencies and imbalances will suppress globalgrowth in the years ahead: 1. The institutional crisis in the euro zone is affecting the willingness to invest. High debt levels in the public and private sectors in a number of countries are also impeding growth. Other factors affecting growth prospects include a democratic deficit, which is hurting future confidence, weak competitiveness in certain countries, a flawed inner market and generally inferior labour and product markets. 2. The fiscal crisis in the US and Japan, including the high public debt levels, is affecting the willingness to invest, hire and spend. 3. Economic policy is no longer as effective at stabilising economic swings: interest rates can’t be cut any lower in major developed economies, the marginal benefit of quantitative easing is low and shrinking, and automatic stabilisers aren’t totally effective when the need for budget consolidation increases. This raises the risk of protectionism and a currency war. 4. Weak balance sheets in banks in developed countries have led to credit austerity and continued financial instability. This is squeezing investment and growth. 5. Insufficient investment in education is creating problems in the labour market and reducing productivity growth. A lack of resources to invest in environmental and climate-smart technologies and infrastructure due to weak government finances will also affect long-term growth.4 Swedbank’s Global Economic Outlook • 21 August 2012
  • 5. 6. Growing income and wealth gaps mean that many people will never reach their potential due to educational, health and employment limitations. There is also a risk that several countries will have to deal with a “lost generation”, criminality and extremism. 7. Problems with capital allocation between and within countries. Undeveloped financial sectors in emerging markets are causing capital to flee and seek out more developed markets, where returns are lower. Low interest rates in developed countries could also distort capital allocation there.In a climate of credit and budget austerity, with a weak riskappetite and reluctance to invest, politicians face growing The courage andchallenges to maintain sound economic policies that increase willingness of politiciansefficiencies while also reducing income gaps, and which improve to implement reformsgrowth prospects in both the short and long term. Politicians who will be criticalare willing and courageous enough to push through structuralreforms that significantly improve the functioning of variousmarkets and incentivise innovation and creativity will be moresuccessful than those who focus solely on budget consolidation.Furthermore, the West has to adapt its welfare systems toavailable financing and acknowledge that huge annual budgetdeficits can no longer be accepted.We have revised our growth outlook downward for 2012 and2013 compared with our April forecast. More importantly, growthwill remain below its potential for several years to come. Anumber of imbalances in the global economy are stifling growthin the form of high debt levels, skewed capital allocation,institutional and political crises, confidence and democraticdeficits, insufficient investment and growing income gaps.Swedbank’s Global Economic Outlook • 21 August 2012 5
  • 6. 2. Downside risks outweigh upside risksUncertainty about global growth is very high, as has been the Forecast errorscase in recent years, and forecast errors increase the further in increase the further inthe future we try to predict. Several risks should be emphasised, the forecast horizonincluding political and psychological risks as well as economic. we goAssumptions about commodity prices entail risks associated withthe weather and geopolitical tensions. We have given our“muddling-through” scenario a probability of 60%. In this scenariogrowth is weak. Even though the problems formulating economicpolicy and building institutions are numerous and monumental,the work is progressing slowly and gradually, just enough that atotal collapse is avoided. Many issues are being addressed at thelast moment, which feeds doomsday headlines that a collapse isnigh. Consequently, financial instability is high in this scenario aswell.However, there are also several more or less optimisticscenarios. We consider the downside forecast risks moreprobable than the upside risks. This applies to how likely it is thatthey will be realised and to the effects on the global economy ifthey are.The probabilities are tied to whether any of the risks are realised, If all the downsidebut keep in mind that the scale is fluid: How much will the crisis risks are fully realised,worsen and how far will commodity prices rise? The effects on the impact will bethe economy vary as a result. If all the downside risks are fully substantialrealised, the impact would of course be huge, compared with ifone of the risks is partly realised and has a modest impact. Thisshows that the probabilities are of limited value, though they doprovide an indication of whether we feel it is more or less likelythat conditions will worsen relative to the main scenario.1. Downside risks (35%)  A growing crisis in the euro zone, where Spain and Italy need support, but where the rescue funds prove insufficient and the European Central Bank (ECB) lacks the mandate to stabilise conditions. One or more euro countries are forced to exit the currency union, with negative consequences for financial stability and growth. The result: depression, deflation and mass unemployment in combination with a wounded financial sector (see chapter 3 on the euro zone crisis).  The US stumbles off a “fiscal cliff” after Congress fails to agree on a budget. As a result, taxes are raised at the same time spending is cut after the turn of the year. If fiscal austerity is fully implemented, GDP growth would be slashed by 4 percentage points and the US would fall into recession.  The failure of the US and Japan to consolidate their public finances in the medium and long term could affect confidence and create concerns. Their status as safe havens, and the reputations of the dollar and yen as safe haven currencies, could change. If nothing else, a reversal from historically low bond yields to very high yields in the wake of a collapse in confidence would make it that much more expensive to finance the government’s debt and could cause a recession.6 Swedbank’s Global Economic Outlook • 21 August 2012
  • 7.  Attempts by Chinese officials to stave off inflation and a housing bubble may have been taken too far with the help of austerity and regulations. Sharp declines in land and housing prices would impact many sectors of the economy, including municipalities. A hard landing is possible in China if growth slows significantly, e.g., if exports are affected by the global crisis at the same time that overcapacity limits investment. If the monetary and fiscal stimulus is insufficient, there is also a risk that unemployment will rise and households will become more cautious. Very low GDP growth could also create political instability.  Higher commodity prices could be caused by new supply problems in food production, e.g., droughts and floods. Geopolitical tension in the Middle East could push oil prices higher than expected. Higher inflation reduces private consumption.  Emerging markets such as India and Brazil have tightened their economic policies to prevent runaway inflation and credit growth. Inflation has eased, allowing more room for stimulus. If commodity prices rise again, inflation will too, limiting opportunities for expansive economic policies. Capital outflows, currency depreciation and falling stock prices could also create financial instability in emerging markets.  Political risks create uncertainty on both the up- and downside. Increased political concerns in connection with the elections in Italy and Germany next year could reduce confidence in the euro zone. Power struggles in the US and China this year could affect political resolve.2. Upside risks (5%)  Resolute action to address the euro zone crisis could strengthen confidence and shorten the recession in the region.  If supply problems are resolved at the same time that weaker demand keeps prices in check, it could help commodity- importing countries and companies. Lower inflation facilitates expansive economic policies.  A consumption boom in Germany could occur in the wake of lower unemployment and declining inflation. Higher real wages strengthen domestic demand and higher imports reduce the current account surplus. Slightly more expansive German economic policy would benefit the export-oriented euro zone countries now in crisis.  If emerging markets stimulate their economies more than expected, growth may rise in the short term, but with a greater risk of bubbles that burst in the medium term.Swedbank’s Global Economic Outlook • 21 August 2012 7
  • 8. 3. Crisis in the euro zoneBelow we discuss the euro zone’s immediate and more long-termproblems as well as the solutions required and what is currentlypreventing decision-makers from choosing them. We also makean attempt to develop various scenarios for the euro zone’sfuture development.Euro zone’s problemsThe euro zone is wrestling with several types of problems, somemore immediate than others. They are related in terms of howthey arose and how they should be resolved.The most pressing problem is increased financial fragmentation Financialand the high bond yields that have resulted in Spain and Italy, fragmentation and thewhich are putting both countries at risk and jeopardising the euro crisis in Greece, Spainzone’s stability. These countries are in a recession, which could and Italy are the mostbecome a depression. Despite its debt reconstruction, Greece pressing concernsappears to be insolvent. There is a lack of confidence that thecrisis can be addressed with the current support mechanismsthat exist. This is creating fears that one or more countries willdefault on their debt payments and have to exit the currencyunion, which would then face the prospect of having to dissolveor undergo a major transformation. Such a process would meanhuge costs within and outside the euro zone. If nothing else, thecrisis has drawn attention to the institutional weaknesses thathave plagued the currency union since its inception.Another, more long-term problem is that several euro countries, The public debt crisisincluding core countries, have high public debts – and in some and banking crisis arecases private debt – as evidenced by the shaky condition of the closely relatedbanking sector. Restructuring public finances and cleaning up thebanking system will take time and entails tremendous risks.Credit austerity, weak growth, high financing costs and volatilityare affecting investment and consumption. With continued highbond yields, even countries that today are mainly looking atliquidity problems may prove to be insolvent. The institutionalframework – the Stability and Growth Pact – was poorlydesigned, far too weak and did little to stop an escalating andunsustainable build-up of public debt.The public sector’s gross debt as a percentage of GDP, 2013 forecast 300 250 200 150 100 50 0 Ge Sp EA UK Be US Po Ir It Gr JpSource: IMF8 Swedbank’s Global Economic Outlook • 21 August 2012
  • 9. A third, more long-term problem is the divergence between the Big differences infairly well-functioning countries to the north and their competitivenesscompetitively weaker neighbours with much bigger imbalances to between north andthe south. An undue focus on nominal convergence allowed the southlatter to join the currency union, and for several countriesexceptions were made so they would meet the criteria. Low realinterest rates and large capital inflows created a real estate andfinancial crisis in several countries, in some cases contributing toa bloated public sector. Rapid wage growth, coupled with lowproductivity growth, weakened the competitiveness of thesecountries and generated huge current account deficits. The needfor structural reforms was widely ignored.Current account balance as % of GDP 10 5 0 Percent -5 -1 0 -1 5 -2 0 96 98 00 02 04 06 08 10 12 G e rm a n y Ir e la n d S p a in G re e c e P o rtu g a l S o u r c e : R e u te r s E c o W inThe mere existence of the currency union didn’t create the The currency unionproblems and imbalances described above, but it has made the has made the crisissituation worse and limits how the countries can resolve their worse and makes itproblems. The crisis countries are at the mercy of the euro zone harder to resolve itto collaboratively find a solution.Other countries such as the UK, US and Japan are alsostruggling with debt, but the biggest concern is how the eurozone’s existing framework will handle the high levels of debt. Inthe US, some states are more competitive than others, but thetransfers between them are larger, so when a local municipalityoccasionally files for bankruptcy the dollar isn’t in jeopardy. Thecredit risk to lend to these municipalities is increasing, however,and their financing costs will remain high for years to come.Other countries that have faced financial and real estate crises in Other countries haverecent years include the US, UK, Iceland, Baltic countries and developed similarDenmark. The difference is that countries with their own central bubbles and debtbanks that aren’t members of the currency union have more tools crises, but have otherat their disposal, e.g., currency depreciation, printing presses and tools at their disposalincreased lending. The confidence crisis in the euro zone stemsfrom with the fact that its members have arrogated monetarypolicy decisions, even though the euro zone hasn’t developed thenecessary crisis management resources and institutionalframework.Swedbank’s Global Economic Outlook • 21 August 2012 9
  • 10. Which institutions are needed and how well are they workingtoday?A monetary union won’t work long-term without a fiscal and A currency union isn’tfinancial union, as well as a central bank that serves as a lender enough – financial andof last resort, in the opinion of many economists (see, e.g., Jean fiscal unions arePisani-Ferry, 2012). The optimal currency area theory also cites needed as wellthe need for increased financial and fiscal integration.However, the EU Treaty contains a “no bail-out” clause, which The EU Treaty hasprohibits countries from paying each other’s debts. The idea was prohibited theto force them to manage their own finances and not turn to others necessaryfor help. This refers to what is called moral hazard, i.e., that the crisis solutions ...nocrisis countries aren’t fully suffering the negative effects of their bail-out clause...actions. The Stability and Growth Pact was counted on to reducethe risk that countries which join the currency union would breaktheir pledge to maintain budget discipline. Unfortunately thereliance on group pressure proved misguided.The ECB is prohibited from monetary financing, which means … no monetarythat the central bank can’t buy bonds from its member countries financing in the ECBand monetise the debt. Aside from the moral hazard, there is a …risk of accelerating inflation, currency depreciation and financialinstability.A financial union or banking union was never part of the plan, … and the banks weresince member countries wanted to retain responsibility for “their regulated andbanks”. But with a common monetary policy and interest rate supervised nationallyconvergence it will be hard to put national borders on banking.This has increased the need for a supranational bankingauthority, which should also be linked to a fiscal cooperation,considering that the balance sheets of the banks andgovernments are closely intertwined.Note that although the treaty prohibits countries from assuming The crisis has forcedeach other’s debts, the crisis has forced the euro zone to do just politicians tothat through the European Financial Stability Facility (EFSF). The circumvent the EUECB also appears to be dabbling with monetary financing by Treatybuying government bonds on the second-hand market. Onereason why the EU Treaty has been contravened is that the riskof an economic meltdown is seen as greater than the moralhazard and the risk of inflation.Are there any permanent solutions and what are theirlimitations?What are the more permanent solutions to the euro zone’sproblems? The financial market has put its faith in the ECB tomanage the crisis, since the central bank has the ability to printmoney in emergencies. Politicians who have a responsibility totheir taxpayers back home, e.g., in Germany, prefer to focus onlong-term problems by demanding reforms and budgetconsolidation and in that way increase confidence in the financialmarket and keep pressure on crisis countries to takeresponsibility for their own economies. These politicians aredemanding that stronger institutions be put in place before more10 Swedbank’s Global Economic Outlook • 21 August 2012
  • 11. support is offered the crisis countries. The fact that the ECB canno longer buy government bonds before the crisis country inquestion has negotiated a program with the EFSF is one way forGermany to tighten rules and encourage reforms, at the sametime that the ECB in this way – as long as Spain doesn’t ask for abailout through the EFSF – gives up an instrument that couldreduce the immediate crisis (at least temporarily).There is a tug-of-war between the need for short-term solutions Crisis managementto support the financial market and crisis countries and those is a tug-of-war andwho’d rather ensure that the institutions are strong enough for the balancing actlong term. The tug-of-war is also evident by the need to promotegrowth, which isn’t always consistent with the need for reformand budget consolidation. While the financial market doesn’tsufficiently understand the political process and importance oftaking a long-term view of the currency union, politicians lack athorough understanding of how the financial market works.There are short-term problems and there are long-term problems, Short- and long-termbut both have to be addressed now. It takes time to increase problems both have tocompetitiveness and reduce government spending, so reforms be addressed now!will have to be implemented immediately. This could meanderegulation, labour market and pension reform, tax reform andprivatisations. Growth would also be positively impacted in theshort term, not least from the increased confidence, which wouldfairly quickly give the economy a jolt. It is also possible that theinstitutions will first have to be strengthened before the crisiscountries receive help. Anything else would be unsustainable.The euro countries wouldn’t be able to withstand another Greekcrisis, which means that the framework first has to be changedbefore Spain can expect to reduce its high bond yields.The euro countries are slowly working toward an optimal solution This falls workingfor the euro’s survival, where the monetary union incorporates groups willfiscal policy and a financial union that allows the central bank to demonstrate whetherserve as a lender of last resort and lays the foundation for a the euro zone hascommon bond market, a so-called Eurobond market. taken a step closer to the optimal solutionThere are several long-term advantages to a eurobond market,and it could be designed so that every country “wins” by being apart at the same time the moral hazard is reduced. A eurobondmarket would increase the effectiveness of the European bond A eurobond marketmarket thanks to the increased volume, but it wouldn’t alleviate would be positive inthe immediate crisis. Redistributing the public debt burden from the long term, butcountries with large debts to those with smaller debts is hardly doesn’t resolve thegoing to improve the euros image and isnt reasonable if there immediate problemsare enough private assets in the crisis country to possiblyredistribute the burden to.To achieve the optimal solution as outlined above requires a The euro zone’sstrong commitment to keep the currency union intact and to democratic deficit is ademocratic principles, which may take more time, but in the long huge riskrun will be more sustainable. By kicking the can down the road,the euro zone’s politicians are not only putting off importantdecisions in the hopes others will make them, but are alsoneglecting to find a balance between support and reformSwedbank’s Global Economic Outlook • 21 August 2012 11
  • 12. pressure and to design institutions that work better than thosecreated when the currency union was formed. The 17 eurocountries, with their varying national interests, also face thechallenge of agreeing on major changes that, despite theirreluctance, now appear to be imminent. The fact that politicianshave been slow to address the crisis and have focused onsolutions unrelated to the central problems (credit ratingsagencies, Tobin tax, etc.) has probably only made it worse.The process to strengthen these institutions is under way based For the vision to haveon Herman Van Rompuy’s draft, where the vision incorporates lasting value willfour building blocks: 1) an integrated financial framework, 2) an require a moreintegrated budgetary framework, 3) an integrated economic democratic processpolicy framework, and one that is especially difficult, 4) ensuringthe necessary democratic legitimacy and accountability of thedecision-making process. Working groups will formulate thedetails of this plan at the same time that the ECB has appointedworking groups to stipulate the forms of bond purchases,provided that the crisis countries follow the programs prescribedby the EFSF/ESM rescue funds.Some immediate questions:1. Will Greece need another bailout since its primary surplus will still have to be very high, and will official lenders accept this? Is it enough that Greece demonstrates a greater commitment to reform for the euro countries? Would other euro countries accept that Greece’s debt ratio would be lower than 120%? The alternative is to give Greece more time to implement the consolidation program, although such a solution also has to be financed.2. Are other euro countries insolvent and how is this being handled? Though Greece’s debt reconstruction may be unique, the actions have probably contributed to Spain and Italys high bond yields, since the financial market sees a higher risk. It is reasonable for banks to take losses, but the problem is that the crisis would then spread to other countries. Next in line could be France and Belgium.3. There is a risk that the ECB will no longer have the instruments to address the crisis if the situation worsens in Spain and Italy. It would take time to find support through the EFSF before the ECB could begin buying bonds? It is important to consider the ECB’s independence; the relatively young central bank is more vulnerable to political pressure. The ECB has said that a program through the EFSF is necessary but not sufficient for it to buy bonds. It claims that it can make its own independent decisions (at least on paper). An alternative would have been if the EFSF, or eventually the ESM if and when it becomes a reality, had been given a banking license to enlarge the fund. Now the ECB is expected to follow bailout programs and boost the bailout funds by buying bonds.4. Germany has to accept higher inflation to allow the crisis countries in southern Europe to adjust their debt levels and become more competitive. Otherwise they face a risk of deflation. Higher prices and wages will reduce Germanys current account surplus, which would also make it easier for the crisis countries to reduce their deficits. The question is how far Germany is prepared to go, probably not further than maintaining price stability for the euro zone as a whole.12 Swedbank’s Global Economic Outlook • 21 August 2012
  • 13. There is great uncertainty whether the working groups will There is a long way tosucceed in creating institutions given the needs that exist, go before anywhether politicians in the euro zone will be able to agree on the decisions are madeproposals and whether the national parliaments will approve the and implementedchanges. Even then it would take some time before the proposalsare implemented.Unless the currency union is more closely integrated, and if The integration has toinstead the next the best solution is chosen, i.e., to develop the go further – theESM and combine it with the ECB’s various tools, there is a risk question is how farthat the financial market will continue to doubt the euro’s survival. member countries areWhile it is difficult to see any alternative to the optimal solution, prepared to gothe integration could vary in terms of degree, i.e., how far thebudget framework is integrated. And what would a banking unionlook like in terms of supervision, intervention for troubled banksand a deposit guarantee?What will happen? There are at least four possible futurescenarios looking forward:1. Our main scenario has a probability of slightly over 50%. The muddling-through scenario is a slow, nonlinear process that leads to a further integration of fiscal policy, the financial sector and economic policy. Thanks to stronger institutions, reforms in crisis countries and budget consolidation, confidence improves. The crisis eases, but the efforts to improve growth prospects, reduce the debt burden and improve competitiveness take a long time.2. Greece exits the euro zone after difficulty agreeing on reforms and budget consolidation, and after the euro countries decide not to provide more money to help reduce Greece’s debt burden. The initial impact on Greece is significant. It is unclear how the euro zone is affected, but the risks are on the downside. The probability of this scenario is just under 50%.3. Additional countries beside Greece have to exit the euro zone after the debt crisis and political and social conditions worsen, with higher unemployment as a result. The currency union is maintained but with fewer member countries. The costs to restore the national currencies in some countries are high and the spillover effects on the other countries are likely to be great. The probability of this scenario, i.e., that Greece and all the other crisis countries exit the currency union, is lower at around 15% in our opinion.4. The currency union is totally dissolved. It seems unlikely that all the countries will decide to reintroduce their national currencies, but political decisions can have surprising outcomes sometimes, so we give this scenario a probability of 5%. The political, geopolitical, social and economic effects would be huge: Europes inner market would dissolve and large parts of the EU cooperation would have to begin anew.The challenges for the euro zone are gigantic. A great deal is atstake. There is still a political commitment to rescue the euro.The alternative to greater integration is continued weakconfidence in the EUs crisis management capabilities with therisk that the financial fragmentation will be long-lasting and thatthe costs for the crisis countries to adapt will be extremely high.Swedbank’s Global Economic Outlook • 21 August 2012 13
  • 14. 4. Our assumptions about the commodityand financial marketsSince our April forecast, commodity prices have fallen at thesame time that stock prices, after gains and losses, areunchanged on a global basis and long-term interest rates for themajor economies have been further reduced. (The opposite istrue of crisis countries such as Spain and Italy). The euro hasweakened against the dollar. In the following, we describe ourassumptions about the financial and commodity markets, whichserve as the basis for our forecast for 2012-2014.Commodity marketsAfter rising significantly during the first quarter, oil prices (Brent) Big swings in oil pricesretreated during the second quarter in the face of a weaker …economy, lower risk appetite and less geopolitical volatility (Iran,Strait of Hormuz). Then, in July and August, the trend againturned higher. A shortage of North Sea oil, a ruptured pipeline inTurkey, and the war and turbulence in Syria and Sudan pushedprices higher, at least short-term. Demand has also risen due tothe slowdown in ethanol production from rising corn prices. In theUS, WTI oil has fallen in price after inventories rose andproduction steadily increased. As a result, the difference betweenBrent and WTI oil again is high at around $20 a barrel.We expect prices to decline in line with the weaker global … but we now assumeeconomy, which is impacting demand. Chinas economy is of that prices will begreat importance to oil prices, and even though activity is now lower this year thangrowing more slowly demand will continue to rise – though not as last yearquickly. Next year Japan will restart its nuclear power plants,which should reduce global demand slightly. Total commodity prices, food prices and commodity prices excluding oil (index) 170 T o ta l c o m m o d ity p r ic e 160 150 140 130 F o o d p r ic e s 120 Index 110 100 90 80 70 T o ta l c o m m o d ity p ric e , e x c l o il 60 50 05 06 07 08 09 10 11 12 S o u r c e : R e u te rs E c o W inIn April we assumed that oil would average $119 a barrel thisyear and $113 next year. With our revised assumptions, we arenow forecasting a price of $110 this year, falling to $104 next14 Swedbank’s Global Economic Outlook • 21 August 2012
  • 15. year. In 2014 oil prices are expected to average $111 a barrel,but uncertainty is obviously very high.Metal prices have fallen and are expected to continue to trend Metal prices continuelower through the end of next year, after which we should see a to trend lower in therecovery as the economy and industrial production gain strength wake of weakeronce emerging markets have seen the results of their expansive investmentpolicies. This is also a reflection of production cutbacks by themining industry, which will eventually push prices higher. Fairlysluggish metal prices have to be seen in light of continued weakglobal investment growth.The biggest drama this summer was reserved for food prices. Dramatic rise in foodCorn, barley and soy bean prices have all skyrocketed due to pricesdroughts (the US, Russia) and floods (Russia). Even if pricesgradually ease, they will probably be higher at the end of theforecast period than they are right now. There is growingcompetition between food production and biofuels, which will leadto shrinking grain inventories and higher food prices in comingquarters. Moreover, export embargos and other trade restrictionscould exacerbate imbalances in the global food markets. Outcome and forecast for commodity prices 2010-2014 (Brent crude, food and metals in US dollar converted to index 2010 = 100) 160 150 140 130 120 Oil Metals 110 Food 100 90 80 2010:1 2010:2 2010:3 2010:4 2011:1 2011:2 2011:3 2011:4 2012:1 2012:2 2012:3 2012:4 2013:1 2013:2 2013:3 2013:4 2014:1 2014:2 2014:3 2014:4In April we warned that weather could disrupt food production, Many risks associatedwhich it did. The risk of higher (and lower) commodity prices still with commodityremains. This also applies to oil prices, since supplies will remain forecastsuncertain for geopolitical reasons. Keep in mind that highercommodity prices usually have a bigger impact on growth whensupplies decrease rather than when higher demand drives upprices.Inflation and interest ratesDespite the recent rise in oil and food prices, commodity prices Lower commodityare expected to be lower in 2012 than in 2011, because of which prices are keepinginflation could fall. The recession in parts of Europe, mainly the inflation in checkeuro zone and the UK, is also easing price pressure fromdomestic demand and the labour market. In some countries,Swedbank’s Global Economic Outlook • 21 August 2012 15
  • 16. such as Spain, tax hikes are keeping inflation relatively highdespite weak demand. Rate of inflation (CPI) in a number of countries 2006-2012 1 7 ,5 I n d ia 1 5 ,0 1 2 ,5 1 0 ,0 C h in a Percent 7 ,5 B r a z il 5 ,0 UK 2 ,5 US G e rm a n y 0 ,0 Japan -2 ,5 06 07 08 09 10 11 12 S o u r c e : R e u t e r s E c o W inIn India and Brazil, inflation has begun to rise again, which is a Emerging marketsproblem given the limited opportunities for more expansive continue to struggleeconomic policy. The rise in inflation is a sign of insufficient with inflation problems,capacity and requires investments, including in education, to while developedalleviate resource shortages and infrastructure bottlenecks. In the countries have toUS, Europe and especially Japan, there is a greater risk of avoid deflationdeflation if the negative forecast risks are realised. This alsoapplies to China. In our main scenario, inflation falls, stabilising ataround 2% in the US and Europe, while Chinese inflation stayswithin the comfort zone. Japan would instead see slight deflationas oil imports gradually decrease and economic conditionsnormalise. Inflation outlook measured by the annual increase in CPI (%) Outcome August Forecast CPI 2011 2012 2013 2014 US 3,1 2,1 2,0 2,2 Euro zone 2,7 2,0 1,8 2,0 o/w Germany 2,3 1,9 1,7 2,0 France 2,1 2,0 1,8 2,0 Italy 2,8 2,7 2,0 2,2 Spain 3,2 1,9 1,6 2,2 Finland 3,4 2,2 2,0 2,0 United Kingdom 4,5 2,5 1,9 2,0 Denmark 2,8 2,4 1,7 2,0 Norway 1,3 1,5 1,8 2,0 Japan -0,3 0,1 -0,1 0,0 China 5,5 3,0 3,5 4,0 India 8,5 7,2 6,6 6,0 Brazil 6,6 5,0 5,2 5,0 Russia 8,4 4,6 6,6 6,9Source: National data and Swedbank’s forecasts.16 Swedbank’s Global Economic Outlook • 21 August 2012
  • 17. Lower inflation means higher real interest rates. Since Interest rates willbenchmark rates can’t be cut much more in most developed continue to decline incountries, low inflation essentially serves as economic austerity. emerging marketsAmong emerging markets, Brazil, India and China still have roomfor rate cuts, but not much (0.25–0.50% in the next two-threequarters), since overheating risks still exist. These countriescould complement monetary easing with fiscal easing, however– a measure most politicians in the developed countries can onlydream of. Policy interest rates 2008-2012 1 5 ,0 B r a z il 1 2 ,5 1 0 ,0 Procent In d ia 7 ,5 C h in a UK 5 ,0 A u s tr a lia US E u ro z o n e 2 ,5 N o rw a y Sweden Japan 0 ,0 08 09 10 11 12 S o u r c e : R e u te r s E c o W inThe European Central Bank (ECB) cut its benchmark rate from The ECB can and1.00% to 0.75% on July 11 and in all likelihood it will cut rates should cut ratesagain in the third (or possibly fourth) quarter, especially since slightly moreinflation is slowing and expectations that the ECB will addressthe crisis have increased since the July 26 statement by CentralBank President Mario Draghi: “Within our mandate, the ECB isready to do whatever it takes to preserve the euro, and believeme, it will be enough”.Benchmark interest rates 2012-2014Policy Interest Rates 17-aug-12 31-dec-12 30-jun-13 31-dec-13 30-jun-14 31-dec-14Federal Reserve 0,25 0,25 0,25 0,25 0,25 0,50ECB 0,75 0,50 0,50 0,50 0,50 0,50Bank of England 0,50 0,50 0,50 0,50 0,75 1,00Bank of Japan 0,10 0,10 0,10 0,10 0,10 0,10The impact of another rate cut shouldn’t be overestimated,however. When it comes to Spanish and Italian bond yields,which have reached record levels and are threatening thestability of the euro zone, other tools are needed. The ECB,which on August 2 decided to announce the following, is trying tocalm the markets:  The ECB can again buy government bonds on the second-hand market, but only if the country needing such support has sought help from the rescue funds, EFSF or ESM, which can buy them directly when issued, i.e., in the primary market. Remember that it is necessary but not sufficient that the country has a bailout program, since the ECB wants to maintain its independence.Swedbank’s Global Economic Outlook • 21 August 2012 17
  • 18.  The ECB is now focused on government bonds with shorter maturities. As a result, 2-year bonds have fallen by about 2.5 bp, while 10-year bonds remain high. There is a risk, however, that the financial market will remain nervous, since the loans will often have to be refinanced. At the same time there is pressure on countries that need help to implement reforms and consolidate their budgets.  Working groups will formulate the details of the bond purchases, which includes the question of seniority, so that the ECB doesnt make it harder for other creditors to get paid back in the event of a debt reconstruction. Another question is whether or not the loans will be sterilised. If they won’t be any longer, quantitative easing becomes a more important consideration. Working out the details will take time. Even getting countries to seek support can take time. There is no assurance either that the euro zone’s governments will approve the ESM. The fact that the Bundesbank doesnt support the ECB’s plan could mean that purchases by the central bank wont be quite as large as the financial market expects. The ECB already has about 212 billion euros in crisis country Buying bonds isnt a bonds on its balance sheet, but its bond-buying plan to date sustainable tool has been tapped very little and with great reluctance. Mario Draghi recommended other solutions when he took over as Central Bank President, and greater focus has been placed on unlimited lending to commercial banks at a 1% fixed rate for three years (about 1 trillion euro) in order to 1) reduce credit austerity and improve lending opportunities, 2) indirectly help the crisis countries by having banks buy their bonds, and 3) indirectly help to strengthen the balance sheets of these banks through the profits they can make by investing in these bonds. Long-term interest rates (2-year government bonds) 8 Ita ly 7 6 5 S p a in 4 Percent 3 2 1 G e rm a n y 0 UK -1 07 08 09 10 11 12 S o u rc e : R e u te rs E c o W in The ECB will actually now be less of a lender of last resort The new strategy is than before August 2, since the bond purchases now require more sustainable – but programs whose terms could take time to draft/meet. The still risky strategy keeps the pressure on reform and ensures that the ECB’s purchases wont fill a “black hole”. As a result, countries that cant print their own money are still at risk of not18 Swedbank’s Global Economic Outlook • 21 August 2012
  • 19. being able to finance their debt if interest rates rise too much (the limit is usually said to be 7%). Since the financial market recognises this dilemma, interest rates on the long end continue to rise at the same time that shorter rates have fallen after expectations of the purchases by the central bank. The UK, US and Japan, through their central banks – the A new round of Band of England (BoE), the Federal Reserve (Fed) and the quantitative easing is Bank of Japan (BoJ) – have resorted to quantitative easing by expected this fall from buying government bonds or other assets on the second- the BoE, Fed and BoJ hand market. We expect an additional easing during the … second half-year in all three countries. The US is likely to focus on buying mortgage and government bonds. The UK is continuing to buy bonds, but there are those who suggest buying other assets (e.g., Adam Posen, who is now stepping down from the Monetary Policy Committee, which sets monetary policy in the Bank of England). Japan has been buying equities and other assets for some time, but hasnt found these measures effective. The financial markets are happy right now, but their joy will be short-lived and they will soon be demanding another easing. In other words, quantitative easing and fixed-rate loans have … but will probably been shown to have a diminishing marginal impact. Long- have a diminishing term interest rates are already relatively low in the US, the marginal impact UK and Japan, as well as in Germany, and in the euro zone’s crisis countries the problem is quite different. There is a limit on how much of their bonds can be held on the balance sheets of commercial banks and central banks. Long-term interest rates (10-year government bonds) 8 I t a ly 7 S p a in 6 5 Percent 4 UK 3 US 2 G e rm a n y 1 Japan 0 07 08 09 10 11 12 S o u r c e : R e u te r s E c o W inSince our April forecast, 10-year bond yields in the US, UK, Negative returns onGermany and even Sweden have continued to decline, touching government bonds – ishistoric lows. Bonds from these countries with shorter maturities it more important to gethave negative returns. Investors seem to think it is more your money back thanimportant to get their money back than to get a positive return. to get a return?Among the reasons for the low bond yields are:Swedbank’s Global Economic Outlook • 21 August 2012 19
  • 20. 1. Benchmark rates are low, and central banks have announced that they will stay that way. Since long-term rates reflect expectations for future short-term rates, long-term rates are also falling. 2. Quantitative easing has put further pressure on long-term bond yields. 3. There are expectations of low inflation and slow growth, as well as the risk of deflation and liquidity traps. 4. Investors are focused on short-term risks (Spain and Italy), while medium-term risks (US, Germany) have been toned down. As a result, investors are seeking what seem like safe investments, but which are only in a relative sense. There is also some question whether investors have become more focused on catastrophic risks since the financial crisis, which is creating a greater need for safety than return.We expect long-term bond yields to remain low, but that the lastpoint above could create a new set of expectations if the crisis inthe euro zone eases somewhat. That could shift the focus to themedium-term problems in the US, which should raise interestrates, since there is little expectation that the country is headedtoward a period of Japanese-like deflation. Consequently,interest rates will probably remain low, though rise slightly, and ifthe emphasis changes from the euro crisis to the US budgetcrisis they might rise even more. German interest rates areaffected by both the flight-to-safety argument, which is keepingrates down at this point, and its future payment responsibility forthe entire euro zone, which is pushing rates higher in the slightlylonger term.Exchange ratesSince our April forecast, the flight-to-safety argument has The flight to safeincreasingly applied to the currency market as well. With the currencies isgrowing concerns in the euro zone, capital has fled the region overshadowing theand the euro has fallen against the dollar. We expect it to currency marketcontinue lower against the dollar for much of the forecast perioddue to weak growth prospects and continued financial instability.The Swiss central bank has intervened to stop the franc fromrising too much in value and had success. The franc is back atthe same level as the beginning of 2011. To avoid having toomany euros in its portfolio, the central bank is selling off some,which is weakening the euro, and at the same time buyingSwedish and Norwegian kronor as well as the Canadian andAustralian dollars, which is strengthening these currencies. Therising trend in these currencies isn’t over, since the crisis in theeuro zone is continuing and the Swiss central bank (and othercentral banks and individual investors) isn’t done with itsdiversification process yet.20 Swedbank’s Global Economic Outlook • 21 August 2012
  • 21. Nominal currency trends in relation to the US dollar, index 2008-08-15 = 100 160 150 S w e d is h K ro n a 140 K o re a n W o n B ra z ile a n R e a l 130 E u ro 120 110 100 Yuan 90 S w is s F ra n c 80 70 Yen 60 07 08 09 10 11 12 S o u rc e : R e u te r s E c o W inChina is not letting the renminbi appreciate quite as quickly and China is not allowinghas even let it weaken against the US dollar, though it has its currency toappreciated against the euro. We now expect the appreciation appreciate as quickly,against the dollar to continue, but at a slower pace than in 2011. a trend that willThe Brazilian real has also weakened against the dollar, which probably continue for acan be seen as a result of weaker growth, higher inflation and whilelower benchmark rates as well as the government’s attempts toweaken the currency with the help of taxes on capital inflows.Weaker currencies in emerging markets reduce the risk of moretalk about a currency war, but increase the risk of rising inflationin these countries.Exchange rates 2012-2014FX 17-aug-12 31-dec-12 30-jun-13 31-dec-13 30-jun-14 31-dec-14EUR/USD 1,23 1,16 1,18 1,20 1,22 1,25EUR/GBP 0,79 0,77 0,76 0,75 0,75 0,75RMB/USD 6,36 6,30 6,20 6,08 5,98 5,85USD/JPY 79 80 83 88 90 90EquitiesThe global stock markets (according to MSCI Global) have Major swings inslightly passed the level they were at when the April forecast was equities andpublished. After declining, equities bounced back once confidence indicatorsexpectations of another quantitative easing rose. Unlike in 2011, reflect expectations ofUS stock markets have been the top performers, while the trend more quantitativeis negative in emerging markets, the euro zone and Japan – easingespecially in comparison with the first half of 2011, beforeconcerns rose during the summer months. Although we arehesitant to forecast stock prices, it can generally be said thatmacroeconomic conditions have weakened, making it harder forcompanies to increase their profits, and it’s uncertain that thishas been fully discounted. If we dont see another quantitativeeasing in the US, UK and Japan at the same time that the ECBdoesnt live up to the expectations it has created (Bazooka), thereis a risk that pessimism will gain the upper hand.Swedbank’s Global Economic Outlook • 21 August 2012 21
  • 22. Stock markets in the emerging world ( MSCI EM), US (S&P 500), euro zone (FTSE EZ 300) and Japan (Nikkei 225) 2007-2012, Index January 2007 = 100 150 MSCI EM 140 130 120 110 MSCI G lobal 100Index 90 80 USA S&P 500 70 FTSE EZ 300 60 50 Nikkei 225 40 07 08 09 10 11 12 Source: Reuters EcoW in In summary, we anticipate lower commodity prices in 2012 than in 2011, but for oil and metals we see an increase in 2013 and 2014. Food prices will continue to rise in 2012 before turning lower. Interest rates will be cut slightly in emerging markets and the euro zone, at the same time they remain low in Japan, UK and US. Another round of quantitative easing is expected during the second half-year, which will keep long-term interest rates low and stimulate equities. Low interest rates, weak growth and inflation, and a growing need for “safe harbours” for investors’ money will help to keep long-term interest rates low in the US and Germany. Note that an extrapolation of recent events could prove risky, but on the other hand it is hard to find much of an argument for rapidly rising interest rates and a stronger euro in these precarious circumstances. Further in the future – in 2014 – conditions may change and interest rates could rise faster than we have assumed.22 Swedbank’s Global Economic Outlook • 21 August 2012
  • 23. 5. Regions/countries: Few tools availableDuring the second half-year growth will slow in the global Unemployment iseconomy, and not until next year do we expect a gradual already high, but isrecovery. Unemployment is increasing mainly in the euro zone, at expected to rise furtherthe same time that it is becoming harder to reduce it in the US. in the euro zoneFiscal austerity is expected mainly in Europe and the US. On theother hand China and Brazil will tap expansive fiscal policies, atthe same time that monetary policy is also being loosened bycutting interest rates.Unemployment (%) in several countries/regions 2 5 ,0 2 2 ,5 S p a in 2 0 ,0 G re e c e 1 7 ,5 P o rtu g a l 1 5 ,0 Percent 1 2 ,5 E u ro z o n e 1 0 ,0 F ra n c e 7 ,5 G e rm a n y US 5 ,0 Japan 2 ,5 05 06 07 08 09 10 11 12 S o u r c e : R e u t e r s E c o W inIn the current recession developed countries have had to tighten When the tools runtheir belts and have mainly resorted to monetary policy in the out, hope rests onform of quantitative easing, the effectiveness of which is probably exchange rateslow, while emerging markets have to take a more cautiousapproach to fiscal and monetary expansion to avoid inflation andother imbalances. Capacity shortages in India and Brazil, forexample, mean that these economies are quickly hitting a ceilingand that inflation is rising. Many countries want to keep realeffective exchange rates from appreciating, as has been the casefor Japan and China since 2008, while the opposite hashappened in the euro zone. With or without interventions, thegoal is that the currencies will depreciate.Real effective exchange rates in a number of countries/regions, index 170 C h in a 160 E u ro z o n e Japan 150 US B r a z il Index 2000-01-01 = 100 140 130 120 110 100 90 80 70 60 00 01 02 03 04 05 06 07 08 09 10 11 12 S o u r c e : R e u t e r s E c o W inSwedbank’s Global Economic Outlook • 21 August 2012 23
  • 24. USA – living a dangerous fiscal life  The slow recovery is continuing and GDP will grow slightly below and above 2% per year during the forecast period.  Unemployment has risen, which should force the Federal Reserve to act with a new program to ease monetary conditions.  If taxes are raised and automatic spending cuts take effect after the turn of the year, the US will fall off a “fiscal cliff” and see another recession. We expect Congress to reach some kind of resolution and avoid most of the austerity.The US economy is continuing its modest recovery. After astrong quarter at the end of last year, GDP growth slowed to0.5% and 0.4% during the first two quarters of 2012. A slowdownin the wake of the unstable political climate and weaker globaleconomy are further darkening the outlook for the second half ofthe year, because to which GDP growth is estimated at 2.1% for2012. Despite a slight rise in quarterly growth from 0.3% to 0.6%next year, annual growth is expected to slow to 1.7% beforeeventually rising to 2.3% in 2014.Among the factors hurting the recovery, besides the global Debt reconstruction,economy, are debt consolidation in the household and banking the global economysectors and continued high unemployment, which is slowing and political (anddomestic demand. Uncertainty about fiscal policy and the fiscal) uncertainty areconfrontational political climate are also affecting confidence slowing the recoveryamong households and businesses.US small business owners and their future confidence and hiring plans 35 1 0 7 ,5 O p t im is m in d e x 30 1 9 8 6 = 1 0 0 ---> 1 0 5 ,0 25 1 0 2 ,5 20 1 0 0 ,0 15 9 7 ,5 Percent Index 10 9 5 ,0 5 9 2 ,5 0 9 0 ,0 < --- S h a re o f -5 c o m p a n ie s p la n n in g t o 8 7 ,5 r e c r u it -1 0 8 5 ,0 -1 5 8 2 ,5 86 88 90 92 94 96 98 00 02 04 06 08 10 12 S o u r c e : R e u t e r s E c o W inHowever, optimism has strengthened among small businessowners compared with recent years, but from a historicalperspective small businesses are still struggling and remaincautious in their hiring plans. In the wake of a cooler globaleconomy, the purchasing managers index has fallen below the24 Swedbank’s Global Economic Outlook • 21 August 2012
  • 25. 50 mark in the last two months, which suggests that growth hashad a hard time gaining traction recently.After the number of working Americans increased by a monthlyaverage of 226 000 in the first quarter of this year, hiring slowedand the increase for the second quarter was only 73 000. It is tooearly to say whether the July figure, 163 000, is the start of amore positive trend. Employment growth is relatively good, butthe labour supply is increasing as well. Unemployment has risenin recent months to 8.3%, from 8.1% in April. The forecast callsfor a slow decline in 2013 and 2014 to 7%, since GDP growth willremain below its potential throughout the period.The housing market has improved slightly, but from extremely The housing market islow levels. Housing prices (Case-Shiller) have now returned to showing glimpses ofthe lows of May 2009. Sales of existing homes have risen by improvement, but thenearly 30% since bottoming out in July 2010, but represent only gains are from low60% of the number sold in 2005. Housing construction has noted levelsa slightly upward trend since last year, but to only about a third ofthe number of homes built before the crisis. Though it isntreasonable to expect the numbers to return their previous levels,thus far the recovery has been shaky and underwhelming and alarge inventory of unsold homes still remains.US household consumption has risen, but cautiously. Retail saleshad trended lower since the beginning of the year, but rose inJuly. Weak incomes and a lack of confidence are keepingconsumers from spending, as evidenced by the savings ratio,which has now risen to 4%. Lower inflation and higherunemployment suggest that the Federal Reserve will have tofurther ease monetary policy. We anticipate some form ofquantitative easing during the second half-year, while interestrates remain at their current low levels for much of the forecastperiod.A more expansive fiscal policy designed to improve the labour If a consensus ismarket would probably be more effective considering that long- reached, fiscalterm unemployment remains high. Instead, fiscal policy will be austerity will slice 4tightened. By how much depends on the decisions made after percentage points offthe presidential election, but if nothing is resolved GDP growth of GDP growthwill drop by 4 percentage points and the US will find itself inanother recession after falling off the fiscal cliff. We expectCongress to delay the tax hikes and reduce the spending cuts.Not everything will be put on the back burner, however, and fiscalpolicy will probably shave 1 percent off GDP growth next year.The presidential election on November 6 between Obama/Bidenand Romney/Ryan is expected to be very close. The currentadministration is feeling heat from the rising unemployment and alack of fiscal clarity, but the opposition will have a hard timegarnering support for tax cuts for the wealthy and spending cutsfor the poor while facing continued uncertainty about themedium-term budget, given the threat of a fiscal collapse in a fewyears.Swedbank’s Global Economic Outlook • 21 August 2012 25
  • 26. China – slowdown and new stimulus  China’s economy is cooling. Exactly how much is hard to say, but we expect GDP growth to fall to 7.9% this year and that the goal to rebalance the economy will be at least partly met, with growth slowing in 2013 and 2014 as well.  If the risk of a hard landing increases, Chinese politicians will choose the easy way out, i.e., increasing investment, though this could create new imbalances and an even harder landing further in the future.China’s slowdown has accelerated. The second quarter sawGDP growth of 7.6%, which means relatively slow quarterlygrowth of less than 2%. Other signs of the slowdown includeelectricity production, which has levelled off; significantly slowergrowth in industrial production, which is more in keeping with aweak purchasing managers index; lower inflows of foreign directinvestment; and decreased demand for commodities in the globalmarket.During the global financial crisis China’s economy slowed due to External demand hadlower external demand, and stimulus programs accounted for previously slowed13% of GDP over a two-year period. Now domestic demand is China’s growth – butslowing, but the crisis in the euro zone is also contributing to now its mainly internalweaker growth in China. Investment, especially in the housing demandsector, has cooled in the face of the growing risk of a housingbubble.This changes the ways that China can utilise economic policy tostimulate the economy compared with the last slowdown. China’scentral bank has already loosened lending conditions (interestrates, reserve requirements), and lending growth is rising again,though this also increases the risk that housing and land priceswill also significantly rise again. The stimulus packages in 2008-2009 created imbalances which had to be corrected. This won’tbe easy to repeat.China’s industrial production, inflation and housing prices in Beijing, annualgrowth rate 2 2 ,5 I n d u s t r ia l p r o d u c t io n H o u s e p r ic e s , 2 0 ,0 B e ijin g 1 7 ,5 1 5 ,0 1 2 ,5 Percent 1 0 ,0 7 ,5 5 ,0 2 ,5 0 ,0 I n f la t io n -2 ,5 05 06 07 08 09 10 11 12 S o u r c e : R e u te r s E c o W in26 Swedbank’s Global Economic Outlook • 21 August 2012
  • 27. In the aftermath of the stimulus packages, there is now a needfor bailouts of local governments, entrepreneurs and propertyowners. In fact, the debt problem is probably greater than officialdata indicate. Loose monetary conditions skewed capitalallocation, and the investment wave that has been drivingChina’s growth was allowed to get out of hand.The country has now taken a step forward by shifting the focusfrom investment and exports to private consumption. The Infrastructureproblem is that when the risk of a hard landing increases, investment isChinese politicians tend to fall back on their habit of stimulating increasing again, butthrough investments and exports. This explains the renewed not as much as ininterest in infrastructure investments, though they wont be as big 2008-2009as before, at the same time that there will be less appetite in theprivate sector considering the overcapacity that already exists. Itwill take a long time to rebalance growth to private consumption.Higher wages, transfers and improved conditions for householdswill gradually increase private consumption to around 35% ofGDP, moving toward the global average, which in some countriesis that double that figure. Political leaders will therefore try tostimulate growth the usual way, without totally succeeding, whichwill contribute to a slower growth rate in the years ahead. Onesign – other than infrastructure investment – is the reluctance tolet the currency appreciate further against the US dollar (it is stillrising against the euro), in order to protect the export sector.However, this could hurt the relationship with the incoming USadministration. President Obama has avoided calling China’sexchange rate policy manipulative, while Romney has threatenedduring the election campaign to take a different tack.We expect China’s central bank to cut interest rates at somepoint this year, especially since prices are beginning to fall at amonthly rate. Reserve requirements are being further reducedand the renminbi has been allowed to appreciate more slowlyagainst the dollar than in 2011. The depreciation against thedollar recently may have accelerated capital outflows, whichrecently exceeded inflows. This surprisingly caused China’scurrency reserves (of about $3 trillion) to shrink.China has many major challenges to address besides There is going to be arebalancing its economy: the environment and climate change, power shift in thedemographics and the pension system, healthcare reform, Politburo this fall and afinancial deregulation and a growing income gap. The power shift new Chinese presidentin the Politburo this fall will mean the replacement of several in March – but withoutmembers. Xi Jinping and Li Keqiang are expected to succeed Hu any major differencesJintao and Wen Jiabao as president and prime minister nextMarch. It is unlikely that the effects of this shift will be evidentinitially; changes will be made slowly. Our forecast is for GDPgrowth of 7.9% this year before it continues to slow to 7.8% in2013 and 7.6% in 2014. The expectation is that China’spoliticians will resist the pressure to significantly stimulate theeconomy, which would cause bubbles, and instead continue torebalance gradually. If not, growth could be higher this year andnext, at the same time that a hard landing inches closer as newimbalances build up and have to be corrected.Swedbank’s Global Economic Outlook • 21 August 2012 27
  • 28. Japan – strong yen and weak demand  After stronger-than-expected growth at the beginning of the year, we are revising GDP growth for 2012 upward to 2.2%, but there are already signs of a slowdown and that growth will fall to 1.3% and next year and 1.2% in 2014.  Japan’s trade deficit is the result of high energy imports, weaker global demand and a strong yen. We expect the yen to weaken during the forecast period.  Notwithstanding the Bank of Japan’s quantitative easing, structural reforms are needed to strengthen confidence in the budget and create greater economic dynamism.After rising by 1.3% in the first quarter, growth has slowed to0.3%. Public spending and investment, including in the form ofreconstruction after the tsunami, earthquake and nucleardisaster, contributed positively to growth, while net exportscontributed negatively. Private investment increased more thanexpected, and households have benefitted from subsidies forgreen cars – a measure that has increased private consumption,but where the impact will be felt in the opposite direction later inthe year.Because of the stronger-than-expected gains at the beginning of We have revised ourthe year, we have revised our GDP growth estimate upward for GDP growth estimate2012 from 1.5% to 2.2%. Considering that the governments upward this year, butcontribution to growth is gradually being phased out and net the outlook beyondexports will remain negative due to the relatively high costs of that is weakerenergy imports and weaker global demand, mainly from Europeand China, the growth rate is projected to fall to 1.3% in 2013and 1.2% in 2014, in line with estimated or potential growth.One reason for the high energy bill is that nearly all 54 of Japan’snuclear power plants have been idled, which has resulted inhigher oil and gas imports, the costs of which have risen by anestimated $100 million per day. During the first half-year Japanreported a trade deficit for the first time in three decades, otherthan during the financial crisis.During the summer two nuclear power plants were restarted, Nuclear power and taxwhich led to major protests, not to mention political policy are the sourceconsequences for Prime Minister Yoshihiko Noda, whose of political tensionpopularity has weakened. Moreover, the veteran politician IshiroOzawa resigned from the ruling Democratic Party of Japan (DPJ)in July and formed a rival party together with MPs who wereunhappy with tax policy, including a highly debated VAT hikefrom 5% to 10%, which now looks like it will be passed. Japan isstill struggling with a primary deficit (budget deficit excludinginterest payments on government debt) of about 8%, however,which means that there still arent any strong measures availableto reduce the public debt burden (gross debt is expected to reach240% of GDP by 2013).28 Swedbank’s Global Economic Outlook • 21 August 2012
  • 29. Another reason for the trade deficit is the relatively strong yen.The nominal effective exchange rate is hovering significantlyabove its long-term average, while the real effective exchangerate is only slightly above the average. The combination ofweaker global demand and a strong exchange rate is puttingpressure on companies, which have surprisingly been morewilling to invest than expected.Nominal and real effective exchange rates 150 140 130 120 110 100 Index 90 80 70 60 50 N o m in a l E ff e c tiv e E x c h a n g e R a te In d e x R e a l E f fe c tiv e E x c h a n g e R a te In d e x 40 30 80 85 90 95 00 05 10 S o u rc e : R e u te r s E c o W inWe expect the Bank of Japan to continue to grow its balancesheet by buying assets. A small supplementary budget is Quantitative easing isexpected before the end of the year to stimulate the economy, expected, but the mostespecially since the global economy is slowing and the governing important thing isparty needs more support in the upcoming election next year. structural reformDeflation is coming back after a period of slight inflation againstthe backdrop of higher commodity prices. The most importantthings Japan can do to make its economy more dynamic are toput a stop to deflation expectations, consolidate its medium-termbudget in order to reduce the future debt burden, especially foryoung people, and strengthen the role of women in theworkplace. Japanese direct investment abroad has increasedowing to the strong yen, but it is also important to welcome moreforeign direct investment in Japan.India – drought and reform fatigue  We have revised our GDP growth estimate downward from 6.7% to 6.2% for 2012, and from 7.3% to 6.5% for 2013. If the reform-weary political climate persists, growth won’t reach beyond 7% during the forecast period.  There are indications that inflation is again rising, which makes it harder for the central bank to loosen monetary policy. One or two rate cuts are possible next year if inflation drops again. India’s public finances are beingSwedbank’s Global Economic Outlook • 21 August 2012 29
  • 30. weakened by food and energy subsidies. There isn’t much room left to stimulate the economy.The annual GDP growth rate slowed significantly in 2011, from Weak monsoon rains9.2% in the first quarter to 6.1% in the last quarter. The trend and tighter monetarycontinued in the first quarter of this year, when GDP grew by policy are hurting5.3%. The decline is slightly larger than expected and can be growthattributed to weaker global demand, unusually weak monsoonrains, which affected agricultural production, capacity shortagesand the effects of the previous tightening of monetary policy.Inflation measured in wholesale prices has fallen lately, whileconsumer prices are again pointing higher. High energy pricesand slightly higher food prices after the recent drought will pushinflation higher, forcing the Reserve Bank of India to take a wait-and-see approach after cutting interest rates in the first quarter.Weaker growth will eventually mitigate inflation, allowing for ratecuts later in 2013.India’s policy interest and inflation rates as well as the growth rate for industrialproduction 2 0 ,0 9 ,5 P o lic y I n t e r e s t 1 7 ,5 9 ,0 R a te --> 1 5 ,0 < - - I n d u s t r ia l P r o d u c t io 8 ,5 1 2 ,5 8 ,0 1 0 ,0 7 ,5 Percent Percent 7 ,5 7 ,0 5 ,0 6 ,5 2 ,5 < - - I n f la t io n - 6 ,0 g r o s s p r ic e s 0 ,0 5 ,5 -2 ,5 5 ,0 -5 ,0 4 ,5 -7 ,5 4 ,0 06 07 08 09 10 11 12 S o u r c e : R e u te r s E c o W inWe expect GDP growth to remain below 7% throughout the If Indians remainforecast period. For the current year we are revising our reform-weary, growthprojection downward from 6.7% to 6.2% against the backdrop of won’t reach beyonda weaker agricultural outlook. For 2013 we project growth of 7% in 2012-20146.5%, instead of 7.3% in the April forecast. With the currentreform-weary political climate and a modest global recovery,Indias GDP growth is projected to rise to 6.8% in 2014.As a result, India’s economy will continue to underperform. Thepace of reform could increase after the former finance minister,Pranab Mukherjee, became president and Prime MinisterManmohan Singh, who has shown a greater interest inmodernising the Indian economy, has taken over the role offinance minister. The situation has been complicated, however,by revelations of new corruption scandals in which the primeminister has been implicated. The most important reforms involvederegulating production and the labour market in order toincrease capacity and economic dynamism, while reducing30 Swedbank’s Global Economic Outlook • 21 August 2012
  • 31. corruption, increasing transparency and revising tax policy onagricultural production.The problem is that the government has demonstrated a lack of The power outagesbudget discipline to date. The drought could lead to higher affecting 600 millionsubsidies, further swelling the deficit. There are few means people in late Julyavailable to stimulate the economy through fiscal policy, at the underscore the needsame time that monetary policy is limited by prospects of higher for infrastructureinflation. India faces capacity shortages (as the power outages investmentaffecting 600 million people in late July demonstrate) and shouldincrease investment in the medium term. About 10% of GDPshould be invested per year to maintain GDP growth of 8%. Indiaalso has to invest in education, reducing poverty and healthcare.The resistance to reform has to stop, and the bar has to be sethigher.Brazil – focus on investments  Tighter economic policy, a less competitive industrial sector and capacity shortages have reduced Brazil’s economic growth, which we forecast at 2% this year.  In addition to rate cuts and a weaker real, the economy is being helped by a long-term stimulus package to increase capacity. Infrastructure investments are a high priority.  We expect GDP to rise by 3.9% in 2013 and 4.1% in 2014 as investments grow and global demand and commodity prices rise slightly.Brazil’s economy has benefitted from the high commodity pricesin recent years, culminating in 2010, when GDP grew by 7.5%, afigure that also received a boost from the recovery following thefinancial crisis. Throughout the previous decade the middle classwas the primary beneficiary of the programs instituted by formerpresident Lula (the so-called Lula model included reforms, astronger labour market, higher wages, increased lending andpublic transfers to households).Since then growth has slowed. There are several reasons why. Industry has lostThe industrial sector has lost ground competitively partly due to a ground competitivelystronger real. Meanwhile economic policy has been tightened at and economic policythe same time that commodity prices have fallen and global has been tighteneddemand has slowed. We expect GDP to grow by 2.0% this year,a downward revision of 1.1 percentage point from the Aprilforecast.Swedbank’s Global Economic Outlook • 21 August 2012 31
  • 32. Brazil’s national accounts, from the user side, annual percentage growth 50 In ve stm e n ts 40 30 Im p o rt P riva te C o n su m p tio n 20 Percent 10 0 GDP -1 0 E xp o rt -2 0 05 06 07 08 09 10 11 S o u rc e : R e u te rs E co W inThe problem with the Lula model was that there wasnt enough The Lula modelfocus on businesses and the conditions necessary to strengthen focused more oncompetitiveness, including an educated workforce and households thaninfrastructure investment. Capacity shortages have pushed businessesinflation higher again and forced the central bank to raise its keybenchmark rate to 12.5%, before cutting to the current 8% owingto slower growth and falling inflation. Another one or two rate cutsare possible, but it is troublesome that inflation is rising again.Unemployment has continued to drop and now amounts to 5.8%,compared with 11.5% in 2004.President Dilma Rouseff realises that the country has majorinvestment needs, at the same time that fiscal stimulus cancomplement the looser monetary policy. A $65 billion stimuluspackage was launched recently to invest in roads, rails, airportsand ports. Shipping a container from Brazil is twice as expensiveas from China, and productivity has to be improved. Productivityhas increased by 1.5% per year in the last decade, comparedwith 4% in China.The stimulus package now being launched has a long-term The stimulus packagefocus. Just over half will be tapped within five years, while the is a long-term measureproject as a whole will be spread over 25 years. Brazil is hosting that is needed to raisethe World Cup in 2014 and the Summer Olympics in 2016, which potential growthalso require huge investments. Investment currently corresponds19% of GDP, but will increase closer to 22%, which is needed toreach a growth rate of around 4%. The country will receive somehelp from foreign direct investment, which grew to $67 million in2011 from $48.5 million in 2010, but the positive trend could bebroken if the global investment appetite runs out and Brazilcannot provide a sufficient return on capital. In the wake of highersoybean prices, a weaker real, gradually increasing globaldemand and the positive effects of stimulus programs, we expectGDP growth to again rise and reach 3.9% in 2013 and 4.1% in2014. Downside risks include global demand, in addition to the32 Swedbank’s Global Economic Outlook • 21 August 2012
  • 33. domestic bottlenecks that are impeding growth in bothinfrastructure and the labour market.Euro zone – without reforms, the slump willbe even worse  The euro zone is technically on the brink of recession and the crisis countries in southern Europe, including Cyprus and Slovenia, may all end up needing bailout programs during the forecast period. Of most immediate concern for the region is Spain, which we expect to seek help this fall.  The ECB will be able to offer support by buying short-term government bonds. Besides the support through the ESM and ECB, Spain will have to continue to reform, however.  Germany and to some extent France have been able to withstand the crisis to date, but we expect shrinking GDP numbers during the second half-year. France in particular will have to work on its budget and competitiveness to avoid a crisis like the one in southern Europe.The euro zone’s GDP shrunk at a quarterly rate of 0.2% in the The euro zone is onsecond quarter after having stabilised during the first quarter. On the brink of recessionthe other hand we also saw a decline in the fourth quarter of last and the crisis isyear, so even though the region isnt it technically in recession worsening(as defined by two consecutive quarters of shrinking GDP), thedata point to a region in severe crisis – not only institutionally andpolitically but also economically and socially. Compared with thesecond quarter 2011, the euro zone has shrunk by 0.4%. Annual GDP growth in the euro zone and several of its member nations (%) 12,0 9,5 7,0 Spanien Tyskland 4,5Procent 2,0 -0,5 Euroområdet Frankrike -3,0 Italien -5,5 -8,0 00 01 02 03 04 05 06 07 08 09 10 11 Source: Reuters EcoWinThe differences in growth rates between euro countries were Italy is shrinking,again significant in the second quarter. The most positive while Germany isquarterly growth, according to Eurostat, was in Slovakia (0.7%), unexpectedly growingfollowed by Germany and Estonia (0.3%) and the Netherlands(0.2%), while France’s GDP held steady, which was better thanexpected. As in previous quarters, Portugal, Cyprus and ItalySwedbank’s Global Economic Outlook • 21 August 2012 33
  • 34. shrunk the most – by 1.2%, 0.8% and 0.7%, respectively –though Belgium and Spain also declined. Finland’s negativegrowth of 1% was also unexpected, but could be revised upward(see the chapter of the Nordic countries below).The downturn in the euro zone, especially in the crisis countries,was expected and should be seen against the backdrop ofbudget cutbacks, credit austerity and concerns about the future,which are reducing confidence among businesses andhouseholds. Rising unemployment is affecting household buyingpower, which is creating a vicious cycle of lower demand, layoffs,budget constraints, cutbacks and lower demand, etc.We have revised our GDP growth estimate downward for Italy The focus shouldnt beand Spain and upward for Germany based on worse and better on individual quarters,results than expected. The negative drivers will persist, and this but rather that theyear GDP is expected to shrink by 0.4% with negative quarterly region wont grow forgrowth in the third and fourth quarters. Next year we anticipate a some timestabilisation or marginally positive growth, but on a quarterlybasis the recovery will be modest at best. Growth will remainweak in 2014 at below 1%. In all likelihood growth will bepractically nonexistent in coming years and the region will shrinkin the short term before stabilising.To achieve this stabilisation, however, the crisis will have to be A stabilisation wouldmanaged convincingly. The focus now shifts to the working require that the crisis isgroups that are focused on greater integration and designing managed well andmonetary support for countries that have programs with confidence increasesEFSF/ESM, and which will be critical to the crisis managementmodel the region chooses. Some help could also come from aweaker euro and slightly lower oil prices.Ten-year bond yields continue to diverge between safeeconomies like Germany and crisis countries such as Spain,Greece, Portugal and Italy. Ireland’s interest rates have comedown in the last year and are closing in on Italys. After the latestmove by the ECB on August 2, there are expectations of largerpurchases of government bonds with shorter maturities, becauseof which two-year bonds have declined but remain high.We anticipate that Spain will apply for a program with EFSF/ESM Spain and possiblywhen the details have been worked out and announced by the Italy will have to applyECB. Italy will likely wait to see what happens in Spain, but if the for bailout programseconomic and political crisis worsens it may have to go the sameroute. Spain can apply as soon as September or October. It willalso be critical whether ESM is given the go-ahead. The first stepis the approval of the German Constitutional Court, after whichseveral other national parliaments will have their say. It isimportant that the period until these decisions are made isrelatively calm. If any new emergencies require attention,European inventiveness will again be put to the test.34 Swedbank’s Global Economic Outlook • 21 August 2012
  • 35. Difference between Germany’s and other countries 10-year bonds 40 35 G re e c e 30 25 Percentage points 20 15 S p a in P o rtu g a l 10 Ire la n d 5 Ita ly 0 F ra n c e B e lg iu m Sweden -5 08 09 10 11 12 S o u rc e : R e u te rs E c o W inIn Germany, the weak purchasing managers index and industrial Germany will have toproduction output in the second quarter reflect the major accept slightly higherchallenges facing exporters, especially since key markets such inflation and wageas southern Europe as well as China and other emerging growthmarkets are slowing. In spite of this, exports remained fairly goodduring the second quarter. Confidence among companies andhouseholds has fallen, so GDP growth of 0.3% was unexpectedlystrong. Lower inflation and relatively low unemployment mayencourage households to keep spending, but we don’t expect aconsumption boom. Although fiscal policy wont be tight, anational debt of around 80% of GDP doesnt leave much room forexpansion. Germany’s contribution to the euro zone will be tomanage the crisis well and accept slightly higher wages andinflation, so that its current account deficit shrinks through slightlystronger imports of goods from crisis countries. ChancellorAngela Merkel has to do whats best for the euro zone, while atthe same time focusing on the election in September of nextyear. Her support remains strong, according to surveys, but if thecrisis in the region worsens it will be hard to maintain it.Support for Francois Hollande of France has slid since he took France’s higher taxesoffice. The honeymoon is over. The auto industry crisis is on entrepreneurs andcontributing to doubts whether the new government’s economic capital may prove riskypolicy can meet the challenges the country faces. France islosing ground competitively and needs more entrepreneurs andinvestment. That could make it difficult to introduce a marginaltax rate of 75% on incomes over 1 million euro a year, asexpected in 2013. This would affect 3 000 households, but couldimpact the willingness of many others to invest. Additionalmeasures include higher wealth and inheritance taxes, an extratax on corporate dividends, a rise in taxes on stock options andsurcharges on banks and petroleum stocks. There is instead arisk that investors and entrepreneurs will flee France. On theother hand, tax cuts are planned for small businesses at thesame time that a state-owned investment bank will beestablished for new and small businesses. Whether thatsSwedbank’s Global Economic Outlook • 21 August 2012 35
  • 36. enough to reverse the trend of high labour costs that are hurtingFrances competitiveness is hard to tell at this point. We expectgrowth to remain low and that the government will have to tightenfiscal policy to meet the budget target in the fiscal pact,something that wasnt explained to voters before the election.In the crisis countries of Greece, Cyprus, Italy, Spain, Portugal The crisis countriesand even Slovenia and Ireland, the situation is precarious. GDP are growing in numberis shrinking (Ireland has not yet released its numbers) at the – Cyprus and Sloveniasame time that unemployment is rising, confidence is falling and also face problemsdemand is slow. Greece is in a depression, and Portugal couldbe soon. Structural reforms are needed to complement budgetcutbacks, without which there will be no foundation for growth inthe slightly longer term. Greece is struggling to convince thetroika and the euro zone’s politicians that it is following the reformprogram and should be given an extension. This could bediscussed further down the road, or another write-off when thecountry is insolvent, but first the new government has to prove itscommitment to reform. Spain is struggling with a lack ofbudgetary discipline by regional authorities, falling housing pricesand rapidly rising unemployment. The pace of reform in Italy hasslowed, at the same time that political parties are positioningthemselves ahead of the election next May. Whether formerPresident Berlusconi intends to continue to pursue his politicalcareer is still hanging over the country. The most important thingfor Italy is to restore its reform efforts and create confidence athome and abroad, something Berlusconi can hardly guarantee.UK – the recession deepens  We have revised our GDP growth estimate downward after a weaker-than-expected start to 2012. The euro zones crisis, budget austerity and slightly weaker competitiveness are slowing growth and deepening the recession.  Lower inflation is allowing for looser monetary policy and this fall the central bank will expand its quantitative easing. Fiscal policy may have to be loosened slightly if the recession continues and worsens.The UK’s recovery since the financial crisis has been weak with GDP has shrunk in theseveral quarters of negative growth, including last three quarters. last three quartersAt an annual rate GDP fell by 0.8% in the second quarter, whichwas worse than expected. Growth is being impeded by fiscalausterity, credit austerity and the previously relatively highinflation, which has made households less willing to spend. Wehave revised GDP growth downward to 0.2% for 2012 and 1.1%for 2013 (from 0.8% and 1.7%). In 2014 growth will reach 1.8%, amodest growth rate from a historical perspective.36 Swedbank’s Global Economic Outlook • 21 August 2012
  • 37. Inflation and policy interest rate 6 P olicy in te re st ra te 5 C P I - service s 4 C P I w ith Procent unch anged 3 taxes 2 CPI 1 C P I, excludin g energy, food , a lcoh ol and tob acco 0 05 06 07 08 09 10 11 12 S o u rce : R e u te rs E co W inInflation has trended significantly lower this year, reaching 2.6% Lower inflationin July. This leaves households with more money to spend. To facilitates monetaryachieve the inflation target of 2%, the Monetary Policy policy and increasesCommittee of the Bank of England recently decided to add the willingness ofanother £50 billion in quantitative easing, mainly in the form of households to spendgovernment bond purchases. In total, the QE program is now at£375 billion. The bank rate will be maintained at 0.5% in 2012and 2013, before a period cautious hikes begins in 2014.Due to the recession, the government has slowed the pace of itsausterity program by maintaining wages in the public sector andstimulating investment. If the recession continues, the IMF feels itwould help to increase public spending.Manufacturing shows continued signs of a slowdown. The A stronger pound andpurchasing managers index is below 50 and the sector is being weak productivitypressured by weak demand from the euro zone. The pound has growth are makingbeen relatively stable against the dollar but has strengthened British industry lessagainst the euro, further crimping competitiveness. In addition, competitiveproductivity has grown more slowly of late, since employmenthas improved to a surprising degree at the same time thatproduction has declined. In spite of this, unemployment remainshigh at 8.2%.Consequently, households remain cautious and are returning totheir normal behaviour now that the Olympics are over. Theeconomic impact of the Olympics is considered fairly small in theshort term, especially since many tourists were discouraged fromcoming due to logistical problems. In the longer term the costswill probably outweigh the benefits, but hopefully the festivitieswill provide a slight boost in confidence, the importance of whichto growth shouldn’t be underestimated.Swedbank’s Global Economic Outlook • 21 August 2012 37
  • 38. Nordic countries – not spared from the eurozone’s crisis  Denmark is cutting its spending at a time when the economy is weaker than normal. Norway’s households, housing market and oil investments are contributing to continued positive growth. The slumping Finnish economy is due to a combination of lower global demand and weaker competitiveness, and hopes have turned to a weaker euro.  The Nordic countries are strongly affected by the global economy through demand for export products, exchange rates and commodity prices. However, relatively low unemployment and a strong social safety net are contributing to decent domestic demand, or in the case of Norway strong demand but with a growing risk of imbalances.The Danish economy grew by 0.4% during the first quarter after Denmark appears tohaving shrunk in the previous two quarters. By moving public have climbed out ofinvestments forward and increasing transfers to the household recessionsector through the reformed pension system, consumption andinvestment have risen during the first months of the year. Currentdebt reductions by households after the housing bubble burst inconnection the global financial crisis in 2008/09, coupled with adeteriorating labour market, mean, however, that privateconsumption will be weak throughout the forecast period. With ashaky housing market, it will take time before constructioninvestment picks up. At the same time fiscal policy will betightened next year to alleviate the growing budget deficit. Theweak global economy, especially in the euro zone, whichreceives nearly 60% of Danish exports, will limit Denmarkseconomic growth to 0.8% this year. Gradually rising externaldemand should push GDP to slightly over 1% in both 2013 and2014, which remains below the country’s long-term growth trendof about 1.6%.GDP growth in the Norwegian economy was 1.4% during the first A strong Norwegianquarter. Measured an annual rate, growth was 4.1%, which krona and growing(together with Iceland’s 4.2%) is the fastest growth in the region. imbalances in theStronger domestic demand is the main driver of growth through housing market arehigher consumer spending and rising investments in the oil forecast risksindustry and housing sector. The strength of the economy,together with the high oil prices, has created upward pressure onthe Norwegian krone, which has led to a lower inflation rate but isalso a competitive disadvantage for exporters. We expectdomestic demand to remain a growth engine throughout theforecast period driven by strong labour market and low nominalinterest rates. GDP will rise by 3.3% in 2012 before slowing to2.0% next year when net exports are expected to contributenegatively to growth. For 2014 we expect GDP growth of 2.5% asexternal demand strengthens slightly. The challenge for theNorwegian economy is the growing imbalances in the real estatemarket. The low nominal interest rates and significant rise in38 Swedbank’s Global Economic Outlook • 21 August 2012
  • 39. housing prices have led to a rapid increase in Norwegianhousehold debt, which isn’t sustainable. Major swings incommodity prices are another risk factor for the economy.The recovery in the Finnish economy accelerated during the first Finland is strugglingquarter after having stood still during the fourth quarter of 2011, with competitivebut then GDP declined again in the second quarter by 1% at a problems inquarterly rate, resulting in a modest increase of 0.6% on an combination withannual basis. Higher consumption and investment accounted for weaker demand – thethe majority of the increase, while net exports contributed weaker euro may helpnegatively. The Finnish electronics industry’s problems with lost slightlymarket share and growing global competition are a contributingfactor to the slower growth rate for exporters than in Sweden andDenmark in recent years. The depreciation of the euro provides acompetitive advantage, however, especially for the forestryindustry. We expect the Finnish economy to grow by an averageof 0.7% in 2012. GDP growth will slow during the second half ofthe year due to the weaker global economy and uncertaintyabout the consequences of the fiscal crisis in the euro countries.For next year and 2014 we expect GDP growth in Finland togradually improve to 1.1% and 1.8%, respectively, provided thatthe economic problems do not worsen in the euro zone.6. Conclusions for our home marketsThe most important export market for Sweden and the Baltic The severe crisis in thecountries is in severe crisis, which will take a long time to resolve. euro zone is affecting usIt is natural, therefore, that we would be affected in various ways in several waysduring this period. This includes deteriorating export opportunitieswith weaker demand and greater difficulty competing, since thereal effective exchange rate depreciates in the euro zone. It alsomeans less willingness to invest by companies in the euro zoneas well as here at home, where concerns are causinginvestments to be delayed. The relatively good situation in whichwe find ourselves can also hurt the pace of reform.Another important aspect is that the euro zone has to focus onthe crisis and lacks the strength to address other strategicconcerns, e.g., Europe’s relationship with emerging markets anda closer integration in the area of services. We are also affectedindirectly if the euro zone and the EU lose momentum in thisrespect.On the other hand, the efforts to unify the euro countries in a It is important tobanking union, fiscal union, economic policy union and political formulate a policy thatunion could mean a closer integration, with countries that don’t addresses the currentbelong to the euro zone on the outside looking in. Estonia is a crisis as well as themember of the euro zone, Latvia and Lithuania have signed the prospects of a closerso-called Euro Plus Pact, while Sweden to date has only said integration between eurothat it supports the fiscal pact. The question therefore is how we countriesshould approach the crisis and the prospect of growingdifferences between the euro countries and other EU countries.It’s only natural that financial professionals issue forecasts howthey think the euro zone’s crisis will be handled and whether aSwedbank’s Global Economic Outlook • 21 August 2012 39
  • 40. particular country could be forced to exit the currency. What ismore striking is that senior politicians in Finland, Latvia and evenSweden have made such pronouncements publicly. Perhapsthey are trying to win over a few euro-sceptic voters. It wouldseem more important to take political responsibility for supportingthose who are trying to resolve the crisis without breaking up thecurrency union.It makes sense that the euro countries are trying to create abanking union, since they share a single currency, their banksoperate across national borders, and there is a strong connectionbetween governments’ and banks’ balance sheets. Countriesoutside the euro zone dont have to and probably wont join sucha banking union, but will have to accept that a closer integrationis now becoming a reality. In some areas, the cooperation couldinclude non-euro countries. The important thing for non-eurocountries is to formulate strategies for those areas.There seems to be little agreement on the costs of dissolving the The costs to dissolve thecurrency union, but they will probably be huge. There is not only currency union are likelythe issue of the instability that would arise from a return to to be huge – it is also innational currencies, but also the more long-term effects for the our interest to avoidEU, the inner market, the cooperation on several levels and seeing that happenEuropes relationship with the rest of the world. It is in our interestas well that the currency union survives this crisis. Cecilia Hermansson40 Swedbank’s Global Economic Outlook • 21 August 2012
  • 41. Economic Research Department Sweden Cecilia Hermansson +46 8 5859 7720 Group Chief Economist Chief Economist, Sweden Magnus Alvesson +46 8 5859 3341 Head of Economic Forecasting Jörgen Kennemar +46 8 5859 7730 Senior Economist Anna Ibegbulem +46 8 5859 7740 Assistant Estonia Annika Paabut +372 888 5440 Acting Chief Economist Elina Allikalt +372 888 1989 Senior Economist Teele Reivik +372 8887925 Economist Latvia Mārtiņš Kazāks +371 67 445 859 Deputy Group Chief Economist Chief Economist, Latvia Lija Strašuna +371 67 445 875 Senior Economist Lithuania Nerijus Mačiulis +370 5 258 2237 Chief Economist, Lithuania Lina Vrubliauskienė +370 5 258 2275 Senior Economist Vaiva Šečkutė +370 5 258 2156 Senior EconomistEkonomiska sekretariatet105 34 Stockholm, tfn 08-58 59 1028 Swedbanks Konjunktur- och Strukturrapport ges ut som en service till våra kunder. Vi oss ha använt tillförlitliga källor och bearbetningsrutiner vid utarbetandet av analyser, redovisas i publikationen. Vi kan dock inte garantera rapportens riktighet eller fullständighet och kan inte ansvara för eventuell felaktighet eller brist i grundmaterialet ellerAnsvarig utgivare bearbetningen därav. Läsarna uppmanas att basera eventuella (investerings-) beslut ävenCecilia Hermanssont, 08-5859 7720. på annat underlag. Varken Swedbank eller dess anställda eller andra medarbetare skall kunna göras ansvariga för förlust eller skada, direkt eller indirekt, på grund av eventuellaMagnus Alvesson, 08-5859 3341 fel eller brister som redovisas i Swedbanks Konjunktur- och Strukturrapport.Jörgen Kennemar, 08-5859 7730ISSN 1103-4897