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Swedbank's Global Economic Outlook, August 2011
 

Swedbank's Global Economic Outlook, August 2011

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Swedbank's Global Economic Outlook, 2011 August: Global growth is slowing – without reforms the world economy is at risk

Swedbank's Global Economic Outlook, 2011 August: Global growth is slowing – without reforms the world economy is at risk

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    Swedbank's Global Economic Outlook, August 2011 Swedbank's Global Economic Outlook, August 2011 Document Transcript

    • Global Economic Outlook by Cecilia Hermansson 17 August 2011 Global growth is slowing – without reforms the world economy is at risk  Since our spring forecast, economic growth, primarily in the US but more recently in the euro zone as well, has slowed. Turbulence in the financial markets has increased and confidence is falling. We have revised our global GDP growth forecast downward to 3.8% this year (4.1%) and expect it to remain just under 4% in 2012 and 2013.  Our main scenario, which we give a probability of 60%, does not include a new global recession, but does anticipate a slower recovery in developed countries due to budget austerity. Economically and politically, we seem to be “muddling through”. Emerging countries are driving the global economy.  The risk picture is weighted heavily to the downside. We give a less favourable scenario – where global GDP growth falls below 2% – a 30% probability. The debt crisis is worsening in the euro zone and causing a major stock market sell-off, currency worries and shrinking economies. Even emerging countries dont seem to be immune. On the other hand, we can’t totally exclude the possibility of stronger growth, upwards of last years 5%. The probability is low, however, at 10%, and requires newfound faith in the political systems in the US, Japan and the euro zone.  This report identifies the needed reforms in the US, the euro zone, China, emerging countries and across national borders. The time for denial is over. We need economic policies that will best help us to overcome the debt crisis that Western countries are now going through and the overheating that worries emerging countries. The EMU is already a transfer union, and a fiscal policy coordinated with the Eurobond market would be a more effective solution. Extensive reforms are needed to strengthen growth prospects over time. Until then decision-makers will have to apply both the gas and the brakes. Cecilia Hermansson Contents: Page 1. Our main scenario: Modest growth in spite of everything 2 2. An increasingly complex risk picture 6 3. Economic policy: Few tools 9 4. Our assumptions about the commodity and financial markets 15 5. A lot depends on emerging economies 23 - USA 24 - China 28 - Japan 30 - India 32 - Brazil 34 - Euro zone 36 - UK 40 6. Conclusions for our home markets 42 Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740E-post: ek.sekr@swedbank.se Internet: www.swedbank.com Responsible publishers: Cecilia Hermansson, +46-8-5859 7720. Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897
    • 1. Our main scenario: Modest growth inspite of everythingSince our spring forecast, the global economy has continued to Economic pessimismmuddle through while financial unrest has grown, which is clearly and the debt crisisreflected in the recent stock market sell-off around the world. Two have caused a majorkey factors are creating nervousness in the financial markets: the stock sell-offdebt crisis in the US and Europe, and the risk of a new globalrecession.The debt crisis is largely a question of a loss of faith in politicians The US debt crisis isto manage crises. In the US, it took a long time to negotiate a the fault of politicianshigher debt ceiling, at the same time that the medium-term debtreduction was insufficient and poorly structured without any taxincreases. A debt downgrade by Standard and Poor’s followedsoon afterward.In the euro zone, the debt crisis has spread from Greece, Ireland The euro crisis isand Portugal to larger countries such as Spain and Italy. worsening as largerInadequate institutional frameworks and increased nationalism countries see interestare undermining the euro cooperation and threatening the rates risecurrencys future. Interest rate differentials between fiscally“sound” and “unsound” euro countries have been driven higher.Poor growth prospects due to the competitive weakness of manycrisis countries also make it harder to manage the budgetconsolidation process.Although the most recent rescue package caused Greek, Irishand Portuguese interest rates to fall, Spanish and Italian rateshave instead risen. The only way to stop this was for theEuropean Central Bank to buy bonds from these large countries,which is hardly a long-term solution.Interest rate differential between German and other EU 10-year government bonds 17,5 15,0 12,5 Percentage points 10,0 G reece 7,5 5,0 Ireland S pain P ortugal 2,5 Italy 0,0 UK F rance B elgium S weden -2,5 07 08 09 10 11 S o urce : R e u te rs E co W in2 Swedbank’s Global Economic Outlook • 17 August 2011
    • The risk of a double dip recession has grown. In GDP terms, this Growing fears of ameans global growth of less than 2%. The nervousness stems double dippartly from the purchasing managers indexes around the world,which are now dangerously close to a reading of 50, signallingthat there is essentially no growth in industry, and partly from therisk that the stock sell-off will have a negative wealth effect andreduce confidence, in turn leading to lower global trade,consumption and investment.Purchasing managers index in various countries/regions 2006-2011 65 60 55 50 45 40 USA UK J a p an 35 E u rola n d C h ina In d ia 30 G lo ba l 25 07 08 09 10 11 S o u rc e : R e u te rs E c o W inDespite the worries in the financial markets, we haven’t changed In spite of everything,our view that the global economy will “muddle through”, although we are sticking by ourwe see growth prospects worsening compared with our spring main scenario, i.e.,forecast. We are also adding something new by extending our that the economy willforecast to 2013. “muddle through”, but with weaker growthOur growth revisions primarily concern the US and Japan, compared with lastalthough the euro zone is also expected to grow more slowly. For springthe US, the key has been a significantly weaker than expectedrecovery this year, which cant be blamed on temporary factorsalone, but stems more so from major structural problems in thelabour and housing markets as well as an antagonistic politicalclimate.For Japan, the focus has naturally been on the earthquake For 2011, we havedisaster in March, which has reduced activity this year, but is revised the US andvery likely to raise it starting late this year and for several Japan downward...quarters to come as the reconstruction progresses. We havealso had to revise our GDP growth estimates upward in several … but we have alsocountries. Germany has strong momentum and is benefitting revised the euro zone,from demand from emerging countries, along with its relative through Germany andfiscal strength, a fairly weak euro and low interest rates. Growth France, upward…slowed more than expected during the second quarter, however,including in France.Swedbank’s Global Economic Outlook • 17 August 2011 3
    • China has surprised with stronger growth than we had projected. … while China hasEven though we see a slowdown in activity going forward, we also surprised on thehave revised our GDP growth forecast upward on the basis of the upside to datestrong results. Many emerging countries are raising interest ratesto reduce the risk of overheating, and this is gradually affectingdemand. When developed countries grow more slowly, it alsoreduces the risk of a hard landing. In the event of a majorslowdown, economic tools are available, since interest rates canbe cut and the government budget can be allowed to expand.Global GDP forecast Autumn Forecast Spring ForecastGDP growth (%) 2010 2011 2012 2013 2010 2011 2012US 3,0 2,1 2,3 2,7 2,9 3,0 3,0Euro zone: 1,8 1,7 1,3 1,3 1,7 1,5 1,5of which: Germany 3,6 2,9 1,8 1,6 3,6 2,4 1,9 France 1,4 1,5 1,5 1,4 1,6 1,5 1,6 Italy 1,3 0,8 0,7 1,0 1,3 0,9 1,0 Spain -0,1 0,6 0,8 1,2 -0,1 0,3 1,0UK 1,3 1,3 1,6 1,8 1,4 1,5 1,8Japan 4,0 -0,2 2,8 1,4 4,0 0,6 3,0China 10,3 9,0 8,4 8,0 10,3 8,8 8,4India 10,4 7,8 7,5 7,5 9,1 8,0 7,5Brazil 7,5 3,8 4,1 4,5 7,5 4,3 4,0Russia 4,0 4,5 4,4 4,2 4,0 4,6 4,5Global GDP in PPP 5,0 3,8 3,9 3,8 4,9 4,1 4,2Global GDP in US dollars 4,1 2,9 3,1 3,1 4,0 3,2 3,4Sources: National statistics and Swedbank’s forecasts. Note: These countriesrepresent about 70% of the global economy. To arrive at total GDP growth,approx. 0.3 percentage points should be added. The World Bank’s weights from2009 have been used, which raises total figures by 0.1-0.2 percentage pointscompared with our spring forecast, when 2009 weights were used.Developed countries arent in the same position as emerging Few economic toolseconomies, since they have already used up their “ammunition” are left in the West ifin connection with the financial crisis and the global recession in economic conditions2008-2009. We still feel, however, that a new slowdown in the worsen…global economy like the one we saw after the Lehman Brothersbankruptcy can be avoided. The global economy is betterprepared today. The financial system, though far from fullyrepaired, is not as unbalanced. This time we don’t have as muchdebt-financed activity, but there is overcapacity still hangingaround since the last recession. If the stock sell-off ends withouttoo much damage to the financial sector and the real economy,the recovery can continue, though at a weaker pace.Nonetheless, growth prospects can be considered fairly decent … but a new Lehmandespite the concerns that currently exist and which the financial Brothers-like crash canmarkets wont be rid of anytime soon. Following are a number of be avoidedadditional reasons why we believe that the global economy willavoid a new recession:  There is a greater awareness after the Lehman Brothers bankruptcy of the costs to the global economy of not addressing financial turbulence in time4 Swedbank’s Global Economic Outlook • 17 August 2011
    •  The financial system, though not yet healthy, is less imbalanced today  Emerging countries would be affected by a slowdown, but still could resort to economic stimulus and gradually increase intraregional trade  Emerging countries are “catching up,” which means high growth  Slower global growth is contributing to lower demand for raw materials, which is slowing the rise in commodity prices, and in turn inflation  High productivity and lower cost pressures through wages and raw materials are raising corporate profits  paving the way for investment and new hirings  Extremely low interest rates for several years will keep investment costs down  Major need for new investment in infrastructure, energy and climateHowever, the recovery will still remain slow in the developedeconomies going forward, and here is why:  Continued debt restructuring in the private sector and low loan demand  Fading impact of economic stimulus  Negative impact on growth of budget consolidation  Higher benchmark interest rates, though further in the future  Little faith in the ability of politicians to resolve crises  High volatility in the financial markets is a cause of concern  Emerging countries will downshift when faced with overheating  Weak labour markets are hurting consumption  Stiffer regulation of the financial sector could make capital more expensive  Remaining capacity surplus on a global levelA lot depends on emerging countries to keep the wheels of the The global economy isglobal economy turning. Yet it is essential for them that dependent ondeveloped countries avoid a new recession and at least maintain emerging countries,some growth in order to preserve demand for imports from and vice versaemerging countries.We are aware that the risks of an economic decline (or perhaps Huge swings makean improvement) are great. In some sense, the situation is worse accurate forecaststoday than after Lehman Brothers if the global economy were to difficult – risks have totruly slide into a new recession, since few economic tools are be carefully analysedavailable to more developed countries – or they are no longer aseffective. In the next section, we discuss alternative scenariosand what could trigger them. It’s also worth noting that it is verydifficult to build an accurate scenario for the years ahead at atime of financial turbulence and when forecasting parameterschange on a daily basis.In summary, the recovery will continue in our main scenario, butit will be slower than in our spring forecast, and GDP growth willaverage less than 4% in 2011-2013. Emerging countriesrepresent two thirds of growth during the period, at the same timethat developed countries are struggling with the debt crisis, acrisis of political faith and structural problems after the financialcrisis, all factors that are restricting growth.Swedbank’s Global Economic Outlook • 17 August 2011 5
    • 2. An increasingly complex risk pictureWhen the global economy is in a period of dramatic change, it isdifficult to make reliable forecasts. The assumptions aboutvarious markets, political decisions and the reactions to them canquickly prove inaccurate.In the following chapter we discuss a number of factors that can We also offer oneproduce better or worse scenarios than our main scenario. better and one worseWhat’s difficult is that the risk picture becomes more complex scenario – but the riskwhen risks affect each other. This makes it important not only to picture is complex andanalyse risks individually, but also the dynamic between them. skewedThe risk picture is skewed, and the forecast risks on thedownside are greater in number, more serious and larger thanthe risks on the upside.We discuss two scenarios other than our main scenario, one withslower growth which we give a 30% probability, and a betterscenario with a 10% probability. Our main scenario is alsorelatively uncertain, with a probability of 60%.Main scenario/low growth scenario with global GDP growthof 3.5-4%In our main scenario, we have projected global GDP growth in We give our mainPPP terms of 3.5-4% in 2011-2013. In this scenario, the debt scenario with 3-4%crisis doesn’t worsen appreciably in the developed countries, but growth a 60%budget austerity does further impact growth prospects. The probability, a betterpolitical process, like the global economy, “muddles through”, as scenario 10% and apoliticians react to the financial turbulence rather than being worse scenario 30%proactive. The market jitters will ease, but a significant rebound isnot in sight. Emerging countries will manage to maintain growthreasonably well with stimulus measures and without majorinflation problems.A recession scenario with global GDP growth in PPP termsbelow 2% next year  A global economic slowdown is already evident, and after a delay the stock market sell-off could lead to even lower demand through negative wealth effects and a further loss of confidence among households and businesses. An accelerated slowdown cannot be checked with interest-rate cuts or more expansive fiscal policies in developed countries. On the contrary, we head toward a period of government debt restructuring which constrains growth.  A new recession in the US becomes more likely after the political crisis has worsened, US debt has been downgraded and households lose confidence, which translates into lower consumption. The labour and housing markets are already developing weakly, and if growth slows further we could see a negative spiral of lower confidence and growth as well as a weaker financial sector. The risk of deflation in the US economy will rise if6 Swedbank’s Global Economic Outlook • 17 August 2011
    • growth slows significantly. The Federal Reserve can give asset prices a boost through quantitative easing, but can do little to strengthen the labour market or growth. Fiscal policy is too tight at present and too loose in the medium term, but American politicians lack the will and courage to do the opposite, which makes it difficult to lift the US out of a new recession.  A new recession in the US would worsen growth prospects in the rest of the world, including the BRIC countries. Another quantitative easing would again increase overheating problems in emerging countries due to increased capital inflows to them and to commodity markets. This would also make it more difficult for emerging countries to rely on an economic stimulus, which could spark higher inflation. As a result, they may not be able to “rescue” the world this time. Increased capital inflows could also lead to a currency war and protectionism. Chaotic currency corrections have been avoided so far, but could be the outcome if the dollar and/or euro weaken substantially.  An expanded debt crisis in the euro zone that spreads to Spain, Italy and even France would be the most important catalyst for a global recession by spreading to the banking system and real economy. This could be the result if political consensus and courage cannot be found to address a larger crisis. For example, the EFSF won’t be big enough if, in addition to Greece, Ireland and Portugal, Spain and Italy also have problems. This would require more than 1 500 billion euros, compared with the 440 billion euros the fund now has at its disposal. The next version of the fund, ESM, wont be enough either, at 700 billion euros. If the big euro countries have problems, responsibility will rest squarely with AAA- rated Germany, France and the Netherlands. The sovereign debt crisis would worsen at the same time that more banks go bankrupt or are rescued by already highly indebted governments. The euro’s collapse would no longer be unlikely if the political will can’t be mustered, which could be the case if responsibility rests squarely on Germany and the Germans tire of financing the rest of the euro zone’s overconsumption.  A huge stock sell-off and anxiety in the financial markets that spreads to the real economy and banking system would be the outcome of a major debt crisis in the euro zone and a new recession in the US.  Social unrest increases in the wake of high unemployment and a sharp decline in future confidence, particularly among young people. Violent protests, revolts and uprisings, especially in developed countries, pave the way for greater populism and nationalism.Swedbank’s Global Economic Outlook • 17 August 2011 7
    • This leads to even greater political impotence, which in turn accelerates the collapse of the euro.  An expanded crisis in connection with the democracy movement in the Arab world spreads to Saudi Arabia, causing oil prices to rise and threatening supplies.  Another reason why commodity prices could stay high in a negative growth environment is if emerging countries develop fairly strongly with high demand for raw materials, while developed countries continue to slide backward with an increased risk of a stagflation scenario.  Even if the effects on the global economy shouldn’t be overestimated, natural disasters, climate change, power shortages and other infrastructure problems, war and terror, and, not least, the “unknown factor” could also hurt future confidence and set back the economy, serving as a catalyst for a major slowdown in an already negative growth climate. A high-growth scenario with global GDP growth upwards of 5% or more next year  Worries about a new recession turn out to be overblown, as evidenced by Chinas strong export data for June. Nervousness in the stock market eases and does not have a major impact on the economy. The recovery continues to gain momentum once sentiment changes from pessimism to optimism.  The financial system has repaired the large part of its balance sheets and is ready to begin lending again, at the same time that consumer debt restructurings wind down, which leads to increased credit demand.  Lower commodity prices and cost pressures create higher profits. With higher productivity and better confidence, the willingness to invest and recruit rebounds.  Decision-makers find the strength and courage to address the current crisis. Instead of reacting, they take the initiative with respect to the euro cooperation, the US medium-term budget consolidation and Japan’s longstanding debt crisis and political crisis. Confidence grows when measures have a tangible effect. Politicians collaborate nationally across parties and also succeed in achieving greater international coordination. Although the measures could weaken growth through austerity, there are greater positive effects from increased confidence, which creates a willingness to invest and consume.8 Swedbank’s Global Economic Outlook • 17 August 2011
    • 3. Economic policy: Few toolsThe same crisis – but it has expanded to the public sectorWhen the financial crisis erupted in 2008, few people predicted The 2008 financialthat the debt problems in the private sector would spread to the crisis is still alive andpublic sector and that it would take years to overcome. An has mutatedeconomic recovery may have begun in 2009, but with thestimulus programs it was hard to tell how self-sustaining it wasand whether it was mostly just a bounceback after the severerecession.Countries with balance sheet problems such as the US, the UK,Spain and Ireland have had a hard time recovering. The balancesheet recession they face requires major structural changes tothe economy. The focus in their case is on debt restructuring andless willingness to borrow and consume. Countries withoutimbalances, such as Germany, Sweden and Finland, haverecovered reasonably well, in no small part due to strong growthin Asia, Latin America, the Middle East and Africa.The problem is that it is the larger industrialised countries Nearly all industrialised(Germany accepted) that are now reporting huge budget deficits countries have debtand swelling government debt. Countries that originally had problemsproblems with private debt are being joined by others with largepublic debt such as Greece, Italy, Belgium and France.There are fears that the public debt crisis will work its way backto the private sector through the banking system and that thenext crisis will include not only credit problems but also currencyproblems due to a collapse of the euro zone. There is also a riskthat the private and public debt restructuring will adversely affectgrowth, without which any debt restructuring will be even moredifficult.Economic tools – then and nowThe realisation that politicians and central bankers do not have The lack ofthe same ammunition to stop a new recession that they did in ammunition is a2008/2009 is now baked into expectations. Back then benchmark cause of concernrates were cut to nearly zero, quantitative easing reduced long-term interest rates and drove up stock prices, liquidity wassupplied, and banks were rescued, at the same time that fiscalpolicy supported the economy through higher spending and/orlower taxes.Stimulus packages were coordinated around the world, includingwith emerging countries, which gained a stronger voice throughthe G20. It was fairly easy to be a politician, and the financialmarkets appreciated the resolute efforts to support the financialsector, asset markets and the economy. Economic policy hasnow become more of a national concern, and in the absence ofany tools it has become much more difficult to be a policymaker.An important distinction from an economic standpoint is thatinterest rates are already low and that it is generally felt thatSwedbank’s Global Economic Outlook • 17 August 2011 9
    • another quantitative easing would have little effect. While aneasing could lead to higher stock prices, they wont last if theglobal economy still shows signs of weakness. At the same timea quantitative easing produces higher capital flows to asset andcommodity markets, with an increased risk of overheating.Furthermore, demand for government bonds is relatively high incountries with a balance sheet recession, since many investorshave to seek out safe havens. This is also evident by the declinein long-term interest rates despite the stock market turbulence.Another important distinction – including from a political A fiscal stimulus maystandpoint – is that there is little or no support for a new fiscal be economicallystimulus. That includes countries where the financial market motivated…could finance one without exorbitant risk premiums, such as theUS, Japan and the UK. For countries with balance sheetrecessions, monetary policy isnt the important thing, sincebusinesses and households have less interest in borrowing.Instead, there is more focus on fiscal policy, especially incombination with structural reforms, to raise growth potential.The crisis in the euro zone leaves few alternatives other than … but there isn’t aausterity, even at a point when the recovery is unravelling. For political consensuscrisis countries, risk premiums are soaring and they are findinghard to finance their deficits. In the US, the Tea Party movementhas made another stimulus, e.g., to help the labour marketrecover more quickly, politically inexpedient. Instead, theemphasis has shifted to reducing the size of the governmentregardless of the potential impact.Political leadership and economic adviceWe have acknowledged that the job of politicians has been mademore difficult by a lack of tools. In addition, the scope of the crisishas become more complex. When a crisis becomes less acute,the focus shifts to moral hazards. The economy cannot bestimulated without considering the driving forces, i.e., whether thesystem is encouraging market participants to create or avoid asimilar crisis in the future. Crisis management now seems tomean biding time. In the euro zone, politicians wont react untilthe financial markets act, and usually ineffectually, which has ledto a steady succession of new summit meetings.A lot of attention is being paid to how voters will react to political The crisisdecisions. This is especially true in Germany, where the managementreluctance to pay for the debt problems of its undisciplined capabilities ofneighbours has grown. Nationalism has been allowed to fester, politicians leave muchand real problems are being obscured. Instead we hear a lot of to be desired …sloganeering: “The euro is stable and secure” or “The euro wontcollapse”. What aren’t being discussed enough are a vision andthe benefits of an integrated Europe.If crisis management has been a stumbling block for politicians, … but contradictoryeconomists seem to disagree on the right advice, which certainty advice fromdoesn’t make it easier for politicians. Some suggest that another economists hasn’tquantitative easing is needed, while others want it to end. Some helped10 Swedbank’s Global Economic Outlook • 17 August 2011
    • want to see a fiscal stimulus, while others want to see rapid, far-reaching austerity programmes.Another difference compared with 2008/2009 is the labourmarket. Unemployment has soared in many crisis countries, ortaken longer to decline. Strikes, demonstrations and violentunrest are a sign of resignation, anger and fear. Many youngpeople are at risk of becoming a “forgotten generation” with alower standard of living for the rest of their lives. Income gapsand social tension are growing.Political developments have become a source of growing Forecasters areconcern when assessing the economy. In addition to economics becoming increasinglyand psychology, political science has to be included for a holistic interested in politicalperspective. A lack of faith in the political process is affecting the riskswillingness to invest and consume and hurting stock prices.One area that has to be better explored is the euro zone’sdevelopment from a democratic standpoint. Can political leadersagree on changes at summits without having to rely oncommissions to voice objections and make improvements? Howdo you create confidence in such a process, which is nowinexorably leading to greater supranationalism as a result of thedebt crisis?In the US and Japan, the bigger question is how politicalcampaigns are financed and what it means to political decisions?In the US, it is never easy to raise taxes on the rich, who notinsignificantly are the ones who pay for election campaigns. Thedivide between politicians and voters is growing, which is makingit more difficult to reach effective economic policy decisions.What’s a sensible policy from an economic perspective?From an economic perspective, we suggest several measuresbelow to reduce the risk of a new recession and slow the crisis ina few years’ time. We focus on developments in the US, the eurozone, China and other emerging countries. We also offersuggestions for better international accords.USA President Obama has to explain the seriousness of the recession (a balance sheet recession) that the US is in, why the usual tools arent working and why fiscal policy is more important than monetary policy at this juncture. Another fiscal stimulus targeting growth and jobs is needed in the short term, but with tighter budget consolidation in the medium term (the opposite of what is now being done). Greater clarity with regard to medium-term fiscal policy would strengthen confidence. Taxes and spending eventually have to be balanced by expanding the tax base, eliminating deductions and increasing taxes on the wealthy. A reassessment of the social security system and defence spending is needed. A new round of quantitative easing is reasonable only if there is another recession and deflation signals increase. The introduction of an inflationSwedbank’s Global Economic Outlook • 17 August 2011 11
    • target to increase the independence of the central bank could improve confidence. Structural reforms are needed to improve the housing and labour markets, with a focus on encouraging hiring and employability, especially among the long-term unemployed. Reshaping the political system is also important to the economy. This includes reforming campaign financing laws, changing the size of voting districts and increasing the effectiveness of Congress.The euro zone The currency union is irrevocable, which has to be realised. If a country is forced to leave (e.g., Greece), expectations are that its currency (drachma) will weaken, leading to capital flight and the spread of the banking crisis to other countries. This wouldnt apply to Germany, where expectations are the opposite, i.e., that the currency (D-mark) would strengthen and lead to capital flows from other countries. Of course in Germany’s case it would also mean lower exports due to a stronger currency and the crisis in the rest of the union. Rescuing one or more countries is less costly than breaking up the entire union. The time for denial should be over within the euro zone, including Germany. The euro zone’s debt crisis is not only a liquidity crisis but also a solvency crisis. Aid packages have to contain better terms and write-offs. For Greece, for example, the percentage agreed to on July 21 is too small, since its debt ratio will reach 150% of GDP and it will lose a decade in terms of GDP growth. The state of denial includes the euro zone’s banks. Excessive write-offs threaten their balance sheets and they therefore have to recapitalise in expectation of the next round of write-offs. The expansion of the European Financial Stability Facility (EFSF) is a step in the right direction, since it can now (if parliament ratifies the proposal) be used to support banks in crisis, not only countries in crisis. It is also time for the crisis countries to stop denying reality. They are waking up too late after risk premiums have risen and their deficits can no longer be financed. The crisis countries have to surprise the financial markets with more extensive reforms and a greater focus on growth and competitiveness – Italy’s nominal growth must exceed the interest rates on its debt. Austerity programmes have to be reasonable based on effectiveness and income distribution, with a sensible balance between spending cuts and higher taxes. The emphasis must be on eliminating bureaucracies, inefficiencies, tax evasion and the informal sector. Privatisations are often necessary, not least to raise productivity. The European Central Bank (ECB) has adopted a questionable attitude toward its responsibility as a lender of last resort. Although the ECB wasnt supposed to assume the responsibility of politicians to rescue governments in need, it has purchased nearly 100 billion euros in government bonds from Greece, Ireland, Portugal and most recently Spain and Italy. This is in addition to just over 400 billion euros in outstanding loans to banks in June, two thirds of which were to banks in Greece, Ireland, Portugal and Spain. The ECB is protective of its independence and now may have to ask governments in the euro zone for a recapitalisation. The question is how long the ECB can keep buying Italian and Spanish government obligations and where to draw the line, as well as what would happen if it withdraws its support? The idea that the EFSF, with an estimated size of 440 billion euros (its lending capacity is now 225 billion euros), would be big enough even if Italy faced major problems is questionable. Instead, the fund would have to triple in size to 1 500 billion euros or more to handle a more serious crisis. The question then is whether France and Germany could maintain their high credit ratings, which they need to get the best interest terms. When12 Swedbank’s Global Economic Outlook • 17 August 2011
    • the European Stability Mechanism (ESM) takes effect in July 2013, conditions will be more stable with a lending capacity of 500 billion euros and a total facility of 700 billion euros. Of this amount, 80 billion euros will be paid through tax revenues and the rest of the capital can be called in or guaranteed. The ECB’s bond purchases and risk of recapitalisation, as well as the EFSF and ESM stability facilities, clearly show that the euro zone has already developed into a transfer union in spite of denials by politicians. The question is what’s the best way to facilitate transfers, so that they are effective economically and acceptable politically. The currency union has to be complemented by greater fiscal coordination, a common bank regulator and a central bank that takes responsibility as a lender of last resort. That would help to instil the confidence in the common currency that politicians are hoping for. A Eurobond market doesnt solve the immediate problem of the need for debt write-offs and support mechanisms. However, it would certainly go hand in hand with greater fiscal coordination and automatic sanctions if budget rules arent followed. A proposal by the think tank Bruegel (“The Blue Bond Proposal” by Jacques Depla and Jakob von Weizsäcker) would pool Eurobonds up to 60% of GDP (about 5 600 billion euros) and assign this tranche – the blue bond – a lower interest rate than the current average. Thanks to the increased liquidity, even countries such as Germany might find the proposal appealing, and the euro’s position as a reserve currency would be strengthened. Member states themselves would have to manage debts in excess of 60% of their GDP. Lower liquidity and higher interest rates would be an incentive to reduce debt to 60%. This proposal addresses moral hazards and maintains budget discipline despite the joint Eurobond. In addition, an institution is needed to oversee the allocation of blue bonds, so that mismanaged countries are no longer allowed to participate. By extension, the federal budget has to expand as well and extend its focus beyond common agricultural and structural policy. The currency union is an economic project that complements the EU’s integration and strengthens the region’s position in the global economy. At the same time it is just as much a political project, which requires a political commitment to support the cooperation. The problem today is that national concerns have taken precedence at the same time that democracy has been overshadowed. It wouldnt be unreasonable to transition from poorly prepared and less-than-transparent summits to commissions that are given more time, produce reports and allow for objections and discussions. Complementing the currency union with a fiscal union, a common bank regulator and a central bank that takes full responsibility will take time, but the important thing is that the process begins with a vision and openness.China A continued – and possibly faster – depreciation of the renminbi is needed to choke off inflation and strengthen domestic demand, which would also reduce global imbalances. It is important that Chinese financial sector and financial markets develop and that renminbi becomes convertible, but a deft touch is required, as well as a change in China’s growth model. Greater openness is needed for foreign players in China’s financial sector, in addition to greater opportunities for the Chinese to do business abroad. The process is under way, and it is important that it continues. Improvements to the social security system would reduce the need to save. Domestic demand could then increase and income gaps would eventually shrink. Increased transparency about debt is important on the part of the national government, public authorities and regions. Officially, government debt as a share of GDP is less than 20%, but all indications are that total debt is higher, 50-70%. To understand how much room there is for a stimulus,Swedbank’s Global Economic Outlook • 17 August 2011 13
    • debt and inflation data have to be more transparent. Better GDP data is also needed.Emerging economies Supply and demand have to be better balanced to avoid overheating, e.g., in India. Fiscal policy has to be tightened where signs of overheating are strong and growth is high, e.g., Brazil. The peg to the dollar has to be removed to avoid external and internal imbalances, e.g., the Middle East. Subsidies have to be reduced to improve economic drivers and reduce budget deficits. This includes increased use of environmentally friendly energy, e.g., the Middle East, India. Efforts to reduce corruption must be intensified in a number of countries, including India, Brazil and China.Across national borders The separation of responsibility between the Basel Committee and the Financial Stability Board (FSB) is unclear, as is the line between the banking system and the shadow banking system. Decisions to regulate capital flows and currencies are made at the national level despite international effects. The G20 has lost steam. Greater efforts are needed to determine whether the Basel III capital requirements are sufficient (which seems doubtful), how banking activities should be managed across national borders (including large institutions and what happens when they fail), and the role of the International Monetary Fund (IMF) in managing global imbalances, volatile capital flows, exchange rate problems and uncertainties about the build-up of foreign exchange reserves. The desire of China and other countries to use Special Drawing Rights (SDR) as a new currency isnt realistic; it would make more sense to prepare for a transition from the dollar as a reserve currency to a triumvirate of the dollar, euro and renminbi – a reality in about a decade given that China’s financial sector will continue to develop and that there is still confidence in the dollar and euro as global currencies.14 Swedbank’s Global Economic Outlook • 17 August 2011
    • 4. Our assumptions about the commodityand financial marketsIn the following, we describe the assumptions that support ourforecast with respect to the commodity, equity, fixed income andcurrency markets. The basis for our assumptions consists ofgrowth and inflation estimates, psychological effects, politicalcommitments and crisis management expectations. Uncertaintyis great, and developments that significantly deviate from ourassumptions could materially change the economic outlook.Commodity marketsThe rise in commodity prices in 2010 and early this year has Slower global growthlevelled off. A weaker global economy is lowering demand for means lowercommodities. Supply problems in commodity markets have also commodity priceseased. Droughts and fires had earlier caused food production todrop, but supplies are now holding up better. The Arab Springhas entered a second phase, and is worrying the oil market less.The quantitative easing in the US has run its course, which hasmeant less investor interest in the commodity markets. We alsobelieve that we have seen the worst of the dollar’s decline intrade-weighted terms, leaving producers no reason to stilldemand compensation for currency fluctuations.Commodity prices (total), food prices and commodity prices excluding oil (index) 175 T o ta l c o m m o d ity p ric e , e x c l o il 150 125 T o ta l c o m m o d ity p ric e Index 100 75 50 F o o d p ric e s 25 00 01 02 03 04 05 06 07 08 09 10 11 S o u rc e : R e u te rs E c o W inIn our spring forecast we predicted that oil, which was tradingaround USD 115 at the time, would fall when uncertainty aboutthe Middle East and the global economy eased. It took a while toprove true, and now the reason has more to do with weak globaleconomic growth. We saw last spring that the risks were on theupside due to problems in the Middle East and Japan.We therefore have to revise upward our previous estimate of Oil price estimatesUSD 105 this year and USD 98 in 2012, since oil prices have have been revisedheld up longer than we expected. Instead we anticipate a price of upward since theUSD 110 this year. As global growth slows, oil will gradually spring forecastreturn to a level of just over USD 97 next year and USD 94 inSwedbank’s Global Economic Outlook • 17 August 2011 15
    • 2013. This is still relatively high and is based on continued strongdemand in emerging countries, which are gradually increasingtheir consumption of raw materials.Commodity prices and projections 2009-2013(Brent crude oil in US dollars per barrel, food and metals in index 2010 = 100) 140 130 120 110 100 90 Food Metals 80 Oil 70 60 50 40 2009  2009  2009  2009  2010  2010  2010  2010  2011  2011  2011  2011  2012  2012  2012  2012  2013  2013  2013   2013  Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4We expect price declines for industrial metals (by 3-6%) and food(by 4-7%) in 2012 and 2013, after they rose by 32% and 20%,respectively, in 2011. Supplies should remain steady while Precious metals rise –demand declines, producing a downward trend. The opposite is while industrial metalstrue of precious metals (primarily gold and silver), which will fallcontinue to rise in price in the immediate future due to jitteryfinancial markets and the US credit downgrade.The risk of lower commodity prices is related to a more The risks are still onpessimistic growth scenario and unease in the financial markets. the upside, andThere are also risks on the upside, which could be realised if we emerging countries arewere to see faster global growth, another quantitative easing in playing a morethe US and a further decline in the dollar. New supply problems important rolein connection with disruptive weather and unrest in the MiddleEast, for example, could contribute to higher prices. It should alsobe noted that emerging countries are increasingly important toprices in more developed countries. Since activity will increasefaster in Asia, Latin America and the Middle East than in moredeveloped countries, commodity prices could still rise more thandesired given weak growth prospects in the West.Inflation and interest ratesLower commodity prices are expected to contribute to a muchmore favourable inflation outlook than in 2010 and 2011.Basically all we need are more stable food and energy prices forinflation to begin to fall on an annual basis. We think inflation willsoon peak for now and turn lower in both developed andemerging countries.The main factors affecting inflation in more developed countries A weak job market andare the budget consolidation and the weak labour market, which budget consolidationare slowing demand, including wage and price pressures. Europe are restraining priceand the US face similar situations, with a lower inflation outlook. and wage pressuresWe expect Japanese inflation to be temporary against the16 Swedbank’s Global Economic Outlook • 17 August 2011
    • backdrop of higher commodity prices, but once they fall we againsee a period of deflation in Japan.Inflation (CPI) in a number of countries 2004-2011 1 7 ,5 In d ia 1 5 ,0 1 2 ,5 C h in a 1 0 ,0 Percent 7 ,5 B ra z il 5 ,0 UK 2 ,5 US G e rm a n y 0 ,0 Japan -2 ,5 08 09 10 11 S o u rc e : R e u te rs E c o W inEmerging countries are finding it harder to rein in inflation. Overheating risks areTighter economic policies are helping to prevent an overheating, easing in emergingand capital inflows should also shrink due to the economic countries, but can’t beweakness and the end to quantitative easing. The key for many totally overlookedemerging countries is to expand their capacity, so that supplybetter meets demand.Inflation outlook measured by the annual increase in CPI (%)CPI 2010 2011 2012 2013US 1,6 3,2 1,7 2,0Eurozone 1,6 2,8 2,0 2,0UK 3,3 4,1 2,5 2,0Japan -0,7 0,2 0,7 0,5China 3,3 5,5 4,2 3,0India 9,2 8,5 6,5 5,2Brazil 5,9 6,4 5,0 4,2Russia 6,9 9,5 8,0 6,5Global CPI 2,8 4,2 3,0 2,6Sources: National statistics and Swedbank’s forecasts.We expect inflation to gradually fall from its current levels and In our main scenario, athat emerging countries as a group will avoid an economic hard hard landing is avertedlanding. Weaker growth in industrial countries will also impactdemand in emerging countries. India has already seen animprovement compared with when monsoon rains caused foodprices to rise sharply. Brazil has to limit credit growth, and withlower global growth and commodity prices its economy shouldslow, reducing price pressures. Chinese inflation will soon peak,Swedbank’s Global Economic Outlook • 17 August 2011 17
    • but a further economic tightening may be needed to sustainablyreduce inflation.A more favourable inflation outlook will relieve central banks of The threat ofthe worry of stagflation in the West. On April 13 the European stagflation will nowCentral Bank (ECB) raised its benchmark rate by 25 bp to 1.25% become less evidentafter inflation rose to high levels, and followed it on July 13 with anew hike to 1.5% before pausing at its latest meeting in August.US, British and Japanese central banks, on the other hand, have The ECB is pausingkept their key rates unchanged. In the British case in particular, and others arethis has been criticised, since inflation peaked at 4.5% in April delaying rate hikesand May before falling to 4.2% in June. The private consumptiondeflator has also risen in the US, to nearly 2%, but with prospectsof lower growth and easing inflation, central banks can now waiteven longer before tightening monetary policy. The Bank ofEngland is waiting until the first half of 2013 to raise rates, andany increases after that are likely to start slowly.Benchmark rates 2000-2010 8 N orway A ustralia 7 Euroarea 6 UK 5 Percent 4 3 2 S weden 1 US Japan 0 00 01 02 03 04 05 06 07 08 09 10 11 Sou rce: R euters E co W inIn our spring forecast, we didnt think the Federal Reserve would We do not expect a UShave to raise rates until the second half of 2012, but due to rate increase beforeweaker growth prospects and modest inflation it has decided to mid 2013wait even longer. Chairman Ben Bernanke has now announcedthat the Fed won’t raise rates until at least mid-2013. This is the“easiest” way for the central bank to create more expansivemonetary policy.The continued shakiness of the US recovery and weakness of Little marginal benefitthe labour market – combined with greater difficulty financing the from an additionalbudget deficit after the credit downgrade – is raising demands for quantitative easinga new quantitative easing of some sort (QE3). We dont rule oneout, but expect that the Fed will want to see signs of deflationbefore taking such a step. It should also be noted that QE2 didn’thave much effect on long-term interest rates initially. In fact, theyrose after the programme was announced. The subsequent18 Swedbank’s Global Economic Outlook • 17 August 2011
    • decline was more likely the result of increased pessimism aboutgrowth.In addition, long-term interest rates are already so low that theeffects on the labour market of trying to push them lower still willprobably be minimal. The costs to expand the central bank’sbalance sheet, which would make exit strategies morechallenging, arent negligible either. The easing – if there is one –should perhaps be seen in light of concerns about financing thehuge budget deficit of about 10% of GDP, the risk of a largerdecline in the dollar, and most importantly the risk of deflation.Given the worries about the euro zone’s growth and thesovereign debt crisis in the periphery countries – coupled with alower benchmark rate in the US and slower inflation – the ECBmay pause until the second half of 2012 before raising rates. Notuntil then do we anticipate a rate hike of 0.25 bp, to 1.75%, to befollowed by another hike in the first half of 2013. The corecountries of Germany and France may be the ones that have toresort to further austerity to keep inflation around the ECB’starget of just under 2%.Benchmark interest rates 2011-2013 16 aug 11 31 dec 11 30 jun 12 31 dec 12 30 jun 13 31 dec 13Federal Reserve 0,25 0,25 0,25 0,25 0,25 0,75ECB 1,50 1,50 1,50 1,75 2,00 2,00Bank of England 0,50 0,50 0,50 0,50 1,00 1,50Bank of Japan 0,10 0,10 0,10 0,10 0,10 0,10We don’t expect the BOJ to raise its benchmark rate during the Japan is still strugglingforecast period. The risk of a new period of deflation is high, with deflation and aespecially since budget cutbacks to stabilise debt and afford the strong yenreconstruction will impact economic demand. The BOJ would liketo weaken the value of the yen and keep interest rates low for thesame reason.Since our spring forecast, long-term market rates (10-yeargovernment bonds) have retreated. British long-term rates havedropped below the low levels seen in 2010, and rates inGermany and the US are well on their way. A more downbeateconomic outlook, lower commodity prices and lower inflation arekeeping the trend pointed downward. Just as importantly, thestock market sell-off is causing many investors to flee to safety,which is also keeping US and European long-term interest rateslow.Despite the credit downgrade, funding costs are now declining, a Growth pessimism andtrend we also saw when Japan’s credit was downgraded in 2002. the stock sell-off areInvestors still turn to the US when stocks are volatile. Over the reducing bond yieldsforecast period, 10-year government bonds will rise by about 100bp in Europe, 75 bp in the US and 50 bp in Japan.Swedbank’s Global Economic Outlook • 17 August 2011 19
    • Long-term interest rates (10-year government bonds) 6 ,0 5 ,5 5 ,0 4 ,5 UK 4 ,0 G e rm a ny Procent 3 ,5 3 ,0 2 ,5 USA 2 ,0 1 ,5 Jap an 1 ,0 0 ,5 07 08 09 10 11 S o u rce : R e u te rs E co W inDemand for safe havens – government bonds from financially Interest rates are alsosound countries – will increase in the years ahead as Basel III affected by tightercreates pressure to better capitalise banks. While this will regulationscontribute to lower bond yields, the costs to maintain more capitalin the banking system are likely to mean permanently highermargins, which in turn will lead to higher market rates. Theimpact of Basel III is difficult to determine, however, especiallysince a more stable financial sector could also help to reduce riskpremiums and thereby lower interest rates. This shows just howmuch uncertainty there still is regarding the effects of Basel III.Exchange ratesSince our spring forecast, the dollar has continued to weaken in The dollar hasnominal terms, and a number of emerging countries have seen weakened since ourtheir currencies appreciate. Brazilian Finance Minister Guido spring forecast, puttingMantega, for one, is concerned. Developed countries such as pressure on emergingSwitzerland and Japan have also tried to keep their currencies countriesfrom appreciating by loosening monetary policy and interveningin currency markets. Such interventions arent usually veryeffective or long lasting. In real terms, the Japanese yen isntespecially overvalued either from a long-term perspective,although the recent change has been a complicating factor for anumber of companies.20 Swedbank’s Global Economic Outlook • 17 August 2011
    • Nominal exchange rates in relation to the US dollar, index 2008-08-15 = 100 160 Brazilean Real 150 Swedish Krona Korean W on 140 130 Euro 120 110 100 Yuan 90 Swiss Franc 80 70 Yen 60 jan m aj sep jan m aj sep jan m aj sep jan m aj sep jan m aj 07 08 09 10 11 Source: R euters EcoW inWe anticipate that the debt crises in the euro zone and the US Debt problems in thewill keep the dollar-euro exchange rate fairly stable initially, after US and euro zone –which the dollar could appreciate against the euro on the basis of euro/dollar exchangeslightly stronger growth and possibly how the debt crisis is rate fairly stable at thismanaged. pointUS dollar, trade-weighted in nominal terms 125 120 115 110 105 A v e ra g e 1 9 9 0 -2 0 1 1 100 Index 95 90 85 80 75 70 90 92 94 96 98 00 02 04 06 08 10 S o u r c e : R e u te r s E c o W inA further credit downgrade could reduce interest in the dollar, If the euro zoneespecially as emerging countries gradually diversify their tackles its debtcurrency portfolios and turn to other investments. problems but the US doesn’t, the dollar couldExchange rates 2011-2013 fall 16 aug 11 31 dec 11 30 jun 12 31 dec 12 30 jun 13 31 dec 13EUR/USD 1,44 1,42 1,38 1,35 1,35 1,30RMB/USD 6,38 6,16 6,00 5,79 5,64 5,44USD/JPY 77 80 83 85 87 90EUR/GBP 0,88 0,88 0,85 0,83 0,8 0,77Swedbank’s Global Economic Outlook • 17 August 2011 21
    • China continues to allow the renminbi to appreciate against thedollar by about 6% per year in nominal terms. Since China’sinflation is higher than the majority of its trading partners, theappreciation is even higher in real terms. Efforts tointernationalise the renminbi continue. Without a well-functioningfinancial market and a convertible currency, China is stilldependent on the dollar, euro, yen and other internationalcurrencies.The Japanese yen is weakening in the wake of a shrinking trade When the crisissurplus and a slightly larger interest rate differential vis-à-vis subsides, the yenEurope and the US. Our assumption that the US won’t replace should weakenQE2 with QE3 should also contribute to a weaker yen.Stock pricesEven before the recent slide, stock markets in developedcountries had performed modestly at best. While markets inemerging countries nearly returned to their 2007 peak, stocks inthe US, euro zone and Japan have a long way to go. Recentmarket jitters are the product of lower global growth expectations,the debt crisis in developed countries, the US credit downgradeand a severe crisis of confidence in the ability of decision-makersto manage crises. Political risks are especially difficult toevaluate, which is creating uncertainty and nervousness.Corporate profits could be affected by poorer growth prospects,though on the other hand cost pressures are easing due to lower Political risks arecommodity and input goods prices. Negative news will garner a influencing marketbigger reaction than positive news. Considering the challenges in psychology right nowhandling the debt crisis and euro cooperation, this will continue tofrustrate the market for some time to come. It is impossible,however, to determine by how much and for how long themarkets will be hurt.Equity prices in emerging countries ( MSCI EM), USA (S&P 500), the euro zone(FTSE EZ 300) and Japan (Nikkei 225) 2007-2011, index January 2007 = 100 150 140 MSCI EM 130 120 110 100 Index U SA S& P 500 90 80 FTSE EZ 300 70 60 50 N ik k e i 2 2 5 40 07 08 09 10 11 S o u rc e : R e u te rs E c o W in22 Swedbank’s Global Economic Outlook • 17 August 2011
    • 5. A lot depends on emerging economiesThe global economy has downshifted to a lower gear. The The global economyrecovery continues, but not as quickly as in 2010, a rebound year has now shifted into aafter the financial crisis and global recession. The risk picture has lower gearalso become more negative. This year growth is being slowed byhigher commodity prices, the Japanese disaster and thecontinuing balance sheet correction. Tighter economic policy willthen be an increasing drag on growth.Annual GDP growth (%) in several major countries/regions 6,00 5,00 4,00 3,00 BRIC‐countries OECD‐countries 2,00 1,00 0,00 2010 2011 2012 2013We expect the slowdown in emerging countries to be modest and Emerging countriesthat this group will remain the biggest contributor to growth (65- account for over two70%). Their growth has trended below the historical average, and thirds of global growthwithout fiscal and monetary ammunition, reforms will be neededto speed their structural transformation and improve the medium-term outlook. Emerging economies have to implement reformsthat immediately reduce the problem of overheating and createmore sustainable domestic demand. That would also help toreduce global imbalances.US current account balance and China’s currency reserves 4 ,5 100 4 ,0 0 3 ,5 -1 0 0 3 ,0 -2 0 0 USD (thousand billions) 2 ,5 -3 0 0 USD (billions) 2 ,0 -4 0 0 1 ,5 -5 0 0 U S c u r re n t a c c o u n t 1 ,0 (rh s ) -6 0 0 0 ,5 -7 0 0 0 ,0 -8 0 0 C h in a s c u r r e n c y -0 ,5 r e s e r v e s ( lh s ) -9 0 0 90 92 94 96 98 00 02 04 06 08 10 S o u r c e : R e u te r s E c o W inSwedbank’s Global Economic Outlook • 17 August 2011 23
    • The US – structural problems are impactingthe economic outlook  Major downward revision of GDP growth against the backdrop of weaker economic data and growing pessimism – growth is too weak to significantly impact unemployment  The debt ceiling agreement is welcome, but the political process was a failure  Debt restructuring is starting slowly, but the long-term cuts seem inadequate to stabilise the debt burdenThe optimism surrounding the US economy late last year was A deeper recession inillusory. Rising unemployment, higher inflation, falling housing 2008-2009 and aprices and political discord on fiscal policy have left Americans slower recovery inanxious. During the first half of 2011 GDP growth has been 2010-11weaker than expected – 1.8% at an annual rate and 0.8% at anannualized rate – which is also less than considered normal in arecovery, when there is usually available capacity. We also nowknow that the recession was deeper than indicated by previousdata, with GDP falling by 5.1% in 2008-2009 rather than 4%.US GDP and inflation (annual change %), and unemployment (% of labour force) 12,5 10,0 10,0 9,5 Unemployment ---> 7,5 9,0 CPI 5,0 GDP - annualized quarterly growth 8,5 2,5 8,0Percent Percent 0,0 7,5 -2,5 Private consumption 7,0 -5,0 deflation 6,5 -7,5 6,0 -10,0 5,5 -12,5 5,0 Q1 Q3 Q1 Q3 Q1 Q3 Q1 08 09 10 11 Source: Reuters EcoWinTemporary factors partly explain the slower development, Both structural andincluding the earthquake in Japan, unusual weather and temporary factorsshrinking confidence in the ability of US politicians to solve the explain the economicbudget and debt ceiling problems. The more important thing, doldrumshowever, is that the structural problems in the US economyhaven’t been resolved and that the labour, housing and creditmarkets aren’t working normally in the wake of the financialcrisis. Balance sheets still need correcting. Without another fiscalstimulus, the US economy will continue to trend below itshistorical growth.24 Swedbank’s Global Economic Outlook • 17 August 2011
    • In addition to the economic crisis, a political crisis is under way. A The US faces both angrowing number of experts are characterising the political system economic and aas dysfunctional. There is little willingness to compromise, and political crisisthe goal for politicians to get re-elected often overshadows thegoal to help the country grow. After the financial and real estatecrises, the US has to find a new identity in economic, political,cultural and geopolitical terms. American households can nolonger be the growth engine for the global economy. Defencespending will shrink and will affect the ability of the US to respondin global hot spots. At home, a structural transformation isneeded, at the same time that the government’s role is shrinkingsince tax hikes wont be tolerated by Congress. Income gaps aregrowing, and it is becoming harder to help those who havedropped out of the system. The negative confidence spiral has tobe broken.Household and corporate expectations for the next half year (Conference Board) 120 110 H o u s e h o ld c o n f id e n c e 100 90 80 70 60 50 40 B u s in e s s c o n f id e n c e 30 97 98 99 00 01 02 03 04 05 06 07 08 09 10 S o u r c e : R e u te r s E c o W inWe expect GDP growth to top out at 2.1% this year. Activity willincrease during the second half year as gas prices fall slightlyand the Japan Effect tapers off at the same time that politicalconcerns ease, giving future confidence a needed boost. Thisrepresents a significant downward revision from our springforecast of 3% and reflects the downturn in future confidence inrecent months in pace with weaker GDP and job numbers.We still expect the growth engine in the form of consumerspending to falter, at the same time that other components in thesupply balance aren’t able to raise growth above its average. In2012, an election year, GDP growth will reach 2.3%, beforeclimbing to 2.7% in 2013, when confidence could grow with newleadership. Monetary and fiscal policy will be tighter, however,which will keep growth below 3%.Swedbank’s Global Economic Outlook • 17 August 2011 25
    • The US Congress has had major problems agreeing on how to “You can always countconsolidate the budget in the years ahead. The increase in the on Americans to do thedebt ceiling was contingent on spending cuts, and at the last right thing – afterminute Republicans and Democrats agreed to raise the ceiling by they’ve tried everythingUSD 2.1- 2.4 trillion by the end of 2012, which means that it won’t else”be an issue in next year’s election campaign. - Winston ChurchillThe debt ceiling will initially be raised by USD 400 billion, then byanother USD 500 billion unless blocked a Congressionalresolution. The remaining USD 1.2-1.5 trillion will be part of apackaged agreement agreed to by a committee ofrepresentatives from both parties and containing spending cuts,tax reforms and other debt reductions. In the first years there willbe little in the way of cutbacks, and consolidation has insteadbeen pushed off to the future. While this may seem reasonablegiven the weak recovery, it creates uncertainty, since anotherCongress will have to implement today’s decision.Total government debt now exceeds 100% of GDP, while the Gross public debt isfederal debt as a share of GDP is just over 70%. Had nothing now greater than GDPbeen done, it would have risen to 90% of GDP by 2030 and thenabout 200% in 2060, after the healthcare reform, which reducesthe debt burden by about 100% of GDP between 2011 and 2060.Federal budget revenues, expenditures and balance 350 50 F in a n c in g n e e d - - > 300 25 250 0 USD (billions) USD (billions) 200 -2 5 150 -5 0 < --- B u d g e t e x p e n d itu r e s 100 -7 5 50 < --- B u d g e t re v e n u e s -1 0 0 0 -1 2 5 70 75 80 85 90 95 00 05 10 S o u r c e : R e u te r s E c o W inThe medium-term plan that would have been needed to stabilise Twice as large athe debt burden in the second half of this decade is thought to be budget consolidationat least USD 4 trillion, or about 20% of GDP. Revised growth could be neededprospects also will mean greater difficulty stabilising the debt as ashare of GDP. The plan now calling for cuts of just USD 2.1-2.4trillion doesn’t go far enough. The US therefore risks anothercredit downgrade. A lower rating could raise funding costs, add tofinancial turbulence and weaken the dollar considerably.The job market will be the focus of the campaign leading up tothe presidential election in November 2012. No president hasbeen re-elected in the last 50 years with unemployment higherthan 7.2%. In July it was 9.1%, which is still higher than at the26 Swedbank’s Global Economic Outlook • 17 August 2011
    • beginning of 2011 even after declining slightly from June. It wasalso just a modest decline compared with the October 2009 peakof 10.1%. Compared with before the crisis, unemployment hasmore than doubled to 14 million. When you include those whoare working part-time not by choice and those who are no longeractively looking for work, 29 million Americans are now countedas unemployed, about half of whom can also be considered long-term unemployed.The housing market has yet to bounce back. Housing The housing marketconstruction appears to have hit bottom, but will remain there for has hit bottom and willsome time. The same applies to new home prices and sales, stay there for a whilewhich have been fairly stagnant and where the latter are back attheir 1998 level. Low interest rates should have helped thehousing market more, but households are continuing to fix theirbalance sheets at the same time that the credit market is havingproblems with new lending. Another critical factor is the vastinventory of unsold housing, which will keep prices low for sometime to come.Housing market 8 27 5 7 25 0 6 22 5 Number of (millions) S ale s of n e w ho m e s 5 20 0 Index 4 17 5 C as e/S h ille r 3 S ale s of e x isting h om e s h o use p ric es for 15 0 1 0 cities ---> 2 12 5 1 10 0 R e side ntial co ns tru ctio n 0 75 90 92 94 96 98 00 02 04 06 08 10 S o u rc e : R e u te rs E co W inInflation measured by CPI has risen due to higher energy andfood prices, although core inflation (excluding energy and food)has also begun nearing uncomfortable levels, at just under 2%.On the other hand, we expect that when food and gas pricesdecline, inflation will ease, giving the Federal Reserve a respitebefore launching a period of rate hikes. We don’t anticipate thefirst hike until the second half of 2013, in line with the Fed’sannouncement.This summer QE2 ended. Since deflation concerns have eased, Demands for QE3we don’t anticipate another quantitative easing. Although a are gaining steamgloomier growth outlook and higher unemployment are nowraising demands for a new easing to keep interest rates low andstrengthen asset prices, the Fed isn’t likely to consider one untilthere are signs of deflation. Besides, another quantitative easingmay not have much impact on growth and jobs, and the sideSwedbank’s Global Economic Outlook • 17 August 2011 27
    • effects on global inflation, commodity prices and capital flows toemerging countries can’t be overlooked.China – growing faster than planned  GDP growth has surprised on the upside, but is expected to slow in quarters to come  Inflation will peak this year and drop to 3-4% in 2012-2013  The goal to “rebalance” the economy will take time and require more reformsExpectations that China’s GDP growth will more visibly slow didnot come to fruition earlier this year when GDP rose in the firsttwo quarters by 9.7% and 9.5% at an annual rate. Despite lowercredit growth and higher inflation, the economy continued to growat a rapid pace.The wheels of the Chinese economy have since begun to slow The wheels of theslightly. This was caused by the rise in interest rates in order to Chinese economy arecheck inflation and is also evident in the purchasing managers now rolling moreindex, which indicates slower economic activity. Slower import slowlygrowth is also a sign of weaker domestic activity. A slightslowdown is already evident on an adjusted quarterly basis, butas usual there is reason to be cautious in interpreting thesesometimes dubious data.However, we are revising GDP growth upward by 25 bp to 9.0%this year on the basis of stronger results. GDP growth will thenfall to 8.4% in 2012 and 8.0% in 2013. This means that the goalin China’s latest five-year plan of average GDP growth of 7% peryear in 2011-2016 in all likelihood will not be reached.Growth in GDP, industrial production and auto sales 2 0 ,0 90 < - - In d u s tr ia l p r o d u c tio n C a r s a le s - - > 80 1 7 ,5 70 1 5 ,0 60 < - - G D P - g r o w th 1 2 ,5 50 Percent Percent 1 0 ,0 40 30 7 ,5 20 5 ,0 10 2 ,5 0 0 ,0 -1 0 04 05 06 07 08 09 10 S o u r c e : R e u te r s E c o W in28 Swedbank’s Global Economic Outlook • 17 August 2011
    • Since the National Party Congress in March, the Chinese The focus is now ongovernment has increasingly focused on reducing the risk of reducing inflationoverheating. Since October, bank reserve requirements havebeen raised nine times and the benchmark rate has increased by125 bp. Lending has fallen to previous levels of around 15% inannual terms. Lending rates are still negative in real terms,however. Inflation jumped to 6.5% in July, but is expected to dropnow that commodity prices aren’t rising as quickly as before. Thegovernment’s new goal of 4% this year (instead of 3%) isn’t likelyto be met. Our estimates are for 5.5% this year and 4.2% next.Housing prices could still fall significantly compared with the How ambitious areslower growth rate to date. Various statistical sources provide a China’s stress tests?mixed picture of housing, which is contributing to considerableuncertainty. According to official sources, stress tests will showthat China’s banks can handle a price decline of 50%, though it isunlikely that all the indirect effects on regional growth have beenanalysed, and the impact on the economy and Chinas regions isprobably greater than on financial stability. A soft landing is stillmore likely than a hard landing, and the risk of overheating nowappears to be easing.Growth in consumer prices and lending 3 5 ,0 9 3 2 ,5 8 3 0 ,0 7 2 7 ,5 6 < --- C re d it e x p a n s io n 2 5 ,0 5 Percent Percent 2 2 ,5 4 2 0 ,0 3 1 7 ,5 2 1 5 ,0 1 1 2 ,5 0 1 0 ,0 C o n s u m e r p ric e s ---> -1 7 ,5 -2 00 01 02 03 04 05 06 07 08 09 10 11 S o u rc e : R e u te rs E c o W inAt the beginning of the year, when the price of oil was higher,China reported a trade deficit for the first time in seven years. Ithas since rebounded to a trade surplus, which also means largercapital inflows but in turn could generate inflation when Chinabuys up foreign currency. If commodity prices start to rise again,the surplus would shrink. This shows how pointless it is to drawany conclusions whether China has begun a path toward“rebalancing” and consistently higher domestic demand based onthese earlier data.The goal of an economic rebalancing should mean a lower Many (extensive)current account surplus, but this year it is again likely to exceed reforms are needed to4% of GDP. Reforms are needed to strengthen the social boost domesticsecurity system, raise household incomes and reduce the demandincentives to save. Moreover, the financial system has to beSwedbank’s Global Economic Outlook • 17 August 2011 29
    • opened up. Many factor prices have to be better deregulated aswell, at the same time that China allows its currency, therenminbi, to continue to appreciate in real terms, through both anominal appreciation and higher domestic costs. If the goals ofthe 12th five-year plan are to be taken seriously, reforms have tobe accelerated.Japan – recovery after the disaster  GDP is expected to decline this year and then trend significantly higher next year with the reconstruction  The debt ratio of 230% has to be cut with the help of taxes and fees, since spending as a share of GDP is already low  The yen has strengthened in nominal terms, but not as much in real terms – interventions may not help muchThe Japanese economy shrunk by 0.7 per cent at an annual rateduring the first quarter, despite that the earthquake and tsunamiwhich jolted large parts of the northeast happened as recently asMarch 11. Besides the diminishing effects of the 2010 rebound,export growth has been slowed by production stoppages and astronger yen, which has also helped to keep import growth high.The Japanese current account balance has swung to the deficitside, which cannot be compensated by domestic demand, sinceconsumption and investment are both decreasing.Annual change in Japan’s national accounts (%) 40 E x p o rts 30 20 Im p o rts 10 P u b lic C o n s u m p t io n Percent 0 In v e s tm e n ts -1 0 P r iv a t e C o n s u m p t io n -2 0 GDP -3 0 -4 0 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 07 08 09 10 11 S o u r c e : R e u t e r s E c o W inGDP fell less than expected in the second quarter, by 0.9% at an The decline in GDP forannual rate (0.3% quarterly). The decline in the first half year is the second quarterpartly a reflection of the total collapse in foreign trade and partly was milder thanbecause domestic demand has dried up. At its low point, expectedindustrial production fell by about 15% before a recovery began.In mid-May the nuclear power plant in Hamaoka was shut downfor safety reasons and manufacturers such as Toyota, Hondaand Suzuki were faced with power shortages. As a result, energyissues also factor into economic risks, as do the yen’s strength,the global economy, fiscal policy and the political situation.Basically it is a question of how quickly production chains can be30 Swedbank’s Global Economic Outlook • 17 August 2011
    • restored and of the faith of the Japanese in their economy andpolitics.We feel that an economic trough was reached during the secondquarter, but that annual GDP growth won’t be positive until thefourth quarter. As a whole, GDP will fall by 0.2% this year beforerising by 2.8% next year as reconstruction progresses. Thegrowth drivers are public and private investment. In 2013 weexpect Japan’s growth to trend downward to its historical averageof just under 1.5%.If demand remains weak, the problems associated with deflation Debt ratios continue towill worsen. If, on the other hand, fiscal policy is used to stimulate rise, while deflationdemand, there is a risk that the debt burden will grow even higher remains a complicatingthan the current 230% of GDP. The budget deficit this year factoralready exceeds 10% of GDP. After parliament passed areconstruction budget of 4 trillion yen (about USD 50 billion or0.8% of GDP) in May, it adopted a 2 trillion yen supplementarybudget on July 25. Another supplementary budget is expected.The goal, however, is not to increase the debt burden. Instead,funds will come from other areas of the budget, though it isuncertain how. Estimates of what the earthquake will cost infiscal terms over several years vary between 2 and 4% of GDP.As the Japanese age and the workforce shrinks, savings willdecline, raising pressure to tighten fiscal policy and avoid higherinterest rates on government debt. Even if the current accountdeficit proves temporary, Japan has to prepare for a lessfavourable debt environment. A budget consolidation could startwith a VAT hike of at least 5-10%, especially since the currentlevel is low even by international comparison. At the same timeother sources of revenue have to be found, since public spendingis already relatively low as a share of GDP.Japan’s debt problems are complicated by low GDP growth and The BOJ could enactdeflation. The recent spurt of inflation is the result of higher even more expansivecommodity prices, which are considered temporary. The policies to try tobenchmark interest rate is essentially zero (0-0.1%), and we weaken the yenexpect it to remain at or near zero throughout the forecast period.The reasons are continued deflation or zero growth in consumerprices, as well as fiscal austerity and a strong yen at least innominal terms (but not as much in real terms). Although the Bankof Japan (BOJ) is trying to weaken the yen, it is questionablewhether the interventions are being effective. Its expanded assetpurchase program and efforts to support increased lending bycredit institutions have increased the bank’s balance sheet fromjust over 20% to 26% of GDP since the financial crisis. Incomparison, the Fed’s balance sheet has grown from about 5%to 15% of GDP.The political situation has worsened. Prime Minister Naoto Kanhas managed to stay in power through the summer only bypromising to step down in August when the supplementarybudget has been approved, bonds have been issued to financethe deficit in the upcoming budget year, and a bill has beenpassed to expand renewable energy. It is unlikely that Kan will tryto get re-elected considering his lack of support among theSwedbank’s Global Economic Outlook • 17 August 2011 31
    • general population and in his own party. If would be helpful if theJapanese had more faith in their politicians, but Kan is the sixthprime minister in as many years to fail to build support. Criticsargue that the government hasn’t acted quickly enough in thereconstruction and hasn’t adequately handled the nuclearaccident or energy policy.India – austerity is slowing growth  GDP growth has been revised downward to 7.8% this year and 7.5% next year and in 2013. To raise growth to the same rate as before the financial crisis, around 9%, will require more reforms.  Monetary policy is being further tightened slightly, and the high rate of inflation will fall later in the year.  The budget consolidation continues, but with very modest goals. The budget deficit will rise to 5-5.5% of GDP.The Indian economy suffers from capacity shortages. Insufficient Capacity shortages arereforms, weak infrastructure and an underperforming causing inflationeducational system are hampering production and the supply of problemsskilled labour, while also exacerbating overheating problems.During the first five months of the year consumer prices rose byan average of 9% on an annual basis. Although inflation isexpected to moderate later this year in pace with oil prices andmore stable weather produces better harvests, high inflationremains a concern and is raising demands for more austerity.As we predicted last spring, the Indian central bank, RBI, hascontinued to tighten monetary conditions, at the same time thatpoliticians have avoided taking greater responsibility byaddressing fiscal policy.The benchmark interest rate was raised as recently as July 26, India’s central bank isby 50 bp to 8%. This is the eleventh rate hike in 18 months, trying to choke offtotalling 3.25 percentage points. One or more rate hikes is not inflation by raisingout of the question to keep commodity prices from spreading to interest ratescore inflation in the strong demand climate that still exists amongboth urban and rural households.Higher interest rates and prices are creating greater costpressures for companies, but on the other hand the real interestrate is only slightly positive. The recent slowdown in theinvestment rate is probably also the result of the weaker globalgrowth, higher commodity prices, lower capital inflows after theArab Spring, and declining future confidence.Higher cost pressures could hurt private investment, which iscrucial to strengthening productivity and competitiveness. Anaccelerated reform process is needed to eliminate bureaucracyfor businesses and reduce corruption.32 Swedbank’s Global Economic Outlook • 17 August 2011
    • Last year GDP grew by slightly over 10%, which was more thanexpected. Since then the trend has been downward, and in thefirst quarter GDP fell to 7.7% at an annual rate – a figure we seecontinuing for the rest of the calendar year. We anticipate thattighter monetary policy will slow growth with a slight delay, at thesame time that fiscal policy is also tightened, though only slightly.Higher price and cost pressures are hurting domestic demand,which is one reason why we see the growth rate falling to 7.5% in2012 and 2013. Private consumption will remain the mostimportant growth engine.Interest and exchange rates 9 ,0 80 P o lic y In te re s t E U R /IN R 8 ,5 75 ra te (rig h t) 8 ,0 70 Rupie to Euro och US dollar 7 ,5 65 7 ,0 60 Percent 6 ,5 55 6 ,0 U S D /IN R (rig h t) 50 5 ,5 45 5 ,0 40 4 ,5 35 05 06 07 08 09 10 11 S o u rc e : R e u te rs E c o W inIndia’s fiscal deficit was 4.7% of GDP in the last budget year(1 April 2010 to 31 March 2011). Higher tax revenues as a resultof stronger economic activity and spending cuts may explain whythe outcome was better than anticipated.Heading into this budget year and the next, the deficit is expected Fiscal policy could beto be 5-5.5% of GDP as growth slows and subsidies increase tighteneddue to higher oil prices. Through privatisations, the national debtcould continue to decline as a share of GDP, from 45% in 2011to 42% in 2013.State elections in May resulted in victories for the governingCongress Party in three of five states. This will give thegovernment greater opportunity to shape the reform processwithout having to negotiate with other parties. More reforms areneeded for growth to return to a long-term rate of around 9%,since supply problems are currently restricting potential growth.Preparations are now under way for the state elections next yearand then the parliamentary elections in 2014. The focus is oncorruption scandals (MP bribery, Commonwealth Games,telecom licenses), which have damaged confidence in the sittinggovernment. Given the lack of alternatives, however, this hasnthurt its chances of retaining power.Swedbank’s Global Economic Outlook • 17 August 2011 33
    • Brazil – growing overheating problems  Austerity is reducing potential growth this year to below 4%, but the effects should ease and slowly contribute to a slightly higher growth rate in 2012 and 2013.  Additional rate hikes cant be ruled out in order to curb rapid price increases and credit growth  Economic risks include a stronger real, a weaker global economy and lower commodity prices, as well as a greater slowdown in the wake of austerity measures.Although GDP grew slightly faster in the first quarter than thesecond half of last year, we expect Brazilian economic activity tocontinue to cool due to tighter economic policy. Domesticdemand will still be able to grow more or less in line with thehistorical trend, especially because of the rapid increase ininvestment. The World Cup in 2014 and Summer Olympics in2016 are contributing to the investment boom, but are alsocreating stronger import growth.Real GDP growth (annualized quarterly and annual growth rates)Households, by way of slower credit growth, will feel the effects Commodity-orientedof austerity the hardest, which will lead to lower personal Brazil is facing aspending. Brazilian exports are currently benefitting from the high slowdown when globalcommodity prices, but when they fall export prospects will worsen commodity pricesfor this commodity-dependent country. declineBrazil will generally continue to develop positively, but will slowslightly to accommodate capacity shortages as well as fast priceand credit growth. We are revising GDP growth downward thisyear to 3.8% after last years rapid 7.5%, before it reaches34 Swedbank’s Global Economic Outlook • 17 August 2011
    • slightly higher levels of upwards of 4.3% when austerity isphased out.Which characterises Brazil as an overheated economy? Thelabour market is very tight, unemployment is record low and it ishard to find skilled workers, which is keeping pressure on wages.Higher commodity prices and demand that exceeds supply inmany markets are also pushing consumer prices higher, which inturn are generating wage growth.Inflation, now around 6.5% on an annual basis, is expected todecline as commodity prices ease, although more rate hikes maybe needed to more aggressively reduce price pressures. SinceApril 2010 the benchmark rate has been raised by 3.75percentage points to 12.5%, and it isn’t out of the question thatwe could see one or two more rate hikes before the austerityperiod is over.The risk if interest hikes are raised too high is that capital inflowsfrom abroad will increase and that the currency, the real, willappreciate more than is desirable. During the financial crisis, aweaker real helped to support the recovery, but since late 2009the real effective exchange rate has risen beyond the levels frombefore the crisis.Policy interest rate (%) and real effective exchange rate (index) 20 180 19 170 18 160 17 R eal P o lic y e ffe c tiv e 16 exchange 150 in te r e s t ra te 15 ra te 140 Procent Index 14 130 13 12 120 11 110 10 100 9 8 90 05 06 07 08 09 10 11 S o u rc e : R e u te rs E c o W inOne factor suggesting further rate hikes is high credit growth. During periods of highWhile debt is relatively limited at this point, it is increasing, and a growth, a budgetlarge share of spending is being done with high-interest-rate surplus should becredit cards. Another factor is that fiscal policy isn’t being attainabletightened enough to prevent an overheating. Capping the budgetdeficit at 3% of GDP during periods of high growth isn’t ambitiousenough, and in the event of a new recession, fiscal policy won’tbe able to support the economy.The political focus is on the new president, Dilma Rousseff, andher decisions. Since her chief of staff and three ministers had tostep down due to corruption allegations, she and her new staffSwedbank’s Global Economic Outlook • 17 August 2011 35
    • have distanced themselves from the previous president, Lula. Itis important that the president can now show that she is stillinterested in accelerating the reform process. Otherwise she willface criticism when the country sees its competitive strengthwane. At the least, corruption has to be stopped.Euro zone – focus on crisis management  GDP growth is expected to slump from 1.7% this year to 1.3% in 2012-2013 with more budget austerity  Inflation pressure is on the decline, and the ECB is likely to take a calmer approach to raising interest rates  Reform work in the euro zone as a whole and in individual countries will be critical in order to weather the storm, rescue the euro and make the region more competitiveThe euro zone’s decent growth last year and increase to 2.1% Good growth numbersannually in the first quarter of 2011 have been overshadowed by have beenthe sovereign debt crisis in several countries and crisis of overshadowed by theconfidence in the entire euro zone’s political and institutional crisissystems. Problematic countries such as Greece, Ireland, Italy,Spain and Portugal certainly have much weaker growthprospects than the euro zone’s economic engines, Germany andFrance.Annual GDP growth in the euro zone and some of its member states (%)Compared with our spring forecast, we expect German GDP We are revising GDPgrowth to be significantly higher this year, at 2.9%. The euro growth downward forzone as a whole will grow by nearly 1.7%, compared with 1.5% in 2012 – but Germanyour spring forecast, but after that signs point to a slowdown to grew more than1.3% in 2012-2013 due to fiscal austerity, weaker confidence expected at the start ofamong households and businesses, and slower growth in this yearindustrial production in response to lower global demand. Thepurchasing managers’ index indicates that industry is no longer36 Swedbank’s Global Economic Outlook • 17 August 2011
    • growing as quickly as before, reflecting supply chain problemsafter the Japanese catastrophe and slower global demand.We believe that the chances of the euro weakening against thedollar are not as high any longer after the Federal Reserve’spledge to keep interest rates low for the next two years. Adepreciation will have to wait. The risk of a euro collapse andactions to rescue countries in crisis are discussed in the chapteron economic policy, where we also suggest measures to easeconcerns about the euro zone’s debt crisis.One reason for being more positive about growth compared with The ECB can now putour spring forecast is that the ECB now expects to ease off on off further rate hikesfurther rate hikes. After the Fed calmed fears of an interest ratehike, the ECB can also delay austerity measures. An inflationrate of around 2.8% in April has now declined to 2.5%. Weanticipate weaker demand when austerity measures furtherreduce price and wage pressures, though with some differencesbetween countries. Crisis countries such as Greece will seeinflation continue to fall from its previous highs. Germany andFrance, on the other hand, which have a greater impact on theeuro zone average, have a more stable but higher inflationoutlook due to stronger demand. Inflation will reach an averageof 2% in 2012 and 2013. Inflation in the euro zone as a whole and in individual euro countries 2007-2011The strength of the labour market varies by country. While Germany hasGermany today has its lowest unemployment in two decades, succeeded in reducingSpain, with its rigid job market, has its highest since 1997, unemployment, whileplacing it on top of the euro zones less than flattering statistics. Spain’s is rising to newThe reform process that has begun in Spain is necessary, but the highsrisk is that unemployment could rise further before it eventuallyslows.Swedbank’s Global Economic Outlook • 17 August 2011 37
    • More reforms are needed in other countries as well to make thelabour market more flexible and to change the pension and socialinsurance systems. Another important factor is the informalsector, which often has a significant presence in southern Europeand means that more people may be working than official datasuggest. Unemployment in the euro zone as a whole and individual countries 2007-2011 22,5 Austria G erm any Eurozone 20,0 Spain Finland France G reece 17,5 Ireland Italy Portugal Netherlands 15,0 Percent 12,5 10,0 7,5 5,0 2,5 07 08 09 10 11 So urce: R euters E coW inIt is critical that the issue of youth unemployment is addressed, More reforms areso that entire generations arent lost during the crisis years and to needed to improve theavoid damaging future confidence. Educational investment will be labour market –needed, but the difficulty in finding the funds – considering the especially for youngausterity plans now on the table to reduce fiscal deficits – may peopleforce a delay.38 Swedbank’s Global Economic Outlook • 17 August 2011
    • Government gross debt (right) and budget balance (left) as a share of GDP% 2011 ‐50 0 50 100 150 200 ‐8,3 Greece ‐3,9 Italy ‐10,5 Ireland ‐5,9 Portugal ‐3,7 Belgium ‐4,4 Eurozone ‐5,9 France ‐1,9 Germany ‐3,4 Austria ‐3,2 Malta ‐6,5 Spain ‐3,8 Netherlands ‐5,1 Cyprus ‐1,2 Finland ‐5,2 Slovakia ‐5,4 Slovenia ‐1,3 Luxemburg 0,1 EstoniaThose countries that have been capital importers in the eurozone since the euro was created, i.e., most of the crisis countries,have larger current account deficits and fiscal deficits than capitalexporters such as Germany, the Netherlands and Finland. Thenthere are countries that have maintained large government debtsfor decades such as Italy and Belgium. France is also knockingon the door of the crisis group, but can avoid a major crisis if itlaunches a tough consolidation phase.The key to the euro zone’s problems is the debt issue, both The focus is on thepublic and private, and the resulting problems for banks, as in debt crisis, growth,Portugal and Ireland, or mainly in the public sector, as in Greece. competitiveness,Another point of emphasis is growth and competitiveness, where budget consolidationcrisis countries, including Italy and Spain, could find it harder to and reformsconsolidate when growth prospects are weak. A third factor isthat consolidation work has been put off too long. After the ECBapplied pressure, Italy has sped up its budget consolidation toachieve a balance in 2013 instead of 2015.Another focus is on divergence within the euro zone. It is only The divergence isnatural that there are differences, but it was hoped that the great within the euromonetary cooperation would negate the need for fiscal zone – we anticipatecooperation if countries abided by the stability and growth pact “German” policies in(which they didn’t) and if they gradually harmonised more countrieseconomically. Fiscal and structural policies have differedbetween Germany on the one hand, where reforms havestrengthened the labour market and productivity while keepingcost pressures under control, and the crisis countries on theother, which have utilised low interest rates to spur consumptionand investment but haven’t reforming their markets to be morecompetitive.Swedbank’s Global Economic Outlook • 17 August 2011 39
    • Current account balance in a number of euro countries 2009 and 2011, % of GDP ‐15 ‐10 ‐5 0 5 10 Luxemburg Netherlands Germany Austria Finland Belgium 2011 Ireland 2009 Eurozone France Italy Spain Portugal Cyprus GreeceFor the euro zone as a whole, it is critical that the reform work Reforms are critical ifcontinues and intensifies. After several years of weak growth – the euro is to surviveand given that the euro zone is riding out the storm bystrengthening its institutions – opportunities for a morecompetitive region may improve.UK – tough times continue  We are revising our GDP growth forecast downward to 1.3%, 1.6% and 1.8% for the years 2011-2013. Foreign trade and investment are the primary growth drivers.  Tight fiscal policy, continued debt restructuring and falling housing prices are crimping household spending. Structural policies have to focus on opportunities for new growth engines and stronger productivity.The British economy has performed weakly in light of highinflation, falling housing prices, a lack of credit, private debtrestructurings and the government’s huge austerity programme,which over all are impeding private consumption. Therepercussions of the financial crisis are clearly negative, and therecovery has been slow to date.In the first quarter of this year GDP grew by 0.5% at an annual GDP has been weakerrate, and during the second quarter growth fell to 0.2%. The than expected …Japanese disaster, poor weather and the Royal Wedding havebeen mentioned as temporary factors that have slowed activity,but without them growth probably would have been only slightlystronger. Productivity growth has been weak since employmenthas held up relatively well, at the same time that adjustmentshave instead been achieved through slower income growth,though this is also affecting demand.40 Swedbank’s Global Economic Outlook • 17 August 2011
    • GDP and the various components in the national accounts 2005-2011 25 E xp o rts 20 15 In ve s tm e n ts Im p o rts 10 P riva te 5 Percent C o n s u m p tio n 0 GDP -5 -1 0 -1 5 -2 0 05 06 07 08 09 10 11 S o u rce : R e u te rs E co W inWe have revised our GDP forecast for this year downward to1.3% from 1.5% last spring after the first half-year turned out tobe weaker than estimated. Growth, which will then see rising to1.6% next year and 1.8% in 2013, will be driven by increasedinvestment through higher earnings as well as the boost to netexports from a weaker pound (at least initially before it is likely toappreciate against the euro).We expect private consumption to remain weak during theforecast period. When the fiscal austerity is phased out, interestrates will instead increase as the Bank of England raises itsbenchmark rate. Since we at the same time see inflation easing,real interest rates will rise and reduce demand. Lending has alsobeen held in check because of the tough position the bankingsystem finds itself in. Meanwhile, the financial sectorsimportance as a growth engine has been undermined and willtake time to repair. The housing market hasnt stabilised either,and we expect it will be a while before housing prices risesignificantly.Inflation and interest rates 2005-2011 1 ,0 1 5 ,0 0 ,9 1 2 ,5 E U R /G B P 0 ,8 1 0 ,0 Percent 0 ,7 7 ,5 0 ,6 5 ,0 0 ,5 B O E p o lic y 2 ,5 U S D /G B P r a te - - > 0 ,4 0 ,0 90 92 94 96 98 00 02 04 06 08 10 S o u r c e : R e u te r s E c o W inSwedbank’s Global Economic Outlook • 17 August 2011 41
    • The government led by Prime Minister David Cameron has been … despite that thecriticised for its tight fiscal policy: “Too much too soon”. At the budget consolidationsame time interest rates have remained low despite anxiety hasnt truly gotten underabout debt in the euro zone, the high rate of inflation at home and waythe budget deficit. Stabilising the governments finances willcreate confidence, especially if the global economy were todeteriorate even more. The risk is that loan demand won’tdecrease as quickly as expected. In combination with lowergrowth, this would limit opportunities to reduce the budget deficit.The huge budget consolidation also means that monetary policywill remain expansive longer than otherwise would have been thecase. At this point there will be no quantitative easing, but thebenchmark rate is being held at around 0.5%. We dont expectrates to be raised until the first half of 2013, when the recoveryhas gained a better foothold.In the meantime inflation will decline since commodity prices arelevelling off, the pound has rebounded after weakening, and VAThikes have ended. Underlying inflation, where the consumer priceindex is adjusted for energy, food, alcohol and tobacco, iscurrently 2.7%, compared with a consumer price index that hasnow begun to drop from a peak of 4.5% in April and May,reaching 4.2% in June. Continued low demand pressuresuggests that inflation will be kept in check in upcoming quarters.The central bank has been right to keep a cool head.6. Conclusions for our home marketsThere is little doubt that future confidence has weakened around The outlook hasthe world since our spring forecast, with a stock sell-off in the worsened this summerwake of increased growth and debt worries. Those who believethat nothing has happened are overlooking the impact ofpsychology and politics on the economy. GDP growth has slowedmore than expected in the US and the euro zone, while Japanand China have developed more strongly. The purchasingmanagers index points to a global slowdown. Households andbusinesses could dampen consumption and investment.Central banks should put off further rate hikes as growth andinflation dampen. Even countries without budget austerity mayhave to adjust their rate hikes to avoid currency appreciation.Finance ministers may have to be more cautious with stimulus It is important that thereprogrammes that entail permanent budget changes. On the other is a possibility of morehand – if conditions allow – a demand stimulus could prove expansive economicuseful, e.g., to prevent unemployment from rising again. The policymost important thing is that automatic stabilisers are allowed towork. In the face of a steady stream of crises (really the samecrisis which has mutated), open economies have to have crisismanagement plans in place. The financial sector is often themost vulnerable, although IT and auto production have also beenat risk in recent years. Businesses and governments thereforeneed to have both margins and preparedness plans.42 Swedbank’s Global Economic Outlook • 17 August 2011
    • The balance sheet recession in the US, the UK, Spain and We need better data toIreland is complicating the recovery. We need better data on evaluate the risk of abalance sheets in the private sector. Wealth and debt statistics balance sheet recessionhave not improved in the same way as the national accounts. Toprovide a better foundation for economic policy, statisticalauthorities should improve this type of balance sheet data.Effective guidelines for fiscal and monetary policy can help to Despite good rules, thefacilitate crisis management: inflation targets, budget targets, housing marketspending caps and rules for the financial sector. The Swedish remains vulnerablehousing market is vulnerable to increased unemployment andfurther stock sell-offs. Higher mortgage rates cant be ruled outeither, even if the Riksbank takes a pause before raising ratesagain, since the banking system could face financing difficulties.EU member states that do not participate in the EMU have to It is important tocarefully following developments in the euro zone while also understand the EMU’strying to promote the cooperation in terms of both support and importance from apolicy design. After the crisis the euro zone could very well be larger growth perspectivestronger than expected, and it would be unfortunate if the gapbetween the EMU countries and the EU countries increases toomuch. From a longer-term perspective, the currency union –along with fiscal coordination and bank regulation – is decisive toEurope’s ability to compete with other strong regions. The eurozone’s success is just as important for its member states as forEU member states, and by extension for our standard of living. Cecilia HermanssonSwedbank’s Global Economic Outlook • 17 August 2011 43
    • SwedbankEconomic Research DepartmentSE-105 34 Stockholm Swedbank, Global Economic Outlook is published as a service to our customers.Telephone +46-8-5859 7740 We believe that we have used reliable sources and methods in the preparation ofek.sek@swedbank.se the analyses reported in this publication. However, we cannot guarantee thewww.swedbank.com accuracy or completeness of the report and cannot be held responsible for anyLegally responsible publisher error or omission in the underlying material or its use. Readers are encouraged toCecilia Hermansson, base any (investment) decisions on other material as well. Neither Swedbank nor+46-8-5859 7720. its employees may be held responsible for losses or damages, direct or indirect,Magnus Alvesson, +46-8-5859 3341 owing to any errors or omissions in Swedbank’s Global Economic Outlook.Jörgen Kennemar, +46-8-5859 7730ISSN 1103-4897