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Swedbank's Global Economic Outlook, 2011 March

Swedbank's Global Economic Outlook, 2011 March



Swedbank's Global Economic Outlook, 2011 March: The global recovery has gained a footing –

Swedbank's Global Economic Outlook, 2011 March: The global recovery has gained a footing –
but the risk of a backlash remains.



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

    • Global Economic Outlookby Cecilia Hermansson 29 March 2011The global recovery has gained a footing –but the risk of a backlash remains The global recovery economy strengthened last year. We have revised our GDP forecast upward by a total of 0.3 percentage points to 4% per year in 2011 and 2012. This still represents a slowdown compared with last year’s strong 4.7%. Tighter economic policies, higher commodity prices and rising inflation at the consumer price level will lead to slower activity during the period. Emerging markets will remain growth engines. Our risk outlook can be compared with the last lap of a 3000 m hurdle race. The hurdles that have to be jumped include Japans disaster, political turbulence in the Middle East, rising commodity prices and their impact on inflation and interest rates, the debt crisis in advanced economies (water jump) and, lastly, the need for changes in the world order to avoid imbalances and new financial crises. We give our main, positive scenario – which assumes that the recovery will continue and policymakers manage the debt crisis in Europe and the increasingly difficult policy mix to simultaneously tighten financial and monetary policy reasonably well – a combined likelihood of 50%. Two stronger scenarios (one sustainable and one less so) have a likelihood of 20%, and two weaker scenarios, with stagflation and a worsening debt crisis, have a likelihood of 30%. The challenges to economic policy are growing. We urge that budget consolidation in Europe continue and begin as soon as possible in the US, and that monetary policy is allowed to remain expansive a little longer while tighter fiscal policies slow growth. Quantitative easing, on the other hand, should be phased out to speed up debt consolidation and increase the focus on much- needed structural reforms. It is also important to break the vicious cycle between public debt crisis and banking crisis, which – in addition to budget consolidation – requires more ambitious stress tests and capitalisation of banks in Europe. Cecilia HermanssonContents:1. Favourable conditions in the global economy 22. In our main scenario the recovery continues 43. Many hurdles must be jumped 64. Our assumptions about commodity and financial markets 115. The optimal economic policy 176. Regions/countries: Most are downshifting 197. Conclusions for our home markets 35 Economic sekretariatet, Swedbank AB (publ), 105 34 Stockholm, tfn 08-5859 7740 E-post: ek.sekr@swedbank.se Internet: www.swedbank.se Ansvarig ugivare: Cecilia Hermansson, 08-5859 7720 Magnus Alvesson, 08-5859 1031,Jörgen Kennemar, 08-5859 7730, ISSN 1103-4897
    • 1. Favourable conditions in the globaleconomyIn 2010 the global economy grew more strongly than we had Last year the globalforecast. The difference can be explained by higher activity in economy grew fasteremerging countries, particularly the BRIC countries, which than expectedaccounted for two thirds of global GDP growth.1 The positivetrend was also due to a surprisingly strong recovery in developedcountries such as Japan, Germany and Sweden. On the otherhand, GDP growth in the US and other euro zone memberslargely met our expectations at the beginning of last year.Contribution to global GDP growth by various countries/regions, 2010 2,00 1,80 1,60 1,40 1,20 1,00 2010 PPP 0,80 2010 US dollars 0,60 0,40 0,20 0,00 US Euro  UK Japan China India Brazil Russia zoneSeen through the rear view mirror, global economic developmentwas generally positive, and current conditions are characterisedby cautious optimism driven by strong global trade, relatively highprofits and increased access to credit in the corporate sector,which as a whole should lead to investments and new jobs.Conditions in many crisis-ridden economies are still weaker than But the situation innormal with respect to the housing, labour and credit markets. crisis-riddenDespite improvements, there are remaining problems of a more economies is weakerlong-term, structural nature, which take time to resolve. than normalThe economic stimulus is still a having positive impact on theeconomy. In emerging countries, stimulus programs have gonetoo far, raising the possibility of an overheating. Here, policy hasto be tightened more than has been the case so far in order toslow growth to more sustainable levels going forward. Indeveloped countries, monetary policies have remained expansivewhile financial policies are being tightened, which will eventuallyimpact growth prospects more negatively.The major differences in how developed countries and emergingeconomies have handled the crisis are clearly evident in thediagram below, which compares industrial production in variouscountries/regions. The US and Europe are now back toproducing slightly more than their 2000 levels, while Japan is on1 The BRIC countries refer to Brazil, Russia, India and China. Refers to GDP growthweighted with purchasing power parity (PPP). In dollar terms, the BRIC countriesaccounted for nearly half of global growth.2 Swedbank’s Global Economic Outlook • 29 March 2010
    • its way to the same level. On the other hand, less is producedtoday than levels before the financial crisis. After a brief dip,production in emerging countries has continued to grow strongly,more than doubling the level of 2000, at the same time that theproduction increase compared with before the crisis is more than20%.Industrial production in various countries/regions, Index 100 = 2000 350 Total 300 US Japan 250 Euro zone Emerging markets 200 Asia 150 100 50 2000m01 2002m01 2004m01 2006m01 2008m01 2010m01There has been a lot of talk of a “two-speed world economy”. It is Two-speedquite natural that emerging economies grow faster than world economydeveloped countries, since they are beginning from a lower leveloften with higher growth in productivity and the labour supply.What is different from previous periods is that the rate of growthin emerging countries has risen, while it has fallen in developedcountries.The latter have a number of Achilles heels, which are slowingdevelopment, including problems in the financial sector, whichare curtailing lending and investments; higher public debt, whichrequires tighter fiscal policies; and higher private debt, whichmust be cleaned up and is keeping consumption in check. That’sin addition to the structural problems in many labour and housingmarkets.In summary, global economic conditions are better thanexpected. Growth is being driven mainly by countries in Asia,Latin America, the Middle East and Africa, while many developedcountries are struggling with structural problems. The economicstimulus could cause overheating in emerging countries andmust be phased out, at the same time that developed countriesare entering a period of austerity. This will make it difficult toexceed the 2010 global growth rate.Swedbank’s Global Economic Outlook • 29 March 2010 3
    • 2. In our main scenario the recovery continuesOur previous view that the global economy is “muddling through”still remains a likely main scenario. The recovery won’t stall, butgrowth is slowing after last year’s rebound. Global GDP growthwill fall from 4.7% last year to 4% this year and next.Global GDP forecast Spring Forecast January ForecastGDP growth (%) 2010 2011 2012 2010 2011 2011US 2,9 3,0 3,0 2,8 2,6 2,7Euro zone: 1,7 1,5 1,5 1,8 1,6 1,5of which: Germany 3,6 2,4 1,9 3,6 2,5 2,0 France 1,5 1.5 1,6 1,6 1,6 1,5 Italy 1,1 0.9 1,0 1,1 1,0 1,1 Spain -0,1 0.3 1,0 -0,4 0,3 1,0UK 1,4 1,5 2,0 1,7 1,8 2,0Japan 4,0 0,6 3,0 3,2 1,5 1,3China 10,3 8,8 8,4 10,1 8,5 8,1India 9,1 8,0 7,5 8,8 8,2 7,5Brazil 7,5 4,3 4,0 7,5 4,8 4,5Russia 4,0 4,6 4,5 4,0 4,3 4,5Global GDP in PPP 4,7 4,0 4,0 4,6 3,9 3,8Global GDP in US dollars 3,8 3,1 3,3 3,7 3,1 3,0Source: National statistics and Swedbank’s forecasts. Note: These countriesrepresent 75% of the global economy. To arrive at total GDP growth, approx.0.3 percentage points should be added. The World Bank’s weights from 2009have been used.This represents a slight upward revision from our January We have revised ourforecast. In the US, the recovery has gained a firmer footing at January forecastthe same time that the country has been reluctant to face up to upward by a total ofits need for tighter fiscal policy and appears to be more focused 0.3 percentage pointson next years presidential election. The euro zone and the UK for 2011 and 2012are being adversely affected by higher inflation and theirupcoming decision to tighten monetary policy earlier.Japan’s GDP growth will decline this year due to the catastrophe,but will increase next year when reconstruction begins. Russia isbenefitting from the rise in oil prices, but at the same time isstruggling with higher domestic inflation. China, India and Brazilcontinue to grow strongly, but have slowed compared with lastyear now that their policies are no longer stimulating theeconomy to the same extent. On page 19 we go into more detailon developments in individual countries.The main factor that is driving global growth is continued strongglobal trade, not least due to high demand in Asia. Despite fearsof increased protectionism, trade has not declined and the keysupply chains in our globalised world remain intact. Corporateprofits have risen at the same time credit has become easier tocome by and interest in new investments to expand existing4 Swedbank’s Global Economic Outlook • 29 March 2010
    • capacity is growing. New hirings are on the rise, which meansthat labour markets in developed countries are gradually, thoughstill slowly, improving. With more people employed and wagegrowth slightly higher, private consumption is rising from lowlevels.In our main scenario, we assume that the economy and There are severalpoliticians will be able to handle the challenges of the Japanese reasons why the globaldisaster, the wave of democratisation in the Middle East and the economy is slowingdebt crisis reasonably well. The question in this case is why the compared with 2010global economy won’t manage to maintain last years GDPgrowth?First, the inventory build-up, which had contributed strongly togrowth, will have a less positive, neutral or maybe even negativeeffect.Secondly, the impact of previous economic stimulus programs inthe form of interest rate cuts, quantitative easing and the boost todemand from lower taxes and higher public spending is fading.What had been positive contributors will instead becomenegative contributors when fiscal policies are tightened in manydeveloped countries, especially in Europe.Thirdly, commodity prices have increased more than previouslyexpected, which will raise inflation at least temporarily in our mainscenario (but if commodity prices continue to rise, inflation willstick around longer). This means that higher energy and foodprices – as well as higher mortgage rates as central banks raiseinterest rates earlier than expected – will leave households withless in than their wallets for other consumption.Fourthly, the growing public debt in many developed countries iscreating uncertainty. In the euro zone, it is looking very much likePortugal may soon need a rescue package, while Spain facescontinued uncertainty whether it will be able to obtain financingthrough ordinary financial markets. In the US, the inability toaddress medium-term budget problems is creating uncertainty.Solid corporate earnings have benefitted stock markets aroundthe world, in turn helping the recovery in the financial sector andreducing the risk of bankruptcies among banks. Uncertaintywhether Greece and Ireland will have to renegotiate their debtsdespite rescue packages is also putting stress on Europeanbanks, where stress tests so far haven’t been ambitious enough.In summary, the recovery is continuing, but growth will slow to4% this year and next. Despite various challenges in terms ofnatural disasters, the Middle East, commodity markets, publicdebt and their impact on economic policy, crisis management,banks and demand, the global economy continues to muddlethrough.Swedbank’s Global Economic Outlook • 29 March 2010 5
    • 3. M Many hu urdles m must be j jumpedIn th uncertain world we live in, ou main sce he n ur enario has to becomp plemented by alterna ative scenaarios. There are a largenumb of risks, some of w ber which we ha discussed and assumed avethat they can be manag ged reasonably well. Of course this e,does necessa snt arily have to be the cas o se.Forecast risks h have so far focused on conditions in the fina r n s ancial Its important to s tsecto deflation a new r or, n, recession ( (double dip), protectio onism, disscuss forec cast riskscurreency tension and the debt crisis in the public sector. Se ns c everal an alternativ nd veof the hurdles have been overcome but could pop up again. It ese s n e, sccenariostook several y years befor deflation became evident in the re n nJapaanese economy after t the financia crisis in the early 1990s. al tThe current deb crisis, wh bt hich has led to tighter economic p d e policy,could still create a new rec d e cession and deflation in several c d crisis-ridde countries though no yet the en en s, ot ntire global economy.The risks can be compared with a 300 m hurdle race. Eac lap e d 00 es chhas five hurdle the four of whic is a water jump th is es, rth ch hatespeecially hard to leap. We summariz the risks below based on e zethe c challenges t economic players must overcome. that global eFirst obstacle: Japan’s ca t atastrophe eThe earthquake tsunami a e, and nuclear crisis mainly affect J Japan At this point it is still t iand its population. The ec conomy will initially shrink due t the to too early to assess the aloss of production and de emand, but will later grow faster than g r full dimension of the nsnorm when re mal econstructio begins a on and is fully implement ted. It Ja apanese dis saster, butmay take many years bef y fore the region recove ers. The co to ost they should be modest bbuild up the re d egion, at le east USD 3 300 billion, will add t the to for the global economy lnatio onal debt, b at 5% of GDP th is negli but his igible given that nJapaan’s current debt has reached around 20 s 00% of GD DP. Apolitical crisis in the wa ake of the catastrophe remai ins aposssibility, espe ecially cons sidering tha oversight of the nu at uclearpowe disaster h been le than sat er has ess tisfactory.The global eco onomy is affected be ecause Japan is a majorecon nomy and tr rading partn especia for Chin and has a big ner, ally na,impa on the g act global suppl chain, inc ly cluding in th case of autos he electronics. While the effects are likely to be felt by indivand e . vidualcomppanies, it shouldnt threaten t the global recovery. The nstruction could alsrecon so benefit certain companie t es incons struction an commod nd dities, for in nstance. Co ommodity p pricesand i interest rate will initial fall as de es lly emand from Japan dec m clines,6 Swedbank’s Gl lobal Economic Outlook • 29 March 2010 M
    • but then rise when the need for raw materials and capital onceagain increases. The strength of the Japanese yen continues tofrustrate, but cant be rectified by interventions.The nuclear disaster affects the need for other energy sources as Public opinion aboutwell as public opinion about nuclear power and investments in nuclear power couldnew plants. It is also affected the political debate in Germany change entirelyafter losses by the CDU and FDP in the regional election inBaden-Württemberg, owing in large part to the nuclear powerissue. Several countries now want to delay any expansion tofurther evaluate safety concerns. In the long-term uncertaintyabout nuclear power could lead to higher energy prices and new,innovative technologies.Second hurdle: Political turbulence in the Middle EastThe wave of democratisation in the Middle East could continue The rise offor several years, affecting the region’s economy, geopolitical democracies in thesecurity and global oil supplies. The upheaval that began in Middle East willTunisia and Egypt and has spread to Libya, Bahrain, Yemen and eventually create newSyria will hurt growth prospects short-term, but could create business opportunitieshigher growth potential over time, which would also benefitinvestors in other parts of the world.The focus at them moment, however, is whether unrest willspread to major oil-producing countries, especially Saudi Arabia,but also Qatar, Kuwait and the United Arab Emirates. The MiddleEast accounts for about a third of oil production, but has around60% of oil reserves. These oil producers have the financialresources to offer concessions that will alleviate some of theconcerns of their citizens. Energy and food subsidies are alreadyhigh in the region, and to buy more time those in power areraising public sector salaries. This could contribute to even higherinflation pressures, which will not be kept in control by higherinterest rates, since many currencies are pegged to the dollar. Asa result, there is a risk of greater political instability in the wake ofrising consumer prices.The effects on the global economy are mainly tied to the price of At this point the focusoil. The West would like to see democratisation, but is most is on the regions roleconcerned about the predictability of oil production. There are as an oil producerpolitical risks as well, such as NATOs involvement in the civil warin Libya as well as relations with China and Russia. Furthermore,Israel’s position in the region is affected by the new powerstructure in Egypt. The rivalry between Saudi Arabia and Irancould also rise to the surface and create tensions in the oilmarket. Political instability in the Middle East makes investors inother emerging countries cognizant of the political risks they face.“Stable” China in particular could be affected by increased riskaversion.Third hurdle: Rising commodity prices and inflation, centralbank actions, including overheating in emerging countriesEven before the democratisation process in the Middle Eastbegan, commodities had risen significantly in price. This was dueSwedbank’s Global Economic Outlook • 29 March 2010 7
    • to the stronger economy, which has increased demand for rawmaterials, as well as supply problems in connection with droughtsand fires, which have reduced food production, the quantitativeeasing, which has increased liquidity and investor interest incommodity markets, and concerns about higher inflation and thedecline in the dollar, which are driving up the prices of metalssuch as gold. The weaker dollar is also contributing to highercommodity prices, since sellers are demanding compensation forthe currency effect. Oil supplies have not yet been affected byconcerns in the Middle East, but prices have risen because ofexpectations of future shortages. Psychology is obviously animportant factor as well.If oil prices rise above current levels and reach USD 120-150 a The more oil pricesbarrel, there is a greater risk that other commodities, inflation rise above the currentexpectations and inflation at the consumer price level will all rise level, the greater theas well, in addition to earlier-than-expected increases in policy risk to global growthinterest rates and slower growth. Higher cost pressures oncompanies reduce their ability to invest and recruit. Householdswill see their wallets shrink, which will hold back consumption.In the developed world, the policy mix for crisis-ridden countriesthat have to clean up their finances has become morecomplicated. There were expectations that monetary policy wouldremain expansive a little longer, so that the budget consolidationwouldn’t threaten growth. Policymakers in key central banks inthe US and Europe may feel that they have to avoid the second-hand effects of higher import prices, however, which could meanthat a period of interest rate hikes is nearing closer.In emerging markets, higher commodity prices have contributedto signs overheating for some time. Central banks have beenslow to tighten monetary conditions, however. Large capital flowsin the wake of the quantitative easing have strengthenedcurrencies, which has worried policymakers, since it could meanweaker export prospects. There is now a greater risk of a hardlanding for countries that won’t or can’t slow inflation.Higher commodity prices, inflation and benchmark interest ratesare certainly among the biggest negative forecast risks for theglobal economy. The situation affects many people and threatensgrowth, jobs and inflation. There is also the risk of stagflation incertain countries.Water jump: Debt crisis in the advanced economiesThe effects of higher commodity prices could threaten the global A public debt crisisrecovery. At the same time we regard the debt crisis in the connected to theadvanced economies as a more difficult hurdle to overcome. The banking sector couldimpact could be felt in both the short and longer term. Risks can create a new financialbe tied to politics, to the economy and to financial markets. This crisis and recessioncould give rise to new recessions and deflation, and once youhave fallen into the water jump it can be hard to get up.Debt restructuring in the private sector, among households,businesses and banks, is far from over. When economic stimulus8 Swedbank’s Global Economic Outlook • 29 March 2010
    • programs are phased out and a period of austerity takes over,new risks could arise for the private sector and pose further risksto the banking system. The IMF estimates that banks in Europe,Asia and the US need around USD 500 billion in new capital.Debt restructuring in the public sector has just begun in Europe,mainly in the UK and crisis-ridden euro members. They have toget their debt down to 60% of GDP from nearly 85%, which couldtake many years, especially since demographics and increasedhealthcare expenditures are making it more difficult.In the US, the national debt is nearing 100% of GDP, yet the The longer the UScountry seems to have put off any comprehensive measures, waits to seriouslyprobably until after the presidential election in 2012. The budget tackle its debt, thedeficit exceeds 10% this year. The longer the US waits to agree greater the risksto a more ambitious medium-term plan across party lines, thegreater the risk for the dollar, for long-term interest rates and forconfidence in the US economy.Expectations are that Portugal will be the next country to need arescue package. Our main scenario includes this assumption. IfSpain finds itself in a similar situation, there will not be enoughcapital in the European Financial Stability Facility (EFSF).In addition, Greece and Ireland’s lenders are expected to have totake responsibility for their less-than-accurate risk assessments,i.e., to write off or renegotiate a portion of the debt they hold. Thiscould put pressure on the euro if the results of the stress tests ofthe banking system that are announced in June show that thereis not enough capital and that national governments will have totake over more banks, e.g., in Germany, Spain and France.Too high of a public debt ratio – around 100% of GDP or more –could affect growth. The possibility of crowding out the privatesector is contributing to this. Competition for capital is increasing.Debt restructuring is already slowing GDP growth by about half ofa percentage point for every per cent of GDP that is being slicedfrom government budgets. In Europe, the day is coming, but inthe US it could take a little while before people feel the effects ofausterity. If politicians do not handle the debt crisis correctly,there will be an increased risk of turbulence in financial marketsand a greater impact on growth and employment.Fifth hurdle: The global order – the global political andfinancial systemReforming the current global order is another long-term New financial criseschallenge. If it doesn’t happen, new financial crises could arise are a greatermore quickly and with a greater impact than otherwise would be possibility if the worldthe case. There is still a lack of efficient institutions to detect, order isnt workingmanage and coordinate measures in the event of a crisis.Countries are acting out of national interests, and rarely areregulations created that work equitably across national borders.The G7 countries, G20 countries, International Monetary Fund(IMF), World Bank, World Trade Organization (WTO) andSwedbank’s Global Economic Outlook • 29 March 2010 9
    • Financial Stability Board (FSB) could all serve as crisis monitorsand coordinators. The lack of strong institutions to managecurrency tensions, large capital flows, protectionism and financialcrises is exceeded only by the even weaker institutions availableto tackle climate change and environmental issues.Emerging countries led by China and India are demanding new The global order has tointernational alliances. China would prefer not to see the dollar as adapt to new globala reserve currency any longer, but hasn’t yet taken responsibility players like China andas a growing economy for developing a viable currency that can Indiabe used outside its borders. With continued currency tensionsand many emerging currencies rigidly pegged to the dollar, thereis a risk that savings imbalances could again create financialcrises. This hurdle, the last on the track, will take time toovercome. If it isn’t, the global economy wont reach the finishline!Alternative scenarios:Below we summarise the alternatives to our main alternative for2011-2112. The probabilities we use are anything but scientificand merely provide an approximate risk level. • Main scenario (see page 4) 50% probability • Stagflation (weaker scenario) 15% probability Higher commodity prices, inflation and interest rates could slow growth primarily in developed countries. Our stagflation scenario contains high inflation and unemployment, and little or no growth. • Worsening debt crisis (weaker scenario) 15% probability If policymakers cannot manage the debt crisis and it worsens, there is a risk of slower growth and financial instability. A rescue package for Spain is included here. • Faster balancing of growth (stronger scenario) 5% probability If China can transition to a consumption-driven economy at the same time that the US gets its growth from investments and exports, savings balances will decrease and growth, though not significantly higher, will at least be more sustainable. • Further stimulus despite the risk of overheating (stronger 15% probability scenario) GDP growth could be stronger than we have predicted if emerging economies fail to slow down at the same time that the US supports another round of quantitative easing (QE3) and other stimulus measures. This higher growth rate is not sustainable, however.10 Swedbank’s Global Economic Outlook • 29 March 2010
    • 4. Our assumptions about the commodityand financial marketsPrice trends in financial and commodity markets are difficult topredict. It is more a question of making reasonable assumptionsthat support the forecast for the real economy.Commodity marketsCommodity prices have risen markedly in the last half year. One There were severalreason is the stronger economy, which is raising demand for raw reasons for the rise inmaterials. Another is supply problems. Droughts and fires have commodity pricesreduced food production. A third reason is quantitative easing,which has increased liquidity and investor interest incommodities. A fourth reason is that inflation concerns havedriven up the price of gold and other metals. The relatively weakdollar is also contributing to higher commodity prices, sinceproducers are demanding compensation for the weaker dollar.Lastly, the democratisation process in the Middle East hascreated uncertainty about future oil production, which has raisedoil prices despite that supplies haven’t yet decreased.In our January forecast we assumed that oil would reach USD 85 We assume an oilthis year and USD 90 next year. We expect the current price of price of USD 105 thisUSD 115 a barrel to drop when uncertainty about the Middle East year and USD 98 nexteases, the pace of the global recovery slows slightly and the yeartemporary effects of the cold weather subside. Our forecast isthat the price of oil will reach an average of USD 105 this yearand fall to USD 98 next year. The risk in these assumptions is onthe upside, since concerns about oil production in the MiddleEast could be deeper and more long-lasting than we haveassumed. Replacing nuclear energy with gas, oil and coal couldprove necessary after the catastrophe in Japan, and could leadto a continuation of the upward trend in oil prices.Commodity prices, total, food prices and commodity prices excluding oil (index) 175 Total commodity price, excl oil 150 125Index 100 Total commodity price 75 50 Food prices 25 00 01 02 03 04 05 06 07 08 09 10 Source: Reuters EcoWinThe long-term price trend should point upward, since many lowand middle income countries are growing quickly and expandingtheir infrastructure. The question, however, is whether we will seeSwedbank’s Global Economic Outlook • 29 March 2010 11
    • any pioneering energy innovations to replace oil. The nuclearcrisis in Japan is creating new incentives for innovations inenvironmentally friendly energy sources.We expect metal prices to continue to rise in 2011 and 2012, butnot as quickly as in 2010. A slightly lower global growth ratesuggests this, when the impact of the rebound is no longer asdominant.Food production has been affected by weather conditions, which Metal and food pricescould occur again in future years, although we see signs that new continue to rise, butagricultural acreage is now being added to boost supply, which not as quickly as lastreduces the risk that food prices will increase as quickly. As with yearmetal prices, we expect food prices to continue to rise but at aslower rate. The risks are how much of food production canreplace energy production and – like always – weather impacts.Inflation and interest ratesThe upward commodity price trend raises inflation expectationsat the consumer price level (CPI), but could also affect growthprospects by raising costs for businesses and reducing theirability to invest and hire new workers, and by weakening realdisposable household income, leaving them less for otherconsumption after paying for more expensive energy and food.It is also critical whether commodity prices continue to rise at thesame rate, or if they rise faster or slower. A one-off effect oninflation would lead to fewer interest rate hikes than if prices risefor a longer period and accelerate.Inflation (CPI) in a number of countries, 2008-2011 17,5 15,0 India 12,5 10,0 China Percent 7,5 Brazil 5,0 2,5 UK US 0,0 Germany Japan -2,5 08 09 10 Source: Reuters EcoWinInflation problems are and have been most evident in emergingcountries. Energy and food account for a larger share ofhousehold spending there as well.In India, weak monsoon rains caused food shortages andsubstantially higher prices at the same time that import pricesrose. Economic policy has been expansive as well. Inflation is12 Swedbank’s Global Economic Outlook • 29 March 2010
    • now headed lower, but the levels will remain relatively highthroughout the forecast period.China has had problems with drought as well, in addition to China’s high inflationhigher import prices on the heels of rising global commodity rate is due to bothprices. The inflow of capital as well as negative real interest rates domestic and externaland rapid credit growth have also driven inflation, which for many factorsis considerably higher than official figures show. Theadministration is now trying to mitigate the price increase, but hasbeen tardy in its attempts to tighten monetary policy. A strongercurrency appreciation would help to slow the rise in import prices,but should be in real rather than nominal terms by increasingwages and prices faster than in the rest of the world. This raisesthe risk of higher inflation through the labour market. Inflation willexceed China’s comfort level of 3% throughout the forecastperiod.In Brazil, large capital inflows and higher import prices havecontributed to inflation problems, which are now being managedwith the help of higher interest rates and tighter fiscal policies. Aslowdown in inflation was noted in March, but concerns abouthigh inflation still remain.In February consumer prices rose rapidly in developed countries,exceeding inflation targets of at or below 2%. On an annual basisthe increases were as much as 6.2% in the US, 4.4% in the UKand 2.4% in the euro zone.To date the UK has been concerned about higher inflation, The policy mix isdespite weak domestic demand. Rising import prices, a weaker becoming especiallypound and VAT hikes are driving the price increases. Inflation will difficult in the UKsubside, but it could take time and require interest rate hikesearlier than desirable from the standpoint of the economy’srecovery.The euro zone’s inflation will slightly exceed the target in 2011.The ECB is expected to begin raising its benchmark rate as earlyas this spring, which could put the recovery at risk in a regionwhere structural debt and financial sector problems weighheavily.The US is also seeing rising energy and food prices, but coreinflation remains low. This will give the Federal Reserve a respitefor its monetary policy, which the administration in particular ishoping for, when the quantitative easing (QE2) runs its coursethis summer.Swedbank’s Global Economic Outlook • 29 March 2010 13
    • Inflation projections measured according to the annual increase in CPI (%) 2010 2011 2012US 1,6 2,3 1,8Euro zone 1,6 2,2 2,0UK 3,3 4,1 2,6Japan -0,7 0,2 0,7China 3,3 5,0 4,2India 9,2 8,5 6,8Brazil 5,9 6,2 4,9Russia 6,9 9,9 9,3Global CPI 2,8 3,7 3,1Source: National statistics and Swedbank’s forecasts.To date only a limited number of central banks in developed Major central bankscountries have begun raising their benchmark rates, including haven’t raised ratesAustralia, Canada, New Zealand, Norway, Poland and Sweden. yet …The Federal Reserve (Fed) in the US, European Central Bank(ECB), Bank of England (BOE) and Bank of Japan (BOJ), on theother hand, have taken a wait-and-see approach. Amongemerging countries, all the BRIC countries have raised theirs, butto a lesser extent than what would have been needed to quicklymitigate inflation.Benchmark interest rates 2000-2010 8 Norway Australia 7 6 Euroarea UK Percent 5 4 3 2 1 US Sweden Japan 0 00 01 02 03 04 05 06 07 08 09 10 11 Source: Reuters EcoWinThe ECB has signalled that its first rate hike will come in April. Its … but the ECB ismain concern is that higher inflation expectations and the expected to beginsecond-hand effects of higher import prices could create raising as soon asproblems further down the road. To a lesser extent it is worried Aprilthat the recovery will lose steam in debt-laden countries. Byraising rates, the ECB is also placing greater pressure oncountries to implement structural reforms.The next central bank to ease off the gas should be the BOE,which will raise rates after the summer to tame uncomfortably14 Swedbank’s Global Economic Outlook • 29 March 2010
    • high inflation despite relatively weak domestic demand. If therecovery fizzles before then, the BOE may wait a little longer.We expect the Federal Reserve to put off any rate hikes untilnext year, probably the spring. Its focus is on how the phase-outof the quantitative easing (which we expect in June) will affectvarious markets. The key is to ensure that economic recovery isfirmly entrenched. Late last fall its rhetoric changed to preparethe market for the first rate hike a few months later.Policy Interest rates 28-mar-11 30-jun-11 31-dec-11 30-jun-12 31-dec-12Federal Reserve 0,25 0,25 0,25 1,00 1,50ECB 1,00 1,25 1,75 2,25 2,50Bank of England 0,50 0,50 1,00 1,50 2,00Bank of Japan 0,10 0,10 0,10 0,10 0,10The BOJ will have to continue (and intensify) its expansivephase. Excluding the effects of higher import prices, the pricetrend in Japan is still deflationary. Depreciating the yen is likely tobe a great priority in the short term.Long-term interest rates have trended higher since Fed Long-term interestChairman Ben Bernanke announced a second round of rates have trendedquantitative easing (QE2) last fall. The intended aim was to higher since last fall –reduce interest rates, but that hasnt been fully achieved. Instead despite the Fedsthe focus has shifted to inflation and the declining dollar. A Treasury purchasescontinued recovery and generally higher inflation in the globaleconomy as laid out in our main scenario, as well as thecontinued need to finance relatively large budget deficits inseveral countries for a while longer, would suggest that long-terminterest rates will continue to track higher.The Basel III rules, which raise banks’ capital adequacyrequirements, along with high government debts and a growingneed for investment to expand business capacity, could increasecompetition for capital in the years ahead, pushing interest rateshigher.Long-term interest rates (10-year government bonds) 6,0 5,5 UK 5,0 4,5 4,0Percent 3,5 Germany 3,0 US 2,5 2,0 Japan 1,5 1,0 0,5 06 07 08 09 10 11 Source: Reuters EcoWinSwedbank’s Global Economic Outlook • 29 March 2010 15
    • Currency trendsCompared with a year ago most currencies have appreciatedagainst the dollar. Among the exceptions are Hong Kong,Pakistan and Egypt. Some currencies have risen more thanothers, particularly the Japanese yen.Nominal exchange rates in relation to the US dollar, index 9 August 2007 = 100 170 160 Brazilean Re 150 Swedish Krona Korean Won 140 Euro 130 120 110 100 Yuan 90 Swiss Franc 80 Yen 70 05 06 07 08 09 10 11 Source: Reuters EcoWinWe expect that slightly stronger growth momentum in the US During the forecastthan in Europe and Japan will strengthen the dollar in 2011-2012. period the dollar couldWhile the ECB will begin to raise its rates earlier, investors are appreciate, but the risklikely to be less optimistic about the euro zone when fiscal and that it could decline ismonetary tightening reduces growth. greater in the slightly longer termWith quantitative easing ending, concerns about inflation and afurther decline in the dollar will diminish, strengthening thedollar’s position. We believe, however, that there is a risk of abigger decline in the dollar in the medium term, and the longerthe US avoids dealing with its financial issues, the greater therisk of a hard landing for the dollar.FX 28-mar-11 30-jun-11 31-dec-11 30-jun-12 31-dec-12EUR/USD 1,41 1,45 1,30 1,25 1,25RMB/USD 6,56 6,40 6,25 6,10 5,95USD/JPY 82,4 81 90 95 95China continues to appreciate the renminbi against the dollar by4-5% per year in nominal terms, but in real terms theappreciation is even stronger. Efforts to internationalise therenminbi continue, including through a pilot project in Hong Kong,but the pace remains relatively slow.The Japanese yen is weakening in the wake of a shrinking trade The yen shouldsurplus and growing interest rate differential against Europe and weaken, even withoutthe US. We expect that current pressure on the yen will decline interventionswhen expectations of a massive capital repatriation fade. Ourassumption that the US will end QE2 without replacing it withQE3 should also contribute to a weaker yen.16 Swedbank’s Global Economic Outlook • 29 March 2010
    • 5. The optimal economic policyIn an uncertain world it is difficult to determine an optimaleconomic policy. What is clear, however, is that global financialstability isn’t assured and that there are a large number of policychallenges left to tackle.A significant risk is the interplay between public and private debton the one hand, and weak banks on the other. A more severedebt crisis in the euro zone, the US or Japan could createturbulence in financial markets through a fragile financial system,which would affect the real economy negatively. This potentiallyvicious cycle has to be broken.So what would be reasonable to do when the recovery isntrobust yet and too much austerity could lead to a new recession?In Europe, the financial markets have helped to create a greater The euro zone’s crisis-push for budget consolidation through higher CDS spreads and ridden countries havefinancing costs. There are few choices for Portugal, Ireland, no alternative to tighterGreece and Spain (PIGS) other than to implement austerity to fiscal policiesbalance their budgets and reduce government debt. The UKdoesnt face the same pressure right now, but without austeritythe sentiment could have quickly turned negative in the financialmarket. The ECB is now expected to begin raising interest ratesas early as this spring, which would make monetary policy lessexpansive.In the US and Japan (before the catastrophe), more fiscal The US and Japan, onstimulus has been introduced in 2011 despite that little impact on the other hand, havegrowth is expected. In addition to procyclical fiscal policies, they been able to continueare maintaining highly expansive monetary policies: quantitative to stimulate theireasing and low interest rates that are not expected to be raised economies – but withuntil next year. significant risksA number of conclusions can be drawn from this policy: • It is not unreasonable that European countries improve their fiscal position. This would ease pressure on the banking sector and stop the increase in government debt, which would potentially slow growth for years to come. • The focus has probably shifted too much to cutting Structural reform spending and raising tax revenue. There is a risk that should go hand in those worse off will have to bear a disproportionate share hand with budget of the burden. Politically influential interest groups that consolidation oppose structural changes, e.g., Greek pharmacies that are resisting competition, are often protected. Instead, deregulated markets could contribute to lower consumer prices. Structural reforms must complement the budget consolidation in order to raise long-term growth potential. • The euro zone – through Germany – is advocating a package of measures to bolster Europe’s competitiveness, although the contents don’t seem to focus on competitive strength; instead it seems more likeSwedbank’s Global Economic Outlook • 29 March 2010 17
    • a negotiating ploy to even out competitive advantages between countries. It would be preferable if the focus were on structural reforms that make labour, goods, services and financial markets more efficient while also strengthening productivity, entrepreneurship, education systems and pensions. • In addition to reducing the risk from public finances, the banking system has to be strengthened through more ambitious stress tests that actually lead to measures that bolster European banks. • The ECB probably needn’t be in such a rush to raise interest rates. Inflation is only marginally above the target, and weaker domestic demand shouldnt lead to much underlying inflationary pressure. • Constantly being a step behind the financial markets in Staying a step behind managing the crisis in the euro zone is far from an optimal the financial market is economic policy. It would be preferable if national far from optimal interests were set aside and that the measures taken matched the supposedly political commitment to the euro. The temporary crisis fund and permanent fund should both be designed to reduce concerns about insufficient liquidity. At the same time the responsibilities of lenders must be clearly spelled out, so that they can reasonably assess their risks when lending to countries that potentially face a crisis. • Irresponsible financial policies in the US create a risk that the dollar will fall and market interest rates will rise in the longer term, which would also adversely affect the rest of the world. • US finances are in worse shape than the euro zone’s, with a higher budget deficit and national debt. The effects of demographics and higher healthcare spending will eventually exacerbate the situation. The US is creating a heavy burden for future generations to bear. • Debt restructuring in the private sector has been slow, Quantitative easing which can also be explained by access to liquidity through and low benchmark low benchmark interest rates and quantitative easing. interest rates have Cranking up the printing presses has also played a part in delayed debt manipulating pricing in various markets and cannot restructuring in the continue. Quantitative easing cannot serve as a private sector replacement for structural reforms, as in the case of mortgage reform in the US. • In summary, budget consolidation, stress tests, structural reforms, the phase-out of quantitative easing and the postponement of interest rate hikes in regions with weak domestic demand are a more optimal economic policy than further fiscal stimulus, higher debt ratios, cranked-up printing presses and a lack of reform.18 Swedbank’s Global Economic Outlook • 29 March 2010
    • 6. Regions/countries: Most are downshiftingDespite the relatively high growth rate in the global economy,there has been a slowdown in both emerging and developedcountries. Still, the prospects of increased global trade,production and living standards in the world as a whole arerelatively good.GDP on an annual basis (%) in several major countries/regions China 12,5 7,5 India Percent Brazil 2,5 US -2,5 Eurozone UK -7,5 Japan -12,5 06 07 08 09 10 Source: Reuters EcoWinThe challenges in the form of overheating risks in emerging It is unusual that UScountries as well as the debt crisis and stagflation in developed unemployment iscountries continue to create uncertainty, however. This is in higher than Germany’saddition to the remaining structural problems in many crisis-ridden countries. The US housing market remains in recession.Unemployment has fallen slightly and is significantly higher thanin Germany, which is benefitting from previous reforms and theeconomic recovery.Labour market in several OECD countries (%) 13 France Germany 12 Euro zone 11 US 10 9Percent 8 7 6 5 4 3 Japan 2 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Source: Reuters EcoWinGiven that corporate earnings continue to rise, though not asquickly as last year, there is room for more investment and newhiring. The private sector must be able to assume the role ofgrowth engine as the public sector shrinks due to the debt crisisand phase-out of stimulus programs.Swedbank’s Global Economic Outlook • 29 March 2010 19
    • US – Stronger growth but budget concerns • Employment is rising, but the weak labour and housing markets, and higher energy prices, are affecting the economic outlook negatively. • Slight upward revision of GDP growth to 3% in 2011 and 2012. No austerity until after the presidential election. • Forecast risks include public finances, which in the long term put currencies and interest rates at risk, even globally.The US economy strengthened more than expected at the end oflast year. Domestic demand grew with the help of monetary andfiscal stimulus as well as an improved job market. As a result, weare adjusting GDP growth upward in our spring forecast.We project that GDP will grow by 3% this year and next. This is Decent growth despiteactually less than what would be expected after a recession, big structural problemswhen there are latent consumption and investment needs.However, the US is wrestling with major structural problems in itshousing, labour and credit markets, which is hampering therecovery. Moreover, higher energy and food prices are keeping alid on consumer confidence and spending.The labour market has improved, but slowly. The decline inunemployment from 9.8% in November of last year to 8.9% inFebruary is due to job growth and a lower labour supply. Theweak job market is creating difficulties for debt-laden, low-incomehouseholds. Demand is affected for small businesses, which arevital to job growth. This is a vicious cycle that is difficult to break.Labour market trends, 1980-2011 12,5 Unemployment 10,0 7,5Procent 5,0 2,5 0,0 -2,5 Labour supply Employment -5,0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 Source: Reuters EcoWinAfter trending downward for five years, the housing market is notyet showing signs of having reached bottom. The zigzaggingtrend in new and existing home sales has been driven bystimulus measures. In April, when tax credits for home buyersexpired, sales fell markedly. A recovery began after that, butsputtered when households became worried about rising gas20 Swedbank’s Global Economic Outlook • 29 March 2010
    • prices, higher mortgage rates and weak job growth. Astabilisation is on the way, but it will take time before home sales,home construction and home prices rise robustly.Housing market trends, 1990-2011 8 275 7 250Number of (millions) 6 225 Sales of new homes 5 200 Index 4 175 Case/Shiller 3 Sales of existing homes house prices for 150 10 cities---> 2 125 1 100 Residential construction 0 75 90 92 94 96 98 00 02 04 06 08 10 Source: Reuters EcoWinDomestic demand is now continuing to grow. Businessinvestment is on the rise, especially in technology. A relativelyweak dollar continues to help exports, but at the same timestronger consumption and investments are leading to higherimports, so net exports are contributing little to growth.The administrations fiscal stimulus, which was approved in It is vital that a budgetDecember, is designed to increase investment and job growth. At agreement is reachedthe same time the effects of previous stimulus programs are now for both short and longfading, which especially affects households that havent yet term to avert anotherfinished eliminating their debt and may want to increase their government shutdown!savings. A policy transition from stimulus to austerity has begun.The Republicans, with a majority in the House ofRepresentatives, are pushing for spending cuts, which areopposed by the Democrats, who have their sights set on growthand next years presidential election. On March 17 Congresspassed a three-week budget extension, but there is still a riskthat the federal government won’t have a budget beyond that.Congress has to pass a budget for the rest of the fiscal year,which ends in September, and for 2011-2012. The US also hasto reduce its medium-term debt. President Obama’s proposalaims to slash the budget deficit by USD 1.1 trillion over a 10-yearperiod, which is less ambitious than his own bipartisancommission, which would cut close to USD 4 trillion. This meansthat debt will remain a major risk in the long term, which couldhurt the dollar and interest rates.Inflation as measured by the CPI is now rising, but core inflation,excluding energy and food, is a modest 1-1.5%. This gives theFed a respite, and we dont expect its first rate hike until nextyear. The latest quantitative easing (QE2) is scheduled to winddown this summer, and we dont expect a third program giventhat the markets should remain stable when liquidity declines.Swedbank’s Global Economic Outlook • 29 March 2010 21
    • Japan – Reconstruction is beginning, butwill take time • Japan’s economy is weakening in the short term, but growth will benefit from the reconstruction, which we expect will take time. • GDP growth will slow to just over 0.5% this year, but could rise to 3% next year driven by investment. • Risks include the overall impact of the disaster, the stronger yen and political indecisiveness.Before the earthquake and tsunami broke out on March 11,Japan had already seen a slowdown in economic activity due tothe strong yen, among other reasons. The disaster, which iscomplicated by the nuclear crisis, will now cause a double diprecession in Japan.We project that GDP will shrink during the first and secondquarters. The factors that are limiting activity are electricityshortages, production disruptions, the loss of exports, increasedenergy imports and slower consumption due to immediateconcerns and damaged confidence. The scope of the disaster ishard to fathom, with over 27 000 dead or missing and 260 000people left homeless. For those who lost everything, the shortageof water, fuel and food remains the biggest challenge.Still, the reconstruction will eventually begin. We expect it to take Lower growth this yearmany years, possibly an entire decade. Growth could turn but higher next year –positive during the second half of this year, driven by public and other factors are farprivate investment. GDP will grow by just over 0.5% this year more importantbefore reaching 3% in 2012. Reconstruction costs are estimatedat 25 trillion yen, or USD 300 billion, about 5% of GDP, whichshould be spread out over a period of 5-10 years. The large partwill probably come in 2012 and 2013, however. Major nuclearproblems are not included in this calculation.Stock prices and exchange rates 15000 115 14000 110 13000 105 USD/JPY 12000 100 USD/JPYIndex 11000 95 10000 90 9000 85 8000 Nikkei, 225 80 7000 75 mar jul nov mar jul nov mar jul nov mar 08 09 10 11 Source: Reuters EcoWin22 Swedbank’s Global Economic Outlook • 29 March 2010
    • The Japanese yen has risen in the wake of the catastropheowing to expectations that capital invested abroad will return toJapan and be used in the reconstruction, and because lesscapital will be exported going forward. In light of Japan’s currentaccount surplus, these expectations seem slightly overblown,since Japan has enough capital to use.An intervention by the G7 countries has weakened the yenslightly, but not enough to make much difference. Because of thecentral bank’s expanded financial asset purchases, quantitativeeasing and liquidity to facilitate the financial system, monetarypolicy has become more expansive than before. This isreasonable since Japan is struggling with deflation problems anda debt ratio that was already rising significantly (estimated at250% by 2015 before the catastrophe).We expect the Japanese central bank to delay any rate hikesduring the forecast period. This, in combination with a shrinkingcurrent account surplus, is weakening the yen slightly.The government and opposition must reach an agreement toincrease the budget deficit and issue more government bonds tojumpstart the reconstruction of the devastated northeast region.Even before the catastrophe, credit rating agencies had begun todowngrade Japans debt, but the question is how far they will gonow that debt will increase even more.There are significant risks in analysing Japan. For one thing, it The crisis isn’t over yethas not been possible to assess the full effects of the disaster on – the nuclear crisisthe economy. For another, we still dont know what the complicates the pictureconsequences of the nuclear crisis in Fukushima will be in termsof the rescue efforts, whether people will be able to return to theregion, export prospects for seafood and agricultural products,energy supplies throughout Japan and their impact on prices, etc.If economic policies were to become highly expansive, which wedont expect, the reconstruction would go faster, the yen wouldweaken and deflation would be replaced by inflation.Another uncertainty concerns the political leadership during crisis The political risk is farand how well the government and opposition are able to work from negligible – and atogether. Confidence in Prime Minister Naoto Kan was low before government crisisthe crisis and probably hasnt grown much, although it hasnt before the end of thefallen either. The opposition isnt unlikely to gain any ground year is likelyeither for defending decisions that lead to a faster reconstruction.Swedbank’s Global Economic Outlook • 29 March 2010 23
    • China – Lower credit growth will lead to asoft landing • The Chinese economy is decelerating, but the growth rate still exceeds the targets set in the five-year plan. • Tighter economic policy will reduce the risk of overheating and accompanying political instability. • Forecast risks include high inflation, real estate prices and difficulties achieving more sustainable growth.At the end of 2010 China’s economy was surprisingly strong, andGDP growth for the full-year reached 10.3%. We now expectChina to grow more slowly in 2011 and 2012, mainly due to lowercredit growth, higher inflation and less of a net contribution fromexports as imports grow due to higher oil prices. Our forecastcalls for growth of 8.8% in 2011 and 8.4% in 2012.China recently concluded its National Party Congress, where the Chinas party congressGDP growth target was set at 7% in 2011-2015. During the is over and ambitiousprevious five-year period, 2006-2010, the goal of 7.5% was new goals have beensurpassed by a wide margin at 11.3%. A contributing reason for set – but can thethe large margin of error was the global financial crisis and Chinese achieverecession, which forced the Chinese administration to stimulate them?the economy, resulting in strong growth in exports andinvestment.In the new five-year plan growth is concentrated more onhousehold consumption. The goal is also to reduce income gaps,protect the environment, improve quality in manufacturing andreduce inflation in consumer and real estate prices.Trends in the credit market, 1998-2011 30 25 Credit Growth 20Percent 15 10 and in large Reserve requirements in small banks banks 5 Lending rate 6 months Deposit rate 6 months 0 98 99 00 01 02 03 04 05 06 07 08 09 10 Source: Reuters EcoWinThe question, however, is whether the countrys efforts to reduceGDP growth are sufficient. There are few economic toolsavailable centrally that will have much of an impact, includinginterest rates, since lending is often local, and many state-ownedcompanies and other important interest groups have access to24 Swedbank’s Global Economic Outlook • 29 March 2010
    • low-interest loans. Local and regional politicians are pushing toraise growth, including by buying up and expropriating land andconstructing new commercial and private property.The high rate of credit growth in recent years has led tooverheating in the real estate market, which has been difficult toslow despite various administrative measures such as mortgagecaps and increased bank reserve requirements. Credit growthhas now been brought down to lower levels, however, andreserve requirements are historically high. On the other hand,real interest rates are still negative.The goal to strengthen households means that wages willincrease more than before, which by itself could add to existinginflation problems. On the other hand, the yuan will appreciatemore quickly in real terms, which will speed up the process ofraising domestic demand and reducing global savingsimbalances. Chinas current account surplus is expected todecline as imports become more expensive and global demandcools slightly. In nominal terms we expect the yuan to appreciateby about 5% against the dollar per year.Households are being hurt by the high rate of inflation, which has Higher inflation isfluctuated around 5% on an annual basis in recent months, but in hurting the economy,reality is considerably higher for many people, since food and but could also createenergy prices have risen substantially. High inflation could lead to political instabilitypolitical instability, and the administration has no choice but tofight inflation.Inflation has risen partly because of supply problems stemmingfrom droughts and higher international commodity prices, but justas importantly because several years of economic stimulusthrough the banking sector have created overheating. The lattercan be influenced, and the lower credit growth which has beenachieved and has been permitted to reach 14% this year is astep in the right direction.China’s transition to slightly weaker growth was evident this Is the slowdownquarter not only in credit growth but also retail and auto sales and temporary or will itamong leading indicators. It is too early to say, however, how last?sustainable the slowdown will be. Not until the effects of the newyear’s celebrations and the cold weather ebb can it bedetermined, for example, whether the trade deficit was temporaryor indicated the beginning of a structural shift.Despite a goal to increase domestic consumption, high inflationcould mean that investments will remain the biggest contributorto growth in years ahead.Swedbank’s Global Economic Outlook • 29 March 2010 25
    • India – Slowdown due to supply problems • Demand is growing quickly, but supply cant keep pace and the government’s reform fatigue is affecting investment. • A slight downward revision in our GDP growth estimate to 8% this year and 7.5% next year presumes that the high rate of inflation will be checked. • The forecast risks are access to foreign capital, the rupee and fiscal and monetary policy, including the pace of reform.India’s economy grew quickly last year. After a high rate ofinvestment compensated for the slowdown in consumption in thefirst half of 2010, investment declined late in the year. We arerevising our GDP growth forecast downward to 8%, then see itdeclining further to 7.5% in 2012.The reasons why activity in the Indian economy will growsomewhat slower going forward are lower capital inflows, inflation– which remains high but is declining slightly – and economicausterity.Many companies in the manufacturing and service sectors will Companies are feelingface higher costs due to oil prices. Increases in other commodity the effects of higherprices are also affecting growth, at the same time that interest cost pressures andrates and salaries are rising, the exchange rate is appreciating in capacity shortagesreal terms, and access to international capital is declining. In thebusiness sector, a tailwind is being replaced by a headwind.Growth in the economy and in various price indexes 20,0 CPI industrial workers 17,5 CPI agricultural workers 15,0 12,5 GDP-growthPercent 10,0 7,5 5,0 2,5 0,0 Wholesale prices -2,5 05 06 07 08 09 10 Source: Reuters EcoWinIn rural areas, the government continues to provide subsidies tooffset rising cost pressures, which is stimulating demand.In urban areas, previous salary increases have contributed tostrong growth in auto and other durable goods purchases. Higherinflation, mainly through higher gas prices, could slow this trendslightly. The middle class is still growing, however, and we expectit to continue to contribute strongly to growth, though slightly less26 Swedbank’s Global Economic Outlook • 29 March 2010
    • so than in 2010. When consumption grows faster thaninvestment, the risk of shortages and higher inflation increases.A faster pace of reform in the Indian economy would help to drive A faster pace of reforminvestment. This is especially true with respect to taxes and would contribute tocompetition in the agricultural and retail sectors. higher investment and reduce cost pressuresPolicies remain focused on subsidising demand in rural areas toreduce the stress of higher producer and consumer prices. Indiais far too dependent on oil, and the subsidies are leading tohigher budget and current account deficits.Interest and currency rate trends 9,0 80 8,5 Policy Interest rate EUR/INR 75 Rupie to Euro och US dollar (right) 8,0 70 7,5 65 Percent 7,0 60 6,5 55 6,0 USD/INR (right) 50 5,5 45 5,0 40 4,5 35 05 06 07 08 09 10 11 Source: Reuters EcoWinSmaller capital flows and larger current account and budgetdeficits are reducing appreciation pressure on the rupee. Sincemonetary policy is likely to remain the principal economic tool, weexpect that the Reserve Bank of India (RBI) will have to furthertighten this year. If oil prices increase beyond our assumptions,there is a risk that monetary policy will be even tighter, which willimpact growth.Major political developments include corruption scandals (MP Political scandals andbribery, Commonwealth Games, telecom licenses) and a number corruption could affectof state elections next month. Even if Prime Minister Singh interest among foreignretains his position (no successor is evident) and the Congress investorsParty stays in power, uncertainty about scandals and thereluctance to institute reforms could affect interest among foreigninvestors. If capital inflows dry up, it could speed up deregulationof the retail sector for foreign investors.Swedbank’s Global Economic Outlook • 29 March 2010 27
    • Brazil – aiming at more sustainable growth • Higher inflation and tighter economic policies are slowing growth to a more sustainable 4-4.5% this year and next. • Tighter fiscal policy is expected after last years elections at the same time that the central bank is again being forced to raise its benchmark interest rate. • Risks are focused on global developments, including commodity prices, and measures to prevent overheating.Last year the Brazilian economy grew strongly by 7.5% afterfalling by 0.6% in 2009. The growth rate slowed during thesecond half of last year as a result of tighter economic policies, astronger currency and higher inflation. This trend has continuedthis year and suggests a more modest growth rate during theforecast period. We have revised our GDP growth forecastdownward to 4.3% this year and 4% in 2012, i.e., to a moresustainable rate.Demand-based GDP growth, annual rate (%) 50 Investments 40 30 Import PrivatePercent 20 Consumption 10 0 GDP -10 Export -20 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 05 06 07 08 09 10 Source: Reuters EcoWinOf course, there is no shortage of challenges facing Brazil’s new Plenty of challengespresident, Dilma Rouseff, who succeeded Lula da Silva on face Brazil’s newJanuary 1 after defeating José Serra on October 31 of last year. presidentAside from the political and social challenges, there areeconomic issues to deal with as well.Large capital flows have strengthened the currency, the real,which has worried policymakers in the government and centralbank. Last year Financial Minister Guido Mantega coined theterm currency war and criticised China and the US. Inflation issignificantly higher than the central banks target of 4.5%, andhigher benchmark interest rates could increase capital flows andreduce the growth rate.Against the US dollar, the real is back at levels from before thecrisis, but in real effective terms the currency is considerablystronger, partly as a result of higher costs in Brazil versus28 Swedbank’s Global Economic Outlook • 29 March 2010
    • abroad. The measures that have been taken, including taxes andtariffs on capital inflows, have not had enough impact.The strong currency is helping to increase domesticconsumption, since imports become less expensive. As a result,consumer prices are accelerating and in combination with higherinternational commodity prices are raising inflation. While astronger currency is easing import prices, it is not enough tocompensate for strong domestic demand. The rate of wageincreases now significantly exceeds inflation expectations, whichis putting further pressure on prices.The benchmark interest rate has been raised by three Benchmark interestpercentage points since April of last year to 11.75%, and we rates are high – butexpect further rate hikes during the year totalling at least 1 further rate hikes arepercentage point. At the same time the government wants to expected during thetighten fiscal policy – by about 1% of GDP down to a deficit of year2.5% of GDP – to reduce pressure monetary policy and restorepublic finances after the election year’s excesses.Interest rate, currency and inflation trends 20,0 180 17,5 170 Policy interest 160 15,0 Real effective exchange rate 150 12,5 Percent 140 Index 10,0 USD/BRL Index 2008 aug =100 130 7,5 120 5,0 110 2,5 100 CPI 0,0 90 05 06 07 08 09 10 11 Source: Reuters EcoWinHigh commodity prices have also benefitted Brazil’s economy asa major commodity producer and exporter. As in many otherlarge emerging countries, the service sector is developing into amore important growth engine. Value-added in productiongenerally has to be improved, however, since the trade surplus isnow based solely on price effects, not volume effects.Global developments pose the greatest risk to the Brazilian Weaker global growth,economy on both the up- and downside. Strong demand, high, trade and commoditystable commodity prices and modest capital inflows are prices are Brazil’sbenefitting the country. A trade war and protectionism would biggest risksadversely affect the outlook, however. It would be positive ifBrazil’s economic policy could successfully reduce inflation andinterest rates. If not, there is a risk of a hard landing later on, withan overheated domestic market and an inflated currency. Howwell exit strategies in other major economies are managed willalso be critical for Brazil. If changes are made too quickly, it couldendanger stability in Brazil.Swedbank’s Global Economic Outlook • 29 March 2010 29
    • Euro zone – Inflation concerns are hurtinggrowth • The recovery continues within the euro zone, but higher inflation and interest rates are slowing GDP growth slightly. • The debt crisis and weak institutions could still affect growth and financial stability. • The euro zone has to consolidate budgets, but that it also needs to strengthen competitiveness through reforms.After rebounding during the first half of 2010, GDP growth tailed Higher inflation andoff during the second half of the year. The reasons were the cold interest rates haveweather, the stimulus phase-out and a slight global slowdown. contributed to a slightThe outlook for 2011 and 2012 is slightly less positive than in our downward revision ofJanuary forecast, despite a stronger global recovery, including growthhigher demand from the US. Commodity price increases have ledto higher inflation at the consumer level, due to which theEuropean Central Bank (ECB) signalled that a period of higherbenchmark interest rates would begin as early as this spring(April). Owing to tighter monetary conditions, together with tighterfiscal policy in a number of countries, we are shaving a tenth of aper cent from our previous GDP forecast. GDP growth is nowestimated at 1.5% this year and next. The financial crisis andrecession have affected countries differently. Germany, with itscompetitive advantages, has regained its status as a stronggrowth engine, while countries in Southern Europe and Irelandare in need of major structural adjustments, which is inhibitinggrowth.GDP growth (%), inflation (%) and government debt (% of GDP) 4 85,0 Inflation 3 82,5 2 80,0 1 77,5Percent Percent 0 GDP Growth 75,0 -1 72,5 Soveriegn debt, % of GDP -2 70,0 -3 67,5 -4 65,0 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 06 07 08 09 10 Source: Reuters EcoWinAlthough the euro has been relatively strong, exports remainedan important growth engine. Investments are gradually takingover, but higher cost pressures could delay more balancedgrowth. If anything, our forecast of a weaker euro couldstrengthen net exports.30 Swedbank’s Global Economic Outlook • 29 March 2010
    • The big challenge for the euro zone is to combine debtrestructuring in the private and public sectors with tightermonetary conditions without threatening growth in domesticdemand. Private debt restructuring means capitalising banks andtrimming their balance sheets, along with cutting household debtratios. Public debt restructuring is a question of balancingbudgets and reducing the public debt-to-GDP ratio, which isheaded toward 100%.The financial markets used to treat the euro zone’s members First risk premiumscollectively with nearly the same risk premium on lending until were too small – anddifferences arose in connection with the financial crisis in 2008. now they’re too big?Premiums rose substantially in 2010 in connection with the crisisfirst in Greece and then Ireland. These countries have soughtand received help from the EU, ECB and IMF. Next in line ispolitically unstable Portugal, which is expected to seek help,especially if attempts to finance its debt in April and June provetoo costly. The financial markets still expect that Greek and Irishloans will have to renegotiated. The impact on European banks isunclear, but will be better understood when the results of thestress tests are reported in June (assuming that the tests areambitious enough this time). There are also expectations thatSpain may need a rescue package, although that seems to havedied down lately as Spain has reduced its dependence onfinancing from the ECB. The question is how the euro zone’sinstitutions can manage these expectations. Will the decisionsmade most recently on March 24-25 suffice?Differences between German and other European countries’ 10-year governmentbonds, percentage points 10 9 Greece 8 7 6 IrelandPercent 5 4 Spain Portugal 3 2 Italy 1 0 -1 UK France Belgium jan maj sep jan maj sep jan maj sep jan maj sep jan 07 08 09 10 11 Source: Reuters EcoWinThere is still not enough financing available through the Important details aboutEuropean Financial Stability Facility (EFSF), since its lending the euro zone’s crisiscapacity, now at 250 billion euros, would be insufficient if Spain, funds are still lackingfor example, should need help. There is an agreement toincrease the fund to 440 billion euros, but no details on how thiswill be done.The permanent fund to replace EFSF in 2013, the EuropeanStability Mechanism (ESM), has a lending capacity of 500 billioneuros. There is uncertainty how it will be financed, since it willinclude five instalments in 2013-17, part of which are guarantees(by the most creditworthy countries) and part are cash paymentsSwedbank’s Global Economic Outlook • 29 March 2010 31
    • that will impact national budgets (and which debt-riddenmembers may find difficult to afford). The reason that thepayments are spread out over five instalments is that Germanycouldn’t convince its voters to finance it in one lump sum.Last year Germany’s GDP grew by 3.6%, which was its highest Good momentum inlevel in many years and at the same time was a result of the big the German economydecline in the previous year, as well as stimulus measures.Domestic demand, including inventory build-up, was the biggestcontributor to growth, which also benefitted other countries in theeuro zone. We expect GDP growth to slow to 2.4% this year and1.9% next year. Less of a contribution from inventory will slow thegrowth rate at the same time that the improving job market couldgive a further boost to domestic demand. A higher inflation ratecould worry price-sensitive consumers, however, and incombination with slightly weaker income growth produce onlymodest consumption. Nevertheless, Germanys economicdevelopment has been positive: its budget deficit is expected tobe below 3% as early as this year (rather than next year, aspredicted), it remains a competitive force and growth isconsiderably higher than its potential of around 1-1.5%.France’s GDP fell by 2.5% in 2009, which was followed by weak No ambitious Frenchgrowth of 1.5% in 2010 – the same rate we expect during the recovery, but noforecast period. After net exports had been the driving force budget consolidationbehind growth, private consumption took over. We anticipate that eitherinvestments and consumption will be the most important drivers,although exports could benefit from Germanys strongdevelopment. Unemployment remains relatively high at just over9%. As a result, consumption growth and domestic inflationremain in check. Rising import prices are contributing to higherinflation, however. To date France has had a less ambitiousbudget consolidation goal, with a deficit estimated at 6% this yearand not reaching 3% until 2013. The risk is that weak growth anda lack of strong action will delay the budget consolidation.Italy’s GDP growth was just over 1% last year, and unlikely it will Political uncertaintysurpass that in 2011, when exports are slowed by weak demand could affect the pacein the euro zone – Italy’s most important export market – at the of reform and growthsame time that competition from emerging countries may lead to ratethe loss of market share. A weak labour market, low confidenceand political instability, and economic austerity, are expected tostifle private consumption. Italy’s reforms have been slowed bypolitical concerns, and a new election cant be ruled out this year.Spain has managed to calm the financial markets somewhat by Expectations of areducing its dependence on support from the ECB, although Spanish rescuethere are still concerns that a rescue package will be needed, not package have droppedleast due to the countrys many weak banks (cajas). Since it hasyet to resolve its crisis management needs in the short term,Spain has to continue to address its budget issues and introducestructural reforms, mainly to strengthen the labour market andpension system. We predict marginal growth this year, followedby a slight improvement to 1% next year, driven mainly by theexport sector.32 Swedbank’s Global Economic Outlook • 29 March 2010
    • UK – Austerity is slowing growth • The recovery in the British economy could get sidetracked when interest rates are raised at the same time that fiscal policy is sharply tightened. • We still expect the economy to grow by 1.5% in 2011 and 1.8% in 2012, but the risks are on the downside. • We anticipate that the BOE will not raise its benchmark rate until after this summer. Inflation could rise further before it starts to fall.The British economy is in tough shape in terms of both businessconditions and economic policy. GDP grew by 1.4% in 2010, butshrunk at the end of the year on a quarterly basis partly due tothe cold weather, which adversely affected the constructionsector.The driving forces during the recovery have been the public The recovery isn’tsector, inventory build-up and higher industrial production and robust, inflation isexports on the heels of a weaker pound and competitive rising and the budgetimprovements. At the same time households have been hurt by must be slashedweaker labour, housing and credit markets. They are still trying torestructure their debt at the same time that the public sector ismaking cuts to reduce budget deficits and the national debt.This, in combination with rising inflation, poses a difficultchallenge for policymakers, who have to begin tighteningmonetary policy at the same time that the budget consolidationintensifies. As a result, the risk of the double dip recession hasincreased. We still expect GDP to grow, but by a modest 1.5% in2011 and 1.8% in 2012.Labour trends, 1992-2010 30 6,3 Total employment Person (millions) Person (millions) 28 6,1 26 5,9 Public sector ---> 24 5,7 22 <---- Private sector 5,5 20 5,3 18 5,1 92 94 96 98 00 02 04 06 08 10 Source: Reuters EcoWinEmployment was still lower at the end of last year than before thecrisis in 2008. The expansion in the public sector continued untillast year, with a million more public workers than at the beginningof year. The austerity package that has now been proposed callsSwedbank’s Global Economic Outlook • 29 March 2010 33
    • for the elimination of up to a half-million public sector jobs. ManyBritish are worried about cuts to healthcare, education andwelfare, and demonstrators have taken to the streets in protest.The goal is to balance the budget in 2014-15, compared with the The pace ofcurrent deficit of around 9% of GDP. The cuts will intensify this consolidation seemsmonth, reaching about 2% of GDP this budget year, followed by reasonable – butausterity cuts of 1.4% in 2012-2013 and just over 1% in each of structural reforms arethe budget years 2013-2014 and 2014-2015. Some critics have neededclaimed that too many cuts will come at the beginning, before therecovery is robust enough. On the other hand, the governmenthas wanted to avoid a crisis similar to what the PIGS countriesare experiencing. Although outstanding government bonds havea relatively long maturity of 14 years, the debt is owned largely byforeign investors, which makes the UK more vulnerable thanJapan, for instance.Inflation and interest rates, 2005-2011 6 Policy interest CPI 5 rate CPI - services 4Procent CPI with 3 unchanged taxes 2 1 CPI, excluding energy, food, alcohol and tobacco 0 05 06 07 08 09 10 11 Source: Reuters EcoWinBOE chief Mervyn King has written several letters to ChancellorGeorge Osborne explaining why the inflation rate of 4.4% is morethan double the target of 2%. VAT rate increases in January2010 and 2011 were mentioned, as was the previously weakpound and substantially higher commodity prices. However, allCPI measures are above the inflation target, including underlyingmeasures.If monetary austerity begins as the negative effects of the fiscal It is reasonable not topolicy become evident, there is a greater risk that the recovery rush into rate hikescould fizzle. This would make it difficult to defend the latest“budget for growth” which was recently presented and could liveup to its name by gradually reducing the corporate tax rate to23% by 2015 as announced. The government has probablyexpected to receive the support of the central bank through acontinuation of its expansive monetary policy. We expect thecentral bank to sit tight during the spring and not begin a periodof cautious rate hikes until the fall. Inflation will slow, but it couldtake time.34 Swedbank’s Global Economic Outlook • 29 March 2010
    • 7. Conclusions for our home marketsA continued recovery, with higher but manageable inflation, isbenefitting businesses and households in our home markets,Sweden and the Baltic countries.Nevertheless it makes sense to prepare for the alternative The worst growthscenarios such as stagflation or renewed financial turbulence, scenarios requirewhich would affect demand in the real economy. The stagflation measures to raisescenario would require companies to deal with higher costs, productivityincluding by raising productivity and efficiencies through cheaperpurchasing solutions and smarter logistics. They wouldnt bewrong to re-evaluate their business models in times ofuncertainty about costs and growth prospects. Many will have toprepare for higher costs when competition for capital increases.Households have to think through their debt-to-equity ratios.Further reducing debt would give them better flexibility later onwhen interest rates are higher.Uncertainty also increases the importance of market analysis.Continuously analysing external risks allows companies tosharpen their strategic thinking.Countries that are now in crisis are implementing structural While others arereforms, which will eventually make them more competitive. Even implementingif this takes several years, countries that are now out front could structural reforms, it isquickly find themselves left behind after years of failing to easy to get passed byinstitute reforms. A structural transformation is under way, – despite betterespecially now that smaller emerging countries that have been in conditionscrisis can strengthen their positions, which increases competitionat home in segments where it hasn’t been as strong to date, i.e.,higher up the value chain.An optimal economic policy means creating sound competitiveconditions by combining efforts to strengthen or consolidategovernment finances with structural reforms that make marketsmore efficient. In Sweden, the focus is mainly on public finances,while reforms have lost steam. The labour market in particularhas major structural problems that must be addressed, includingyouth and long-term unemployment.Another conclusion is that it is important to strengthen We benefit ourselves ifcompetitiveness throughout Europe – and not in accordance with all of Europe becomesthe divisive competitive pact now being discussed. What is more competitiveneeded instead are measures to strengthen integration in theregion’s various product markets and capitalise on its advantagesin labour division and specialisation, especially in the servicesector, which is undeveloped from a regional perspective.Countries that rank high in terms of competitiveness, like Swedenand Estonia, have a lot to offer to speed up the pace of reform inEurope. Cecilia HermanssonSwedbank’s Global Economic Outlook • 29 March 2010 35
    • SwedbankEconomic Research Department Swedbank’s Global Economic Outlook is published as a service to our customers. WeSE-105 34 Stockholm, Sweden believe that we have used reliable sources and methods in the preparation of the analysesTelephone +46858597740 reported in this publication. However, we cannot guarantee the accuracy or completeness ofek.sek@swedbank.se the report and cannot be held responsible for any error or omission in the underlyingwww.swedbank.se material or its use. Readers are encouraged to base any (investment) decisions on otherLegally responsible publisher material as well. Neither Swedbank nor its employees may be held responsible for losses orCecilia Hermansson, +46858597720 damages, direct or indirect, owing to any errors or omissions in Swedbank’s Global Economic Outlook.Magnus Alvesson, +46 858593341Jörgen Kennemar, +46858597730ISSN 1103-4897