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Global Economic Outlook Q4 2012 by Deloitte


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  • 1. GlobalEconomicOutlook4th Quarter 2012
  • 2. Preface Global Economic He says that “plenty of things could go wrong” and that the UK is headed for a “shaky and tepid recovery.” Outlook In my article on Japan, I indicate that Japan’s economy remains on shaky ground. With severe external headwinds, a highly valued currency, continued deflation, declining real wages, and stag- nant consumer spending, Japan is not experiencing a significant recovery. Moreover, the central Q4 2012 bank has chosen not to expand its policy of quantitative easing despite falling prices. Finally, a political dispute with China appears to be having a negative impact on the industrial economy. Thus, the outlook for Japan is not especially good. Ira Kalish, Deloitte In his article on India, Pralhad Burli discusses the fact that India’s economy is operating below potential. He says that the outlook for a return to high growth Global Economic Outlook Research in the United States Will 2013 Be a Turning Point? published quarterly by is not especially good. The country faces a number of downside risks, including (Deloitte Services LP) Deloitte Research uncomfortably high inflation, which has restrained the central bank; external headwinds; and an uncertain policy environment. On the other hand, the govern- Editor-in-chief ment has proposed several new reforms that, if enacted, would likely lead to better Ira Kalish long-term growth. The problem is that severe political opposition remains. Thus, I t has probably been said too many times, but it is worth repeating now. The world economy is at a uncertainty prevails. Managing editor crossroads. Every major region seems to be at a potential turning point. In Europe, the leaders of Next, I discuss the outlook for Russia. Against the wind of much of the global Ryan Alvanos the Eurozone are moving slowly toward more integration, while periodically fighting back against economy, Russia’s central bank is tightening monetary policy in order to restrain Contributors new crises. In the United States, slow growth continues, but various forces seem destined to push inflation. In the midst of a global slowdown, this is likely to lead to a slowdown in Pralhad Burli the economy either toward recession or faster growth. In China, the economy has landed softly, growth. Indeed, there are signs that this is already happening. Alexander Börsch but the next steps depend on the decisions of a new leadership. And in India, the government has Brazil, on the other hand, is moving in a different direction. In my article on Carl Steidtmann attempted to kick-start the reform process just as the economy seems to have stalled. At the very Brazil’s economy, I note that the central bank has cut its benchmark interest rate Ian Stewart least, the next year will be an interesting one. by over 500 basis points in the past year. It has clearly chosen to focus on growth Editorial address In this issue of the Global Economic Outlook, our economists from around the world offer their rather than inflation, which remains above the central bank’s target. The outlook, 350 South Grand Street perspectives on these and other issues. First, Alexander Borsch discusses the Eurozone situation. therefore, is for stronger growth next year. The most notable short-term issue is Los Angeles, CA 90013 He notes that, while the crisis appears to have ebbed in the wake of new policies by the European the potential impact of US monetary policy on Brazil’s exchange rate. Tel: +1 213 688 4765 Central Bank, the underlying problems remain unresolved. He suggests that, other than collapse, Finally, Neha Jain and Satish Raghavendran offer a perspective on the econ- the Eurozone has four options to move forward. These range from modest efforts to enforce existing omy of South Korea. At a time when South Korea has achieved an enviable level constraints to full-scale integration in the form of a political union. of affluence, it now faces short-term obstacles to growth. With export demand Next, Carl Steidtmann looks at the US economy and notes that the situation is historically weakening, the domestic economy is at risk due to excessive consumer debt, accumulated to fund unique. That is, never before has growth “been so anemic for so long.” He demonstrates that, histor- an increasingly consumer-driven economy. Longer term, Neha and Satish point out that South ically, such slow growth usually leads to a recession, or sometimes to accelerated growth, but never Korea needs to shift the focus of its economy away from manufacturing in favor of services. to simply more of the same. Thus, we appear to be in new territory. He suggests that the economy has been the beneficiary of “luck and resilience” that are likely to be severely tested in 2013. This will be due to a range of factors, including fiscal policy, headwinds from Europe, and risky mon- etary policy. Consequently, he sees a high risk of recession. In my examination of China’s economy, I point to evidence that a soft landing is underway. Moreover, I suggest that the current policy regime is likely to modestly boost economic output Dr. Ira Kalish in the coming months. Yet many questions remain, not the least of which concern the policy Director of Global Economics Deloitte Research choices to be made by the incoming leadership. As such, there is some degree of uncertainty about China’s outlook. In his article on the British economy, Ian Stewart says that the UK may be turning the corner but not perhaps in the way that many would like. He says that although growth should resume in 2013, the situation warrants concern, given all the remaining problems—both external and internal.2 3
  • 3. Contents 6 Geographies India: Cautious Optimism | 30 30 Uncomfortably high inflation, external headwinds, and an uncertain Eurozone: Four Models for Future Governance  6 policy environment are adding downside risk to India’s economy, which is operating below its potential. The government has proposed The Eurozone’s crisis appears to have ebbed after the European Central several reforms that could improve long-term growth, but political Bank’s recent policy responses. However, many of the region’s underly- opposition is adding a dose of uncertainty to India’s economic outlook. ing problems remain unresolved. Discounting a complete collapse, the Eurozone has four fundamental governance models to choose from. Russia: Slowing Down | 36 12 United States: Uncharted Waters | 12 Despite a global economic slowdown, Russia’s central bank decided to tighten monetary policy in an attempt to curtail inflation. This may 36 The US economy has benefitted from a combination of luck and resil- lead to a slowdown in growth. ience, and ongoing anemic growth in the United States is historically unprecedented. A wide range of factors, including fiscal policy, head- winds from Europe, and risky monetary policy may loom over the US Brazil: Chasing Growth | 38 economic outlook into 2013. Brazil’s central bank decided to focus on growth rather than inflation, which will likely result in stronger growth next year. The US monetary China: When Exports Decline | 20 policy could have a significant impact on Brazil’s exchange rate. 20 The current policy regime may continue to boost economic output in the coming months, paving the way for a soft landing. Uncertainty pertain- Korea: S(e)oul Searching | 42 38 ing to China’s economic outlook stems from the policy choices that will South Korea has achieved an enviable level of affluence, but weaken- be made by the country’s incoming leadership. ing export demand and excessive consumer debt may put the brakes on economic growth. In the longer term, South Korea may need to United Kingdom: Turning the Corner, Slowly | 22 consider a move away from manufacturing in favor of developing a service-based economy. The United Kingdom’s current downturn is likely coming to an end, but myriad internal and external problems remain, which could result in a shaky and tepid recovery. 22 Appendix 42 Japan: An Elusive Recovery | 26 External headwinds, a highly valued currency, continued deflation, stagnant consumer spending, and declining real wages are hindering Charts and Tables | 46 Japan’s economic recovery. Furthermore, despite falling prices, the gov- GDP growth rates, inflation rates, major currencies vs. the US dollar, ernment has decided against expanding its policy of quantitative easing, yield curves, composite median GDP forecasts, composite median cur- and a political dispute with China is having a negative impact on Japan’s rency forecasts, OECD composite leading indicators industrial economy. 264 5
  • 4. Eurozone GeographiesEUROZONE Dr. Alexander Börsch is Head of Research, Deloitte Germany Eurozone: Four Models for Future Governance by Dr. Alexander BÖrsch T he euro crisis is now officially in its fourth year. It started in October 2009 when the Greek government admitted that its budget a renewal of the Eurozone’s original guid- ing principles with a focus on member state responsibility to a political union with nation- of the German constitutional court that the euro rescue strategy is in principle consistent with the German constitution, given certain fact that there is no clear vision about where the Eurozone is heading in terms of gover- nance structures and architecture. The euro deficit was much higher than it previously state-like features. limitations, removed doubts about the future crisis includes a debt crisis, a banking crisis, stated. In the years that followed, the crisis not In early October, the euro looks as if it is of the rescue mechanism. The Dutch elections a growth crisis, and a competitiveness crisis. only deepened in Greece and spread to other on a slow road to recovery, at least measured resulted in a stable pro-euro coalition. Taken That is why it is unrealistic to hope for grand countries, it also exposed serious flaws in the against recent expectations. Many experts con- together, and contrary to more apocalyptic bargains and comprehensive solutions to cut governance of the euro and the Eurozone. sidered September to be the decisive month for predictions made during the summer months, the Gordian knot. However, a clear vision for There are basically four options to reform the fate of the euro, and expectations tended to early autumn has been a comparatively quiet the future of the Eurozone’s governance struc- the Eurozone’s governance. The two main be pessimistic. From that perspective, things time for the Eurozone. tures is a precondition for political action and dimensions that will determine the future developed fairly well. The decision of the However, this situation is not a reliable for kicking the can in the right direction. shape of the Eurozone are the possible com- European Central Bank to renew its bond pur- predictor of future events. Part of the dif- binations of extended political integration chase program has reassured the financial mar- ficulty in solving the euro crisis is due to the and fiscal transfers. The options range from kets and bought important time. The decision 6 7
  • 5. Global Economic Outlook: 4th Quarter 2012 Eurozone Geographies Is there a light at the end deteriorating. The ifo Business Climate Index Figure 2: Current account [% of GDP] of the recession tunnel? continued to fall in October, the sixth consecu- 10 tive monthly decline. At first glance, no. The latest data on the Nevertheless, there are some cautious signs France 5 economic sentiment in the Eurozone reinforce that reforms in the crisis countries are begin- Germany the trend of the last months. The European ning to gain traction and yield positive results. 0 Greece Economic Sentiment Indicator, which mea- Among these are the reduction in the current Ireland sures the outlook on the part of business, account deficit and the improvement in price -5 Italy consumers, industry, and services, continues competitiveness. Unit labor costs in Greece, -10 Spain to decline for the Eurozone as a whole as well Spain, and Ireland have fallen quite substan- as for the crisis countries, with the exception tially and are forecasted to continue to do so Eurozone -15 (17 countries) of Spain. Also, the outlook for Germany is (see figure 1). -20 Figure 1: Unit labor costs 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 [2000 = 100] Source: OECD 140 Germany Eurozone resort to devaluations. Second, rules to prevent future crisis and support the way out of the 130 Greece excessive budget deficits in the form of the current crisis. Spain Maastricht criteria are enough to guarantee the Conceptually, there are two main dimen- 120 France stability of the euro. Third, specific provisions sions of Eurozone reform. The first is politi- Italy for crisis management are not needed. Crises cal integration. The question is whether the 110 Ireland will not happen if members stick to their obli- Eurozone needs deeper political integration gations and follow the Maastricht rules. and a transfer of decision making to the 100 The euro crisis has made it blatantly obvi- European level or whether the primacy of ous that these assumptions do not hold any the member states needs to be preserved and longer. Crisis management has become the strengthened. The second dimension concerns 90 almost-exclusive focus of European political fiscal transfers between member states. Fiscal 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Eurostat leaders. The rules of the Maastricht treaty have transfers can, in principle, be used for emer- prevented neither excessive budget deficits nor gency measures or in an institutionalized form. the resulting threats to the euro. The euro did not initiate a broad dynamic toward reforms Options for the Eurozone Equally remarkable is the development of other main pillar is the governance of the and higher competitiveness. The burning ques- Combining these two dimensions in the current account deficits of the crisis coun- euro itself. tion, therefore, is how to redesign and amend a matrix illustrates the main options for tries. Greece managed to reduce its current the euro’s governance structure to prevent European policy makers. account deficit from an extremely high level. Governing the Eurozone Spain achieved the same, and Ireland managed Fiscal transfers between member states to turn its deficit into a surplus (see figure 2). The institutional architecture of the In other words, fundamentals are beginning Eurozone was built on three main assumptions. Low High to improve. While this is not yet reflected in First, mechanisms compensating for the loss Degree of further business expectations, the conditions for an of the exchange rate as an adjustment tool are political integration Low Maastricht 2.0 Emergency union improvement are being built. not needed. Countries will adjust to the new High Coordinated association Political union While reforms in the crisis countries are currency regime by internal reforms and will crucial for a recovery in the Eurozone, the modernize their economies once they cannot8 9
  • 6. Global Economic Outlook: 4th Quarter 2012 Eurozone Geographies Maastricht 2.0 While it is obvious that the European sanction mechanisms; the method works similar intention, and so has the European The original Maastricht treaty from 1992 Union cannot become a nation-state overnight, mainly through peer pressure. Stability Mechanism, the main instrument to includes three main elements: it could assume the functions of a nation-state A greater coordination of the economic guarantee the liquidity of governments that in key areas to guarantee the survival of the policies of member states would require lose access to financial markets. • Member states must not run a budget defi- euro. These key functions would include a enlarging the scope and the depth of coor- Whether this approach can work and bring cit of more than 3 percent of GDP. banking union, common deposit insurance, dination, as well as pal- the euro into shallow at least some mutualization of debt, and larger pable sanctions. Areas that waters depends on • They must have a debt level of no more redistribution through fiscal transfers between offer themselves to greater whether the crisis is than 60 percent of GDP. the Eurozone’s member states. coordination in order to due to a temporary These moves would imply a centralization support a smooth function- exceptional situation • Eurozone members should not be liable for, of fiscal policies and therefore a much stronger ing of the euro include wage or to deeper insti- nor assume, the commitments or debts of role of the EU in fiscal policy, if not a European policy, pension policy, and tutional flaws in the any other member state. finance ministry with corresponding compe- fiscal policy. For example, governance of the In this original Maastricht framework, tencies. As this would touch upon the core a coordinated association Eurozone. If the lat- it is the member states that are exclusively functions of national parliaments, a political could aim at preventing the ter is true, the case- accountable and responsible for healthy union might need to follow to ensure demo- emergence of large imbal- by-case approach is public finances. As long as the rules work, the cratic control. In other words, in economic and ances in the Eurozone by unlikely to work, and stability of the euro is not threatened as over- financial matters, the EU would become the mutually adjusting national bridge financing is indebtedness and resulting instability cannot main actor and decision maker. While there economic policies. not enough to let the be an issue. are many proposals and plans on how and in storm pass. However, the rules obviously failed, and which areas European integration should move Emergency union the main elements of the original Maastricht forward, concrete steps have not been taken, Outlook provisions, such as the debt ceilings, are under and workable plans have not been developed. The model of an emer- pressure. Others, such as the no-bailout clause, gency union comes quite The most con- have been totally pushed aside. The option of a Coordinated association close to the current working sistent options of Maastricht 2.0 scenario would need to include of the Eurozone in the face the four are the strengthening the original provisions, ensuring Currently, the European Union is a com- of the crisis. It is a series of Maastricht 2.0 sce- compliance, and providing a framework that plex combination of national, supranational, rather unsystematic emer- nario and the political puts national responsibility for public finances and intergovernmental decision making. gency measures that try to union as they define first. This implies that future crises of the euro While the big political decisions regarding prevent the worst on a case- clear responsibilities are to be prevented by an improved version the Eurozone are taken in the Council of by-case basis. The worst, of for decision making, of the original framework. Some of the recent the European Union by the national govern- course, is a fragmentation of either on the level of reforms in the EU—above all, the debt brake— ment leaders, the day-to-day business in the the Eurozone. This process the nation-state or on go arguably in the direction of Maastricht 2.0. EU’s areas of competence is carried out by does not have a well-for- the European level. the European Commission. National eco- mulated goal, but is highly Both are ambitious. Political union nomic policies remain firmly in the hands of event-driven. The Maastricht 2.0 national governments. While it is true that the would need to address A future political union is being widely To be sure, there have been some attempts European Union has been and overcome obvious discussed. It builds on the idea that the funda- to achieve a higher coordination of national built in times of crisis and that a step-by- weaknesses in the old institutional architec- mental reason for the euro crisis is the fact that economic policies. The last decade saw the step process is not a bad thing in itself, the ture. The formation of a political union would there is no nation-state standing behind the introduction of the “open method of coordina- question is whether the measures add up to imply a transfer of authority unseen in the his- euro that defends it unconditionally. So, saving tion.” This method aims at directing national something that prevents future crises. So far, tory of the nation-state with many foreseeable the euro may require the establishment of a policies toward common and agreed goals. It the bailouts—especially in the case of Greece— and unforeseeable challenges. The main issue, European nation-state—or at least something rests on instruments such as evaluation and bought time, tried to keep states liquid, and however, is what the preferred option for the that resembles a nation-state. benchmarking of policies. There are no hard forced them to introduce reforms. The ECB’s future of the Eurozone actually is. announced bond purchase program has a10 11
  • 7. United States GeographiesUSA Dr. Carl Steidtmann is Chief Economist at Deloitte Research United States: Uncharted Waters by Dr. Carl Steidtmann F rom the performance of the US economy to the unprecedented policy mix being employed to address the current malaise, the growth has neither accelerated nor fallen into recession. What is also unprecedented about the United States is in uncharted economic waters. weakness of the current recovery is that it is The US economy’s performance over the past following a deep recession. Historically, deep 18 months has been unprecedented. There recessions create pent-up demand. During has never been a time when growth has been a recession, businesses put off investments, so anemic for so long. There have been 14 and inventories are drawn down. Consumers instances since the end of the Second World put off purchases of cars and homes. Young War when real economic growth fell to less people stay at home with their parents, put- than 2 percent. In 11 of those cases, a reces- ting off marriages and delaying the process of sion followed within two quarters of hitting household formation to save money. When a the 2 percent stall level. In three cases, expan- recovery comes, much of this pent-up demand sion reaccelerated. This is the first case where gets released, producing a strong recovery. In 12 13
  • 8. Global Economic Outlook: 4th Quarter 2012 United States Geographies the three years following the end of the Great The performance of the labor force has also However, the mix of the decline in overall Figure 3: Real per capita disposable income Depression in 1933, real GDP rose a sizzling been uncharacteristic. Throughout the past labor force participation does not fit the nar- Five-year growth 38.9 percent. That has not been the case this 50 years, labor force participation has risen rative of retiring baby boomers. Over the past Percentage change over the past five years time; growth is up a modest 5.8 percent in the as women and baby boomers moved into the five years, even as participation rates for other 25 two and a half years since the end of the reces- work force. With the baby boomers approach- age cohorts have fallen, boomers have lingered sion, which is the slowest pace of growth for ing their retirement years, one would expect in the labor force. Since the beginning of the 20 any recovery since 1948 (see figure 1). labor force participation to begin to fall. last recession in December 2007, labor force participation among the 55–64-year-old cohort 15 has actually risen slightly from 69.2 to 69.6 (see figure 2). 10 Figure 1: Real GDP change—recession and recovery % change Over the same period of time, participa- 5 25 Recession 10 quarters of recovery tion among 16–24-year-olds has plummeted from 61 to 55.6. Of the 4.3 million jobs created 0 20 since 2010, nearly 3 million of them went to workers over the age of 55. The inability of -5 15 young people to gain a footing in the labor 1964 1970 1976 1982 1988 1994 2000 2006 2012 market will stunt their career development Source: US Bureau of Economic Analysis 10 and earning power for years to come. It will also make it more difficult for them to service Household net worth In trillions of dollars 5 their student loans. The default rate for the first three years on student loans has jumped $120 80.0 0 billion or roughly 13.4 percent of all outstand- 70.0 ing student debt. 60.0 -5 1948 1953 1957 1960 1969 1973 1981 1990 2001 2007 A falling standard of living 50.0 Source: Bureau of Economic Analysis 40.0 Weakness in the labor market has translated 30.0 into an unprecedented decline in the standard Figure 2: Labor force participation Percentage of the cohort population of living (see figure 3). Real per capita income 20.0 has dropped over a five-year period for the first 10.0 75.0 time in the post-World War II era not once but twice in the past five years. Slow job growth 0.0 1964 1970 1976 1982 1988 1994 2000 2006 2012 70.0 coupled with declining labor market partici- Source: Federal Reserve Board of Governors pation has made for a toxic combination for income growth. In addition, record low inter- 65.0 est rates have cut deeply into interest income, 60.0 Over 16 55 to 64 55.0 16 to 24 50.0 1997 2000 2003 2006 2009 2012 Source: US Department of Labor14 15
  • 9. Global Economic Outlook: 4th Quarter 2012 United States Geographies sending it down from $1.4 trillion in May 2008 The Fed’s response the previous efforts at QE, this one has no end give a boost to exporters, it will result in higher to $986 billion in August 2012. Faced with a weak labor market and a date and no set amount. The Fed will buy $40 import prices, particularly for energy. In addition to the decline in per capita declining standard of living, the Federal billion in Treasuries and mortgage-backed The case for quantitative easing is that by income, the household sector has also experi- Reserve’s response to the current business con- securities every month until unemployment suppressing interest rates, the Federal Reserve enced an unprecedented decline in net worth. ditions has also been unprecedented. Founded falls below a level that is deemed acceptable by will force investors to take more risk in both After peaking at $67.3 trillion in the third in 1913, it took the Federal Reserve 95 years to the Fed. Most Fed watchers expect QE3 to go the bond market and the stock market. The quarter of 2007, household net worth fell to grow its balance sheet to just under $1 tril- on through 2013 at the very least, resulting in reduction in interest rates and the increase in lion. In the fall of 2008, in a $600 billion expansion of the Fed’s balance investor risk taking will give a boost to assetFigure 4: Federal Reserve’s balance sheet response to the collapse of sheet at the very least. prices in the housing market, the stock market,Trillions of assets Lehman Brothers, the Fed Quantitative easing is not a risk-free policy. and the bond market. The corresponding rise pursued its first round of Printing money for the purpose of buying in wealth from these three developments will 3.50 quantitative easing (QE), government debt risks higher inflation and a bring about a recovery in the housing market purchasing a wide variety weaker dollar. While a weaker dollar would and induce consumers to spend more and 3.00 of financial assets in the businesses to invest more. process of doubling its balance sheet to just over 2.50 $2 trillion (see figure 4). The purpose of the first round of QE was to 2.00 provide liquidity to the banking system that was 1.50 reeling from the shock of the Lehman bankruptcy. In the fall of 2012, the 1.00 Fed initiated a second round of quantitative easing, adding another $1 0.50 trillion to its balance sheet through the purchase of 0.00 mortgage backed secu- 2007 2008 2009 2010 2011 2012 rities and US Treasury bonds. While the bank- ing system no longerSource: Federal Reserve Board needed liquidity, the Fed’s objective was to lift $51.2 trillion in the first quarter of 2009, a asset prices in an attempt to encourage invest- stunning $16.1 trillion destruction of wealth. ment from banks and businesses and spending Since then, wealth has climbed due entirely to from consumers. the rise in the value of financial assets. Even Two years later, with unemployment still with the rebound, net worth is still down $4.7 above 8 percent and the economy still growing trillion from its peak, and it actually fell by at a subpar rate of growth, the Fed has initiated $300 million in the second quarter of this year. a third round of quantitative easing. Unlike16 17
  • 10. Global Economic Outlook: 4th Quarter 2012 United States Geographies Figure 5: The fiscal cliff components The downside argument against more quan- Taken together, the tax increases and In billions of dollars titative easing is that it results in a mispricing spending cuts that make up this year’s fiscal of risk. It reduces the income of retirees who cliff come to roughly $600 billion. While there depend on low-risk, interest-bearing assets. is no guarantee, there does seem to be some $250 $221 It also gives a boost to the price of food and agreement on at least some of the elements energy, reducing the purchasing power of of the fiscal cliff. Both sides are on record as $200 all consumers. favoring a phase out of the payroll tax cuts. The 2 percent payroll tax holiday that went into $150 The fiscal cliff effect in 2010 represents roughly $95 billion in $105 $95 additional taxes. The automatic minimum tax $100 The debate in gets bigger every $65 $65 “ the United States year. The fix for $50 $18 $26 over fiscal policy the automatic $11 revolves around If the fiscal cliff isn’t minimum tax $0 the pending plus the “Doc fix” s s s s n s fix ts ut ut fit fiscal cliff (see addressed, as I’ve said, I for Medicare are sh tax c ll t ax c he rt a xe ca r et axe ue str atio sb en e Do c d ing cu figure 5). What also likely to gain ro Ot q ble s en Bu ay ble Se p is remark- don’t think our tools are bipartisan sup- P Af fo rda Jo Ot he rs able about this port as they have debate is how strong enough to offset in the past. Source: Congressional Budget Office unremarkable The big stick- it really is. Over the effects of a major fiscal ing point will be the past decade, extending the more and more shock, so we’d have to Bush tax cuts significant increase in the fiscal contraction off into uncharted waters. Current monetary of the tax code for high-earning and a sharp recession in early 2013. policy risks higher inflation and lower incomes has become a think about what to do in households. This for retirees and lower spending power for ” part of a year- was the point of Conclusions and observations everyone else. The fiscal cliff impasse all but end dance that contingency.” contention back guarantees a more restrictive fiscal policy and between political in August 2011 The US economy has shown a combination potentially another credit downgrade. Sluggish parties, making —— Ben S. Bernanke, Federal Reserve chairman that led to the of luck and resilience in avoiding a recession employment growth, declining labor force longer-term tax downgrade of while growing well below its potential for the participation, and shrinking real incomes are and investment US debt by the past 18 months. That resilience and luck are a dangerous combination that could push the planning for businesses and individuals more credit rating agencies. A second impasse over going to be tested in 2013 as the economy sails economy into recession in 2013. challenging. In most years, indexing of the this issue could result in another downgrade. automatic minimum tax and various invest- While the outcome of the fiscal cliff debate ment and R&D tax credits were among these remains uncertain, at the very least, it seems items. Medicare’s “Doc fix” also seemed to certain that the United States will face much require a yearly vote. tighter fiscal policy in 2013 than it has in Three factors make this year’s fiscal cliff recent years. With an economy growing near 2 debate different: one is size, the second is tim- percent, tighter fiscal policy will slow growth ing, and the final issue is the reaction of the in the short term. A failure to resolve any of bond rating agencies. the issues of the fiscal cliff could result in a18 19
  • 11. China GeographiesCHINA China: When Exports Decline by Dr. Ira Kalish C hina’s economy is slowing down, but a soft landing is still a possibility, thanks to various measures undertaken by the govern- Industrial production was up a relatively mod- est 8.9 percent in August. Automobile sales were up 8.3 percent in August, far slower than ment that are helping to offset economic the pace of the last few years. All of this news headwinds from Europe. Just the same, the suggests that China’s economy is weaker than to hold the currency steady. Evidently, China’s actions. The central bank cut the benchmark country is experiencing an abundance of bad expected, and the anticipated rebound is not authorities are averse to allowing currency interest rate and reduced banks’ required news. In September, for example, HSBC and yet here. It also boosts expectations that the depreciation as it would likely draw criti- reserves, thereby boosting bank lending. In Markit published a purchasing manager’s index Chinese authorities will engage in further mea- cism from foreign governments. Given this addition, the government has increased public that suggests that Chinese manufacturing was sures to stimulate the economy. political climate, China’s central bank has been investment in infrastructure. in negative territory for the 11th consecutive Meanwhile, weakness in the industrial sec- intervening to keep the currency steady by The result of these measures has been month. The PMI was 47.9 in September com- tor is having a negative impact on investment trying to mitigate rising inflation and declin- positive. China’s government announced that pared to 47.6 in August; a reading below 50.0 into China. In August, China experienced ing currency that could kindle political unrest. new local currency lending increased by $111 indicates a decline in activity. The weakness a net outflow of capital for the third time in Yet at the same time, it is assuring that money billion in August, the biggest August increase was largely related to poor export performance. 2012. This means that investors are moving supply growth continues at a moderate and on record. This is very likely due to the recent The sub-index for export orders reached its money out of China, perhaps as a result of the rising pace. cuts in interest rates and the reduction in lowest level in 42 months, and the sub-index declining profitability of Chinese companies One effect of the weakening industrial banks’ required reserves. Indeed, the broad for employment was also in negative territory. and pessimism about the Chinese economy. sector is a decline in Chinese company profit- money supply increased 13.5 percent in August Exports are the primary culprit. China’s To facilitate the outflow and prevent a drop in ability. The profits of China’s industrial com- from a year ago. Increased lending is welcome, government reported that total exports were the value of the currency, the central bank sold panies fell in August for the fifth consecutive given that several indicators have lately been up a very modest 2.7 percent in August from foreign currency. The central bank is boosting month. Profits were down 6.2 percent from a disappointing. The question now is whether a year earlier. Exports to the EU were down domestic credit in order to offset the negative year ago, the fastest rate of decline this year. the government will choose to take further 12.7 percent from a year earlier, and Chinese impact on the money supply of sales of foreign Corporate revenue continues to increase, but actions aimed at stimulating the economy. imports fell 2.6 percent in August to their currency. When a country experiences a net export-oriented companies are struggling to With a change of leadership about to take place weakest performance since 2009. This was outflow of capital, it either leads to a decline maintain sales by cutting prices, resulting in in Beijing, major decisions may be put on partly due to declining commodity prices, but in the value of the currency or a decline in the weaker profitability. hold until the new leaders have time to assess it also reflected weakening demand in China. money supply if the central bank intervenes To deal with the slowdown in economic the situation. activity, the government has taken a variety of 20 21
  • 12. United Kingdom GeographiesUK Ian Stewart is Chief Economist at Deloitte Research in the United KingdomUnited Kingdom: Turningthe Corner, Slowlyby Ian Stewart T he last five years have seen the worst growth performance by the UK economy since the 1920s. The UK economy saw a deep was the hallmark of most postwar boom bust cycles. The United Kingdom has also escaped Great Depression levels of unemployment. recession in 2008–2009 and entered a milder Indeed, employment has risen for the last second recession in the last quarter of 2011. three years as job growth in the private sector The current cycle’s GDP levels are comparable has outstripped public-sector job losses. Ben to those of the 1920s. However, this compari- Broadbent, a member of the Bank of England’s son overstates the degree of stress facing busi- Monetary Policy Committee, recently observed nesses and households today. that, had the normal, pre-recession relation- Low interest rates and forbearance on the ships held, the number of jobs in the United part of lenders have helped soften the damage Kingdom would have fallen by 8 percent over to the economy in recent years. UK interest the last five years. Instead employment has rates and government bond yields today are stayed roughly unchanged. The result is that at the lowest level since the foundation of the the UK unemployment rate today is well below Bank of England in 1694. Debtors have not the peaks seen in the previous, milder UK faced an acute interest-rate squeeze, which recessions of the ’80s and ’90s.22 23
  • 13. Global Economic Outlook: 4th Quarter 2012 United Kingdom Geographies Relatively low unemployment has helped inflation has almost halved in the last year to on a UK recovery, which is widely expected shape today, and the larger corporates who support consumers during a period of acute 2.5 percent—should lend additional support to to be powered by demand for British exports responded to the CFO survey are not espe- difficulties. Other factors are also becoming consumer spending power. from abroad. cially constrained by cash or capital shortages. more positive for consumers. Most of the big The outlook for a battered consumer sector While the UK consumer outlook has The big problems seem to be the weakness tax rises are past. Sharply lower inflation—CPI is starting to look up. Real disposable incomes brightened marginally and corporates are of Europe’s economies and a climate of mac- have risen 1.7 percent over the last year, having continuing to roeconomic declined through 2011. And consumer spend- hire, businesses uncertainty. ing is rising once again. Given that consumer spending accounts for over 60 percent of the remain cautious. The third-quarter The universal assumption After successive waves of bad UK economy, an upturn in consumer activ- ity should lend significant support to growth Deloitte Survey of UK Chief among economists—at least macro news fol- lowed by policy next year. The universal assumption among econo- Financial Officers suggests that big for now—is that the worst has stimulus and equity rallies, mists—at least for now—is that the worst has passed for the UK economy. All 37 indepen- corporates increas- ingly subscribe passed for the UK economy. UK corporate CFOs may need dent forecasting groups that provide GDP to the notion that some convincing forecasts to the Treasury expect UK growth we are in a low- to turn signifi- to bounce back in 2013. Most believe that the growth world. Perceptions of macro-uncer- cantly more positive on expansion. current slowdown in the United Kingdom is tainty and of the risk of continued recession The United Kingdom’s current downturn drawing to an end, and that steady growth will are widespread. Corporates are increasingly seems to be drawing to an end. Growth should resume in the first quarter of next year. focusing on defensive balance-sheet strategies, pick up next year. But, as the continued dif- ut a better test is what kind of growth including cash generation, cost control, and ficulties in the euro area highlight, plenty of is expected next year. The news here is not leverage reduction. things could go wrong. For now, the United encouraging. Consensus forecasts for UK GDP In 2008, a combination of a shock to Kingdom seems to be heading for a shaky and growth for 2013 have dropped from 1.8 per- demand and a credit crunch caused a deep tepid recovery. cent to 1.3 percent in the last four months—a recession. The financial system is in far better pretty weak rate of growth for an economy used to growing at 2.5 percent a year. Our guess is that most economists would say that the risks to their UK growth forecasts lie on the downside. Many of the problems facing the United Kingdom exist elsewhere in the world. After a lull over the summer, worries about the euro area are growing. Hopes that a bond-buying program by the European Central Bank would crack the euro’s problems have dissipated. Meanwhile, the United States may be on course for sharp tax hikes and cuts in public spending in three months’ time. Unless politicians strike a postelection deal, the so-called fiscal cliff could derail America’s recovery. Such exter- nal uncertainties constitute a significant drag24 25
  • 14. Japan GeographiesJAPAN Japan: An Elusive Recovery by Dr. Ira Kalish J apan’s economy has been mostly sluggish for some time, despite the increased govern- ment spending on reconstruction following The government also reported that the compensation of workers continues to decline, with total wages to workers in Japan in the last year’s earthquake and tsunami. Although second quarter only marginally higher than in there have been periodic bursts of economic 1991—21 years ago. This means, of course, that activity, such as the 5.5 percent growth rate in unit labor costs are declining, thereby improv- the first quarter of this year, growth has mostly ing the competitiveness of Japanese products. been disappointing. For example, the Japanese Yet that improvement is largely offset by the government reported that the economy grew negative impact of a highly valued Japanese at an annual rate of only 0.7 percent in the yen. On the other hand, declining wages second quarter. This was revised down from contribute to declining purchasing power the original growth estimate of 1.4 percent and stagnant consumer spending. This wage in the second quarter. The slow growth was decline also contributes to deflation, which largely due to weak private investment as well remains a serious problem in Japan. as weaker-than-expected public spending This begs the question of whether the on reconstruction. central bank will act according to its goals. The Bank of Japan has set a formal inflation target 26 27
  • 15. Global Economic Outlook: 4th Quarter 2012 Japan Geographies of 1.0 percent, yet prices continue to decline the Bank of Japan chose to leave its asset This unexpected increase could bode well for brand vehicles in China dropped sharply. despite a more aggressive monetary policy. For purchasing program unchanged at 55 tril- capital spending in the months ahead. While the vehicles are mostly assembled in the past year, the Bank of Japan has engaged in lion yen (US$700 billion). In addition, the Just at a time when the Japanese economy China, many of their parts are made in Japan. quantitative easing: the bank purchases assets Bank of Japan downgraded its assessment of hardly needs bad news, the political dispute Consequently, if this dispute results in a sus- such as government bonds in order to inject the outlook for growth and inflation, saying, between Japan and China over a group of tained decline in Chinese demand for Japanese liquidity into the economy. The idea is to boost “Economic activity is leveling off.” Unusually, islands is starting to have a real impact on the products, it could have real consequences for the money supply, thereby creating some infla- the economy minister attended the latest meet- economy. Japan’s major automotive companies Japan’s already troubled industrial sector. tion. Other goals include keeping market inter- ing of the bank’s policymaking committee. He report that, in September, sales of Japanese est rates low and putting downward pressure said that he wanted to express his “sense of on the value of the yen. Yet the policy, which crisis” to the bank. Clearly he failed to move involved purchases of 45 trillion yen worth of the bank toward a more aggressive stance. Still, assets (roughly US$570 some observers now believe billion), has yet to that the bank will boost the result in any inflation. Japan’s major quantitative-easing policy at Perhaps that is because its next meeting, especially if it is not very aggres- automotive it continues to downgrade its sive compared to what assessment of inflation. has been done by the companies Meanwhile, some indica- US Federal Reserve or tors suggest that the health the Bank of England. report that, in of the Japanese economy is Consequently, on not improving. The well- September 18, 2012, September, sales known Tankan survey, the Bank of Japan which measures confidence boosted its program of of Japanese brand among manufacturers, quantitative easing by declined in September. This 10 trillion yen, demon- vehicles in China was the fourth consecu- strating that the bank tive decline in this quar- is concerned about dropped sharply. terly measure. In addition, continued deflation exports fell in August for the and a high-valued yen. third consecutive month, It also means that the bank recognizes that the declining by 5.8 percent year over year, and Federal Reserve’s new third round of quanti- imports fell 5.4 percent due to a recent slide tative easing is likely to put downward pres- in oil prices, marking the sharpest decline in sure on the US dollar and, therefore, upward nearly three years. Industrial production fell pressure on the yen. Yet again, the question of in July, and purchasing managers’ indices for whether this will be sufficient must be asked. both manufacturing and services were down By October, with Japanese government in August. On the other hand, new orders for officials urging a more accommodative policy, machinery rose 4.6 percent from June to July.28 29
  • 16. India GeographiesINDIA Pralhad Burli is Senior Analyst at Deloitte Research, India India: Cautious Optimism by Pralhad Burli A step forward, but will A ll of a sudden, the cogs of government policy have been set in motion. While the government’s reform agenda momen- the government retract? tarily raised hopes, the implementation of The government decided to allow foreign the reforms remains uncertain. The economy, players to invest up to 51 percent in multi- however, is not out of the woods yet. Weak brand retail. This announcement opens up industrial production, an erratic and delayed India’s retail sector for multinational retail monsoon, muted global demand, and policy giants, but there are some restrictions. Retail uncertainty cloud India’s economic outlook. stores can be set up only in cities with a popu- Meanwhile, inflation remains elevated, and the lation of more than 1 million. The minimum government’s woes arising from a high fiscal investment must be $100 million, and at and current account deficits continue to con- least 50 percent of the investment must be in strain the economy. Growth projections have back-end infrastructure within three years. been lowered several times, and analysts pre- Moreover, state governments will have the dict that India will grow at less than 6 percent right to decide whether or not they will allow during the 2012–2013 fiscal year. 30 31
  • 17. Global Economic Outlook: 4th Quarter 2012 India Geographies foreign direct investment (FDI) in the retail strike soon after the reforms were announced. Limited options, limited action Through its current policy stance, the RBI sector in their respective states. Furthermore, the National Federation of LPG In April 2012, the Reserve Bank of India has reiterated that containment of inflation The decision to allow FDI in retail can Distributors of India has threatened to go on (RBI) aggressively cut its policy rate by 50 basis remains its primary focus. Driven by a rise in potentially eliminate several inefficiencies that a strike against the government’s multiple-rate points. In its mid-quarter review in June, it did food prices, consumer price inflation came in mar India’s retail sector. However, the politi- policy on cooking gas cylinders. Some state not opt for further policy easing. While the at 10.3 percent in August 2012. Food prices cal consequences of the decision have already governments have intervened by increas- domestic economy remained fairly sluggish for consumers accelerated to 12.0 percent in cropped up. The government faced significant ing the limit on subsidized cylinders to nine, between June and September, global macro- August from 11.5 percent in July. Meanwhile, political backlash from the opposition parties while others have waived state taxes on the economic weaknesses did not subside either. revised CPI data for July remained at 9.9 as well as its allies. One of the government’s sale of diesel. The backlash against the subsidy Industry participants anticipated that the RBI percent. Vegetable prices witnessed the high- allies has already withdrawn its support from reform is just beginning, and political parties would cut interest rates and prop up India’s est increase at over 20 percent during August. the ruling coalition. While the government is and trader unions are demanding a rollback of negative investment climate. However, in its Currently, inflation is well beyond the cen- unlikely to collapse on the back of this deci- these reforms. The ensuing outcome is difficult policy meeting in September, the RBI main- tral bank’s comfort level. In addition, a weak sion, the implementation of the FDI policy to predict. tained its monetary stance and kept the policy monsoon is expected to have a significant is unlikely to be smooth. The government’s The central government is unlikely to backtrack on its Given India’s huge subsidy bill rose substan- tially, owing to a decline policy stance because state governments make the final consumer base and in the value of the rupee and elevated prices of decisions about whether or not to allow retailers into a rising middle petroleum products. While the subsidy draw- the country. But, as of this writing, only 10 states have class, global retail down is unlikely to solve India’s fiscal woes, it is decided to allow FDI in multi-brand retail. The suc- companies are considered to be a step in the right direction. India’s cess of multinational orga- nizations that enter India’s excited about their high-deficit problem raises the interest rates retail space may depend on how they and the govern- growth prospects. for domestic borrowing, which impacts private ment are able to assuage the investment; it also fears of those who are likely restricts the monetary to be affected by their presence. Given India’s policy options of the central bank because defi- huge consumer base and a rising middle class, cits are usually financed by borrowing funds global retail companies are excited about their from the central bank. growth prospects. However, retail outlets have Meanwhile, the finance ministry approved faced the ire of angry mobs in the past, and 49 percent FDI in the insurance and pen- multinational retailers will likely tread cau- sion sector, up from the current ceiling of 26 tiously amid uncertainty. percent. However, the bill is yet to be approved Another policy decision that met stiff politi- by the parliament. In addition, the government repo rate unchanged at 8 percent. However, impact on grain production, and farm output cal opposition was the reduction of subsidies has proposed allowing foreign minority stakes the cash reserve ratio (CRR) was lowered by may experience a contraction this year. As on diesel and cooking gas. The government in the aviation, electricity trading, and broad- 25 basis points to 4.5 percent. The CRR cut is such, food price inflation is likely to persist. decided to restrict supply of subsidized cook- casting industries. Finally, the government likely to inject primary liquidity in the banking However, abundant rainfall in the latter half of ing gas to six cylinders per household in a year will also divest its equity ownership in some system to the tune of $3.1 billion and would the monsoon season will likely ensure ade- and increase the price of diesel by 5 rupees per state-owned corporations. It may be relatively likely have a larger cumulative impact on the quate irrigation for the winter crop. liter, which led to political resistance. All major easier to implement these reforms as they are economy through the money multiplier. political parties also participated in a day-long unlikely to face significant political roadblocks.32 33
  • 18. Global Economic Outlook: 4th Quarter 2012 India Geographies Finally, the government’s recent policy market participants, thus crowding out to currency risk. The Reserve Bank of India’s announcements regarding an upward revi- private investment. timely intervention stemmed the decline and sion in diesel prices and a partial curtailment In the 2012–2013 fiscal year, the govern- bolstered investor confidence. As a result, the in subsidy on cooking gas are likely to put ment expects the fiscal deficit to be restricted rupee has appreciated in recent months, after upward pressure on inflation in the short term. to 5.1 percent of GDP. However, that target witnessing a steep drop between February and However, over the medium term, these initia- seems ambitions and is likely to be missed. June this year. However, if India’s economic tives are expected to help the central bank to Subsidies on oil and other petroleum prod- prospects do not improve or investors flee to manage inflation and strengthen India’s macro- ucts, fertilizers, and expenses on social welfare safer assets as the European crisis deepens, the economic fundamentals. The central bank may programs will make it extremely difficult to rupee could experience some volatility. adopt an easier monetary policy if inflation contain the fiscal deficit. Furthermore, any India’s economy is operating below its declines to manageable levels. decision to deregulate diesel prices further or potential, and a return to pre-crisis levels of cut subsidies is likely to face political hurdles. growth is unlikely in the near Twin deficit, twin challenge In the absence of additional fiscal reforms, future. Given the global economic the central government’s deficit will likely uncertainty and India’s domestic While the government’s reform Some of India’s macroeconomic chal- range between 5.6 and 5.9 percent of GDP. macroeconomic challenges, the lenges stem from its twin deficit problem. Combined with the deficit of the state govern- downside risks to the economy plan is a welcome sign, it may Government expenditures exceed revenues, ments, the overall deficit could be as high as 9 outweigh the upside. In an resulting in a fiscal deficit, and the country percent of GDP. already-inflationary environment, be too early to celebrate. imports more than it exports, leading to a Moreover, ambiguity pertaining to the a weak monsoon is likely to push current-account deficit. Persistent current government’s policy around taxation of foreign food prices even higher, which account deficits put pressure on the exchange capital flows led to a huge exodus of foreign may dampen domestic consump- rate, and additional government borrow- funds from India. This put additional pressure tion. Furthermore, a weak performance in the ing increases the borrowing cost for other on the exchange rate and exposed importers agricultural sector does not bode well for the economy. Finally, India will remain vulnerable to the geopolitical tensions in the Middle East, which may lead to a spike in global oil prices. While the government’s reform plan is a wel- come sign, it may be too early to celebrate.34 35
  • 19. Russia GeographiesRUSSIA Russia: Slowing Down by Dr. Ira Kalish I t is unfortunate that, at a time when the global economy is decelerating and major central banks are taking more aggressive action investment. In addition, a rising currency would hurt the competitiveness of noncom- modity exports and, by boosting imports, Second, business investment accelerated due to strong cash flow, especially in the energy sector when energy prices were rising. Third, govern- to boost growth, Russia’s central bank finds would damage the trade balance. ment spending rose early this year in anticipa- it necessary to tighten monetary policy. In The question, of course, is whether the tion of the election in March. The lingering mid-September, the Central Bank of Russia central bank’s rate increase is a one-off action effects of fiscal stimulus remain. boosted its benchmark interest rate by 25 basis or the start of a new round of monetary policy Many of the factors that contributed to points, citing the risk of rising inflation and, tightening. Some analysts believe that the cen- strong growth of domestic demand have importantly, rising expectations of inflation tral bank has only just begun, and that more already begun to reverse, even before the in the marketplace. The inflation problem rate increases are in the cards. That is because central bank raised interest rates in September. stems largely from rising food prices, as well core inflation has lately accelerated from 3.6 First, the acceleration of inflation has eroded as from the freeing of administered prices, but percent in April to 5.9 percent in August— the gain in real income for consumers. In the central bank has noted that this can create above the central bank’s target of 5–6 percent. addition, banks have already begun to tighten expectations of inflation that lead to more Moreover, although economic growth recently lending standards for household borrowing. inflationary behavior among businesses and has slowed largely because of export weakness, Second, fiscal policy was tightened once the workers. The bank sees this as a greater prob- domestic demand has remained strong. As a election ended. Stimulus from the government lem than slowing output growth. result, there have been considerable wage pres- has begun to diminish. Third, investment has There could be a silver lining to this other- sures in a tight labor market. The unemploy- begun to decelerate owing to weakening cor- wise cloudy situation: Increasing interest rates ment rate has fallen from 6.1 percent a year ago porate profits. The latter have been hurt by the will boost capital inflows into Russia, causing to 5.2 percent in August. This was the lowest rapid rise in wages as well as by the weakness a rise in asset prices and a boost to wealth. rate of unemployment recorded since the end of demand in Western Europe. Moreover, such capital flows would have the of the Soviet Union. Wages, consequently, have The end result is that the domestic side of effect of boosting the value of the Russian risen about 15 percent in the past year. the economy is showing signs of weakness, ruble, thus reducing import prices and reliev- Why has domestic demand been so strong? which will only be exacerbated by the tighten- ing some of the inflationary pressure. First, consumer spending has grown rapidly, ing of monetary policy. Thus, Russia appears On the other hand, rising interest rates in part due to rising real wages and in part due headed for a slowdown. could stifle already weak private sector to a rapid increase in consumer leveraging. 36 37
  • 20. Brazil GeographiesBRAZIL Brazil: Chasing Growth by Dr. Ira Kalish T he Central Bank of Brazil has been easing monetary policy in order to boost growth, having decided that the slowdown in economic lower than a year ago), there are signs of economic renewal. Unemployment has fallen to a record low of 5.5 percent. Moreover, while activity is more worrisome than the level of second-quarter GDP was hardly up from a year inflation. Yet going forward, the central bank ago, it did grow at an annual rate of 1.6 percent will have to find the right balance between the from the first quarter, a significant improve- goals of higher growth and lower inflation, ment from earlier quarters and the fastest rate lest one of the goals becomes unattainable. of growth since early 2011. Thus, the easing of Moreover, with the US Federal Reserve hav- monetary policy is evidently working despite ing initiated a third round of asset purchases negative global headwinds. Indeed, second- (quantitative easing), Brazil is one of many quarter growth improved despite severe emerging countries to be concerned that the export weakness. US policy will cause a boost in the value of the Not only has monetary policy been eased, local currency. Brazil’s policy will thus aim to fiscal policy also has contributed to growth. also keep the currency competitive. The government has cut the interest rate The central bank has cut the benchmark charged by its development bank. It has also SELIC rate 11 times in the past year. The rate boosted spending on public investment, pro- has declined by 525 basis points, reaching a vided tax incentives for consumer spending on record low of 7.3 percent in September of this durable goods, and sold concessions for private year. Although economic growth remained sector development of public infrastructure. feeble during the first half of 2012 (real GDP Meanwhile, inflation remains slightly was up only 0.5 percent in the second quarter, higher than the central bank target of 4.5 38 39
  • 21. Global Economic Outlook: 4th Quarter 2012 Brazil Geographies percent. In September, consumer prices were around, the government has chosen to impose up 5.3 percent from a year ago. Moreover, a new round of capital controls on portfolio this was the third straight quarter in which investment that aim to discourage hot money inflation accelerated. All these indicate a from flowing into Brazil. One effect of these developing problem. controls has been to shift inbound money from The other big issue is the currency. During portfolio to direct foreign investment. Despite the past year, as interest rates were cut, the weakness in the global economy, foreign direct Brazilian real declined by 22 percent against investment has remained strong. the US dollar. While a cheaper currency tends What can be expected going forward? It to be inflation- seems likely that ary, it also leads to more With stimulation from both Brazilian growth will recover in competitive pricing of non- the Central Bank of Brazil and 2013, barring a deeper crisis commodity exports. This the government, domestic in Europe or a recession in the has been seen as a good demand, including both United States. With stimula- tion from both offset to the weakness in consumer spending and public the Central Bank of Brazil global demand for Brazilian investment, is picking up. and the govern- On the other hand, there are a few things productivity growth, and often contribute to exports. Yet, ment, domes- that worry observers: rising inflation, increased inflationary pressures. The fiscal deficit could the recent tic demand, protectionism on the part of the government, become worrisome if it is financed through decision by the US Federal Reserve to engage including both consumer spending and public a rising fiscal deficit, and the continued weak monetary creation (which causes inflation) or in a third round of quantitative easing will, it investment, is picking up. With lower interest state of the global economy. Protectionism has if it leads to higher market interest rates (which is feared, cause the Brazilian real to increase in rates and increasing foreign direct investment, involved a variety of government regulations would discourage private sector investment). value. This was the fear two years ago during private sector investment should pick up in aimed at boosting the domestic content of If, however, growth accelerates sufficiently, that the last round of asset purchases by the US 2013. Moreover, Brazil is now seen as a favor- manufactured goods. Historically, such rules in itself could relieve the fiscal deficit by driv- Federal Reserve. At that time, Brazil imposed able location for investment in energy, manu- have tended to encourage inefficiency, reduce ing an increase in tax revenue. a tax on inbound portfolio investment to facturing, and offshored services. discourage a rise in the currency. This time40 41
  • 22. Korea GeographiesKOREA Dr. Satish Raghavendran Neha Jain is an Analyst is Vice President, Com- at Deloitte Research, munications Excellence, India Deloitte Consulting Ser- vices India Pvt. Limited Korea: S(e)oul Searching by Dr. Satish Raghavendran and Neha Jain T he world today knows Korea not only for its smartphones but also for “Gangnam Style,” the recent pop single by rapper Psy that rapid industrialization from the 1960s to 1980s resulted in double-digit growth rates, which set the trend for robust private consumption holds a Guinness World Record for being the in future decades. Today, private consump- “most liked video in YouTube history.” The tion accounts for almost half of Korea’s GDP. music video is shot in the affluent Gangnam However, similar to many developed econo- district of Seoul, which benefited from Seoul’s mies, rising levels of affluence have led to a rapid economic development and planned consistent increase in conspicuous consump- expansion of in the 1970s. The video’s humor- tion as Korean households strive to achieve ous compilation of unusual dance moves can a higher social status. One of the immediate be perceived as a social satire of the materialis- consequences has been the rise in household tic lifestyle of Gangnam’s elite residents. It also indebtedness; Korean household debt stands depicts two fundamental characteristics of the as high as 160 percent of disposable income, Korean economy: conspicuous consumption which is even higher than the rate in the and rising income inequality. United States right before the subprime crisis. Consumption has long been the main driver of the Korean economy. Historically, 42 43
  • 23. Global Economic Outlook: 4th Quarter 2012 Korea Geographies Rising household debt Record-high household debt levels have Korea’s export reliance is a result of an the service sector’s efficiency and productiv- prompted policy action from the government. outward-looking strategy adopted in the 1960s. ity. The service sector has traditionally been Korean consumer debt is equivalent to over So far, the government has adopted a loose The strategy envisaged economic growth protected by several regulations that should 80 percent of Korea’s GDP and has expanded monetary policy stance to relieve pressure on through labor-intensive manufactured exports, be loosened in order to attract more competi- by an average of almost 9 percent per year borrowers; on the other hand, it has tightened giving Korea a competitive advantage over tion and encourage investment in vocational since 2005. Data from the Central Bank of measures for lending institutions to keep a countries with limited human resources. The training for employees. This strategy would Korea shows that at the end of the first quarter check on household debt. The government government greatly encouraged foreign direct also empower highly skilled professionals to of 2012, outstanding loans by the depository faces an additional task of reviving private investment (FDI) in the manufacturing sector, drive innovation and reduce income disparities and other financial corporations stood as high consumption, which has been declining as which made up for the shortage of domes- and migration of highly skilled professionals to as $757 billion—the highest level in the seven overstretched households are tightening their tic savings. This strategy served Korea well foreign countries. years for which data is available. What is worri- purse strings. Growth in private consump- for the next few decades, leading to rampant Moreover, a healthy and vibrant service some is the fact that household indebtedness tion, which is the main driver of growth after industrialization and a rapidly expanding sector can exert positive externalities on the is rising in a sluggish economy with stagnant exports, is slowing down as well. After register- export sector. manufacturing sector. In short, there is a room income growth and declining property prices. ing a growth rate of 4.4 percent in 2010, private However, in recent years, this outward- for the services sector to increase its share to Rising real estate mortgages, especially at consumption growth almost halved to 2.3 looking strategy and the openness of the the GDP and provide immunity to external a time when external headwinds are having percent in 2011 and is forecasted to slow down economy have exposed it to external economic shocks. Indeed Korea’s large conglomerates, an adverse impact on the domestic economy, to 1.9 percent this year. Underlining weaker conditions including trade demand, currency chaebols, can also play an important role in the present a growing risk to the banking sector. consumer sentiment, retail sales have also fluctuation, and volatile capital inflows. While development of the service sector; currently Recent statistics from the central bank show experienced steady declines over the past few macro prudential measures taken by authori- only about 4 out of Korea’s large enterprises that around 70 percent of outstanding loans in months. Policy makers are thus faced with the ties and the resilience of the economy itself are operating in the service sector as com- the banking sector are in the form of real estate dilemma of reviving consumption while ensur- has cushioned the landing so far, manufactur- pared with 12 out of 30 large enterprises in the mortgages, exposing the sector to fluctuations ing the stability of household debt. ing—Korea’s export-oriented growth engine— United States. in property prices. Real estate prices in Seoul has lost its magic in the wake of major global There is also a need to alter the export-led have already begun to contract; after negligible The eggs and the export basket economic and geopolitical events. strategy in order to move up the value chain. growth in 2011, property prices have already There are opportunities in newer technol- dropped 1.2 percent since the beginning of this Korea’s growth engine is losing steam pri- Soul searching in Seoul ogy areas; nanotechnology, pharmaceuticals, year. Further softening of the housing market marily due to decelerating domestic consump- and energy offer employment to its skilled could lower the value of household borrowers’ tion, declining investment, and weaker export This is perhaps a wake-up call for the South workforce and encouraging entrepreneur- collateral and further amplify indebtedness. growth. The export sector contributes to about Korean policy makers to identify a new growth ship. Diversification to high-value exports will Another concern stems from the growing half of Korea’s GDP, leaving the economy vul- engine that will catapult the economy back to provide some immunity to strong competi- involvement of the nonbanking sector (credit nerable to external headwinds. Korea’s exports, a growth trajectory. Korea’s historic success tion from its neighbors that produce low-cost card companies and mutual savings banks) in which mainly consist of electronics and semi- as a manufacturing champion came at the manufactured goods. Perhaps geographical household debt. With looser regulations than conductors, suffered a quarter-over-quarter expense of the country’s service sector, which diversification to emerging trading hubs in those imposed on the regular banking sector, contraction of 1.4 percent during the second was starved of capital and innovation that was the Middle East and Africa could also reduce these institutions typically enforce less strin- quarter of 2012. In the month of August alone, directed toward manufacturing. dependence on its current trade partners. gent qualifying conditions on loan applicants exports declined by 6.2 percent year-over-year, However, the recent export slowdown The South Korean economy is at a tipping but charge a higher rate of interest. Moreover, the sixth month this year in which exports and its negative impact on the manufactur- point to explore new growth engines instead around 90 percent of household loans are sub- have fallen. Exports to its main markets— ing industry have highlighted the need to of trying to stoke engines that are beset with ject to floating interest rates, leaving borrow- China, Japan, the United States and the EU— diversify away from both exports and manu- fatigue. South Korean policy makers need to ers vulnerable to a rise in interest rates. While all contracted. The outcome of the Eurozone facturing while striving for a more balanced design forward-looking policies that include the central bank has kept interest rates low, debt crisis is uncertain, but depressed demand and sustainable growth model. Although the expansion of the service sector, export diversi- expected economic recovery in the next few conditions are likely to persist for a few years government has taken some steps to expand fication, and regional development while also years could tighten policy rates and push up and are expected to weigh down Korean its service sector, it has become imperative being mindful of the trade-offs. It is indeed variable mortgage rates. manufactured exports. to design more focused policies to improve time for soul searching in Seoul.44 45
  • 24. Global Economic Outlook: 4th Quarter 2012 AppendixAppendix Yield curves (as of October 10, 2012)* US Treasury bonds & notes UK gilts Eurozone govt. benchmark Japan sovereign Brazil govt. benchmark China sovereign India govt. actives Russia‡ 3 Months 0.10 0.33 0.02 0.10 7.75 2.78 8.18 5.80 1 Year 0.16 0.24 0.03 0.10 7.41 2.23 8.03 6.38GDP growth rates (YoY %)* GDP growth rates (YoY %)* 5 Years 0.68 0.75 0.55 0.18 8.97 2.74 8.03 7.94 (Note: Indias fiscal year is April-March) 8 20 10 Years 1.74 1.78 1.51 0.77 9.82 3.26 8.12 8.56 6 15 Composite median GDP forecasts (as of October 10, 2012)* 4 2 10 US UK Eurozone Japan Brazil China Russia 0 2012 2.2 -0.4 -0.5 2.3 1.6 7.7 3.75 5 -2 2013 2.05 1.15 0.4 1.2 4.1 8 3.6 -4 0 2014 2.6 2.15 1.3 1.2 4.1 7.5 3.85 -6 -5 -8 Composite median currency forecasts (as of October 10, 2012)* -10 -10 Q4 12 Q1 13 Q2 13 Q3 13 2012 2013 2014 -12 -15 GBP-USD 1.6 1.6 1.6 1.6 1.6 1.6 1.6 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11 12 12 07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11 12 12 Euro-USD 1.28 1,27 1.26 1.25 1.28 1.25 1.28 USD-Yen 78 80 81 83 78 83 85 US UK Eurozone Japan Brazil China India Russia USD-Brazilian Real 2 1.98 1.96 1.95 2 1.95 1.99Inflation rates (YoY %)* Inflation rates (YoY %)* USD-Chinese Yuan 6.31 6.29 6.27 6.23 6.31 6.21 6.18 (Note: Inflation data for India is based on the WPI) USD-Indian Rupee 54.33 53.59 53 52 54.33 51.75 51 6 16 USD-Russian Ruble 31.05 30.94 31.2 31.29 31.5 31.46 32.51 5 14 4 12 OECD composite leading indicators (amplitude adjusted)† 3 10 US UK Eurozone Japan Brazil China India Russia 2 8 Oct 10 100.07 101.57 101.30 100.21 101.22 101.27 101.41 101.99 6 Nov 10 100.26 101.58 101.44 100.36 101.30 101.49 101.31 102.41 1 4 0 Dec 10 100.47 101.61 101.57 100.52 101.34 101.60 101.18 102.72 2 Jan 11 100.66 101.62 101.66 100.64 101.27 101.58 100.97 102.88 -1 0 Feb 11 100.78 101.60 101.69 100.69 101.10 101.47 100.68 102.91 -2 -2 Mar 11 100.81 101.54 101.65 100.67 100.89 101.33 100.31 102.77 -3 -4 Apr 11 100.73 101.40 101.54 100.60 100.61 101.18 99.91 102.55 Jan May Sep Jan May Sep Jan May Sep Jan Mar May Jul Jan May Sep Jan May Sep Jan May Sep Jan Mar Jun 09 09 09 10 10 10 11 11 11 12 12 12 12 09 09 09 10 10 10 11 11 11 12 12 12 May 11 100.58 101.19 101.37 100.50 100.24 101.03 99.53 102.31 US UK Eurozone Japan Brazil China India Russia Jun 11 100.37 100.89 101.14 100.43 99.79 100.90 99.25 102.13 Jul 11 100.14 100.51 100.86 100.38 99.31 100.77 99.07 101.98Major currencies vs. the US dollar* USD-Yen 1.8 100 Aug 11 99.96 100.11 100.58 100.35 98.87 100.64 98.95 101.91 Sep 11 99.91 99.75 100.31 100.34 98.51 100.53 98.89 101.91 1.7 95 Oct 11 99.99 99.48 100.11 100.41 98.25 100.41 98.91 101.96 1.6 Nov 11 100.20 99.34 99.97 100.51 98.08 100.28 98.98 102.05 1.5 90 Dec 11 100.45 99.32 99.89 100.64 98.07 100.13 99.00 102.12 Jan 12 100.68 99.40 99.85 100.76 98.18 100.00 98.94 102.13 1.4 Feb 12 100.85 99.50 99.83 100.83 98.41 99.89 98.79 102.02 85 1.3 Mar 12 100.92 99.60 99.80 100.85 98.63 99.74 98.56 101.66 1.2 Apr 12 100.90 99.69 99.75 100.80 98.80 99.56 98.31 101.06 80 1.1 May 12 100.82 99.76 99.67 100.69 98.94 99.45 98.06 100.32 Jun 12 100.71 99.86 99.58 100.55 99.09 99.39 97.83 99.63 1 75 Jul 12 100.61 99.99 99.48 100.40 99.26 99.39 97.62 99.11 Jan May Sep Jan May Sep Jan May Sep Jan May Sep 09 09 09 10 10 10 11 11 11 12 12 12 Aug 12 100.55 100.12 99.38 100.26 99.45 99.40 97.47 98.82 GBP-USD Euro-USD USD-Yen (RHS) *Source: Bloomberg ‡MICEX rates †Source: OCED*Source: Bloomberg Note: A rising CLI reading points to an economic expansion if the index is above 100 and a recovery if it is below 100. A CLI which is declining points to an economic downturn if it is above 100 and a slowdown if it is below 100.46 47
  • 25. Global Economic Outlook: 4th Quarter 2012 AppendixAdditional resources Contact information Global Economics Team Global Industry Leaders U.S. Industry Leaders Asia Pacific Ryan Alvanos Consumer Business Banking & Securities and Economic Deloitte Research Deloitte Services LP Lawrence Hutter Deloitte LLP Financial Services Robert Contri Outlook October 2012 USA UK Deloitte LLP Weathering Headwinds Tel: +1.617.437.3009 Tel: +44.20.7303.8648 Tel: +1 212 436 2043 China: When exports decline Indonesia: Maintaining expansion Japan: Contraction in the cards e-mail: e-mail: e-mail: Philippines: Growth from within Energy & Resources Consumer & Industrial Products Pralhad Burli Deloitte Research Peter Bommel Craig Giffi Deloitte Services LP Deloitte Netherlands Deloitte LLP India Netherlands Tel: +1.216.830.6604 Tel : +91.40.6670.1886 Tel: +31.6.2127.2138 e-mail: e-mail: e-mail: Health Plans and Health Sciences & Government Dr. Alexander Börsch Financial Services John Bigalke Deloitte & Touche GmbH Chris Harvey Deloitte LLP Germany Deloitte LLP Tel: +1.407.246.8235 Tel: +49 (0)89 29036 8689 UK e-mail: Tel: +44.20.7007.1829Deloitte Research Thought Leadership e-mail: Power & Utilities and Dr. Ira Kalish Energy & Resources Deloitte Research Life Sciences & Health Care John McCueDeloitte Review Issue 11 Deloitte Services LP Robert Go Deloitte LLP USA Deloitte Consulting LLP Tel: +216 830 6606 From mad man to superwoman: The inevitable rise of the chief marketing officer in the age of the Tel: +1.213.688.4765 USA e-mail: empowered customer. e-mail: Tel: +1.313.324.1191 e-mail: Public Sector (Federal) Cloud wars: How incumbents can respond to cloud disruption. Dr. Carl Steidtmann Robin Lineberger Deloitte Research Manufacturing Deloitte Consulting LLP The engagement economy: How gamification is reshaping businesses. Deloitte Services LP Hans Roehm Tel: +1.517.882.7100 USA Deloitte & Touche GmbH e-mail: The Ito factor: In the digital startup world, Joi Ito is a bona fide rock star, but the outspoken entrepreneur Tel : +1.303.298.6725 Germany Tel: +49.711.16554.7130 Public Sector (State) faces his biggest challenge yet in revitalizing MIT’s venerable Media Lab. e-mail: e-mail: Bob Campbell Deloitte Consulting LLP Pulling ahead vs. catching up: Trade-offs and the quest for exceptional profitability. Ian Stewart Public Sector Tel: +1.512.226.4210 Deloitte Research Greg Pellegrino e-mail: bcampbell@deloitte.comAsia Pacific Economic Outlook: China, Japan, Philippines, and Indonesia. Deloitte & Touche LLP Deloitte Consulting LLP UK USA Telecommunications, Media Tel: +44.20.7007.9386 & Technology Tel: +1.571.882.7600 e-mail: Eric OpenshawPlease visit for the latest Deloitte Research thought leadership or contact e-mail: Deloitte LLPDeloitte Services LP at: Telecommunications, Media Tel: +1 714 913 1370 & Technology e-mail: Jolyon Barker Deloitte & Touche LLPFor more information about Deloitte Research, please contact UKJohn Shumadine, Director, Deloitte Research, part of Deloitte Services LP, Tel: +44 20 7007 1818 e-mail: +1 703.251.1800 or via e-mail at Follow us on @DU_Press48 49
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