EMEA Emerging Markets Research                                                                                            ...
Summary and conclusions – Part 1                                                                                        Gl...
Summary and conclusions – Part 2                                                                                        DM...
Global growth and inflation 2010 2012E                                                                                    ...
Population distributions among major DM and EM countries                                                                  ...
US 2011 Economic Outlook: Continuation of fiscal stimulus – Part 1                                                        ...
US 2011 Economic Outlook: Continuation of fiscal stimulus – Part 2                                                        ...
US consumers have been adjusting as their debt burden declines                                                            ...
US household saving rate has risen and US labor costs have fallen                                                         ...
US home sales have slumped as tax support faded                                                                           ...
US shadow housing inventory a risk to house prices                                                                        ...
Euro                                                                                E ro area 2011 Economic O tlook Underp...
Euro                                                                                E ro area 2011 Economic O tlook Underp...
Remarkably positive indicators for German households                                                                      ...
A three speed E                                                                                   h        d Euro area rec...
Euro area: G                                                                                E          Growing evidence of...
Scope for Euro area household saving to moderate as public saving picks up                                                ...
The extent of the fiscal journey in the periphery of the Euro area                                                        ...
Evidence of b k f di stress i the E                                                                                E id   ...
European bank redemptions likely to be heavy in 1H11                                                                      ...
Japan 2011 Economic Outlook: Underpinnings and Risks – Part 1                                                             ...
Japan 2011 Economic Outlook: Underpinnings and Risks – Part 2                                                             ...
China 2011 Economic Outlook: Underpinnings and Risks – Part 1                                                             ...
China 2011 Economic Outlook: Underpinnings and Risks – Part 2                                                             ...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Ru...
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Michael Marrese Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011, with Special Emphasis on Russia

  1. 1. EMEA Emerging Markets Research 25 March 2011Developed and Emerging Market Growth, Inflation and Policy Challenges in 2011,with Special Emphasis on RussiaMichael MarreseACEMEA EM Economics and Strategy(44-207) 777-4627(44 207) 777 4627michael.marrese@jpmorgan.comAnatoliy Shal(7 495) 937-7321anatoliy.a.shal@jpmorgan.com t li h l@jJ.P. Morgan Securities Ltd.See the end pages of this presentation for analyst certification and important disclosures.J.P. Morgan dJP M does and seeks t d b i d k to do business with companies covered in it research reports. A a result, i ith i d i its h t As lt investors should b aware th t the firm may t h ld be that th fihave a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making theirinvestment decision.
  2. 2. Summary and conclusions – Part 1 Global growth to slow in 2011 to 3.3% from 3.8% in 2010 due to: the supply shortages and higher energy prices as a consequence of the Japanese earthquake and tsunami; fiscal consolidation among some DM countries; and globally tighter monetary policy. The US has opted for two years of fiscal stimulus, rather than addressing its unsustainable underlying structural fiscal deficit. 2011 will be a year of par growth for DM (2 3% compared to 2 3% annually during 2002-2007 (2.3% 2.3% 2002 2007 11 flation and Policy Challenges in 201 and 2.5% last year), while EM is forecast to grow 6.0% (compared to 7.0% annually during 2002-2007 and 7.2% last year). The disappointment surrounding DM is that unemployment remains unacceptably high in the US, Japan and peripheral Europe. Moreover, social contracts are being negotiated in a disappointing direction in DM. Enormous differences across EM, depending mostly on interdependence with Asia. The output gaps of Asian EM mostly closed by mid-2010, while Brazil’s closed in early 2010. Except for Argentina (gap closed well before 2009), most Latin countries will see their output gap d sappea disappear in 2011. Mexico will lag. For EMEA EM, most output gaps will be pos t e 0 e co ag o , ost positiveDeveloped and Emerging Market Growth, Inf throughout 2011, with exceptions in Israel, Poland and Turkey. DM headline consumer price inflation in 2011 is expected to be 2.3%oya in 4Q11 (compared to 1.6% in 4Q10). EM headline consumer price inflation is forecast at 5.7%oya in 4Q11 (compared t 5 6% i 4Q10) and i problematic i I di Chi ( d to 5.6% in 4Q10), d is bl ti in India, China, I d Indonesia, K i Korea, B il Brazil, M Mexico, Egypt, Turkey, Russia, and parts of Eastern Europe. Asset price inflation and/or excessive credit extension to the private sector have caused monetary policy tightening in much of EM Asia ( yp y g g (including China), Brazil, Chile, Peru, Israel, g ), , , , , d Turkey, Serbia and Georgia. 1
  3. 3. Summary and conclusions – Part 2 DM countries have much worse fiscal and debt figures than EM countries (slide 29), which implies the need for prolonged DM fiscal consolidation. This is a factor likely to constrain DM growth this year and beyond. Global imbalances—in terms of current-account balances (slide 24) and massive financial account movements given widening interest rate differentials between DM and 11 flation and Policy Challenges in 201 EM—have become less of a major problem in part because Japanese retail investment abroad is being repatriated back to Japan and in part because China’s current account surplus is narrowing rapidly. The likelihood that there will be a global financial crisis within the next few years remains substantial. On the negative side for EM (slide 29), political risks remain high as recent turmoil in the Middle East and North Africa has demonstrated. Moreover, ease of doing business isDeveloped and Emerging Market Growth, Inf relatively poor, corruption perception indices are high in selected EM countries, and the young in EM countries often are discouraged by high unemployment rates. d M 2
  4. 4. Global growth and inflation 2010 2012E inflation, 2010-2012E Real GDP and inflation forecasts Real GDP (%oya) Real GDP (%q/q, saar) Consumer prices (%oya) 2010 2011 2012 1Q11 2Q11 3Q11 4Q10 4Q11 USA 2.8 2.9 2.9 2.5 3.5 3.5 1.2 2.5 1 United Kingdom 1.3 1.7 2.7 2.8 2.0 2.5 3.4 3.8 Germany 3.5 3.3 2.2 4.5 2.5 2.5 1.6 2.3 France 1.5 2.3 2.4 3.5 2.0 2.5 1.9 2.1 Italy 1.1 1.4 2.1 1.5 1.5 2.0 2.0 1.9 11 flation and Policy Challenges in 201 Spain -3.7 -0.1 1.0 1.0 1.0 1.5 2.3 0.7 Japan 4.0 0.9 2.8 1.2 -1.0 2.0 0.1 0.4 China 10.3 9.4 9.0 8.7 8.8 9.0 4.7 3.3 Korea 6.1 4.2 4.6 5.0 4.0 5.5 3.6 3.2 Malaysia y 7.2 5.1 4.4 5.2 5.1 5.4 2.0 3.7 India 8.5 8.0 8.7 7.9 8.4 13.2 9.2 8.5 Brazil 7.5 4.0 3.8 3.9 4.8 4.9 5.6 6.1 Mexico 5.5 4.5 3.5 2.0 8.0 2.5 4.2 3.7 Russia 4.0 4.5 5.0 3.5 3.0 3.5 8.2 9.7 South Africa 2.8 3.7 3.8 3.6 3.7 4.0 3.5 5.9Developed and Emerging Market Growth, Inf Turkey 8.3 4.5 5.0 - - - 9.1 11.3 Poland 3.8 4.0 4.2 3.5 4.0 4.5 2.9 2.9 Israel 4.7 4.5 4.0 4.5 4.5 4.5 2.5 3.8 Saudi Arabia 3.8 5.3 4.8 - - - 6.1 6.2 United Arab Emirates 2.2 3.6 3.8 - - - 2.7 3.1 M Nigeria 3.8 4.0 4.2 - - - 3.1 3.6 Global 3.8 3.3 3.6 3.4 3.4 3.7 2.7 3.2 Developed markets 2.5 2.3 2.7 2.5 2.3 2.7 1.6 2.3 Emerging markets 7.2 6.0 6.0 5.8 6.2 6.4 5.6 5.7 1. FY 2011/2012 d Source: J.P. Morgan 3
  5. 5. Population distributions among major DM and EM countries Population distributions EM Countries in general have younger populations Population in millions, % in each age group than DM countries. In EMEA EM, Russia and Poland Total Median 0 14 0-14 15 59 15-59 60 60+ have relatively older populations (older than even that of population age the US), while South Africa and Turkey have relatively Germany 81 44.9 13.3 60.2 26.4 young populations. Turkey’s population is particularly young relative to that of EU countries. Japan 126 44.8 13.2 55.8 31.0 The structure of China’s population is changing p p g g 11 UK 63 40.0 40 0 17.3 17 3 60.1 60 1 22.5 22 5 flation and Policy Challenges in 201 rapidly given the relatively low share of its population France 65 39.9 18.5 58.5 23.1 aged 0-14 years. China’s aged 0-14 year old cohort is 17.6% of its total population compared to: India’s 29.7%; Russia 139 38.7 15.2 66.2 18.7 South Africa’s 28.6%; Mexico’s 28.3%; Turkey’s 26.5%; Poland 38 38.5 38 5 14.7 14 7 65.4 65 4 20.0 20 0 Brazil s Brazil’s 26.2%; and the USA’s 20.1%. China’s median USA s China s age and its +60 cohort are projected to rise rapidly, which US 313 36.9 20.1 61.4 18.6 will be yet another reason (along with rapid growth in China 1,337 35.5 17.6 69.1 13.2 nominal and real wages) for China’s current-account surplus to narrow rapidly (slide 24). Brazil 203 29.3 26.2 63.7 10.0Developed and Emerging Market Growth, Inf Among DM countries, the US has a relatively young Turkey 79 28.5 26.5 64.1 9.3 population. For example, the median age for the US is Mexico 114 27.1 28.3 62.3 9.4 36.9, whereas it is 44.9 for Germany, 44.8 for Japan, 40.0 for the UK, and 39.9 for France. The provides the US with India 1,189 26.2 29.7 62.0 8.4 an advantage with regards to potential real GDP growth. M South Africa 49 25.0 28.6 62.9 8.6 Source: US Census estimates 2011 d 4
  6. 6. US 2011 Economic Outlook: Continuation of fiscal stimulus – Part 1 We forecast US growth in 2011 of 2.9%, compared to 2.8% last year. This 2011 growth forecast benefits from: all Bush tax cuts being extended; the payroll tax holiday; and accelerated depreciation. 2011 will be a year of extended fiscal stimulus. Near-term headwinds include the fiscal contraction of state and municipal governments, higher 11 energy prices, and a stagnant construction sector. After tax support for house purchases i d t t t ti t Aft t tf h h flation and Policy Challenges in 201 evaporated, home sales have slumped (slide 9). Distressed home sales as a share of all US home sales has stayed at about 30% (slide 10). New home sales have been stuck at low levels. We forecast 2.5%q/q saar real GDP growth this quarter, rising to 3.5% in 2Q11. Business surveys and more timely weekly readings on initial jobless claims are pointing to an upturn in employment growth. The 4-week weekly average of jobless claims has dropped from 418,500 in the week of the February labor market survey to 386,500 in the week of the March labor market survey. surveyDeveloped and Emerging Market Growth, Inf US corporate profits are up. Capex surveys suggest businesses will spend. On aggregate, state and local government budgets are in balance. Yet further belt tightening is M forthcoming, as balances have been achieved by temporary measures. Federal transfers to sub-federal levels of government are forecast to decline from US$59bn in FY2011 (ending June 30) to US$6 billion in FY2012. This withdrawal of federal support is equivalent to a decline of 2.5% in total state and local receipts, and will eat up a good share of the increase in revenue associated with stimulus-induced faster growth. growth d 5
  7. 7. US 2011 Economic Outlook: Continuation of fiscal stimulus – Part 2 The CPI is up to a 3-month run rate of 1.8% saar, including the surge in air fares. The core PCE price index is forecast to be up 1.3% saar in the three months through F b i i d i f b 1 3% i h h h h h February. Import prices are also accelerating, up 1.4% saar in February and 6.9%oya. The price of imported manufactured goods has also accelerated. 11 flation and Policy Challenges in 201 US unemployment rate will remain high for many years, averaging 8.4% in 2012. Fed on hold throughout 2011, and we do not expect another round of quantitative easing after QE2. Tremendous contrast between expansion of corporate borrowing and the de-leveraging by the household sector. Non-financial corporate debt increased 4.5% q/q saar in 3Q10, the third consecutive quarterly increase, and the financing gap rose to US$127.9 billion at an annual rate. Yet households are still paying down both mortgage debt and consumer credit. p y g g gDeveloped and Emerging Market Growth, Inf According to the latest data, household debt service has fallen below 12% of household disposable income, from a high of almost 14% in 2007 (slide 7). d M 6
  8. 8. US consumers have been adjusting as their debt burden declines US household wealth US household debt service ratio % of disposable income % 650 15 14.0 600 14 550 13 Historic average 500 12 11 flation and Policy Challenges in 201 11.9 450 11 400 10 52 56 60 64 68 72 76 80 84 88 92 96 00 04 08 80 84 88 92 96 00 04 08 Source: J.P. Morgan Source: J.P. Morgan Household debt Household debt % of disposable income % of household and nonfinancial corporate assets 140 130.2 25 120Developed and Emerging Market Growth, Inf 20 116.1 100 Historic 80 Average 15 60 10 M 40 5 20 0 0 52 56 60 64 68 72 76 80 84 88 92 96 00 04 08 52 56 60 64 68 72 76 80 84 88 92 96 00 04 08 d Source: J.P. Morgan Source: J.P. Morgan 7
  9. 9. US household saving rate has risen and US labor costs have fallen US saving rate US employment cost index %, sa %oya y 14 8 Benefits 7 12 11 flation and Policy Challenges in 201 6 10 5 8 Compensation p 4 6 3 4 Wages/salariesDeveloped and Emerging Market Growth, Inf 2 2 1 M 0 0 80 85 90 95 00 05 10 02 03 04 05 06 07 08 09 10 11 Source: J.P. Morgan Source: J.P. Morgan d 8
  10. 10. US home sales have slumped as tax support faded US housing turnover Single-family home sales per household 0.08 End of Federal tax support (end-April 2010) 0.07 11 flation and Policy Challenges in 201 0.06 0.05 0.04 Historical average 0.03Developed and Emerging Market Growth, Inf 0.02 0.01 M 0.00 68 71 74 77 80 83 86 89 92 95 98 01 04 07 10 Source: J.P. Morgan d 9
  11. 11. US shadow housing inventory a risk to house prices Distressed sales and home prices %oya y % 20 45 LoanPerformance House Price Index Distressed sales as % of all home sales 15 40 Case-Shiller House Price Index 35 11 flation and Policy Challenges in 201 10 30 5 25 0 20 -5 15Developed and Emerging Market Growth, Inf -10 10 -15 5 M -20 0 2006 2007 2008 2009 2010 2011 Source: J.P. Morgan d 10
  12. 12. Euro E ro area 2011 Economic O tlook Underpinnings and Risks – Part 1 Outlook: After more than a year of Western European recovery, Euro area growth has slowed. Euro area GDP rose 1 1%q/q saar in 4Q10 with German growth (1 5%) higher relative to the rest of the region (slide 1.1%q/q, 4Q10, (1.5%) 12). Euro area ex Germany composite PMI remains weak relative to Germany’s PMI. Euro area ex- Germany domestic final sales have stagnated, while Germany’s domestic final sales have risen sharply over the past year. Slide 14 summarizes our view of a three-speed European recovery: rapid in Germany; solid in Western Europe ( y p (ex. Germany); and slow in p p y) peripheral Europe. p 11 flation and Policy Challenges in 201 Euro area IP (ex. construction) rose 0.3%m/m in January, construction output rose 1.8%m/m, while exports to outside the Euro area climbed to 3.6%m/m. We expect a further strengthening of IP in February, with modest gains in construction output as well. We see the Euro area’s export prospects as bright bright. In Greece, fiscal and structural progress remains impressive, yet the 2009 fiscal deficit was 15.4% of GDP and the forecast for the 2010 fiscal deficit is 9.4%. We forecast that Greece would need a 6.5% of GDP permanent primary fiscal surplus post-2013 if it were to keep its public debt to GDP stable atDeveloped and Emerging Market Growth, Inf 158% (slide 15). For Ireland, the yield to maturity on its 10-year government debt has risen from 5.70% on September 1 to 9.89% on March 23 (well after the IMF/Euro area/ECB offered Ireland a EUR67.5bn financial support package). We estimate that Ireland would need a 3.1% of GDP permanent primary surplus post-2013 if it were to keep its public-sector debt to GDP stable at 135%. M Funding stress for Greek, Irish and Portuguese banks on the whole has remained high, and these banking systems have not issued any debt (other than short-term) so far in 2011. d 11
  13. 13. Euro E ro area 2011 Economic O tlook Underpinnings and Risks – Part 2 Outlook: Spain in a number of ways has de-coupled from Greece, Ireland, and Portugal, and its 10-year yields t maturity narrowed 40b t 5 21% f i ld to t it d 40bp to 5.21% from J January 18 t M h 23 to March 23. Our growth forecasts for Germany have been revised up because German households have become increasingly confident about the future and in part because German export growth has remained strong. Now we see German GDP up 3.3% this year (compared to Euro area growth strong 3 3% 11 flation and Policy Challenges in 201 of 2.2%). The Euro area has begun to see growth in bank loans to households and non-financial companies ( p (slide 15). ) One upside risk to Euro area growth is that European households have scope to lower their saving rate as public-sector saving in the Euro area increases (slide 16).Developed and Emerging Market Growth, Inf We expect the ECB to raise its main policy interest rate 25bp to 1.25% in early April. Note that the Euro area business surveys in February were at a level far above that consistent with the ECB staff’s growth forecast. d M 12
  14. 14. Remarkably positive indicators for German households Consumption across the Euro area German consumer confidence Index, 1Q02=100 % balance 130 Greece 20 125 10 120 Spain 0 115 France -10 110 11 flation and Policy Challenges in 201 -20 105 Italy 100 -30 Germany 95 -40 02 03 04 05 06 07 08 09 10 00 01 02 03 04 05 06 07 08 09 10 11 Source: J.P. Morgan Source: J.P. Morgan German retail confidence German household fears about unemployment % balance % balance 20 80 10Developed and Emerging Market Growth, Inf 60 0 40 -10 -20 20 M -30 0 -40 -50 -20 00 01 02 03 04 05 06 07 08 09 10 11 00 01 02 03 04 05 06 07 08 09 10 11 d Source: J.P. Morgan Source: J.P. Morgan 13
  15. 15. A three speed E h d Euro area recovery Euro area economic sentiment Inx, sa, 100 is post-1990 average 120 Germany 110 11 flation and Policy Challenges in 201 Core, ex Germany 100 Periphery 90Developed and Emerging Market Growth, Inf 80 70 M 07 08 09 10 11 Source: J.P. Morgan d 14
  16. 16. Euro area: G E Growing evidence of monetary traction i id f i Euro area bank lending %oya y 20 Nonfinancial corporate loans 15 11 flation and Policy Challenges in 201 10 Household loans 5Developed and Emerging Market Growth, Inf 0 M -5 2000 2002 2004 2006 2008 2010 Source: J.P. Morgan d 15
  17. 17. Scope for Euro area household saving to moderate as public saving picks up S f E h h ld i d bli i i k Financial positions of Euro area sectors % of GDP, 4-qtr moving sum 6 Household 4 11 flation and Policy Challenges in 201 2 External 0 Corporate -2 -4Developed and Emerging Market Growth, Inf -6 Government -8 8 M 2000 2002 2004 2006 2008 2010 Source: J.P. Morgan d 16
  18. 18. The extent of the fiscal journey in the periphery of the Euro area The achievement of debt sustainability in 2013 JPMorgan Government objective for Primary position 2010 Gross debt peak estimate of equil Journey from 2010 primary position primary position Greece -3.7 158.0 6.5 10.2 5.9 11 flation and Policy Challenges in 201 Ireland -9.6 135.0 3.1 12.7 1.9 Spain -7.3 70.2 1.1 8.4 0.1 Portugal -4.4 86.6 2.1 6.5 1.9 Italy -0.3 119.2 4.1 4.4 2.6 Belgium -1.1 101.4 3.0 4.1 0.8 France -5.0 87.4 2.2 7.2 -0.1 Germany -1.3 80.0 1.5 2.8 0.5 UK -7.4 85.5 2.1 9.5 1.9Developed and Emerging Market Growth, Inf Source: J.P.Morgan. The JPMorgan estimate of the equilibrium primary position is based on a regression of the primary position on the level of gross debt for eight Euro area countries over the period 1997-2007 (Bel, Fr, Ger, It, Neth, Port, Sp and Au). The equation is primary position = -2.72 + 0.055*gross debt. No additional risk premia has been added for very high levels of debt. It does not matter much if the analysis is done in terms of net debt. d M 17
  19. 19. Evidence of b k f di stress i the E E id f bank funding in h Euro area periphery i h Use of ECB refinancing by country % of liabilities 20 Greece 11 15 flation and Policy Challenges in 201 10 Ireland Portugal 5Developed and Emerging Market Growth, Inf Spain M 0 2008 2009 2010 2011 Source: J.P. Morgan d 18
  20. 20. European bank redemptions likely to be heavy in 1H11 Quarterly European bank funding needs for 2011-2012 €bn 160 Senior Subordinated Government Guaranteed 140 12.8 21.6 10.1 11 120 24.7 24 7 flation and Policy Challenges in 201 21.3 23 13.9 100 50.8 0.7 26.7 16.8 80 9 20.9 60 15.3 107.1 107.6 102.1 40 76.8 68 77.3 77 3 6.7 67Developed and Emerging Market Growth, Inf 13.4 53.5 50.6 20 23.2 0 M Q111 Q211 Q311 Q411 Q112 Q212 Q312 Q412 Source: J.P.Morgan d 19
  21. 21. Japan 2011 Economic Outlook: Underpinnings and Risks – Part 1 In light of a catastrophe that is larger than any other since the end of WWII, the BoJ has been injecting liquidity aggressively into the banking system and the Bank expanded the system, size of its asset purchase program to JPY10trn (2% of GDP), from JPY5trn. The G-7 has conducted coordinated USD purchases against JPY since Friday March 18. The direct damage from the earthquake and tsunami is expected to be at least 3% of 11 flation and Policy Challenges in 201 GDP. The earthquake and tsunami will likely pull down growth in 2Q11 (to -1.0% saar from +2.2%), but we expect a rebound in 2H11. Labour productivity has risen, contributing to the surge in profit of Japanese manufacturing firms. In fact, Japanese corporate profits have recently exceeded US corporate profits (measured in USD). Given yen strength and the abundant cash of Japanese firms, we expect Japanese firms to increase overseas investment, especially in EM.Developed and Emerging Market Growth, Inf The supplementary budget is expected to be at least 2.0% of GDP, financed with JGB issuance, a temporary hike in the consumption tax, and use of contingency budgetary funds. d M 20
  22. 22. Japan 2011 Economic Outlook: Underpinnings and Risks – Part 2 CPI deflation continued in 2010, recording -0.7%y/y. We expect the rate of over-year-ago decline in core (ex fresh food) CPI to increase again in February after falling 0 2%pt in February, 0.2%pt January. We still believe that the underlying pace of the CPI’s exit from deflation will be very gradual. The BoJ established its asset purchase plan and is expected to keep its virtual zero rate 11 flation and Policy Challenges in 201 policy until it judges that price stability has been achieved (so at least through 2012). Fiscal consolidation is an urgent issue. Yet JGB yield remains low at 1.3%. The natural disaster and the uncertain political situation dim the prospects of near-term fiscal consolidation. consolidation 94% of JGBs are held by Japanese investors. investors Once Japan’s current account falls into deficit, non-residents will need to finance Japan’s fiscal deficit. Unless the market is convinced of Japan’s fiscal discipline, bond yields will rise markedly. In 2011, Japan is projected to have a 2.8% of GDP current-account surplus.Developed and Emerging Market Growth, Inf The consumption tax rate is now 5%, but in order to avoid much higher government borrowing costs in say 3-5 years time, that rate will likely increase steadily. d M 21
  23. 23. China 2011 Economic Outlook: Underpinnings and Risks – Part 1 The Chinese economy’s momentum turned up significantly in 4Q10, with real GDP rising 12.7%q/q 12 7%q/q saar (our estimate) following 9 9%q/q saar expansion in 3Q For 2010 we forecast estimate), 9.9%q/q 3Q. 2010, that GDP rose 10.3%. For 2011, we forecast 9.4% growth mostly on the basis of domestic demand growing at a brisk pace. We expect local governments to start new projects early next year. This 11 flation and Policy Challenges in 201 investment drive, together with central government efforts to meet its 5.8 million unit housing target, is likely to coincide with solid private consumption growth and the gradual fading of the inventory drag. Note that we revised down our 1H11 forecast modestly in light of the downward revisions we have made in our forecasts for 1H11 US and Japanese growth. Historically, 1%-age Historically a 1% age point change in US GDP growth (with its associated impact on the global economy) leads to about a 5%-age point change in China’s export growth. Chinese policymakers have turned their attention toward inflation, which we expect to rise 5.3%oya in March, and to remain elevated through mid-year. The PBoC announced onDeveloped and Emerging Market Growth, Inf March 18 that the reserve requirement ratio for financial institutions’ yuan deposits would be raised 50bp effective from March 25. This is the third hike in 2011, after six hikes in the RRR last year. The RRR for small and medium banks to 18.0% and for large banks to 20.0% (compared to the historical high of 17.5% in mid-2008). These policy changes, we believe, are designed to cool the housing market manage inflation and prevent overheating market, inflation, overheating. M We expect policymakers to continue with their multi-front approach. We look for continued monetary normalization in coming quarters, including more RRR hikes, interest rate hikes, and further CNY appreciation. d 22
  24. 24. China 2011 Economic Outlook: Underpinnings and Risks – Part 2 Yes, gradual currency appreciation will continue. Yet, Chinese officials argue that their low value-added value added exporters (textiles and footwear) have little room to raise prices Should these prices. low value-added exporters lose market share, unemployment would rise swiftly, according to Chinese officials. China’s M2 money supply growth eased in February, rising 15.7%oya, compared to 17.2% 11 flation and Policy Challenges in 201 growth in January. That growth was the slowest in %oya terms since July 2010. Seasonally adjusted M2 rose a moderate 0.8% m/m in February, following no growth in January. With regard to the risks to growth policy dynamics this year, we believe that the Chinese growth-policy year government still places the maintenance of stable economic growth as a high policy priority, hence is not keen to over-tighten in 2011. Note that if nominal wage growth continues to accelerate faster than inflation, then this willDeveloped and Emerging Market Growth, Inf strengthen domestic demand and help to reduce China’s current-account surplus. d M 23

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