Global Economic Forecast by EIU [August 2010]

Country Forecast

Global outlook

August 2010

Economist Intelligence Unit 26 Red Lion Square London WC1R 4HQ United Kingdom

Key changes since June 11th 2010

• The OECD's leading indicators continue to point to a mild softening of growth in the developed world, after a period of rapid rebound from the worst of the recent economic crisis. Although the sustainability of the recovery remains in doubt and notwithstanding a slowing of growth, the Economist Intelligence Unit does not expect any of the large developed economies to sink back into full-blown recession over the short term. We therefore maintain our forecast for global growth in 2010 and 2011 broadly unchanged at 4.2% and 3.6% at purchasing power parity rates, respectively, and at 3.2% and 2.6% at market rates.

• We have raised our forecast for Japanese real growth in 2010 to 3%, from 2.8% previously, to reflect the strength of the export sector. Japan now looks set to deliver its strongest growth performance since 1991. Growth will, however, fall back sharply in 2011, as domestic demand remains too weak to offset slowing export growth.

• In mid-June the Chinese government announced that it would replace the renminbi's fixed peg to the US dollar with a more flexible currency regime. We do not, however, expect the Chinese government to permit sharp movements in the renminbi and, as such, maintain our forecast of a gradual appreciation of the Chinese currency against the US currency over the forecast period.

• In the second quarter commodity prices slumped in the wake of concerns about sovereign default in the euro zone and signs of monetary tightening in China. However, our forecasts are largely unchanged, as prices had run well ahead of fundamentals earlier in the year. We see little upside from current price levels in the second half of 2010.

• The devastating oil spill off the coast of Louisiana in the US will result in lower US oil production this year, but high stocks in the US and only subdued demand growth suggest there will be little upward pressure on oil prices. The medium-term implications could be greater, given that production costs may rise and deepwater drilling may not resume quickly.

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Global outlook 1

Contents

2 World growth and inflation

9 Regional summaries

28 Exchange rates

30 World trade

32 Commodity prices

39 Global assumptions

Country Forecast August 2010 www.eiu.com © The Economist Intelligence Unit Limited 2010

2 Global outlook

World growth and inflation (Forecast closing date: July 9th 2010)

World summary (% change)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Real GDP growth (PPP exchange rates) World 4.4 5.0 5.1 2.8 -0.7 4.2 3.6 4.0 4.1 4.2 OECD 2.7 3.1 2.7 0.6 -3.3 2.5 1.7 2.0 2.2 2.3 Non-OECD 7.4 8.1 8.8 6.2 3.0 6.6 6.1 6.4 6.3 6.3 Real GDP growth (market exchange rates) World 3.6 4.0 3.9 1.7 -2.2 3.2 2.6 2.9 3.0 3.1 North America 3.1 2.7 2.2 0.4 -2.5 3.3 2.0 2.1 2.4 2.4 Western Europe 2.1 3.2 2.7 0.7 -4.1 0.8 0.9 1.5 1.8 1.8 Transition economies 5.6 7.3 7.3 4.6 -5.6 3.1 3.6 4.2 4.2 4.3 Asia & Australasia (incl Japan) 5.1 5.5 6.1 2.8 0.5 5.6 4.3 4.5 4.3 4.3 Latin America 4.9 5.6 5.6 4.0 -2.1 4.1 3.4 4.2 4.1 4.2 Middle East & North Africa 6.1 5.9 5.6 6.1 1.4 4.5 4.4 4.6 4.6 4.8 Sub-Saharan Africa 6.8 6.7 7.0 4.8 0.5 4.4 4.5 5.5 5.0 5.0 Inflation (av) World 3.0 3.3 3.4 4.9 1.6 2.9 2.7 3.0 3.2 3.3 OECD 2.2 2.2 2.1 3.2 0.0 1.3 1.2 1.7 2.0 2.2 Trade in goods World 7.5 9.1 7.6 3.7 -11.2 6.8 5.3 6.3 6.4 6.3 Developed countries 5.6 7.1 4.9 0.9 -12.3 4.9 3.6 4.3 4.7 4.6 Developing countries 10.8 12.4 11.8 8.0 -9.6 9.5 7.6 8.7 8.4 8.2

Source: Economist Intelligence Unit.

Concerns about the sustainability of the global recovery rise

Renewed fears in late May and early June about contagion in the euro zone from the debt travails in southern Europe and, more generally, a mixed global macroeconomic data flow have cast doubt on the sustainability of the global economic recovery and contributed to an increase in market volatility. Recent US non-farm payroll data have been particularly disappointing—in May only 41,000 jobs were created in the private sector, compared with a typical tally for this stage in the cycle of around 300,000 jobs a month, and in June 125,000 jobs were lost. Other concerns include the failure so far of the EU-IMF €750bn (US$937bn) package of support for struggling euro zone members to stabilise these countries' debt markets and signs of slowing growth in China's economy.

The OECD's composite leading indicator, which is designed to predict turning points about six months ahead, points to a mild softening of growth in the developed world after a period of rapid rebound from the depth of the earlier global economic crisis. In the US this is echoed in the leading index of the Economic Cycle Research Institute (ECRI), which also points to a slowdown in the pace of the US recovery. It remains difficult to assess the sustainability of the global recovery, given the importance of temporary factors such as inventories and fiscal stimulus in kick-starting the initial spurt. Although private consumption has strengthened substantially in many countries, this is not in itself a sign that the global economy has moved beyond restocking and stimulus-driven growth.

Editor: Robert Ward (editor); Caroline Bain, Aidan Manktelow, John Bowler (consulting editors) Editorial closing date: July 9th 2010 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: To request the latest schedule, e-mail [email protected]


Global outlook 3

OECD leading indicators(% change, month on month)

Source: OECD.

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Fiscal stimulus has in many cases been directly addressed to provide support to households, for example through tax relief. In other cases, stimulus helped to boost employment growth and therefore provided support for the economy. Although this stimulus may still generate sufficient autonomous private-sector-driven momentum, in the longer term fiscal consolidation, household retrenchment and banking sector balance-sheet repair will constrain growth. In some countries, including the US, the fiscal tightening will even lead to renewed weakness over the short term, although, in the absence of a severe external shock, the Economist Intelligence Unit does not expect the US to slip back into a full-blown recession.

Corporate profit growth is strong On a more positive note, companies and consumers are slowly rebuilding confidence and are adjusting their consumption, investment and hiring behaviour to suit a more benign outlook. Importantly, businesses are also no longer cutting their inventories. Destocking had been a main factor behind the earlier decline in GDP, and restocking now provides a massive but short-lived boost to growth. In the US, the impact amounted to 3.8 percentage points of the 5.6% annualised GDP growth in the fourth quarter of 2009 and 1.9 percentage points of the 2.7% GDP growth in the first quarter of 2010. Many companies are also in robust financial health, having cut workers and salaries during the worst of the crisis. In the US, for example, corporate profits rose by a blistering 31% year on year in the first quarter of 2010, which is only the sixth time in 60 years when profits have grown by 30% or more.

The key question is whether other sources of demand will be sufficient to maintain the strength of the recovery beyond 2010. Optimists point to emerging markets, where, with the exception of swathes of central and eastern Europe, the recovery has generally been exceptionally vigorous. These economies have, however, also become heavily dependent on policy support, which, given the lack of balance-sheet problems, has had a strong and quick effect on growth. In view of the weakness of many of their key developed-country markets, it therefore remains unclear how vigorously these economies will be able to grow once this support starts to be withdrawn.

Private-sector balance sheets in a number of major economies have improved since the height of the crisis, as consumers have been forced to scale back liabilities. However, this has been partly matched by a rising indebtedness of


4 Global outlook

the public sector, adding to concerns about sovereign risk. In this sense, major economies such as the US have merely shifted liabilities from one part of the economy to the other and just postponed, rather than avoided, a needed adjustment. For many developed countries, the extra fiscal burden from the financial crisis comes just as population ageing is already starting to exert increased pressure on the public purse. Addressing the needs of demographic change will, therefore, further complicate governments' ability to undertake fiscal reforms.

2011 will see a deceleration throughout the developed world

Despite the recent improvement in many developed economies the private sector is still overstretched, with highly indebted households facing a protracted period of balance-sheet adjustment. As these imbalances come to the fore again from late 2010, we still expect a slowdown in the US, and growth in the euro area will continue to be weak in 2011. (Japan, in contrast, does not have the private-sector indebtedness problems of its developed-country peers—growth in 2011 will rather be constrained by other structural problems, including Japan's weak public finances and a deceleration in key export markets.) This will hurt not only the countries directly concerned, but also their trading partners and countries vulnerable to a decline in risk appetite. However, at least in our main scenario, this will entail a softening of growth rather than a renewed widespread fall in GDP. Companies are aware of risks on the horizon. As a result, they will keep inventories, often the single most important driving force for an economic contraction, under control in the short term.

Growth in 2012-14 should, however, be more stable and on a sounder footing than in 2007-11. A return to the heady growth rates seen before the crisis, which were only possible because of excessive credit growth, is unlikely. The US will need several years during which private consumption grows by less than overall demand, while the public sector will also have to retrench in the medium term. In western Europe, fiscal tightening will weigh on growth in many countries. In addition, as wage subsidies have encouraged labour hoarding to contain unemployment, a return to healthy job growth will take a long time, since companies have ample room to increase production without hiring new workers. Some economies in western Europe, including Spain and the UK, as well as many countries in central and eastern Europe will take a long time to absorb the consequences of earlier lending excesses and declining competitiveness. Asia will be the strongest region in terms of economic growth, although the need to scale back the massive credit expansion in China that was implemented in 2009 could lead to some instability.

Sovereign risk has moved to the centre with the European fiscal crisis

Concerns about fiscal sustainability, particularly in the developed world, will remain a source of market turbulence. Although the EU-IMF financial support package has, in theory, bought euro zone policymakers time to try to stabilise the weaker peripheral countries, euro area support could still vanish if coun-tries in receipt of the bailout funds fail to make required adjustments or if rich member states tire of supporting troubled neighbours. The looming announcement of European bank stress tests could also trigger volatility if the results lack credibility in the eyes of the markets. We expect that, given its massive debt burden, Greece will ultimately have to restructure its debt, which could lead to fresh fears about contagion within the euro zone and thus new


Global outlook 5

turbulence. In addition, other countries with poor fiscal positions, including the UK, Japan or even the US, could come under close scrutiny by the markets.

The fiscal crisis in the euro area has caused accelerated moves towards fiscal consolidation, not just in countries immediately affected by the surge in bond yields in May and June, but also by sounder countries such as Germany. Meanwhile, since outside Europe the global recovery is continuing, an increasing number of countries have moved towards withdrawing some of the extraordinary monetary stimulus that they introduced in response to the global financial crisis. The US has already terminated many of its unorthodox monetary policy measures, although in our view US interest rates will only start to rise in the third quarter of 2011.

In the emerging world, which has been less affected by the financial crisis, financial conditions have become too expansionary. At the same time, these countries are more vulnerable to inflation, as price expectations are less well anchored and commodities make up a large part of the consumer price index. Consequently, we expect interest rate hikes and other tightening measures in many emerging countries in 2010, and some countries, including Malaysia, India and Brazil, have already raised their rates in recent months. China has also made early moves, ordering banks to rein in credit growth sharply and raising its reserve requirement for banks three times.

Risk scenarios

Events may diverge from the Economist Intelligence Unit's forecast in ways that affect global business operations. The main risks are represented by the following scenarios. Very high probability = greater than 40% likelihood that the scenario will occur over the next two years; high = 31-40%; moderate = 21-30%; low = 11-20%; very low = 0-10%. Very high impact = change to global annual GDP compared with the baseline forecast of 2% or more (increase in GDP for positive scenarios, decrease for negative scenarios); high = 1-1.9%; moderate = 0.5-0.9%; low = 0.2-0.5%; very low = 0-0.1%. Risk intensity is a product of probability and impact, on a 25-point scale.

Negative scenario—Sovereigns default as public debt spirals out of control

High probability; High impact; Risk intensity = 16 Concerns about the sustainability of public debt positions in a number of countries have risen sharply in recent months. Heavily indebted sovereigns—including developed economies, notably in the euro zone—could struggle to raise private financing even at higher interest rates, and some could default. Emerging-market defaults would create some ructions, but as developed-country sovereign bonds have traditionally been considered risk-free, defaults by such governments would wreak havoc on asset markets and investor psychology. Banks would face write-downs on their government debt portfolios, and financial sector guarantees by governments that default would be exposed as worthless. Financial systems would therefore come under renewed pressure, and there would be serious implications for economic growth.

Negative scenario—Developed economies fall into a deflationary spiral

Moderate probability; Very high impact; Risk intensity = 15 Deflationary pressures remain strong in key developed economies, and could yet overwhelm the policy response designed to prevent a deflationary spiral. Notwithstanding concerns on the part of some observers about the inflationary impact of unorthodox monetary measures (quantitative easing), we still see deflation as the greater risk, partly because such measures can be unwound before inflationary pressures rise unduly. Deflation would blunt the effectiveness of macroeconomic policymaking, delay balance-sheet adjustment in highly indebted economies, and encourage consumers and firms to prioritise debt repayment over consumption. It would hit profits and lead to lower investment. If deflation took hold, the global economy would face prolonged stagnation.


6 Global outlook

Negative scenario—The global economy experiences a double-dip recession as stimulus fades

Moderate probability; Very high impact; Risk intensity = 15 Massive macroeconomic stimulus has stabilised the global economy and allowed growth to return. However, there is a risk of a renewed decline when the impact of the stimulus fades from the second half of 2010 onwards, as it takes time to absorb persistent fundamental imbalances. Our baseline forecast is for a soft patch in some key economies, including the US, in 2011 as stimulus is wound down; the risk is of a deeper downturn, including renewed contraction in several leading economies. A new wave of countries, whose finances have been weakened by the earlier downturn, would require multilateral assistance, and companies that had barely survived the initial recession would fail.

Negative scenario—New asset bubbles burst, creating renewed financial turbulence

Moderate probability; High impact; Risk intensity = 12 Massive monetary stimulus, combined with the ongoing global recovery, has led to concerns about new asset bubbles, particularly in emerging markets. Emerging-market assets have surged and other risky asset classes such as commodities have seen strong rebounds. It is questionable whether bubbles have yet formed on a broad scale, but the risk of shocks to the global economy from market corrections is rising. New asset bubbles may be vulnerable to painful corrections as central banks in emerging markets tighten monetary policy, fiscal stimulus is withdrawn, and the weak foundations of recovery become apparent. The resultant dislocations, including a shock to banks and a rise in risk aversion, would reinforce and deepen a renewed economic slowdown.

Negative scenario—Protectionism takes hold, undermining globalisation

Moderate probability; High impact; Risk intensity = 12 The rise in protectionism as a result of the downturn has been less severe than might have been expected. But the risk remains even as recovery proceeds, as reduced levels of demand heighten competitive pressures. Greater protectionism would be disruptive for businesses. Some firms would be shut out of markets, others would see profitability hit by having to choose local suppliers over cheaper imports. Given the closely integrated nature of the global economy, governments would find it difficult to close off many aspects of trade. However, trade disputes are likely to increase as populist policies clash with countries' international obligations. If introduced on a large scale, protectionism would seriously slow economic recovery.

Negative scenario—The Chinese economy crashes

Low probability; Very high impact; Risk intensity = 10 China's economic growth rates have been spectacular, and among the quickest in the world to rebound to pre-crisis levels. The country is key to the global recovery. However, the surge in bank lending during 2009 raises the risk of a build-up of non-performing loans, with implications for the whole economy. Although the risks to China's economy are greater in the long term, growth could start to slow sharply in 2011. The dangers to the economy would be compounded by a double-dip recession in developed markets or a rise in protectionism. China's fiscal position remains strong, but it is questionable whether the government could repeat the massive stimulus seen in 2009 to stave off another slowdown.

Negative scenario—The euro zone breaks up

Low probability; Very high impact; Risk intensity = 10 The economic crisis has exposed serious weaknesses in the euro zone. First, highly indebted peripheral euro zone economies face painful adjustment processes to restore their competitiveness. Second, richer countries have had to sign up to potentially huge bailouts of more profligate members. The resultant strains could lead to the break-up of the euro zone. This scenario would be hugely destabilising for the global economy. The weaker ex-members would default as their currencies plummeted and funding costs soared. Banks globally would be severely shaken. The US dollar would shoot up, choking off the US recovery and also hitting countries with currencies tied to the dollar, notably China.


Global outlook 7

Negative scenario—Economic upheaval leads to widespread social and political unrest

Moderate probability; Moderate impact; Risk intensity = 9 The global economic crisis is having a severe social impact. Outbreaks of violent protest since its onset have so far been limited. However, given higher unemployment and poverty, weak growth and, in particular, fiscal austerity measures in many countries, protests could yet increase in frequency and intensity. In some cases, this could bring the survival of governments into question. The risk is that instability becomes systemic, with political crises in certain countries affecting others through contagion or through the actions of populist new regimes seeking to assert themselves. Widespread social and political unrest would carry a considerable economic and financial cost.

Positive scenario—Emerging-market growth surges

Low probability; High impact; Risk intensity = 8 We continue to doubt that a sustainable return to pre-crisis growth rates is possible for emerging economies while demand in the developed world remains weak. The current strong upturn in emerging markets is driven to a considerable extent by their own stimulus measures and by the inventories cycle. However, it is possible that their rebound could become self-sustaining—many leading emerging economies have performed above expectations in recent months. In particular, if inflation remains in check, against a background of loose monetary policy autonomous demand in emerging markets could prove sufficient to sustain a continued, mutually supporting surge in growth, even as the impact of temporary factors fades. This scenario would see many emerging markets substantially outperforming our baseline forecast.

Positive scenario—Confidence revives, prompting a stronger rebound in demand

Low probability; High impact; Risk intensity = 8 We continue to believe that risks to the global economy are concentrated on the downside. However, there remains some upside risk. If the problems that have weighed on sentiment in recent months, notably in the euro zone, are contained, market confidence could re-emerge. With monetary conditions still loose, improved market sentiment could foster a stronger rebound in private demand, creating sufficient self-sustaining impetus in the private sector for robust growth to survive the withdrawal of stimulus measures. However, this depends on an absence of further shocks, and we view this scenario as only a low probability. A fuller discussion of these scenarios can be found online at http://gfs.eiu.com/. Austerity will weaken jobs recovery

Unemployment has risen sharply in many countries as a result of the global recession. Although the world economy is now recovering, policy is entering an austerity phase that could imperil demand and job creation in the developed world. This could lead to prolonged high unemployment. In particular, the Economist Intelligence Unit forecasts that even by 2014 unemployment will still be substantially above pre-crisis levels in fiscally troubled European countries as well as in the US. The International Labour Organisation (ILO), an agency of the UN, estimates that 34m people worldwide became unemployed between 2007 and 2009 as a result of the global economic downturn. Recorded rates of unemployment rose dramatically during this period. In the US the unemployment rate rose from 4.6% at the start of 2007 to 10% at end-2009. In Spain it went from 8.2% to a shocking 19% in the same period. With the global economy now growing again, employment prospects have started to pick up, reflecting stronger demand in most countries. However, the improvement in the employment picture is uneven, and the fall in unemployment has been only marginal so far. The latest monthly data from the ILO show a fractional fall of 0.2 percentage points in the global rate of unemployment as reported by 60 countries, compared with a year ago. (The ILO cautions that its estimates cover a limited number of countries and may be revised later.) The improvement is entirely the result of progress in the developing world. Unemployment rates have continued to rise year on year in developed countries, although at a slowing pace.


8 Global outlook

The dual nature of the global recession and subsequent recovery reinforces this picture. Rich countries have generally been harder hit by the financial and economic crisis than large emerging markets, and many have seen correspondingly steep rises in reported unemployment. The US, with its relatively flexible labour market, provides perhaps the starkest example of the effects of the recession on employment. The economy has shed 7.4m jobs since employment peaked in November 2007. Two key indicators of the continued weakness of the labour market are the high numbers of long-term unemployed and of people in part-time work. According to the US Bureau of Labour Statistics (BLS), the number of people who have been unemployed for 27 weeks or more is now 6.8m, a rise of over 5m in the past two years. The weak economy has also forced more people to turn to part-time work; BLS data show that 3.1m more people are working part-time for "economic reasons"—either because of slack business conditions or an inability to find full-time employment—than two years ago. Unemployment rates remain stubbornly high in many countries despite improving economic activity. Employment and unemployment are generally regarded as lagging indicators, as companies are reluctant to rehire until they are confident that business is improving, so some of the recent revival in economic output may not yet have filtered through to jobs data. In the US the civilian unemployment rate was 9.5% in June, down only slightly from around 10% at the end of last year. At the same time much of the recovery in global economic activity has been driven by temporary factors, such as the end of destocking and fiscal stimulus. These effects cannot last, so global economic growth in 2011 will struggle to continue at a level that is able to support a recovery in employment. More jobs may even be lost as global growth slows again. The ILO reckons that discretionary fiscal stimulus created or saved nearly 15m jobs in the G20 countries in 2009-10. The obvious, and ominous, implication is that some of these gains could be reversed as stimulus is withdrawn. Compounding the problem is the policy shift towards fiscal austerity in a number of countries. The sovereign debt crisis in the euro zone has put pressure on governments to make public-sector cuts. This pressure has extended beyond the euro zone itself, as the drastic fiscal retrenchment plans outlined by the UK government illustrate. These factors will either lead directly to job losses or make it harder to create new jobs. Even in the US, which has major fiscal weaknesses but is not under the same immediate pressure as European markets, the fiscal deficit has become such a politically prominent issue that there is little appetite for further stimulus. The US Senate recently refused to approve a bill to extend unemployment benefits, and substantial new spending on job creation is unlikely. The weakness of public-sector finances in many countries bodes ill for employment, not only because of the prospect of redundancies as government budgets are cut, but also because in most cases the private sector is unlikely to be strong enough to take up the slack. Indeed, it is largely because of public-sector support, in the form of policy stimulus, that the private sector has recovered to the extent that it has. Without this support, it faces a return to more difficult conditions. In addition, public-sector lay-offs would be likely to reduce consumer spending, making it harder for private companies to stay profitable and hire or retain staff. The tougher environment will also lead to pay freezes, reductions in benefits and a weakening of employees' ability to negotiate wage increases. This is likely to add to households' financial hardship, further undermining consumer spending. Indeed, our forecasts for OECD countries indicate that wages will fail to keep pace with inflation in the UK, Spain, Greece, Ireland and the Netherlands in 2011. The implications for employment in individual countries over the next five years remain mixed. In broad terms, within the OECD those with the worst prospects are Iceland, the "southern periphery" euro countries, the UK and the US. By 2014 employment will have failed to recover to anything like pre-crisis levels in these countries. In Spain, we forecast that the jobless rate will still be 15.6% in 2014, some 7 percentage points above the level in 2007. In the UK it will be 8.3%, and in the US 7.4%. Germany will be an honourable exception; unemployment will fall to an average of 5%, from 8.4% in 2007. However, this reflects the fact that relatively recent labour reforms have fundamentally lowered unemployment in Germany compared with the years before the global crisis.


Global outlook 9

Regional summaries North America growth and inflation (% change)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 US Real GDP growth 3.1 2.7 2.1 0.4 -2.4 3.3 2.0 2.1 2.3 2.4 Inflation 3.4 3.2 2.9 3.8 -0.3 1.7 1.3 1.9 2.5 2.8 Canada Real GDP growth 3.0 2.9 2.5 0.4 -2.6 3.4 1.9 2.2 2.7 2.6 Inflation 2.2 2.0 2.1 2.4 0.3 1.7 1.8 2.0 2.4 2.4


US growth will slow from the second half of 2010

The US recovery remains driven by fiscal and monetary stimulus and by the end of destocking, which will bring GDP growth to 3.3% in 2010. However, these forces will weaken during the second half of 2010, leaving the economy more dependent on the strength of autonomous private-sector demand. The Economist Intelligence Unit's forecast, which is much more pessimistic than the consensus, particularly for 2011, relies on the assumption that the underlying fundamentals of the economy will still hold back the private sector. As a result, the economy, when it is deprived of its principal drivers of stimulus and restocking, will weaken again later this year, leading to growth of just 2% in 2011.

Private inventories contributed 3.8 percentage points to the 5.6% annualised GDP growth rate reported for the fourth quarter of 2009, and 1.9 percentage points to the expansion of 2.7% in the first quarter of 2010. Fiscal stimulus was also an important driver for growth. According to a report by the Council of Economic Advisers on the impact of the American Recovery and Reinvestment Act—the main stimulus package enacted in February 2009 and worth US$787bn—the budgetary impact amounted to US$112bn in the first quarter, compared with US$83bn in the fourth quarter of 2009. Most estimates from the government and other economists suggest that the level of real GDP in the first quarter was around 2-3% higher than it would have been without the stimulus. However, according to an analysis by the non-partisan Congressional Budget Office from February 2010, the impact of the stimulus on the level of GDP will fade from the third quarter of 2010.

Some small additional measures to support the economy are likely subsequently. However, these additional measures will only slow down the withdrawal of fiscal support, rather than provide a new boost to GDP growth. More substantial new stimulus that is sufficient to make a real difference to growth would require a new sharp downturn, as there is no appetite in Congress or among the electorate for a further rise in the public deficit, and the Greek crisis has highlighted the dangers of spiralling budget deficits. For this reason the tax cuts that were enacted by the previous administration of George W Bush and are due to expire in 2011 are also unlikely to be extended.

Fed rates are not expected to rise until the third quarter of 2011

Monetary policy has also provided massive support for the economy, as the Federal Reserve (Fed, the US central bank) has cut interest rates and made ample use of unorthodox measures (quantitative easing). Monetary policy


10 Global outlook


support is being withdrawn. The Fed completed its purchases of US$300bn worth of US Treasury bonds in October 2009, and its purchases of US$1.3trn worth of mortgage-backed assets guaranteed by Freddie Mac and Fannie Mae, the government mortgage agencies, and US$200bn worth of debt issued directly by these agencies ran out in March this year. So far the impact of the phasing out of these purchases has been muted, although it is difficult to single out the effect of Fed purchases on bond yields from all the other factors influencing yields. A more substantial rise in bond yields is possible, with serious implications for the economy.

The target for the federal funds rate, the Fed's main policy instrument in normal times, is still a band of 0-0.25%. The Fed has continued to indicate that it will keep interest rates at exceptionally low levels for an "extended period". Given the normal relationship between interest rates, inflation and the output gap, and assuming our macroeconomic forecasts are correct, interest rates have to remain at their extremely low level until at least the middle of 2011, and we do not forecast a rate hike until the third quarter of next year. This is much later than the consensus view. The consensus view of a faster tightening is premised on a strong and sustained economic recovery and on the view that excess capacity will not exert much downward pressure on prices.

Private consumption, the key source of demand for the economy, seems likely to remain subdued for some time. Given the high unemployment rate, wage growth is also likely to remain weak. Employment is likely to recover substantially this year, since it fell much more sharply than output during the recession. But the initial snap-back in staff levels will reflect hiring to reverse cuts that were made in the face of fears of a severe depression. Companies, aware of the risks to the outlook, will be reluctant to rebuild their payrolls quickly—witness the disappointing non-farm payroll data for May and June. The rise in the number of long-term unemployed people who are losing their benefits and, more importantly for potential growth, their skills also gives cause for concern.

US stock of unsold homes('000; months of supply)

Source: National Association of Realtors.

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Jan01

Feb2000

Real estate problems will also continue to weigh on growth. Home sales surged in February, March and April, but this was driven mainly by home buyers bringing forward purchases in order to benefit from a subsidy for first-time buyers worth US$8,000 that expired at the end of April. Since then the news

Consumption is depressed by low wage growth and wealth losses

Global outlook 11


from the housing market has been grim, with sales of new single-family homes, for example, crashing by around one-third in May to an annualised rate of just 300,000. This was the lowest number since 1963, when records began, and the weakness was relatively evenly spread around the country. The stock of unsold housing also rose in May to around nine months of supply, well above the four to five months seen in a healthy market. Foreclosures also remain at worryingly high levels, suggesting continued downward pressure on the asset quality of US banks.

Thus, a sustained recovery in house prices, which are more important than construction because they determine household wealth, is still a long way off. The earlier sharp decline in house prices, and in many cases very high loan-to-value ratios at the time of home purchase, have left around one-quarter of households nationally in a position of negative equity, according to First American CoreLogic, a real estate research firm. The surge in unemployment in 2009 has also undermined the ability of many home owners to service their debt, and government programmes to help restructure mortgages often provide a respite but not a full resolution. This means that there is still a large amount of housing likely to come into foreclosure, and many homes already held by banks as a result of foreclosures have not yet moved onto the market.

The earlier steep fall in house prices has cut directly into households' wealth. Despite a recovery in the third and fourth quarters of 2009, household net wealth is now 4.9 times disposable annual income, compared with 6.2 times as late as mid-2007. Access to consumer credit has also been tightened, so consumers have been under pressure to improve their balance sheets. However, the net savings rate has risen only moderately, from an annual average of 1.7% in 2007 to 4% by end-2009, and had declined again to 2.7% by March 2010.

US: home foreclosures(no.)

Source: Bloomberg.

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

AprJan10

OctJulAprJan09

OctJulAprJan08

OctJulAprJan07

OctJulAprJan06

OctJulApr2005

The experience of other countries that have been affected by real estate and banking crises suggests that there is potential for a much sharper increase in the savings rate. In the UK, which is also suffering from a property downturn and excessive household indebtedness, the gross household savings rate has surged from -0.7% in the first quarter of 2008 to 8.4% in the third quarter of 2009, before receding to 7% in the fourth quarter. For now, we expect only a moderate increase in the US savings rate, but the risk of a bigger rise—with severe repercussions for private consumption—is high.

The risk of a sharp rise in the savings rate remains

12 Global outlook

The rise in the savings rate and the weakness of incomes mean that private consumption will grow at only a subdued pace, after increasing faster than overall GDP during the boom years. This will entail a shift in the composition of economic growth away from consumer-oriented goods and services towards a higher share of exports. But there is a high risk that sustained US dollar strength will undermine the country's export performance.

Some momentum will be regained in the medium term, with annual average GDP growth of 2-2.5% in 2012-14. This will be much lower than the heady annual average rate of 3.2% in the 1990s and also weaker than the pace of 2.7% during the last decade up to the start of the crisis in 2007. This reflects the fact that investment in productive capacity will remain on a weaker trajectory than before the crisis and that households, banks and the government will have to continue the process of rebuilding their balance sheets for some time. Also, a shift to a more export-oriented economic structure would initially require structural adjustment that will be painful. Labour force growth is likely to weaken somewhat, and this is unlikely to be offset by productivity growth.

Canada has good economic fundamentals

Although the Canadian economy contracted slightly more than that of the US during the recession, Canada's fundamentals are much healthier than those of the US. Most importantly, the financial sector has been much sounder, which has meant that households have been able to benefit from very low interest rates and house purchases have surged. Interest rates are likely to start rising soon and the government is taking measures to contain the housing boom, but this will only partly offset the positive impact from a strong financial sector. Also, the government finances are in good shape structurally, despite a marked deterioration in 2009. Nevertheless, Canada's high exposure to the US means that it would inevitably be affected if, as we expect, the US economy slows in the second half of 2010 and in early 2011.

Japan growth and inflation (% change)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Real GDP growth 1.9 2.0 2.3 -1.2 -5.3 3.0 1.3 1.3 1.1 1.1 Inflation -0.3 0.2 0.1 1.4 -1.4 -0.9 0.5 1.0 1.1 1.2


Japan: consumer prices(% change, year on year; seasonally adjusted)

Source: Ministry of Internal Affairs and Communications.

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

Excl food & energyAll items

1009080706050403022001


Global outlook 13

Japan's recovery remains weak and depends on fiscal stimulus

First-quarter GDP growth came in at a blistering annualised rate of 5%, albeit largely on the strength of a robust 6.9% rebound in exports of goods and services, as Japan benefited from its proximity to the booming Chinese economy and some recovery in US import demand. Even assuming more moderate export growth over the remainder of the year, we now expect Japan's real GDP growth to reach 3% (2.8% previously) in 2010, the economy's fastest rate of expansion since 1991.

But Japan is still struggling to revive domestic demand. Deflation is entrenched, and the government's very weak fiscal position limits its options in terms of applying stimulus once the export bounce has come to an end. Private consumption growth, although positive at 1.3% in the first quarter, was lower than expected. The government's stimulus measures will help to boost private consumption growth to 2.1% in 2010, but they will begin to fade before the end of this year, and fiscal consolidation will begin to bite in 2011. Our forecast that Japan's real GDP will expand by only 1.3% in 2011 reflects the constraints imposed by a declining population, increasingly limited fiscal flexibility, and weakening US demand for Japanese exports.

Like their US peers, Japanese firms have seen a sharp rise in profitability on the back of cost cutting—witness the 10% quarter-0n-quarter increase in recurring profits in the first quarter indicated in the corporate survey of the Ministry of Finance. This has been reflected in the second-quarter Tankan survey of corporate sentiment published by the Bank of Japan (BOJ, the central bank), which reported that sentiment in the manufacturing sector turned positive after seven successive quarters in negative territory. Particularly encouraging were indications that firms were planning to increase investment by 3.8% in the 2010 fiscal year, as well as a further easing of firms' perceptions of excess employment (although this remains in positive territory, signifying excess). Importantly, sentiment at small and medium-sized businesses, which account for the vast majority of employment in Japan, continued to improve in the second-quarter Tankan survey (although it remained in negative territory). On a more negative note, monthly wages, which registered increases in March and April for the first time since July 2008, slipped again in May, falling by 0.6%.

The risks are on the downside One risk to our forecast is the strength of the yen, which is limiting the extent to which the country's manufacturers are able to benefit from the expansion in global trade in 2010-11. The yen's strength has put Japanese manufacturers at a particular disadvantage vis-à-vis their South Korean counterparts—they compete against the South Koreans in a variety of key sectors, including electronics and the automotive industry, and South Korean firms continue to enjoy the fruits of the sharp devaluation of the won in 2009. The yen's strength against the euro—in mid-June the yen was trading at around ¥112: €1, up from an all-time low of nearly ¥170:€1 in mid-2008—puts Japanese exporters at a particular dis-advantage in the euro area.

The BOJ will not pursue an aggressive anti-inflation policy

Against this background, even the BOJ's ultra-accommodative policy stance does not provide sufficient support to overcome deflation. We forecast that the BOJ will keep its policy rate, the overnight call rate (OCR), at its current level of 0.1% until the fourth quarter of 2011. Given that nominal interest rates are near zero, the government is keen for the BOJ to pursue more aggressive quantitative easing


14 Global outlook

by purchasing unconventional assets such as corporate bonds, stocks and mortgage-backed securities. The BOJ is dubious about the efficacy of such a policy, given its experiences of the 1990s, and has instead launched a plan to "strengthen the foundations of economic growth". This measure makes ¥3trn (US$32.5bn) of capital available to commercial banks to lend to companies in a number of targeted sectors. Eventual policy tightening from 2011 will be slow, with the OCR forecast to rise to 1.75% by end-2013 and to remain at that level in 2014.

Public indebtedness will continue to rise

Japan's already dire fiscal position will continue to deteriorate. We forecast that the gross public debt stock will rise to 213% of GDP by end-2014, by far the highest level in the developed world. On the basis of our forecast of a primary budget deficit of 4.2% in 2014, the government has no prospect of making inroads into this over the forecast period. The fiscal crisis in the euro area has raised the risk of tensions in Japanese bond markets, although this is not part of our main scenario.

The new prime minister, Naoto Kan, who enjoys a reputation as a fiscal hawk, has suggested capping Japanese government bond issuance in the coming financial year 2011/12 (April-March). One touchstone of Mr Kan's willingness to tackle the deficit, however, will be his attitude towards an increase in the consumption tax. At 5%, this tax is low by the standards of Japan's developed-country peers, and raising it will be a key part of broader fiscal reform. Mr Kan's predecessor as prime minister, Yukio Hatoyama, had indicated that he would not raise the consumption tax until after the next lower house election. The outcome of the election for the House of Councillors (the upper house of parliament) on July 11th will have a bearing on the government's ability to push through painful fiscal adjustment. If Mr Kan can deliver a Democratic Party of Japan (DPJ) majority in the upper house election, the prospects for a more effective government will improve.

Western Europe growth and inflation (% change)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 GDP growth Euro area 3.7 3.0 2.6 0.8 -4.0 0.7 0.8 1.4 1.7 1.8 EU27 2.0 3.2 2.8 0.7 -4.2 0.7 1.1 1.6 1.8 2.0 EU15 1.9 3.0 2.6 0.7 -4.2 0.8 0.9 1.4 1.7 1.8 New membersa 4.8 6.5 6.2 3.9 -3.6 1.4 3.0 3.7 3.6 3.7 Consumer price inflation Euro area 2.0 2.0 2.1 3.1 0.2 1.2 1.5 1.6 1.7 1.8 EU27 2.2 2.2 2.4 3.4 0.7 1.6 1.8 2.0 2.0 2.1 EU15 2.0 2.1 2.1 3.2 0.6 1.4 1.6 2.0 2.0 2.1 New membersa 3.4 3.1 4.1 6.1 3.1 2.6 2.5 2.4 2.2 2.6

a Bulgaria, Cyprus, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, Slovakia and Slovenia (excluding Malta).


Debt problems create doubts about the euro area's very survival

The euro area is in the worst crisis since its inception, although we still expect a weak recovery to continue, with GDP growth of 0.7% in 2010 and 0.8% in 2011. Large debt burdens and imbalances within the euro area have caused the markets to lose confidence in the solvency of peripheral euro area sovereigns


Global outlook 15

and the viability of the single currency. Concerns about the euro have not been alleviated by a €110bn (US$138bn) bailout of Greece or the announcement on May 10th of a European Stabilisation Mechanism (ESM), which could provide €750bn of financial assistance to euro zone members. At the same time as the ESM was announced, the European Central Bank (ECB, the euro area's central bank) launched a programme of buying government bonds to restore liquidity in the bond market. So far the impact of these measures has been marginal. Yields on peripheral euro area government bonds have remained high. Meanwhile banks from Greece, Spain and Portugal are struggling to raise funding on interbank markets and remain reliant on ECB liquidity facilities.

Pressure on government bond markets and euro area interbank markets may ease once markets have a clear idea how the ESM will function in practice. However, even if the ESM works well, it merely buys time and does nothing to resolve the structural problems of restoring solvency and addressing imbalances within the euro are. At present there are no signs that politicians or electorates are prepared to undertake the reforms necessary to strengthen the euro area, such as the introduction of fiscal transfers between stronger and weaker states.

The main risk is that several euro area countries are now in a situation where even drastic fiscal consolidation measures will not restore fiscal solvency. Although fiscal consolidation may achieve its objective of reducing government expenditure and raising tax revenue, it may have such an adverse impact on the economy that the debt to GDP ratio continues to rise rapidly. Greece has already implemented massive consolidation measures and is planning more cutbacks. But it is doing this amid a continued sharp quarter-on-quarter fall in GDP, with a contraction of 1% in the first quarter of 2010.

Fiscal consolidation could push economies back into recession

An additional concern is that the consolidation efforts required in Greece and, to a lesser extent, other peripheral economies will lead to civil unrest, so that governments' resolve will waver. As a consequence, we now forecast that Greece will eventually be forced to restructure its debt, probably in 2012. A survey by Bloomberg published in early June suggested that 41% of investors and financial analysts believed that Greece would have to quit the euro area. Some 20% expected that Portugal would have to leave the single currency. At this stage, we still believe that Greece and Portugal will stay in the euro area. The costs for these countries of leaving the euro area are high. In addition, the impact on other peripheral countries would be severe, as their ability to stay in the euro area would also come into serious question. Rather than weak peripheral countries leaving the euro, another potential outcome would be for Germany and other strong countries to leave. This might prove less catastrophic financially than forced exits by weak members, but it would still create massive instability in financial markets.

The fiscal adjustments in peripheral countries, mainly Greece, Portugal, Ireland, Spain and Italy, will weigh on GDP in these economies. Other countries will also seek to reduce their deficits faster than previously thought to avoid provoking market speculation about downgrades. The German government, for example, has already abandoned earlier proposals for new tax reductions planned for 2011 and instead has announced fiscal consolidation measures


16 Global outlook

worth €80bn over the next four years, including cuts in public-sector pay and a reduction in public payrolls.

The depth of the earlier recession still means that there is some scope for recovery, albeit only a feeble one. In the first quarter euro area GDP grew by 0.2% from the previous quarter. In May the European Commission's overall business climate indicator (incorporating consumer confidence and sentiment from key sectors) stood at its highest level since May 2008. It stabilised in June despite the escalation of the debt crisis. Indicators for the level of inventories in the manufacturing and retail sectors suggest that inventories are still at very low levels. This is important, because recessions are typically driven by destocking in response to sudden shocks. Consequently, it is less likely that the euro area economy will suffer a second contraction, although this cannot be ruled out in the event of a renewed episode of intense turbulence in global capital markets stemming from the euro area debt crisis.

Export-oriented countries, such as Germany and the Netherlands, continue to benefit from buoyant emerging-market demand and the broader recovery of the world economy. German manufacturing orders were up by 30% year on year in April, and in late June some companies were worried about being able to meet expanding order books. The depreciation of the euro since late 2009 will be a boost for the region's exporters. Although in normal times the impact of currency depreciation is contained by countervailing monetary policy action, in the current circumstances the ECB is unlikely to offset the effect through higher interest rates, so the depreciation of the euro could be an important stimulus. However, those countries most under pressure (Greece and Portugal) lack the export base to benefit strongly from this, having focused for years on domestic markets. In addition, labour markets in these countries are rigid and private-sector wages are unlikely to adjust quickly to restore their competitiveness.

Euro area banks are to run stress tests in July

Fragilities in the banking sector stemming from the bursting of the residential and commercial real estate bubbles in a number of countries are being compounded by likely asset impairments related to stresses in government bond markets of peripheral euro area countries. But EU policymakers are refusing to recognise the possibility of defaults on euro area sovereign debt. This will obscure the true picture of the state of banks' balance sheets and undermine the credibility of stress tests which large euro area banks are to undergo before the end of July.

In its Financial Stability Review in June the ECB lowered its estimate for cumulative write-downs on loans and security holdings for euro area banks for the 2007-10 period to €515bn, from €553bn in its December 2009 report, but it raised its estimate for losses on loans, and the risk that loans in this category are still understated is high. Banks have already made large write-downs and loan-loss provisions, so that the ECB expects only an additional €90bn of write-downs will be necessary (net of write-backs resulting from a rise in the value of some securities). But again the risks to the downside are high, and given the length of the downturn and the risk of impairments on peripheral euro area sovereign exposure, some banks may be severely stretched. Concerns about asset quality and the imposition of tighter regulations will continue to weigh on banks' lending behaviour, restricting the supply of credit to borrowers.


Global outlook 17

In April loans to households were up by 2.2% from a year earlier, a recovery from their fall of 0.2% last September. Loans to euro area non-financial corporates declined by 3.7% year on year. These figures are still extraordinarily weak. In part, this reflects low demand for financing, but there is also survey evidence that tight lending conditions are preventing companies from making investments.

The global financial crisis has precipitated the unwinding of domestic imbalances, including the surge in house prices over the last decade, and has exposed structural problems in the public finances of a number of countries. The housing market is a concern not just for Ireland and Spain, but also for a number of other euro area countries. In France, for example, house prices in the fourth quarter of 2009 were down by 7.3% from their peak, despite having gained some ground from the trough in the second quarter. Apart from its impact on the financial sector, the weakening of real estate markets is having a direct effect on growth through falls in construction activity. However, the negative effect on private consumption is lower than in the US and the UK, as borrowing for consumption against the value of a home has been much less widespread in the euro area.

ECB starts bonds purchases after earlier reluctance

On May 10th the ECB announced that it would start buying public and private bonds in an attempt to contain disorderly conditions in some euro area bond markets and to support the €750bn rescue package announced on the same day. Previously the ECB had refused to buy bonds (with the exception of ultra-safe covered bonds), in contrast to its US and UK counterparts, which had engaged in large bond purchase programmes (quantitative easing). The ECB's change of mind has raised concerns about political interference, although the measures can also be justified fundamentally. Despite the fact that the ECB's reputation for orthodoxy has been undermined, we do not think that it will try to restore this by a premature tightening of monetary policy. Our forecast is that the ECB will start raising interest rates even later than we had previously thought, in the third quarter of 2012 (rather than the fourth quarter of 2011), as it will offset tighter fiscal policy with looser monetary policy. Despite some concerns by observers, we do not believe that the ECB interventions will lead to a surge in inflation as deflationary pressures for the euro area are intensifying, despite some upward pressure from higher commodity prices. Year-on-year consumer price inflation was 1.4% in June.

The new UK government focuses on fiscal consolidation

The UK emerged from its recession in the fourth quarter of 2009, later than other major economies, and growth prospects remain uncertain. This reflects the importance in the economy of the overextended financial sector, the after-effects of an earlier decline in house prices, and weakness in the important euro zone export market. Following the change in government in May, the coalition announced an ambitious five-year programme of dramatic fiscal tightening, with the dual budgetary aims of eliminating the large structural hole in the public finances and placing the public debt burden on a declining path within the next five years. Although fiscal tightening is required to restore confidence in the UK economy, the plan will have a negative impact on growth in the short term and could push the economy back into recession. GDP in the UK contracted by 4.9% in 2009, the first full-year contraction since the early 1990s and the worst since the second world war. We expect only a modest rise


18 Global outlook

of 0.8% in 2010, and growth is expected to remain weak in the subsequent years. Apart from fiscal consolidation, this will be the result of continued balance-sheet adjustment of the household and financial sectors.

The Bank of England (BoE, the central bank) halted its huge programme of quantitative easing in February 2010, having reached its £200bn limit. Fears that the end of the asset-purchase scheme would trigger a surge in bond yields have so far proved unfounded—despite record issuance and persistent above-target inflation, yields on ten-year gilts have fallen in response to euro sovereign risk woes and the weakness of sterling. While we expect no change in BoE policy on quantitative easing in the near term, underlying economic weakness, evidence of renewed financial stress and harsh fiscal tightening ahead mean that an expansion of quantitative easing is possible. The scale of fiscal austerity implies that the pace of any monetary tightening will be gradual. There is a real possibility that upside price pressures could lead to the BoE raising rates sooner than it would like given the weakness of the economy. However, our central forecast is for the policy rate to remain on hold until mid-2011, rising to 1.25% by year-end.

Turkey has withstood the fiscal crisis in the euro area well

The Turkish economy contracted by 4.7% in 2009 (its worst performance since the Turkish financial crisis in 2001), but a healthy recovery is under way and the economy is set to grow by 5% in 2010 and 3.9% in 2011. More restrictive financial conditions, the weakening of demand from western Europe and soaring unemployment have hurt consumption, gross fixed investment and exports. However, Turkey has survived the global financial crisis and the fiscal crisis in the euro area surprisingly well. In fact, despite the tremors in neighbouring Greece, the Turkish lira has appreciated against the euro and lost value only moderately against the US dollar. To support the economy, the Central Bank of Turkey has cut interest rates aggressively, taking the policy overnight borrowing rate from a recent high of 16.75% in October 2008 to 6.5% since November 2009. Although interest rates are currently negative in real terms, we expect the Central Bank to keep the overnight borrowing rate at its current level during most of 2010, with a shift to a tightening cycle from late 2010.

Western Europe: net external asset positions(% of GDP)

Source: Economist Intelligence Unit, Country Risk Service.

-100

-80

-60

-40

-20

0

20

40

(US)UKGermanyIrelandFranceItalyGreeceSpainPortugal


Global outlook 19

Transition economies growth and inflation (% change)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 GDP growth Transition economies 5.6 7.3 7.3 4.6 -5.6 3.1 3.6 4.2 4.2 4.3 East-central Europea 4.4 6.4 5.9 4.3 -2.4 1.7 3.0 3.7 3.6 3.7 Balkansb 4.6 6.5 6.0 5.7 -5.8 0.4 3.3 4.3 4.6 4.8 Balticsc 9.0 9.6 9.2 -1.0 -15.6 -1.9 2.9 3.3 3.7 3.9 CISd 6.5 8.2 8.4 5.3 -7.3 4.4 4.3 4.6 4.7 4.7 Consumer price inflation Transition economies 8.8 7.1 7.5 11.8 8.1 5.4 5.2 4.9 4.6 4.4 East-central Europea 3.6 3.1 4.0 5.9 3.3 2.9 2.6 2.4 2.2 2.6 Balkansb 8.3 6.9 5.3 8.8 5.0 4.1 3.3 2.9 2.7 2.6 Balticsc 4.2 4.7 7.2 12.1 3.1 -0.2 1.4 2.1 2.6 2.9 CISd 12.3 9.6 9.8 15.7 11.5 7.2 7.2 6.6 6.3 6.0

a Czech Republic, Hungary, Poland, Slovakia and Slovenia. All members of the EU. Slovenia joined the euro zone in 2007, Slovakia joined in January 2009. b Bulgaria, Croatia, Romania and Serbia. Bulgaria and Romania are members of the EU. c Estonia, Lithuania and Latvia. All members of the EU. d Commonwealth of Independent States: Azerbaijan, Kazakhstan, Russia and Ukraine.


Eastern Europe has started a slow recovery

Although eastern Europe will underperform its emerging-market peers in 2010, the region has begun to recover. Exports and industrial output are rebounding in most countries. The region has also been benefiting from the global recovery in risk appetite—but falls since April suggest that its currency and bond markets may not be immune to contagion from euro zone problems. Business and consumer sentiment in the region is fragile, and concerns remain about the impact of the financial and economic crisis on medium-term growth potential.

Public debt sustainability will loom large

The sustainability of public debt will loom large, particularly in the early years of our forecast period. Although in 2009 governments that had to seek support from multilateral creditors broadly delivered on the agreed fiscal targets, they may find it more difficult to repeat this feat in 2010, as fiscal hurdles have been set higher—although fiscal retrenchment might have to be accelerated if market sentiment towards the region sours. The sharp improvement in current-account positions in 2009 should, however, support external debt sustainability.

Only a moderate economic recovery is forecast in 2010, with average growth of 3.1%. The pick-up in leading trade partners in the euro zone will be modest, and there is little prospect of a strong rebound in foreign direct investment and external bank loans. Credit conditions will still be generally tight, and private consumption will be constrained by high unemployment. As noted above, in many countries fiscal tightening will be on the agenda as a means of restoring investor confidence in solvency. The recovery in the region is expected to strengthen thereafter, as progress is made in balance-sheet consolidation, although expansion, at 3.6% in 2011, will be sluggish by pre-crisis standards.

Poland will remain robust, but Hungary is still vulnerable

Poland has been an exception to the region's poor performance. It was the only country in the EU to avoid a recession in 2009, and will also outperform the rest of the EU in 2010. It is less exposed to international trade than other countries in the region and, like the Czech Republic and Slovakia, less reliant on foreign borrowing. The Czech Republic and Slovakia, however, are suffering from their heavy reliance on the automotive sector.


20 Global outlook

Hungary has experienced some of the greatest strains in the region because of its sizeable twin deficits (budget and current account) going into the crisis, and high foreign-currency debt exposure. Indeed, Hungary is one of only a few countries set for another year of contraction in 2010. Alarmist comments by the new government about the public finances, intended to discredit the previous government politically, spooked markets in early June. However, Hungary's budget deficit and public debt are modest by Greek standards (at 4% and 78% of GDP in 2009, respectively), and the government is likely to maintain a restrained fiscal policy. It has stated its commitment to budget targets agreed with the IMF and the EU, and their support will continue to constrain the risk of a banking collapse or sovereign default.

The Baltic states' currency pegs remain at risk

In the Baltics, Latvia will see a third and Lithuania a second year of contraction in 2010, while Estonia will return to growth. There is still a moderate risk that Latvia will have to break up its currency board and devalue. Our central forecast is that the Bank of Latvia (BoL, the central bank) will keep the lat within its current narrow band against the euro. The BoL's capacity to defend the peg is supported by financing from the IMF and other official creditors. Moreover, Latvia has made considerable progress on "internal devaluation", cutting wages and costs. Nevertheless, there remains a moderate risk that the authorities could opt for a currency devaluation if growth fails to recover. A collapse of the lat would lead to widespread defaults of borrowers with unhedged foreign-exchange exposure. This could lead to a domino effect of devaluation and default among other countries in the region with currency boards. Wide fiscal deficits will rule out meeting the criteria for euro zone entry for Latvia and Lithuania for several years. Estonia is aiming to join in 2011—entry now looks set to be approved by Ecofin, the council of euro zone economy and finance ministers, in July, after the European Commission positively assessed Estonia's readiness in May.

The Balkans will eke out a meagre recovery of 0.4% in 2010. Continued external imbalances mean that a number of Balkan economies remain vulnerable to crises. In addition, the Balkan countries are exposed to fallout from Greece's problems because of investment, trade, remittance and banking links. Romania faces tough austerity measures, and the economy will contract by 0.6% this year, before returning to growth in 2011. Resistance to cuts could create political instability. Bulgaria, meanwhile, will grow by just 0.1% this year. Its ability to respond to the crisis has been constrained by the lev's peg to the euro and the need to maintain a tight fiscal policy. We expect the currency board arrangement to be maintained.

Russia is returning to growth, but it will be subdued by recent standards

Russia and Ukraine will both return to growth in 2010, at 4.8% and 3.5% respectively. In Russia, the government's large stimulus package, an upturn in external demand and lower interest rates now that a degree of financial stab-ilisation has been achieved will underpin a robust performance. But growth will still be subdued by recent standards and, given structural problems, is likely to remain so in the medium term. The outlook for demand for steel, Ukraine's key export, is favourable, and risks to the country's short-term outlook have decreased following its agreement with the IMF in July on a new lending programme, expected to be confirmed by the IMF board later in the month.


Global outlook 21

There is some upside potential to the forecasts for Russia and Ukraine, provided that the recovery in the global economy is sustained. Russia, in particular, will benefit from sustained higher prices for oil and base metals.

Asia and Australasia (excl Japan) growth and inflation (% change)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Real GDP growth 7.3 7.9 8.9 5.6 4.6 7.4 6.5 6.7 6.6 6.6 ASEAN 5.8 6.0 6.5 4.2 1.0 5.6 5.1 5.5 5.5 6.0 China 10.4 11.7 13.0 9.6 9.1 9.9 8.3 8.4 8.2 8.0 India 9.3 9.4 9.6 5.1 7.7 7.9 8.1 8.3 8.2 8.0 Inflation 3.5 3.9 4.8 7.1 2.8 5.1 4.0 4.0 4.0 4.0 ASEAN 6.9 8.1 5.6 9.9 2.8 4.9 5.0 4.8 4.8 4.0 China 1.7 1.8 4.8 6.0 -0.7 3.1 3.3 3.4 4.1 4.1 India 4.2 6.2 6.4 8.3 10.9 11.5 5.8 5.2 5.2 5.5


Asia is in the midst of strong stimulus-driven recovery

Growth in Asia and Australasia (excluding Japan) is forecast to strengthen from 4.6% in 2009 to 7.4% in 2010, with a moderate slowdown to 6.5% in 2011. Although strong, the growth rates are still slower than before the global downturn. A strong recovery in trade has been under way since the second quarter of 2009, and domestic demand has held up well in many countries. Historically, most Asian recoveries have relied on exports, while investments and private consumption have remained weak until well after the end of a recession. But this time the situation is atypical. The recovery in many countries is driven by large fiscal stimulus packages and loose monetary conditions. According to IMF model-based estimates published in April 2010, fiscal stimulus in Asia itself and in major trading partners contributed 3.5 percentage points to GDP growth in 2009. The stimulus in China was the most important in absolute size and relative to GDP, but many other governments have implemented aggressive fiscal measures to support the economy.

Concerns about bubbles have increased While there is uncertainty whether fiscal measures in advanced economies have achieved their goal of rekindling autonomous private-sector demand, the Asian measures seem to have been successful. In fact, there is concern that several markets, including residential housing in China, have reached bubble territory. Although this is creating independent growth momentum, ultimately it will exert a substantial negative influence on the economy when the bubble bursts. We believe that Asian economies are well equipped to withstand the impact of fading stimulus, both domestically and internationally, but there is a risk that it will trigger the bursting of bubbles.

Inflation is also a concern, given that interest rates are still low in many countries (although an increasing number of central banks have started raising rates). A surge in capital inflows owing to the recovery of risk appetite last year and near-zero interest rates in the developed world have also boosted inflationary pressures and the risk of asset bubbles. These capital flows have faded in the wake of the European fiscal crisis and the concomitant surge in risk aversion, but have not reversed on a large scale, as they did following the collapse of Lehman Brothers. The rise in commodity prices associated with strong growth in emerging-market economies is also contributing to concerns


22 Global outlook


about inflation in the region. Although domestic conditions have for a while called for interest rate hikes, central banks have been reluctant to tighten monetary policy for fear that higher interest rates would draw in even more foreign capital. Nevertheless, given the strength of the recovery, the central banks of Malaysia and India have in recent months started to raise their interest rates, and China has tightened monetary and credit policies. This followed the start of rate hikes in late 2009 in Australia, which was the first developed economy to raise interest rates. Other emerging Asian economies are likely to follow suite.

Asian economies have weathered the global crisis in 2008 surprisingly well, and also seem well prepared should the European fiscal crisis spiral out of control (not our main scenario). Their financial exposure to the European countries most affected is small. However, Europe is an important export market, and Asian growth could falter if the weakness in the European economy intensifies. However, slower growth might also be beneficial in helping to contain domestic inflationary pressures. An additional risk is that further turmoil in Europe could trigger the unwinding of excessive asset price increases in Asia.

With growth in the developed world expected to remain subdued throughout the forecast period, there is likely to be a continued focus on cost cutting. This could drive further relocation of manufacturing and support services to outsourcing nations in Asia. However, Asia will not be able to rely on export-led growth in the new global environment, and raising domestic demand will be a key policy challenge.

China: industrial production(% change, year on year)

Source: National Bureau of Statistics.

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

20.0

22.0

24.0

100908070605040302012000

We forecast that real Chinese GDP growth will rise from 8.6% in 2009 to 9.9% in 2010, followed by a slowdown to 8.3% in 2011. China's strong performance in 2009 reflects the rapid deployment of the government's economic stimulus package and a massive increase in bank lending. Easier credit conditions have also lifted private investment and consumer confidence. Housing markets have expanded at a rapid pace in 2009 and early 2010, with large increases in house and land prices. This has raised concerns about overheating, and since early 2010 the People's Bank of China (the central bank) has tightened monetary policy by raising the reserve requirement ratio and, more importantly, imposing limits on bank lending. The authorities have also imposed measures to curb

China tightens controls on bank lending, raising the risk to growth

Global outlook 23

real estate speculation, but it is not clear whether the impact of these measures can be sustained. Although there are concerns that tightening may cause stress in the banking sector and the non-performing loan ratio is likely to rise, we believe that the normalisation process will run relatively smoothly for the real economy. However, asset markets will experience volatility owing to uncertainty about policy measures.

Taiwan and South Korea have rebounded strongly from lows induced by the weakening of electronics demand in the developed world in late 2008. Both countries provided massive fiscal stimulus, so that South Korea even managed to escape a technical recession in 2010. The South Korean central bank raised the policy rate, the base rate, on July 9th from a record low of 2% to 2.25%, but we expect policy to remain accommodative at least until late 2010. Fiscal stimulus will also be withdrawn over the course of 2011. We forecast that South Korean GDP will grow by an impressive 5.9% in 2010 and ease to around 4% in 2011. Taiwan will grow by 7.6% in 2010 and 4.3% in 2011, following a decline of 1.9% in 2009.

ASEAN is benefiting from strong trade, stimulus and capital inflows

The main economies in the Association of South-East Asian Nations (ASEAN), Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam, are all benefiting from the strong recovery in global trade and the strength of demand from China, particularly for raw materials. Most of these countries have introduced massive stimulus programmes that are still supporting GDP growth. They are also boosted by strong capital inflows that have abated only mildly in the face of the European fiscal crisis and the resulting rise in global risk aversion. The combination of a strong recovery in trade, fiscal stimulus and capital inflows has raised some concerns about overheating and rising inflation. Malaysia has already raised its interest rates in March, and other countries have allowed their currencies to strengthen. There will be further scaling back of stimulus across the ASEAN countries. Thailand will continue to underperform, as the political crisis will undermine investor and consumer confidence. Vietnam's economy will grow strongly, but excessive credit growth in recent years raises substantial risks for the banking sector.

India has started to tighten monetary policy early

Growth in India is expected to accelerate from 7.7% in fiscal year 2009/10 (April-March) to 8.1% in 2011/12. India was less exposed to the downturn in global trade, and the outcome would have been even better had it not been for the poor south-west monsoon in 2009/10. The government has provided fiscal stimulus and, like the ASEAN economies, has benefited from a reversal of earlier capital outflows. The economic expansion and price increases—the wholesale price index grew by 10.2% year on year in May—related to lower agricultural output have forced the Reserve Bank of India (RBI, the central bank) to start raising interest rates in March. On July 3rd the RBI raised the benchmark interest rate by 25 basis points, and we expect further rate rises to take the repo rate to 6% by the end of 2010 and to 6.5% by the end of 2011. However, the RBI will be mindful that higher interest rates could undermine the government's fiscal consolidation plan, encourage volatile capital inflows and exert upward pressure on the rupee. India's main macroeconomic weaknesses are the poor state of the public finances and the high level of public debt. Barring any problems caused by the country's fiscal vulnerability, growth is expected to


24 Global outlook

strengthen in subsequent years, as it will continue to reap the benefits of ongoing economic opening and gradual improvements in infrastructure.

Australia is benefiting from strong growth in China's commodity demand

In Australia, GDP grew by 1.3% in 2009, making the country the best-performing industrialised economy. We have revised down slightly our forecast of real GDP growth in 2010 to 2.7% (2.9% previously), following the release of first-quarter data showing weakness in private consumption and investment growth. A slight slowdown in growth, to 2.6%, is expected in 2011, as export growth weakens in tandem with slower growth in China, as the effect of its extensive fiscal stimulus measures fades. Consumer confidence indicators show that optimism about future prospects is waning, partly because of interest rate rises, which have a strong impact on the spending power of Australia's highly indebted household sector. The two main risks to our forecast are a more marked downturn in China's demand for Australia's raw materials or a crash in the local housing market. House prices have doubled in real terms since 1999, and growth in demand for housing is likely to be curbed by the fact that the government's grant for first-time home buyers, which was increased as part of the stimulus package, was cut sharply at the end of 2009.

Latin America growth and inflation (% change)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Real GDP growth 4.9 5.6 5.6 4.0 -2.1 4.1 3.4 4.2 4.1 4.2 Mercosura 5.5 5.3 6.7 5.4 -0.4 4.4 3.6 4.4 4.3 4.5 Inflation 6.2 5.2 5.4 7.7 5.8 6.7 6.9 6.5 5.8 5.7 Mercosura 8.3 6.5 6.3 8.8 7.5 8.9 9.5 9.5 8.1 7.9

a Full members: Argentina, Brazil, Paraguay, Uruguay and Venezuela.


Latin America's recovery broadens out, helped by growth in the US

Following a contraction of 2.1% in 2009, we expect Latin America to post a solid recovery of 4.1% in 2010. Policy stimulus and Chinese demand enabled the region's commodity exporters to lead the recovery, with Brazil emerging from the downturn as early as in the second quarter of 2009. But in the past six months a recovery of demand in the US has been supporting a strengthening of activity in those countries that are more dependent on the US market, such as Mexico. Growth is expected to slow in 2011 and to be just above 4% in subsequent years. This is below the average of 5.2% registered in the boom years of 2004-07, but represents a positive performance relative to the region's historical trend growth rate.

The slowdown forecast for 2011 principally reflects trends in the global economy. The worst-affected countries will be those in the US-dependent north, where growth will decelerate as the US economy softens on the back of fading policy stimulus. Meanwhile, slowing Chinese demand and somewhat weaker commodity prices will have a negative impact on growth in the region's commodity exporters.

Across the region, low savings and investment rates remain a constraint on capital accumulation and capacity growth. Regulatory problems, rigid labour laws and protectionism are other factors holding back growth. In many


Global outlook 25

countries, political environments will not be conducive to the legislative reforms needed to address these issues.

Brazil is in danger of overheating After a mild contraction as a consequence of the global crisis in 2009, Brazil's economy is rebounding strongly, to the extent that there is currently a risk of overheating. In light of consistently strong recent economic indicators, we have revised our forecast for GDP growth in 2010 up to 7.8%, from 6.3% previously. Growth is being driven by a combination of an increase in the labour force, higher wages and an expansion of credit. Consumer spending is rising at a rapid pace. Brazil's terms of trade have been supported by the rally in commodity prices, and the country is benefiting from strong demand for iron ore and other raw materials from China. We expect growth in Brazil to slow to a more sustainable pace of 4.5% in 2011.

Following interest rate cuts totalling 500 basis points in early 2009, a cycle of monetary policy tightening is now under way. In February the Banco Central do Brazil (the central bank) raised banks' reserve requirements, and in late April it raised its benchmark interest rate, the Selic, by 75 basis points to 9.5%. A series of further increases is expected later this year. The government adopted some measures to support the economy during the recession and the primary fiscal surplus has shrunk, but not to the extent that this will compromise fiscal solvency. The presidential election in October 2010 is unlikely to cause financial instability, as both leading candidates are committed to a continuation of orthodox macroeconomic policy management.

Mexico recovers, helped by a return to growth in the US

Following a contraction of 6.6% in 2009, the Mexican economy is expected to grow by 4.6% in 2010 and 3.5% in 2011. The severity of the decline in 2009 was partly the consequence of close ties to the US, which takes 80% of Mexico's manufactured exports and is an important source of remittance income, and was also partly driven by the outbreak of swine flu in April. In addition, unlike some countries, Mexico prioritised maintaining hard-won fiscal stability over economic stimulus. A recovery is now under way, and growth in 2010 is likely to be higher than in most other countries in the region, but this is mainly because the severe downturn left more room for a rebound. Mexico will be affected more than many other parts of Latin America by the softening of US GDP growth expected in 2011. On the policy front, Mexico faces structural challenges to raise its rate of sustainable growth. Not least, it will suffer from a decline in oil-related tax revenue owing to the depletion of Cantarell, its largest oilfield. The current government is seeking to avoid unpopular decisions so that major economic reforms are unlikely during the current administration, which will be in power until 2012.

Argentina finally reaches agreement with hold-out creditors

In Argentina, the economy grew officially by 0.7% in 2009, helped by a surge in public spending ahead of the mid-term election in June 2009. Fiscal expansion has continued, and this, together with booming demand in Argentina's main trade partners, particularly Brazil, is providing an impetus to growth. We forecast growth of 4.5% in 2010. A trade dispute with China threatens to hit exports of soybeans, a key crop. We expect growth to slow in 2011, as investor jitters increase in the run-up to the presidential election and real incomes are eroded by inflation.


26 Global outlook

In April the government finally reached agreement with most of the hold-out creditors on a debt restructuring on similar terms to those agreed with a majority of creditors in 2005. The number of hold-outs continuing to reject the government's terms is probably small enough for a line to be drawn under Argentina's 2001 sovereign default. This means that Argentina will regain access to international capital markets, although it will face a high risk premium.

Middle East & Africa growth and inflation (% change)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Middle East & North Africa Real GDP growth 6.1 5.9 5.6 6.1 1.4 4.5 4.4 4.6 4.6 4.8 Inflation 6.7 7.6 8.8 13.7 6.6 6.9 7.2 6.2 6.2 6.4 Sub-Saharan Africaa Real GDP growth 6.8 6.7 7.0 4.8 0.5 4.4 4.5 5.5 5.0 5.0 Inflation 9.5 6.7 6.8 11.7 9.1 7.8 7.2 6.8 6.4 6.4

a Refers to Angola, Kenya, Nigeria and South Africa only.


Higher oil prices and government spending will boost growth in 2010-11

Economic growth in the Middle East and North Africa (MENA) is forecast to pick up in 2010, supported by higher oil prices, a stronger global economy and loose domestic policy conditions. Access to global financing will improve, but will remain less accessible and more expensive than before the global financial crisis. Growth will also be boosted by a modest pick-up in oil production, despite OPEC's continued restraint. By 2011 oil output will start to grow more strongly. This, together with persistently high government spending in oil-producing countries, particularly on infrastructure development projects, will fuel regional growth averaging 4.1% a year in 2012-14.

Countries in North Africa, which are highly dependent on the EU as an export market and as a source of workers' remittances, will record more modest growth, given the subdued economic outlook for the EU and some appreciation in their currencies. Growth is unlikely to be sufficient to reduce currently high levels of unemployment among these countries' typically young populations.

OPEC's limits on oil output will constrain Saudi growth

A sharp drop in oil output in 2009 meant that Saudi Arabia struggled to grow, despite a large increase in government spending. The economy is forecast to grow by an average of 3.7% a year in 2010-11, limited by only a modest pick-up in oil production. The government will continue its countercyclical fiscal policy—it is planning US$400bn of public investment in 2009-13—but growth in the non-oil private sector will be hampered by the subdued outlook for domestic corporate credit, at least in 2010. Ambitious plans for investment in the development of the petrochemicals, oil refining, phosphates and gas sectors could lift Saudi's GDP significantly thereafter.

In the UAE, the economy is expected to grow by just 2.6% in 2010, reflecting the OPEC-mandated constraints on oil production that are expected to remain in place throughout the year and the negative impact on consumer and business confidence of the effective default of a state-owned conglomerate, Dubai World, in late 2009. Economic growth should revive in 2011, as confidence returns and banks resume lending. In May Dubai World announced that it had reached an agreement on its debt restructuring with creditors, which will help to restore


Global outlook 27

confidence. We forecast growth of 3.6% in 2011, but the risks are on the downside; many real estate projects have been cancelled or postponed, and these may not resume if previous growth levels are not attained.

Egypt is investing heavily in infrastructure

Egypt's economy grew by a relatively robust 4.7% in fiscal year 2008/09 (July-June) against a backdrop of global economic recession in the first half of 2009, driven by strong domestic demand. The outlook for economic growth over the next five years is positive. Ongoing economic reforms, including tax cuts, are boosting investor confidence and lifting private consumption, and these trends will continue over the next five years. Strong domestic demand, buoyed by a large and growing population and a vast government-led programme to upgrade Egypt's infrastructure, will make up for some loss of export growth in the first part of the forecast period. Export growth will be supported by strong expansion in the industrial and energy sectors, as well as by a better diversification of Egypt's export mix. However, strong import growth and some structural bottlenecks, for instance in the labour market, will constrain overall growth. Egypt's high dependence on the tourism sector will also leave the economy vulnerable to regional tensions.

Boosted by higher commodity prices, Africa will grow by 4.5% in 2010-11

Africa weathered the global economic downturn relatively well, with estimated GDP growth of 0.5% in 2009, largely because of China's early recovery and its appetite for raw materials, which benefited commodity exporters in the region. Supply problems with a number of African agricultural commodities, such as tea and cocoa, meant that lower export volumes were offset by markedly higher international prices. Regional economic growth is expected to rebound strongly to average 4.5% in 2010-11. Demand will be boosted by a positive terms-of-trade shock as a result of higher commodity prices. By 2012-14 the regional economy is forecast to average growth of around 5.2%.

South Africa is forecast to grow by 2.8% in 2010, supported by a rise in global demand (especially for minerals), but domestic demand will be slower to recover. The rebound will be relatively fragile—despite a sharp decline in interest rates—because the jobs lost in 2009 (about 870,000) will not be fully replaced in 2010, and private investment is likely to remain subdued until there is evidence of a sustained recovery. Losses caused by strike action and slow growth in Europe (a key partner) will also constrain growth. Helping to offset this, public investment and consumption are expected to remain fairly strong, as the government persists with its fiscal stimulus. We expect real GDP growth to accelerate to 3.7% in 2011, helped by ongoing public investment and a rebound in private investment. However, structural constraints (such as skills shortages) and a hesitant global revival mean that growth will not be sufficient to bring about a marked decline in unemployment. There is a risk that electricity shortages will re-emerge in 2010-11, constraining energy-intensive sectors, as new base-load power stations are not expected to come on stream until 2013-14.

Political uncertainty could undermine Nigeria's economic outlook

In Nigeria, robust growth of 6.7% is forecast this year, driven largely by a strong performance from the non-oil sector, particularly agriculture, wholesale and retail trade, and services. GDP growth is expected to moderate to 5.8% in 2011, as a result of a slight slowdown among Nigeria's Western trade partners and increased political uncertainty at home because of forthcoming elections.


28 Global outlook

Indeed, given the possibility of a period of severe political disruption, growth prospects could be damaged more significantly. Structural problems, such as the dire infrastructure and widespread corruption, will continue to restrict economic prospects.

Exchange rates

A recovery in the euro is likely to be short-lived

As the European debt crisis escalated and spread during the first half of 2010, the euro came under intense pressure. This trend was accentuated by concerns about a double-dip recession, which prompted investors to reduce risk and flee to traditional safe havens such as US Treasuries, the Swiss franc and the yen. The US dollar strengthened from around US$1.50:€1 in November 2009 to a low point of US$1.19:€1 in June 2010. The announcement of a €750bn (US$937bn) European rescue package on May 10th failed to brake the single currency's decline, as sentiment about the euro and its prospects for survival remained overwhelmingly poor. Since breaching the US$1.20:€1 threshold the euro has staged a recovery and was trading at US$1.26:€1 in early July. The euro's bounce coincided with an improved tone in the debt markets of some peripheral euro area countries, notably Spain and Italy. But the main reason for this recent rally is the record short positions which traders had built up against the single currency, leaving the market vulnerable to a short squeeze. Once these technical market dynamics have played out, the euro is likely to come under renewed downward pressure, as concerns about debt default and a break-up of the euro area will again come to the fore. This is not to say that the US, Japan and some other OECD countries are without their own problems in respect of debt sustainability. In particular, any threat to the AAA rating for US Treasuries would damage sentiment towards the dollar. However, the risks are most acute in some members of the euro area.

The euro area's debt crisis also means that the monetary policy of the European Central Bank (ECB) will be kept looser for longer. The Economist Intelligence Unit now forecasts that the ECB will not raise interest rates until the third quarter of 2012 (previously we expected the first rate hike in the fourth quarter of 2011). At the same time, we continue to expect that the Federal Reserve (Fed, the US cental bank) will start tightening in the second half of 2011 (Fed funds futures imply a first rate hike in early 2011, continuing to move back the expected start of tightening towards our forecast). This means that interest rate differentials will move increasingly in favour of the dollar. Consequently, we have made a substantial revision to our forecast for the US dollar:euro exchange rate, to US$1.26:€1 in 2010, compared with US$1.30:€1 previously. We expect the exchange rate to fluctuate at around US$1.20:€1 in 2011-14.

The yen plays its traditional role as a safe haven

Like the dollar, the yen has fulfilled its traditional role as a haven during periods of risk aversion. The Japanese currency has made large gains against the euro and has also strengthened against the dollar in recent weeks. The yen has strengthened despite the poor state of the Japanese economy. Foreign portfolio equity inflows into Japan were strong, at least in the first four months of this year. But the yen's strength primarily reflects its safe-haven status, the widening current-account surplus and the fact that its attraction as a funding vehicle for


Global outlook 29

carry trades is diminished now that policy rates are also close to zero in the US and the euro area, reducing opportunities for interest rate arbitrage. Over the medium and long term the yen is likely to weaken as demographic changes further erode Japan's savings rate, which will reduce the current-account surplus and could leave Japan increasingly dependent on external savings. Funding Japan's massive public debt will be a particular concern. However, in the current climate the yen is unlikely to weaken materially, particularly as sentiment towards the Japanese currency is overwhelmingly negative among traders, which leaves it vulnerable to short squeezes.

A tough budget will ease concerns about sovereign debt risk in the UK

In the UK, concerns about fiscal solvency, which have been a factor weighing on sterling, will diminish following the aggressive fiscal tightening announced by the new coalition government in June. However, this may not necessarily translate into sterling strength, as fiscal austerity may result in monetary policy being kept looser for longer to support the economy. The large funding needs of UK financial institutions over the next 18 months are also a potential source of weakness for sterling. On a fundamental basis, we view sterling as somewhat undervalued against the euro and—to a lesser extent—the dollar. This is one factor in our forecast of a mild further appreciation of sterling, which we expect to continue throughout the forecast period.

Emerging-market currencies will continue to fluctuate in line with the ebb and flow of global risk tolerance, commodity markets and global liquidity. The risk aversion stemming from the escalation of the European fiscal crisis in April and May led to a fairly mild depreciation of flexible emerging-market currencies. In fact, the crisis means that the ECB's monetary policy will be easier than previously expected, so that emerging markets will continue to benefit from abundant global liquidity. The liquidity infusions by developed economies during the crisis contributed to a strong recovery of emerging-market currencies following the losses recorded in late 2008.

Inflationary pressures in emerging markets will lead an increasing number of their central banks to start tightening their monetary policy. These pressures are partly a consequence of a surge in food prices, but they also reflect broader inflationary forces, as some of these economies are staging a strong recovery and are running up against capacity constraints. Malaysia, Brazil and India are among the countries that have already raised rates, and more countries will join them in tightening. Interest rate differentials may be less important as drivers of currency movements for emerging markets than for developed economies, but inflation will encourage some countries with managed floats to allow their currency to appreciate.

China makes its exchange-rate policy more flexible

On June 19th China announced that the renminbi's fixed peg to the US dollar—in place since mid-2008—will be replaced by a more flexible currency regime. The move should help to deflect foreign criticism of China's exchange-rate policy, but its broader economic impact will depend on the pace of appreciation. We expect the renminbi to strengthen this year, but at a very gradual pace. This may not be enough to mollify China's more strident critics, notably some members of the US Congress, particularly if US job creation remains subdued. But the move to a more flexible regime—similar to the one prevailing from mid-2005 until the onset of the global financial crisis—is a step


30 Global outlook


in the right direction that will help to boost domestic consumption and to balance the global economy.

Meanwhile, fears that China could undermine the dollar by shifting large parts of its reserves have been calmed by assertions by Chinese poliymakers that they continue to see US Treasuries as a vital component of their reserves.

China: exchange rates(Rmb; Jan 2005=100)

Source: Haver Analytics.

95

100

105

110

115

120

125

130

135EuroUS$

JulAprJan10

OctJulAprJan09

OctJulAprJan08

OctJulAprJan07

OctJulAprJan06

OctJulAprJan2005

World trade World trade (% change; goods)

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 World trade 7.5 9.1 7.6 3.7 -11.2 6.8 5.3 6.3 6.4 6.3 Developed countries 5.6 7.1 4.9 0.9 -12.3 4.9 3.6 4.3 4.7 4.6 Developing countries 10.8 12.4 11.8 8.0 -9.6 9.5 7.6 8.7 8.4 8.2


World trade has been recovering at a rapid pace. According to the CPB Netherlands Bureau for Economic Policy Analysis, which assembles global trade data, the volume of world trade in goods in the first quarter of 2010 rose by 17% on the year-earlier period. The recovery should be set in context. The main reason for the rapid growth is the scale of the earlier downturn in late 2008. In terms of national accounts data, world trade is estimated to have shrunk by 11.2% in 2009. The impact of the fall in world GDP on world trade growth was amplified by the fact that exports can show up several times in trade statistics, as intermediate products may be processed in several countries before reaching the location of final demand. In addition, highly cyclical consumer durables and investment goods are more commonly traded than other goods and services.

The Economist Intelligence Unit currently expects global trade to grow by 6.8% in 2010, as manufacturers and retailers in the OECD, and particularly in the US, restock in order to meet the pick-up in demand. However, the expected slowdown in US growth in 2011 will reduce the rate of growth in world trade in that year. World trade is subsequently expected to grow by an annual average rate of 6.3% in 2012-14, driven by much faster growth in developing countries, as they continue their integration into the global economy. As consumers and companies in the developed world keep a close eye on costs,

World trade growth is boosted by restocking in the OECD

Global outlook 31

lower-cost producers from emerging markets will continue to gain market share. Trade between emerging markets will show the most dynamism. Despite the recovery, world trade growth will remain well below the peak years of globalisation in 2003-07.

Emerging Asia is expected to see the fastest rates of export growth, led by China, although the initial burst of recovery will make way for more moderate growth rates. Trade growth in the developed world is currently recovering relatively strongly, but the pace will remain well below the rates of growth seen in the emerging world.

World trade talks will not affect trade during the forecast period

The Doha round of world trade negotiations under the auspices of the World Trade Organisation (WTO) since 2001 remains in limbo. At the G20 summit in Pittsburgh in the US in September 2009 world leaders reaffirmed the goal of finalising an agreement by the end of 2010. The most important obstacle at the moment is a difference of opinion over the extent to which developing countries, such as India, can protect themselves temporarily against a surge in imports of agricultural goods. Developed economies, particularly the US, are pushing for a more aggressive reduction of trade barriers for manufacturing goods by developing countries, such as Brazil and India. Despite an apparent lack of enthusiasm in the US, an agreement appears possible, although the deadline this year is likely to be pushed out, as it has been many times before. Even if an agreement is reached, ratification would be problematic, and imple-mentation would take time. World trade negotiations are therefore unlikely to have more than a marginal impact on trade flows over the forecast period.

Trade liberalisation on the bilateral and regional level has made more progress, particularly in Asia. The Association of South-East Asian Nations (ASEAN) has concluded three free-trade agreements (FTAs) with Australia, New Zealand and India. India concluded an FTA with South Korea in July 2009, and South Korea signed an agreement with the EU in October. A host of further FTAs and other arrangements to deepen economic ties (including through foreign direct investment and trade in services) are in the pipeline. The EU has launched formal negotiations with Canada and ASEAN, and there are extensive discussions on various issues to deepen trade relations between the US and the EU.

Rise in protectionism has been limited but remains a concern

According to estimates by the WTO, new import-restricting measures intro-duced by the G20 governments between September 2009 and February 2010 amounted to 0.4% of global trade. New measures introduced during the (longer) period of October 2008 to October 2009 affected 0.8% of global trade. Given that the measures are often not prohibitive (not completely eliminating trade in the affected goods) and that at the same time some trade restrictions have been eased, this is a surprisingly small rise in protectionism during the worst recession since the second world war. We believe that a surge in protectionism later is unlikely, and the increase in trade restrictions may partly be reversed. But there is a risk that a growing number of countries will implement measures making use of loopholes in WTO agreements or breaching WTO rules in subtle ways. This means that lengthy proceedings in WTO committees will be needed to scale back such measures. More aggressive use of WTO rules to contain dumping could also amount to rising protectionism.


32 Global outlook

The widespread perception that China manipulates its exchange rate to gain global market share means that Chinese exports will be a source of anger among policymakers in some parts of the world. Whether China's decision in June to introduce more flexibility into its exchange-rate policy can appease its foreign critics will depend on the rate at which the renminbi is allowed to appreciate against the US dollar.

Commodity prices Commodity price forecasts 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Oil prices Brent; US$/b 54.44 65.39 72.71 97.66 61.86 80.00 78.50 82.25 78.25 75.50 Non-oil commoditiesa Total 4.0 31.2 20.8 12.4 -22.5 10.9 2.4 2.3 3.5 3.9 Food, feedstuffs & beverages -0.5 16.1 30.9 28.3 -20.4 -3.4 0.0 2.1 6.5 7.2 Beverages 20.4 8.6 14.5 18.8 1.0 8.3 -9.6 -9.8 -4.0 4.2 Grains -4.8 25.7 35.4 29.1 -28.9 -12.6 6.5 7.5 14.0 10.8 Oilseeds -9.3 3.0 46.4 32.6 -22.1 1.3 0.9 3.0 3.0 3.5 Sugar 37.9 49.5 -32.0 30.1 29.6 4.3 -15.9 -0.3 -2.2 3.4 Industrial raw materials 10.2 49.6 11.2 -5.1 -25.6 33.7 5.1 2.5 0.2 0.0 Metals 16.5 62.4 10.6 -9.1 -28.4 30.7 7.4 4.8 2.7 2.7 Fibres -10.0 6.4 18.1 2.3 -11.5 26.5 1.0 -1.9 -3.4 -4.2 Rubber 12.7 38.7 7.0 16.4 -25.6 62.2 -1.0 -4.2 -9.0 -11.7

a % change in US dollar prices.


Oil: Dated Brent Blend oil prices averaged almost US$77/barrel in the first quarter of 2010, before soaring to over US$85/b in April on the back of improved US economic data and strong physical demand from Asia and the Middle East. Prices subsequently slumped by about 20% in the first three weeks in May, before a partial recovery by the end of the month. Prices remained volatile in June and fell by 8.5% in the last week of the month—perhaps partly owing to the repositioning of portfolios by investment funds at the end of the quarter.

The market's unease was a reflection of two key concerns: doubts about sovereign creditworthiness in the euro zone amid signs of a commitment to fiscal tightening in the region, and questions about the extent of the likely slow-down in China as a result of monetary tightening. A stronger US dollar only added to the lower trend in prices. Given that the Economist Intelligence Unit does not envisage a hard landing for China's economy and expects the euro zone to survive, if somewhat weakened, we forecast that prices will strengthen in the second half of the year, as the market once more focuses on relatively robust consumption growth.

A robust recovery in oil consumption will support prices in 2010

Oil prices in 2010 will be supported by robust consumption growth in Asia, particularly China, the positive impact of monetary and fiscal stimulus on consumption in the US and Japan, and persistent constraints on OPEC output. Prices will also benefit from investor inflows seeking a return in the prevailing environment of low interest rates and ample liquidity. However, the underlying


Global outlook 33

fundamentals of the oil market are little changed, with stocks at still-high levels and ample spare capacity in OPEC member states to meet any recovery in global consumption, suggesting there is little scope for prices to rally more strongly. As the impact of the stimulus fades in 2011, the dollar strengthens in response to tighter US monetary policy and OECD consumption growth wanes, we expect prices to ease from an average of US$80/b in 2010 to US$78.5/b in 2011.

Conservation and the adoption of renewables will constrain OECD demand

Following two consecutive years of falling global oil consumption, we expect demand to start to recover in 2010 and to average annual growth of 1.7% in 2010-14. We have revised up our forecast of US consumption growth in 2010 to 0.8% (0.2% previously), following the release of data showing a revival of industrial demand for oil; petrol (gasoline) consumption remains subdued, reflecting the depressed nature of household consumption. However, we have revised down our forecast of EU consumption on the basis of recent data showing that consumption was 3.5% lower in year-on-year terms in April, and given only a weak regional economic outlook. The revisions offset each other, and we still expect OECD consumption to grow by 0.2% in 2010. In 2011-14 OECD oil consumption is expected to contract by an annual average rate of 0.2%, reflecting the increasing use of ethanol and biofuels in the transport sector and higher standards of fuel efficiency. Growth in consumption will be concentrated in non-OECD countries—particularly China, the Middle East and India—as their economies grow strongly, incomes rise and governments continue to subsidise retail fuel prices.

OPEC is unlikely to change its output policy in September

In response to falling prices, OPEC members agreed to swingeing cuts in output totalling 4.2m barrels/day (b/d) from January 1st 2009. The initial response from member states was good, and by end-March 2009 OPEC members had cut about 75-80% of the agreed total. Since then compliance has slipped, mainly in Iran and Angola, and the International Energy Agency (IEA) estimated compliance at just 58% in May 2010. OPEC is to meet again in September, but unless there is a dramatic move in market prices in the meantime, we do not expect any change in the output ceiling, in recognition of only modest growth in consumption.

After two consecutive years of decline non-OPEC production is estimated to have grown by 3.5% in 2009, boosted by progressively higher Russian and former Soviet Union output over the course of the year, increased production from Canada's tar sands and a steady increase in supply from Brazil. These additions to supply more than offset the dramatic decline in output in Mexico and in the North Sea. We have revised down slightly our forecast of non-OPEC production in 2010-11 owing to the moratorium on US drilling in the Gulf of Mexico (see box), which we believe will delay projects in that region for some time, even if the moratorium is lifted after six months. We forecast that non-OPEC output will grow at a relatively subdued annual average rate of 1.1% in 2010-14, led by increased production in Brazil and Canada and by Caspian producers.

OPEC is sitting on considerable spare capacity

OPEC output declined sharply in 2009 as a result of withholding supply, but in more conducive market conditions OPEC could produce at a much higher level. Saudi Arabia has a number of large projects coming on stream, and Nigeria,


34 Global outlook

Angola, Algeria, Qatar and Libya also have the potential to increase output. However, the call on OPEC will be limited. As compliance slips, production is expected to grow by 3.2% in 2010, although this is still significantly lower than available capacity. Saudi Arabia is expected to be particularly cautious about ramping up production, unless there is a marked recovery in demand. In the latter half of the forecast period we expect growth in OPEC supply to average just over 3% a year on the back of higher output from Nigeria, Angola and the Gulf producers. Geopolitical risk does, however, weigh heavily on our supply forecasts—tensions between the West and Iran over its nuclear programme remain high, and an intensification of security problems in Iraq or Nigeria is possible.

Global oil supply/demand outlook (m barrels/day unless otherwise indicated)

2008 2009 2010 2011 2012 2013 2014 Total world oil production 86.31 84.83 86.55 88.43 90.15 91.96 93.69 Non OPEC 47.12 48.78 49.34 49.87 50.20 50.74 51.41 OPEC 36.56 33.35 34.41 35.71 37.04 38.24 39.26 Processing gains 2.63 2.70 2.80 2.86 2.91 2.97 3.03 Total world oil consumption 86.01 84.85 86.43 87.82 89.34 90.90 92.45 OECD 47.57 45.47 45.54 45.45 45.34 45.24 45.15 Non-OECD 38.44 39.38 40.89 42.37 44.00 45.66 47.29 Stock change (%) 0.30 -0.02 0.12 0.61 0.81 1.06 1.25 Call on OPEC 38.89 36.07 37.09 37.95 39.14 40.16 41.04


Ample capacity will act as a constraint on prices throughout 2010-14

A rebound in consumption growth in 2010, coupled with persistent OPEC supply constraint, will support oil prices this year. However, a steady strengthening of the US dollar, relatively high global stocks and ongoing economic uncertainty will prevent significant price increases. Notwithstanding the US dollar's strength, we expect investors to continue to invest in the market, given the generally low interest rate environment, robust growth in developing economies (and thus demand for energy) and the uncertain outlook for other asset markets. We expect the impact of economic stimulus packages to fade into 2011 and for a renewed downturn in OECD demand to emerge (with a consequent build-up in stocks), suggesting that prices will ease to around US$78.5/b in that year. Prices are subsequently expected to rise, based on optimism about the growing pattern of consumption in the emerging world. At the same time, however, increasing use of biofuels will also start to have an impact on the transport sector in the developed world (where the impact is greatest because of higher levels of car ownership), and fuel efficiency will see improvements. China will also be under pressure to reduce the energy intensity of its growth, both from international sources and domestically, as it seeks to curtail an increasing reliance on imported oil. Heightened efforts at conservation and improved efficiency are expected, but they will only serve to prevent more dramatic increases in China's consumption, as incomes and levels of car ownership rise. These trends, together with the prospect of large increments in supply (particularly by Kazakhstan and Brazil) from 2014, suggest that prices will start to ease in 2013-14.


Global outlook 35

Deep trouble

The massive oil spill from the Deepwater Horizon rig in the Gulf of Mexico could have significant medium-term consequences, not only for BP, the UK-based operator of the rig, but for global oil-supply prospects, the oil market and the price of oil. In particular, drilling in ultra-demanding environments will become costlier and politically fraught. But a resultant focus on relatively accessible onshore oilfields would bring its own problems, both for the industry itself and for countries that wish to diversify their oil supplies. The US president, Barack Obama, is hoping that the Gulf of Mexico disaster will provide a much-needed catalyst for efforts to enact climate-change legislation and encourage the US to switch to alternative energy sources. While this might happen to a certain degree—particularly if efforts to contain the BP oil spill fail—the strength of the oil industry lobby in the US and the country's entrenched car culture make a big drop in oil consumption unlikely. In other rich countries, too, concerns about the safety of deepwater drilling may rise, but are unlikely to stop such exploration altogether. Regulatory scrutiny One inevitable consequence of the spill will be a tightening of the regulatory environment, not necessarily just for deepwater offshore drilling. In the US all drilling, including onshore and shale-gas drilling, is likely to be more heavily regulated and more closely monitored. Elsewhere, authorities in the UK and Norway have recently announced closer supervision of offshore drilling. On June 22nd Brazil's Petrobras said that regulators might tighten offshore-drilling standards in Brazil after BP's oil spill. Petrobras is undertaking an ambitious offshore drilling programme, entailing about US$120bn in exploration and production costs. Regulator-driven efforts to raise safety standards and prevent future disasters similar to that of the Deepwater Horizon stand to raise production costs. The cost of insuring oil installations will also rise. Independent oil companies, which typically operate in technically challenging oilfields that are already expensive to drill, are likely to be particularly hard hit. In the Gulf of Mexico, for example, such changes could leave all but the largest oil companies unable to afford to drill. Oil-security issues One of the vote-winning policies that Mr Obama promised in his election campaign was to reduce US dependence on imported oil, particularly from unstable regions and countries such as the Middle East, Nigeria and Venezuela. Indeed, he had approved the expansion of drilling operations in the Gulf of Mexico only shortly before the BP oil spill. The president has since retracted that approval and has announced a six-month moratorium on new drilling. Initially, this is likely to lead the US to import more oil from OPEC countries in the Middle East and Africa. The majority of non-OPEC drilling now occurs in increasingly challenging and high-cost locations, such as in ultra-deep water in Brazil and Russia's Arctic. If the BP oil spill results in such projects falling out of favour, the consequence would be a further boost to the market positions of national oil companies, the majority of which are in OPEC countries. Middle East producers, for example, typically operate onshore at much lower cost than independent offshore drillers. However, a greater reliance on Middle East oil would raise strategic problems for the US and would be unpopular with the public. Canada's oil sands provide a possible alternative, but there are concerns about the negative environmental impact of this method of production. A boon for alternative energy? There are already reports of companies preparing to ramp up production of batteries for electric cars in the wake of the BP oil spill. However, electric cars are still expensive, and the limits on battery performance and the recharging infrastructure are a deterrent to would-be buyers. Furthermore, alternative energy sources typically still require high levels of capital investment and depend on fiscal subsidies. Given the need to reduce fiscal deficits in much of the developed world, governments may no longer be able to afford alternative-energy development programmes.


36 Global outlook

In any event, the major international oil companies are unlikely to sit back and see their traditional business disappear. The moratorium on drilling in the Gulf of Mexico has resulted in the idling of 33 drilling rigs. Operators of permitted deepwater wells still being drilled have been ordered to halt drilling at the first safe stopping point and secure their wells. However, in mid-June a US district court judge in Louisiana granted a preliminary injunction blocking the US Department of Interior's moratorium on deepwater drilling. The court found that the US government had failed to justify the moratorium. A subsequent appeal was also rebuffed by the courts and in July 2010 the Obama administration issued a new moratorium order. However, the conditions of the new order differ little from the original moratorium and could also be blocked. The court's stance suggests that there is a powerful movement keen to resume drilling in the Gulf of Mexico. The moratorium has substantial implications for employment as well as for US oil security. Concerns over these issues were probably reflected in a Reuters/Ipsos poll in the US in mid-June, in which 56% of respondents felt that offshore drilling was necessary for the US to produce its own energy, while only 38% thought it was a bad idea. The Economist Intelligence Unit expects that it will be some time before deepwater drilling resumes in the Gulf of Mexico, given higher regulatory standards and companies' caution about the media scrutiny that new drilling will attract. But US oil stocks are high, and the outlook for global oil demand is subdued. As a result, lower supply from the Gulf of Mexico over the next couple of years will not prompt a surge in oil prices or in investment in alternative energy. However, if deepwater drilling worldwide were to suffer a prolonged setback, then these could be the eventual outcomes.

The medium-term outlook for base metal prices is positive

Hard commodities: Prices for base metals rose strongly in the fourth quarter of 2009 and, although volatile, prices generally moved higher in the first quarter of 2010. Strong Chinese buying and the prospect of restocking in the OECD, where inventories were typically at historical lows, coupled with the positive impact of government stimulus packages on demand underpinned the rise in prices. Investor interest was also strong. However, prices were highly volatile in the second quarter, peaking at new recent highs in April only to plunge in May and June, in some cases by as much as 20%. Concerns about sovereign credit risk in the euro zone and the uncertain impact of monetary tightening in China drove prices lower. We expect China to remain the primary source of demand growth in 2010-11, but we also expect Chinese demand growth to ease in the second half of the year as a result of government efforts to cool down the property market, in particular. Unless an individual commodity has an especially tight market balance or negative supply developments, this suggests that prices will struggle to improve much from current levels.

In the medium to longer term, we expect prices for base metals to rise in response to robust growth in the developing world and ongoing urbanisation, and the fact that the supply profiles for many metals tend to be volatile. Mining output can easily be hampered by inclement weather, energy shortages, transport bottlenecks, union activity or a difficult regulatory environment. Furthermore, while Chinese companies have been investing heavily in base metal projects in the last year, private-sector companies elsewhere have struggled to raise financing since the onset of the credit crisis. This could mean that supply in 2011-14 will be lower than currently forecast, and that prices will be higher.

The fundamentals for most agricultural commodities are supportive of prices

Soft commodities: In 2009 agricultural commodity prices benefited from the general return of investor risk appetite and from weather-related disruptions to supply in many key producers. The exception was the grains complex, where bumper harvests, lower output costs and weaker demand kept prices at low


Global outlook 37

levels. The outlook for this year's grain harvests is also good, and we envisage only limited upward pressure on prices in 2010-11.

Reduced supplies of arabica coffee, cocoa, tea and oilseeds supported prices in 2009/10, despite only muted growth in consumption. Although output levels are generally expected to recover this year and next, stocks are now at very low levels and consumption is expected to revive, suggesting that there will be no immediate return to lower prices.

A poor harvest in India and sustained demand from the biofuels industry also led to much higher sugar prices in 2009. However, an improving outlook for India's sugar production in 2010 prompted a dramatic fall in global sugar prices in the second quarter. Prices have since rallied, as it became clear that stocks are still at very low levels in relation to consumption needs. Further price gains are possible in the short to medium term, as more importers come back to the market to restock, but more generally the supply outlook remains healthy, and we expect prices to fall in 2010-11, before stabilising in 2012.

Agricultural prices, more generally, will be supported in 2010-14 by the structural shift upwards in demand, given the increase in emerging-market consumption (particularly for livestock feed), population growth and the impact of biofuels production. There is also ongoing structural change on the supply-side, reflecting increasing urbanisation (and less arable land), declining global water levels, low levels of investment and the unpredictable consequences of climate change on weather patterns.

Individual commodity price forecasts 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Aluminium (US$/tonne) 1,899.5 2,594.0 2,661.2 2,620.9 1,706.8 2,082.8 2,121.3 2,128.3 2,250.0 2,300.0 Barley (US$/tonne) 131.5 151.2 263.4 256.3 155.0 168.8 178.8 185.0 190.0 205.0 Coal (US$/tonne, Australia) 49.1 49.1 65.7 127.1 71.8 99.9 88.8 72.5 80.0 85.0 Cocoa (US cents/lb) 69.8 72.1 88.6 117.1 131.0 144.0 136.1 136.7 130.0 125.0 Coffee (Arabica) (US cents/lb) 114.9 114.4 123.5 139.8 143.9 167.9 148.6 136.0 123.0 130.0 Coffee (Robusta) (US cents/lb) 50.6 67.6 86.6 105.2 74.6 73.0 72.6 62.2 60.0 65.0 Copper (US cents/lb) 166.8 305.6 322.3 316.2 233.6 320.0 347.5 375.0 380.0 390.0 Cotton (US cents/lb) 55.2 58.6 64.8 72.1 62.7 86.7 88.0 84.3 80.0 75.0 Gold (US$/troy oz) 444.9 604.3 696.7 871.8 973.0 1,187.3 1,242.5 1,245.0 1,100.0 1,010.0 Iron ore (US cents/dry metric tonne unit) 65.0 75.3 82.9 140.6 114.2 133.3 121.3 110.0 125.0 120.0 Lead (US cents/lb) 44.3 58.4 117.2 95.0 78.0 91.2 106.3 115.0 120.0 130.0 Maize (US$/tonne) 98.9 123.1 170.1 227.8 172.0 168.0 185.0 207.5 233.8 240.0 Natural gas (US$/mmbtu, Europe) 6.33 8.47 8.56 13.41 8.71 8.03 8.24 8.41 8.46 8.48 Natural gas (US$/mmbtu, US) 8.92 6.72 6.98 8.86 3.95 4.42 4.39 4.89 4.77 4.88 Nickel (US$/lb) 6.7 11.0 17.0 9.6 6.6 10.1 10.8 10.4 10.0 10.3 Oil: Brent (US$/b) 54.4 65.4 72.7 97.7 61.9 80.0 78.5 82.3 78.3 75.5 Oil: Dubai (US$/b) 49.2 61.4 68.4 93.8 61.8 79.2 77.7 81.4 77.5 74.7 Oil: IEA (US$/b) 54.0 64.9 72.1 96.9 61.4 79.4 77.9 81.6 77.6 74.9 Oil: WTI (US$/b) 56.4 66.1 72.3 99.6 61.7 79.6 79.3 83.1 79.0 76.3 Palladium (US$/troy oz, London) 203.5 318.8 350.3 353.2 257.4 464.9 423.8 400.0 325.0 300.0 Palm oil (US$/tonne) 422.0 478.3 780.3 948.6 682.8 824.1 890.7 949.5 915.0 925.0 Platinum (US$/troy oz) 896.2 1,135.0 1,299.0 1,563.2 1,204.8 1,579.1 1,595.0 1,600.0 1,550.0 1,500.0 Rapeseed oil (US$/tonne) 669.3 793.8 969.1 1,329.2 858.8 897.8 998.4 1,092.0 1,070.0 1,100.0 Rice (US$/tonne) 291.0 311.0 335.4 676.0 566.3 494.3 472.5 465.0 490.0 550.0 Rubber (US$/tonne) 1,667.5 2,312.8 2,474.4 2,880.8 2,142.5 3,475.0 3,441.7 3,297.4 3,000.0 2,650.0


38 Global outlook


Individual commodity price forecasts 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Silver (US cents/troy oz) 733.8 1,156.9 1,340.8 1,500.0 1,469.4 1,791.7 1,848.3 1,852.1 1,636.4 1,502.5 Sorghum (US$/tonne) 104.3 139.3 185.3 207.8 167.8 171.3 181.3 186.3 190.0 200.0 Soybean oil (US$/tonne) 544.8 598.8 881.4 1,258.3 848.8 917.3 908.8 914.7 970.0 995.0 Soybeans (US$/tonne) 267.8 265.5 378.2 474.9 409.8 377.3 387.5 398.8 425.0 450.0 Soymeal (US$/tonne) 232.5 220.3 320.5 451.6 420.0 394.0 325.0 297.0 335.0 370.0 Steel (US$/tonne) 504.3 556.0 554.8 889.1 489.2 656.7 542.4 515.0 500.0 600.0 Sugar (US cents/lb) 9.9 14.8 10.1 13.1 16.9 17.7 14.9 14.8 14.5 15.0 Sunflowerseed oil (US$/tonne) 677.3 658.0 1,021.9 1,498.9 854.8 956.4 1,133.6 1,286.1 1,200.0 1,090.0 Tea (US$/kg) 1.6 1.9 2.1 2.3 2.7 2.7 2.2 1.7 1.9 2.1 Tin (US$/lb) 3.4 4.0 6.6 8.4 6.2 7.8 8.8 8.4 8.0 7.9 Wheat (US$/tonne) 158.5 200.3 268.7 340.9 234.8 192.0 200.0 208.8 240.0 280.0 Wool (Aus cents/kg) 706.3 752.8 955.3 891.5 804.3 911.0 913.8 925.0 915.0 900.0 Zinc (US cents/lb) 62.6 147.6 147.2 85.3 75.1 94.6 108.0 125.0 135.0 142.0


Global outlook 39

Global assumptions (Forecast closing date: July 9th 2010)

Global forecast 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 Real GDP growth (%) World (market exchange rates) 3.6 4.0 3.9 1.7 -2.2 3.2 2.6 2.9 3.0 3.1 US 3.1 2.7 2.1 0.4 -2.4 3.3 2.0 2.1 2.3 2.4 Japan 1.9 2.0 2.3 -1.2 -5.3 3.0 1.3 1.3 1.1 1.1 Euro area 3.7 3.0 2.6 0.8 -4.0 0.7 0.8 1.4 1.7 1.8 China 10.4 11.7 13.0 9.6 9.1 9.9 8.3 8.4 8.2 8.0 World (PPP exchange rates)a 4.4 5.0 5.1 2.8 -0.7 4.2 3.6 4.0 4.1 4.2 OECD 2.7 3.1 2.7 0.6 -3.3 2.5 1.7 2.0 2.2 2.3 Non-OECD 7.4 8.1 8.8 6.2 3.0 6.6 6.1 6.4 6.3 6.3 World trade growth (%) Goods 7.5 9.1 7.6 3.7 -11.2 6.8 5.3 6.3 6.4 6.3 Consumer price inflation (%; av) World 3.0 3.3 3.4 4.9 1.6 2.9 2.7 3.0 3.2 3.3 US 3.4 3.2 2.9 3.8 -0.3 1.7 1.3 1.9 2.5 2.8 Japan -0.3 0.2 0.1 1.4 -1.4 -0.9 0.5 1.0 1.1 1.2 Euro area 2.0 2.0 2.1 3.1 0.2 1.2 1.5 1.6 1.7 1.8 China 1.7 1.8 4.8 6.0 -0.7 3.1 3.3 3.4 4.1 4.1 OECDb 2.2 2.2 2.1 3.2 0.0 1.3 1.2 1.7 2.0 2.2 Export price inflation (%) Manufactures (US$) 3.6 3.7 8.7 8.5 -3.3 0.4 -1.4 1.6 2.4 2.9 Commodity prices Oil (US$/barrel; Brent) 54.44 65.39 72.71 97.66 61.86 80.00 78.50 82.25 78.25 75.50 % change 42.1 20.1 11.2 34.3 -36.7 29.3 -1.9 4.8 -4.9 -3.5 World non-oil commodity prices (US$; % change) 4.0 31.2 20.8 12.4 -22.5 10.9 2.4 2.3 3.5 3.9 Food, feedstuffs & beverages -0.5 16.1 30.9 28.3 -20.4 -3.4 0.0 2.1 6.5 7.2 Industrial raw materials 10.2 49.6 11.2 -5.1 -25.6 33.7 5.1 2.5 0.2 0.0 Main policy interest rates (%; end-period) Federal Reserve 4.25 5.25 4.25 0.10 0.10 0.10 0.25 2.75 4.50 4.50 Bank of Japan 0.00 0.25 0.50 0.10 0.10 0.10 0.25 1.00 1.75 1.75 European Central Bank 2.25 3.50 4.00 2.50 1.00 1.00 1.00 1.75 3.00 3.00 Bank of England 4.50 5.00 5.50 2.00 0.50 0.50 1.50 2.50 3.00 3.00 Exchange rates (av) US$ effective (2005=100) 100.0 99.7 95.8 92.5 97.0 97.7 100.9 100.4 99.1 97.4 ¥:US$ 110 116 118 103 94 93 93 93 92 92 US$:€ 1.25 1.26 1.37 1.47 1.39 1.26 1.19 1.18 1.18 1.21 Rmb:US$ 8.19 7.97 7.61 6.95 6.83 6.79 6.60 6.47 6.26 6.04 US$:£ 1.82 1.84 2.00 1.85 1.56 1.48 1.47 1.49 1.54 1.63 C$:US$ 1.21 1.14 1.08 1.07 1.14 1.04 1.06 1.11 1.13 1.13 ¥:€ 137 146 161 152 131 117 111 109 109 110 £:€ 0.68 0.68 0.68 0.79 0.89 0.85 0.81 0.80 0.77 0.74 Exchange rates (end-period) ¥:US$ 118 119 112 91 93 94 93 92 92 91 Rmb:US$ 8.07 7.79 7.29 6.83 6.80 6.67 6.55 6.43 6.12 5.97 US$:€ 1.18 1.32 1.46 1.39 1.43 1.20 1.19 1.18 1.20 1.21

a The 82 countries covered by the Economist Intelligence Unit's Country Forecast service plus Iceland and Luxembourg. b Excluding those countries with GDP deflator inflation averaging above 10% during the 1990s.



Global Economic Forecast by EIU [August 2010]

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