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Global Economic Prospects 2013

Global economy remains fragile; high-income countries suffering from slow growth. Read more ...

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July 2010

Prospects Weekly: Global industrial production reaches inflection point

A slowdown in global industrial production is becoming evident, as the inventory cycle is drawing to a
close, notably in the United States, and as fiscal support measures in key economies are being withdrawn.
Growth in industrial output is expected to slow in high-income countries and the large developing economies, especially in China, which has been leading the business cycle. The Euro Area continues to lag other economies, with exports being the main driver of the recovery, notably for Germany. Stronger exports boosted business and consumer confidence, despite concerns about European sovereign stress.
Global industrial production (IP) growth is moderating in line with a normal recovery. Purchasing managers’ indexes (PMIs) point to moderation in the pace of IP growth in major developing countries (Brazil, Russia, China, India, and South Africa) and in core high-income economies. June manufacturing PMIs suggest a slowdown to near 7% among the BRICS in the third quarter from nearly 10% in the second, and to 3.1% in core high-income countries from 7.5%―as growth in China and the G3 countries ease. The fall below the threshold "50" mark for China’s new orders and output PMI components suggests that East Asian economies, which benefitted from strong Chinese import demand, will see moderation in coming quarters. Taiwan (China) reported a monthly decline in factory and export orders in June; and IP corrected sharply in Singapore after an impressive six-month rise. 
Euro-Area confidence surveys surprise to the upside. Confidence surveys for July unveiled surprising improvement in expectations for the economic outlook, jobs, investment returns and more confidence in banking systems. Germany’s IFO business climate index unexpectedly surged to a 3-month high, up 4.4 points to 106.2; and the EM flash manufacturing PMI jumped to 61.2 as consumer confidence increased to pre-crisis levels. Core Euro zone countries are viewed to moderate to a near-trend growth pace, as the positive contribution to growth from inventories is likely to run its course by the third quarter, and bank funding stress will continue to weigh on growth. Pent-up demand for durables and the effects of monetary policy should aid growth. Germany’s IP is likely to ease to a still robust 12% pace in the third quarter down from 22% in the second (saar). 
EU stress test results reveal that seven banks failed to maintain a minimum 6% Tier-1 capital ratio; €3.5bn in capital to be raised. Covering 91 European banks, the test focused on how they would cope with another economic downturn and losses on trading portfolios of government bonds. A group of five Spanish cajas (unlisted savings banks), Germany’s Hypo Real Estate, and the Agricultural Bank of Greece failed the tests. These banks would require €1.84bn, €1.25bn and €243mn respectively. In an adverse ‘sovereign stress’ scenario, the EU banking system’s average aggregate Tier-1 capital ratio would decline to 9.2% by 2011 from 11.2%, with overall impairments totaling €566bn. Some of the test assumptions were considered overly benign by analysts, but the disclosure of sovereign debt exposure is broadly seen as a positive, and spreads have narrowed by 24 basis points since the release of the results. The key test is still on the funding side, with European banks having to refinance €1.6trn by 2012. 

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Prospects Weekly: Global recovery at a new stage

The large gap in global capacity utilization has narrowed substantially since March 2009, led by a strong rebound in developing countries. Although it has also come down, excess capacity remains much more pronounced in high-income countries, given their lagged and slower pace of recovery. In concert with higher capacity utilization rates, inflationary pressures have firmed somewhat in 1H-2010 over 2H-2009 in developing countries on strengthened private consumption (led by South Asia)—but remain below pre-crisis levels. Cross-border debt flows to emerging markets rose modestly in June from very low levels in May, fully driven by corporate bond issuance. Continued lack-luster bank-lending has contributed to a shift to corporate-bond financing, which reached $53bn in 1H-2010, up 82% vs. the pre-crisis level in 1H-2008.
Differentiation in the pace of economic recovery between high income and developing countries is evident in the shifts in capacity utilization rates. Excess capacity in developing countries has diminished significantly, as over two-thirds of the gap posted in Q1-2009 (vs. the pre-crisis trend) has closed. Spare capacity in high-income countries has also diminished, but only by about one-third over the same period—reflecting a lagged and slower pace of recovery in output. Capacity utilization in the U.S., for example, reached 74.1% in June 2010, up from a post-crisis low of 68.2% in June 2009—but remains 7.3 percentage points below the long-term average (1967-2007). An expected deceleration in global output in 2H-2010 is likely to be mirrored in slower gains in capacity utilization—or even declines in utilization rates in some cases. 
The median global inflation rate rose in 1H-2010 vs. 2H-2009, although it remains below pre-crisis levels. Price pressures firmed in developing countries (LMICs), led by a rekindling of headline inflation in South Asia. This reflects a strengthening in domestic demand and somewhat accommodative monetary conditions. In contrast, moderating price pressures—with deflation in some countries (Ireland, Japan, Spain, notably in core prices)—has recently become evident in some highincome countries (HICs), given weak domestic demand and fiscal austerity measures. Global price pressures are likely to ease ahead, given an expected moderation in economic activity and lagged transmission of moves toward monetary policy normalization (policy-rate hikes) in some countries (Brazil, India, and Peru, among LMICs). Disinflation—and in some cases deflation—could become more pronounced in some HICs. 
Emerging market debt-inflows from abroad inched up in June, after sharply reduced flows in May tied to European debt woes. Corporate bonds fully accounted for the rise with 14 deals. No EM-sovereigns sought bond financing and banklending was unchanged. However, in 1H-July, Mexico successfully launched a $1bn sovereign-bond. As bank-lending has remained extremely low (partly reflecting consolidation of balance sheets), corporations have increasingly turned to bond markets. Spreads for EM-corporates have narrowed from 1,140bps in Oct-2008 to 371bps in Jul-2010, as investors’ appetite for EM-assets has improved. In contrast, corporate bond issuance has declined in the U.S. and Europe by 29% and 33% (y/y), respectively, in 1H-2010. 

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Prospects Weekly: U.S. inventory restocking may be coming to an end; latest readings show rise in trade imbalances

The boost to U.S. growth provided by the restocking of depleted inventories may be coming to an end. The U.S. trade deficit and China’s trade surplus have both widened of-late, as overall trade flows continue to rise. The rapid increase in China’s trade surplus reflected a 44% (y/y) rise in exports in June, even as slowing domestic demand saw imports decelerate to 33% from 47% in May (y/y). In the U.S., European weakness and a rise consumer demand conspired with an elevated oil-import bill to lift its trade deficit to $700bn (annualized) in May. Emerging market bond-issuance firmed somewhat in June after anemic activity in May, but remained subdued. Spain and Greece launched successful sovereign issuances in July, although Greece was restricted to 6-mo. T-bills. Meanwhile, as the ECB reduces access to long-term emergency lending, commercial interbank rates in Europe are rising in reaction to increased demand.
Restocking of depleted inventories in the U.S. appears to be diminishing, suggesting that inventories are now consistent with underlying demand and will contribute less to growth going forward. The contribution of inventories to growth in sales remains positive at one percentage point in May, but down sharply from an 8.2 percentage-point contribution in November 2009. Restocking (after a severe drawdown in the acute phase of the crisis) added 1.9 percentage points to GDP in Q1-2010 vs. 3.8 percentage points in Q4-2009. Sales remain well below their pre-crisis growth path and are still expanding rapidly (12.7% annualized during the three months ending May), as are inventories (5.9% annualized over the same period). These growth rates compare with long-term averages of 4.3% and 3% for sales and inventories, respectively. 
Latest readings show a rise in trade imbalances in the months prior to China’s decision to introduce a more flexible renminbi. China’s merchandise trade surplus rose in June with a surge in capital goods exports, while the U.S. trade deficit expanded in May with import growth outpacing export growth. Since the renminbi’s peg against the dollar was lifted, it has appreciated 0.8% vs. the dollar (or 10% at an annualized rate, as of Jul-14 close). Over the longer-run, this could support a firming of import demand in China and contribute to a reduction in China’s surplus. However, in the short-run it could lead to increased imbalances by making U.S. imports more expensive. 
Emerging market bond issuance firmed somewhat amid mixed signals from European markets. Led by $3.1bn in Telecom bonds in Mexico, emerging market issuance rose to $7.1bn in June from a mere $3.5bn in May. Following the withdrawal of ―442bn in long-term bank financing, European interbank rates have been rising and now stand at 0.85 bps (close Jul-15), still well-below the effective ceiling created by the ECB’s 3-month window, which is available in unlimited quantities at 1%. ECB lending to commercial banks has declined some ―250bn since July 1, as banks are increasingly relying on the commercial interbank-market. Despite rising Euribor rates, the spread between the 3-mo. Euribor and overnight (Eonia) rates has remained relatively stable and in line with early-2010 levels, suggesting that rising risk premiums have not contributed to the increase in Euribor rates. In July, Spain successfully issued new bonds, indicating an easing of concerns around European sovereign debt. Greece was also able to tap markets, but was restricted to 6-mo. T-bills, vs. 10- and 15-year bonds for Spain. 

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Prospects Weekly: Leading indicators point to slower growth in the third quarter

Leading indicators point to slower growth in the third quarter. Retail sales volumes have begun to moderate in a number of countries, undermined by a jobless recovery in high-income countries and the gradual withdrawal of stimulus measures that have spurred household consumption. On the production side, developing countries have surpassed pre-crisis output levels, but the United States and Europe do not appear to be on track to regain pre-crisis growth paths. Although consumer confidence and purchasing manager readings point to slower growth in June, the outlook remains positive. Short-term funding pressures appear to still be an issue in European banking markets, but bank-to-bank counterparty risk assessments may have eased, even as other financial markets remain concerned about the solvency of European bank debt.
Global retail sales volumes slowed in April, stagnating in high-income countries but still rising a robust 8.2 percent in developing countries. High-income retail sales were undermined by weak job creation and the expiry of fiscal stimulus measures. Compared with a year ago consumer demand fell 0.4 percent in Japan, following the scaling back of the government’s “eco-points” system that led consumers to buy eco-friendly durable goods. Real consumer spending increased only 0.3 percent in the United States from a year ago, partly because weak labor market conditions saw personal income grow only 0.4 percent. A 10 point plunge in the Conference Board’s consumer confidence index to a still positive 52.9 suggests that consumer demand growth in the U.S. may weaken further in June.  
The recovery in industrial production continued through April / May with developing countries having regained precrisis output levels. The recovery in Europe and the United States continues to lag and does not appear to be on track to close with pre-crisis growth trends. In contrast, Japanese activity continues to expand rapidly. Recent purchasing manager surveys and weak employment data in the U.S.A. suggest a slowing in growth rates may be in store. While worrisome, especially in the context of the debt situation in Europe – which has yet to show up in IP data – such a slowing has been expected as bounce back factors that have driven growth fade. Indeed, PMI indicators remain in positive territory – suggesting continued growth – and are higher than the average levels observed during the past two recoveries (2002-03 and 2004-07). 
Euro interbank offer rates (Euribor) continue to rise even after last week's repayment of €442bn of ECB loans. Although the immediate challenge of paying the initial 1-year loans has passed, funding pressures remain high–perhaps because banks continue to seek private-sector financing to repay the €110bn in 6-day ECB debt that was taken on. Indeed, higher Euribor rates do not seem to reflect increased counter-party risk assessments as the spread between the 3-month Euribor and overnight (Eonia) rates has been stable since May. Nonbank investors remain skittish however. Credit default swaps on the debt of European banks have risen by 100 basis points since April and continued to rise in recent weeks.  

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Prospects Weekly: European banking under some pressure

Last weekend the G-20 convened in Canada, and while recognizing that countries need to adjust fiscal accounts at different speeds, the high-income economies agreed to halve their fiscal deficits by 2013 and stabilize debt-to-GDP ratios by 2016. Planned budget cuts across the OECD through 2011 could amount to $560bn, or 1.4% of GDP. Monetary authorities in high-income countries are expected to hold-off on policy interest-rate hikes, given fiscal-consolidation efforts. But, developing-country rates are expected to continue to rise as recovery takes hold. As a consequence, rising interest rate differentials are likely to prompt a rise in carry trade activity and associated capital flows. An upswing in Euribor rates since May reflects heightened risk-aversion, concerns about European bank-exposures to bad debt, and an increase in funding demand as €442bn in ECB emergency-loans came due today. These concerns—combined with mounting evidence of a coming slowdown in global growth in 2H-2010—contributed to a sell-off in global equity markets, with the World MSCI down 4.3% in the last week (as of July 1).
The G-20 appears to have reached consensus on a “growth friendly” approach to budget cuts. IMF suggestions that “one shoe does not fit all” and the U.S. Administration’s view that recovery is too fragile for “traditional” budget cuts, received some support from the Europeans. Greece, Ireland, Portugal and Spain have announced measures to reduce budget shortfalls by some $82bn, or 4.5% of their GDP through 2011. Larger countries of Europe are also moving toward deficit reduction, with cuts amounting to $75bn. These range from 1.8% of GDP for Italy, 1.6% for the U.K. and 1% for France through 2011. The measures are targeted to achieve sustainable public sector debt-levels, and in turn hoped to stave off worse consequences from ongoing fiscal problems. 
Large interest-rate differentials between developing- and high-income countries are likely to remain or widen, increasing carry-trade opportunities. While central banks in a handful of high-income countries (including Australia, Canada, and Norway) have recently raised short-term policy rates—many high-income countries are expected to refrain from raising rates until private sector activity has gained firmer footing, especially with plans to tighten fiscal policy. As monetary policy continues to tighten in developing countries, incentives to undertake carry-trades may intensify with investors borrowing short-term at lower interest rates in high-income countries to invest in higher-returning instruments in emerging markets—potentially generating unwanted and disruptive capital flows. 
Euro interbank offer rates (Euribor) have risen since May and continued to increase today, as €442bn in ECB emergency loans came due. Funding pressures associated with the repayment (€199bn has been paid off) may have contributed to the recent climb in Euribor. However, a generalized increase in risk aversion, and specific fears about the solvency of some European banks may also have been at play. Of the €243bn of ECB debt that was rolled over, €111bn was put into six-day loans—suggesting that debtor banks still hope to repay this debt in the days to come using private-sector funding. How successful they are in doing so will be a key indicator of banking-sector health. As repayment-related demand eases, Euribor rates should begin to decline. 

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