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Global Economics & Country Risk Conference

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The global economic outlook Back to the future? Lower oil prices and a US-centric global recovery … …But can a lost decade be avoided?

Nariman Behravesh, Chief Economist, +1 781 301 9101, [email protected]

11 November 2014

ECONOMICS

© 2014 IHS

Back to the future?

• The US is a locomotive of global growth, after an eight-year hiatus.

• US oil production will exceed that of Saudi Arabia for the first time since 1991.

• Oil prices are at their lowest levels since the end of the recession.

• A strengthening dollar is helping many other economies, much like the 1980s, 1990s and 2000s.

• Is there a new “cold war”?

• Is the “peace dividend” eroding?

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Global Economics & Country Risk Conference / November 2014

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The world economy: Reasons for optimism

• Global growth has been remarkably stable at 2.5% - not great, but not bad either.

• Lower oil prices will likely boost 2015 growth by 0.2 to 0.4 percentage points.

• Monetary stimulus by the Bank of Japan (aggressive), People’s Bank of China (small so far), and the European Central Bank (promised, but not delivered yet) will support growth.

• US and UK economic growth remains solid (at around 2.5% to 3%).

• Japan’s growth will be sustained but weak.

• The Chinese government will do whatever it takes to prevent growth from collapsing.

• India is a bright spot.

• World trade growth is beginning to pick up (very) modestly. 3


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The world economy: Reasons to be concerned

• Europe’s growth has stalled, and Germany has not been immune. • Deflation is a growing menace in the Eurozone. • Some large emerging markets (notably Brazil and Russia) are in

recession, and the prospects do not look good. • Debt levels in many parts of the world (Europe, Japan, China, other

emerging markets) are dangerously high. • The risks of policy mistakes (too much austerity, botched central bank

“exit strategies”, and lack of structural reforms) are elevated. • In particular, apprehensions regarding the Chinese governments ability

to juggle its multiple challenges are rising. • Geopolitical troubles could reverse the recent drop in oil prices. • Longer-term, the probability of “secular stagnation” in may parts of the

world (especially the Eurozone and some large emerging markets) is higher now than before.

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(Index, over 50 indicates expansion)

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Purchasing managers’ indexes for manufacturing show the US leading the expansion

Sources: Institute for Supply Management (US), Markit, National Bureau of Statistics (China)

Purchasing managers’ indexes

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Purchasing managers’ indexes for services also point to a strong US

Sources: Institute for Supply Management (US), Markit, National Bureau of Statistics (China)

Purchasing managers’ indexes

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After a slow start to 2014, global real GDP is rising at a moderate pace

Real GDP

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The emerging markets growth premium is the lowest since the early 2000s

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Real GDP growth in the United States, Eurozone, and Japan

Real GDP

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Real GDP growth in key emerging markets

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Asia-Pacific (excluding Japan) and Sub-Saharan Africa will achieve the fastest growth in real GDP

Real GDP

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Growth in world trade volume is beginning to pick up

Real GDP and trade

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The pace of globalization has slowed after exceptional gains in the 1994-2008 period

World imports’ share of GDP

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Some current-account imbalances persist

Current-account balance

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Oil prices have retreated as strong supply growth eclipses geopolitical concerns • The continuing boom in US oil production is lowering prices and

stabilizing global oil markets.

• Weak global oil demand (especially from China), high Saudi Arabian production, and a surge in Libyan production have contributed to recent price declines.

• Downside risks: OPEC is slow to react, the Saudis fight for market share, and global demand remains lackluster.

• Upside risks: Stronger demand growth (thanks to lower prices), renewed disruptions in Libya, slower production growth in North America, and rising geopolitical tensions.

• Bottom line: prices will likely remain in the mid-$80s (for Brent, and mid-$70s for WTI), but there could be a lot of volatility.

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Industrial materials prices are falling as new supplies are sufficient to meet demand growth

Industrial materials prices

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US crude oil: A big drop – but for how long?

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Crude oil and natural gas prices

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Crude oil prices will rise in the long run

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Price of Dated Brent crude oil

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Winners and losers from low oil prices

• Winners: • US consumers are likely the biggest winners – with a “tax cut” worth at least $70 billion. • European consumers will benefit proportionally less because of high gasoline taxes. • Emerging market consumers will also benefit less because of large fuel subsidies. • Energy-intensive industries (e.g. agriculture and transportation). • Governments in oil-importing countries with large fuel subsidies.

• Losers: • US producers (although IHS estimates that current break-even point is well below

current prices). • Major oil exporters – especially those with difficult public finances, where the “fiscal

break-even point” is above $100, including Iran, Russia, and Venezuela.

• Net effect: • In the US, the net effect on consumers and producers of oil is still a small positive,

despite rising US production. • Similarly, the net effect on oil-importing and oil-exporting countries around the world will

be a small boost to growth.

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Consumer price inflation varies by region, but is not a threat

Consumer price inflation

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Fiscal and monetary policies

• Austerity remains in force in the Eurozone and will likely become more intense in Japan next year.

• The US, UK, and Japan have had tight fiscal policies but loose monetary policies – the Eurozone has had tight fiscal and monetary policies …

• … This helps to explain why the single currency area is doing so poorly. • Not only are the ECB’s policies tight, they have de facto become tighter. • Japan has once again provided big monetary stimulus because of weak growth

and anticipated fiscal tightening in 2015. • The Fed and the Bank of England have stopped expanding their balance

sheets, but any interest rate hikes are still a long way off (summer of 2015 at the earliest).

• In the final analysis the benefits of QE (lower interest rates, improved bank balance sheets, higher asset prices, and a boost in confidence) have outweighed the potential costs (inflation, financial instability, and increased inequality).

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Fiscal deficits are diminishing in North America, Western Europe, and Japan

Federal budget balance

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Eurozone fiscal deficits are shrinking – dramatically in some cases

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The Bank of England will likely lead the upturn in policy interest rates

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Policy interest rates in key emerging markets will hold steady or decline

* One-year loan rate

Policy interest rates

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Long-term government bond yields will rise from exceptionally low levels

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CPI inflation rate - monthly

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CPI inflation rate - annual

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Real short-term interest rates – a risk for the Eurozone and the UK

Short-term interest rate

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Central bank balance sheets – shrinking in the Eurozone

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The dollar: Rising, but still competitive

Real trade-weighted dollar index

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Exchange rates per US dollar

Quarterly averages

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Many emerging-market currencies have depreciated and are vulnerable

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Vulnerable countries depend on external financing: Current-account and fiscal balances Percent of GDP, 2013 External financing

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The US economy is gaining momentum

• Accelerations in consumer spending and homebuilding, along with continued robust capital spending, will support growth.

• The oil price decline, if sustained, will add around 0.2 to 0.4 percentage point to growth.

• Consumers will cautiously boost spending in response to gains in employment and real disposable income, lower oil prices and improved finances.

• The recovery in homebuilding is proceeding slowly, as young adults delay household formation and homeownership.

• Global market growth, strong cash flow, replacement needs, and technological advances reinforce capital spending.

• Interest rates will rise over the next three years as monetary accommodation is withdrawn.

• The stronger dollar is still low by historical standards and not (yet) a big threat.

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US real GDP growth will be sufficient to bring further reductions in the unemployment rate

Real GDP and unemployment

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US household deleveraging continues on the mortgage side – lowest debt ratio since 2002

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Source: People’s Bank of China

Real spending

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The secret isn’t out yet in Washington: The federal budget deficit is unproblematic

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US federal debt ratio to stabilize just under 75%–but the biggest problems come later, as the population ages

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Unconventional sources of oil and natural gas are boosting US energy supplies

US energy supply and demand

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The US current-account deficit: Thanks to falling oil imports going, going, gone?

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North American business cycles are synchronized

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Canada will achieve moderate, balanced growth

• Real GDP growth picked up in the second quarter, led by surging exports, auto sales, and homebuilding.

• The net impact of the oil price decline will be a small positive (around 0.1 percentage point).

• Gains in employment and income will support household spending, but rising debt burdens will restrain it.

• The Bank of Canada will begin to raise interest rates in late 2015.

• Continued development of the oil sands is raising energy production.

• The drop in oil prices has put downward pressure on the Canadian dollar, which will remain below parity with the US dollar.

• Western provinces, led by Alberta, will achieve the fastest growth, although weaker oil prices will knock a few points off growth.

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Economic reforms shape Mexico’s outlook

• Mexico is benefiting from solid growth in the US economy through trade, capital inflows, and remittances.

• The construction cycle is bottoming out; exports and public investment (including transportation infrastructure) will support 4% growth.

• The oil price drop will likely shave off 0.2 percentage off 2015 growth.

• Global automakers are investing in substantial new capacity in Mexico.

• Consumer spending growth will pick up in response to income gains.

• Constitutional changes will open Mexico’s oil and gas industries to foreign investment and eventually reverse the decline in oil production.

• President Peña Nieto’s agenda also includes reforming education and labor markets, increasing competition in communications industries, and broadening the tax base.

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Western Europe has turned the corner, but risks of deflation are rising • After a protracted recession, the Eurozone economy is growing again – though

growth this year will only be around 0.8%.

• Rising consumer and business confidence, low interest rates, improving export markets, and pent-up demand for durables will support growth.

• Lower oil prices will add about 0.2 percentage point to growth

• Extended fiscal austerity, still-significant banking sector problems, and weak consumer finances will restrain growth in several countries.

• The United Kingdom, Ireland, Germany, and Sweden will lead the region’s growth, while Italy, Spain, Greece, and Portugal will lag.

• The ECB averted a meltdown, but has done little for growth—moreover falling inflation is becoming a bigger risk (there is already deflation in Italy, Spain, Greece, Portugal, Cyprus and Slovakia), pushing up real interest rates and the euro.

• Western Europe is vulnerable to a further escalation of the crisis in Ukraine.

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Eurozone confidence indexes are rising

Positive replies minus negative replies

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The Eurozone economy will slowly recover

Real GDP

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Real GDP growth in Europe’s major economies

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European unemployment rates have diverged

Unemployment rate

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Japan’s economy on a better but sluggish growth path

• The sales tax increase from 5% to 8% in April is creating economic volatility: After a surge in the first quarter, consumer spending fell in the second, but is expected to rise in the third quarter.

• IHS expects 1.1% growth this year and 1.2% in 2015, and a small boost from lower oil prices (0.1 to 0.2 percentage point)

• The Bank of Japan’s aggressive monetary stimulus and sales tax increases will spark consumer price inflation of 3% this year and 2% in 2015 – this spring the core CPI rose the fastest since 1991

• Future growth will depend on how effectively the new Abe administration implements reforms in labor and product markets – so far there is been very timid.

• The recent stimulus by the Bank of Japan make it more likely that the October 2015 (second round) sales tax hike will go through.

• The huge cash hoards of Japanese companies are both a source of concern and a potential basis of strength.

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Japan’s economy has limited growth potential

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Percent of GDP, latest available Corporate cash holdings

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Asia-Pacific will achieve solid, not spectacular, growth

• Asia’s performance will be shaped by political transitions and the pace of domestic macroeconomic reforms.

• India’s economy is reviving, but the new BJP government has been slow to use its mandate to launch essential economic reforms.

• Indonesia’s new government seems on track to enact reforms such as the reduction of fuel subsidies.

• Political turmoil and the military coup in Thailand are undermining economic performance and foreign investment in manufacturing.

• As the global economy improves, South Korea, Taiwan, and Vietnam will see faster growth, supported by rising high-tech exports.

• The region’s outlook for consumer spending is bright, thanks to robust income growth and deepening financial markets.

• Risks include a China hard landing, slow progress on economic reforms, and territorial disputes in the South China Sea.

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Real GDP growth in Asia-Pacific

Real GDP

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China’s economic growth has slowed

• Real GDP increased 7.3% year on year in the third quarter, down from 7.5% in the second quarter and the slowest pace since early 2009.

• Lower oil prices will only add about 0.2 percentage points to growth next year.

• Persistent weakness in real estate and related heavy industry was offset by strength in exports and consumer spending.

• The recent easing of liquidity conditions will have little real impact on new financing due to tightening bank regulations.

• A hard landing triggered by a financial crisis is not the biggest threat facing China; a more serious concern is prolonged low growth.

• In the medium term, China will need to reform state-owned enterprises and the financial sector – otherwise a Japan-style scenario with lots of “zombie” companies is a big risk.

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China’s economic growth will downshift in the long run

Real GDP and industrial production

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China’s lending has stabilized at a high level

Source: People’s Bank of China

Lending flows

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India’s growth recovery remains tentative

• Relapses in manufacturing production suggest continued weakness in consumer spending and private investment.

• Agricultural output is likely to suffer from poor monsoon rains.

• Wholesale price inflation subsided to a five-year low of 2.4% year on year in September, while consumer price inflation moderated to 6.5%.

• The Reserve Bank of India is likely to hold interest rates steady into 2015 because of potential price pressures from currency depreciation.

• The BJP’s initial policy steps have been cautious. Much needs to be done to open markets, upgrade infrastructure, reduce food and fuel subsidies, and raise productivity.

• The recovery in economic growth will be gradual, but long-term growth potential is high if reforms are implemented.

• Growth will be boosted (0.3-0.4 percentage point) by lower oil prices.

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South America: Deteriorating investment climates

• The region’s economic growth has slowed in 2014, with Argentina, Venezuela, and Brazil in recession.

• Falling prices for oil and other commodities are hurting export income.

• Low oil prices will help Argentina, Brazil and Chile, but hurt Colombia, Ecuador and Venezuela.

• In Argentina, a sovereign debt default, high inflation, foreign-exchange controls, and import restrictions are obstacles to growth.

• Venezuela faces a long recession with soaring debt-servicing costs, high inflation, product shortages, and political unrest

• In Colombia and Peru policy stimulus and resource development are supporting robust growth.

• Tax increases are slowing Chile’s growth.

• The region’s long-term challenges include inadequate infrastructure, restrictive business environments, and income inequality.

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Real GDP growth in South America

Real GDP

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Brazil’s economy faces competitive challenges

• High labor and capital costs, an overvalued currency, complex taxation, and inadequate infrastructure are hurting competitiveness.

• Fixed investment has been declining since mid-2013.

• High debt burdens and slow job growth are restraining consumer spending.

• Industrial production began to recover in July and August, suggesting that the economy is stabilizing after a mild two-quarter recession.

• The re-election of Dilma Rousseff means more of the same in terms of failed policies – which is not encouraging for growth prospects.

• As a net importer of oil, Brazil will see a small positive impact from the recent drop in oil prices.

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The Ukraine crisis influences Emerging Europe

• The Eurozone’s gradual recovery will help the economies of Central Europe and the Balkans by increasing trade and capital flows.

• The Russia-Ukraine conflict brings the risk of trade and energy-supply disruptions. Ukraine’s economy will contract 7% in 2014.

• Russia’s aggression in Ukraine and the resulting sanctions will do long-term damage by discouraging investment in Russia.

• Despite weak export markets, Poland’s economy is benefiting from monetary stimulus and a revival of domestic demand.

• In Turkey, policymakers’ efforts to reduce the large current-account deficit and stabilize the economy will dampen economic growth.

• Both these large Central European countries will see a boost (of up to 0.5 percentage point) in 2015 growth from lower oil prices.

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Real GDP growth in Emerging Europe

Real GDP

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Russia’s outlook deteriorates as sanctions increase and oil prices fall • Russia’s incursions in Ukraine have led to new sanctions, capital flight,

reduced credit availability, and declining investment.

• The central bank has raised its policy rate from 5.5% to 9.5% in 2014 and has effectively stopped intervening in currency markets to support the fragile rouble.

• High inflation is eroding consumer purchasing power and confidence.

• Real GDP is projected to decline 0.3% in 2014, followed by a bigger drop of 1.7% in 2015 due to the cumulative impact of lower oil prices and sanctions.

• Sanctions will reduce access to oil field technology and Western capital, leading to a decline in oil production in 2016 and beyond.

• Unfavorable demographics, outmoded manufacturing capacity, and an overburdened infrastructure will limit medium- and long-term growth.

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The Middle East and North Africa

• Regional political instability and the war against the Islamic State and Khorasan cloud the economic outlook.

• Lower oil prices will hurt Saudi Arabia, Kuwait, Iran, UAE, and Libya, but help Jordan, Lebanon, Morocco, and Tunisia.

• After two years of contraction, Iran’s economy is stabilizing – sanctions on the energy and financial sectors will likely remain in place.

• Political and security risks limit Egypt’s economic growth.

• Addressing job creation, economic diversification, and competitiveness will be critical to regional stability over the medium term.

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© 2014 IHS

-9

-6

-3

0

3

6

9

Saudi Arabia UAE Israel Iran Egypt Iraq

Annu

al p

erce

nt c

hang

e

2012 2013 2014 2015 2016-20

67


Real GDP growth in the Middle East and North Africa

Real GDP

© 2014 IHS

Sub-Saharan Africa will sustain rapid growth

• Commodity export revenues remain a key driver of growth.

• Expanding domestic markets, income gains, and regional integration will support 5-6% economic growth in the decade ahead.

• Macroeconomic management is improving substantially, poverty is declining, and foreign direct investment is rising.

• Poor infrastructure (especially power generation), political instability, and corruption remain obstacles to economic development.

• An end to mining strikes in South Africa is bringing renewed growth, but producers face strong labor and electricity cost pressures.

• Lower oil prices will help South Africa and Zambia, but hurt Angola, Mozambique and Nigeria.

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© 2014 IHS

0

2

4

6

8

10

Nigeria South Africa Angola Ghana Ethiopia Kenya

Annu

al p

erce

nt c

hang

e

2012 2013 2014 2015 2016-20

69


Real GDP growth in Sub-Saharan Africa

Real GDP

© 2014 IHS

What could bring about much slower global growth?

• US – growth in the labor force, capital expenditures, and productivity remain anemic for an extended period.

• Secular stagnation and persistent deflation in Europe – especially in the crisis economies.

• Lack of structural reforms and further degradation of growth in the emerging world – including China and India.

• Further slowdown (reversal?) in globalization.

• Onerous regulatory and tax environments.

• Badly conceived (and implemented) energy and environmental policies that could thwart the development of unconventional energy.

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IHS Board Meeting/ August 2014

© 2014 IHS

Not all the long-term risks are on the downside

• Inherent resilience of the US economy manifests itself.

• Unconventional energy revolution goes global.

• Progress on European structural reforms payoff.

• Success of Abenomics leads to a Japanese economic renaissance.

• Key emerging markets develop effective reform plans.

• Globalization becomes an engine of growth again.

• Tax and regulatory reforms are implemented in key economies.

• Existing and emerging technologies pay off in terms of higher productivity growth.

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IHS Board Meeting/ August 2014

© 2014 IHS

0

2

4

6

8

NAFTA OtherAmericas

WesternEurope

EmergingEurope

Mideast &N. Africa

Sub-Saharan

Africa

Japan OtherAsia-

Pacific

Annu

al p

erce

nt c

hang

e

1993-2003 2003-13 2013-23 2023-33

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Long-term world economic growth by region

Real GDP

© 2014 IHS

-1

0

1

2

3

NAFTA OtherAmericas

WesternEurope

EmergingEurope

Mideast &N. Africa

Sub-Saharan

Africa

Japan OtherAsia-

Pacific

Annu

al p

erce

nt c

hang

e

1993-2003 2003-13 2013-23 2023-33

74


Population growth is slowing across regions

Population

© 2014 IHS

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

80s 90s 00s 10s 20s 30s

Dec

ade

aver

age

grow

th ra

te

United States Canada United Kingdom Germany* France Italy

75


Labor force growth

Labor force

* German data starts in 1992 Source: IHS Global Link Model

© 2014 IHS

-1.0

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

80s 90s 00s 10s 20s 30s

Dec

ade

aver

age

grow

th ra

te

Japan China Russia* India Brazil*

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Labor force growth (continued)

Labor force

* Russia data starts in 1995; Brazil starts in 1996 Source: IHS Global Link Model

© 2014 IHS

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

80s 90s 00s 10s 20s 30s

Dec

ade

aver

age

grow

th ra

te

United States Canada United Kingdom* Germany* France* Italy*

77


Capital stock growth

Capital stock

* German data starts in 1991; UK, France, and Italy in 1986 Source: IHS Global Link Model

© 2014 IHS

0

2

4

6

8

10

12

80s 90s 00s 10s 20s 30s

Dec

ade

aver

age

grow

th ra

te

Japan* China Russia* India Brazil

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Capital stock growth (continued)

Capital stock

* Japan data starts in 1986; Russia in 1996 Source: IHS Global Link Model

© 2014 IHS

-0.5

0.0

0.5

1.0

1.5

2.0

2.5

3.0

80s 90s 00s 10s 20s 30s

Dec

ade

aver

age

grow

th ra

te

United States Canada United Kingdom* Germany France* Italy

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Total factor productivity growth

Total factor productivity

* United Kingdom data starts in 1989; France in 1986 Source: IHS Global Link Model

© 2014 IHS

-1

0

1

2

3

4

5

80s 90s 00s 10s 20s 30s

Dec

ade

aver

age

grow

th ra

te

Japan China Russia India Brazil

80


Total factor productivity growth (continued)

Total factor productivity

Source: IHS Global Link Model

© 2014 IHS

0 5 10 15 20 25 30

AustraliaGermany

United StatesNetherlands

FranceSwedenCanada

JapanItaly

United…Portugal

SpainIrelandGreece

Loss of potential economic output

81


Percent reduction, 2007-13 Potential output

Source: Laurence Ball, “Long-Term Damage from the Great Recession in OECD Countries”

© 2014 IHS

Implications of global economic trends

• Global growth will be more US-centric.

• Europe and Japan will do a little better, but not as well as the US.

• The sharp deceleration in emerging markets is worrisome, and a return to the boom years of the 2000s is unlikely—but another crisis is also unlikely.

• Emerging markets will not enjoy another resurgence without stronger productivity growth.

• China’s locomotive role is diminishing.

• Lower oil prices, more monetary stimulus, and more solid US growth will provide the foundations for a modest acceleration of global growth.

• Europe and some emerging markets have the highest risk of secular stagnation.

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