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Industrialised countries
US
The US economy has so far this year shown remarkable momentum, with more growth than expected, and this seems likely to continue. After growth slowed significantly in the first half of last year (1H11) — due mainly to a reduction in stimulus efforts — it was not clear whether the economy would be able to recover from its sub-2% levels. However, after 3.0% expansion in the fourth quarter (4Q11), the first estimate for 1Q12 stands at 2.2%, which signifies a successful continuation of output activity and is roughly in line with this year’s growth expectations.
Furthermore, while the major support factor in 4Q11 was a build-up in inventories, the details of 1Q12 GDP show that private household consumption contributed the most to this expansion, at two percentage points (pp), and that inventories were again at much lower levels. This positive trend was reflected in an improving labour market. The unemployment rate fell from 8.2% to 8.1% in April and non-farm payroll additions stood at 115,000, after additions of 154,000 in March. However, many medium- and long-term issues remain, and these will probably weigh on the recovery for some time. The ‘participation rate’ has come down again, to 63.6% — a new low and long-term unemployment still stands at a high level of 41.3%; however, this is lower than the 42.5% of March and is, indeed, the best figure for more than two years. Looking at private household spending, consumer sentiment remains at higher levels than in the previous year, amid improvements in the labour market, and it is expected that private consumption will continue to grow.
The consumer confidence index of the Conference Board was set at 69.2 in April, only slightly lower than the peak February level of 71.6, which was the highest level for 12 months. The other consumer sentiment index of importance, that of the University of Michigan, confirmed this development at 76.4, the highest level since January 2008. The Federal Reserve Board (Fed), at its most recent meeting at the end of April, acknowledged the improvements in the labour market, while noting that some parts of the housing market continued to be depressed, even though there was a general positive trend there. The Fed continued to refrain from further quantitative easing measures or other extraordinary monetary supply mechanisms, but stressed that it was closely monitoring the moderately expanding economy. It highlighted the fact that strains in the financial markets and the high oil and gasoline prices were of major concern for the economy. Most importantly, it expected a gradual improvement in the labour market; however, if this does notmaterialize, it should be taken as a major sign for further extraordinary monetary measures.
The Fed kept its key policy rate between 0% and 0.25%. Inflation remains elevated, although it has come down significantly since last September when it peaked at 3.9%. It has since fallen to 2.7% in March, the exact same level as in March last year. If this were to continue, it would allow the Fed to apply further appropriate monetary measures. The important housing sector continued to improve from still-depressed levels. Pending home sales rose by 4.1% month-on-month (m-o m) in March, and the February figure, which was reported at –0.5% m-o-m initially, was revised up to 0.4% growth, according to the National Association of Realtors. Pending home sales are considered a leading indicator of progress in real estate, because they track contract signings. Thus it is worthy of note that the yearly change in the house pricing index of the Federal Housing Finance Agency (FHFA) has turned positive for the first time for almost five years at a monthly price rise of 0.5% y-o-y in March, and a 0.3% increase m-o-m. Existing home sales fell slightly in March to 4.48 million, from 4.63 million in January and 4.60 million in February, but remained at solid levels.
Output-related indicators were mixed in the US, with factory orders showing a monthly decline of 1.5% in March and industrial production falling by 0.2% m-o-m in the same month, for the first time since April last year. The Institute for Supply Management’s (ISM’s) figure for the manufacturing sector was slightly higher at 54.8 in April, after 53.4 in March. The ISM figure for the services sector declined, but was still at a high level of 53.5 in April, after being 56.0 in March. All in all, the US economy is showing remarkable robustness, particularly compared with other OECD economies, although it is running with a much higher budget deficit of around 8%, which has a weighted average of 5.6% in 2012. With some uncertainties remaining, the US economy is expected to expand at 2.3% in 2012, broadly in line with the annualized 1Q12 level.
Japan
The Japanese economy continues to recover, with both exports and domestic demand posting solid growth rates. This momentum is fuelled by slightly improving external trade activity compared with the end of last year — and local stimulus efforts that are lifting domestic demand. Growth activity, however, is still relatively low and the negative effects of last year’s triple-disaster continue to be felt. In particular, decisionmaking with respect to the supply of nuclear energy will be of importance. Currently, there is no nuclear reactor online, and it is expected that the effects of this will be felt in the energy-intensive summer season. Power-cuts would be possible, with a negative impact on industrial production. Furthermore, the unusual situation of a trade deficitmight have an effect on the country’s economic structure.
Exports have posted the first expansion on a yearly basis since last September, increasing by 5.9% y-o-y. This growth is due to the very low base level from last year. However, exports also rose on a monthly basis, by 14.1% m-o-m in March and by 20.6% in February, which indicates that, although the momentum has slowed, expansion remains at high levels, and, with the current improvements in global trade and manufacturing, this is expected to continue. This trend is supported mainly by industrial supplies, which grew in February and March by 14.8% and 18.8% m-o-m respectively, and by capital equipment, which grew in February and March by 20.8% and 17.5% respectively. Both categories are the most important areas for exported goods.
On a yearly basis, imports grew more than exports in March, when they expanded by 13.1% y-o-y, moving the trade deficit to 520.7 billion yen on a seasonally adjusted basis, the lowest level for six months. This was also due to the rising value of the yen. However, it remains to be seen how this situation will develop, as it will depend on the future development of the yen and the decisions that will be made on the nuclear energy sector. The domestic side of the economy continued to improve, with the retail trade increasing by 10.3% y-o-y in March, again a significant low base effect, but also a solid gain from the previous month of 15.5% m-o-m, to support this trend. Motor vehicle sales were strong at 50.4% y-o-y and highlighted the success of the current stimulus. The most recent household survey showed a 3.4% yearly increase in household spending, which was a slight decline on a monthly basis of 0.5%, when excluding highly volatile items.
With the stimulus continuing, the domestic side is expected to improve further in the coming weeks. This should be supported by the low unemployment rate of 4.5% in March. The so-called job-openings ratio improved very slowly, by 0.01 points from last month, and now stands at a factor of 0.76. The number of job-openings continued to increase, rising by 1.7% m-o-m. This slow momentum of improvements in the labour market is expected to continue. The uncertainty about production, due to power shortages in the summer time and the dependence of the economy on a continuation of the recovery in international trade, and the stimulus to support domestic demand should both dampen major hiring increases.
However, an improvement in output can be observed in industrial production and in leading indicators for the coming weeks. Industrial production increased by 15.5% y-o-y in March, a monthly rise of 1.0%. Machinery orders point to a continuation of the current expansion. Excluding volatile items, they increased by 4.8% in February, after 3.4% in January. The expectation of economic growth in the near future is also reflected in the purchase managers index (PMI) provided by Markit. While, for the manufacturing sector, it declined slightly from 51.1 in March to 50.7 in April, it was still above the 50-level, which indicates expansion. The same applies for the services sector, which at 51.0 was above the 50 level, although it had fallen from \ 53.7. These output-related indicators point to an expanding economy, which still seems to be fragile and dependent on supportive factors, such as international trade further picking up and local stimulus measures.
Japan’s economy is still in relatively weak, and, while it is expected to expand, one has to consider the base effect from last year. After last year’s decline of 0.7%, the absolute GDP level was comparable with the levels of 2006. Taking all the above into consideration, the forecast remains unchanged at 1.8% for the current year, and additional signs of improvement will be needed for any further upward revision.
Euro-zone
The Euro-zone continues to be embattled by the consequences of its self-induced austerity measures on the one hand and by the once-again weakening financial situation of some of its members on the other. Output activity continues to decline and it remains to be seen whether, in 2H12, growth will turn positive, as widely expected. Considering the most recent leading indicators, it is not obvious that the economy will recover in the coming months. Moreover, ten year yields for treasury bonds in most of the peripheral economies, including Spain and Italy, have risen in recent weeks. Added to this, the political uncertainty about the future development of the Euro-zone — caused by the outcome of the most recent presidential elections in France, upcoming parliamentary elections in France and the Netherlands, probable new elections in Greece and a referendum on the fiscal pact in Ireland — is higher than it was some months ago.
This uncertainty has already had a weakening effect on the Euro exchange rate, but this could be supportive of a recovery in the coming months for the major exporters, i.e. Germany and France, as well as for smaller member economies like the Netherlands or Austria. It is hard to predict what the outcome of all the political possibilities will be, and, while the upcoming developments will need to be monitored carefully, it is important to focus on the current facts to conclusively evaluate future developments. Austerity measures seem to be successful, in terms of bringing down debt levels and budget deficits. The Euro-zone’s budget deficit is expected to be lowered to 3.2% in 2012 from 6.3% in 2010, according to the latest estimates from the spring analysis of the International Monetary Fund (IMF). This is a remarkable achievement, however, since growth has been relatively subdued in the recent months. While austerity measures hit mostly the weaker peripheral economies in 2011, it remains to be seen how this will affect the member economies in 2012. So far, it seems that only the major and most robust of the 17 member economies will escape a decline.
Furthermore, currently most leading indicators point to a continuation of the slowdown, and it is hard to say whether the Euro-zone will be able to recover in 2H12. The worries about the ability to manage the sovereign debt burden have grown recently, with yields moving up for most of the ailing economies in the group. Although the European Central Bank (ECB) has injected more than one trillion euros in the two rounds of extraordinary money supply in its three-year, long-term refinancing operations (LTRO) (the first of which it provided at the end of last year and the second just at the end of February), this large amount of monetary supply was again overshadowed by uncertainties about the Euro-zone’s ability to grow and doubts about its political capability to manage the sovereign debt situation. With the most recent discussions in Europe about the need to not only cut costs, but also to foster growth — as, for example, in the US — uncertainty among investors has been rising again, as it is unclear which direction the Euro-zone leaders will pursue in the end.
It currently seems that a dual approach will be likely, i.e. to continue reducing the debt burden, while, at the same time, introducing structural changes to enable growth in the future. But there is still a lot of discussion, and no clear ideas nor details have emerged so far, again raising uncertainty among investors. In addition to this, the political situation in Greece, after the recent elections, is unclear, and, with the likelihood of a new round of parliamentary elections in June and the probability that, at some point, Greece might leave the Euro-zone, developments are unclear. At the same time, Spanish ten-year yields remain at almost 6% and Italy’s risk-premium is only a fraction lower. In the meantime, output-related indicators remain negative. Industrial production fell by 1.9% y-o-y in February, a third consecutive month of decline. Within this, manufacturing saw the most significant decline of –2.4% y-o-y, compared with –0.4% in January.
Even more worrying, manufacturing orders, as a leading indicator of future growth, plunged in February by a significant 5.8% y-o-y, after falling in January by 4.2% and declines of 0.2% in December and 2.3% in November. Construction in the Euro-zone fell by almost 10% y-o-y in February. This negative trend in output is accompanied by a declining trend in retail trade, which is, however, improving, with a decline of 0.5% y-o-y in February, after –1.6% inJanuary. This should not come as a surprise, with the labour market being in serious turbulence with an unemployment rate of 10.9%, the highest on record since the initiation of the Euro-zone in 2001. Spain’s unemployment rate rose again to a new peak of 24.1%. Youth unemployment stood at 22.1% for the Euro-zone, also the highest level on record, of which Spain is the most exposed with a staggering 51.1%, i.e. more than half Spain’s youth is currently jobless.
This negative development is reflected in the PMI figures. The manufacturing PMI stood at 45.9 in April, after an already low 47.7 in March and considerably lower than the 49.0 from February, which had already predicted a decline in the sector. The services sector, with its much higher weight within the economy, was also recorded at the below-growth-indicating level of 50, at 46.9 in April, which was a significant decline from the March level of 49.2. The evidence is relatively strong that the weakening of the Euro-zone will continue in the coming months. Taking this into consideration, the forecast for GDP growth in 2012 has been revised down to –0.4% from –0.3% last month. This decline could become even more accentuated, if the uncertainty about the future development of the Euro-zone prevails.
Emerging markets
The global economy is expected to grow, in purchasing power parity (PPP) terms, at 3.3% in 2012. Since, in the major economies — the US and other large OECD countries — disposable personal income has been falling in inflation-adjusted terms, strong consumer spending, that earlier this year seemed promising, may not continue. The jobs market also softened in March, after a strong start to the year. Decelerating economic growth in major emerging markets is yet another indicator of a slowdown in the global economy. We expect the Chinese economy to grow at 8.2% this year, compared with 9.2% in 2011. The expansion of India’s economy is also moderating and this is now forecast to grow at below 7% in the 2012 fiscal year. However, despite the overall weakness in the global economy, fundamentals have been improving in many emerging markets (EMs) in recent weeks. Most developing countries now have shifted their focus to economic growth targets, rather than curbing inflation and overheating. The reduction of benchmark interest rates in India on 17 April by 50 basis points (bp) and in Brazil on 18 April by 75 bp are cases in point. However, despite similarities in general terms, the economic policies adopted by the EMs to support economic growth differ significantly, according to their circumstances. While, in many emerging Central and Eastern European countries, tight monetary policy is still on the agenda to curb elevated inflation, in Asia and Latin America a more accommodative monetary policy is being adopted, to address concern about sluggish economic growth. Inflation in Latin America has been moving down, allowing policy-makers to turn to economic growth policies. Inflation appears to be contained in China and emerging Asia, as well as in some emerging markets in Eastern Europe and the Middle East, with the exception of some countries, notably India and Turkey, where it remains high.
In Eastern Europe, the economic slowdown in the Euro-zone has dented the immediate growth prospects and raised doubts about the medium-term outlook. The impact of a dip in global growth in 2012 should be less severe on these countries than in 2009, since most have closed or considerably reduced, their large external imbalances. However, the 2012 recession in the Euro zone will act as a sharp brake on economic activity in Eastern Europe, because of weaker trade, investment and financing through the banking channels. External bank loans and foreign direct investment (FDI), both of which helped drive growth in the pre-crisis years, are likely to be constrained in 2012. Business and consumer sentiment in the region are also fragile. In addition to faltering external demand and the weak outlook for credit, domestic demand remains generally anaemic, given high unemployment, excess capacity in some cases and the inability of governments with considerable budget deficits to splash out on stimulus packages. These factors point to a slowdown in economic activity in 2012.
The outlook for Asian countries in 2012 is mixed. According to the Economist Intelligence Unit (EIU, May 2012), Asia’s export-driven economies, such as Singapore, Hong Kong, Malaysia and Taiwan, slowed in the second half of 2011, due largely to sluggish demand in the West, particularly in the EU. Flooding in Thailand in November was also a factor, interrupting supply chains for some electronic components. Recent data suggests that the industrial production cycles in these countries have bottomed out and are now recovering. China, India, South Korea, the Philippines and, to some extent, Indonesia are large emerging economies in Asia with strong and growing domestic demand and hence are less dependent on external demand. Therefore, the economic crisis in Europe and a slowdown in the OECD are expected to affect these economies less than the others.
Economic growth in South American countries is supported by China's demand for soft and hard commodity exports. Historically low OECD interest rates, coupled with improving investor perceptions of the region’s potential, will continue to benefit the larger economies and those well integrated into the global financial markets. However, last year’s volatility in the foreign exchange markets of these economies — when the Brazilian real and Mexican peso fell by 16.6% and 12.3% respectively against the US dollar in September 2011 — highlighted the vulnerability of the region to shifts in market sentiment, given its large external financial requirements and the volatility of global portfolio flows. In addition to the risks arising from an uncertain global economic outlook, Latin American policy-makers face other challenges. In monetary and credit policy, they will have to strike a balance between supporting domestic demand and keeping inflation under control. As capital inflows cause currencies to appreciate, manufacturers will struggle to maintain competitiveness. In Brazil, which is set to become a large oil-producer and oil-exporter, the problem of the "Dutch disease" will be particularly acute.
Economic growth slowed in the Middle East and North Africa (MENA) region in 2011, as a result of political upheavals and civil unrest. Most of the countries that experienced serious troubles last year will witness something of a bounce-back in 2012, as the political and economic scene stabilizes (albeit to varying degrees). However, those countries that are still convulsed by internal strife, such as Egypt and especially Syria, will continue to suffer economically (EIU, May 2012). In North Africa, recovery will be constrained by weaker EU demand, which will lead to lower workers' remittances from Europe and tourist inflows. In Brazil, a series of initiatives are envisaged to shield domestic industry from external competition. India now has cut its interest rate, adopting a more aggressive growth policy. The country’s rupee is expected to remain under pressure, due to its current account and government deficit. Meanwhile, data released in recent weeks implies a rebound in China’s manufacturing activity. In Russia, investment demand remained firm in April, while consumption growth looked to be losing momentum. The labour market is also tight, considering the low unemployment rate. The table below summarizes our estimate of the BRIC countries’ economic performance at a macro level.
Brazil
Considering the popularity that the Brazilian President enjoys in recent polls, it is expected that her government’s economic initiatives, intended to lift growth in a slowing economy, will gain support from the public, at least in the short term. Concern about the pace of economic activity, particularly in the industrial sector, continues to dominate the policy debate in Brazil. The government’s economic package is meant to complement the Brasil Maior plan launched in August 2011, and includes measures to increase public and private investment, enhance competitiveness — particularly through special incentives to boost productivity and innovation — and reduce production costs. It consists of three main pillars: action to curb exchange-rate appreciation — such as financial transaction taxes on international flows (IOFs), which were recently extended to cover all loans maturing within the next five years; changes to the corporate tax structure; and measures to stimulate domestic production (EIU, May 2012).
The key aspect of the new plan is the second pillar, namely changes to the intricate corporate taxes — focused on shifting companies' payroll contributions to the social security system, which amounted to a tax rate of 20% on payrolls — introducing a new tax on turnover, with a rate varying between 1% and 2.5%, depending on the sector. In addition, the government has announced that it will boost public-sector credit, with a new transfer of 45 bn reals (US $27bn) to the Banco Nacional de Desenvolvimento Econômico e Social (BNDES, the state development bank). The government raised concern about the high level of interest rates charged by Brazilian banks on corporate mand consumer borrowing. After four consecutive 50 basis-point cuts since \ the easing cycle began in August 2011, and two consecutive cuts of 75 basis points in March and April 2012, the Selic policy rate is now at 9%. Given lower inflation than expected in March and a still weak economic recovery, the Central Bank of Brazil (BCB) is likely to cut the rate by another 25 or 50 basis points in May, before going on hold until the end of the year. However, the recent aggressive cutting has renewed concern about the BCB's commitment to achieving the central inflation target (4.5%), and inflationary expectations for 2012 and 2013 have continued to drift up.
The public sector primary surplus for February was above market expectations. Over the last 12 months, this surplus has been 3.3% of GDP and, in the first two months of 2012, the government had already achieved a primary surplus of R35.5bn, or 25% of the yearly target, which is about 3.1% of GDP. Brazil’s net public sector debt is expected to be around 37.5% of GDP. Output growth is estimated to have slowed to 2.9% in 2011 and economic data released since the \ beginning of 2012 shows that the economy remained sluggish in the first two months of the year. However, leading indicators still point to an upturn later this year. Despite monetary policy easing and supportive measures, manufacturing will struggle as competitive weaknesses will continue to be exposed by a strong real, and, in the short term, there is still an inventory overhang to work through. It is expected, however, that economic activity will pick up in the second half of the year and, by late 2012, GDP will be growing by around 4% on annual basis, providing momentum into 2013.
The inflation rate eased to 5.24% in March, from 5.85% in February and a peak of 7.3% in September 2011 (EIU, May 2012), as the surge in commodity prices that began at the end of 2010 fell out of the annual series. Inflation will be muted until midyear. March inflation, which came in much lower than expected, has brought annual inflation well below the Central Bank’s estimates for the first quarter of around 5.4%. Therefore, there is increasing speculation that the Central Bank will continue the cycle of rate cuts to a level slightly below the current 9%. After the exchange rate appreciation in late February, the BCB intervened in the currency markets and the Ministry of Finance lifted the 6% financial transaction tax on overseas loans and bonds in March. This weakened the real to R1.88 to the US dollar on 19 April, as investors went on the defensive, fearing other measures. Assuming that a full-blown Euro-zone debt crisis and a Chinese hard landing are avoided, the real will remain strong, owing to sizeable capital inflows seeking investment opportunities, and healthier debt and GDP growth dynamics, compared with advanced economies.
China
China's rate of real GDP growth slowed in the first quarter of 2012, to 8.1% year-onyear, compared with 8.9% in the last three months of 2011. However, on a quarter-onquarter basis, the picture was much more stable, with the seasonally adjusted growth rate slowing only marginally. The National Bureau of Statistics (NBS) stated that consumption had contributed 76% of total economic growth in the first quarter of 2012. This appears to be a relatively strong performance, given that the value of retail sales in January-March was up by just 14.8% year-on-year, representing a slowdown from growth of 17.1% in 2011 as a whole. Further support has come from rapid wage growth — per-head disposable income for urban residents was up by 14% year onyear in the first quarter of 2012, according to the NBS, while the equivalent figure for rural residents was 17% (EIU, May 2012).
Slowing down on investment lies at the root of the recent moderation in economic activity. Fixed asset investment growth has slowed notably, although it remained fairly rapid in the first quarter of 2012, at 20.9% year-on-year. Those looking out for an upturn in investment will have been given hope by relatively strong credit growth in March, which helped to lift the net increase in renminbi-denominated lending in January-March to Rmb2.5 trillion (US $395bn), compared with Rmb2.3 trillion in the year-earlier period. Much of the slowdown in investment has been concentrated in the housing sector. It is estimated that new residential-construction starts were down by 5.2% year-on-year in January-March, to record their first contraction since 2009. Property prices are falling in many cities, and some distress sales of landholdings are taking place.
The picture for net exports is similarly poor. However, according to China's customs authorities, merchandise exports expanded faster than imports in the first quarter of 2012: exports increased by 7.6% year-on-year, while imports rose by 6.8%. The country posted a trade surplus of $1bn on a customs basis in January-March this year, compared with a deficit of $2 bn in the year-earlier period. The swing largely reflected weak imports of raw materials, in line with the slowdown in domestic construction. Although exports are no longer as important to China as formerly, rebalancing the economy away from its dependence on investment will be a crucial goal. Economic growth will nevertheless continue to rely on rates of investment that are unsustainable in the long term, even as consumption is boosted. This implies the need for economic reforms on several fronts.
The China 2030 report, published in February by the World Bank with backing from the People's Bank of China (PBC, the central bank) and the Development Research Centre (a think-tank under the control of China's cabinet, the State Council), showed that the authorities in China are in agreement that a series of well-planned and administered reforms is required for more harmonious and inclusive economic growth. Financial reforms, in particular, are mentioned in this report and other official reports as being among the priorities. China raised its official rural poverty threshold in late 2011, thereby more than quadrupling the number of residents eligible for income support. Redistributive tax reforms, further to those announced in 2011, could be enacted in 2012–16. Officials will also support workers' efforts to secure substantial pay increases, but state welfare services will remain underdeveloped, despite growth in spending on health, education, pensions and poverty alleviation.
China recorded an estimated budget deficit equivalent to 1.1% of GDP in 2011, although this does not include a large amount of off-budget expenditure. Expenditure on education, healthcare and other forms of social welfare will continue to grow faster than other areas of public spending. At central government level, revenue growth will remain strong, as the domestic economy continues to expand rapidly. On the monetary policy front, the People’s Bank of China (PBC, the central bank) raised interest rates several times between October 2010 and July 2011, but it has shifted towards a policy more supportive of economic growth since late 2011. It is expected that the PBC will move to boost domestic liquidity, notably through reductions in bank reserve requirements, open-market operations and guidance to the state-owned banking sector on credit issuance. It will also step up efforts to deepen the domestic bond market in order to reduce companies' dependence on banks when raising capital (EIU, May 2012).
In an important move for the future of China's currency, on 14 April the Chinese authorities widened the band within which they will allow the renminbi to trade, doubling the permitted daily adjustment from 0.5% to 1%. Given that the renminbi has recently been subject to bouts of depreciation, as well as appreciation, the change may not imply a faster strengthening of the local currency. However, it may presage greater volatility in the path of China's exchange rate. This will be an important step, as the government tries to prepare international traders for a move towards a more market-determined (and volatile) exchange rate. Although the renminbi's value probably remains some way below the level that would be set by a free market, there is a growing sense in foreign-exchange markets that China’s currency is no longer guaranteed to rise automatically.
India
Given India’s slowing economy, large public deficit and a rising subsidy bill, many had expected some hard measures of reform in the country’s fiscal year budget announced on 16 March by the finance minister. However, there has been no major proposal for economic reform in the government’s budget statement. The budget set a deficit target of 5.1% of GDP in 2012/13 and announced rises in services and excise taxes to help achieve this. This deficit target is far above the authorities’ 4.6% deficit target for 2011/12 and takes into account increases in services and excise taxes, as well as import duties, as part of a bid to raise 400 bn rupees (US$ 7.8bn) in additional tax revenue. This deficit target is based on an assumption that global oil prices will average US$ 115/b and that real GDP growth will reach 7.6%. It is believed that, without a reliable parliamentary majority, efforts to implement structural economic reform will continue to be hindered. So a growth rate for the 2012 fiscal year of more than 7% for the Indian economy seems unlikely, considering the current circumstances of the economy. This means that the government’s ability to meet its subsidy reduction target is far from assured.
Dual government budget and current account deficits on the one hand and elevated inflation that exerts downward pressure on private consumption growth (the main driver of economic expansion, accounting for nearly 60% of nominal GDP) on the other, together with high interest rates, are deterring capital investment. Therefore, we expect economic growth of slightly below 7% for India in 2012. In fact, recent data releases, including national accounts data for the fourth quarter of 2011, indicate a significant slowdown in economic activity. After 13 consecutive increases in the repurchase (repo) rate, the interest rate at which the Reserve Bank of India (RBI, the central bank) supplies funds to the banking system, since January 2010, the RBI cut its benchmark rate by a surprising 50 basis points, reducing the repo rate to 8.00%. The RBI has already cut the cash reserve ratio in April, to increase the liquidity, particularly in the economy, needed for manufacturing expansion. Rates are likely to continue to fall in the future, if the government succeeds in curbing the elevated inflation.
Wholesale price inflation rose to a non-seasonally adjusted 7% year-on-year in February, from 6.6% in January. Food articles and manufactured food products have a 24.3% weighting in the wholesale price index. In its review of monetary policy, released in January, the RBI mentioned high global oil prices, the recent depreciation of the rupee and the persistent fiscal deficit as sources of inflationary pressure. In view of these factors, it is expected that inflation will remain high and elevated throughout 2012 and into next year. The rate of consumer price inflation accelerated to 8.8% year-on-year in February, from 7.7% in January. Overall, inflation in the food and beverages category averaged 6.6%, but, in some categories, the rate of price increases was of particular concern. These included: milk and milk products (up by 15.8%); oil and fats (12.8%); and eggs, fish and meat (10.6%) (EIU, April 2012).
The rupee is forecast to depreciate in the short term. India’s widening trade and fiscal deficits have put pressure on the currency. A poor outlook for the global economy, which, combined with decelerating economic growth in India, has led to a sharp slowdown in the capital inflows on which the country relies to finance its persistent fiscal and current-account deficits. The slowdown in global economic growth in 2012 is likely to reduce capital inflows to India further and to worsen both the trade and fiscal positions, with the consequence that further downward pressure could be exerted on the local currency. The current account deficit is forecast to widen in the short term, from the equivalent of an estimated 2.2% of GDP in 2011 to 2.4% in 2012, owing to subdued global demand and relatively strong import growth. Merchandise export growth (in US dollar terms) is expected to slow, while imports continue to grow. As import expansion will be from a much higher base, the country’s trade deficit will widen. Capital inflows have been financing India’s persistent current account deficit, but the sovereign debt crisis in the Euro-zone and political strife in the Middle East create the possibility of greater investor risk aversion reducing prospects of DFI growth in India in the 2012/2013 fiscal year.
Russia
In his speech to parliament on 11 April, Vladimir Putin set out the priorities for his new presidential term: halting the decline in Russia's population; developing the Russian Far East; and creating 25 million high-skilled jobs. He announced that the federal budget would be in balance by 2015. The use of any windfalls from oil and gas revenue would be restricted under new fiscal rules. Noting that, among the G8 economies, Russia had the fastest growth rate and was the only one not running a budget deficit, he predicted that Russia would become one of the world's five largest economies, measured at purchasing power parities, in two or three years. However, real GDP growth slowed to 3.2% in March, down from 4.8% in February and 3.9% in January. Other recent economic data also point to weakening growth momentum. Export demand remains weak and investment growth has slowed, reflecting weak construction activity. Investment spending growth slowed to 4.9% year-on-year in March, from an average of 15% in the first two months of the year (EIU, May 2012).
It seems that high oil prices have reduced the motivation for reform in Russia. On the one hand, Russia is set to join the World Trade Organization (WTO) in 2012, and there have been some promises of reforms, and, on the other hand, a vision set out by Mr Putin endorses state capitalism, citing China and South Korea as examples. Although he has defended the state corporations created under his rule, however, Mr Putin has also supported policies such as privatization, WTO entry, improving the business climate and pension reform. The budget's reliance on oil has increased greatly. From 3.6% of GDP in 2007, the non-oil budget deficit widened to 13.9% of GDP in 2009 and has since narrowed only modestly. Additional expenditure on defence, public-sector workers' pay and pensions means that Russia would require oil price of about $120/b to balance its budget in 2012, up from only $55/b in 2007.
The original 2011 budget plan expected a deficit of nearly 4% of GDP, but high oil prices boosted tax revenue well above the budget forecast. The price of Urals Blend crude averaged $109.5/barrel in 2011, well above the budget assumption of $75/b. This helped the budget to return to a surplus, at 0.8% of GDP. The government boosted spending pledges in the run-up to the presidential election. According to official medium-term fiscal projections, the non-oil deficit is expected to be about 10% of GDP over the coming three years. According to estimates from the Ministry of Economic Development, annual real GDP growth slowed in March to 3.2%, from 4.8% in February and 3.9% in January. On a seasonally adjusted basis, monthly GDP fell by 0.6% in March, after increasing by 0.5% in February. Other recent economic data also points to weakening growth momentum. Export demand remains weak and investment growth has slowed markedly, reflecting weak construction activity. Investment spending growth slowed to 4.9% year on-year in March, compared with average growth of 15% in the first two months of the year. The volume of seasonally adjusted retail sales in March remained unchanged from February, and retail sales for the first quarter were flat, compared with the final quarter of 2011. Growth in real household incomes was stagnant in the first quarter. Year-on-year industrial output growth fell to 2% in March from 6.5% in February.
In March, there was a seasonally adjusted decline of 1.2% on the previous month. Manufacturing output growth fell to the lowest rate for over 12 months, rising by just 2.4% year on year. It should be noted, however, that the extent of the apparent slowdown in March has been slightly exaggerated by the fact that output in February was boosted by an extra working day caused by the leap year, while, in March, there was one less working day, compared with the same month in 2011. In December 2011, the Russian Central Bank (RCB) cut the refinancing rate from 8.25% to 8%. At the same time, the repo rate, which is the key rate for providing liquidity to the banking system, remained unchanged at 5.25%. As inflation has decelerated, the RCB's concerns have shifted towards risks to growth. However, the RCB seems committed to its 2012 inflation target of 5–6%, and inflationary risks stem from a tight labour market. The decline in inflation is thus unlikely to lead to near-term cuts in interest rates. The RCB left base rates unchanged at its meetings in February, March and April. It sees the recent decline in inflation as being the result of delays in increasing regulated tariffs until July (instead of January, as usual), as well as a rouble appreciation. The RCB is also cautious because consumer lending is expanding.
The growth prospects for the Russian economy will remain dependent on international commodity prices. The economy expanded robustly in 2011, driven by strong private consumption growth. Real GDP rose by 4.2, well below rates before the recession of 2009. It is estimated that economic growth will decelerate in 2012 to a forecast 3.7%, as global economic growth slows. Part of the reason for the relatively robust GDP growth in 2011 was strong growth in agricultural output. However, this was a recovery from a poor performance in 2010. Also global financial turbulence is expected to affect investment and consumer expectations in Russia. The share of fixed investment in GDP is much lower than in many emerging markets. Impediments to faster growth include a relatively weak banking sector, the economy's high and growing dependence on natural resource sectors and manifold institutional weaknesses. Energy output growth will remain sluggish, with oil companies struggling to increase production as existing fields are depleted and recovery becomes more difficult (EIU, May 2012).
Despite the weakening of the rouble, inflation decelerated in late 2011, mainly because of falling food prices. Year-on-year consumer price inflation fell to 6% at the end of 2011 (although the annual average inflation, at 8.4%, was higher than in 2010). Russia, like other emerging economies, experienced a weakening of its currency in reaction to the uncertain global outlook and flight from risk. At the end of 2011, the value of the rouble against its euro/US dollar currency basket was down by nearly 4%, compared with the start of the year. The low point was in early October, when the rouble was 14% below its 2011 peak, which was reached in July. In 2011, Russia recorded a trade surplus of $198.4 bn, which helped push the current account surplus above $100 bn. This was the result mainly of a 34% increase in exports of oil and gas, although other exports rose by nearly 24% year-on-year. In contrast to the improving trade in goods balance, trade in services moved deeper into deficit, with payments for services approaching $100 bn. The rapid growth in transactions on the services account testifies to the increasing openness in the economy, although Russia pays nearly twice as much for services as it earns.
OPEC Member Countries
Growth in business activity in Saudi Arabia’s non-oil private sector rose to a ninemonth high in April, boosted by strong output and new orders, a survey has shown. The SABB HSBC Saudi Arabia PMI, which measures activity in the manufacturing and services sectors, rose to 60.42 in April from 58.73 in March. This seasonally adjusted index stayed well above the 50-point mark distinguishing growth from contraction. April’s PMI data was reflective of strong demand conditions in the Saudi Arabian non-oil private sector economy. Bank loans increased by 5% in the fourth quarter of last year from the previous three months to 242 billion riyals (US$ 64 billion), according to the Saudi Arabian Monetary Agency report. Saudi inflation was 5.4% in March, unchanged from February, according to recent data from the Central Department of Statistics and Information. Inflation is expected to be at 4.4% for 2012, curbed by a strong dollar and subdued inflationary pressures in Saudi Arabia’s trading partners. The Saudi Central Bank is expected to keep its key interest rates unchanged in May, as inflationary pressures remain under control.
The Central Bank of Nigeria (CBN) has resumed aggressive monetary-tightening, following an increase in the inflation rate to 12.1% in March, from 11.9% in the previous month. The CBN has raised its policy rate by six percentage points to a record 12% since 2010 to curb price pressures. Inflation is still below the central bank’s estimated peak of 14.5% in the first half of this year, giving the Monetary Policy Committee room to keep the benchmark rate unchanged next month. The budget assumption for inflation is intended to be in single digits, but a recent announcement by the National Bureau for Statistics (NBS) showed an inflation figure moving further from the budget’s target. Nigeria may have started to count the gains from the partial removal of subsidies on petrol, with a 40% drop in oil imports recorded in the first quarter of the year. This development, which is said to have reduced pressure on the nation’s foreign exchange reserves, is also said to be capable of raising the trade surplus to 12.5% of GDP.
Oil prices, US dollar and inflation
On a monthly average, the movements of the US dollar from March to April against the main reference currencies were relatively limited. The dollar was almost flat against the euro and the Swiss franc in April, with a 0.3% increase and a 0.1% decline respectively. But, against both the yen and the pound sterling, it lost 1.2%. However, particularly since the beginning of May, concern about the near-term developments in the Euro-zone has increased, which has put the euro under increasing pressure to devalue. Many observers have argued over the past few months that the euro seems over-valued, compared with the dollar, although it has remained relatively resilient, even during the major turbulences in the Euro-zone at the end of last year. The re-emerging uncertainties in the Euro-zone might now open the floodgates to accelerate a depreciation of the euro. This might also be to the advantage of the embattled Euro-zone economy, so that it can enjoy a competitive advantage in international trade, which would be welcome for, primarily, the ailing peripheral member countries, but could also provide a lift for the bigger exporters, like Germany and France.
Since the beginning of May, the euro has lost around 1.5% in only about one and a half weeks, moving below the crucial $1.30/€ level, which so far has been the lower limit of the trading band in recent months. The nearterm developments will, to a large extent, depend on the political responses to the continuing crisis, including the future policy of the ECB. Moving east, as the Bank of Japan continued to support the weakening yen in the foreign exchange market, this currency held its crucial level above the ¥80/$ exchange rate in April, when it averaged ¥81.490/$. However, in the second week of May, it moved below the ¥80/$ level. In nominal terms, the OPEC Reference Basket price lost $4.79/b, or 3.9%, over the past month, falling from $122.97/b in March to $118.18/b in April. In real terms, after accounting for inflation and currency fluctuations, the Basket price fell by 3.7%, or $2.77/b, to $72.53/b from $75.30/b (base June 2001=100). Over the same period, the US dollar fell by 0.1% against the import-weighted modified Geneva I + US dollar.
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