The recovery in the US continues. The recently announced second release of the 4Q11 GDP number was revised up to 3.0% and 2.8% on an annualized basis. This marks the highest level of quarterly growth of the previous six quarters after three quarters of continuous outperformance of the previous quarter. Private inventories, unchanged from the first estimate, were the main driver for this 4Q11 number and contributed 1.9 percentage points (pp) to the 3.0%. However, this build-up in inventories might also have occurred in anticipation of improving consumer patterns.
The labour market has shown sufficient improvement in the past months to support a positive development in domestic private consumption. The unemployment rate of 8.3% in January is expected to remain at this level for February. This compares to 8.5% in December and an average of 9.0% for 2011. Consumer confidence stood at 70.8 in February compared to 61.5 in January, a significant increase, according to the Conference Board. This current level compared to an average of 58.1 in 2011, almost the same level as in February 2011 when it stood at 72.0. While following a different methodology, the consumer sentiment index of the University of Michigan is also only slightly below last year’s February level of 75.3, confirming a positive trend at 75.3, after 75.0 in January. Additions to consumer credit were $19.4 bn in December, almost unchanged from November when they grew by $20.4 bn. This could be a supportive factor, particularly with personal income growing by 0.3% m-o-m in January.
The housing sector, a major source for wealth creation and economic activity in the US, has very recently seen a slightly negative development after solid improvements in the second half of 2011, highlighting the continuing fragile situation. Existing home sales have seen double-digit growth since July 2011, while growth in December moved back to 2.6% y-o-y and stood at only 0.7% in January. House prices are still in decline on a yearly basis according to the federal housing finance agency (FHFA) at a rate of –0.8% y-o-y in December, which is better than –2.3% in November. Prices have improved in 2H11 on a monthly basis and were up by 0.7% in November and December, the highest rise since January 2009. Thus, signals remain mixed and have to be closely monitored in the coming months.
Output related indicators softened slightly recently. Monthly growth in industrial production was flat in January, after an increase of 1.0% m-o-m in December. The ISM number for the manufacturing sector was lower as well, while still indicating a solid expansion, at 52.4 in February after 54.1 in January. The ISM for the services sector increased to 57.3 from 56.8 in January. Taking the most recent softening of the recovery in consideration, while at the same time acknowledging a continued improvement in the labour market and consumption levels, the GDP growth forecast for 2012 remains unchanged at 2.2%.
A year after the tragic triple disaster that hit the country, the consequences can still be felt. The impact has obviously been severe but it has been more serious than initially thought. After the tsunami of 11 March that culminated in the nuclear accident and in many other problems in the country’s energy supply, many observers have kept their growth numbers for 2011 at more than 1%. This was only based on the assumption that the consequences would play out with the same magnitude as they did during the Kobe earthquake of 1995, after which the economy recovered relatively swiftly. This time, however, the consequences obviously have been on a much bigger scale with three major events hitting the country.
The impact of the third disaster — the nuclear accident at the Fukushima plant and problems at other nuclear facilities — following the Tsunami and earthquake have had the unforeseen consequence that the power supply disruptions had longer lasting effects, not only in the affected areas but also via electricity shortages and supply disruptions nation-wide. In addition, even without these external factors, the economy was hit in March when a slow down was already evident. It should be noted that already in 4Q10 growth was declining at 0.6%. Subsequent reconstruction efforts, and the fiscal and monetary stimulus announced shortly after the triple disaster, then helped to support growth in the 3Q11 by 7.0%, after two consecutive negative quarters of –6.8% and –1.5%, respectively. However, only in 4Q11 was growth recorded at negative levels again, standing at –2.7%. This quarterly pattern shows the volatility and current challenges that the economy faces. Growth in 2012 is now expected to be significantly better, when compared to the previous year for several reasons: Firstly, the Diet has approved a stimulus package in November of ¥12.1 trn. Its considerable size of around 3.5% of GDP means that it should have an effect, even with a multiplier of below 1.
Secondly, there will be continued reconstruction efforts by the private sector, which will be leveraged by this stimulus package, although a considerable amount will be taken from current income and private reserves as well. These efforts are expected to rebuild areas affected by the triple disaster; in addition, consumer confidence should come back over the course of the current year. Thirdly, exports are expected to improve due to positive developments in Japan’s major trading partners, mainly the United States and China and, to some extent, Europe. This should have a positive impact on domestic income and consumption through a second-round effect. This expected positive development is anticipated in the current 2012 growth forecast. Some of the most recent indicators already mirror this trend as well, while remaining volatile. Therefore, the economic situation still needs close monitoring. Private machinery orders have seen a severe decline of 7.2% m-o-m in December after a strong uptick in November when they grew by 14.7%, after 3.3% growth in October.
While it was domestic orders, which increased 18.4% m-o-m, which supported November’s strong increase, domestic orders were also the main reason for pushing down orders in December, falling by 11.7% m-o-m. Foreign orders were volatile as well, increasing by 20.3% m-o-m in November and then by just 5.6% in December. This supports the observation that Japan’s main trading partners, China and the US, seem to be reversing the trend of a global slow-down, which had been observed at the end of 2011. The support from the order side already had a readthrough to the output numbers for December. Although industrial production was still negative on a yearly base in January at –0.9%, the trend was positive with December at –2.9% y-o-y and a decline of 4.2% m-o-m in November.
Exports again declined in January and at a slightly higher rate than in December. They fell by 8.0% y-o-y after a decline of 7.7% in December, which caused the first calendar year trade deficit for Japan since 1980. While the triple disaster of 1H11, a strong yen and a weakening global economy, as well as the floods in Thailand causing further supply disruptions all took their toll last year, developments in 2012 should provide improvements, particularly on a yearly base. In addition, the yen has recently weakened from around ¥77/$ to around ¥81/$, which should allow a further improvement in the competitiveness of Japanese products Encouragingly, the domestic side of the economy has also improved. Seasonally adjusted retail trade numbers have risen by 2.7% m-o-m in January, after an increase in December 1.2%. The slightly positive trend of the economy had a correspondingly positive effect on the Purchasing Managers Index (PMI), which stayed at almost the same level of 51.2 in February, compared to 51.1 in January.
The PMI for manufacturing in January moved to 50.5 from 50.7, according to Markit. More importantly, especially when it comes to its contribution to GDP, the services sector PMI increased to 51.2 in February, after 51.0 in January. So taking the most recent developments together, it should be concluded that while some areas are still in decline on a yearly comparison, particularly exports and industrial activity, there are signs of a bottoming out. Manufacturing output also seems to be supported by improving consumption. Taking the continuing deceleration into consideration, while also acknowledging an improvement in the underlying economy and the expected support of the stimulus package, growth expectations for 2012 remain unchanged and the GDP forecast for 2012 remains 1.8%.
While the Euro-zone was fighting a substantial crisis at the end of the last year, triggered by those members with weak public finances, the situation is now perceived by many observers as having improved over the course of the past weeks. Greece had announced in November that it would pursue a referendum, causing a political crisis in the country. The cabinet then stepped down to make place for an interim government. The weakening situation triggered a government change in Italy as well, which as the world-third biggest debt market was at the center of worries at the end of 2011. As part of this mélange, Spain also felt the heat of its high deficit in combination with the softening of its economy. Only at the beginning of January, after a short period of relief following the December Euro-zone summit, did the Euro weaken again to a level below $1.30/€. An important step towards improving the Euro-zone’s situation was shoring up the banking system in the Euro-zone through expanded monetary supply from the European Central Bank in the form of a second three-year long-term refinancing operation (LTRO).
About 800 banks participated in this €530 bn operation, which not only helped to support their balance sheets but provided incentives for them to buy sovereign debt bonds and, most crucially, bring down their yields. This facility comes after an LTRO already had been injected into the market at the end of the last year in order to dispel fears about the stability of the Euro-zone system. This brings the total amount of funds which have been injected into the monetary system to more than €1 trn. Since January, some confidence in the Eurozone has re-emerged and yields for ailing Euro-zone countries have fallen to more sustainable levels. The euro has been trading again at comfortable levels above $1.30.
Despite this revived confidence, there are many uncertainties about this year’s development, which are on one side economically rooted but which have potentially greater influence coming from the political side. First, there most probably will be elections in Greece in April; after this event, it will be seen how the structure of the recently agreed bail-out package will continue. It cannot be ruled out that there will be probably some changes demanded by a newly elected government, but this remains to be seen. Moreover, there are presidential elections in France in April and May, which will probably also bring some changes to the political landscape of the Eurozone, given that the current presidency is ranked second in the current polls.
Taking the ideas of the current leading candidate into consideration, an implementation of these should be expected to have an impact on the future structure of the emergency bail-out mechanism, taxes and financial market regulation. Furthermore, Ireland has announced that it will hold a referendum on the fiscal union of the European Union (EU) that was agreed upon in December. This probably will be followed by other EU members, which could have an impact on the recently implemented sovereign bail-out facilities. One very important aspect to the financial market in the Euro-zone should be mentioned here as well: the decision that Greece will probably have to make on how to deal with its outstanding debt, if its offer to private sector bond-holders is not agreed to by enough participants. If they choose to opt for a default, then this could have severe consequences. According to the Institute of International Finance (IIF), the body representing the majority of private debt holders, a recent estimate put the cost of a default at €1 trn.
The real economy has witnessed some improvements since the beginning of the year. While most indicators remain volatile, the major positive development has certainly been that the Euro-zone leaders were able to convince the market about its ability to fight sovereign debt issues. Nevertheless, the real economy is still suffering from austerity measures, even though this has certainly been one important factor that has helped to calm the markets. In addition, the high debt service in many economies in combination with soft tax revenues, record levels of unemployment and muted domestic consumption all have to be considered. The latest available data for industrial production data in December shows a decline of 1.2% m-o-m, lower than November at –0.4%. So the negative momentum has continued. Manufacturing orders as a lead indicator point to some improvements amid volatility, as they have increased by a better-than-expected 3.3% in December, after a decline of 1.8% m-o-m in November and a rise of 1.4% m-o-m in October.
This volatile development with modest improvements is also reflected in the PMI numbers provided by Markit. The manufacturing PMI stood at 49.0 in February, compared to 48.8 in January, while the services sector, with its much higher weight in the economy, was 48.9, once again below the growth-indicating level of 50. Weak 4Q11 GDP development was confirmed by Eurostat, the EU’s official statistical office, with a 0.3% quarterly decline. It now seems very likely that such negative growth will continue in 1Q12. The labour market in particular is not performing well, with the unemployment rate hitting new highs of 10.7% in January. Despite this, retail trade in the Euro-zone increased by 0.3% m-o-m in January, the first expansion in five months. With the now confirmed decline in 4Q11 and its expected continuation in 1Q12, in addition to so many other uncertainties remaining for the near-term future, the GDP growth forecast for 2012 remains unchanged at –0.2%.
Developing countries are affected by the reduced demand for their exports from OECD countries as well as less investment capital from the developed world. The recession in Europe and below-trend growth in the US are all affecting emerging markets (EMs) in Asia,Africa and Latin America. On the other hand, the monetary tightening cycle, pursued rather rigorously in 1H11 in many EMs to prevent overheating, has either come to a halt or gone into reverse as central banks have started to lower interest rates. Since late August 2011, apart from many OECD countries, countries such as Brazil, Chile, Russia, Serbia, Indonesia, Georgia, Pakistan, the Philippines, Thailand and Turkey, among others, have all lowered their interest rates. Even China, whose economy grew by 9.2% in 2011, lowered the reserve ratio for banks in November, the first step in a concerted monetary easing cycle.
Although the impact of weak growth in OECD countries is beginning to make an appearance in EMs, the pattern is by no means uniform. According to the Economist Intelligence Unit (March 2012), industrial production fell in exporting EMs of Southeast Asia in December and GDP was weak in the final quarter of last year. Industrial production was almost flat in India in December and fell in Poland. Most noticeably, exports were fading in key Asian economies such as Taiwan and South Korea. The decline in trade has been apparent in the sharp declines in global shipping rates, especially in the Baltic Dry Index, which plunged in December and January.
In mid-February developing economies in Asia were slowing in the face of global economic troubles and earlier domestic efforts to contain inflationary pressures. Credit conditions also tightened in Asia as Europe’s banks came under severe pressure and responded by cutting foreign lending. Policymakers are already abandoning steps to cool domestic demand: overheating is no longer the greatest threat facing economies. In fact, renewed weakness in export markets and tighter external financing conditions are already persuading some policymakers to turn their attention back to stimulating their economies. There is still scope for renewed fiscal stimulus in most countries, although it is more limited than it was before the financial crisis. There is also room in most economies for monetary loosening.
The short-term economic outlook between developing countries is diverging, based on economic data released for the last quarter of 2011 and the first two months of 2012. Most export-driven economies, including Singapore, Hong Kong, Malaysia, Taiwan and, to a lesser extent, Sri Lanka, have been affected by poor demand conditions in the EU and US. Some EMs that were hit by natural disasters, notably Thailand, are now expected to see stronger expansion in 2012 as reconstruction efforts gather momentum and as output returns to normal levels. Pakistan also falls into this category as the economy will continue to be buoyed this year by a recovery from the flooding of 2010. A third group comprises countries where domestic dynamics this year will take priority over external ones; these include China, Indonesia, South Korea, the Philippines and India. Although these countries will be hit by weakening export expansion, and most will experience slower growth, many will see an offsetting rise in domestic demand that will prove sufficient to render the downturn very mild.
In South Korea's case, the forecast recovery of consumption and investment from their relatively depressed levels in 2011 will actually be sufficient to drive acceleration in GDP growth (EIU, March 2012). Early in 2011, Latin American economies faced accelerating inflation and currency appreciation. The policymakers in these countries responded by tightening monetary policy and by putting in place an array of measures to prevent their currencies from appreciating in order to support the competitiveness of their export sectors. These included "macro-prudential" measures (including tightening reserve and capital requirements, and reducing company and bank borrowing overseas through taxation measures) in some countries and/or direct intervention in the foreign exchange market in others. A further slowdown is expected in the first half of 2012 before economic growth in Latin America accelerates. We forecast economic expansion in the region of around 3.4% in 2012.
Economic growth slowed in the Middle East and North Africa (MENA) region in 2011 as a result of political upheaval and civil unrest. Although uncertainty about social stability remains high in this region, a recovery is expected to gather pace in 2012, supported by still-high global oil prices and assuming no further serious outbreaks of political upheaval. However, weaker EU demand will constrain North Africa's exports. Growth prospects in Egypt will also be hampered by domestic political instability. Offsetting this, regional growth in 2012 will be supported by massive infrastructure and industrial development in Saudi Arabia, expansionary fiscal policy across the Gulf Cooperation Council (GCC) states and a bounce-back in Libyan growth. A relatively strong recovery in 2012 is perceived for those countries most affected by the unrest, notably Libya, Egypt and Tunisia. However, if the interim leaders in these countries are unable to restore social stability and achieve public acceptance of the new political order, widespread unrest may begin again, which in turn would undermine the economic recovery in these countries. A further risk to the region’s economic forecast is escalating tensions between Iran and the West. The ratcheting up of sanctions on Iran, including the EU's decision to gradually introduce an embargo on Iranian oil imports, has led to growing concern over the security of the Straits of Hormuz, a vital artery in the global oil trade. Heightened security concerns and possible disruptions to oil output could exert destabilizing effects on oil markets and increase oil price volatility.
Ironically, these developments might actually be positive for regional growth as they are likely to lead to higher international oil prices, boosting the fortunes of the GCC and even Iran. Despite the overall weakness of the global economy, fundamentals have been improving in many EMs in recent weeks. According to JP Morgan, (March 2, 2012), there are signs of strong gains in EMs in Asia and in Latin America. The underlying pace is captured by global PMI which according to JP Morgan is tracking close to a 2% of global IP growth of around 5 percent. According to this report Global Manufacturing PMI was 51.1 in February, which indicates expansion of manufacturing activities, compared to January’s 51.9 reading. Rates of expansion of new orders and employment, more or less, remained the same while input prices rose faster than previous month at 56.6 in February compared to 52.6 in January this year indicating a sharp rise in cost inflationary pressures in February. The rate of increase in cost inflation has now reached a five-month peak.
China was among the larger manufacturing nations that saw its manufacturing activities grow while the periphery of the Euro-zone had the weakest performance. Apart from the large developed manufacturing nations that were generally more exposed to cost pressures, the rates of increase in production costs in India, where the core measure of inflation remains uncomfortably high, have also been significant. However, the seasonally adjusted HSBC Services Business Activity Index for India was 56.5 at the end of February, down from 58.0 in January, indicating a strong monthly rise in output, with expansion now sustained for four months. Manufacturing production growth also eased but remained firm. Following the expansion of manufacturing activities, international trade flows also posted an improvement.
This is expected to have a positive impact on the manufacturing sector of export-oriented EMs of Southeast Asia. In fact, economic growth in Asia appears to be accelerating although China’s economy might slow down in the coming months, to some extent, consistent with its housing market adjustment. Inflation is also decelerating in China as estimations show CPI to have subsided to 3.6% in February. This will pave the way for more accommodating monetary policy in the country. Activity is gaining speed elsewhere in Asia, with PMIs in Korea and Taiwan reaching thresholds above 50 in February for the first time since mid-2011. The labour market was reported to be improving last month in many EMs, as payroll numbers increased in the major developed and developing countries. However, the overall rate of jobs growth remains below the average for the current sequence of increase.
Although manufacturing output is expected to rise in India following its low rate of growth in 4Q11, the Indian government has indicated that GDP will slow down to a three-year low after the Central Statistical Organization of India noted that the economy will probably average 6.9% in the current fiscal year. This latest forecast is in line with our estimate of 7.1% GDP growth in 2012. As tight monetary policy is believed to have affected economic activities in India, the Indian central bank (RBI) has come under pressure to ease its monetary policy. While it is expected that the RBI will release more liquidity to alleviate excessively tight inter bank liquidity conditions, a cut in policy interest rates may be delayed until April when the government is due to consolidate the country’s annual budget. A combination of fiscal restraints and monetary easing seem more consistent with India’s economic growth in the
Brazil, on the other hand, is feeling the effects of capital inflows from major OECD economies with an appreciation of the Brazilian real damping its exports. In response to persistent currency appreciation, the country has taken measures to impose restrictions on corporate issuance of external debt and on the anticipation of export payments, which have been among the most important spot market inflows this year (JP Morgan, 2 March 2012). In Russia, a landslide victory for Mr. Putin in the presidential election on Sunday, 4 March, might help to reduce uncertainties affecting economic activities in the country. However, it is to improve the investment climate and privatization will be pursued with less vigor.
Despite a surge in spending in December, the federal budget recorded a small surplus of 0.8% of GDP in 2011 mainly because of high revenues from oil and gas which increased by 47% compared with 2010 (EIU, February 2012). Brazil's economic slowdown, which brought about a slight contraction of GDP in 3Q11, led policymakers to begin to reverse the tightening cycle adopted since January 2011. In the context of solid fiscal results and spending restraints, the Banco Central do Brasil (BCB, the Central Bank) has eased monetary policy, cutting the policy rate by 200 basis points between August 2011 and 18 January 2012. To boost credit, the BCB also reversed the credit curbs, introduced in late 2010 when Brazil was at risk of overheating, and adopted a package of measures in December to make credit cheaper and stimulate growth. There are prospects for further stimulus measures in 2012. As fiscal policy turns more expansionary this year, there will be less room for policy interest rate cuts than there might be if fiscal and quasi-fiscal policies were more disciplined than envisaged. We discuss the performance of the four major emerging economies, i.e., the BRIC economies in more detail below.
As was expected, Brazil’s central bank cut its policy interest rate, the Selic, on its Wednesday, 7 March meeting by 75 basis points (bp), more than the expected 50 bp. This is the fifth cut in a row of interest rates in Brazil since last August. This decision brings Brazil’s policy rate to 9.75%, only the second time on record that it has been below 10%. The country has the highest real interest rates in the world for a large economy because of its past history of runaway inflation and bloated government spending. The BCB has justified its move by citing its concern over lackluster economic growth.
Official figures released last week show that industrial production in January fell 2.1% compared with December and 3.4% compared with a year earlier. Brazil’s GDP grew by only 2.7% in 2011, about a third of the previous year's increase and the second-lowest level of growth since 2003. This weak performance is partly due to the strong Brazilian real, which has encouraged a flood of cheap imports, undercutting domestic industries. High inflation has also reduced the competitiveness of the economy.
The latest policy move comes as inflationary expectations remain above target. According to the BCB’s February 2012 Bulletin, “Focus”, inflationary expectations are running at 5.3%. In January, the CPI increased by 0.56% compared to December. While this has eased annual inflation to 6.22% from 6.5% in December, the service sector’s price inflation remains high. The government has raised about $14 bn through the sale of licenses to operate three business airports in an auction that was aimed at accelerating investment ahead of the 2014 World Cup and the 2016 Olympics. Investments in Brazil’s ageing airports have struggled to keep pace with the growth in air travel, which has doubled in the past decade as household incomes have increased significantly (EIU, March 2012).
The state operator of airports will keep a 49% share in the privatized airports and part of revenue is intended for upgrading other airports which are still managed by the state. The monetary easing cycle seems to have begun to have an impact on economic activities. According to the BCB’s publications, output expanded by 1.3% m-o-m in November, followed by a further expansion of 0.6% in December, reversing a threemonth contraction. Brazil’s recovery is reflected in trends in industrial output, (comprising manufacturing and the extractive industries), as well as retail sales. Industrial production increased by 0.9% on a m o-m basis in December. Production of most manufacturing categories recovered with the production of durable goods showing a significant rise of 7%. According to the EIU (March 2012), the business confidence index has been improving in recent months and reached close to 58 at the end of January. The trade deficit in January widened for the first time since January 2011. While a strong currency and the recovery of the economy have fueled demand for imports, Brazil’s exports have also been on the rise. However, it is expected that the trade surplus will decline in 2012 as the domestic economy grows faster than Brazil’s main trade partners in the OECD.
Chinese premier Wen Jiabao, in his statement to the country’s National People’s Congress (Chinese Parliament), indicated that China’s target for GDP growth in 2012 was 7.5%. He has been quoted as saying that the government prefers balanced economic growth over higher growth rates that might cause imbalances, social unrest and environmental concerns. However, many observers believe that this statement should not be taken as a strict target but rather as a general guideline and perhaps even a minimum acceptable growth rate. Our forecast is that China’s economy will grow around 8.2% in 2012. This is in line with most forecasts of Chinese economic growth. This is, of course, less than last year’s 9.2% growth but there are signs that fixed asset investments and manufacturing activities are moderating.
According to “China Confidential” (Financial Times, March 2012), fixed asset investments recorded a significant decline in February. There are also reports of a decline in China’s daily iron and steel output of as much as 5.5% in the first ten days of February compared to the first ten days of January. Imports of rolled steel, generally seen as an indicator of market demand, fell 44.1% y-o-y in January. The annual growth of fixed asset investments may be less than 20% in February, compared to an average growth rate of 23.8% in 2011. It is worth noting that fixed asset investments accounted for 46% of GDP last year. Inflation is also moderating, reflecting a muted economic reality. The cost of living index has now dropped to below 4% on a y-o-y basis for the first time since September 2010.
Consumer spending has been resilient in February and, according to the same Financial Times report, has increased by 0.6% compared to January. Car sales in February rebounded from January’s sharp decline. Car sales grew by 25% in February compared to February 2011. According to the China Passenger Car Association, around 2.5 million cars were delivered in the two first months of 2011. It is expected that retail car sales will increase in March as there are signs of a rebound in sales after the Chinese New Year. Following the Chinese Premier’s report to the National People Congress this week, in which he advocated a more “pro-active fiscal policy”, some tax cuts are expected to be initiated to boost consumer spending. It is believed that tax cuts rather than expenditure increases are favored by the government in the current circumstances.
Also, high-yielding bonds are to be launched by banks to finance lending to small and medium enterprises. Another important point in China’s economic policy is its determination to reform its financial system and to make the renminbi an internationally convertible currency under capital accounts and expand its use in cross-border trade and investment. Data from the State Administration of Foreign Exchange shows that the country’s current account surplus plunged in 2011 to $201.1 bn from $303 bn in 2010. The fall in the current account surplus from the equivalent of 5.2% of GDP in 2010 to 2.9% (EIU, March 2012) implies faster growth of domestic demand compared to external demand for Chinese goods and services. It also implies that the renminbi is not as undervalued as it once was.
In parallel with foreign trade, foreign direct investment (FDI) in China fell in y-o-y terms in three successive months from November 2011 to January 2012, although FDI in 2011 was $116 bn slightly more than $105.7 bn in 2010. As China has begun to diversify its outbound investments, its sovereign wealth funds have begun to include more investments in infrastructure abroad. China’s longrunning outbound expansion in the energy sector has also continued. Chinese companies in the energy sector have been involved in investments in many countries and regions including Canada, East and West Africa and the Middle East.
The Indian government has set a target to reduce their budget deficit from 4.8% of GDP in fiscal year 2010/2011 to 3.7% in 2016/2017. The official deficit for 2011/2012 was 4.6% of GDP but the deficit increased beyond what was expected and reached around 5.3% of GDP in 2011. This tightens the government’s capacity to use fiscal stimuli to boost economic growth amid decelerating rates of growth. On the monetary policy front, the Indian central bank (RBI) has been reluctant to reduce its policy rates to curb inflationary pressures. There have been 13 increases in the repurchase (repo) rate (the interest rate at which the RBI supplies funds to the banking system) since January 2010 and the rate now stands at 8.5%. By these increases, India has managed to control inflation and the wholesale price index (the Indian benchmark price index) has fallen to 6.6% in January, its lowest level since November 2009. This has obviously come at a cost and GDP growth declined to around 7% in 2011 from 9.6% in 2010. For this reason, Indian policymakers have had no choice but to consider easing monetary policies to prevent a further deterioration in economic growth. At its recent meeting, the RBI cut the cash reserve ratio, although it left the repo rate unchanged.
Economic expansion in India has been slowing since early 2011. We forecast an economic growth around 7% for 2012 for India. Although there are signs of weakness in different sectors of the economy, private consumption is expected to begin to pick up in 2Q12 encouraging more investment and output expansion. The services sector is the main driver of economic growth in India and it is expected to growth by 9% in 2012 down from around 10% in 2010. The constraint to economic expansion is believed to be infrastructure bottlenecks, a shortage of skilled labour and lower productivity in more traditional sectors of the economy.
The rupee is expected to depreciate in the short-term as a widening trade deficit and public sector borrowing requirements put pressure on the currency. However, if economic growth turns out to be higher than expected in 2H12, there is room for a modest appreciation of the rupee considering the lower economic growth of India’s economic partners in the OECD. The current account deficit is forecast to widen in the short term to around 2.8% of GDP in 2012 (EIU, March 2012). It is expected that manufacturing export growth will decline while service sector exports will remain strong, albeit with decreasing growth rates as information technology and business processes continue to attract foreign investments. According to the EIU (March 2012), capital inflows have been financing India’s persistent current account deficit. The deepening sovereign debt crisis in the Euro-zone and low economic growth in the US and other OECD countries pose the risk of downside trend of FDI in India, which could further deteriorate its growth prospects.
Russia managed to maintain a small fiscal surplus of about 0.8% of GDP at the end of 2011 despite the traditional surge in government spending in the last quarter of the year, thanks mainly to higher revenues from oil and gas. However, lower budget revenues are projected for 2012, consistent with a decline in the government’s planned oil and gas revenues that are supposed to be RB 700 bn (about $22 bn) less in 2012 compared to 2011. The government may consider a tax reform in line with Mr. Putin’s promises in December 2011 to improve the tax structure in favour of the business community. Economic growth is expected to continue to remain close to the 3.5-4% range in 2012 compared to 4.3% in 2011. A strong harvest in 2011 helped to bring inflation down and to increase real wages and disposable income. Demand was strong in 2011 and is expected to grow at a similar pace in 2012, supporting a more demand-driven economic growth. The agriculture sector expanded by 16.1% in 2011 while construction rose by 4.8%, although growth in manufacturing slowed down in 4Q11. In 2011, Russia’s oil output rose by 1.2% while crude exports continued to decline. Natural gas production increased by more than 3% in 2011 mainly due to production increases by independent producers.
Consumer prices rose by 0.4% on a m-o-m basis in December. Annual inflation at the end of 2011 was 6.1%. There was a moderate food price increase, which was a significant contributor to the moderation of inflationary pressures in the Russian economy. According to preliminary estimates from the Russian central bank (RCB), net capital outflows reached $84.2 bn in 2011, the second highest outflow after the financial crisis of 2008. According to the EIU (March 2012), around $30 bn of the capital outflows in 2011 have been labeled “fictitious transactions” by the RCB — representing capital flight. If uncertainty surrounding the economic policies of the new administration does not subside in the coming months, capital flight in 2012 could continue at the same pace or even increase, affecting the country’s overall economic growth.
OPEC Member Countries
Annual inflation in Saudi Arabia was flat at 5.3% in January, similar to that in December, the country’s Central Department of Statistics and Information said in a report. The government’s cost of living index was almost unchanged at 139.1 points in January, compared with 139.0 points in December 2011, according to the Statistics Department. Inflation in the Kingdom is expected to moderate to an annual average of 4.4% in 2012, due to negligible external price pressures, resulting from lower commodity prices, a strong dollar; subdued inflation in its trading partners will underpin the decline.
Venezuela’s economy expanded at the fastest pace since 2008 in the 4Q11 as record oil revenues allowed the government to boost fiscal spending. The economy expanded by 4.9% in the 4Q11 from a year earlier, according to the Venezuelan central bank. The average oil export price of $101.06/b last year compared with $71.97 in 2010. The oil sector expanded 1.8% in the 4Q from a year earlier, the non-oil sector rose 5.1% and private consumption rose 5.3%, the bank said in a report. Manufacturing grew 5% in the 4Q. Financial institutions and insurance grew the most, rising 18.8%. Investment rose 11.6%, the central bank said. The government had a current account surplus of $4.58 bn in the quarter, while FDI was $1.5 bn.
Oil prices, US dollar and inflation
The US dollar weakened in February against all major currencies with the exception of the Japanese yen. Compared to the yen, the US dollar managed a gain of 1.8%, while it lost 2.5% versus the euro and 2.6% compared to the Swiss franc. Compared to the pound sterling, the US dollar lost 1.8%. The average exchange rate of the US dollar compared to the euro stood at $1.3221/€ in February, in contrast to a January rate of $1.2913/€. The euro’s strength followed a brief phase of weakness in January, after concerns regarding the development of the Euro-zone sovereign debt crisis at the beginning of the year re-emerged. Since then, the positive sentiment, driven by the major support from the European Central Bank (ECB) along with Euro-zone leaders, has again strengthened the currency, pushing it back up again above the $1.30/€ level. For most of February, the euro traded within the band of $1.32/€ to $1.34/€. The economy is still suffering from the high sovereign debt yields and the potential political events of Greece’s upcoming elections in combination with the French elections in April and May, and the Irish referendum on the EU fiscal union.
These will certainly be major political elements influencing the euro’s near-term development. At the same time, most recent indications have pointed at a continued slow-down in the Euro zone. On the other hand, the US economy continues to recover, but there are signs that it might again decelerate somewhat in the coming months, a trend that is currently slightly weakening the US dollar. So it seems that as long the Euro-zone is managing to contain the issues of its sovereign debt sphere, the exchange rate will not change dramatically. Compared to the Japanese yen, the US dollar development has been more dramatic, since for the first time in many months it has managed a considerable gain of around 5%. This has pushed the exchange rate above the ¥80/$ level for the first time since mid-2011 to around ¥81/$ at the beginning of March. This comes at a time of increasing external demand on energy in Japan, as well as its highest monthly account balance deficit in January since 1985. In nominal terms, the OPEC Reference Basket price gained $5.72/b or 5.1% from $111.76/b in January to $117.48/b in February. In real terms, after accounting for inflation and currency fluctuations, the Basket price rose by 3.9% or $2.69/b to $72.32/b from $69.63/b (base June 2001=100). Over the same period, the US dollar fell by 1.2% against the import-weighted modified Geneva I + US dollar basket while inflation remained flat.