Global Economic Outlook Global Economic Research...economic cycle, signaling that the current growth cycle has several more years to run. The periods that stand out in this sense are

Global Economic Outlook

December 2014

Contents

Global 2

US 2

Europe 3

Japan 4

Australasia 5

Canada 6

Emerging Markets 7

Global Forecasts 12

Overview

Global Economy—The global macro backdrop remains uneven, but the sharp

drop in oil prices should provide a lift to growth in 2015.

United States—The US economic cycle is broadening and gaining speed. An

official rate hike is expected by mid-2015.

Europe—Falling oil prices are likely to boost growth in coming quarters, but

inflation is set to move even lower, so more monetary easing still looks likely.

Japan—A weak gross domestic product (GDP) outcome and a fresh election

inject uncertainty into the economic outlook.

China—Tame inflation and weak growth will demand more rate cuts.

Contributors

Joseph Carson*

Guy Bruten*

Anthony Chan

Kenneth Colangelo*

Fernando Losada*

Emma Matthy*

Alexander Perjessy*

Dennis Shen*

Danielle Simon*

Vincent Tsui

Darren Williams*

*This contributor is not licensed by the Hong Kong SFC and does not intend to provide investment advice in Hong Kong

AllianceBernstein World Economic Growth Forecasts

As of December 1, 2014

Calendar-year forecasts

*Emerging Europe, Middle East and Africa

Source: AllianceBernstein

6.1%

3.0%

2.6%

2.4%

2.4%

1.6%

0.5%

1.0%

0.8%

5.9%

2.8%

3.1%

3.7%

2.4%

1.0%

1.7%

1.5%

1.1%

Asia ex Japan

United Kingdom

Global

United States

Canada

EEMEA*

Japan

Latin America

Euro Area

AB 2014

AB 2015

Global Economic Research

GLOBAL ECONOMIC OUTLOOK—December 2014 2

Global Outlook The global growth cycle remains slow and uneven. Based on the latest forecasts,

global GDP is expected to grow by 2.6% in 2014 and by 3.1% in 2015. This

lackluster growth environment, along with low—if not declining—inflation in some

countries, is expected to compel central banks to ease policy further. In this group,

we‘d include the European Central Bank (ECB), Bank of Japan (BOJ), People’s Bank

of China (PBOC) and a number of central banks in developing economies.

The continued sharp drop in crude-oil prices has been the most important

development for the global economy in the past month. At its current levels, the

global spot oil price has fallen roughly 30% in a span of three months. The markets’

initial reaction: Bond yields have slid further, reflecting the prospect of substantially

lower headline inflation. The direct impact on headline inflation varies from country to

country, but history shows a very high correlation between changes in oil prices and

consumer price inflation in almost all countries.

In the short run, global financial markets will try to identify the winners and losers.

There’s no question that the decline in oil prices will dampen growth prospects for

many oil-exporting nations and sharply reduce the earnings of energy-related

companies, which will probably curtail production growth and trigger capital-spending

reductions at some point.

At the macro level, lower oil prices represent a huge transfer of income from oil-

exporting nations to oil-consuming nations. And with global oil consumption running

at approximately 90 million barrels a day, the cumulative effect of a $20–$30 per-

barrel reduction in the price of oil translates to hundreds of billions of dollars a year.

The impact of this benefit will accumulate over time. History shows that global growth

has been markedly faster one and two years after sharp oil-price declines. Following

the oil plunge of 1986, global growth averaged 4.8% for the next two years; it

averaged 4.2% for the two years after the 1998 price decline.

By mid-2015, financial markets could face faster global growth and a Federal

Reserve that’s starting to normalize monetary policy. US growth continues to run

relatively fast, while labor markets are tightening faster than the Fed expected and

core inflation is on the path that policymakers predicted. All this continues to support

our view that US monetary policy should start normalizing no later than mid-2015.

With the ECB, BOJ and PBOC moving in the opposite direction, the growth and

monetary policy outlook continues to favor a stronger US dollar.

US Outlook The US economy has posted reasonably fast growth over the past two quarters, with

real GDP growth averaging 4.3% annualized, a big change from the weather-related

contraction of 2.1% in the first quarter. The strong rebound in economic growth has

been more or less in line with our expectations; in a fundamental sense, it’s a

continuation of the relatively fast recovery that started to surface in mid-2013, when

the economy grew by 4% annualized in the second half.

The stronger and broader gains in real GDP since mid-2013 reflect the changing

nature of the current business cycle and the transition to a more traditional cycle. As

we’ve stated in previous commentaries, the pace of real GDP growth in the early

years of the current business cycle has been held down by two factors: household

deleveraging and fiscal drag. Now consumers are starting to borrow again: Bank

Slow and

uneven growth

for now

US growth cycle

is strengthening

Sharp oil-price

decline creates

winners and

losers

Global growth

should be

stronger in six

to 12 months

Faster consumer

spending cycle

ahead

US still in growth

leadership role


lending standards have eased while consumer spirits have been lifted by the broad

improvement in labor markets and financial positions. Also, spending at the federal,

state and local government levels has turned positive on a year-over-year basis for

the first time since early 2010.

One of the better ways to illustrate the future course of the US economy is to monitor

trends in leading economic indicators. The Index of Leading Economic Indicators has

shown a very consistent pattern over the course of the business cycle. Specifically, it

tends to grow very fast in the initial stages of economic recovery and then moderates

through the end of the cycle.

Occasionally, the index has made a noticeable U-turn about midway through the

economic cycle, signaling that the current growth cycle has several more years to

run. The periods that stand out in this sense are 1967, 1995 and 2014.

The 1967 signal was followed by strong growth and 3.5 more years of economic

growth; the 1995 signal was followed by five more years of expansion at a 4% growth

rate. Clearly, no two cycles are the same, but the fast 7% growth in leading indicators

over the past year matches the gains of both 1967 and 1995. If history is any guide,

the current trend in the Index of Leading Economic Indicators is sending a similar

positive message about growth in 2015 and beyond.

Given our optimism about the pace of economic growth, we expect the Fed to begin

raising official short-term rates at or before mid-2015.

Europe Outlook Recent survey data have been disappointing, with the Purchasing Managers’ Index

for manufacturing and services dropping to 51.1 in November, from 52.1 in October.

This is the lowest reading since August 2013, and it’s consistent with quarterly

economic growth of little more than 0.1%. In other words, the euro area is barely

growing at all as we approach year-end.

Much of the weakness in euro-area growth has been from adverse external

developments and their knock-on impact on investment spending, especially in

Germany. The bad news is that these factors could continue to weigh on growth in

coming months. The good news is that the recent decline in the price of oil—down

25% in euro terms since September—represents a boon for the economy. So this is

likely to support growth in coming quarters.

One way of illustrating this point is to consider real-wage and salary income. Actual

data for nominal-wage and salary income are available only up to the second quarter

and show a 2.1% year-over-year increase (up from a low of 0.5% last year).

However, if we assume a similar growth rate for the second half of the year and

deflate this using November inflation (+0.3%), it points to a real increase of 1.8%.

This would be the best showing since the fourth quarter of 2007 and a large

improvement over the average year-over-year growth of –0.6% between 2009 and

2013. With fiscal pressure now minimal, it’s little wonder that consumer spending (up

1.1% year-over-year in the third quarter) has started to pick up.

The drop in the oil price doesn’t change the medium-term outlook for euro-area

growth, which remains challenging, in our view. But just as geopolitical risks have

weighed on euro-area growth over the last couple of quarters, the lower oil price is

likely to provide an important boost in coming quarters. This supports our view that

growth should pick up somewhat in 2015, to 1.1% for the year as a whole, a modest

Weak recent

survey data

Leading

indicators

suggest upside

risk to growth

Lower oil prices

to boost real

income

Fed to raise rates

by mid-2015


improvement on 0.8% growth this year. While the ECB will welcome the growth boost

from cheaper oil, it will be less pleased by the likely impact on headline inflation

(which could turn negative) and inflation expectations. Historically, the ECB has

tended not to react to the impact of falling oil prices on headline inflation (though not

the impact of rising oil prices, as was demonstrated in July 2008 and April 2011,

when it tightened policy even though growth was weak). There were hints of this

approach recently, when ECB Governing Council member and Bundesbank

president Jens Weidmann argued that the recent decline in oil prices was a “mini

stimulus package,” which lessened the need for more action from the ECB.

But this approach belongs to a bygone era. The ECB’s main concern now is that a

protracted period of very low inflation could lead to a collapse in inflation

expectations. This would prove very difficult to reverse (as it was in Japan). ECB

president Mario Draghi recently argued that it was critical for the bank to “raise

inflation and inflation expectations as fast as possible” and that it was ready to alter

the “size, pace and composition” of its asset purchases to achieve this goal. In light

of this, it’s not so easy for the ECB to ignore even a supply-driven drop in headline

inflation—especially one that could push it into negative territory. That’s why we

continue to expect the ECB to provide fresh monetary stimulus, including sovereign-

bond purchases, early in the new year.

Japan Outlook The policy and political landscape in Japan has been through a big shake-up in the

past few weeks. The Halloween easing from BOJ governor Haruhiko Kuroda seemed

as if it would add a degree of certainty to the policy outlook. Alas, it didn’t. After a

period of feverish expectations, Prime Minister Shinzō Abe has decided to postpone

the second leg of a two-part consumption tax (value-added tax, or VAT) hike,

dissolve the lower house of parliament and call fresh elections.

The final straw was third-quarter growth, with GDP significantly weaker than

expected. It shrank by 1.6% during the quarter on a seasonally adjusted, annualized

rate (SAAR), compared with a consensus estimate for 2.2% growth. On a year-over-

year basis, GDP fell 1.1%. This is the second straight quarter of contraction, following

a decline of 7.3% (SAAR) in the second quarter, as the full impact of the first tranche

of the VAT hike in April manifested itself.

For those who ascribe to the consecutive-quarters litmus test, this means Japan is

back in recession. A big part of the weakness is from inventory behavior—a larger-

than-expected drawdown sliced 2.6% (SAAR) off the bottom line. That said, private

domestic demand growth is hardly rosy—it’s flat for the quarter and down 2% year

over year. The GDP release more or less confirms what “hard” data have been

saying for a while—that activity is very weak—despite stronger readings in survey

data, such as the BOJ’s quarterly Tankan survey.

While the quarter was dismal, most of the data for September have been relatively

upbeat. On a month-over-month basis, industrial production was up by 2.9%,

machinery orders were up by 2.9% (the fourth increase in a row), housing starts

jumped by 4.1%, retail sales grew by 2.8%, and export volumes rose by 1.8%. So

conditions were definitely improving during the quarter.

This should somewhat temper the gloom. However, key questions arise from both

the data outcome and Mr. Abe’s decision to hold early elections:

Fresh

uncertainty

injected by early

elections…

…reinforced by

weak GDP

outcome

Mixed blessing

for the ECB

Further

monetary easing

still likely


Over the six quarters since the start of the BOJ’s qualitative/quantitative easing in

April 2013, GDP is up by only 0.3% (and is down by 1.1% over the past year).

This is a very disappointing outcome relative to expectations. Is it possible to

continue defining Abenomics as “on track,” given this backdrop?

What does the postponement of the VAT hike mean for the broader thrust of

fiscal reform? Research by the International Monetary Fund (IMF) and others

suggests that a move to a 20% VAT rate will be required to achieve fiscal

sustainability. If a relatively popular government with a broad-based reform

program falls at the first hurdle (raising the VAT from 5% to 8% in April 2014),

what does it mean for future reform efforts?

Are there any monetary policy implications stemming from this decision? After all,

Mr. Kuroda likely signed up for the entire Abenomics package, including fiscal

reform. Mr. Kuroda has been vague when questioned on this issue, but there’s

clearly the possibility of more tensions between the BOJ and Mr. Abe.

When the dust settles on the December 14 election, the real question will be whether

Mr. Abe can turn the growing perception of failure into a platform to renew his reform

effort. Simply winning the election isn’t enough.

Australasia Outlook Last month, we laid out a scenario in which the Reserve Bank of Australia (RBA)

would again contemplate easing monetary policy. The argument revolved around

four factors: (1) growing angst surrounding the commodity market downturn; (2) a

recognition that housing construction momentum was ebbing; (3) an upward drift in

the unemployment rate; and (4) acknowledgment that there was enough inflation

headroom.

Those factors are, by and large, falling into place, and it’s worth revisiting a couple of

them. The most clear-cut is the commodity story. A continued decline in the iron-ore

price to below US$70 per metric tonne (MT) has again ignited the gloom around

Australia’s commodity sector. This has been reinforced by the sharp fall in oil prices.

While Australia isn’t yet recognized as a large-scale energy producer (as, for

example, Norway and Canada are), the completion of seven new liquefied natural

gas (LNG) megaprojects over the next four years will catapult Australia to the

position of one of the largest LNG exporters on the globe, according to the Bureau of

Resources and Energy Economics.

A large part of that export capacity has long-term contracts attached. Nonetheless,

prices remain variable and are generally linked to oil prices. In other words, a

sustained period of lower oil prices certainly has implications for revenues,

profitability and other results from the projects. One way this decline in national

income spreads across the broader economy is through declining tax revenue, which

applies more fiscal stress.

The other area worth exploring is inflation headroom. The decline in oil prices—in

Australian-dollar terms, they’re down 18% to date in the fourth quarter versus the full

third quarter—could trim 0.3% from headline Consumer Price Index (CPI) inflation.

Given that the relatively large drop in the fourth quarter of 2013 falls out of the

calculation, this means that the annual CPI inflation rate could conceivably fall to

1.5% in the fourth quarter—below the bottom of the RBA’s target band.

Case for RBA

rate cuts and

weaker AUD

gains more

traction


Just as important in determining the inflation story is the wages picture. Here, things

couldn’t be clearer. Wage inflation, by any metric, is running at or close to historical

lows. And with productivity trending higher, unit labor-cost growth is close to zero—

clearly tilting the risks on core inflation to the downside.

Over the next six months, the combination of unemployment drifting higher and

inflation moving lower clearly puts a return to monetary-policy easing on the RBA’s

agenda. A renewed rate-cut cycle beginning in mid-2015 seems increasingly likely, in

our view.

Canada Outlook For several months, the Bank of Canada (BOC) policy statement has highlighted the

downside risks to growth and was willing to overlook recent higher-than-anticipated

inflation. The bank didn’t have confidence that the economy was on a steady growth

path. However, after the recent spate of stronger-than-expected data, the bank has

adjusted its tone, and a change in its policy stance might not be too far in the future.

Third-quarter real GDP of 2.8% followed the upwardly revised 3.6% annualized

growth print for the second quarter. The strong outcome came as a surprise to us,

the market consensus and—importantly—the BOC. Furthermore, it wasn’t only the

headline growth figure that was strong; the details underpinning the third quarter’s

expansion were also encouraging. The long-awaited rotation to an export- and

investment-led growth cycle appears finally to be under way. Net exports have

contributed positively to overall growth for four consecutive quarters. This hasn’t

happened since 2008 and has only happened twice since 1998. Also, business

investment is finally responding to the pickup in exports, and it contributed to growth

for the first time this year.

Inflation has also been higher than anticipated over the past several months.

Headline inflation has been above the 2% target for seven consecutive months,

reaching 2.4% year over year in October. The BOC’s measure of core inflation has

picked up as well, to 2.3% in October. While headline inflation is likely to come down

because of the continued decline in oil prices, it’s not certain that core inflation will

decelerate.

In its December policy statement, the BOC stopped short of sounding hawkish, but it

has certainly moderated its dovish tendency by both acknowledging the recent

improvement in growth and expressing more concern about household imbalances.

Still, while the statement finally acknowledged that inflation has risen by more than

expected, the bank continues to insist that underlying inflation remains below 2%.

The BOC recognized that the economy “is showing signs of a broadening recovery,"

specifically highlighting the pickup in business investment. But it also points out that

the continued decline in oil prices presents downside risks to both inflation and

investment in the fourth quarter.

The most striking change, and the only adjustment presented without caveat, was

that the bank now believes that household imbalances “present a significant risk to

financial stability." While falling commodity prices could give the bank justification to

keep the policy rate on hold for a few more months, the change in language

surrounding financial stability risks reducing the flexibility afforded by the potential of

lower headline inflation.

BOC finally

addressed

stronger-than-

expected data

GDP has been

strong for two

straight quarters

Growth rotation

is seemingly

under way


On the whole, the latest statement suggests that there’s an increasing risk the BOC

will hike rates by the middle of next year, but we still see the BOC’s move coming

after the Fed’s—not before. Nonetheless, the prospective change in monetary policy

and the better-than-expected economic performance should result in less currency

depreciation than we had previously expected. So we’ve revised our Canadian dollar

forecast down slightly, to 1.15 by the middle of 2015 versus our previous forecast of

1.18.

Emerging-Market Outlook

Latin America: Saudi Arabia blocked requests for production cuts presented by

most other OPEC member countries; so on November 27, OPEC decided to leave

the current quota unchanged, at 30 million barrels per day. The quota is roughly 1

million barrels per day higher than OPEC's own estimate of demand for its oil in

2015. Venezuela and Algeria had suggested cuts of 2 million barrels per day.

The decision conveys the implicit message that Saudi Arabia has abandoned its

long-standing policy of supporting prices, leaving equilibrium prices to be determined

by global demand and supply forces. Crude prices fell sharply on the news and could

soften further in the near term—benchmark Brent is now trading around US$70 per

barrel, some 37% lower than its June peak. The next ordinary OPEC meeting is

scheduled for June 2015, although an earlier extraordinary meeting can’t be ruled out

if price movements are extreme in the next few weeks. In the meantime, it remains to

be seen whether high-cost shale-oil producers will be squeezed out of the market at

current prices. Oil prices are now expected to remain low, at least over the near term,

so oil exporters stand to lose the most and oil importers will be on the winning end.

In Latin America, Venezuela represents the extreme case of an oil exporter that will

be severely harmed by low crude prices; oil represents close to 95% of the country's

exports and nearly half of its fiscal revenues. We estimate that for each dollar the

price of the Venezuelan crude mix is lower, the country loses more than US$600

million worth of cash flow for the public sector per year. So the current drop in

benchmark prices poses a tremendous challenge for the government. The more oil

prices drop, the deeper the adjustment authorities will have to make.

In the past few weeks, there have been preliminary signs of policy adjustment,

although it’s still far from what’s needed to stabilize both the fiscal bottom line and the

external accounts picture. In the near term, Venezuelan oil could trade as low as

US$60 per barrel or less, which will require a sharp devaluation of the official

exchange rate, an increase in domestic gasoline prices, the sale of assets (e.g., the

CITGO refinery in the US) and financial engineering to make ends meet. The

government has been slow to react so far, but the intensifying decline in oil prices will

probably push it to speed up the adjustment.

Mexico appears to be safer in the near term because the government completed a

hedging strategy for oil prices at US$79 per barrel. Also, net oil exports are small.

Fiscal tightening will be needed beyond 2015 if oil-price weakness proves to be more

permanent, since the hedge covers only the 2015 fiscal year. Besides, lower oil

prices could make investment in public-private joint ventures in the energy sector

less attractive, although the marginal cost of extraction in the Gulf of Mexico is low.

Crude output is the weakest link, as PEMEX’s production came out below projections

this year, and it isn’t clear whether the declining trend could be reversed in 2015.

OPEC seems to

have abandoned

oil-price support

Venezuela: in

the eye of the

storm

Increasing risk of

rate hike likely to

slow currency

depreciation

Mexico’s oil-

price hedging

strategy helps


We don’t expect recent oil-price movements to cause any change in monetary policy

because Banco de México already lowered the tasa de fondeo aggressively and will

be waiting for the first US fed funds rate hike to move again.

Chile and Uruguay are the top beneficiaries of lower oil prices in Latin America. Chile

is a net energy importer, to the tune of 5% of GDP per year. With other factors given,

lower oil prices should result in more modest current account deficits, lower inflation

rates and stronger CLP and UYU. In Colombia, Banco de la República left its

reference rate unchanged at 4.5% in late November, by unanimous vote. However,

the sharp drop in oil prices is likely to dampen activity, so if the weakness in oil prices

persists in the coming weeks, a more accommodative monetary policy in 2015

shouldn’t be ruled out, despite the recent currency depreciation.

President Dilma Rousseff confirmed that the economic team for her second term in

office will be composed of Joaquim Levy as finance minister, Nelson Barbosa as

planning minister and Alexandre Tombini as central bank governor.

Levy’s appointment was welcomed by the market, as he brings a much needed dose

of fiscal orthodoxy to the table, and Rousseff hinted that he will have the green light

to implement the necessary tightening. He will have to work, however, under the

institutional constraints already in place, as the bulk of current spending is

earmarked, and the real economy isn’t expected to grow fast next year, limiting

expectations of robust tax collection. There’s also some uncertainty regarding the

real leeway that Rousseff will provide to the team. Although Levy has a clearly

orthodox view of economic policy, the president said that the government "will

continue to prioritize social inclusion, employment, access to education and

infrastructure investment," possibly as a way to quiet some criticism levied by the

leftmost groups of the Workers’ Party ruling coalition.

Meanwhile, Levy already presented a basic plan to Rousseff, calling for a primary

fiscal surplus of 1.2% in 2015 (below the official projection of 2% but well above an

estimated 0.5% for the current year) and no less than 2% of GDP from 2016 on. That

would be the minimum surplus required to stabilize the debt/GDP ratio and prevent

sovereign rating downgrades in coming years. Levy also committed to increasing the

transparency of fiscal accounts, as "greater certainty of the actions of the public

sector ... is an important ingredient ... in the decisions to increase investment." He

said that increasing the national savings rate will be a priority. He added that the

government "must change" the strategy of injecting Treasury resources into the

development banks and that capital markets will have to play an increasingly

important role in stimulating growth.

Barbosa, in turn, said that he will also work toward increasing the primary surplus

and will coordinate the investment programs of the federal government. Tombini, who

remains in his post, added that the central bank's priority will be to guarantee that

inflation returns to the 4.5% medium-term inflation target and that the bank must

prevent macroeconomic adjustments from spilling over into the economy in the form

of persistent increases in inflation. This hints that the bank will maintain a tightening

bias.

Meanwhile, the official statistics office IBGE reported that GDP expanded by 0.1%

quarter over quarter but shrank by 0.2% year over year during the third quarter. The

figure came out below expectations of a 0.2% quarter-over-quarter increase. During

the past four quarters, GDP expanded by 0.7% year over year, while the increase

year-to-date was 0.3% year over year. We expect an even lower number for the full

year 2014, which will produce no positive carryover effect for 2015. Given the

Brazil: new

economic team

in place


expected tightening of fiscal and quasi-fiscal policies to be in place next year,

chances are good that consumption will be soft, which suggests another year of very

subdued growth, even with a possible contraction in activity during the first semester.

The disappearance of 43 students in Guerrero State, allegedly resulting from a

conspiracy between local authorities and criminal groups, has justifiably given rise to

popular discontent. In addition to the Guerrero events, President Enrique Peña Nieto

was hit by media allegations of graft in his inner circle. Thus, the president’s

popularity indices have dropped sharply, to less than 40% in December—a decline of

more than 10 points since August. These are the lowest approval ratings for a

Mexican president in over two decades, exacerbating what has become a serious

political crisis.

The government has reacted by enacting several new security measures, chief

among them the replacement of municipal police forces by state-level forces, which

are less susceptible to organized crime. The federal government will also have

greater ability to intervene in municipalities where the infiltration of criminal groups is

more evident. While the measures are welcome developments to improve the

country’s security conditions, their results will likely be felt over the medium term,

which suggests that Peña’s popularity won’t recover significantly for a while. The

political turmoil hasn’t hit the Mexican economy yet because macroeconomic

fundamentals are robust. But the possible negative impact on consumer and/or

business confidence should be monitored in the coming weeks.

Asia ex Japan: Falling oil prices are a swing factor for Asia, given its position as a

growing net energy importing region. The gain in income from lower oil prices should

have a positive impact on consumption and investment. But before that impact

occurs, weak growth plus intensified disinflation will ensure more policy

accommodation (especially monetary) until the growth and inflation cycles eventually

turn. We therefore expect monetary policy in Asia to be increasingly independent of

the US Fed in the run-up to the Fed’s expected policy normalization sometime in mid-

2015.

We expect further rate cuts in China, Korea, India and Vietnam in the next six months

and stable policy rates in the rest of the region. However, the lower carry on the back

of expected USD strength will add depreciation pressure on most Asian currencies.

This is despite the fact that many Asian countries—such as Korea, Taiwan,

Singapore, Malaysia, the Philippines and China—are still running sizable current

account surpluses. These surpluses are expected to increase further with improved

terms of trade as the oil price falls further.

In terms of oil impact, Malaysia is the region’s only (marginal) net oil exporter, but its

surplus position has been declining continuously over the past decade; oil production

is no longer a core factor in the country’s balance of payment position. Palm oil is a

more important commodity-exporting item for the country, and the recent palm-oil-

price cycle has remained sticky, showing little correlation with the global crude-price

trend.

India is in a “sweet spot”: Falling oil prices have closely followed those of the food

cycle. Because the country is a heavy oil importer and because food and energy

matter a lot to inflation and state subsidies, the combined effect of declining energy

and food prices has enhanced India’s inflation, fiscal and external outlook. This has

happened despite the fact that the Modi administration has still been slower to

implement structural reforms than the market has hoped. While fiscal consolidation

will remain in place, falling inflation and still-sluggish growth will exert increasing

Falling oil price is

a swing factor for

Asia

Mexico: political

turmoil

Malaysia is only

a marginal net

oil exporter

India is in a sweet

spot as both oil

and food prices

decline


pressure on the Reserve Bank of India (RBI) to cut the policy rate in order to

stimulate the economy. RBI governor Raghuram Rajan, at the latest policy meeting,

provided strong guidance that room for a rate cut will exist by early 2015. We think

it’s reasonable to start factoring in the easing of India’s interest-rate cycle as well as

a downshift of local bond yields in the coming year.

In China, cheaper oil will exert more disinflation pressures on the economy, which

has already been undergoing a structural slowdown. The PBOC has resorted to

directly cutting banks’ lending and deposit rates as a means to lower system-wide

funding cost. This will help leveraged sectors roll over debt and provide room and

time for a slow deleveraging process. Tame inflation will support more rate cuts and

reductions in the Reserve Requirement Ratio (RRR) in the coming year. This, in turn,

will help set a floor to the current economic deceleration and minimize a credit crisis,

in our view.

Emerging Europe, Middle East and Africa: The Russian ruble remained under

intense pressure the past month. The pressure came from a further sharp decline in

oil prices, which accelerated after the OPEC meeting ended without a commitment to

cut oil production. Determined to conserve foreign exchange reserves in the face of

Western financial sanctions, Russia’s central bank (CBR) by and large continued with

its new hands-off policy, allowing the ruble to depreciate by an additional 15%—that’s

in line with a similar decline in the crude price during the month.

So far this year, the ruble has lost about a third of its value against a trade-weighted

basket of foreign currencies. The depreciation will help offset the negative impact of

lower oil prices on Russia’s current account, as well as on the fiscal balance. But the

weak ruble will also push up inflation if the depreciation isn’t reversed. Even under

the CBR’s own very benign estimate of the exchange-rate pass-through (about 13%

in 12 months), Russia’s inflation rate could be expected to increase by close to 4.5%

relative to what it would have been otherwise.

The bulk of this pass-through into consumer prices still remains to materialize over

the next six months, and will be only partly offset by the disinflationary pressures

from an economy sliding into recession. We’ve therefore increased our 2015 forecast

for Russia’s inflation rate, and we believe that the risks to our forecast remain

asymmetrically skewed to the upside. This will make it very difficult for the central

bank to cut rates, even as economic output contracts next year—and even if the

central bank decides to dismiss the ruble weakness as a temporary shock to inflation.

In fact, we believe that the central bank may even hike rates during the next few

months to prevent an overshoot of the ruble’s equilibrium. For now, the CBR has

tightened “by stealth,” restricting ruble liquidity and allowing interbank interest rates to

drift well above the key policy funding rate.

In the meantime, the real economy continues to suffer under the perfect storm of

sanctions and lower oil prices—with the oil impact dwarfing that of the sanctions. Yet

third-quarter GDP data were stronger than expected, showing year-over-year growth

of 0.7%, only marginally down from 0.8% in the second quarter. According to the

details of the third-quarter GDP report released last month, economic growth was

almost miraculously rescued and kept in positive territory by an unusually strong

boost from agriculture, with output (mainly due to another bumper-crop grain harvest)

jumping 10% year over year.

This is unlikely to repeat itself in the current quarter or next year, and we expect that

the economy will slide into an outright recession in 2015. The collapse in oil prices

will further undermine investment demand by large, state-owned enterprises (which

…cushioning the

impact of lower

oil on fiscal and

external

accounts…

Russian ruble

sold off further

with oil…

…but weak ruble

will push up

inflation

The economy is

likely to slide

into recession

next year

Tame inflation

and weak growth

call for more

interest-rate cuts

in China


account for nearly a third of all investment spending in the economy). Low oil prices

will also further undercut real wage growth in an economy where the oil and gas

sector contribute about one-quarter of overall national income. Meanwhile, the ability

of the government to pump-prime the economy through fiscal spending will be greatly

constrained, given that nearly 50% of federal fiscal revenues come from the energy

sector. However, policymakers will likely use part of the 4.5% of GDP available to

them in the Reserve Fund to finance some infrastructure projects.

Needless to say, an outright decline in oil revenues will be even more damaging now

that most Russian entities are effectively cut off from international capital markets

because of the Western sanctions connected with the Ukraine crisis. This means that

Russian companies and the government won’t be able to “smooth” their capex and

current spending by borrowing, other than what they borrow from already

overextended and increasingly stressed domestic banks.

Frontier Markets: The decision of OPEC to keep oil production at current levels

weighed heavily on the price and has put increased pressure on African oil

producers.

Faced with the dilemma of falling revenues and increasing dollar demand, the

Nigerian central bank decided to devalue its official exchange rate peg from

NGN155/USD to NGN168/USD and expand the target band to +/- 5% from +/-3%.

With these moves, combined with a 100 basis-point increase in the policy rate to

13% and a 500 basis-point increase in the cash reserve requirement for private

sector deposits to 20%, we believe that the country is firmly in a tightening cycle.

More actions may be necessary to stem capital flight.

While the latter two moves were largely expected, the currency devaluation wasn’t,

and it represents the view that lower oil prices are structural, not cyclical. This view is

seemingly confirmed by OPEC’s decision not to cut production. A tightening of policy

will likely weigh on growth, but with February elections next year likely to spark

increasing uncertainty, the central bank must get ahead of the curve and assure

investors and the public that unexpected devaluations won’t become the norm.

x Oil producers

continue to face

pressures, as

revenue

becomes

threatened

AllianceBernstein Global Economic Forecast

EOP EOP EOP EOP2014F 2015F 2014F 2015F 2014F 2015F 2014F 2015F 2014F 2015F 2014F 2015F

Global 2.6 3.2 2.6 3.1 2.2 2.4 2.9 2.7 1.97 2.26 3.07 3.44

(PPP Weighted) (3.1) (3.7) (3.0) (3.5) (2.6) (3.0) (3.6) (3.4)

Industrial Countries 1.7 2.6 1.7 2.4 1.4 1.7 1.5 1.3 0.28 0.84 1.70 2.26

Emerging Countries 4.0 4.3 4.2 4.2 3.7 3.7 5.4 5.2 5.19 4.96 5.74 5.78

United States 2.6 3.8 2.4 3.7 1.7 2.5 1.7 1.9 0.13 1.50 2.50 3.50

Canada 2.4 2.2 2.4 2.4 2.6 2.2 2.0 2.2 1.00 1.50 2.40 4.00

Europe 1.2 1.7 1.3 1.5 0.5 1.1 0.7 0.7 0.16 0.23 1.09 1.25

Euro Area 0.7 1.5 0.8 1.1 0.3 0.9 0.5 0.6 0.05 0.05 0.85 1.00

United Kingdom 3.1 2.7 3.0 2.8 1.2 1.5 1.5 1.3 0.50 1.00 2.10 2.25

Sweden 1.9 2.4 2.2 2.3 0.0 1.2 -0.1 0.8 0.00 0.00 1.20 1.35

Norway 2.8 2.0 2.6 2.2 2.0 1.6 2.0 1.9 1.25 1.25 2.00 2.25

Japan 0.4 2.4 0.5 1.7 2.5 1.0 2.7 1.0 0.10 0.10 0.50 0.75

Australia 2.6 2.0 3.1 1.9 1.5 2.2 2.4 1.7 2.50 2.00 3.00 3.25

New Zealand 3.8 2.4 3.1 3.3 0.9 1.6 1.3 1.1 3.50 3.75 3.90 4.25

Asia ex Japan 5.9 6.0 6.1 5.9 2.5 2.9 3.0 2.8 3.70 3.35 3.99 3.70

China2 7.1 6.7 7.3 6.8 1.5 2.2 2.0 2.0 3.00 2.50 3.20 2.80

Hong Kong32.9 3.0 2.5 3.0 5.0 3.5 4.4 4.2 0.50 1.00 1.82 2.10

India45.6 5.8 5.3 5.6 5.7 6.0 7.4 5.8 8.00 7.75 8.10 7.80

Indonesia55.2 5.6 5.1 5.5 6.3 4.2 6.4 5.7 7.50 7.00 7.60 7.30

Korea63.0 3.9 3.4 3.6 1.5 2.2 1.4 1.9 2.00 1.75 2.65 2.40

Thailand71.5 3.0 0.5 3.9 1.7 2.5 2.0 2.0 2.00 2.00 3.30 3.50

Latin America81.0 1.8 1.0 1.5 4.8 4.4 4.6 4.8 7.77 8.00 9.27 9.54

Argentina -1.0 0.7 -0.4 0.6 29.0 26.0 32.0 27.0

Brazil 0.2 0.7 0.2 0.5 6.5 6.5 6.5 6.8 11.75 11.75 12.30 12.50

Chile 1.5 3.5 1.7 3.1 3.0 3.0 2.9 3.0 3.00 3.50 4.50 4.90

Colombia 4.6 4.2 5.0 4.1 3.0 3.3 2.6 3.2 4.50 5.00 6.70 6.90

Mexico 2.8 3.5 2.1 3.4 4.0 3.3 3.9 3.4 3.00 3.50 6.00 6.40

EEMEA 1.1 1.3 1.6 1.0 7.0 5.6 6.5 6.1 7.92 7.62 8.38 9.33

Hungary 2.6 2.2 3.2 2.1 -0.2 3.0 -0.1 1.5 2.10 2.10 3.75 4.75

Poland 3.3 3.6 3.3 3.3 -1.0 1.9 0.0 0.4 2.00 2.00 2.50 3.05

Russia 0.0 -0.6 0.7 -0.8 8.9 6.0 7.6 7.9 10.00 9.00 10.25 11.00

South Africa 0.7 2.9 1.3 2.3 5.5 6.1 6.1 5.1 5.75 6.50 8.00 9.25

Turkey 2.5 4.0 3.0 3.2 8.9 6.9 8.9 6.3 8.25 9.00 8.15 9.75

1) Official and long rates are end-of-year forecasts. 6) Korea: Overnight call rate and 10-year government bond yield

Long rates are 10-year yields unless otherwise indicated. 7) Thailand: 1-day repo rate and 10-year bond yield

2) China: Official rate is considered the 7D repo rate and 10-year government bond yield. 8) Latin American Inflation and Rates includes Brazil, Chile, Colombia, and Mexico

3) Hong Kong: Base rate and 10-year exchange funds yield Note: Real growth aggregates represent 31 country forecasts, not all of which are shown.

4) India: Overnight repo rate and 10-year government bond yield Note: Blanks in Argentina are due to the distorted domestic financial system so we do not forecast.

5) Indonesia: Intervention rate and 10-year government bond yield

Source: AllianceBernstein

4Q/4Q Calendar 4Q/4Q Calendar

December-14Official Rates1 (%) Long Rates1 (%)Real Growth (%) Inflation (%)

The information contained herein reflects the views of AllianceBernstein L.P. or its affiliates and sources it believes are reliable as of the date of this publication. AllianceBernstein L.P. makes no representations or warranties concerning the accuracy of any data. There is no guarantee that any projection, forecast or opinion in this material will be realized. Past performance does not guarantee future results. The views expressed herein may change at any time after the date of this publication. This document is for informational purposes only and does not constitute investment advice. AllianceBernstein L.P. does not provide tax, legal or accounting advice. It does not take an investor’s personal investment objectives or financial situation into account; investors should discuss their individual circumstances with appropriate professionals before making any decisions. This information should not be construed as sales or marketing material or an offer or solicitation for the purchase or sale of any financial instrument, product or service sponsored by AllianceBernstein or its affiliates.

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