Q4 2011 Global Scenario Analysis - September 7 2011

8/3/2019 Q4 2011 Global Scenario Analysis - September 7 2011

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Roubini Global Economics

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Q4 2011 Global Scenario Analysis:High Risk of Recession in Advanced

Economies

By Christian Menegatti, Rachel Ziemba and the RGE Economic Research Team

September 7, 2011


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Short TermDMs Stalled and on the Verge of Recession, EMs Slowing

Macro and policy risks in the eurozone (EZ) and U.S. increase downside risks to global growth.

With developed markets (DMs) at a standstill, the limited number of policy bullets raises the risk ofrecession.

Likely triggers include insufficient or too slow policy responses, a negative feedback loop in the EZ

periphery or a Lehman-like shock in the event of a disorderly default.

Asset market correction creates negative wealth effects, weighing on consumption and investment.

Emerging market (EM) expansion eases, but policy makers have more space than in DMs.

The silver lining: Tempered commodity prices, resulting from weaker global growth and a lack of new

supply shocks, give consumers around the world a modest reprieve.

Medium TermBetween Stagnation, Inflation/Disinflation and Gradual Rebalancing

Gradual rebalancing proceeds, assuming policy responses are appropriate and the EZ avoids disorderly

default.

But demand stays short of what is needed to close output gaps in DMs, normalization of policy remains

slow and growth is below potential. Even in the best case, growth is below trend. Policy mistakes, EZ instability, limited policy tools in DMs and a spike in commodity prices due to lower

supply (OPEC) threaten to keep economies in stagnation with frequent dips.

DM fiscal sustainability requires deleveraging in the public sector, which has taken on private debt.

2

Global Overview



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3

Updated Global Growth Forecasts


New Baseline (60% risk of recession in DMs) July Forecasts

2011 2012 2011 2012

U.S. 1.5 0.6 1.0 2.4 2.6

Eurozone 1.7 0.4 - 0.8 1.9 1.6

Japan -0.4 1.6 - 2.0 -0.7 3.2

G7 1.3 0.9- 1.2 1.9 2.5

Advanced Economies 1.4 0.8 - 1.2 1.9 2.4

Emerging and Frontier Markets 6.3 5.4 - 6.1 6.5 6.5

Asia/Pacific 5.9 6.0 - 6.7 6.1 6.9

Emerging Asia 7.6 7.0 - 7.5 7.7 7.7

EM Asia ex-China, India and Indonesia 4.4 3.5 - 4.2 4.7 5.0

Latin America 4.5 2.6 - 3.6 4.7 4.7

Emerging Europe 4.2 2.5 - 3.4 4.7 4.0

Middle East and Africa 3.4 2.3 - 3.0 3.5 4.0

BRIC 7.5 6.8 - 7.4 7.6 7.7

World 3.8 3.0 - 3.6 4.1 4.4

1. U.S., Canada, Japan, the UK, the eurozone, Sweden, Norway, Australia, Switzerland

2. Japan, Australia, China, India, Hong Kong, Indonesia, Malaysia, the Philippines, Singapore, Vietnam, South Korea, Taiwan, Thailand3. Asia/Pacific ex-Japan and Australia

4. Hong Kong, South Korea, Malaysia, the Philippines, Singapore, Taiwan, Thailand, Vietnam

5. Brazil, Argentina, Mexico, Chile, Peru, Colombia, Venezuela

6. The Czech Republic, Hungary, Poland, Turkey, Russia

7. Israel, Egypt, Saudi Arabia, the UAE, South Africa


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Global Scenario Analysis Flowchart

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Present to End of 2011 2012

DMs are at stall speed,

while EMs are growing

near potential. DMs

face a risk of falling

into recession in 2011.

DMs fall into recession,

likely in late 2011 or early

2012. Triggers include a

financial crisis following

disorderly default(s) in the

EZ and policy mistakes (lack

of or insufficient timely

support).

The growth environment isvolatile, but DMs avoid

technical recession (thoughnot growth recession) andEMs keep growing around

potential.

2013-15

A weak, U-shaped recovery

continues, with volatile

growth in DMs (amid

balance-sheet repair and

possible EZ uncertainty) and

EMs growing near potential.

China's broken investment-

led growth model gives out.

Gradual rebalancing ensues.

A deep recession takes hold

of DMs and possibly globally,

requiring an aggressive,

coordinated policy response.

~55%

~45%

Probability

Adequate policy support

(QE and fiscal stimulus

across DMs and possibly

some EMs) staves off the

failure of systemic

institutions.

The policy response is

inadequate (no QE or

too-little, too-late QE;

lack of adequate fiscal

stimulus and possible

fiscal drag).

Probability

60%

40%

Policy Response


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The lingering EZ periphery debt crisis and the huge political economy problem preventing its

solution have returned to the fore.

The U.S. at stall speed implies the need for stimulus, but political issues and the debt

downgrade have contributed to policies that accentuate unnecessary and harmful fiscal drag.

Even as temporary shocks (Japan supply-chain disruptions, oil price spike) wane, underlying

growth is weak.

Net effect since June:

The risk of DM recession has increased to about 60% in the near term, with risk of

stagnation and prolonged recession in the medium term at around 50%.

Weak performance means minimal chance of strong global growth.

There is less chance of a weaker version of a U-shaped recoverya growth recession in

which DM expansion falls to a pace consistent with rising (rather than slowly falling)

unemployment.

DM weakness puts greater pressure on China/EMs but could delay Chinas hard landing

as inflation (the likely trigger) remains subdued. It raises the risk of a crash rather than a

slow burn.

5

What Has Changed? Downside Risks Dominate in DMs



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Policy responses are effective, including fiscal, monetary and targeted policies to

deal with underlying vulnerabilities (U.S. mortgage market, etc.) and potentiallyinvolving global policy coordination.

The EZ crisis reaches an orderly resolution, limiting risk of contagion.

U.S. high-grade corporates with strong balance sheets do more capex and hiring

than expected, a positive for labor income and consumer confidence, although

capacity utilization remains low.

Moderation of oil prices provides a reprieve to global consumers, offsetting other

negative wealth effects.

Stronger-than-expected growth in EMs (which need less balance-sheet repair and

have stronger macroeconomic frameworks) supports income growth and

consumption, though credit growth threatens to contribute to instability.

Asset reflation from accommodative policy creates positive wealth effects,leading to balance-sheet repair (this has not worked very well in the past).

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Upside Risks to Our Baseline Scenario



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Near-Term Outlook: Leading Indicators Flashing Orange


Global PMIs have fallen significantly, with several at or below the neutral level.

Forward-looking components (new orders) are underperforming output.

Inventories are starting to pile up. OECD leading indicators point to slowdown in many economiesthe business cycle has turned.

New Orders Decline Signals Weaker Output Ahead (Global) OECD Leading Indicators Point to Turn in Business Cycle

85

90

95

100

105

U.S. Euro Area Total OECD Major Asia

30

3540

45

50

55

60

65

70

US ISM China Europe

40

45

50

55

60

65

China Export orders Japan Export orders

Singapore New Orders India Export orders

45

47

49

51

53

55

57

59

61

63

Output New Orders New Export Orders

Manufacturing PMIs Converging to Neutral


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Monetary stimulus is the path of least resistance in DMs as fiscal austerity isongoing, even in countries that economically have space to provide stimulus.

QE3 in the U.S. is now a baseline scenario, but it may be too little and too late

and not deal with underlying issues in housing or offset fiscal drag.

Other DM central banks (such as the Bank of England) may join in QE or credit

easing.

Softer headline inflation will allow central banks in EMs to stay on hold.

Effective dollar pegging means many EMs will import ZIRP, risking extensive

capital inflows.

Political pressures are forcing fiscal consolidation in DMs and leading to greaterreliance on macroprudential regulations.

For more, see RGEs Central Bank Watch.

8

Monetary Policy Shifting to Easing: Back to QE

http://www.roubini.com/analysis/161399.phphttp://www.roubini.com/analysis/161399.php


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9

Hope of a V-Shape Is Gone


Since early 2011, RGE has successively reduced the likelihood of the rosiest

scenario, a V-shaped recovery (or strong, sustainable global growth without policysupport), to a negligible level due to the following short-term factors constraining

medium-term growth:

A lack of resolution of old threats to the recovery (e.g., the EZ crisis)

The need for deleveraging in DM public sectors

The double dip in the U.S. housing sector, which poses risks to wealth, personalconsumption and the balance sheets of financial institutions, as well as recent

equity corrections that may exacerbate this negative wealth effect

Still-high commodity prices that have dampened consumption and required

removal of accommodation

Inadequate rebalancing of global demand, adding to global excess capacity

Rising risks of a short-term hit to confidence and a negative feedback loop in H2

2011 from asset corrections


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10

Stagnation/Recession Very Likely in Short Term


The probability of a negative feedback loop/stagnation/double-dip scenario is

higher (60%) than before (15-20% in the spring and 30-40% in July), as

negative macroeconomic surprises and faltering confidence continue to showup in the data.

The slowdown is more than a soft patch, and policy makers (particularly in

DMs) will find themselves without policy bullets or unwilling to use the ones

they have.

Possible triggers include policy mistakes (or inadequate policy responses) or a

major financing shock stemming from disorderly default by sovereigns or

systemic financial institutions.

The recovery remains policy-dependent in DMs that are relying on ZIRP and

withdrawing the key fiscal prong.

If DMs were to experience sharp demand destruction, EMs would suffer as

real economic and financial links exacerbate the ongoing slowdown, though

most (especially in Asia and LatAm) still have policy space for stimulus.

Emerging Europe requires more balance-sheet repair and retains less policy

space.

di k h d ill h


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11

Medium Term: Weak, U-Shaped Recovery Still the

Baseline, but Risk of Deep, Prolonged Recession Is High


In the medium term (five-year horizon), a weak, U-shaped recovery amid balance-sheet repair remains our central scenario, as it has been all along.

But given the macroeconomic deterioration, the political impasse in the U.S. and

continued uncertainty in the EZ, the risk of falling into a protracted recession with

inadequate policy responses is high (45%).

As gradual deleveraging continues, investors will search for yield to maximize realreturns, bringing capital to EMs, as well as commodities, and adding to EM

monetary trilemmas.

Regulatory changes encourage the buildup of leverage outside investment banks

(in the shadow banking system) and in EMs with space to borrow more. Although

EMs like Brazil and Turkey still have low overall outstanding credit, debt-servicecosts could dampen consumption.

Slow policy normalization will plant the seeds of the next crisis in EMs and DMs.


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Roubini Global Economics



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Several coincident stresses raise short- and medium-term risks:

Amid U.S. cyclical slowdown, political gridlock stands in the way of necessary

stimulus and reforms to deal with underlying vulnerabilities (e.g., the housing

market).

EZ policy makers are running out of time. Despite more significant moves from

the European Commission/ECB, debt levels are still too high, raising the risk of acountry exiting in the medium term.

The end of the Chinese investment bubble is a medium-term (post-2013) risk, but

DM recession could bring risks forward. The end of Chinas investment and lending

binge will weigh on domestic and global growth.

Global rebalancing has been insufficient.

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A Perfect Storm?



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Eurozone Political Economy Problem


Could the Eurozone Break Up? Possible Over a Five-Year Horizon

The current muddle through approach to the EZ crisis is not a stable

disequilibrium; rather, it is an unstable disequilibrium.

Either the member states move from this disequilibrium toward a broader

fiscal, economic and political union that resolves the fundamental problems

of divergence (both economically and fiscally and in terms of

competitiveness) within the union

or the system will move first toward disorderly debt workouts and

eventually breakup, with weaker members departing. Over a five-year

horizon, the odds of a breakup are about 40%.
http://www.roubini.com/analysis/157656.phphttp://www.roubini.com/analysis/157656.phphttp://www.roubini.com/analysis/157656.phphttp://www.roubini.com/analysis/157656.php


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EZ Scenario Analysis


Developments in the EZ periphery have deteriorated even more

than we previously anticipated, forcing European policy makers to

take more extensive efforts, including debt restructuring similar to

what RGE advocated.

In the short term, a muddle through scenario is likely, but risks to

confidence are very high. Debt levels are still too high to finance.

In the medium to long term, there are greater chances of either a

disorderly outcome or deeper integration.


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U.S. Fiscal Outlook


After the debt ceiling charade, it is very unlikely well see further fiscal stimulus at a

moment in time when the economy, in our view, is navigating toward recession.Only when it is clear the economy is in another downturn, and it is too late to avoid

one, the discussion about stimulating the economy fiscally might resume.

Effective fiscal stimulus in the form of a jobs program, comprehensive support to

stabilize the housing sector or infrastructure spending is less likely than some form

of tax-based stimulus that comes with a lower multiplier.

A credible commitment to long-term fiscal consolidation needs to be made

immediately; however, front-loading the fiscal austerity does not make sense as the

resulting fiscal drag would exacerbate the downturn. The current path of policy is

the exact opposite of optimal.

The necessary primary adjustment to prevent an eventual fiscal train wreck in the

U.S. is 5.4% of GDP. Spending cuts cannot be limited to discretionary spending;

meanwhile, some of the fiscal adjustment will have to occur on the revenue side

the split could be 3.4% from spending cuts versus 2% from tax increases.


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Precedents Suggest Chinese Slowdown

Country Peak Year

Growth

Before

Growth

After

Hong Kong 1997 4.9 1.3

Indonesia 1996 7.1 0.4

Malaysia 1995 9.3 5.0

Thailand 1995 9.0 0.6

South Korea 1991 9.7 7.3

Japan 1990 5.1 1.5

Singapore 1984 8.7 5.8

Philippines 1983 4.6 0.0

While investment/GDP has peaked, growth

has slowed. A current account surplus and financial

repression will prevent a liquidity crisis, but

not domestic banking problems.

Investment is continuing to drive growth in

2011, raising the risk of future problems.

Source: National Statistics, Gapminder, RGE

Note: Average growth rates five years before/after, %, y/y


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Chinas Broken Growth Model

Chinas slow grind is consistent with our baseline view of weak, U-shaped global growth

in the medium term.


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19

None of Chinas Medium-Term Scenarios Is Rosy



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Chinas Broken Model: Why No Drastic Slowdown

Before 2013? The 2012-13 political cycle encourages policy makers to be extremely risk-averse. GDP

growth is still the key metric for promotion.

The political cycle will encourage more lending in H2 2011, taking local government debts

to RMB19 trillion by the end of 2012 from RMB15 trillion at the end of 2010.

Up to 30% of these may eventually turn into nonperforming loans (NPLs).

Source: Ministry of Finance, Ministry of Railways, Peoples Bank of China, ADB, RGE estimates

The Chinese Governments Contingent Liabilities in 2010 (RMB, billions)

Given the tenor of loans,

we assume the problemloans will really begin

hitting balance sheets in

2013.

It takes time for loans to

be classified as NPLs, and

banks had a 230%coverage ratio at end-

Q1sufficient to get

through 2012 with

government support.


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21

EM Consumption Cant Pick Up the Slack Yet


0

2,000

4,000

6,000

8,000

10,000

12,000

US Europe Japan Key EM

Private consumption, annualized, 2010

Note: Europe includes the EZ and UK; Key EM includes BRICS plus Indonesia and Turkey.

Source: IMF, national statistical agencies, RGE

Balance-sheet repair in DMs will

subtract from aggregate demand.

Negative wealth effects, forced

deleveraging and fiscal consolidationpose further risk to demand.

EM consumption is not yet

a sufficient offset, largely because

China is still investment-driven.


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Q4 2011 Global Scenario Analysis - September 7 2011