SLEA Innauguration_Key Note_Dr Koshy Mathai

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    International Monetary Fund

    World Economic

    October 14, 2011

    and

    Some Thoughts on

    Sri Lanka

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    Activity is under threat: internal and global demand

    rebalancing are not advancing.

    This is symptomatic of long-standing policy challenges

    that ur entl need to be addressed:

    More inter-temporal fiscal adjustment as well asbank and household balance sheet repair inadvanced economies;

    More rebalancing of demand in key Asian surplus

    economies.

    2

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    RECENT DEVELOPMENTS

    Bad newsmostly unexpected:

    Euro area strains increasing dramatically.US Q1, Q2weaker underlying growth momentum, especially forconsumption.

    Global stock market correction.

    Good newsmostly expected:

    Japan is recovering well.

    EM growth is still strong.Oil prices have moderated.

    3

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    Global activity has slowed noticeably.

    World Trade(annualized percent change of three-month moving

    average over previous three-month moving average)

    20

    40

    60

    Purchasing Managers Index (PMI)(index)

    55

    60

    65

    -80

    -60

    -40

    -20

    0

    Trade value

    CPB trade volume index

    2000 04 Jun.

    11

    06 0802

    4

    30

    35

    40

    45

    50

    Manufacturing:

    advanced economiesManufacturing:

    emerging economiesServices: advanced

    economiesServices: emerging

    economies

    2007 Aug.

    11

    08 1009

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    Equity markets have fallen sharply andvolatility has increased drastically.

    Equity Markets(index; 2007=100; national currency)

    100

    120

    140

    DJ EURO STOXX

    S&P 500

    Asia

    Latin America 70

    80

    90

    U.S. (VIX)

    Emerging

    Markets (VXY)

    Implied Volatility(percent)

    May 10, 2010

    0

    20

    40

    60

    80

    2000 04 Sep.

    11

    06 0802

    0

    10

    20

    30

    40

    50

    60

    Jan-00 Jan-02 Jan-04 Jan-06 Jan-08 Jan-10 Sep.

    11 5

    10

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    Financial stability risks have increased dramatically,

    especially in the euro area.

    300

    350

    400Spain

    Italy

    Belgium

    France

    Government Bond Spreads(two-year yield spreads over German bunds;

    basis points)

    July 21, 2011

    80

    100

    U.S. dollar

    Euro

    Interbank Spreads(three-month London interbank offered rate

    minus three-month government bill rate;basis points)

    July 21, 2011

    6

    -50

    0

    50

    100

    150

    200

    250

    Jan-10 Jul-10 Jan-11 Jul-11

    May 10, 20100

    20

    40

    60

    Jan-10 Jul-10 Jan-11 Jul-11Sep.

    11

    Sep.

    11

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    Equity Fund Flows to Emerging Markets(billions of U.S. dollars, weekly flows)

    Capital flows to EM have turned negative.

    1.0

    1.5

    2.0

    QE2 (Nov. 3)

    4

    6

    8

    EMEA

    LatAm

    Asia excl. Japan

    Global

    Total

    QE2 (Nov. 3)

    Bond Fund Flows to Emerging Markets(billions of U.S. dollars, weekly flows)

    Source: EPFR Global. 7

    -1.0

    -0.5

    0.0

    0.5

    Jan-10 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 May-11 Aug-11

    Greece crisis

    Ireland crisis

    -8

    -6

    -4

    -2

    0

    2

    Jan-10 Mar-10 Jun-10 Sep-10 Dec-10 Mar-11 May-11 Aug-11

    Ireland crisis

    Greece crisis

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    Oil prices have retreated but

    are still above January 2011 levels.

    Food and Oil Prices

    130

    140

    110

    120

    Food

    (index, 2010m1 = 100; left scale)

    Jun. 11 WEO for 2012

    8

    90

    100

    110

    120

    70

    80

    90

    100

    Oil

    (US dollars a barrel; right scale)

    Jan. 11 WEO [for 2012]

    Aug. 11 WEO [for 2012]

    Jan.

    2010

    Aug.

    11

    Jul.

    2010

    Jan.

    2011

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    Consumption in advanced economies is struggling to recover fromfiscal withdrawal, but M&E investment is still doing well.

    6

    9

    12

    Emerging

    economies2

    Real Private Consumption(annualized percent change from preceding quarter)

    0

    10

    20

    Emerging

    economies2

    Real Gross Fixed Investment(annualized percent change from preceding quarter)

    -6

    -3

    0

    3

    Advanced

    economies

    1

    092007 08 10 11:

    Q2

    -40

    -30

    -20

    -10

    Advanced

    economies1

    092007 08 10 11:

    Q2

    9

    of which:

    machinery and

    equipment

    1Australia, Canada, Czech Republic, Denmark, euro area, Hong Kong SAR, Israel, Japan, Korea, New Zealand, Norway, Singapore, Sweden, Switzerland, Taiwan Province of China, United Kingdom, and United States.2Argentina, Brazil, Bulgaria, Chile, China, Colombia, Hungary, India, Indonesia, Latvia, Lithuania, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Romania, Russia, South Africa, Thailand, Turkey, Ukraine, and

    Venezuela.

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    Employment presents major challenges to recoveryU.S. in new territory.

    48

    52

    United States

    Employment-Population Ratio

    (percent)

    1

    2

    Family Income Expectations1

    (percent)

    32

    36

    40

    44

    Euro area

    901960 80 10200070

    10

    -4

    -3

    -2

    -1Euro area

    United

    States

    901980 95 Jun.

    11

    2000851U.S. data are from Reuters/University of Michigan Surveys of Consumers and represent the

    difference between the percentage of people who think family income will go up and those who

    think it will go down. EU data are from the family financial situation index in the European

    Commission Business and Consumer Surveys. Both series are smoothed and harmonized.

    05 10

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    WEO FORECAST AND RISKS

    Key assumption underlying the baseline: financial

    recovery delayed but not derailed.

    1. Euro area crisis does not run out of control.

    2. Global financial volatility does not escalate.

    3. No major tightening of bank lending conditions.

    11

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    6

    8

    10

    12

    Emerging Asia

    MENA6

    8

    10

    12

    More uneven recovery: > 6 percent growth in EM

    < 2 percent growth in AE

    = 4 percent global growth.Real GDP Growth

    (percent change from a year earlier)

    Advanced Economies Emerging Economies

    -12

    -10

    -8

    -6

    -4

    -2

    0

    2

    4

    MENADev. AsiaLAC

    2011 2012

    4.0 3.6

    8.2 8.0

    4.5 4.0

    Current WEO

    Latin America

    -12

    -10

    -8

    -6

    -4

    -2

    0

    2

    4

    United StatesEuro area

    Japan

    2011 2012

    1.5 1.81.6 1.1

    -0.5 2.3

    Current WEO

    2000 02 04 1006 08

    12

    2000 02 04 1006 08 12 12

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    Downward revisions are larger for AE than EM.Various EM have policy space to counteract the slowdown.

    Revisions(percent; current-June 2011 Quarterly Update )

    0.5

    1.02011

    2012

    United States Euro area Japan Middle East and

    North Africa

    Developing Asia Latin America and

    the Caribbean

    -1.0

    -0.5

    0.0

    13

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    Inflation has begun to moderate.

    Headline Inflation(Annualized percent change of three-month moving

    average over previous three-month moving average)

    6

    8

    10

    12

    Core Inflation(Twelve-month change)

    6

    8

    10

    WorldAdvanced economies

    Emerging market economies

    062002 04 Jul.

    11

    08-6

    -4

    -2

    0

    2

    4

    WorldAdvanced economies

    Emerging market economies

    14

    10-2

    0

    2

    4

    062002 04 Jul.

    11

    08 10

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    3

    4

    5

    6

    World GDP growth2

    2

    3

    4ROW CHN+EMA OCADC

    DEU+JPN Oil exporters U.S.

    Global demand rebalancing is stuckEM not making up for less AEconsumption. Structural reforms and XR adjustment are needed.

    Global Imbalances1

    (percent of world GDP)

    Country Contributions to Global Consumption

    Growth1 (percent)

    -3

    -2

    -1

    0

    1

    2

    India

    China

    Other emerging and developing economiesAdvanced economies

    -3

    -2

    -1

    0

    Discrepancy

    1996 2000 04 08 121 CHN+EMA: China, Hong Kong SAR, Indonesia, Korea, Malaysia, Philippines, Singapore, Taiwan Province

    of China, and Thailand; DEU+JPN: Germany and Japan; OCADC: Bulgaria, Croatia, Czech Republic, Estonia,

    Gr

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