Roubini Global Economics
David Nowakowski, Senior Director of Research
© Roubini Global Economics Copyright 2014 Reproduction or redistribution prohibited without prior written consent.
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• Global Overview—Themes, Risks, Forecasts
• Here We Go Again? Property Bubbles & Banking Risks
• Macro-Prudential Brakes and Opportunities:
Infrastructure and Reform Needs
• Appendix: The World in 2014-2018
Contents
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Global Themes
• Growth prospects weak but improving
• EM structural weaknesses being exposed
• Chinese rebalancing
• Gradual Fed normalization; experiments with “macro-pru”
• More central bank action ahead in Europe, Japan
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Some Old Tail Risks remain but have changed
Tail Risks lower, but have not disappeared:
• Eurozone break-up (Grexit; Italy/Spain lose market access)
• U.S. fiscal crisis (high deficit, government shutdown, debt
ceiling fight, unfunded liabilities at state & federal level)
• Public debt crisis in Japan
• Low-flation and deflation
• Geopolitics: Iran–Israel War, Middle East turmoil
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• Fed QE and ZIRP exit – risk of going too fast
• New asset bubbles/financial instability – risk of going too slow
• China hard landing
• EM crises and fragility
• Secular stagnation/Japanification
• Geopolitics: Russian Revanchism, Chinese expansionism,
North Korea, EU Secession (Scotland, Catalonia, UK)
5
Rising Tail Risks
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Selected Growth Forecasts: A Lower “New Normal”
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U.S.: Structural Challenges and Opportunities
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Challenges
• Baby boomers retiring; workforce will
grow by 0.5% rather than 1%
• Risk of permanent labor-market damage
• Low capex in spite of high profits
• Regulation that makes credit, financial
services more expensive
• Income and wealth inequality
• Political gridlock
Opportunities
• New technologies
• Shale gas/oil
• Fiscal space for greater infrastructure and
education programs
• Sound immigration policies
• Deep financial sector
Bottom line: Potential/trend growth in U.S.
will be 2.5-2.8%
Close to the End of U.S. Household Deleveraging
Potential Growth Still Strong
Chinese Shadow Banking: Risky, Not Fatal
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• Total debt reached 240% of GDP in
2013
• Asset quality has deteriorated; there
will be more defaults in 2014
• But state-owned banks are still
primary suppliers of credit, and
liabilities in shadow system have
longer maturities than in DMs
• This should help policy makers to
contain contagion effects
• Nevertheless, slow-moving financial
crisis will weigh heavily on growth for
next few years
• 20% chance of acute crisis (most likely
trigger is falling property prices)
Unsustainable Debt Dynamics (CNY, trillions)
Trust Assets By Borrower Type (CNY, trillions)
Source: Bloomberg, Haver, MoF, ADB, BIS, China Trustee Assoc., RGE
150
160
170
180
190
200
210
220
230
240
250
0
50
100
150
2003 2005 2007 2009 2011 2013
Loans Shadow Finance
Gov. Bonds PBoC Bonds
Pol. Bank Bonds Corp. Bonds
Total % of GDP (right axis)
0
2
4
6
8
10
12
2010 2011 2012 2013
Infrastructure Industry Financial Institutions Real Estate
Stocks IPOs Bonds Others
Overvalued Housing Markets Vulnerable
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• Home prices: extremely elevated in Norway, France, Canada, the UK, Sweden and Australia
• Debt service: at historical lows and rising incomes mean a catalyst for correction will await rate
hikes or recession – end of QE is not likely to be the spark, if forward guidance succeeds
• Emerging markets: only Hong Kong stands out, but Turkey’s and China’s markets are ripe for a
downturn and Brazil shows cause for concern
Percentage deviations compared to long-term averages; positive = overvalued; negative = undervalued
Financial Wealth Has Rebounded
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• Central Banks have reflated
assets with low rates and QE
• Corporates have maintained
discipline and benefitted from
productivity, unemployment
record profits
• SWFs and public pensions
have long-term challenges in
an era of lower expected
returns
• Huge wealth, inequality,
deficits, and high gov’t debt
could be a toxic mix
Household Financial Net Worth, % of GDP
Household Borrowing (Debt/GDP)
Source: National Central banks, Haver, RGE
40
50
60
70
80
90
100
110
120
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Eurozone Japan UK U.S.
100%
150%
200%
250%
300%
350%
99 00 01 02 03 04 05 06 07 08 09 10 11 12 13
Eurozone Japan UK U.S.
Scenarios: Near-Term Downside Risks Avoided 2014-15 Scenarios
• Liquidity buys time for eurozone fiscal/political integration; modest growth & inflation
• U.S. GDP back to potential
• Chinese rebalancing is delayed
• Global sentiment encourages reforms
• EM capital outflows and credit hang-over: slower growth and disruptive overshoots
• Disorderly events/politics in eurozone
• Chinese rebalancing turns into a hard landing
• External shocks or policy mistakes restart U.S. private deleveraging
• DM growth and unemployment high, wages and inflation low
• Eurozone muddles through: debt sustainability a concern
• Chinese slow grind, growth shifts to 7%
• Modest fiscal consolidation
70% 65% gradual
rebalancing; low and
volatile growth environment
25% 20% steady
recovery toward
normalization
2014-15 2016-18 Probability
5% 15% severe
recession in at least one
major region
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2016-18 Scenarios
• Eurozone reform growth, rebalancing
• U.S. innovation extends dominance; bubbles and New Normal fate avoided
• Chinese rebalancing is delayed
• EM adjusts to post-QE; credit moderates; reforms/investment boost potential GDP
• EMs enter inflation-depreciation-default loop
• Eurozone politics fragments, with disorderly defaults in Spain or Italy; exit risk returns
• China: economic and political upheavals
• U.S. debt fragility, unfunded liabilities, and financial bubbles/busts have global spillovers
• New Normal for DMs: low growth, deflation, periodic debt restructurings and bail-ins
• China grows at 4-6%, financial crisis avoided as banks recapitalized
• EM growth slows due to credit tightening and opportunity cost of missed reforms
Under All Scenarios, Role Of Governments Rising
Leviathan Redux? • State Capitalism • Sovereign Wealth Funds • Conclusion: despite high deficits, governments will not be idle investors
Return of the Nanny State (for financials, anyway) • Dodd-Frank, Volcker Rule • Basel III, Solvency II, Counter-cyclical add-ons and “macro-pru” • Quantitative Easing, Credit Easing • Stress Tests, Resolution Regimes • Fed, BoE, ECB become supervisors, regulators, lenders of first/last resort • Conclusion: Banks are more constrained in an era of higher regulation
Reform School • Demographic certainty means status quo is dangerous for governments • “Reform” is a catch-all – important to know what it means. • 90% of it is legal or legislative, not economics per se. • OECD categorization of “areas for reform”
Avoiding Stagnation Huge reform needs in EM & DM
• Labor participation disabilities, disincentives, retirement reform, gender equality
• Unempoyment “active labor market policies”; reduce labor costs, wage & union reform, hiring/firing policies
• Productivity Increase quantity and quality of infrastructure Increase provision and effectiveness of education Expand and support innovation
• Competition Product market regulations Reduce public ownership Strengthen competition framework
Reduce barriers to trade and FDI
Shift tax burden from labor & income consumption, property, or activities with negative externalities (pollution, finance)
Cut subsidies to housing, energy, agriculture, etc.
Promote financial & capital market (BRIC especially)
Improve efficiency of government, healthcare
Enforce rule of law See OECD, “Economic Policy Reforms 2014”
Governments Face Short & Long-term Budget Pressures
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Infrastructure Needs Huge; Unlikely To Be Met
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• U.S. needs $500bn annually just to maintain existing infrastructure
(American Society of Civil Engineers)
• EU funding needs for transport, energy, communication $325bn annually
(European Commission)
• Global estimate for capital 2013-2030 is $70 trillion; $4 trillion annually
(World Bank)
• Deficits and Demographics Will Strain Government Finances
World Population: 6.1 billion (2000) 8.8 billion (2050)
Developed Countries: 1.2 billion now, 1.2 billion in 2050, 1.1 billion in
2100; Southern & Eastern Europe could lose 1/3rd of population
Avg Age in Europe will increase from 3748; % of 65+ will double
Where will credit come from? Capital Markets! • International Debt outstanding, has stagnated
• Domestic debt mostly sovereigns & financials; “only” $8 trillion in corporate debt
$0
$10,000
$20,000
$30,000
$40,000
$50,000
$60,000
$70,000
$80,000
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
20
07
20
08
20
09
20
10
20
11
20
12
20
13
USD
bill
ion
Domestic Debt - Corporates Domestic Debt - All International Debt - All
Source: Haver, BIS
17
Summary:
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The good news: No secular stagnation!
Jury is still out on Europe, but full ”Japanification” unlikely
“Slow, old, but still rich” is the overall verdict, but not necessarily fated
UK, Germany, Ireland taking risks to over-achieve
U.S. will continue to support global economy via productivity growth
Chinese rebalancing to be gradual The challenges: Plenty of rebalancing ahead, and staying on course will be tough
Chinese slowdown and rebalancing toward consumption will have fallout…
…together with end of a commodity supercycle
…political instability in some EMs
…policy tightening in DMs and EMs
…credit booms in China and many EMs, and new housing bubbles
Permanent loss of output and reduced potential growth in EM and DM (especially Europe) if structural reforms occur too slowly
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Growth Trends: Most Countries Set For Secular Slowdown
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Eurozone public debt sustainable, but not in all countries
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• Eurozone government debt/GDP will
likely peak around 96% in 2014
• Fiscal deficits will continue to fall, but at
a slowing pace: from 4% of GDP in 2012
to 1.5% in 2018
• Continued fiscal consolidation and return
to weak growth will enable this fall
• Some countries face unsustainable debt
dynamics (Italy, Spain, Portugal), while
others should return to sustainability
through improved nominal GDP growth
(Ireland)
• We expect some forms of ALME (Active
Liability Management Exercises) to deal
with debt/GDP ratios rising beyond 130%
Sustainable Public Debt at Eurozone Level (% of GDP)
Unsustainable Public Debt for Some Eurozone Economies (% of GDP)
Source: Bloomberg, Haver, RGE
0
40
80
120
160
200
2006 2008 2010 2012
Greece
Italy
Portugal
Ireland
Spain
-4.5
-4.0
-3.5
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.082
84
86
88
90
92
94
96
98
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Fiscal deficit (RHS) Debt/GDP (LHS)
Low inflation will persist
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• In 2013, sharp increase in % of items in
eurozone inflation index with low or
negative annual inflation
• Energy was biggest driver, but
disinflation spread to other goods
• As of February 2014, all countries in the
eurozone had inflation below 2%, the
ECB’s target
• Ample slack in the goods and labor
markets and weak demand prospects
imply continued low inflation
• We believe inflation far below the 2%
target will eventually force the ECB to
ease further (refi rate cut, negative
deposit rate cut, quantitative easing)
Disinflation and Deflation Are Spreading Across Goods/Countries
All Eurozone Countries Now Have Sub-2% Inflation
Source: Bloomberg, Haver, RGE
0%
10%
20%
30%
40%
50%
60%
70%
Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14Total Weight of Items with HICP <= 1 % Total Weight of Items with HICP <= 0 %
0
2
4
6
8
10
12
14
-6%
-1%
4%
9%
14%
Jan-2006 Jan-2007 Jan-2008 Jan-2009 Jan-2010 Jan-2011 Jan-2012 Jan-2013 Jan-2014
Countries with HICP <= 0 % (RHS) Euro Area y/y % change
Min y/y % change Max y/y % change
Debt Trajectory and Active Liability Management Exercises
Guarantees: • Issuance guaranteed by a more creditworthy entity • Insurance
Collateral: • Secured bonds, senior to other bonds (U.S. “tobacco
bonds,” EU lottery revenues) • Sequestration of revenue streams
Liability Management: • Maturity extensions via debt swaps, including
deferral, capitalization or PIK of interest due
Loans (following an ECCL program): • IMF or ESM would lend long term at low rates
(compared to bond yields) • ESM and ECB could also conduct secondary-market
purchases
OSI (in cases where multilateral, bilateral loans comprise large part of overall debt burden): • Lending gets extended and reduced in real terms
through a combination of measures
PSI (external debt and/or local law debt) • Default or debt swaps (voluntary or forced)
0
20
40
60
80
100
120
140
160
180
200
2006 2008 2010 2012 2014 2016 2018 2020 2022
Greece
Italy
Portugal
Spain
Ireland
Projections
Debt-GDP Ratios (%) ALMEs
ALME Examples Portugal: • Sovereign Debt Swap – 3 Dec 13 Italy: • Debt Exchanges – 18 Nov 13 • Debt Buyback – 10 Dec 13 Cyprus: • Bonds maturing in 2013-2016 exchanged for same
coupon/par amount but longer maturities
Eurozone: RGE Forecasts (2016-2018 averages)
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Output gap of around 2.5% of GDP, potential for catch-up growth
• Lack of demand will make it hard to close that gap
Potential growth low in the eurozone
• Low public investment—lack of fiscal space
• Demographic change kicking in—except in France
• Structural reforms slow—progress in Spain and Portugal, little in Italy, France, Greece
Cyclical unemployment will become permanent, and turn into structural unemployment
• Hurting growth potential, reinforcing the negative impact of demographic change
Bottom Line: No Japanification
• Inflation low, but will remain positive
• Potential growth low, but Germany (30% of eurozone economy) to grow robustly
• Major risk: World demand—the critical growth driver for most eurozone countries
GDP Inflation CA Gov. Debt 3m Eonia 10y Rate
Baseline 1.5% 1.6% 2.4% 94% 0.7% 2.2%
Upside 2.5% 2.5% 2.0% 80% 1.5% 3.5%
Downside 0.5% 0.0% 3.0% 110% 0.1% 1.0%
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