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Global

EconomicOutlook3rd Quarter 2012

The Summer LullEurozone:Back to black

United States:Five reasons for worry

United Kingdom:Back into recession

India:

Losing its way


2/50

Ira Kalish, DeloitteResearch in theUnited States(Deloitte Services LP)

The global economy seems to take two steps orward ollowed by one or two steps back, andit mostly has to do with Europe. Each time the Eurozone starts to seem more stable, the crisisrears its ugly head again. Te result is downward movement o European economic activity and

increased uncertainty. Both o these actors, in turn, have a negative impact on growth everywhere

else. oday, we are seeing deceleration o growth in most o the worlds major economies. We are

seeing new policy responses in some markets, changing direction o interest rates and curren-

cies, and a higher degree o uncertainty than at almost any time in recent memory. Once again, we

attempt to make sense o a conusing situation.

In this edition o the Global Economic Outlook, we begin with Alexander Brschs take on the

Eurozone crisis. O course, this is a moving target with signicant news taking place every ew

days. Consequently, Alexander oers an analysis o the conicting orces at work in the search or

a solution. Specically, he highlights the conict between the economic logic o urther scal and

nancial integration and the politics and decision-making process o the ull European Union. He

concludes that the nature o the EU means that reorms will only take place in small steps. In other

words, reorms will entail kicking the can down the road, which as Alexander points out, is not

necessarily a bad thing i the can is kicked in the right direction.

Next, Carl Steidtmann provides his analysis o the U.S. economy. As usual, Carl is worried about

the outlook; indeed, his article is entitled Five Reasons or Worry. Among the ve reasons, and

probably the most worrisome, is the contagion eect rom Europe. Carl notes three mechanisms by

which the European problems are being transmitted to the U.S. economy. He concludes that theU.S. economy has dodged one bullet aer another. Given the very slow growth now under way, and

given the ve reasons or worry, he suggests that the United States may be running out o luck.

In the next article, I provide my view on the outlook or China. I ocus on the balancing act

that the Chinese government must undertake. On one hand, there is concern about the economic

slowdown, the duration o which has taken policy makers by surprise. On the other hand, there

is equal concern about the troubled state o bank balance sheets. Tere is an aversion to enabling

imbalances to ester and worsen. Hence, the authorities are ollowing a narrow path designed to

minimize the downturn while avoiding a deeper nancial crisis.

In his article on the British economy, Ian Stewart notes that Britains economy remains 4.3

percent smaller than it was in 2007, and prices are 16 percent highera perormance ar worsethan that o Germany or the United States. Yet, given the headwinds coming rom Europe and the

Global Economic

OutlookQ3 2012

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Preface

continuing scal discipline o the British government, it is unlikely that things will improve much in

the near term despite the more aggressive monetary policy now under way.

Next up is my analysis o the Japanese economy. I note that Japan has been on something o a

roller coaster, alternating rom recession in 2011, to strong growth in the rst quarter o this year, to

the possibility o another downturn. I look at the actors that will determine whether Japan man-

ages to attain steady growth. Tese include external demand in Europe and China, reconstruction

spending, a newly aggressive monetary policy, and whether or not Japan enacts a large tax increase.

In our next article, Pralhad Burli looks at the slowdown in India, which has been worse than

many analysts expected. Pralhad examines the actors that are inhibiting a quick recovery or the

Indian economy. Uncomortably high ination and a steady decline in the value o

the rupee have prevented the central bank rom implementing an easier monetary

policy. Furthermore, external headwinds and the governments ailure to imple-

ment market-riendly reorms are taking their toll on business sentiment in India.

In my analysis o Russias economy, I note that there are actually some posi-

tive actors inuencing the economy. Tese include strong consumer demand,historically low ination, and increased government spending on inrastructure.

Unortunately, these actors are likely to be overwhelmed by negative inuences

that will cause growth to decline in 2012 and 2013. Te most important actors are

the recession in Europe, the slowdown in China, and the decline in the price o

oil. In addition, both domestic and external uncertainty are undermining invest-

ment, thereby hurting longer-term growth prospects.

Finally, in my discussion o Brazil, I note that the country is experienc-

ing a considerable slowdown this year largely owing to deceleration o external

demand. Te global situation has also led to a reversal in the direction o Brazils

currency, creating problems or capital accumulation and ination. On the otherhand, Brazil continues to experience strong consumer demand. However, high

levels o debt and deault threaten to slow the consumer boom. Finally, monetary

policy has eased considerably, setting the stage or an economic rebound in 2013.

Dr. Ira KalishDirector o Global Economics

Deloitte Research

Global Economic Outlook

published quarterly by

Deloitte Research

Editor-in-chief

Ira Kalish

Managing editor

Ryan Alvanos

Contributors

Pralhad Burli

Alexander Brsch

Carl Steidtmann

Ian Stewart

Editorial address

350 South Grand Street

Los Angeles, CA 90013

Tel: +1 213 688 4765

[email protected]

We are conducting a survey is to determine the level o reader satisaction o Deloittes Global

Economic Outlook. Te survey results will help us understand your needs and modiy our

product to better serve them. We ask that you provide your candid eedback. Your responses

will remain anonymous. Te survey will take only 510 minutes to complete. You can access

the survey by clicking on this link or by pasting it in the address bar o your internet browser:

https://survey.deloitte.com/wsb.dll/3333/GEOsurvey.htm

Tank you or sharing your opinions.

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Geographies

Eurozone: Back to black | 6Economic news rom the Eurozone suggests that the euro crisis is prob-

ably more severe and deeper than ever. A combination o economic

and political issues is threatening the viability o the Eurozone in its

current orm. Te nature o the European Union implies that reormswill only take place in small steps.

United States: Five reasons or worry | 12A wide range o structural problems pose a continuing threat to eco-

nomic growth in the United States. Tree undamental mechanisms are

transmitting European problems into the U.S. economy.

China: Balancing the long term and the short

term | 20Te Chinese government is trying to strike a balance between theeconomic slowdown and its banks troubled balance sheets. Authorities

are ollowing a narrow path designed to minimize the downturn while

avoiding a deeper nancial crisis.

United Kingdom: Back into recession | 24Te British economy remains 4.3 percent smaller than its was in

2007. Given the headwinds coming rom Europe and the continu-

ing scal discipline o the British government, it is unlikely that

things will improve much in the near term despite a more aggressive

monetary policy.

Japan: A roller coaster ride | 28Te Japanese economy continues to swing dramatically between down-

turns and recoveries. External demand in Europe and China, recon-

struction spending, changing monetary policy, and the possibility o a

large tax increase may go a long way in dictating whether or not Japan

can steady its growth engine.

Contents

6

12

20

24

28

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India: Losing its way | 32Te economic slowdown in India has been worse than many analysts

expected. Uncomortably high ination and a steady depreciation

o the rupee are inhibiting a quick recovery or the Indian economy.

Furthermore, external headwinds and the governments ailure to

implement market-riendly reorms are taking their toll on business

sentiment in India.

Russia: External headwinds slow growth | 38Te Russian economy is currently enjoying strong consumer demand,

historically low ination, and increased government spending on

inrastructure. Unortunately, these actors are likely to be over-

whelmed by the recession in Europe, the slowdown in China, and the

decline in the price o oil. In addition, both domestic and external

uncertainty are undermining investment, thereby hurting longer-term

growth prospects.

Brazil: Shiting capital ows, slowinggrowth | 42Brazil is experiencing a considerable slowdown this year as external

demand decelerates. Te global situation has also led to a reversal in

the direction o Brazils currency. Te country continues to experience

strong consumer demand, but high levels o debt and deault threaten

to slow the consumer boom. But avorable monetary policy may set the

stage or a rebound in 2013.

Appendix

Charts and tables | 46GDP growth rates, ination rates, major currencies vs. the U.S. dollar,

yield curves, composite median GDP orecasts, composite median cur-

rency orecasts, OECD composite leading indicators

32

38

42

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The glimmer o hope that the Eurozonescrisis reached a positive turning point in

the rst quarter turned out to be all-too-aint

as the regions economic woes returned with

ull orce in Q2. In act, the crisis is probably

more severe and deeper than ever, and it is

threatening the viability o the Eurozone in its

current orm.

Te reasons are political as well as eco-

nomic. Te rise o the radical le in Greece

aroused new ears about a Greek exit rom the

Eurozone. Te so-called Grexit, once consid-

ered unthinkable, has become a distinct pos-

sibility. However, the second round o Greek

elections in June resulted in a pro-euro coali-

tion. Meanwhile, the French presidential and

parliamentary elections resulted in a socialist

victory that is straining the Franco-German

consensus on the handling o the euro crisis.

Te situation in the nancial markets wors-

ened in the second quarter. Risk premiums

or Italian and Spanish bonds increased, and

concerns about the uture o the Eurozone ledto capital drains rom periphery countries and

greater insecurity about the Eurozones uture.

Te Spanish banking sector will receive up

to 100 billion euros to oset non-perorming

loans rom the real estate bubble, making Spain

the rst big Eurozone country to apply or a

European bailout. Whether or not the deci-

sions taken at the European summit in late

June will bring back the glimmer o hope in Q3

remains to be seen.

Eurozone outlookcontinues to be grim

Eurozone GDP stagnated in the rst quarter

o 2012 and was marginally (0.1 percent) below

the level it achieved in the rst quarter o 2011.

Te unemployment rate lingers at 11.2 percent,

the highest unemployment rate in the history

o the Eurozone. Looking behind the curtain

o averages reveals persistently wide variation

Eurozone: Back to blackBy Dr. Alexander Brsch

UROZONE

Dr. Alexander Brschis Head o Research,Deloitte Germany

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GeographiesEurozone

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between the northern and

southern Eurozone mem-

bers (see gure 1). Austrias3.9 percent unemploy-

ment rate is the lowest in

the Eurozone, and Spains

is the highest. In act, the

Spanish unemployment rate

is only very slightly below

the U.S. unemployment rate

at the height o the Great

Depression in 1933 (24.9

percent).

Te Economic

Sentiment Indicator (ESI) or the Eurozone,

which includes condence indicators rom

industry, services, and consumers, ell to 89.9

in June (see gure 2). Te long-term aver-

ageand the threshold between a negative

and a positive outlookis 100. Condence

in industry and services ell in May and June.

However, as a ray o hope, the retail trade indi-

cator rebounded in June aer a sharp all in

May. Consumer condence ell slightly aer an

increase the month beore. Interestingly, con-

sumer expectations about their own nancial

situation improved in the Eurozone.

Te economic climate in Germany is still

slightly positive, according to the ESI, but it is

declining. Tis is conrmed by the Germany-

specic ZEW index. From May to June, it

experienced the sharpest all on a monthly

basis in 14 years. While the index is a snapshot,

its all could signal that the euro crisis is start-

ing to hit Germany.

Global Economic Outlook:3rd Quarter 2012

0

20

Jun

12

May

12

Apr

12

Mar

12

Feb

12

Jan

12

Dec

11

Nov

11

Oct

11

Sep

11

Aug

11

Jul

11

Jun

11

40

60

80

100

120

89.1

100.5

79.7

89.9

74.1

Spain

Germany

Italy

Euro area

Greece

Figure 2: Economic sentiment indicator

[100 = Long-term average]

Source: European Commission

Source: Eurostat

F gure 1: Unemp oyment rate

in percentage

0

5

10

15

20

25

30

Austria Netherlands Germany Italy Euro area Greece Spain

3.95.2 5.4

10.2 11

21.724.3

8


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GeographiesEurozone

Solving the crisis: Economicsmeets EU politics

Te renewed crisis has generated many

ideas about how to solve it. Te proposed solu-

tions on a European level include scal union,

the introduction o euro bonds, European

deposit insurance, and a banking union. Yet,

these proposals would require a much higher

degree o integration than currently exists in

Europe. What they have in common is that

they imply substantial redistributions in terms

o money and risk between northern and

southern Eurozone countries to recreate the

peripherys access to unding. Te economic

rationale is that, as a whole, the Eurozones

debt-to-GDP ratio is comparatively avor-

able. In act, the Eurozone ran a budget decit

o 4.1 percent o GDP in 2011, which is less

than hal the size o the decits in the UK and

the United States. Tereore, the ragmented

nature o European debt is one o the key prob-

lems (see gure 3).

While the economic logic is intuitive, anysolution needs to consider the character o

the European Union and its decision-making

process. Te European Union basically remains

an association o nation-states with supra

national characteristics and many veto points

and actors. Realizing a true scal union on a

European level, or instance, would

require completely overhaul-

ing the EUs character. It would

require a harmonization o scalpolicies, and by implication, such

harmonization would need to

span very idiosyncratic European

welare states and tax systems. Te

associated loss o national sover-

eignty would be unprecedented

in EU history. o be o any rel-

evance or the current crisis, this

quantum leap would need to be

undertaken quickly.

Lessons rom EU integrationLooking back at the development o the

European Union reveals two lessons. First,

comprehensive moves toward integration take

time. Consider the most recent step toward

integration, the Lisbon reaty. Te draing o

the EUs constitutional treaty started in 2001,

and it took three years to nish and sign it. It

was then rejected in several national reerenda,

and a new treaty had to be developed. Te

Lisbon reaty nally came into orce at the end

o 2009.

Second, there are dierent sorts o integra-tion, and the European Union tends to avor

one over the other. European integration theo-

rists argue that European integration is biased

toward negative integration. Negative integra-

tion is about market creation and removing

barriers to ree trade and competition. Te

single market was the major milestone in this

regard. Positive integrationthe harmoniza-

tion and centralization o policies and regula-

tionshas always been much harder. It oenailed due to the very dierent public policies

and governance structures o the member

states as well as their diverging interests.

A substantial jump in integration and the

corresponding transer o sovereignty to the

European level would require consent on both

Source: Eurostat

F gure 3: Bu get e c t 2011[% of GDP]

-12

-10

-8

-6

-4

-2

0

Euro area USA

-9.6

-8.3 -8.5

-3.9

-9.1

-4.2

-1

-4.1

UK Spain Italy Greece Portugal Germany

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an intergovernmental and a national level. It

is quite likely that these decisions would need

to be conrmed through reerenda in somecountries, while in others, it would become an

electoral ocal point. Whether or not the elec-

torates in the creditor and debtor nations are

in avor o a deeper political union or o higher

inter-European redistribution is an open ques-

tion. Tis uncertainty would be a drag on the

nancial markets and the credibility o plans

about deeper integration.

Far-reaching plans or deeper integration

and big-bang solutions will thereore ace very

substantial hurdles. It cannot be excluded that

the depth o the cur-

rent crisis could gener-

ate completely new

patterns o integration.

However, i history is

any guide, the way out

o the current crisis

will likely be a step-

by-step process. It will

likely avor solutionsthat solve pressing

problems over ones

that require compre-

hensive institutional or

systemic reorms.

Two certaintiesand a trade-o

Tere are twocertainties about the

Eurozones uture.

First, Eurozone coun-

tries need to delever-

age and bring their

scal houses in order

because public debt

has reached clearly

unsustainable levels. Second, the Eurozone

needs growth.

While these two certainties may go handin hand in the medium and long term, they

tend to be contradictory in the short term.

Reducing state expenditure and, thereore,

aggregate demand during a period o high

unemployment and spare capacity does not

help growth.

Worse, traditional economic stimulus is not

viable. While the interest rate, which is cur-

rently at 0.75 percent, could be lowered, it is

unlikely to have a signicant eect. Liquidity

is not the problem. Investors unwillingness

to nance troubled

Eurozone countries

is at the heart o the

crisis, so comprehen-

sive decit spending

is also not a realistic

option. Moreover,

postponing scal con-

solidation is dicult

because it would shat-ter the already-ragile

condence o the

Eurozones investors.

Design o fscalconsolidationis crucial

Given that there

is no alternative toscal consolidation,

two components are

crucial: timing and

design. In terms o

timing, a gradual

approach to scal

consolidation would

benet growth in crisis

countries. However, it


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Geographies

can only work with credible plans or medium-

term consolidation. A more gradual approach

requires a clear roadmap or decit reduction.

Aer all, investors want to be sure that they will

be repaid at some point in the uture. Tus, theprospects or the medium- and long-term scal

sustainability and economic growth are crucial

signals to investors and nancial markets.

Growth has a dual meaning. It reers to

short-term growth in the business cycle as well

as to the economys long-term growth potential.

Bringing these two together to the largest degree

possible should guide the design o scal consol-

idation. Tree actors are critical in this regard:

Multiplier efect: In the short term, themultiplier eect o government spending is

an important way to preserve growth. For

example, money owing to low-income

households is likely to have a high multiplier

eect as a large percentage o this money will

be spent.

Composition o consolidation: Te nature o

scal adjustmentswhether they ocus on

cutting public spending or increasing taxes

makes a dierence or growth. Empirically,

spending cuts are less damaging to economic

growth than tax increases.

Investment versus consumption orientation:

When it comes to public spending, structure

is just as important as size. Public expendi-ture supports the economys growth potential

most eectively with investments in educa-

tion, inrastructure, and technology. Tus,

a ocus on these areas as opposed to purely

consumptive spending raises growth pros-

pects and productivity. Currently, the budget

priorities in the crisis countries are geared

toward consumption, or example, in the

orm o pensions, while investment-oriented

spending lags behind the European average(see gure 4).

Te euro crisis is now in its third year. Te

combination o a public debt, a banking crisis,

and an economic crisis impedes quick solu-

tions and brings politicians and economists into

unchartered territory. Te institutional set-up

o the European Union will avor small steps

or can-kicking solutions. Tis is not neces-

sarily a bad thingi the can is kicked in the

right direction.

Eurozone

gure . u c spen ng on pens ons an e uca on, expen ure

[or latetst year available]

Source: Eurostat

0

2

4

6

8

10

12

14

1618

Italy

15.3

1.3

4.7

10.1

1.4

5.01

13.6

0.6

4.09

12.5

1.6

5.79

11.3

2

5.41

Spain Greece* Portugal EU 27

Public pension spending%/GDP 2010

R&D spending%/GDP 2010 (or latest year available)

Public spending in education%/GDP 2009

11


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13/50

GeographiesUnited States

economy can somehow decouple rom Europe

is not supported by the data. Te correlation

between U.S. and Eurozone economic growthover the past decade has been a very high 89

percent. Europes recession will be transmitted

to the United States through trade, European

investment in the United States, banking, and

the perormance o U.S. companies with mate-

rial European operations.

Transmission mechanism: Trade

Te recession in Europe is having a directimpact on U.S. exports (see gure 2). Europe

accounts or roughly a quarter o all U.S.

exports. Coming out o the deep slump in

2009, U.S. exports to Europe soared, rising

more than 25 percent by early 2011 rom the

previous year. As the European nancial

crisis grew, U.S. export growth slowed.

However, exports were still up 15.6

percent as recently as February o

this year. In April, exports were down

2.8 percent, a dramatic 18.4 percent

contraction in the pace o growth in

just two months. Te last time we saw a

collapse o this magnitude was in the

all o 2008, making U.S. exports

to Europe another recession

marker or both the U.S. and

the European economies.

Te contraction o trade is

having a negative eect on a num-

ber o trade-dependent industries.Manuacturing has been particularly

hard hit. Tis showed up in weak indus-

trial production numbers in the United

States and a June Purchasing Managers

Index below 50 or the rst time since 2009,

a sign o contraction in the manuacturing

sector. Going orward, manuacturing is acing

a much more dicult road as new orders or

a number o trade-dependent manuacturing

sectors have been trending down since the rsto the year.

Even as the construction industry shows

some signs o lie in the United States, new

orders or construction equipment have allen8.7 percent since the rst o the year. While the

oil patch in the United States is in the midst o

a drilling boom, businesses that supply equip-

ment or the sector have seen orders plummet

29.6 percent. In all o these cases, the weakness

in new orders or these capital goods is coming

rom outside o the United States.

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Transmission mechanism:The banking system

As the banking system has grown more

global, credit contractions in one part o the

world can have negative eects elsewhere.

Te contraction o credit in Europe is putting

pressure on European banks to raise capital.

Tey can do this by issuing new equity or by

selling assets. As selling equity dilutes existing

shareholders, most European banks have taken

the latter option o selling assets.

As Europeans divest themselves o U.S.-

based assets (see gure 3), it contracts bank

reserves in the United States, reducing the

availability o credit. Te U.S. Federal Reserve

has more than oset this contraction o

reserves through multiple rounds o quantita-

tive easing. Still, as the Europeans sell their U.S.assets and go home, it puts downward pressure

on prices while reducing the availability o

capital or investment in the United States.

Transmission mechanism:Corporate proftability

U.S. businesses do more than just trade with

Europe. Many have set up shop and conduct

business in Europe. From automakers to quickservice restaurants, U.S. businesses have exten-

sive operations in Europe. And like the rest o

the continent, the European operations o U.S.

businesses are hurting. In the rst quarter o

this year, problems with European operations

were a common excuse given or disappointing

earnings. Tat excuse has continued in com-

pany guidance or soon-to-be-released second

quarter results.


Source: Organization for Economic Cooperation and Development

Figure 1: GDP growth rates: United States and Eurozone

Percentage change, year-over-year

2002

-5

-4

-3

-2

-1

0

1

2

3

4

2003 2004 2005 2006 2007 2008 2009 2010 2011

U.S.

Euro Zone

-30

-20

-10

0

10

20

30

40

1998 2002 2006 2010

F gure 2: U.S. exports to Europe

Percentage change, year-over-year

Source: U.S. Department of Commerce

F gure 3: Eurozone nvestment n t e Un te States

In billions of dollars, 12 month moving totals

Source: U.S. Department of Treasury

-200

-150

-100

-50

0

50

100

2002 2004 2006 2008 2010 2012

14


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Te contraction in U.S. company earnings

in Europe has translated into an actual decline

in rst quarter earnings o U.S. companies in

total. While prots rom domestic businesses

rose by $41.7 billion, prots rom overseas

operations ell by $48.1 billion. For the rst

time since the ourth quarter o 2008, prots

declined by $6.8 billion (see gure 4). As a

share o GDP, prots shed 20 basis points to

12.8 percent. Tis declining share o GDP is a

reection o the growing pressures on margins

due to increased labor and regulatory costs.

As rms eel the pinch on prots, we can

anticipate that they will respond with renewed

emphasis on cost cutting in an eort to restore

margins. As a result, weakness in job growth

and business investment can be expected to

ollow the decline in protability.

Source: Bureau of Economic Analysis

0

50

100

150

200

250

2009 2010 2011 2012

F gure 4: Corporate pro tsQuarter-over-quarter change in billions of dollars


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The liquidity trap deepensAn increase in cash levels since the rst o

the year is a clear sign that the level o eco-

nomic uncertainty has risen (see gure 5).

While uncertainty over Europe has grown, so

too has concern over the scal cli aced by

the U.S. government, the uture status o health

care reorm, the uture role o the ederal gov-

ernment in regulating oil and natural gas drill-

ing, and the pace o roll out o Dodd-Frank

regulations. Banks and corporations have

responded to this growing level o uncertainty

by holding more cash.

Since the rst o the year, cash holdings by

U.S. commercial banks have risen by $129.9

billion or 8 percent. Cash as a share o total

assets has grown by 59 basis points to 13.4

percent. Beore the recession hit in late 2007,

cash holdings by commercial banks averaged

less than 4 percent.

While corporate cash took a small hit dur-

ing the recession, their stash o cash has risenby more than $220 billion since the end o the

recession to $1.29 trillion.

Te problem with banks and corpora-

tions holding more cash is that it deepens the

Federal Reserves liquidity trap. A liquidity trap

occurs when the demand or money rises and

osets the central banks eorts at increasing

money supply. Not surprisingly, the demand

or money goes up during a recession as busi-

nesses, households, and banks all attempt tohold more cash out o a ear o insolvency

or unemployment. Te banks signicantly

increased their cash holdings during the

20082009 recessionary period. Cash holdings

or both banks and corporations rose again last

year due to banking problems in Europe, and

they are rising again or much the same reason.

Source: Federal reserve board

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

2007 2008 2009 2010 2011 20120.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1988 1992 1996 2000 2004 2008 2012

F gure 5:Non-financial corporation cash holdingsIn trillions of dollars

Commercial bank cash holdingsAs a percentage of total assets


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Structural labor market problemsdampen employment growth

Te labor market remains a major drag on

economic recovery. Long-term unemployment

set records even as the economy has recovered.

Median duration o unemployment, which has

only rarely exceeded 10 weeks during the most

severe recessions, jumped to 25 weeks in mid-

2010 and remains above 20 weeks three years

into a recovery.Jobs are getting harder to nd, and more

job seekers have simply given up looking

or work. Te result has been a signicant

drop in the rate o labor orce participation.

Workers who are not looking or work are not

accounted among the unemployed. Were the

labor orce participation rate at the same level

as it was at the beginning o the recession, the

unemployment rate would be a ull 2 percent-

age points higher.

Historically, there has been

a close relationship between job

openings and the unemployment

rate (see gure 6). As the number

o job openings increased, not

surprisingly, the unemployment

rate ell. Since the beginning o this

recovery, there has been a shi in

this relationship. Given that the

labor orce participation has allen

sharply, one might suspect that it

would take ewer job openings to

drive down the unemployment rate

since a declining rate o labor orce

participation pushes down the rate

o unemployment. In act, the exact

opposite has happened.

Since the rst o the year, the rate o job

openings has averaged 2.5 percent o total

employment. In the last decade, that level o

job openings would correspond to an unem-

ployment rate o around 6 percent. During

this recovery, there has been a shi in the

relationship between job openings and the

unemployment rate. It now takes a much

higher rate o job openings to drive down the

unemployment rate. Te shi in this relation-

ship is a reection o an increased incidence ostructural unemployment.

While jobs are being created, they dont

match up with either the skills or the geo-

graphical location o the unemployed.

Reducing structural unemployment is a

dicult task that requires some combination

o retraining the unemployed and increasing

labor orce mobility.


Source: U.S. Department of Labor

Figure 6: A mismatch of skills: Job openings and the unemployment rateMonthly data

1.5

2.5

3.0

3.5

4.0

4.5

3 4 5 6 7 8 9 10

Dec 2000 - April 2009

May 2009 - April 2012

Linear (Dec 2000 - April 20009)

Linear (May 2009 - April 2012)

Unemployment rate

Job

openings

17


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A missing job creator: Newbusiness ormation

A second reason or the weak perormance

o the economy in general and employmentgrowth in particular has been the unprec-

edented low rate o new business ormation.

During the recession o 20072009, the pace

o new business creation ell to its lowest level

in more than 30 years (see gure 7). At the

same time, the pace o business destruction

rose although not nearly to the levels seen in

the 2001 or the 19811982 recessions. Given

the severity o the recession, it is surprising

that the pace o business destruction was notsignicantly higher.

Te long-term decline in new business cre-

ation is due, in part, to demographics. An older

population is going to be more risk averse

and less likely to start new businesses than a

younger population. Even though the trend

in new business creation has been downward,

the sharp all in 20082009 was unprecedented

and could reect the cost o higher levels o

business regulation.

This time really is dierent:The private sector de-levers

Over the past 80 years, deep recessions

have always been ollowed by robust recover-ies. In the rst three years o recovery rom

the Great Depression in the 1930s, real GDP

growth averaged more than 10 percent a year.

Aer the oil shock recession o 19731974, real

growth averaged 5.1 percent or the next three

years. Te double-dip recessions o the early

1980s were ollowed by three years o growth

that averaged 5.3 percent. In each case, once

the Federal Reserve began to ease credit policy,

pent-up demand in credit-sensitive segmentso the economy like housing and autos soared.

One o the big dierences between then

and now is the role o debt. In each o those

previous deep recessions, the private sector

came out o the recession in a position to take

on more debt. Tat has not been the case this

time. o the degree that the increase in debt

is a loan o uture growth to the present, debt

deleveraging is a repayment or past growth

by the present. Households, businesses, and


Source: U.S. Department of Labor

8.0

10.0

12.0

14.0

16.0

18.0

1977 1980 1983 1986 1989 1992 1995 1998 2001 2004 2007 2010

Creation Destruction

F gure 7. New us ness creat on an estruct on

As a percentage of the total number of business establishments

18


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nancial institutions have all been aggres-

sively reducing debt. While this is a healthy

and necessary development, it creates a majorheadwind or current growth.

Even with the unprecedented reduction in

debt over the past our years, debt levels today

are only back to where they were in early 2005

(see gure 8). Much o this reduction in debt

has come rom the write down o deaulted-

upon mortgages. Millions o homeowners are

still underwater. With the oreclosure rate run-

ning near record levels, a lot o mortgage debt

remains to be written down.

As banks write down the bad debt they

are carrying on their books, prots will suer

and additional capital will need to be raised

either through the sale o assets or the issuing

o more equity. Either way, banks will have less

capital to lend in the short run, which will keep

the private sector deleveraging or some time

to come. As households and businesses de-

lever, money that could have gone to current

spending is used to pay down debt. In all cases,

deleveraging leads to slower growth.

Conclusions and observationsTe U.S. economy has dodged one bullet

aer another over the past year in a successul

and unprecedented eort to avoid recession.

On a year-over-year basis, the U.S. economy

has managed to grow less than 2 percent or

our consecutive quarters. Te previous record

o less than 2 percent growth without a reces-sion was the three-quarter stretch rom Q4

2002 to Q3 2003. Every other case where less

than 2 percent growth lasted more than two

quarters was associated with a recession. With

the recession spreading in Europe, the abil-

ity o the U.S. economy to continue growing

in the ace o its our structural issues seems

increasingly unlikely.

F gure 8: Pr vate sector e t as a s are o GDP

Source: Federal Reserve Board

0%

50%

100%

150%

200%

250%

300%

350%

72 77 82 87 92 97 02 07 12

19


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Chinas policy makers continue their

balancing act. On the one hand, they want

to revive economic activity at a time when

it is slowing ar more than previously antici-

pated. o do this, they have eased monetary

policy with the goal o boosting credit-market

activity. On the other hand, they are cognizant

o the volume o potentially troubled assets

held by banks and are taking action to protect

the integrity and liquidity o bank balance

sheets. Tis, however, means some stiing o

credit activity.

Te dilemma aced by the government is

partly due to the negative impact o the crisis

in Europe. Te European Union is Chinas

largest export market and is now in a deeper

recession than was expected. Chinas exports

to Europe were up only 3.2 percent in May,

while exports to the United States were up 23

percent. Although overall export growth was

strong, it was entirely due to the United States.

Export growth would have been ar stronger i

not or the recession in Europe. Te slowdown

in exports to Europe has had a negative impact

CHINA

China: Balancing

the long term andthe short termBy Dr. Ira Kalish

20


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GeographiesChina

on industrial activity. For two months in a row,

a purchasing managers index or manuac-

turing in China has declined and been below

the critical 50.0 level, below which activity

is declining.

Another actor slowing the Chinese

economy is the lagged eect o last years

monetary policy tightening, which had a nega-

tive impact on the growth o credit, including

consumer- and housing-related credit. For

example, the automotive industry is now acing

diculties as consumers stay home and dealer

inventories pile up. Te housing market has

decelerated signicantly as wellalthough

house prices increased in May or the rst time

in 10 monthslikely reecting the impact

o lower interest rates. Te decline in hous-

ing investment has had a direct impact on

industrial activity. Finally, Chinese company

prots declined in May or the second month

in a row, reecting the pricing pressures o a

stagnant market.

Te result o all these events has been a con-

tinuing slowdown in growth, with real GDP

21


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growth declining or ve consecutive quarters.

For the past year, the government has takenaction to oset the slowdown. Tis has mostly

involved a loosening o monetary policy. First,

there were reductions in the required reserve

ratio or banks, with the goal o boosting the

volume o lending. Lately, however, the central

bank has become more aggressive, with two

interest rate cuts in June and July o this year.

Te result has been accelerated growth o the

money supply and bank credit. In addition, the

government has engaged in a more (but not too)aggressive scal policy.

Consider the act that, in 2008, ollowing the

near collapse o global nancial markets, Chinaimplemented a massive monetary and scal

stimulus in order to oset the negative impact o

weak global demand. Tat stimulus was success-

ul in osetting the collapse o export demand.

However, much o that stimulus money was

loaned by state-run banks to local govern-

ments, which spent the money on inrastructure

and other projects. oday, local governments

are having diculty servicing that debt, and

there is a general recognition that the invest-ment was excessive. Te return on much o that

Te decline in housing investment has had

a direct impact on industrial activity.

22


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GeographiesChina

investment was negative. Consequently, now

that China is slowing again, the central govern-ment is reluctant to repeat such a policy, espe-

cially given the high level o local government

debt. Instead, the central government is taking

smaller steps to boost growth: gradual easing o

credit conditions, targeted spending on some

inrastructure projects, tax incentives or con-

sumers to spend on automobiles and appliances,

and more lending to small businesses. Bigger

projects, however, are being avoided.

Given the recent history o excessive invest-ment in inrastructure and other xed assets,

the government is keen to avoid a urther

buildup o debt. Indeed, the volume o nonper-

orming loans held by Chinese banks increased

in the most recent two quartersthe rst time

since 2005 that this measure had increased or

two consecutive quarters. Consequently, while

monetary policy has been aggressive, bank-

ing regulation has been equally aggressive in

the opposite direction. Specically, the China

Banking Regulatory Commission plans to

retain the maximum loan-to-deposit ratio at

75 percent and may take other actions aimed at

constraining credit growth. In addition, the gov-

ernment has placed limits on bank lending to

local governments lest their nancial condition

worsens. Te purpose o these actions is to

reduce liquidity and deault risks. Te regula-tors are concerned that, with lower interest rates

and lower reserve requirements, the already

large number o bad assets held by banks could

increase i lending grows too quickly.

Another important action taken by the gov-

ernment has been to retard the appreciation o

the currency. While other countries have com-

plained, China has chosen to prevent urther

appreciation lest exports become less competi-

tive at a time o weak export demand. Tis, ocourse, is only a temporary measure, and it will

be in Chinas long-term interest or the currency

to rise urther in value.

Finally, one interesting reason behind the

governments reluctance to engage in more

aggressive measures to boost growth is that the

big coastal cities o China continue to experi-

ence shortages o labor. Even though actory

output has stalled, the actories still have trouble

lling their labor requirements. Tis is because

there has been a sharp decline in the volume o

migration rom Chinas rural areas to the big

coastal cities. Tis means that Chinas authori-

ties need not worry too much about social

unrest rising rom urban unemployment.

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Our article on the United Kingdom inthe last Global Economic Outlook noteda sharp rise in UK business condence and a

generally more positive tone or the economy.

We concluded, however, that macro risks

and sentiment could change swily, and thatthe United Kingdom was not out o the

woods. Tat has proved to be something o

an understatement.

It has since emerged that the United

Kingdom ell back into a double dip recession

in the ourth quarter o 2011 and the rst quar-

ter o 2012. Te economy has scarcely grown

in the last 18 months. Te level o UK output

today is 4.3 percent lower than it was on the

eve o the recession in late 2007. In the UnitedStates and Germany, output has risen over

this period. Te contraction in UK GDP since

2008 has been greater than the shrinkage in the

Spanish economy.

Many o the actors used to explain the

weakness o UK growthrom high commod-

ity prices, indebted consumers, and a ragilenancial systemafict other countries. So

why has UK growth been so slow? Part o the

explanation may lie in tighter scal policy.

According to IMF data, the squeeze on public

spending, aggravated by tax rises, has been on

par with that seen in Ireland and Spain.

But a possibly more signicant actor is

the weakness o UK consumer spending.

Household spending is 5.2 percent lower

today than in late 2007. In the United States,which has witnessed a housing market crash

United Kingdom: Backinto recessionBy Ian Stewart

UK

Ian Stewart is ChieEconomist at DeloitteResearch in theUnited Kingdom

24


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GeographiesUnited Kingdom

25


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and sharply higher unemployment, household

spending rose 2.1 percent over this period.Indeed, no industrialized country outside the

euro area periphery has suered such a erce

contraction in consumer spending as in the

United Kingdom. In part, the squeeze on UK

consumers reects the very high rates o ina-

tion being generated in the United Kingdom in

recent years.

Despite suering a deep downturn, UK

consumer prices are today almost 16 percent

higher than they were in late 2007, more than

twice as large an increase as in the United

States or Germany. But this period o ination

seems to be drawing to an end. From a peak o

over 5 percent last autumn, UK ination could

drop to as low as 1 percent by the end o 2013.

Further declines in ination should oer some

respite to consumers over coming quarters.

But just as the pressure o high ination on the

UK economy has started to ease, a major new

source o riskthe mounting crisis in the euro

areahas emerged.

Te crisis has severely aected the outlook

or growth in the United Kingdom, as well as

in other northern European economies such

as Sweden, Germany, and the Netherlands.

Te eect o economic and nancial shocks

in the euro area is being transmitted to the

rest o Europe through trade ows, nan-

cial conditions, and business condence.

Prolonged weakness in the euro area, the

United Kingdoms largest export market, posesa potent threat to hopes o export-led recovery.

UK business sentiment has zigzagged

over the last year, driven by events in Europe.

According to Deloittes 2012 CFO Survey,

condence among UK chie nancial ocersplummeted on the gathering euro crisis in the

second hal o 2011, rose in March 2012 as the

European Central Bank injected liquidity into

the banks, and in June registered its sharpest

decline since the survey started in 2007. CFOs

now see an average probability o 36 percent

that one or more countries leave the single

currency by the end o this year, up rom 26

percent in March.

UK policymakers responded to these chal-

lenges by announcing a urther 50 billion o

quantitative easing (QE) on July 5, taking the

total program o money creation to 375 bil-

lion. With UK government bond yields already

at historic lows, the eects o this urther

round o QE are likely to be limited. We do not

see signicant scope or a relaxation o scal

policy. Te government has been adamant on

its program o scal consolidation, and a major

change here would represent a political deeat

on a core element o coalition policy. Te gov-

ernment does, however, seem likely to use its

low cost o borrowing to subsidize lending to

the private sector, although the scale and eec-

tiveness o such policies can only be guessed at.

Te heavy liing o macro policy seems likely

to come rom urther rounds o QE, coupled

with attempts to improve the availability and

price o credit. Such measures will not be able

to ully oset the dampening eect o the euro

crisis. Even outside the euro area, the outlookor UK growth over coming quarters will hinge

critically on events in Europe.


26


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GeographiesUnited Kingdom

Indeed, no industrialized country outside the euro

area periphery has suered such a erce contraction

in consumer spending as in the United Kingdom.

27


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Japans economy seems to be on a dizzy-ing roller coaster ride. In 2011, the economyexperienced negative growth. Ten, in the

rst quarter o 2012, the economy grew at an

annual rate o 4.1 percent, one o the best rates

o growth o any developed economy. Now

there is ear that the economy may actuallycontract again in the second quarter. What is

going on?

o begin, the recession o 2011 was largely

the result o the March 2011 earthquake and

tsunami. Recovery was always bound to come

eventually. Ten the very strong growth in the

rst quarter o 2012 was a bit deceptive. More

than hal the growth stemmed rom strong

consumer spending, especially purchases o

automobiles. Yet this growth was boosted bytemporary government incentives that have

since expired. Business investment actually

declined in the rst quarter, and exports were

at. So the strong perormance did not repre-

sent a sustainable burst o activity.

Heading into the second quarter, it is

increasingly apparent that the strong growth

o consumer spending will not be repeated.In act, retail sales in April declined rom the

previous month. Te automotive incentives are

gone. Business investment, on the other hand,

is expected to grow due to reconstruction

spending. Te latest ankan survey o business

sentiment reveals improved condence on the

part o Japanese business executives, especially

in the nonmanuacturing sector. Exports grew

at a strong pace in April, largely because o the

very strong growth o exports to the UnitedStates. Exports to Europe and China, on the

Japan: A roller coaster rideBy Dr. Ira Kalish

JAPAN

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GeographiesJapan

29


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other hand, have altered. As Europe contin-

ues to slide, it is likely that Japans exports to

Europe will continue to decline. Meanwhile,

imports o energy continue to grow due to

the ongoing idling o Japans nuclear reactors.

Consequently, the deteriorating trade balance

could make a negative contribution to eco-

nomic growth in the second quarter.

As or the coming

year, there are a number

o actors that will inu-

ence the perormance

o the Japanese econ-

omy. O course, recon-

struction spending will

have a strong positive

impact, and the slow-

down in Europe and

China will have a strong

negative impact. What

other actors will makea dierence? Monetary

policy has been rela-

tively aggressive com-

pared to recent Japanese

history. On the other

hand, monetary policy

has been relatively reti-

cent compared to that o some other countries.

Indeed, a debate is raging over whether the

degree o quantitative easing (asset purchasesby the central bank) undertaken so ar is su-

cient. Quantitative easing (QE) is intended

to boost expectations o ination, thereby

reducing real interest rates. Recently, there

have been several rounds o increased QE. One

measure o successul QE is whether ination

has increased. In Japan, ination has increased

only slightly, and it appears that expectations

have barely moved. Another measure o QE

is the impact on the exchange rate. While the

yen initially depreciated at the start o each

round o QE, it appreciated thereaer, but

there has been no sustained eect on the yen.

Consequently, it is

reasonable to say that

QE has not yet had its

intended impact. Will

the Bank o Japan do

more? Te answer is

that we dont know.

Another actor

inuencing the econ-

omy will be govern-

ment scal policy. For

now, the government

is intent on raising thenational sales tax, rst

rom 5 to 8 percent next

year, then rom 8 to 10

percent in 2015. Te

purpose is to close the

long-term budget gap

that will result rom

the pension and health costs associated with

an aging population. Fiscal consolidation is

unambiguously a good ideaat least in thelong run. Te problem, however, is that the tax

increase is intended to take place in the short

runwhich could stie growth. Tere has

been a huge national debate about this, with

one action o the ruling party opposing the

As o writing this

outlook, it is not

clear whether the

tax increase will

actually become law.

I it does, expect anegative impact on

growth in 2013

30


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GeographiesJapan

prime ministers proposed tax increase with

such vehemence that it has decided to leave the

party. As o writing this outlook, it is not clear

whether the tax increase will actually become

law. I it does, expect a negative impact on

growth in 2013.

Finally, an important actor that will inu-

ence growth will be the value o the yen. O

course, monetary policy will play a role, but

there are other inuences as well. Lately, Japan

has been seen as a sae haven or investors

despite the act that Japans sovereign debt

is more than 200 percent o GDP. Investors

recognize that the debt is sustainable, mostly

held domestically, and that Japan has a stable i

dysunctional political system. Te extremely

low return on Japanese sovereign debt reects

the act that investors have great condence in

Japan. Te very high value o the yen reects

this as well. At a time o great uncertainty,

especially concerning the uture o Europe,the sae-haven aspect o Japan has led to an

uncomortably high value o the yen. Tis in

turn has hurt export competitiveness. Tus,

the two actors that are most likely to inuence

the yen are events in Europe and decisions

made by the Bank o Japan. Neither can be

easily predicted.

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While the global macroeconomicenvironment is contributing to Indiasdecelerating growth, everyone knows that

Indian GDP woes are at least partly sel-

inicted. Te economy has been badly hurt by

a dearth o market-riendly economic policies.Moreover, bureaucratic reluctance to make

key decisions amid ears o gra charges is

resulting in a state o policy inertia. In act,

some o the governments policy actions may

have done more harm than good. For example,

the proposal to tax cross-border transac-

tions involving the transer o Indian assets

resulted in widespread concern among inves-

tors and pushed the government into damage-

control mode.

Slipping awayTere is little doubt that the pace o eco-

nomic expansion has slowed signicantly.

Indias economy grew at 5.3 percent in the

quarter that ended in March 2012, its low-

est rate in seven years. Te growth rate or

the 20112012 scal year came in at 6.5

percent, substantially lower than the 8.5

percent achieved a year earlier in 20102011.

Agriculture, the single largest employer in the

country, grew at a dismal 1.7 percent in the

last quarter o 20112012. Poor growth in the

agriculture sector will likely impact the entire

economy because rural consumption is a major

contributor to GDP growth. Less money in the

hands o the rural consumers will signicantlyconstrain their purchasing power.

India: Losing its wayBy Pralhad Burli

INDIA

Pralhad Burli is SeniorAnalyst at DeloitteResearch, India

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GeographiesIndia

33


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In addition, growth in the industries and

the services sector was lower than expected.

In the last quarter o the 20112012 scal year,

the industries and the services sector grew at

1.7 and 7.9 percent respectively compared to

7.0 and 10.6 percent during the same period

in the previous year. Te manuacturing sector

contracted 0.3 percent aer a 7.3 percent

expansion over the same period a year ago.

Furthermore, the corporate sector experi-

enced one o its worst decelerations in recent

times. Declining external demand added

to the woes o export-oriented industries.

Lower demand or Indian goods abroad and

domestic weakness are weighing heavily on

business sentiment.

Meanwhile, interest rates are high, and

borrowing costs remain elevated, resulting in

a drag on business investment. However, the

Reserve Bank o Indias (RBIs) mid-quarter

monetary policy review suggests that the eec-

tive lending rate remains lower than levels seen

between 2003 and 2008 when India managed

robust growth. Tis suggests that Indias high

interest rates are not the only drag on the

countrys GDP.

Government proposes, andopposition disposes

One o most anticipated policy reorms

pertaining to Indias $450 billion retail market

has been marred by roadblocks. Te govern-

ment decided to allow 51 percent oreign direct

investment (FDI) in multi-brand retail, which

would have paved the way or global retail

giants to enter the Indian market. However,sti opposition and widespread protests orced

the government to backtrack. Meanwhile,

the government has allowed 100 percent FDI

in single-brand retail. Similarly, the govern-

ment was orced to deer the Pension Fund

Regulatory and Development Bill. With little

support rom the other parties that orm

the coalition and a vocierous opposition,

34


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GeographiesIndia

F gure 1: Rupee-Do ar exc ange rate

Source: Oanda.com

50

51

52

53

54

55

56

57

Mar 27

2012

Apr 11

2012

Apr 26

2012

May 11

2012

May 26

2012

Jun 10

2012

Jun 25

2012

INR/USD

proposals or allowing higher FDI in insur-

ance, deense, and aviation may be urther

delayed. Other key reorms are unlikely to see

the light o day anytime soon.

A rock and a hard placeIn its monetary policy review meeting

in June 2012, the RBI kept its policy rates

unchanged even though the markets expecteda rate cut. Clearly, the RBI is more concerned

about high ination than lackluster GDP

growth. Tere could be two reasons or the

current stance. First, the RBI surprised the

market with a larger-than-expected rate cut in

April, so it held back this time around. Second,

the RBI believes that the role o interest rates

in holding back investment is relatively small

in the current environment. As such, a reduc-

tion in interest rates could heighten ina-

tionary pressure, which is lingering at airly

elevated levels.

Te RBI will continue to closely moni-

tor both external and domestic actors, and

it will likely ocus on reining in ination and

managing liquidity. Te choices beore the

RBI are limited, and its policy decisions will

likely be heavily inuenced by the growth-

ination dynamic.

35


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When will it stop?Te Indian rupee (INR) has been one o

the worst perormers among the BRIC cur-

rencies, setting record lows almost every

other week. Te rupee experienced signicant

volatility, alternating between periods o rapid

decline and mild recoveries. Between April 1,

2012, and June 20, 2012, the rupee uctuated

between $51.19 and $56.49a decline o over

10.3 percentbeore recovering to $55.86. OnJune 19, the value o the rupee against the U.S.

dollar ell 1.1 percent in a single day. As o this

writing, the rupee has once again embarked on

a depreciating path (see gure 1).

Tere are several reasons why the rupee has

been under pressure over the past ew months.

Amid uncertain global macroeconomic condi-

tions, investors tend to ock to saer assets.

Tis predisposition resulted in a huge outow

o unds rom India. Furthermore, European

banks will likely continue to deleverage, exert-ing pressure on the rupee. Indias widening

trade decit is another actor that contrib-

utes to the slide o the rupee as importers

demand more oreign currency to pay or their

purchases, resulting in a downward spiral. In

addition, India runs a decit on its current

account and requires external capital ows to

bridge the gap. Dismal economic perormance

and the possibility o weak exports while the

Eurozones crisis deepens and Chinese growth

decelerates are chipping away at investor con-

dence. As a result, India is unable to attract

sucient FDI inows. Finally, Indias oreign

exchange reserves, although sucient to pay

or over six months o imports, are not largeenough to allow the reserve bank to requently

intervene in the oreign exchange market. In

times o excessive volatility, the reserve bank

has intervened in the oreign exchange market,

but its ability to stem the slide

has been compromised.

Instead, the RBI initiated

measures to restrict the rupees

declining value. First, the RBI

relaxed the interest rate ceilingon oreign currency non-resi-

dent (FCNR) deposits. Second,

it allowed higher limits on intra-

day trading. Tird, on May 10,

2012, the RBI instructed exporters to liquidate

50 percent o the dollars in their accounts

within two weeks to help release greenbacks

into the market. Furthermore, exporters were

mandated to exhaust the available dollar bal-

ance in their accounts beore tapping markets.

Finally, the government deerred a controver-

sial set o tax proposals, which brought some

relie to the rupee by stemming the ight o

capital. Improving investor sentimenteither

Te Indian rupee (INR) has been

one o the worst perormers among

the BRIC currencies, setting recordlows almost every other week.

36


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GeographiesIndia

because o a avorable development in Europe

or breakthrough policy decisions in India

could potentially reverse the rupees downward

trend against the dollar. Te others measures

will, at best, have a temporary impact.

Not surprisingly, rating agencies made

downward revisions to their outlooks on

India and suggested that the countrys sover-

eign credit rating aces the prospect o being

downgraded to junk status. Markets did not

respond negatively to the news, but India islikely to conront a spate o challenges in the

coming months. Owing to a huge subsidy bill,

the government is nding it extremely dicult

to bridge the scal gap. Furthermore, a rising

import bill urther exacerbated its current

account decit. Additionally, ongoing ina-

tion suggests that India may need to address

structural macroeconomic actors rather than

simply relying on monetary policy. Moreover,

the political situation does not bode well or

the countrys growth prospects. India will

experience slower GDP growth in the com-

ing quarters, and growth orecasts or the

20122013 scal year range between 6.0 and6.5 percent.

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Ater real GDP grew 4.3 percent in 2011,

rst-quarter GDP was up 4.9 percentrom a year earlier. Tis was the result o strong

consumer spending and elevated oil prices.

Ten, in the second quarter, things started to

change. First, Europes recession deepened,

negatively aecting export revenue or Russia.

Second, Chinas economy slowed, which also

had a negative impact on exportsespecially

given that China is Russias largest export

market aer the European Union. Tird, the

price o oil dropped substantially, also reducing

export revenue. Fourth, the crisis in Europecontributed to a renewed ight to saety among

global investors, which included capital ight

rom Russia. Tis had an adverse eect on

business investment. Indeed, business invest-

ment as a share o GDP in Russia is low relative

to most emerging markets. Failure to invest not

only reduces current growth; it also has a nega-

tive impact on uture growth.

Russia: External headwindsslow growthBy Dr. Ira Kalish

RUSSIA

Te Russian economy started 2012 on a positive note. Yet Russia is no more immune to the inu-

ences o the global economy than the other BRIC nations, and may be even more vulnerable. With

Europe in crisis, China slowing, and oil prices declining, it is likely that growth in 2012 will be

signifcantly slower than in 2011.

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GeographiesRussia

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Positive inuencesSome positive actors contribute to

the outlook or Russia: Consumer spend-

ing has remained reasonably robust, the

result o strong real-wage gains, tax incen-

tives, strong growth o consumer credit,

and pent-up demand. Retail sales have been

particularly strong.

In addition, ination lately has been sur-

prisingly low. In April, consumer prices were

up only 3.6 percent rom a year earliera

post-Soviet record low. Tis increase helps to

boost real wages. It also provides the centralbank with some wiggle room to loosen mon-

etary policy without worrying about ination.

On the other hand, ination was temporarily

suppressed by some price controls. As these are

removed, it is widely expected that ination

will rebound.

Finally, the recent high price o oil enabled

the government to run a decit much smaller

than anticipated. Tis provided the govern-

ment with room to engage in a modest degreeo stimulus through increased spending.

Indeed, the government intends to boost

investment in public inrastructurepartly as

a way to oset the deceleration in private-sec-

tor investment. On the other hand, the recent

drop in the price o oil means that the role o

scal policy in boosting growth could be com-

ing to an end.

Negative inuencesTere are many actors that will retard

growth in the coming year. Naturally the

troubles in Europe and the slowdown in China

are top o mind, as is the drop in the price o

oil. Te impact on the industrial sector has

been considerable. In April, industrial produc-

tion was only 1.3 percent higher than a year

earlier, having decelerated substantially rom

2011. In addition, investment remains weak

due to political uncertainty, worries about

the Eurozone situation, and capital ight. Te

latter has been driven by the global ight tosaety as well as by political uncertainty within

Russia. Not only does capital ight inuence

the level o investment, it also has the eect o

depressing the value o the ruble. While the

ruble was riding high during the period o

rising oil prices, lately it has come under pres-

sure. Tis in turn will stymie the ability o the

central bank to ease monetary policy urther.

Aer all, the central bank might eel compelled

to intervene in currency markets in order tostabilize the ruble.

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GeographiesRussia

Risk

Perhaps the biggest risk to Russia comesrom the Eurozone situation. o determine

the vulnerability o Russias nancial system to

Europe, the central bank recently conducted

stress tests on Russias top banks, analyzing

the impact o GDP growth o 2 percent and a

1520 percent decline in the price o oil. Te

central bank concluded that such a scenario

would lead banks to lose roughly one-quarter

o their capital. Tis suggests that a more

severe drop in economic growth and the price

o oil could have a devastating impact on the

health o Russias nancial system.

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Anumber o things have changed inBrazil recently. In our last quarterlyreport, we noted that Brazils leaders were con-

cerned about upward pressure on the currency

stemming rom an abundance o portolio

capital owing into the country. Now they are

concerned about downward pressure on the

currency and a ight o capital. In early 2012,

Brazil seemed headed or a modest decelera-

tion in growth. Now Brazils economy appears

headed or a considerable slowdown, the result

o strong headwinds rom Europe.

Let us begin by considering the capital

market situation. wo things have changed

in the past ew months. First, global markets

have been spooked by tremendous uncertainty,

mainly about the uture o the Eurozone. As

such, there has been a general ight to saety.

Brazil is not alone among emerging countries

in experiencing a ight o capital heading

to perceived sae havens. Te United States,

Japan, Switzerland, and the United Kingdom

have all been the recipients o capital looking

or saety. Second, Brazils central bank, like

those o several other emerging countries, has

signicantly cut its benchmark interest rate in

order to stimulate sagging economic activity.

Indeed, in the past year, the benchmark rate

has been reduced by 400 basis points. Te

eect, o course, is to make the country less

Brazil: Shiting capital

ows, slowing growthBy Dr. Ira Kalish

BRAZIL

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GeographiesBrazil

43


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44


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Brazil

attractive to oreign portolio investors who

are in search o higher returns. Consequently,

Brazil is no longer attracting vast amounts

o portolio capital. Te end result has been

downward pressure on the currency. While

that is a good thing rom the perspective o

exporters, it has the potential to boost ination

beyond the already uncomortably high level.

Next, what about growth? On the negativeside, the industrial sector has begun to witness

declining activity. Te latest purchasing man-

agers index ell below the critical 50.0 level,

below which activity is believed to be alling.

Tis is due largely to the impact on exports

rom the slowdown in Europe and China.

Moreover, the crisis in Europe has probably

had a negative impact on business condence

and willingness to take risks. Te result has

been a sizable slowdown in the growth o over-all economic activity.

On the positive side, Brazil has experienced

strong consumer spending growth, which

has helped to oset the negative impact on

industrial output stemming rom the Eurozone

crisis. In part, this spending has been ueled

by consumer borrowing, itsel due to the

attractiveness o historically low interest rates.

Unortunately, consumers have borrowed a bit

more than they can handle. Te result has beena sizable increase in the deault rate on con-

sumer loans, especially automotive loans. Tis

is likely to dampen consumer borrowing and

spending going orward. Moreover, banks have

tightened lending standards aer witnessing an

increase in their rate o nonperorming loans.

Tus, the boom in consumer spending may be

coming to an end.

Te tightening o bank lending standards

also means that the impact o lower interest

rates is being negated. I banks are reluctant

to lend, lower ocial rates will not matter.

Indeed, the rate o private-sector credit expan-

sion has decreased recently. o deal with thisand oset the private-sector credit crunch, the

government is stepping in with more subsi-

dized loans or private-sector companies.

Tere are a number o reasons to be

cautiously optimistic about Brazils likely

perormance in the coming year. First, the

central bank has managed to aggressively ease

monetary policy while retaining its credibility

regarding ination. Second, the governments

nances are in reasonably good shape. Terecent announcements o modest scal stimu-

lus are not likely to seriously impair Brazils

scal probity or shake nancial markets. Tird,

the banking system is believed to be reason-

ably robust; consequently, the rise in the rate o

nonperorming loans is not expected to endan-

ger the health o major banks. Finally, Brazils

upcoming hosting o the World Cup (2014)

and Summer Olympics (2016) is expected to

boost the level o investment and, thereore,contribute to aster growth.

Barring a disintegration o the Eurozone,

Brazil is expected to experience acceleration in

economic growth by 2013.

Geographies

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Appendix

75

80

85

90

95

100

1

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

Jan

09

May

09

Sep

09

Jan

10

May

10

Sep

10

Jan

11

May

11

Sep

11

Jan

12

Mar

12

-4

-2

0

2

4

68

10

12

14

16

Jan09

May09

Sep09

Jan10

May10

Sep10

Jan11

May11

Sep11

Jan12

Mar12

-3

-2

-1

0

1

2

3

4

5

6

Jan09

May09

Sep09

Jan10

May10

Sep10

Jan11

May11

Sep11

Jan12

Mar12

-15

-10

-5

0

5

10

15

20

Q107

Q207

Q307

Q407

Q108

Q208

Q308

Q408

Q109

Q209

Q309

Q409

Q110

Q210

Q310

Q410

Q111

Q211

Q311

Q411

Q112

-12

-10

-8

-6

-4

-2

0

2

4

6

8

Q107

Q207

Q307

Q407

Q108

Q208

Q308

Q408

Q109

Q209

Q309

Q409

Q110

Q210

Q310

Q410

Q111

Q211

Q311

Q411

Q112

U.S. JapanU.K. Eurozone Brazil RussiaChina India

Brazil RussiaChina IndiaU.S. JapanU.K. Eurozone

GBP-USD Euro-USD USD-Yen (RHS)

USD-Yen

*Source: Bloomberg

GDP growth rates YoY % *

Major currencies vs. the U.S. dollar*

GDP growth rates YoY % *(Note: India's fiscal year is April-March)

Inflation rates (YoY %)* Inflation rates (YoY %)*(Note: Inflation data for India is based on the WPI)

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Appendix

Yield curves (as on April 6, 2012)*

U.S. TreasuryBonds & Notes

UKGilts

Eurozone Govt.Benchmark

JapanSovereign

Brazil Govt.Benchmark

ChinaSovereign

India Govt.Actives Russia

3 mo 0.09 0.35 -0.02 0.10 7.75 2.78 8.18 5.80

1 Y 0.18 0.23 0.01 0.10 7.41 2.23 8.03 6.38

5 Y 0.62 0.59 0.32 0.18 8.97 2.74 8.03 7.94

10 Y 1.49 1.54 1.25 0.77 9.82 3.26 8.12 8.56

Composite median GDP forecasts (as on July 12, 2012)*

U.S. UK Eurozone Japan Brazil China Russia

2012 2.1 0.1 -0.4 2.5 2.7 8.2 3.8

2013 2.2 1.5 0.7 1.4 4.5 8.4 3.7

2014 2.9 2.0 1.3 1.05 4.05 8.0 3.8

Composite median currency forecasts (as on January 9, 2012)*

Q3 12 Q4 12 Q1 13 Q2 13 2012 2013 2014

Gbp-usD 0.8 0.8 0.79 0.79 0.8 0.79 0.78

eo-usD 1.24 1.23 1.24 1.25 1.23 1.25 1.28

usD-Y 99 100 101.5 104 100 102 109.5

usD-bz r 2 1.97 1.74 1.94 1.97 1.9 1.83

usD-C Y 6.32 6.3 6.12 6.21 6.3 6.15 6.11

usD-id r 56 54.5 49 52.75 54.5 50 51

usD-r r 32.55 32 31.91 32.1 32 31.55 31.89

OECD composite leading indicators (Amplitude adjusted)

U.S. UK Eurozone Japan Brazil China India Russia

J 10 99.92 101.79 100.87 99.99 101.04 100.99 101.43 100.43

ag 10 99.93 101.67 100.98 100.02 101.02 101.00 101.37 100.94

s 10 100.01 101.61 101.10 100.09 101.07 101.17 101.32 101.45

Oc 10 100.16 101.60 101.24 100.20 101.18 101.43 101.26 101.93

nov 10 100.36 101.62 101.38 100.36 101.26 101.64 101.15 102.34

Dc 10 100.58 101.65 101.50 100.53 101.29 101.72 101.02 102.65

J 11 100.78 101.66 101.59 100.66 101.22 101.66 100.80 102.79

11 100.91 101.65 101.61 100.73 101.05 101.49 100.49 102.81

m 11 100.94 101.59 101.57 100.72 100.84 101.30 100.11 102.67

a 11 100.87 101.46 101.45 100.65 100.55 101.09 99.69 102.43

my 11 100.72 101.25 101.27 100.54 100.19 100.92 99.29 102.18

J 11 100.51 100.96 101.03 100.45 99.74 100.78 98.97 101.99

J 11 100.29 100.59 100.75 100.39 99.26 100.67 98.74 101.83

ag 11 100.12 100.20 100.45 100.35 98.83 100.55 98.60 101.74

s 11 100.08 99.85 100.18 100.34 98.48 100.43 98.54 101.73

Oc 11 100.19 99.59 99.96 100.40 98.22 100.28 98.56 101.78

nov 11 100.42 99.46 99.81 100.51 98.07 100.12 98.62 101.87

Dc 11 100.70 99.45 99.73 100.63 98.07 99.94 98.63 101.95

J 12 100.95 99.53 99.69 100.75 98.22 99.79 98.55 101.98

12 101.12 99.62 99.67 100.83 98.49 99.68 98.40 101.91

m 12 101.17 99.69 99.65 100.85 98.77 99.54 98.18 101.60

a 12 101.11 99.71 99.61 100.81 98.99 99.37 97.97 101.04

my 12 100.94 99.69 99.55 100.71 99.15 99.22 97.79 100.32

*soc: boog miCeX Source: OCeD

no: a g Cli dg o o cooc xo dx ov 100 d covy ow 100. a Cli wc dcg o o cooc

dow ov 100 d owdow ow 100.

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Additional resources

Deloitte Research Thought Leadership

Deloitte ReviewIssue 11

From mad man to superwoman: Te inevitable rise o the chie marketing ocer in the age o the

empowered customer.

Cloud wars: How incumbents can respond to cloud disruption.

Te engagement economy: How gamication is reshaping businesses.

Te Ito actor: In the digital startup world, Joi Ito is a bona de rock star, but the outspoken entrepreneur

aces his biggest challenge yet in revitalizing MIs venerable Media Lab.

Pulling ahead vs. catching up: rade-ofs and the quest or exceptional protability.

Asia Pacifc Economic Outlook: China, India, Singapore, and Tailand.

GovCloud: Te uture o government work

Please visit www.deloitte.com/research or the latest Deloitte Research thought leadership or contact

Deloitte Services LP at: [email protected].

For more inormation about Deloitte Research, please contact

John Shumadine, Director, Deloitte Research, part o Deloitte Services LP,

at +1 703.251.1800 or via e-mail at [email protected].

July2012

Asia Pacifc

Economic

OutlookInthIsIssue:

China

India

Singapore

Thailand

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Appendix

Contact inormationGlobal Economics TeamRyan AlvanosDeloitte ResearchDo svc lpusat: +1.617.437.3009-: [email protected]

Pralhad BurliDeloitte ResearchDo svc lpidt : +91.40.6670.1886-: @do.co

Dr. Alexander BrschDeloitte & Touche GmbHGermanyTel: +49 (0)89 29036 [email protected]

Dr. Ira KalishDeloitte ResearchDo svc lpusat: +1.213.688.4765-: [email protected]

Dr. Carl SteidtmannDeloitte ResearchDo svc lpusat : +1.303.298.6725-: [email protected]

Ian StewartDeloitte ResearchDo & toc llpuKt: +44.20.7007.9386-: [email protected]

U.S. Industry LeadersBanking & Securities andFinancial Services

ro Co

Do llpt: +1 212 436 2043-: [email protected]

Co & id podc

Craig GifDo llpt: +1.216.830.6604-: [email protected]

h p d hscc & Gov

John BigalkeDo llpt: +1.407.246.8235-: [email protected]

pow & u degy & roc

Jo mcC

Do llpt: +216 830 6606-: [email protected]

pc sco (d)

Robin Lineberger

Do Cog llpt: +1.517.882.7100-: [email protected]

pc sco (s)

Bob CampbellDo Cog llpt: +1.512.226.4210-: [email protected]

tcoco, md& tcoogy

ec Ow

Do llpt: +1 714 913 1370

-: [email protected]

Global Industry LeadersConsumer BusinessLawrence HutterDo llpuKt: +44.20.7303.8648-: @do.co.k

Energy & ResourcesPeter BommelDo ndndt: +31.6.2127.2138-: o@do.

Financial ServicesChris HarveyDo llpuKt: +44.20.7007.1829-: [email protected]

Lie Sciences & Health CareRobert GoDo Cog llpusat: +1.313.324.1191-: [email protected]

ManuacturingHans RoehmDo & toc GhGyt: +49.711.16554.7130-: [email protected]

Public SectorGreg PellegrinoDo Cog llpusat: +1.571.882.7600-: [email protected]

Telecommunications, Media

& TechnologyJolyon BarkerDo & toc llpuKt: +44 20 7007 1818-: [email protected]

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