Global scenario service - Oxford Economics · 2012. 11. 30. · Global scenario service December...

Global scenario service December 2011

Contents

Executive Summary.................................. ................................................ 1

1 Overview .......................................... ................................................ 5

2 Baseline scenario ................................. ........................................... 6

3 Disorderly Eurozone default ....................... .................................. 11

4 China hard landing ................................ ........................................ 17

5 Corporate reawakening ............................. .................................... 21

6 Conclusion ........................................ ............................................. 26


1

Executive Summary

The global economic outlook has worsened in recent months and we have further downgraded our GDP forecasts. In particular, the Eurozone financial crisis has continued to intensify, despite a number of attempts by EU leaders to stem it.

Financial conditions in the Eurozone have deteriorated so far that the prospect of a breakup has become a genuine threat. The possible failure by Italy and Spain to refinance €180 billion in government debt by March now poses the largest single source of risk to global financial stability. Eurozone banks have started to tighten lending conditions, and the financial crisis has spilled over into the real economy. We now estimate that the Eurozone re-entered recession in 2011Q4, with zero GDP growth forecast in 2012 as a whole.

Furthermore, the economic picture in the emerging markets has also weakened, which will limit the prospects for EU exports. Recent PMI data in China have been disappointing with both the manufacturing and services PMI dropping in November to the lowest level since February 2009. Elsewhere, Q3 GDP data for Brazil showed zero growth and India has seen a sharp slowdown in industrial output investment. We have cut our forecast for growth in India to 6.8% for 2012 from 8.1% three months ago and for Brazil to 3.1% from 4.5%. World growth (at PPP) is now seen at 3.4% in 2012, down from 4%.

A brighter spot in the global economy is in the US where recent data releases have generally outperformed expectations. However, the pace of the US recovery remains moderate, held back by weakness in the housing market and high household debt. We forecast GDP growth at just 2.4% for 2012, after 1.7% in 2011. Furthermore, the US is still at risk from a further deterioration in global financial conditions.

As 2012 approaches, the global economy is at a dangerous juncture. The risks around our central forecast look heavily skewed to the downside. Radical changes in policy look necessary to preserve the Eurozone, including a much expanded effort by the ECB. We currently place a probability of just 45% on our central forecast.

Disorderly Eurozone default

We assign a 30% probability that the Greek debt restructuring does not happen in a relatively orderly manner. In this case, a whole range of scenarios are possible, ranging from multiple disorderly defaults within the Eurozone to a Greek exit of the Eurozone to a wider euro breakup. In this report, we focus on a broader set of countries exiting the Eurozone. We place a 10% probability on this more extreme scenario.

The failure to agree a credible and permanent solution to the crisis leads financial and business confidence to collapse. Italy and Spain are unable to refinance debt maturing in early 2012, which triggers a series of disorderly defaults. With the peripheral economies unwilling to accept even greater austerity measures, the Eurozone breaks apart. Five economies – Greece,


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Portugal, Ireland, Italy and Spain – leave the euro in early 2012 and establish new national currencies.

The exiting countries see their new currencies depreciate sharply, while the residual euro appreciates. The introduction of new currencies causes huge economic disruption and significant implementation costs, and the newly independently operating central banks do not raise interest rates to a level which would prevent a surge in inflation because of the fragility of their economies. The series of defaults has a significant impact on banks’ balance sheets across the world, causing interbank markets to freeze up in a similar way seen in the aftermath of Lehman Brothers and leading to a severe credit crunch.

In this scenario, the five exiting countries suffer a decline in GDP, relative to the baseline, of 12-19% in 2012-13, while the core Eurozone countries suffer a decline averaging around 10% by end-2013. US GDP growth slows to just 0.7% in 2013, with a weaker dollar mitigating the effects of weaker global growth, but the UK suffers a more severe downturn because of its closer trade and financial links with the Eurozone, with GDP about 5% below baseline by end-2013. Growth in China slows to about 6½% a year in 2012 and 2013.

Interest rates rapidly fall to near zero in most of the major economies and remain there until 2014 as central banks attempt to offset the impact of the financial shock on growth and prevent a deflationary spiral.

China hard landing

Overheating concerns have subsided in emerging markets and the main concern now appears to be a China hard landing, stemming from financial imbalances and an over-inflated property sector. The scale of the credit stimulus the government pursued in 2009 and early 2010 to help China through the global financial crisis has raised concerns about the robustness of the banking sector and, in particular, about contingent liabilities to local government investment vehicles.

These concerns would be aggravated if exports slowed sharply or poor returns to infrastructure investment at the local level threatened local government finances and the profitability of the industrial sector. This could lead to a sharp increase in non-performing loans (NPLs). A surge in NPLs and a deterioration in banks’ balance sheets in China would freeze the amount of credit available to the banking system for investment. In addition, the risk premium in China would rise, pushing up the cost of borrowing. As a consequence, investment would fall sharply, hitting GDP growth and leading to lower employment, which would subsequently weigh on consumption.

Another trigger for banking sector stress is the property market. Over-capacity in the commercial property market could lead to a sharp correction, and the resulting increase in perceived risk could lead to a more generalised fall in asset prices. The property sector accounts for a significant portion of total investment flows in China and a sharp correction in this sector would reduce investment, resulting in lower employment and growth.


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Knock-on effects onto business and consumer confidence from a collapse in the property sector would likely further depress demand, leading to a hard landing for GDP growth. In this scenario, Chinese GDP growth would fall to around 6.6% next year and to below 5½% in 2013.

Weakened prospects for Chinese exports have caused us to raise the probability on this scenario to 15%, from 10% three months ago. Still, this is a relatively low probability, as we anticipate that the Chinese authorities will be able to respond more aggressively to slowing growth. Already, the central bank has cut reserve requirements for Chinese banks to ease credit conditions in the slowing economy.

The impact of a Chinese hard landing on the rest of the world would be noticeable through trade linkages and financial contagion, although the inevitable sharp drop in commodity prices would mitigate some of the impact. In this scenario we would expect the US to grow by around 2.2% in 2012 and 1.8% in 2013 and Eurozone GDP would fall by around 0.3% in 2012 and grow by just 0.8% in 2013.

Corporate reawakening

On the upside, credible plans to deal with fiscal stresses are developed and an easing of tensions in the MENA region leads to oil prices falling back. This encourages the corporate sector to invest and boost its workforce, as well as easing pressure on the purchasing power of households. Industrialised countries will lead the way, with beneficial spillover effects on emerging markets. We attach a relatively low probability of 10% to this scenario.

In developed countries, the corporate sector has built up large financial surpluses and, in this scenario, the restructuring of the global financial system and stability brought about by fiscal consolidation lead business to spend these funds quicker than in the baseline rather than paying down debt as seems to be the case currently. This enhances confidence in industrialised economies, leading to a quick recovery in demand. In this scenario, US GDP would grow by 3.2% in 2012 and accelerate to 4.0% in 2013, whereas in the Eurozone economic activity would expand by around 0.6% next year and 2.2% in 2013.


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Figure 1: map of downside risks

Figure 2: Summary scenario results

2009 2010 2011 2012 2013

Oxford Forecast (45%)US -3.5 3.0 1.7 2.4 2.6Eurozone -4.2 1.8 1.6 0.0 1.3China 9.2 10.4 9.0 8.1 9.1World 2005 PPP -1.0 4.6 3.7 3.4 4.5

Eurozone break-up (10%)US -3.5 3.0 1.7 1.7 0.8Eurozone -4.2 1.8 1.6 -4.6 -3.1China 9.2 10.4 9.0 6.6 6.7World 2005 PPP -1.0 4.6 3.7 1.5 2.3

China hard landing (15%)US -3.5 3.0 1.7 2.2 1.8Eurozone -4.2 1.8 1.6 -0.3 0.8China 9.2 10.4 9.0 6.6 5.3World 2005 PPP -1.0 4.6 3.7 2.9 3.3

Corporate reawakening (10%)US -3.5 3.0 1.7 3.2 4.0Eurozone -4.2 1.8 1.6 0.6 2.2China 9.2 10.4 9.0 9.4 10.1World 2005 PPP -1.0 4.6 3.7 4.1 5.6

Alternative GDP growth forecasts

Gov

ernm

ent s

tres

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�Disorderly Eurozone default (30%)■ Eurozone (EZ) authorities fail to agree

on a credible solution to tackle the crisis■ Pushes one or more country into a

disorderly default■ Run on banks, share prices plunge,

credit conditions tighten■ Business and consumer confidence

dives, deep recession ensues■ 10% probability on a full EZ break-up

Corporate stress

�China hard landing (15%)■ Commercial property crash &

external weakness leads to banking sector stress

■ Flight from risk leads to falling share & property prices

■ Investment slumps in China as government recapitalises banks

■ Asian supply chain affected as domestic engine of growth stalls

�Corporate reawakening (10%)■ Strong corporate liquidity feeds into

investment■ This raises business and consumer

confidence■ Banks’ balance sheets improve and

credit conditions loosen■ Strong growth helps fiscal

consolidation and lowers bond yields

�Oxford forecast (45%)■ Eurozone avoids disorderly default and

steps taken to shore up banks■ Risk premia fall, and consumer and

business confidence gradually recover■ But recovery in advanced economies

limited by high debt, weak job growth and fiscal retrenchment

■ Emerging markets robust as policy eases and growing middle class support consumer spending and trade


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1 Overview

This paper sets out the assumptions behind Oxford Economics’ central forecast for the global economy and outlines the key risks around that projection. The last six months have seen heightened uncertainties surrounding the global economy, as well as significant downgrades to Oxford Economics’ central forecast. In light of the heightened uncertainty, Oxford Economics currently places a relatively low probability of 45% on its central forecast. It is therefore especially important to consider alternative outcomes for the global economy. In this analysis, we have considered three alternative scenarios based on modelling work using our Global Economic Model, two downside scenarios and one upside. The scenarios considered are a Eurozone break-up, a China hard landing and a revival of corporate investment.

The Oxford Global Economic Model is a fully integrated Global Economic Model used for forecasting and for performing ‘what if’ analysis. The Model covers 46 economies in detail including the US, Japan, most EU economies, China, India and other leading emerging markets, as well as providing headline indicators for another 30 economies. The Model provides a rigorous and consistent structure for analysis and forecasting, and allows the implications of alternative global scenarios and policy developments to be readily analysed and quantified, taking into account all of the linkages between economies – e.g. through trade volumes and prices, financial markets and capital flows, oil and commodity prices, exchange rates etc.

The document is organised as follows:

� Section 2 describes our central forecast for the global economy.

� Sections 3-5 outline the three alternative scenarios and summarise the results from modelling these using the Global Economic Model.

� Section 6 concludes.


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2 Baseline scenario

� The global economic outlook has worsened in recent months and we have further downgraded our GDP forecasts. In pa rticular, the Eurozone financial crisis has continued to intensif y, despite a number of attempts by EU leaders to stem it

� Financial conditions in the Eurozone have deteriora ted so far that the prospect of an EU breakup has become a genuine threat. Possible failure by Italy and Spain to refinance €1 80 billion in government debt by March now poses the single large st risk to global financial stability

� Furthermore, economic activity in the emerging mark ets has started to slow, limiting the prospects for EU exports. We have downgraded our forecast for all of the major emergers, and we now expect global growth (at PPP) at 3.4% next year, down from 4% thr ee months ago

� A brighter spot in the global economy is in the US where recent data releases have generally outperformed expectations. However, the pace of the US recovery remains moderate, and the U S is still at risk from a further deterioration in global financial co nditions

� We currently place a probability of 45% on this bas eline scenario

EU leaders fail to halt crisis…

The global economic outlook has worsened in recent months, resulting in a further round of downgrades to our GDP forecasts. In particular, the Eurozone financial crisis has continued to intensify, despite a number of attempts by EU leaders to stem it.

EU leaders met again on December 8-9 but their new proposals look unlikely to turn around market sentiment. The proposed ‘fiscal compact’ is not the fiscal union many observers were hoping for, and is likely to prove unworkable. And the Eurozone’s bailout funds still lack sufficient firepower to form an effective ‘firewall’ against financial contagion.

…and Eurozone split now a risk

Meanwhile, financial conditions in the Eurozone have deteriorated so far that there is now a genuine threat to the cohesion of the Eurozone. Funding pressures have become acute for Eurozone banks and some of the weaker Eurozone states are seeing accelerating outflows of bank deposits. Banks have begun to tighten credit conditions again in response.

Most worrying of all, Italy and Spain need to refinance around €180 billion of government debt by March, which will be very difficult unless market conditions improve substantially. The consequences of a failure to rollover this debt would be dramatic – in our view this ‘rollover risk’ now poses the single most serious threat to global financial stability.


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The financial crisis in the Eurozone has also spilled over into the real economy. The PMI surveys have continued to point to contracting output and we now forecast that the Eurozone re-entered recession in 2011Q4, with zero GDP growth in 2012 as a whole.

Emergers also slow…

The prospects of exports buoying growth in Europe and elsewhere have also been set back by a weakening picture in the emerging markets. November PMI data for China was disappointing, with contracting activity both in manufacturing and services - the latter implying that economic weakness might be spreading from the export dependent sectors to what has until now been a very robust domestic market

Elsewhere, Q3 GDP data for Brazil showed zero growth and India has seen a sharp slowdown in industrial output investment. The latter trend is especially worrying given the importance of investment in fuelling India’s economic ‘take off’ in recent years.

We have cut our forecast for growth in India to 6.8% for 2012 from 8.1% three months ago and for Brazil to 3.1% from 4.5%. World growth (at PPP) is now seen at 3.4% in 2012, down from 4% in our September 2011 forecast.

…but US a brighter spot – for now

A brighter spot in the global economy at present is the US where recent data releases have generally outperformed expectations, and there is evidence that the Fed’s loose monetary policy may be feeding through to the economy more effectively than that of other major central banks.

The pace of the US recovery nevertheless remains moderate, thanks to chronic weakness in housing and an overhang of household debt that is restraining a consumer recovery. We forecast GDP growth at just 2.4% for 2012, after 1.7% in 2011.

This leaves the US still at risk from a further deterioration in global financial conditions. Some potential risk factors are already visible; US dollar LIBOR has been forced up in recent months and the latest credit data showed deleveraging by foreign banks curbing overall lending.

World economy at dangerous point

As 2012 approaches, the global economy is at a dangerous juncture. Radical changes in policy look necessary to preserve the Eurozone, including a much expanded effort by the ECB. Without this, other economies may have to consider major policy shifts themselves to ease the economic fallout.

Such measures would include an extension of the expansionary monetary policy approaches seen since 2009. But a shift towards more unorthodox approaches is also possible, involving policies such as heavy FX market intervention and – more damagingly – the use of protectionism and perhaps exchange controls.


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Chart 2.1: US GDP Chart 2.2: Eurozone GDP

Chart 2.3: World GDP Chart 2.4: US CPI

Chart 2.5: Eurozone CPI Chart 2.6: World C PI

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Chart 2.7: US government bonds Chart 2.8: Eu rozone government bonds

Chart 2.9: US interbank rates C hart 2.10: Eurozone interbank rates

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2010 2011 2012 2013 2014 2015Real GDP

North AmericaUnited States 3.0 1.7 2.4 2.6 3.0 3.1

Canada 3.2 2.4 2.1 2.6 2.7 2.7

EuropeEurozone 1.8 1.6 0.0 1.3 1.9 2.0

Germany 3.6 3.1 0.6 1.7 2.1 2.0

France 1.4 1.6 0.0 1.6 2.0 2.0 Italy 1.2 0.6 -0.8 0.0 0.8 1.4

UK 1.8 0.9 0.4 1.9 2.8 2.8

EU27 1.8 1.6 0.2 1.7 2.4 2.5

AsiaJapan 4.1 -0.5 1.7 3.3 2.4 1.5

China 10.4 9.0 8.1 9.1 8.8 8.3India 8.7 7.1 6.8 9.5 9.2 8.6

World 3.9 2.8 2.6 3.6 3.8 3.7

World 2005 PPPs 4.6 3.7 3.4 4.5 4.7 4.5

World trade 14.3 6.5 4.8 7.4 7.4 7.1

Inflation (CPI)North America

United States 1.6 3.0 2.3 2.4 1.8 2.3Canada 1.8 2.9 1.9 2.0 2.2 2.2

EuropeEurozone 1.6 2.7 1.7 1.5 1.8 1.8

Germany 1.1 2.3 1.6 1.8 1.8 1.8

France 1.5 2.1 1.5 1.7 1.9 1.9

Italy 1.5 2.8 1.8 0.7 1.8 2.0UK 3.3 4.5 2.2 1.7 1.8 1.9

EU27 2.1 3.1 1.8 1.6 1.8 1.8

AsiaJapan -0.7 -0.2 0.3 0.7 0.9 0.8

China 3.3 5.6 3.5 3.0 3.0 3.0

India 12.0 9.0 6.5 4.8 4.4 4.1

World 3.4 4.5 2.5 2.1 1.9 2.1Exchange Rates

US$ Effective 75.4 70.9 73.9 77.2 80.2 80.9$/€ 1.3 1.4 1.3 1.3 1.3 1.2¥/$ 87.8 79.9 79.7 92.6 94.6 93.3

Commodity PricesBrent oil ($/bl) 79.5 111.4 98.6 101.4 101.4 104.7

Summary of International Forecasts


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3 Disorderly Eurozone default

� We assign a 30% probability that a Greek debt restr ucturing does not happen in a relatively orderly manner. We assig n a 10% probability on an extreme scenario involving multip le countries defaulting and leaving the Eurozone

� In our extreme scenario, failure to resolve the sov ereign debt crisis causes the Eurozone to break up, with Greece, Portu gal, Ireland, Italy and Spain leaving and re-establishing new nat ional currencies

� The new national currencies depreciate sharply, whi le the residual euro appreciates. Banks suffer heavy losses, causin g a severe credit crunch

� GDP growth in other major developed economies also turns negative, and growth slows significantly in the eme rging markets. As a result, world GDP growth falls to just 1.5% in 2012 in PPP terms

Our baseline forecast assumes that the Eurozone governments continue to ‘muddle through’ the crisis. It assumes some restructuring of Greek debt, as planned in the October 2011 package, alongside the implementation of the policies agreed at the EU summit of early December. It also assumes that the ECB continues to offer support in sovereign debt markets.

However, market sentiment already appears to be turning against the deal agreed in early December. There is an expectation that governments will be forced to bring in new measures, possibly including allowing the ECB to make a greater volume of bond purchases or mutualisation of Eurozone debt among the member states, although both options face major political obstacles.

We assign a 30% probability that the Greek debt restructuring occurs in a disorderly manner. Within this worse case, a whole range of scenarios are possible, ranging from multiple disorderly defaults within the Eurozone to a Greek exit of the Eurozone to a wider euro breakup. In this report, we focus on a broader set of countries exiting the Eurozone. We place a probability of 10% on this extreme scenario. The failure to agree a credible and permanent solution to the crisis leads financial and business confidence to collapse. Italy and Spain are unable to refinance debt maturing in early 2012, which triggers a series of disorderly defaults. With the peripheral economies unwilling to accept even greater austerity measures, the Eurozone breaks apart. Five economies – Greece, Portugal, Ireland, Italy and Spain – leave the euro in early 2012 and establish new national currencies.

The exiting countries have suffered a substantial loss of competitiveness over the past decade and, as such, we would expect the new national currencies to depreciate sharply. In addition, euro exiting countries would almost certainly see large-scale capital outflows initially, leading their exchange rates to ‘overshoot’ fair value. At the same time, the residual euro is likely to strengthen significantly, given the greater focus on the stronger northern European economies.


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The introduction of new currencies in the exiting countries causes huge economic disruption. There would also be substantial costs related to the redenomination of contracts from euros into the new currencies, including legal costs. Though euro exiting countries do increase nominal interest rates following a surge in inflation, they cannot raise rates to levels that would be needed to keep inflation down, given the need to support their fragile economies.

The series of defaults has a significant impact on banks’ balance sheets across the world, but particularly in the Eurozone and exiting countries. Credit conditions are tightened back to 2008/09 levels.

Outside of the Eurozone, heightened uncertainty sends stock markets down sharply. Business confidence is dampened by the weaker outlook and increased uncertainty, which has a negative impact on investment in all countries. Furthermore, trade linkages with the Eurozone depress demand for countries’ exports, particularly in countries like the UK.

The key assumptions of this scenario are -

� The five exiting countries default and their new debt is re-denominated in the new currencies. Their new currencies depreciate sharply. In the first year, national exchange rates drop by 50% against the euro in Greece, 25% in Italy, Spain and Portugal, and by 15% in Ireland.

� Equity prices fall by 30% initially in Greece and remain 10% below central scenario levels at end-2016. In the other four exiting countries, equities fall by 20% initially and remain 8% below base by the end of our forecast period. Elsewhere in the Eurozone, equities fall by 15% initially, but subsequently recover such that they are back in line with the baseline forecast by 2016. Stock markets fall around 10% initially in the other major economies, and recover to the level seen in our central scenario by 2016.

� Banking sectors in both the exiting countries and the Eurozone suffer massive losses and tighten credit standards dramatically.

� Government bond spreads initially rise by 1600bp in Greece, 1100bp in Portugal, Italy and Spain, and by 700bp in Ireland.

� The risk premium for emerging markets rises by a similar level to that seen at the worst point of the global financial crisis at the end of 2008.

� Business and consumer confidence drops sharply in the short term in reaction to the heightened uncertainty and sharp declines in equity prices.

The results of this scenario may be summarised as follows –

� In the exiting countries , GDP drops sharply in 2012-13, falling 7-8% below our central scenario in 2012 and 12-19% below in 2013.

� The Eurozone is plunged into a deep recession in 2012-13, with GDP falling by around 10% relative to the baseline. Although short-term interest rates fall to very low levels, this is more than offset by the scale of the financial shocks and the effects of a stronger euro.


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� US GDP growth slows to just 0.7% in 2013, with a weaker dollar mitigating the effects of weaker global growth. The UK suffers a more severe downturn because of its closer trade and financial links with the Eurozone, with GDP about 5% below baseline by end-2013.

� In China growth dips to about 6½% in 2012-13, thanks to the effect of weak world growth on exports and the large scale of the financial shock which damages local asset markets and pulls down FDI. The GDP impact on the smaller Asian emergers is also large, especially for those highly geared to exports such as Singapore and Taiwan. In response, the emerging market economies reduce interest rates to mitigate the impact from weakened economic activity.

� The residual euro initially appreciates sharply, rising to about $1.60 per euro by end-2012 as the narrower focus on the stronger northern European core strengthens sentiment.

� Interest rates fall to near zero in most of the major economies and remain there until 2014 as central banks attempt to offset the impact of the financial shock on growth and prevent a deflationary spiral. Inflation falls below 1% in the major developed economies in 2013.

� World GDP growth in PPP terms slumps to just 1.5% in 2012 in the wake of recessions in the major economies and a sharp slowdown in the main emerging countries. From 2014 a recovery sets in as the financial shock fades, with GDP growth averaging more than 5% a year in 2015/16.


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Chart 3.5: Eurozone CPI Chart 3.6: Worl d CPI

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2010 2011 2012 2013 2014 2015Real GDP


Canada 3.2 2.4 0.8 1.5 4.4 3.4

EuropeEurozone 1.8 1.6 -4.6 -3.1 3.9 5.5

Germany 3.6 3.1 -3.8 -3.0 3.8 5.5

France 1.4 1.6 -4.8 -3.6 3.3 5.1 Italy 1.2 0.6 -8.4 -5.5 2.3 3.6

UK 1.8 0.9 -1.6 -0.8 3.1 4.3

EU27 1.8 1.6 -5.0 -3.1 3.6 5.7

AsiaJapan 4.1 -0.5 0.1 1.3 1.9 2.1

China 10.4 9.0 6.6 6.7 8.6 9.8India 8.7 7.1 4.2 9.6 9.9 9.1

World 3.9 2.8 0.4 1.2 4.3 5.2

World 2005 PPPs 4.6 3.7 1.5 2.3 5.0 5.8

World trade 14.3 6.5 0.6 3.3 10.7 10.5Inflation (CPI)

North AmericaUnited States 1.6 3.0 1.9 0.6 1.6 2.8Canada 1.8 2.9 1.9 1.0 0.6 1.2

EuropeEurozone 1.6 2.6 0.0 -0.6 1.3 1.9

Germany 1.1 2.3 -0.2 -0.6 1.3 1.9 France 1.5 2.1 -0.2 -0.6 1.4 1.4 Italy 1.5 2.8 10.0 10.0 3.8 3.6UK 3.3 4.5 2.4 0.7 2.3 2.3EU27 2.1 3.1 2.7 1.9 2.0 2.5

AsiaJapan -0.7 -0.2 -0.2 -1.8 -0.9 0.6

China 3.3 5.6 3.2 1.5 2.5 4.1 India 12.0 9.0 7.2 2.9 4.1 3.9

World 3.4 4.5 2.5 1.0 1.4 2.3

Exchange Rates

US$ Effective 75.4 70.9 69.6 73.0 75.9 76.1

$/€ 1.3 1.4 1.6 1.6 1.5 1.4

¥/$ 87.8 79.9 79.9 93.8 94.9 93.2


Summary of Eurozone Break-up


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4 China hard landing

� With the rising importance of China in the global e conomy, many are concerned about the impact should this engine of gl obal growth sputter. In our second downside scenario, to which we assign a probability of 15%, we assess the global impact of a hard landing in China

� A downturn in trade, coupled with a correction in t he commercial property sector in China leads to a sharp rise in n on-performing loans

� A surge in NPLs and a deterioration in banks’ balan ce sheets in China freezes the amount of credit available to the banking system for investment, hitting growth and employment

� A flight from risk leads to a rise in borrowing cos ts in emerging markets and a slowdown in growth

� Weaker world demand leads to lower oil prices which provide an offset to weaker trade growth in the advanced econo mies

Overheating concerns have subsided in emerging markets and the main concern now appears to be a China hard landing, stemming from financial imbalances and an over-inflated property sector. The scale of the credit stimulus the government pursued in 2009 and early 2010 to help China through the global financial crisis has raised concerns about the robustness of the banking sector and, in particular, about contingent liabilities to local government investment vehicles.

These concerns would be aggravated if exports slowed sharply. China’s initial resilience to the recent deterioration in Europe appears to be waning. Both the manufacturing and services PMI dropped in November to the lowest level since February 2009. And while, as expected, export orders were down, domestic orders also fell sharply. Some of these may be an over-reaction to external weakness, but it also suggests that the domestic economy is starting to slow sharply in the face of the credit tightening of the past 18 months. Indeed, fixed asset investment which has been a significant driver of growth over 2011, fell on the month in November. In addition, the construction sector may be showing the strains of the slowing in the property market.

Poor returns to infrastructure investment at the local level could threaten local government finances and the profitability of the industrial sector. This could lead to a sharp increase in non-performing loans (NPLs). In addition, the risk premium in China would rise, pushing up the cost of borrowing. As a consequence, investment would fall sharply, hitting GDP growth and leading to lower employment, which would subsequently weigh on consumption.

Another trigger for banking sector stress is the property market. Over-capacity in the commercial property market could lead to a sharp correction, and the resulting increase in perceived risk could lead to a more generalised fall in asset


18

prices. The property sector accounts for a significant portion of total investment flows in China and a sharp correction in this sector would reduce investment, resulting in lower employment and growth.

Knock-on effects onto business and consumer confidence from a collapse in the property sector would likely further depress demand, leading to a hard landing for GDP growth. In this scenario, Chinese GDP growth would fall to around 6.6% in 2012, slowing further in 2013.

Weaker prospects for Chinese exports have caused us to raise the probability on this scenario to 15%, from 10% three months ago. Still, this is a relatively low probability, as we anticipate that the Chinese authorities will be able to respond more aggressively to slowing growth. Already, the central bank has cut reserve requirements for Chinese banks to ease credit conditions in the slowing economy. This transition will be aided by the sharp drop in commodity prices that would be a consequence of weaker Chinese demand.

The assumptions used in this scenario are as follows:

� Property prices fall sharply bringing prices back to 2009 level by the beginning of 2012

� A slowdown in demand for China’s exports and a slump in the construction sector leads to a weak profitability and banking sector weakness

� Non-performing loans in China rise sharply to around 20% of GDP

� Liabilities of local governments rise and alarmed at the scale of bad loans, the government stops the flow of credit through the banking system while it recapitalises the banking sector

� Share prices in China fall by about 50%

� A flight from risk leads to a rise in emerging market spreads by 100 basis points over the course of 2012. This pushes up the cost of borrowing in emerging markets leading to slowing consumption and investment

� A rise in risk premia and financial contagion leads to falls in share prices in the major financial centres in the US, Euro area and the UK

The results of this scenario may be summarised as follows:

� The impact on the economy begins in 2012 H1 with a sharp slowing in investment growth, particularly investment funded through bank loans or directly from the government. The slump in construction related activity, estimated to be around 15% of GDP, contributes to growth in China slowing to 6.6% in 2012 and to 5.3% in 2013.

� Falls in share prices and weaker export growth impact on the advanced economies. However, lower oil prices help to offset some of the impact with oil prices falling to $85 by end-2013. Overall growth in the US is 0.8% points lower in 2013 and 0.5% points lower in the Eurozone.

� Higher costs of borrowing and weaker trade hit other emerging markets with growth slowing below 5% in the emerging market bloc as a whole in 2012.


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Chart 4.1: US GDP Chart 4.2: China GDP


Chart 4.5: China CPI Chart 4.6: World CPI

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China: CPI% year


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China hardlanding

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China hardlanding

BaselineForecast


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2010 2011 2012 2013 2014 2015Real GDP


Canada 3.2 2.4 1.9 2.2 2.9 2.9

EuropeEurozone 1.8 1.6 -0.3 0.8 1.7 1.9

Germany 3.6 3.1 0.4 1.2 1.9 2.0

France 1.4 1.6 -0.1 1.2 1.9 2.0 Italy 1.2 0.6 -1.0 -0.3 0.6 1.1

UK 1.8 0.9 0.1 1.3 2.7 3.1

EU27 1.8 1.6 -0.1 1.2 2.2 2.5

AsiaJapan 4.1 -0.5 1.2 2.4 2.1 1.9

China 10.4 9.0 6.6 5.3 7.6 9.9India 8.7 7.1 6.4 9.2 9.2 8.5

World 3.9 2.8 2.2 2.7 3.5 4.0

World 2005 PPPs 4.6 3.7 2.9 3.3 4.2 4.8

World trade 14.3 6.5 3.3 5.3 7.2 8.0



EuropeEurozone 1.6 2.7 1.6 0.9 0.9 1.2

Germany 1.1 2.3 1.5 1.1 0.8 1.2

France 1.5 2.1 1.5 1.1 1.0 1.4

Italy 1.5 2.8 1.8 0.2 1.1 1.5UK 3.3 4.5 2.1 1.2 1.3 1.6

EU27 2.1 3.1 1.7 1.0 1.0 1.2

AsiaJapan -0.7 -0.2 0.2 0.1 0.2 0.7

China 3.3 5.6 3.4 2.0 2.0 2.7

India 12.0 9.0 6.3 3.7 3.2 3.5


US$ Effective 75.4 70.9 74.0 77.8 81.4 82.3$/€ 1.3 1.4 1.3 1.3 1.3 1.2¥/$ 87.8 79.9 79.9 94.0 97.8 97.1


Summary of China Hard Landing


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5 Corporate reawakening

� Our final scenario is an upside scenario in which b usinesses increase investment and boost hiring. We assign thi s scenario a probability of 10%

� In developed countries, the corporate sector has bu ilt up large financial surpluses, and stability brought about by fiscal consolidation leads business to spend these funds q uicker than in our baseline scenario. This boosts confidence, lead ing to a quick recovery in demand

� The risk premium currently factored into the oil pr ice falls due to increased political stability in the MENA region

� The result is a rise in world GDP growth at PPP exc hange rates to more than 5½% pa in 2013

Our final scenario is an upside scenario, which assumes that credible plans to deal with fiscal stresses in the Eurozone are developed and that easing political tensions in the MENA region lead to lower oil prices. This alleviates the uncertainties facing the global economy and encourages the corporate sector to invest and boost its workforce. Industrialised countries will lead the way, with beneficial spillover effects on emerging markets. We attach a relatively low probability of 10% to this scenario.

In developed countries, the corporate sector has built up large financial surpluses and the restructuring of the global financial system and stability brought about by fiscal consolidation lead business to spend these funds quicker than in our baseline scenario. This enhances confidence in industrialised economies, leading to a quick recovery in demand.

The assumptions used in this scenario are as follows:

� Quarterly business investment growth rises by 1.5% above our central forecast through 2013 in the major economies.

� Oil prices in 2013 fall $15 below baseline. Some of the spike in early-2011 in oil prices is assumed to be a result of a higher risk premium due to heightened uncertainties in the MENA region, so the lower political tensions ease this risk premium.

The results of this scenario may be summarised as follows:

� In the major developed economies, corporations expand their workforce. Workers’ wages rise and, combined with a fall in oil prices, their real disposable incomes increase. With total employment up and more disposable income for workers, consumers increase their spending.

� In the US, GDP grows by 3.2% in 2012 and 4.0% in 2013, before slowing back towards baseline in 2015. Meanwhile, Eurozone GDP growth remains at 0.6% in 2012 and then rises to 2.2% in 2013.


22

� Emerging market economies benefit from trade links with the developed world and higher capital inflows. Domestic demand remains buoyant, and China sees growth of about 9½% in 2012 and then just over 10% in 2013. For the world as a whole, GDP grows by 4.1% and 5.6% in 2012 and 2013 respectively at PPP exchange rates.

� On the supply-side , higher investment leads to a rise in the capital stock and higher total factor productivity. This boost to the supply-side means that higher demand does not create inflationary pressures.


23



Chart 5.5: Eurozone CPI Chart 5.6: World CPI

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Corporate reawakending

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2

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Eurozone: 10-year government bonds%


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2010 2011 2012 2013 2014 2015Real GDP


Canada 3.2 2.4 2.9 3.1 2.7 2.5

EuropeEurozone 1.8 1.6 0.6 2.2 2.2 1.8

Germany 3.6 3.1 1.2 2.7 2.6 2.1

France 1.4 1.6 0.6 2.7 2.4 1.7 Italy 1.2 0.6 -0.3 0.9 1.0 1.1

UK 1.8 0.9 1.0 3.0 3.1 2.5

EU27 1.8 1.6 0.9 2.7 2.7 2.2

AsiaJapan 4.1 -0.5 2.5 4.7 3.3 0.9

China 10.4 9.0 9.4 10.1 9.4 8.0India 8.7 7.1 7.5 10.8 10.1 8.2

World 3.9 2.8 3.3 4.7 4.4 3.5

World 2005 PPPs 4.6 3.7 4.1 5.6 5.3 4.3

World trade 14.3 6.5 6.0 9.0 7.6 6.4



EuropeEurozone 1.6 2.7 1.6 1.1 1.4 1.8

Germany 1.1 2.3 1.5 1.3 1.3 1.6

France 1.5 2.1 1.4 1.1 1.4 1.6

Italy 1.5 2.8 1.7 0.3 1.5 2.0UK 3.3 4.5 2.1 1.4 1.7 2.1

EU27 2.1 3.1 1.7 1.2 1.5 1.9

AsiaJapan -0.7 -0.2 0.2 0.0 0.1 0.6

China 3.3 5.6 3.3 2.2 2.1 2.4

India 12.0 9.0 5.9 3.2 2.9 3.7


US$ Effective 75.4 70.9 73.8 77.3 80.5 80.8$/€ 1.3 1.4 1.3 1.3 1.3 1.3¥/$ 87.8 79.9 80.0 93.1 94.7 92.6


Summary of Corporate Reawakening


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6 Conclusion

The relatively low probability of 45% placed on our baseline scenario reflects the fact that there are considerable uncertainties surrounding this forecast. As a result, alternative outcomes for the world economy need to be considered. In this analysis, we have explored three alternative scenarios for the world economy – a Eurozone break-up, a hard landing in China and a revival of corporate investment. On the whole, we see the balance of risks surrounding our central forecast as skewed towards the downside.

For the major countries, we have weighted the GDP growth rates in each scenario by their estimated probability of occurrence. In this risk-weighted scenario outlook, growth in 2012 in all major economies is lower than in our baseline scenario. In the US, GDP expands at a similar pace to our baseline scenario in 2012, but growth falls 0.2% points below baseline by 2013. In the Eurozone, which faces the largest downside risks, GDP shrinks by 0.6%, while the UK and Japan grow about 0.2% slower than in our baseline. Emerging market growth is also slower than in the baseline. Global growth at PPP is 3.3% and 4.5% in 2012 and 2013 respectively.

2010 2011 2012 2013 2014 2015Real GDP


Canada 3.2 2.4 2.0 2.4 3.0 2.8

EuropeEurozone 1.8 1.6 -0.6 0.8 2.1 2.4

Germany 3.6 3.1 0.1 1.2 2.3 2.5

France 1.4 1.6 -0.5 1.0 2.2 2.3 Italy 1.2 0.6 -1.7 -0.6 1.0 1.5

UK 1.8 0.9 0.2 1.6 2.8 3.0

EU27 1.8 1.6 -0.4 1.2 2.5 2.8

AsiaJapan 4.1 -0.5 1.5 3.0 2.4 1.6

China 10.4 9.0 7.8 8.2 8.7 8.7India 8.7 7.1 6.5 9.6 9.4 8.6

World 3.9 2.8 2.3 3.3 3.9 3.9

World 2005 PPPs 4.6 3.7 3.3 4.5 4.9 4.6

Risk-weighted GDP growth


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Chart 6.1: Risk-weighted GDP growth

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2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Risk weighted average: GDP growth% year


Eurozone

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BRICS

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Global scenario service - Oxford Economics · 2012. 11. 30. · Global scenario service December...

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