Outlook 2011 ENG - Robobank

8/8/2019 Outlook 2011 ENG - Robobank

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Outlook 2011


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Contents

Foreword 4

Weak economic recovery in 2011 not entirely unexpected 6

United States: anaemicrecovery 8China:fromturbo-chargedtomoresustainablegrowth 11Japan: adullrecovery 14United Kingdom:governmentbankingeverythingonausteritymeasures 16Eurozone: aUnionofconsiderabledifferences 18ECB:remainingcautious 23Bond markets: anewchapterinthemarketscrisis 26Currency markets: policyofdollarweakness 31Credit markets:notallmarketswelcomeissuance 34

The Netherlands: becoming accustomed to a lower growth path 36

Global economic challenges in 2011 and beyond 48

Forecast Table 63

Literature 64

Websites 65

Colophon 66

Disclaimer 67

Outlook 2011 3


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Extremely disappointing, yet not unexpected. This is how our economists

describethecontinuationofthisyearssluggisheconomicrecoveryintheyear

aheadinourOutlook2011.Wearestillclimbingoutofthedeepestrecession

sincethe1930s.Whiletheworldeconomicactivitypickedupsomewhatlast

year, therecovery is far fromrobustand theprospect offullyreturning toglobalprosperityisstillalongwayoff.

Letsstartwiththehomefront.Aftershrinkingbyaneyewatering4%in2009,

theDutcheconomywasabletoregainasolidfootingin2010.TheNetherlands

benefited from thepick-upinworldtradeandthe economy isexpected to

growby1% in2010.Oureconomists forecastaverageGDPgrowthtobe

around1%inthecomingyears.GrowthintheNetherlandswill,therefore,

beslightlymoremoderatethanin2010andmuchmoremoderatethanwhat

thecountryhadbecomeaccustomedtobeforetheglobalfinancialcrisis.

Thereareseveralreasonswhyeconomicgrowthisslowingdown.First,the

globalrecoveryislosingsteam.ThishasanimmediateimpactontheNether-

landsinlightofitsopeneconomy.Ontopofthat,theDutchgovernmentwill

carryoutmassiveausteritymeasuresintheyearsaheadandtheuncertainties

concerningconsumerconfidenceand,consequently,alsoconsumerspending

willpersistin2011.

ConsumersintherestofEuropeandtheUnitedStatesarealsonotfullyparti-

cipatingintherecovery.Sowecannotexpectthemtothrusttheglobaleconomy

forwardin2011.Thesameappliestoalesserdegreetothebusinesscommu-

nity.Thenecessaryfiscalbelt-tighteningmeasuresbeingconductedbyhighlyindebtedgovernmentsand theuncomfortablyhighunemployment ratesin

manycountriesdonotcreateaverystimulatingbusinessclimate.Thismakes

ithardlysurprisingthatbusinesseswillagaintakeanextremelyconservative

approachtotheirinvestmentplansinthecomingyear.

Thedeeperunderlyingproblemis,however,thatafterthreeyearsoffinancial

crisis, the large and undesirable global and European imbalances remain

intact.TheUScurrentaccountdeficitremainshugeandisonceagainwidening,

whileChinaisartificiallykeepingthevalueofitscurrencylow.Meanwhile,the

maincentralbanksaremaintainingtheirextremelyaccommodativemonetary

policybykeepingpolicyratesultralowandcrankingupthemoneyprinting

presses.Sadly,thesemeasuresarenolongerexpectedtoproducemeaningful

4 RabobankOutlook 2011 Slow recovery no surprise

Foreword


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effects.ThisiswhyinourOutlook2011wearecallingforagenuinelysustainable

solutiontotheglobalimbalances.Thiscanbeachievedifweakconsumerspending

in current account deficit countrieswill be compensated by stronger consumer

spending incurrentaccountsurplus countries.This globalrebalancingactcould

reducebothunemploymentandgovernmentdebt intheadvancedeconomiestomoreacceptablelevels,whileatthesametimereducingtheriskofdeflation.Whats

more,currentaccountsurpluscountrieswillbenefitthemselvesfrommoresustai-

nablegrowththatisalsolessvulnerabletoadverseexternalshocks.

NumerousG20summitswill,however,comeandgobeforeastartcanbemadeon

implementingthissolution.Thisisunfortunatebecausethetimeisnowripefor

structuralreforms.Doingnothingandhopingforareturntopastgrowthratesis

unrealistic. The credit crisis has made it painfully clear where the global and

Europeanbottlenecksarelocated.Forcefulmeasuresneedtobeintroducedifwe

wishtoavertanotherglobalcrisisinthefuture.Thisnecessityhasbeenunderscored

bytherecentoutbreakoftheEuropeansovereigndebtcrisis.Isincerelyhope,there-

fore,thatpoliticiansbothinthedeficitcountriesandalsointhesurpluscountries

willtakethemuch-neededmeasures.Ihopeyouenjoyreadingthispieceandare

inspiredbyourvisionsfornextyear.Wishyouallmuchhealth,happinessandsuccess

in2011.

Piet Moerland

ChairmanoftheExecutiveBoard

RabobankNederland

Outlook2011 5


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During the past year we witnessed a lacklustre economic recovery.

And the outlook for 2011 does not look much better. This may be

disappointing, yet considering the severity of the recession, it is

not altogether surprising. In the United States, as well as in a

number of European countries, consumers were living beyond

their means for years. The global crisis exposed this fact

mercilessly, while it also revealed serious shortcomings in the US

and European financial sectors and weaknesses in public finances.

Economic actors are busy repairing their balance sheets -

a necessary but prolonged process that will put a drag on

economic growth. However, with sky-high government debt in

many countries and rising unemployment, the adjustment process

will not be easy. In this uncertain economic climate, businesses

remain cautious in their investment decisions.

Weak economic recoveryin 2011 not entirely

unexpected



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Few lasting reforms

Itisquitealarmingthatafter3yearsoffinancialupheaval,majorimbalancesinthe

globaleconomyremainintact.TheUScurrentaccountdeficitremainshighandis

risingonceagain,whileChinaiskeepingitsexchangerateartificiallylow,andinthe

process saw a spectacular rise in its currency reserves (over US$ 2,600 bn in

September2010).Themajorcentralbanks,suchastheUSFederalReserve(Fed),the

EuropeanCentralBank(ECB),theBankofJapan(BoJ)andtheBankofEngland(BoE)

arekeepinginterestratesultralow,anddonotseemtochangetheirmonetarystance

anytimesoon.BoththeFedandtheBoEarepursuingapolicyofquantitativeeasing

(QE). This is a monetary experiment of unprecedentedproportions, with many

knownandunknownrisks.Itappearsthatthesolutionssoughtbymonetaryand

fiscalpolicymakersintheshorttermoftenconsistofmoreofthesame-purelyto

avoidaccusationsofbeinginactive.

Change we can believe in?

Yetallisnotdoomandgloom.TheUSandEuropeancompanieshaveseenprofits

reboundthroughacombinationofcost-cuttingandproductivitygrowth.Perversely,

perhaps, theEuropeandebt crisisis serious enoughtoforcea drastic changeofcourse,whichmeansurgentlyneededreformswillbecarriedout.Theresultwill

eventuallybehealthiergovernmentfinances.Meanwhile,wecontinuetobelievethat

Asiaisliterallygrowingintoitsroleasaglobalgrowthengine.Aslow,painfulprocess

hasbeensetinmotion,buttheendresultmaybeamorestableglobaleconomy.

Allard Bruinshoofd

Eddie Clarke

Jane Foley

Adrian Foster

Elwin de Groot

Shahin Kamalodin

Jan Lambregts

Tim Legierse

Philip Marey

Elisabeth Selk

Financial Markets Research & Economic Research Department

Authors

Outlook2011 7


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Afteradeeprecession,theworldslargesteconomyreturnedtogrowthinthesecond

halfof2009.Followingsevererestructuring,businessesarenowinahealthierstate.

Corporateinvestmenthasresumed,inventorieshavebeenrebuiltandprivatesector

jobsgrowthiscomparablewiththeaftermathofthetwopreviousrecessions (figure

1).Oncethedreadeddoubledipfailedtomaterialiseinthethirdquarterof2010,it

mightseemthatthewayhasbeenclearedforcompaniestoinvestanewin2011and

takeonnewstaff.Thatsaid,therecoverywillbeaslowprocess.Householdsareina

worsestate thancompanies.Thedownsideofcorporaterestructuringis sky-high

unemployment(figure 2).Moreover,theoverleveragedUSconsumerisstillweighed

downbyamountainofdebt.Untilthecrisis,thedebtburdenwasoffsetbygrowingwealth amid rising asset prices. During thecrisis, however, assetshave dropped

considerably,especiallyhouseprices.Thismeansthatconsumersnowhavetorepair

theirbalancesheetsbysavingmoreandspendingless.

Weak recovery a problem for policy makers

ItisnotonlytheUSconsumer,butalsothegovernmentthathastotightenitsbelt,

both at the federal andthe local level. Concerns inthe capitalmarkets about the

sustainabilityofUSpublicfinanceshaslimitedthescopeforanewwaveofeconomic

stimulusmeasures (figure 3).Moreover, DemocratsandRepublicans canscarcely

agreeonanything,leavinglittletobeexpectedoffiscalpolicy.Accordingly,theFedhas

desperatelygoneontheoffensivebyexploringtheverylimitsofitsmandate.TheFed

hasadualmandate,aimedatstableinflationandmaximumemployment.Sinceinfla-

tioniscurrentlytoolowandunemploymenttoohigh,theFedbelievesthatasecond

roundofquantitativeeasingisjustified.Whilethissoundsplausibleenough,itgreatly

lowersthethresholdforfurthermonetaryexpansion.Inlate2008,thethreatofanew

GreatDepressioninducedtheFedtoturnonthemonetarytap;nowin2010abelow-

parrecoveryseemstobeenough.Unfortunately,buyinguptreasurypaperinthis

Figure 2: from a high unemployment rate

Source: Reuters EcoWin

Figure 1: Normal recovery in labour market

Source: Reuters EcoWin, Rabobank

-0.3

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1 3 5 7 9 11 13 15 17 19 21 23 25 27 29 31 33 35

1990-1991 2001 2008-2009

% mom % mom

t in months after recession

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% of the labour force % of the labour force

United States: anaemic recovery



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second round of quantitative easing is unlikely to boost domestic demand. The

problemisnotthatinterestratesaretoohighintheUS.Onthecontrary,the10year

yieldongovernmentbondsiscurrentlyonlyjustabovethelowestpointitreached

duringtherecession. Inanycase,itis time forconsumers toreducedebtandnot

continuetoconsumeoncredit.

America playing with fire

StilltherearepositiveaspectstotheFedsmonetarypolicyexperiment.Theunder-

utilisationofcapacityispushingdowninflation,whichmaygiverisetodeflationary

expectationsamongconsumersandcompanies.Bycrankinguptheprintingpress,(figure 4) theFedmaycurtailtheseexpectations,reducingthelikelihoodofadeflati-

onaryspiral.Inaddition,expansionarypolicywillmakethedollarcheaper,whichis

good for thetradebalance.TheUScurrentaccountdeficitvis--vistherestofthe

worldis,bydefinition,thedifferencebetweenthegovernmentsbudgetdeficitand

thesavingssurplusoftheprivatesector.Amorefundamentalsolutionfortacklingthe

structuralimbalancesintheUSeconomywouldbetoshrinkthegovernmentsbudget

deficitandtoreduceconsumerdebt(byboostingsavings).

Inthemediumterm-ifcapacityutilisationimproves-higherinflationexpectations

may eventually lead tohigher inflation(towards 4%),whichwillreducethedebt

burdenofboththepublicandtheprivatesectorinrealterms.Thismightseemagood

thing,butthemainquestioniswhethertheFedcanpreventinflationenteringinto

doubledigit territory in thelong term.By initiatinga secondroundofQEunder

currentcircumstances,theFedhasjeopardiseditscredibilityasaninflationfighter.

Andiftheinflationgeniedoesescapefromthebottle,anewVolckerwillbeneeded-

just asin the early1980s - tosqueeze inflationoutof the economy bymeansof

interest rate hikesandoneormore recessions (Volckerneeded two in the early

Figure 4: Feds monetary policy experiment


Figure 3: No more budgetary scope

Source: Congressional Budget Office

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% GDP % GDP

Budget deficit

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120

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80

100

120

07 08 09 10

Monetary base M1 M2

% yoy % yoy

Outlook2011 9


10/68

1980s).Inthemeantime,thebuild-upofliquiditycouldleadtonewbubblesinthe

financialmarkets,bothintheUSandelsewhere.

Low interest rates, but not indefinitely

Heldbackbyconsumersandthegovernment,theworldslargestconsumermarket

will beunable toexperiencea vibrant recovery. Instead,Americawill facemajor

policychallengesinthecomingyears.Attemptstoacceleratetherecoverywithextre-

melyloosemonetarypolicyareunlikelytosucceed,andmayevenbackfire,blowing

upfinancialbubbles togetherwithhigh inflation. In fact, the failure totacklethe

structuralimbalancesinthegovernmentbudgetmayultimatelyleadtoaUSsovereigndebtcrisis.So,althoughtheUScapitalmarketinterestrateswillbelowforthetime

being,upwardpressurewillbuildintheyearsahead.

Table 1: United States, key data

Year-on-year change (%) 2009 2010 2011

GrossDomesticProduct -2.6 2 2 Privateconsumption -1.2 1 2

Governmentspending 1.6 1

Privatesectorinvestment -18.4 4 9

Exports -9.5 11 7

Imports -13.8 14 10

Inflation -0.3 1 1

Unemployment(%) 9.3 9 9

Governmentbalance(%GDP) -9.9 -9 -7

Governmentdebt(%GDP) 79.5 87 92




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Theworldssecondlargest economy put ina stellar performancein 2010witha

growthrateofcloseto10%.However,itwasayearwithtwofaces:duringthefirst

half, the Chinese economy grew robustly, but thereafter growth lost momentum

(figure 5).Thedownshiftwasvirtuallyinevitableastheglobalrestockingprocess

sloweddownandtheChinese centralbankpursuedpolicies todampen excessive

credit growth. In 2011 we expect less dynamism in the export-oriented sectors

comparedtothisyear,amidaslowdownoftheglobaleconomicrecovery.Againsta

weakerworldeconomicbackground,weexpectChineseexportstoincreaseby14%y-o-yin2011-wellbelowthe30%growthachievedin2010.

Robust growth in consumption

AlthoughtheChineseeconomyisstilldependentonanexport-ledmodel,domestic

demandstartedtohaveastrongerrolein2010.Thiswasevidentinthepreparations

fortheWorldExpoinShanghai,whichinvolvedalotofconstructionactivityinthe

Yangtzedelta,whichstagnatedoncetheExpoopenedinMay.Theexhibitionitselfwas

amajoreventintheShanghairegion,andprovedtobeaconsiderablestimulusfor

domesticspending.Theeventattracted73millionvisitors,mainlyfromotherpartsof

China.

Duringthecomingyears,Chinesegrowthwillincreasinglybearthehallmarksofthe

twomainbastionsofeconomicgrowth:urbanisationandmodernisation.Oneeffect

of thiswillbethat consumer spendingwill contributemoretoeconomicgrowth.

Chinapessimistsliketopointoutthatconsumerspendingonlyaccountsforameagre

35%ofGDP.Thisrepresentsadeclinecomparedtothelevelof46%reachedadecade

agoandwellbelowthelevelsseenintheneighbouringASEANcountriesand the

Figure 6: Housing market not fundamentally overheated

Source: Bloomberg

Figure 5: 2010: a year with two faces


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05 06 07 08 09 10

House prices Nominal GDP growth

% yoy % yoy

4

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16

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14

16

05 06 07 08 09 10 11

GDP growth Forecast Average since 2005

% yoy % yoy

China: from turbo-charged to more sustainable

growth

Outlook2011 11


12/68

worlds rich countries (where it averages some 55%).However, this comparison

masksthefactthatChineseconsumptiongrewataround9%inthepasttwodecades,

outstrippinggrowtheveryyearsince1992inthosetwogroupsofcountries.Consump-

tiongrowthwassimplyexceededbyotherfactors;forinstancetheshareofinvest-

mentgrowthineconomicactivityrosefrom25%intheearly1990stoover40%in

2010.Basedonthisrobustgrowthofconsumption,theChineseeconomycanachieve

atrendannualgrowthrateof8-9%,evenwithoutathrivingglobaleconomy(see also

box 1, Asia Wagon or locomotive?).Ofcourse,thispresupposesthatthecontribu-

tions from investment andexportsdonotentirelyevaporate.Vigorousgrowth in

thosesectorscouldpushGDPgrowthintodouble-digitnumbers.

Policy development

Thestrongriseinhousepricesofrecentyearsiscreatingabubbleriskinanumberof

regions.However, forthe economy asawhole,the rise inhousepriceshas been

running lower thannominalGDPgrowth forsome time (figure 6).Moreover, the

Chinesecentralbank(PeoplesBankofChina,PBoC)hasinitiatedacycleofmonetary

tightening, whichmeanswe canexpect interest rates tobe raised incrementally

duringthecourseof2011.However,theprocessofmonetarytighteningwillbeimple-

mentedcautiously,andwillbeinsufficientlyaggressivetoslowtheeconomydownin

anymeaningfulway.Thesameappliestoexchangeratepolicy,whichseemstopermit

anannualappreciationrateof3-5%fortheYuanvis--vistheUSdollar.Weexpect

thistocontinuein2011.Inthisrespect,anychangestopolicyarelikelytohavean

evolutionaryratherthanarevolutionarycharacter.



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The major Asian economies have clearly surpassed the

industrialisedcountriesintermsofeconomicgrowthduring

recentdecades.Thisregularlygivesrisetothequestionasto

whether the region can assume the roleof the engine that

drivesglobalgrowth.

Asiawasnotsparedinthetwomostrecentglobaldownturns.

Forthisreasonalone,cautioniscalledforwhenitcomestothe

domestic strength of theregion,which ismeant todrive it

forward in times of widespread economic headwinds. Theregionseconomicprospectsarecloselylinkedtotherestof

theglobaleconomyduetotheinterconnectednessoftradeand

capital flows. However, in the absence of strong economic

growthintheindustrialcountries,theincreasingAsianshare

inglobaleconomicactivity definitely startstomakeadiffe-

rence.Andthisisbecomingincreasinglymorerelevant,inlight

ofweakereconomicrecoveryintheUSandEurope.

Ifweconsider,ingeneralterms,whattypeofeconomymight

constitute the locomotive for globaleconomic growth, then

onecriterion is that it shouldbe relatively open.Openness

permits domestic growth to spill over to the surrounding

countries.InAsia,exportsaccountforaroundonethirdofGDP.

Althoughthisquantityissomewhatinflatedbyahighdegree

of inter-regional specialisation, involving considerable

re-processingand largeinter-regionalgoods flows, it isstill

wellabovethe10%fortheUSandtheEUs15%.

Secondly,alargeandrapidlygrowingeconomyisanobvious

candidate for growth locomotive. In figure 7,we look at a

numberofcountriesandregionsandcomparethesizeoftheir

economiesbackin2002withtheaverageGDPgrowthofthe

followingfiveyears.Thoseeconomiesintheaboverightcorner

ofthe figurearethestrongest candidates.The figureshows

thatnosinglecountryinthe5yearsprecedingthecrisiscan

reallylayastrongclaimtothetitleglobalgrowthdriver.Any

claimtheUSmighthaveisbasedpurelyonitseconomicsize.

Figure 8 showsa similarhierarchyofcountriesand regions

basedongrowthoutlookforthecomingfiveyears.Themost

strikingelementisthatAsia(excludingJapan)hasnowmoved

tothetoprightcorneronthebasisoftheincreasedsizeofthe

combinedeconomy.ThegrowthofChinaisanimportantfactor

inthis,but it isthe regional interconnectednessthatcauses

Chinasmomentumtodrivetheentireregionforward.Thus,

Asiaisgrowinginitsroleasanenginefortheglobaleconomy.

Of course, many Asian products are still destined for the

Western consumer markets, which means the global cycle

remains relevant for thecontinent asawhole. Nonetheless,

evenwithoutstrongglobalgrowth,Asiassheersizeandincre-

aseddomesticdemandmeansitcancontinuetooutpacethe

growthofthetraditionalindustrialcountries.

Box 1: Asia Wagon or locomotive?

Figure 8: but Asia steaming ahead

Source: Bloomberg, Rabobank

Figure 7: No obvious engine yet

Source: Bloomberg, Rabobank

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China

Non-Japan Asia

Hong Kong,South-Korea, Taiwan

ASEAN

Japan

VS

Eurozone

Average growth 2003-2007 (%)

Sizeofeconomyin2002(USD

bn)

0

2

4

6

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0 2 4 6 8 10 12

China

Non-Japan Asia

ASEAN

Japan

US

Eurozone

Average growth 2010-2014 (%)

Sizeofeconomyin2010(USD

bn)

Hong Kong,South-Korea, Taiwan

Outlook2011 13


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Withintheglobaleconomy,Japanisclearlyawagonandnotalocomotive.Although

Japanistheworldsthirdlargesteconomy,itisheavilydependentonexternalgrowth

to drive its own economy forward. Japanese economic recovery is expected to

continueinto2011,butatadistinctlyslowerpace.For2010asawhole,GDPgrowth

willbesome3%y-o-y,whilefor2011weexpectarateofjustbelow2%.Thiswill

leavetheeconomy2%smallerinsizeattheendof2011thanthepre-recessionlevel.

Big spenders reach retirement

ThelowerGDPgrowthrateischieflyduetoaslowerpaceofgrowthinconsumer

spending(figure 9).TheJapaneselabourmarketprovedtobeveryresilientduringthe recession, with unemployment never exceeding thepeak of 5.6% reached in

mid-2009.Thedownsideofthesmallnumberofjoblossesisthatsincetherecovery,

companies have not needed to hire more workers. Another factor dampening

spendinggrowthisthechangingageprofileoftheworkforce.Asalargecohortof

babyboomersreachespensionage,theyarebeingreplacedbyyoungerconside-

rablylesswellpaidworkers.Thus,evenwithasustainedeconomicrecovery,the

nationalwageincomemaystagnate,slowingthemomentumofconsumerspending.

By contrast,weexpectcorporate investment tomake a stronger contribution to

growthin2011asovercapacitygraduallydisappearsandtheneedformaintenance

andreplacementofmachineryreturns.Betweenthefirstquarterof2008andthe

troughinthethirdquarterof2009,corporateinvestmentshrankby25%.Compared

tothislargefigure,theinvestmentgrowthweenvisagefor2011lookslikesmallbeer,

but will nonetheless contribute to economic momentum. Companies profits

reboundedstronglyduring2010,triggeringmodestgrowthincorporateinvestment

thisyear.Weexpectthistrendtocontinuein2011.

Figure 10: Trade balance positive once more

Source: Bloomberg

Figure 9: Consumer a drag on recovery

Source: Bloomberg

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GDP Investment Private consumption

% yoy % yoy

-15

-10

-5

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10

15

-60

-40

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0

20

40

60

06 07 08 09 10 11

Trade balance (r) Imports (l) Exports (l)

% yoy Yen (trillion), 12m sum

Japan: a dull recovery



15/68

The pain of the strong yen

TheJapanesetradebalanceimprovedinlinewiththerecoveryofglobaldemand,and

thetradesurplusof2010islikelytoberepeatedin2011 (figure 10).However,the

pre-crisis surplus levels will not be emulated next year while global growth is

receding,theinventorycycleisnormalisingandtheyenremainsstrong.Duringthe

courseof2011weexpecttoseetheyenlosesomegroundwhenhigherinterestrates

intheUSinduceJapanesedepositholderstoparktheirsavingsabroadoncemore.

Monetary policy mostly window dressing

TheBankofJapanhasengagedinopticalmonetaryexpansionbyreducingitspolicyrateinlate2010toabandwidthof0.0%-0.1%.Italsoannounceditsintentiontobuy

up5.000bnworthofsecuritiesonthemarket,inordertoreduceinterestrates

alongtheentireyieldcurve.Theseareminimalmonetaryfillipsgiventhesizeofthe

economy,whichmakelittleornodifferencetothegeneraloutlook.

Table 2: Japan, key data


GrossDomesticProduct -5.2 3 1 Privateconsumption -1.0 1 1

Governmentspending 2.5 -

Privatesectorinvestment -18.4 5

Exports -24.1 29 11

Imports -16.8 12 12

Inflation -1.4 -





Outlook2011 15


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In2010theUKgovernmentheraldedaneweraofbudgetaryconsolidation,announ-

cingmeasuresdesignedtosavea totalof81bn.Theaimistoshrinkthebudget

deficitfromsome11%ofGDPin2009toapproximately1%ofGDPby2016.British

Chancellor of the Exchequer, George Osborne, revealed dramatic reductions to

severalkeydepartmentsoverthenextfouryears1,a18bnfallinwelfaresupport

andconfirmedthatabouthalfamillionjobs(outofaworkforceofsome6m)willbe

lostinthepublicsectorby2014-15.

Plan B?

TheBritishgovernmentisbankingonthehopethatthisfiercefiscaltherapywillnot

stifletheeconomicrecovery.However,recentresearchsuggeststheopposite.2Andif

thepaceofeconomicactivityalreadyhistoricallylow (figure 11)shouldfalter

afterall,thenMrOsborneseemstobelievethatasecondroundofquantitativeeasing

woulddothetrick.ButhowwiseisitfortheChancelloroftheExchequertoputall

hiseggsintheBankofEnglandsbasket?Notverywiseatallinourview.Asecond

roundofmonetaryexpansionwillnotoffsetthebloodlettingonthefiscalsidenow

thatcapitalmarketinterestratesarenearrecord-lows.Evenafurtherdepreciation

ofthepoundsterlingwillnotworkmiraclesifglobaldemandremainsweak.Andthe

UKbanksarealsonot likely toopenthespigotswhilefacingmassiveheadwinds

goingforward.Againstthisbackground,thegovernmentcannotexpecttheheavily

indebtedprivatesectorwhichisstillrepairingitsdamagedbalancesheetstofill

thegapleftopenbythegovernment.Thedoubledipinthehousingmarketwillmake

thisevenlesslikely.Thereisthereforeaneedfora crediblePlanBforinstance

temporarytaxcutsaswellassupportfrommonetarypolicy,iftherecoveryfalters

duetotheausteritymeasures.

Figure 11: Modest recovery

Source: Reuters EcoWin, Capital Economics

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0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16

1973-1978 1979-1984 1990-1995

1929-1934 2008-2009

Index Index

GDP volume index

(start of recession = 100)

Quarters

United Kingdom: government banking everything on

austerity measures



17/68

No further QE in Britain just yet

ThereismuchdebateabouttheissueofsupportfromtheBoE.Fearsforahesitant

economicrecoverymeanthattheBoEisemphaticallykeepingopentheoptionof

furthermonetaryexpansion.However,thestubbornlyhighinflationmakesitdiffi-

culttoexplainafurtherroundofQEtotheBritishpublic.Infact,theBoErecently

raiseditsshortterminflationforecast,andnowexpectspricestorisefasterthrough-

out2011thanitwouldbecomfortablewithonthebasisofitsinflationtarget.This

inflationarypressure,coupledwithhigherthanexpectedeconomicgrowthinthethirdquarter,meansthatasecondroundofQEhasbeenpostponedfor thetime

being.WeattributeonlyasmallchanceofQEinspring2011;thoughthiswouldbe

dependent ona downward trend in inflation.However, in our view, there is no

questionofQEbeingshelvedaltogether.

Table 3: United Kingdom, key data


GrossDomesticProduct -5.0 1 1 Privateconsumption -3.3

Governmentspending 2.6 1 -1

Privatesectorinvestment -20.1 4 7

Exports -11.1 5 7

Imports -12.3 7 3

Inflation 2.2 3 2





Outlook2011 17


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Intheeurozone,theeconomicrecoverythatwassetinmotioninthesecondhalfof

2009continuedinto2010(figure 12).However,thepaceofGDPgrowthof0.5%

duringthepastfivequarterswaslessstrongthantheaveragecontractionof1.1%in

thefiveprecedingquarters. Thismeanseconomicactivityin thethirdquarter of

2010wasstillover3%belowthepeakinthefirstquarterof2008.Weexpectthe

recoverytochugalongatamoretemperedpacein2011.Asaconsequence,activity

willstillnothavemadeupthegroundlostbythattime.Ifwescratchbeneaththe

surfaceofoveralleurozonegrowth,weseemajordifferencesamongstthemembers

(figure 13).Threeofthefourfastestgrowingeconomiesof2003-2007,willstagnate

orshrinkin2010-2011.WithGermanyinthelead,theexportorientedeconomiesareabletotakefulladvantageoftherecoveryinworldtrade.SeeBox2Onelabour

marketisnotthesameasanotherforananalysisofthecorrespondinglylargediffe-

rencesbetweenlabourmarketsintheEuropeancountries.Onaccountofthetepid

economicrecovery,lowenergypricerisesandanexpectedappreciationoftheeuro,

inflationisexpectedtodeclineto1%duringthecourseof2011.Averagedoverthe

year,inflationwillprobablyrunat1%,thesameasin2010.

No help from monetary or exchange rate policy

Justaselsewhereintheworld,thestallingofeconomicgrowthintheeurozonewas

causedpartlybyagraduallydiminishingeffectoftheexpansionarymonetarypolicy.

TheEuropeanpolicyratehasbeenlowforsometimeandwedonotexpectany

furtherunconventionalpolicymeasuresfromtheECB.Flaggingworldtradegrowth

combinedwith a furtherexpectedappreciationof theeurowillweighon export

growthin2011.

Figure 13: Sprinters and non-starters

Source: Niesr, Rabobank

Figure 12: Recovery continues, though below par


-3

-2

-1

0

1

2

3

4

5

6

7

8

910

2004 2005 2006 2007 2008 2009 2010 2011

90

95

100

105

110

GDP volume, qoq growth GDP volume, 2004Q1 = 100

%

index

Eurozone GDP, constant prices, seasonally

adjusted, realisation and forecast -6

-4

-2

0

2

4

6

-6

-4

-2

0

2

4

6

IE GR FI ES AT NL BE FR DE IT PT

2003-2007 2008-2009 Verwachting 2010-11

Average annual GDP growth (%) in selected periods

% %

Eurozone: a Union of considerable differences



19/68

Nowhereisthesociallegacyofthedeepeconomiccrisismore

visible than in the labourmarket. Governments have been

obliged tointervene. For theG20 summitin Pittsburgh, the

InternationalLabourOrganisation(ILO)calculated the total

effect of all G20 stimulus measures to yield around 0.5%

additional employment for 2009-2010. Despite all the

measures,ahistoricnumberof4.3millionjobshavebeenlost

intheeurozonesincethecrisis.Atthesametime,thisnumber

wastobeexpectedonthebasisofhistoricalexperience (see

figure 14),andisthereforenotsosurprising.3

However,thebreakdownofjoblosseslooksdifferentfromthe

usualpattern.Adisproportionatelylargenumberofjobswere

lost in the construction sector, mainly as a result of the

downturninthepropertymarkets.Largelossesalsooccurred

intheindustrialsector.Regionaldisparitieswereevenmore

marked.Spainaloneaccountedforalmost50%ofalljobslost

intheeurozonebetweenthesecondquarterof2008andthe

fourthquarterof2009.Likewise,Ireland,PortugalandGreece

saw a disproportionatenumberof jobs lost.Meanwhile, in

Germany,employmentremainedunchanged,eventhoughthe

eurozoneslargesteconomycontractedmorethantheregional

average.

Themain reason for Germanysexceptionalpositiononthe

jobsfrontisthewidespreaduseoffacilitiestoshortenworking

hours. Additional government subsidies meant that the

numberofpeoplein thekurzarbeitschemerosetoover1.5

million in 2009. Thus the number of hours worked per

employee in Germany declined muchmore rapidly than in

previous recessions (-2.6% between the second quarter of

2008 andthe fourthquarterof2009),andwhencompared

withSpain,forinstance(+0.9%).Spanishcompaniesopteden

massetodismissworkerswithtemporarycontracts.Moreover,

it appears Germany is still benefitting from the important

Hartzlabourmarketreformsthatwereimplementedbetween

2003 and 2005.These include changes to the amount and

durationofunemploymentbenefitonecanreceive,theintro-

ductionofnewformsofemploymentsuchasmini-jobsandimprovedefficiencyamongrecruitmentagencies.Inaddition,

ageneralpolicyofwagerestraintimprovedGermanyscompe-

titiveness.Consequently,theGermanlabourmarketwasina

position to recover relatively quickly, with unemployment

reachingitslowestlevelinover18yearsinOctober2010!

A number of other eurozone countries, including Austria,

Belgium and the Netherlands followed Germanys example

and managed to contain the job losses (see figure 15). By

making good use of the new pressure valves, a group of

eurozonecountrieshasmanagedtodampentherecessionary

effectsonthelabourmarket.Thisisapositivedevelopment,in

thatadestructionofhumancapitalwasprevented.However,

theresultsatEuropeanlevelhavebeenasgoodaswipedout

bythesharpdeclineinemploymentintheperipheralecono-

mies,particularlyinSpain.

Figure 14: Big job losses consistent with past experience


-1.0

-0.5

0.0

0.5

1.0

-3 -2 -1 0 1 2 3

1970 - 1989 1990 - 2006 2007 - present

Employmentgrowth(heads)%q

oq

GDP growth % qoq

Figure 15: Large differences in hours worked

Source: Eurostat, Reuters EcoWin

DE

FR

IT

ES

NLFI

AT

IE

PT

BE

-4

-3

-2

-1

0

1

2

-12 -10 -8 -6 -4 -2 0

small impacton hours/employee

large impacton hours/employee

GDP volume (%-point)

Hoursworkedperemployee(%-point)

Change from start (2008Q2) to end (2009Q4) of the recession

Box 2: One labour market is not the same as another

Outlook2011 19


20/68

North-South divide

Themainreasonsforthetepidrecoveryintheeurozoneandthelargedifferences

between countries can be found in the macroeconomic imbalances within the

currencyunion.Inthedebateaboutglobalimbalances,theeurozonehasoftenbeen

overlooked.Duringthepasttenyears,thecurrentaccountonthebalanceofpayments

ofthecurrencyunionasawholehasbeenlargelyinbalance.However,thismasks

largeimbalancesbetweenthememberstatesthateasilymatchthoseofthemuch

citedglobalimbalances.Inrecentyears,theMediterraneancountriesandIreland

haveaccumulatedlargedeficitsontheircurrentaccounts (figure 16).Since2003on

anincreasingbasis,moregoodsandserviceshavebeenconsumedinthesecountries

thanhavebeenproduced.Themirrorimageoftheseperipheralcountriesdeficits

arelargecurrentaccountsurplusesinthenortherncountriesoftheeurozone.Thehighlevelofconsumptionandinvestmentinthedeficitcountrieshasbeenfinanced

toalargeextentbythesurpluscountries.Consequently,inthedeficitcountries,the

debtburdenforcompanies,householdsandgovernmentshashugelyincreased.

Governments intervened

Theglobalrecessiontriggereda suddenU-turninthebehaviourofhouseholdsand

companies.Thestrong contraction inprivate consumption andprivate investment

meantthathouseholdsandbusinessesweretransformedfromnetborrowersintonet

savers. Theresulting hole indomestic spendingwas partly filled bygovernments

through automatic stabilisers and fiscal stimulus measures. The ensuing budget

deficitswerelargely financedbyexternalfunds,whichlimitedthereductionof the

currentaccountdeficit(figure 16).Accordingly,thereisstillasignificantamountofnet

lendingandborrowingbetweenthecountriesintheeurozone,butgovernmentshave

assumedtheroleofdebtorinsteadofhouseholdsandcompanies.

but now have to retrench

Governmentscannottakeonthis role indefinitely.Now thatthey areindangerof

Figure 16: Intra-European imbalances


-3

-2

-1

0

1

2

3

-3

-2

-1

0

1

2

3

96 97 98 99 00 01 02 03 04 05 06 07 08 09 10

DE NL BE LU FI AT ES

IT FR GR PT

IE SI SK CY MT

% eurozone GDP % eurozone GDP

Current account balance,

Cyprus from 1999, Belgium/Luxembourg from 2002



21/68

losinginvestorconfidencebecauseoftherapidlydeterioratingfiscalpositions(andin

thecaseofGreeceandIreland,havealreadylostit),itisnecessarytoreducethebudget

deficits. The governments of Greece, Ireland, Portugal and Spain have already

embarkedonmajorausterityprogrammesin2010.In2011theywillgoevenfurther.

Meanwhile,theprivatesectorisengagedinrestoringordertoitsbalancesheetandis

thereforenotinapositiontoincreasespending.Moreover,itisquestionablewhether

thesurpluscountrieswouldbepreparedtofinanceanewriseinspending.Inanycase,

higherinterestrateswillnowbecharged.

The absence of the Southern European consumer

Thefeeblegrowth,orevencontraction,ofdomesticspendinginthedeficitcountries

willnotbefullyoffsetbyhighergrowthinthesurpluscountries.Sincethelatterarebenefittingfromglobaleconomicgrowth,andthefinancialpositionofbothgovern-

mentandtheprivatesectorisconsiderablyhealthierthaninthedeficitcountries,we

expecttoseegrowthindomesticspending.However,inordertoplugtheholeofthe

lowerconsumptiongrowthinthedeficitcountries,spendinginthesurpluscountries

wouldhavetogrowatamuchfasterpacethaninpreviousyears.Thiswouldappearto

beanunrealisticprospectin thenearterm.Forconsumers,thereisnoincentiveto

suddenlybecomemorespendthriftthanbeforetherecession.Moreover,thesurplus

countrieswillalsostartreducingtheirbudgetdeficitsin2011,whichwillactasadrag

on spending growth in the eurozoneas awhole.Figure 17 illustrates this for the

growthofprivateconsumption.Intheperiod2003-2007,Spain,Ireland,Greeceand

Portugalcontributedadisproportionateamounttothegrowthofprivateconsumption

intheeurozone,inrelationtothesizeoftheireconomies.Fornextyearweexpectto

seeacontractionofconsumptionvolumeinthesecountries.Despiteanexpectedrise

inspendinggrowthintheremainingeurocountries,theabsenceofacontribution

fromtheperipherywill ensurethattotalconsumptiongrowthin2011willremain

limitedto1%.

Figure 18: Recovery of competitiveness needed

Source: Bank for International Settlements

Figure 17: Absence of Southern-European consumer

Source: Niesr, Rabobank

-2

-1

0

1

2

-2

-1

0

1

2

02 03 04 05 06 07 08 09 10 11France Germany

Italy Benelux

Spain Greece Portugal Ireland

Other Eurozone

Eurozone private consumption growth,

realisation and forecast,

4-q avg w.r.t. previous 4-q avg

% %

80

90

100

110

120

130

80

90

100

110

120

130

99 00 01 02 03 04 05 06 07 08 09 10

Austria Belgium Finland France

Germany Greece Ireland Italy

Netherlands Portugal Spain

index index

real trade-weighted exchange rates

based on consumer price differentials,index January 1999 =100

Outlook2011 21


22/68

Learning to compete again

Thereductionoftheimbalancesintheeurozonewillmainlybeachievedduringthe

nextyearbymeansoflowerimportgrowthinthedeficitcountries.Inordertorealise

afurthercorrectionbymeansofhigherexportgrowth,deficitcountriesmustalso

restorecompetitiveness.Thegapthathasgrownintherealtrade-weightedexchange

ratesofthevariouseurocountrieshasnarrowedsomewhatsince2008,butremains

verywide(figure 18).4Forinstance,Irelandisstill10%moreexpensiverelativetoits

tradepartnersthanearly1999,whereasGermanyis10%cheaper.Inordertonarrow

thisgapfurther,yearsofadjustmentarenecessary.Thiswillbesoughtpartlythrough

lowernominalwagegrowthinthedeficitcountriesandpartlybymeansofproducti-vitygrowthbasedonstructuralreforms.

Table 4: Eurozone, key data


GrossDomesticProduct -4.1 1 1 Privateconsumption -1.2 1

Governmentspending 3.0

Privatesectorinvestment -13.0 - 2

Exports -13.1 11 6

Imports -11.9 9 5

Inflation 0.3 1 1







23/68

Onthebackofeconomicrecoveryandimprovedsentimentinthefinancialmarkets,

theECBstartedtophaseoutitsexpansiveliquiditypolicyinDecember2009.In

2010itstoppedissuingnewliquiditywithamaturityoflongerthanthreemonths,in

ordertogetabettergriponmoneymarketinterestrates.However,thecrisisinthe

marketforEuropeangovernmentbondsforcedtheECBtotemporarilyloosenits

policy;butultimatelyinthesecondhalfof2010wesawa sharpreductionofthe

surplusliquidityinthemoneymarketsasanumberoflargeloansmatured.The

moststrikingamountwastherepaymentofone-yearloansamountingto442bn

on1 July2010. Financial institutions onlypartly replaced these loanswith new

loans,withshortermaturities(figure 19).Asaresult,excessliquidityinthemoneymarket declined, which placed upward pressure on money market rates. In

mid-October, the3-monthEuribor rate creptabove1% again - theECBsofficial

policyrate (figure 20).However,ratesonloanswithashortermaturityremained

wellbelowthisthreshold,becausetheECBcontinueditspolicyoffullallotment.

Is complete normalisation a feasible goal?

AlthoughtheECBindicatedinSeptember2010thatitplanstocontinueitsmoney

marketoperationsonthebasisoffullallotmentuntilatleast18January2011,ithas

notconcealeditsintentiontodiscontinuethispracticesoon,becauseitreducesthe

incentiveforbanksto lendmoney toeachother.Moreover, the lastingexpansive

moneymarketsituationmeansshort-termmoneymarketinterestrateswillremain

belowtheofficialpolicyrate-theratethattheECBsaysisappropriate,giventhe

financialandeconomiccircumstances.Theabovepolicyalsoreducestheincentive

forsomefinancialinstitutionstogettheirfundingfromothersourcesbesidesthe

ECB.Inlightoftheturbulenceinthemarketforgovernmentpaper,notallfinancial

institutionshaveeasyaccesstothecapitalmarkets.Datafromnationalcentralbanks

showthattheIrish,Greek,PortugueseandSpanishfinancialinstitutionshavebeen

Figure 20: Return to normalisation of money market rates


Figure 19: Phasing out of loose liquidity policy


0

100

200

300

400

500

600

700

800

0

100

200

300

400

500

600

700

800

Jan-10 Apr-10 Jul-10 Oct-10

Long term Other

EUR bn EUR bnECB loans related to monetary policy operations

0

1

2

3

4

0

1

2

3

4

09 10

EONIA 3M Euribor ECB policy rate

% %% %

ECB: remaining cautious

Outlook2011 23


24/68

making disproportionate use of the ECBs liquidity facility. These are the very

countriesthatarestrugglingwithheftybudgetdeficitsandwaninginvestorconfi-

dence.

Itisaviciouscirclethatisdifficulttobreakoutof.IftheECBfurtherrestrictsthe

liquiditythathasbeenmadeavailablebydiscontinuingfullallotment,thenitcanbe

expectedthat(i)theinterbankrateswillrisefurtherduetoafreshriseincounter-

partyriskandliquiditypremiumsand(ii)thatthedifferencesinthefinancialhealth

ofvariousbankswillhaveagreaterimpactontheir(shortterm)fundingcosts.This

willposemajorchallengesforcountriesthataremakingdisproportionateuseofthe

ECBsfacilities.Discontinuingthe fullallotmentpolicywould,therefore, resultin

furtherturbulence.Inviewofthecurrentsituationofthebondmarkets,weexpecttheECBtopostponethisdecisionforthetimebeing.Thisdoesnotmeanthatitwill

beshelvedindefinitely.WeexpecttheECBtotakethisstepduringthecourseof2011.

It may possibly relieve the pain with a number of (temporary) compensating

FearofdeflationstilllurksinthebackgroundintheUSandthe

eurozone(figure 21).Recently,parallelswithJapan-styledefla-

tionisoftendrawnbymarketparticipants,withthesuggestion

thattheUSandtheeurozonearelikelytoheadforaprotracted

periodofdeflation,economicstagnationandfurtherdeclining

interestrates.Thereareatleastfiveargumentsagainstsuch

comparison.5

First,thebubblesintheJapanesemarketsweremuchlarger.

Bycomparison,thehousingbubblesintheUS,theUK,Ireland

andSpainweresmallfry.Mindyouthat theroyalpalacein

Tokyowasworthmore than allthe real estatein California

together during the peak of the boom. The Japanese stock

market was also significantly overvalued prior to the lost

decade.Intheearly1990s,theprice-to-earningsratioofthe

Nikkei-225wasaround50,whiletheAmericanS&P-500,the

UKsFTSE-100andtheGermanDAX-30registered18,11and

11 respectively, in early 2008. The implosion of the much

largerJapaneseassetbubbleshadfarmoresevereandlong-

lastingwealtheffectsontheeconomy.

Figure 22: Japanese prices only now reach normal levels

Source: Eurostat, Rabobank

Figure 21: Deflation lurks

Source: IMF, Rabobank

0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.0

0.1

0.2

0.3

0.4

0.5

0.6

94 96 98 00 02 04 06 08 10

IndexIndexIMF Deflation Vulnerability Indicator

Moderate risk (e.g. Germany, France, Italy, Portugal, Greece and the US)

Low risk (e.g. the UK, Sweden, Australia, China)

High risk (e.g. Ireland, Japan and Spain)

0

20

40

60

80

100

120

140

0

20

40

60

80

100

120

140

60 65 70 75 80 85 90 95 00 05 10

US EMU-11 Japan

Index IndexComparative price levels

(CPI, 2005 benchmarks)

Box 3: Not another Japan



25/68

measures.Thesecouldinclude,forinstance,atemporaryloweringofthedifference

betweentheofficialpolicyrateandtherateonthemarginallendingfacility.

Conventional monetary policy remains expansive in 2011

Monetarypolicywillnecessarilybe constrainedbyeconomic circumstances. Our

scenario is based onmoderate economic recovery,with theovercapacity in the

economyslowly,butsurely,diminishing.Weenvisageaverageinflationtoremain

wellbelowthe2%targetin2011.ThisisnoreasonforustofearaJapanscenario-

seealsobox3.Upwardinflationaryrisksarechieflyintheareaofthecommodity

markets,government-regulatedpricesandindirecttaxes.Lookingahead,weexpect

theeconomicrecoverytogearupanotchin2012.BasedonpastactionsbytheECB,

thiscouldmeanaslighttighteningofthepolicyratein2011,butbynomeansanaggressiveratehike.TheECBswishtonormalisepolicyassoonascircumstances

permitremainsa factorthatwetakeonboardinourforecastforthepolicyrate,

albeitontheconditionthatthesituationontheEuropeanbondmarketimproves

AsecondargumentisthatJapaneseconsumerpriceshadrisen

tounsustainableheights.Thiswaspartlyduetotheenormous

expansionincredit;expressedasapercentageofGDP,domestic

credit jumped 67%-points between 1982 and 1996. With

hindsight,deflationwasutterlyunavoidable.Onlynow,twenty

tothirtyyearslaterareJapaneseconsumerpricesonalevel

withthoseintheUSandtheeurozone(figure 22).

Third, Japan entered its crisis with severe demographic

headwinds.Theworkforcepeakedin1995andhasbeenshrin-

kingeversince.PopulationageinginJapanhasresultedina

higherdependencyratio,leadingtoweakerconsumerdemand

andhencefallingprices.Bycomparison,thecountriesthatare

nowexperiencingthebiggestassetpricecorrections(theU.K.andtheUS)havedistinctlybetterdemographics,withgreater

populationgrowthandlessserious,thoughrising,population

ageing.

Fourth, at the time, the yen appreciated significantly on a

trade-weightedbasisduringthefirstfouryearsofthecrisisa

direct consequence of the countrys large current account

surplus.Thisledtofurtherdeflationarypressure.Thecurrent

situationintheUSandEuropeisclearlydifferent.

ThefifthargumentisthatJapanesepolicymakerswereslowto

implementfiscalandmonetarystimulusmeasurestobolster

growth.However, current economicpolicymakers in theUS

and the eurozone were quick to respond with support

measureswhenthecrisismadelandfall.Theyalsotackledthe

problems in the banking sector promptly, whereas Japan

alloweditszombiebankstoroamfortoolong.Lestitbecome

apopularpastimetocriticiseJapanesepolicymakersfortheir

failuretotacklethecrisisatthetime,weshouldnotforgetthat

thecardswerestackedfarmorenegativelyagainstthem,with

much larger bubbles imploding. In our view, it would be

misguided to place excessive trust in the current policy

responseonthebasis that policymakershavelearnedfrom

pastmistakes.

On the whole, we dont believe that Japan is the correctscenarioforestimatingtheconsequencesofdeflation.Thisis

nottosaythatdeflationrisksdonotexist.Thereiscurrentlya

highdegreeofsparecapacityinthewesternworld,andaccor-

dingtoeconomictheory,thisshouldputdownwardpressure

onprices.However,thesetextbooknotionstendtounderesti-

matetheimpactofdownwardwagerigidityandwellanchored

inflationexpectations.Inaddition,thereistheongoingprocess

ofdeleveraging,whichmaytakeyearsandwillhaveadeflatio-

naryeffect.Sowearenotoutofthewoodsyet,eventhough

Japansexperienceisnottherightcompasstogoby.Nonethe-

less, it is a reassuring thought that long-termdeflationhas

beenararephenomenoninthepost-warera.

Outlook2011 25


26/68

significantly.WeexpectthattheECBwilltakeafirststepinlate2011towardsgradu-

allynormalisingitspolicyrate.Weexpecttofirstseeanincreaseinthepolicyrateof

25bps,tobefollowedbyafurtherriseof125bpsin2012.Atthesametimeitmust

beemphasisedthatpolicywillremainexceptionallyexpansivein2011(includinga

negativerealinterestrate)andeveniftheofficialratereaches2.5%bylate2012,this

willbefarfrombeingrestrictive.

TheEuropeanbondyieldspreadswidenedsharplyduring2010 (figure 23).Fora

numberofcountries,theyieldongovernmentbondsvis--vistheGermanbench-

mark reached a euro-era peak. The enormous budgetary problems in Greece

triggeredaconfidencecrisis,whichthreatenedtospreadtoagrowingnumberof

eurozonecountriesduringthecourseof2010.Policymakersintervenedagainanda

numberofcountrieswereforcedtoimplementausteritymeasures.Nonetheless,the

situationremainsprecarious.

Debt crisis exposes underlying problems

The past year has brought fundamental problems and imbalances within the

eurozoneintothedaylight.Particularlyintheso-calledperipheralcountries,these

problemsareconcentratedinfourareas:(I)sluggishgrowthoflabourproductivity

owing toa lack ofboth innovation andcompetition (Portugal andSpain), (II) a

deteriorationofcompetitivenessresultingfromhighgrowthinnominalwagesinthe

past,(III)apropertymarketbubble(SpainandIreland)amidsharplyfallinginterest

ratessincejoiningtheeurozone,and(IV)inadequatebudgetarysupervision(Greece

andPortugal).Togetherthesefactorsultimatelymanifestedthemselvesassizeable

current account deficits and/or vigorous growth of credit (see also the earlierparagraphNorth-Southdivide).

Systemic risk

Themarketslossofconfidenceintheeurozoneduring2010isexacerbatedbythe

highleveloffinancialandeconomicinter-connectednesswithintheregion.Thishas

resultedinasharpincreaseintheperceivedsystemicrisk.Liquidityinthesmaller

sub-marketsdriedupandyieldsofriskiergovernmentbondsrosetosuchextreme

highsthataccesstothecapitalmarketbecameincreasinglydifficultforanumberof

countries.Greecewasthefirstvictimandeventuallyhadtobebailedoutwithajoint

loanof110bnbytheIMFandtheEU.Shortlyafterwards,furtherfinancialmarket

distresscompelledEUleaders,incollaborationwiththeIMF,tosetupaEuropean

FinancialStabilityFacility(EFSF)fortheperiod2010tomid-2013,tofunctionasa

Bond markets: a new chapter in the markets crisis



27/68

safetynetifothergovernmentsneedfundinginthefuture.TheECBpledgedtointer-

veneinthemarket(bybuyingtreasurypaper),inordertoimprovethefunctioning

of distressedmarkets (figure 24). A severe package of austerity measureswas

imposedonGreece,andSpainandPortugalhadtopledgetoimplementextraauste-

rity measures quickly and decisively. Although the European negotiations were

alwaysconductedonaknifeedge,weassumethatthepolicymakersneveractually

sawthedissolutionoftheeuroasarealalternative. See also box 4, No winners if the

currency union falls apart.

Germany and France throw a cat among the pigeons

Duringthesummer,marketsentimentimprovedsomewhat,astheabovemeasures

begantobearfruit,theliquiditysituationimprovedandanumberofgovernmentbond auctions in theperipherywent better than expected.A crucial element in

restoringcalmwasthatbysettinguptheEFSF,theEUleadershadgivenastrong

signalthattheywouldnotletaeurozonememberdefault,providedthatthestate

committedtoextraausteritymeasures.However,thisnotioncameunderthecoshin

theautumn,when Germany (and laterwith support fromFrance) called for the

replacementoftheEFSFafter2013withamuchmorestringentCrisisResolution

Mechanismthatwouldforceprivatesectorbondholderstobearpartofthelossesif

acountrygetsintodifficulty.

Are the markets over-reacting?

UncertaintysurroundingthereplacementoftheEFSF,plusalowlevelofliquidityin

somebondmarketshasdramaticallypushedupbondyieldsforGreece,Portugaland

Irelandsincemid-October.Yetthereismoretothisthanmeetstheeye.Thefactthat

theyieldspreadswerealreadysubstantialevenbeforetheannouncementofthese

plansindicatesthatinvestorswereneverfullyconvincedthatsovereigndefaultwas

offthetable,evenafter theestablishmentof theEFSF.It isnotsosurprisingthat

closerbudgetarysupervisionmustbeinplaceinthefuture.Moreover,Germanyonly

Figure 24: No unconditional ECB support

Source: ECB

Figure 23: Segmented market for government bonds


0

2

4

6

8

10

12

14

0

2

4

6

8

10

12

14

08 09 10

Germany Ireland Netherlands Greece

Portugal Italy Spain

% %

Yield on 10-year government bonds

0

10

20

30

40

50

60

70

0

10

20

30

40

50

60

70

May-10 Jun-10 Jul-10 Aug-10 Sep-10 Oct-10 Nov-10

EUR bn EUR bnCumulative ECB purchases of government bonds

Outlook2011 27


28/68

wantstohavethenewmechanismapplytonewdebt.Therewould,therefore,appear

tobenodirectreasontoresellexistinggovernmentbondsatpricesthathavefactored

inahigh probabilityofdefaultor restructuring. Inany case, therewill bemany

technicalandpoliticalbarrierstobeovercomebeforeamechanismisinplacethat

providesenoughincentiveforcountriestogettheirpublicfinancesinorder,without

furtherincreasingsystemicrisks.Itisentirelypossiblethatitwillbeacaseofthe

barkbeingworsethanthebite.

The destination is clear but the road is rocky

WithitsproposaltosetuptheEFSF,theEUhasmanagedtobuyitselfsometime.The

ultimate goal isclear formost countries: (I)improved governmentfinances, (II)

The costs of a potential break-up of the euro would be

enormous.Inaddition,theentireprocesswouldbesurrounded

byamassivedegreeofuncertainty.Thiswould,therefore,bea

veryunattractivepolicyoptionforallthecountriesinvolved.

Wehaveidentifiedatleastfivesetsofeconomiccoststhatare

associatedwithpartial(individualcountriesleavingtheeuro)

ortotaldissolutionofthesinglecurrency.

First,thecontinuityofcontractsimpliesthatonceacountry

leavestheeuro,itmaynotconvertitseurodenominatedassets

andliabilitiestoitsowncurrencyonaparitybasis.Apartfrom

completebankruptcy of anexitingcountry, aweak country

will see its net debt position shoot upin its new currency,

becauseitsowncurrencywillimmediatelydepreciatesharply.

Forsimilar reasons itis unattractiveforstrongcountriesto

leavethesinglecurrency,eveniftheydontrelishhavingtopay

forEuropeansafetynets.Strongcountriesthatleavewillsee

thevalueoftheirnetassetsasexpressedintheirnewcurrency

declinebecausethenewcurrencywillappreciatesignificantlyagainstthestronglyerodedeuro.

Second,creditmarketshavebecomestronglyinterconnected

sincetheintroductionoftheeuro.Thismeans,thatevenifa

relativelysmallcountryleavestheeurozone,heavylossesare

incurredinthefinancialsector-bybanks,investmentinstitu-

tionsandpensionfunds,butalsointhecorporatesectorwhere

internationalinvestmentssuddenlyplummetinvalue.

Third,theexchangerateriskre-emergesiftheeurobreaksup.

Thisextrariskwillresultintheneedforadditionalbuffersin

internationalfinancialflows,butalsomakestheinternational

fragmentation of production chains and the ensuing trade

flowslessattractive.

Fourth,theintra-eurozonetradewouldimplode.Thiswillbea

heavyblow for thefinancial sector, companies, households,

thetaxbaseofgovernmentsandthegeneralstandardofliving

oftheeurozonepopulation.

Fifth, it isanillusion toexpect that any countrycansimply

leavetheeuroinanorderlymanner.Therewillinevitablybe

manymonthsbetweenthetimethattheexitisannouncedand

the actual reintroduction of the national currency. In the

interim,everyone-speculators,companiesorevenordinary

deposit-holders-willmovetheirmoneytothesafesthaven.

Collectively,thiscanonlyresultincompletepanicandchaos,

whichwouldmakethecollapseofLehmanBrothersseemlike

childsplay.

Europeanpoliticiansarealltooawareoftheseconsiderations.

Ironically,thismakesthenegotiationsforaEuropeansolution

to the debt problems even more complicated, precisely

becausenosinglecountrycanaffordtopenaliseunreasonably

tough demands by allowing the negotiations to fail. The

politicalwranglingabouttheinstitutionalisationoftheEFSFin

theautumnof2010 fullyexudesthesestrategic negotiating

factors.Infuturecrisissituations,itislikelythatnegotiations

will again - in an apparently incomprehensible way - be

conductedataknifesedge,simplybecauseaccidentswilldo

nobodyanygood

Box 4: No winners if the currency union falls apart



29/68

morestringentbudgetarysupervision inthefuture (includinga bettersanctions

policy)and(III)structuralreformsinordertosteereconomiesontoafundamentally

higher andmore sustainable growth path. Although experience teaches us that

budgetarydisciplineisbetterinthelongrunforeconomicgrowth,thepathtobe

taken is exceptionally rocky. Greeceand Ireland have seen that severe austerity

measures are painful in theshort term.During thebondmarket crisis, theECB

indicateditswillingnesstoplayaroleinimprovingthefunctioningofthemarket,

butcertainlynotatanyprice.Itwasloathtopurchasetreasurypapereveninthe

monthofOctoberandinearlyNovember,comparedtotheMay-Juneperiod (figure

24).ThiscanbeinterpretedasasignalthattheECBdoesnotwanttofollowtheFeds

footsteps.

Germany still a safe haven

WhatdoesallthismeanforEuropeancapitalmarketinterestrates?Althoughwefeel

themarketshaveover-reactedtotheFranco-Germanproposals,wedonotenvisage

thatyieldsonperipheralgovernmentpaperwillfallbacktoearly2010levelsany

timesoon.NotevenifcountriesseeksupportfromtheEFSFand/ortheIMF-a

scenariothathaslookedmorelikelyinrecentweeksandhasevenbecomerealityin

thecaseofIreland.ThismeansthatGermanbundswillcontinuetofulfiltheirimpor-

tantfunctionofsafehaveninto2011.Atthesametime,ifothercountriespursue

theirreformedpolicies,adeclineinthespreadsforanumberofsmallercountries

mightbepossible.Therewillbeupwardpressureontheyieldsonthelargeliquid

benchmarks,suchasGermanyandFrance.Ourlong-termswaprateestimatesare

largelydeterminedbythisdevelopment,whichiswhyweanticipatea rise inthe

10-yearswaprateofsome50bpsoverthecourseoftheyear(2011).Thismeans

long-term(risk-free)interestrateswillremainexceptionallylow,whichisconsistent

withourvisionofmoderateeconomicgrowthandcontrolledinflation.

Fromariskperspective,wenotethatalsoduringthecourseof2010thebehaviour

ofinstitutionalinvestorsagaininfluencedtheswapcurve,withtheultra-longendof

thecurve(30-50years)droppingfasterthanshorterswaprates.Thiscanpartlybe

attributedtothefactthatlowinterestrates(incombinationwithrisingyieldsonperipheral government paper) induced institutional investors to hedge against

furtherdeclinesininterestrates.Inourbasecasescenario,inwhichEuropeanbond

market sentiment recovers somewhat and the swap curvemoves upwards, this

couldleadtotheoppositereactionintheultralongswapratesduringthecourseof

2011.Thiswillthenresultinasteeperriseinthelongsegmentoftheyieldcurve.

Fed chips in big time

When analysing interest rates in theeurozone, wealso have to take account of

developmentsintheUS.For2011,weexpecttoseeonlyminorinterestraterises.

EarlyNovember,theFedannouncedanewprogrammeofpurchasingtreasurypaper

worthUS$600bn.AslongastheFedpursuesthispolicy,wedontseeinterestrates

onUSgovernmentbondsmovingupveryaggressively.Officially,theprogrammeis

Outlook2011 29


30/68

meanttorununtilmid-2011.Inourview,however,therewillnotbesufficientimpro-

vement intheeconomyby thentodeter theFed fromextending theprogramme.

Accordingly,marketratescanbeexpectedtoremainsubduedinthesecondhalfof

2011.

Thatsaid,thedownwardpotentialislikelytobelow.Afterall,alotofnegativityhas

alreadybeenpricedin.Infact,the10-yearUS$swaprateinmid-Novemberwasnot

farabovethe troughof18December2008,althoughthecurrentsituationonthe

marketsandintheeconomyisfarfrombeingasdramaticasinthedarkdaysoflate

2008.Inourview,thelongtermrisksforUSinterestrateswillbemoreontheupside.

Uncertaintyaboutthelongtermconsequencesofthispolicyoninflationhasalready

resulted inhigher inflation premiums in themarket (figure 25). As soon as theeconomypicksup,inflationexpectations couldrise fairlyquickly.And if theFed

respondsbystallingitsbondpurchasingprogramme,thiswillresultinhighercapital

marketrates.Likewise,USfiscalpolicycanultimatelyleadtorisinginterestrates.

Figure 25: Rise in US inflation expectations

Source: Bloomberg

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Theinternationalcurrencywarwasthedominantthemeincurrencymarketsduring

thesecondhalfof2010.TheBrazilianFinanceMinisterwhousedthattermclearlyhad

asenseofdrama,buthedidtouchanerve,particularlyinthelightoftheFedsproposed

newroundofquantitativeeasing.TheUScentralbankpolicyisexpectedtoresultina

weakerdollar(figure 26) andispartofawelcomeadjustmentintheglobaleconomy.

Thismeanswehaveto seethe strongdollarstancepostulatedby theUS Treasury

Departmentforwhatitreallyis.Thisrealityhashithome,andmarketsnowexpecta

broadweakeningofthedollarin2011.

Anorderlydepreciationofthedollarwouldgosomewaytowardsrepairingthegaping

hole intheUScurrentaccountbalance amajorelementof global imbalances.Of

course,onlyinadditiontotheU-turnofAmericanhouseholdsandthefederalgovern-

mentfromspendingtosaving.Sowhilewegoalongwiththeideaofaweakerdollar,the

followingquestionsremain:Againstwhichcurrenciesisthedollartodepreciate?And

towhatextent?

The euro an escape valve once again

Clearlytherealisationthatglobalimbalancesneedtobetackledhasplacedthespotlight

fullyonChina(figure 27).Chinasenormouscurrentaccountsurpluscombinedwitha

currencythatiskeptartificiallylowisraisingeyebrowsthroughouttheworld.Increa-

singdomesticpricepressureandexternalpoliticalpressureoughttoinducetheChinese

centralbanktofurthertightenmonetarypolicyduring2011.Weshouldthenseehigher

interestratesandaquickeralbeitinabsolutetermsstillgradualpaceofapprecia-

tionfortheYuanagainsttheUSdollar.

Figure 26: Dollar weakness


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Currency markets: policy of dollar weakness

Outlook2011 31


32/68

Notwithstanding theG20 discussions about theglobal imbalances, it is difficult to

envisage20countriescomingupwithauniformframeworkinwhichcurrentaccount

balancesandexchangeratesareadaptedinanorderlyway.Amuchmorelikelyscenario

isthattheemergingeconomiesincludingChinawillcontinuetoresistanyappreci-

ationoftheirnationalcurrency.Andthisiswhywearelikelytoseetheeuroactingas

anescapevalvefordollarweaknessagain,whichisoneofthemainreasonswhywe

envisageastrongereuroagainstthedollarin2011.

The ECB wants to raise rates earlier

Anappreciationoftheeuroagainstthedollarwilltakeplacedespiteconcernsabout

debtsustainabilityintheEuropeanperiphery,althoughtheremaywellbeconsiderable

volatility.Fromabilateralpointofview,weexpecttheECBtoraiseinterestratesearlierthantheFed,whichwillalsogiveapositiveimpulsetotheeuro/dollarrate.Apartfrom

alltheconcernsaboutthesustainabilityofEuropeanpublicfinances,Europemoreover

makesitclearthatitisawareofthelargeproblemsitfacesandthatitisdoingitsbest

toaddressthese.IntheUSontheotherhand,thisawarenessseemstobelimitedtothe

membersoftheTeaPartymovement,atleastinsofarasthisideologyaspirestomake

thegovernmentapparatusassmallaspossible.ItseemsEuropehasthedubioushonour

ofbeingthefirsttorecognisetheextentofitsproblems,whereaspolicymakersinthe

UScanhardlydenytheirproblemsanylonger(figure 28),anymorethantheycandeny

thedollarweaknessthatwillinevitablyfollow.

Upward potential for sterling; the yen to lose ground

Andwhatwillthismeanfortheeuro-sterlingrateandtheeuro-yenrate?Sterlingisstill

some 20% cheaper vis--vis the euro compared to 2007.Onemight ask why the

currencyhasnotyetmadeupthelostground.Thishastodowithalonglistofconcerns

about theUK.These include thefragile publicfinances,apossibledowngradingof

Britishcreditworthinessbythemainratingagenciesandanaemiceconomicprospects.

Meanwhile,thesurprisinglystronggrowthfiguresfor2010havehelpedtopushauste-

Figure 27: China in the spot lights


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ritymeasuresthroughandhavedeflectedtheimminentthreatofadowngradingofthe

Britishgovernment.ItcannotbedeniedthattheUKeconomyisbattlingwithstrong

headwinds,butsincesomuchnegativityisalreadypricedinto themarkets,wesee

roomforamodestdropintheeuro-sterlingrate.

Atthesametime,weexpectthattheyenwillhavetoconcedesomeofthegroundgained

thisyearagainsttheeuroin2011.Theyenappreciatedinanenvironmentofextremely

lowinterestratesandconsiderableriskaversion.Thistemporarilydeflectedtheatten-

tionof investors from therelativeyieldsand Japanese domestic factors,neither of

whichsupport theyen.Andwedont expectthat thecurrencyinterventions ofthe

JapanesecentralbankandtheJapaneseFinanceMinistrytofundamentallychangetheexchangeratedevelopment;howeverwedorecogniseadownwardriskintheyen-dollar

exchangeratethankstotheseinterventions.

Figure 28: What weak government finances?

Source: IMF, US Budget Office, Reuters EcoWin, Rabobank

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Outlook2011 33


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TheEuropeancreditmarketsperformedwellin2010.Investoranxietyhaslargely

been limitedto thebondmarketsin theperipheralstates.However, liquiditydid

deteriorategraduallyinthesecondarymarkets,withfallingyieldsandbondissuance.

ThisyearhasbeendifficultfortheEuropeanbankswhichweresufferingfromthe

rise ingovernment bondyields in theperiphery.Butmoreparticularly financial

institutionsstruggledbecausethepoliticalsupportbaseforaidhasdroppedtorock

bottom.

Thewindowforissuancehasnotalwaysbeenopen,atleastforbanksoutsidethetoptier.However,since thenewBaselcapitalrequirementshavealreadybeenmade

known,wesawanumberofbanksapproachthemarketinordertoconsolidatetheir

capitalpositionaheadoftheposse(DeutscheBank,StandardChartered,BBVA).In

particular,theBaselregulationswillrequireastrongercapitalbufferforthetrade

book,whichmeansthatbanksthatarestronglyinvolvedininvestmentbankingwill

need evenmore reserve capital.Bankswill find partofthesolution inretaining

profits, but also amarket for contingent convertible debt, or similar, has to be

developed.Withregardtoseniorunsecureddebt(notbackedbyspecificcollateral

bytheissuer)wesawthatthemostsolidbanksstillhadaccesstothese,whereas

smallerandlesssolidbankshadtoseekalternativesolutions,includingthecovered

bondmarket(backedbyspecificcollateral).

2010sawfewerissuancesthanwehadexpectedfromthesolidupperechelonsofthe

corporatesector,whileinvestorsavoidedsharesandliquidinstrumentsinfavourof

bonds.Marketscurrentlyperceivebondstobeasaferhaventhanshares,whichis

supportedbytherelativelystabledevelopmentofcreditspreads.Intheabsenceof

issuancebythemajorcorporatenames,investorsareseekingoutyieldsintherelati-

vely less solid segments of thebondmarket. However, they have becomemore

cautious, inview of the low levelsofabsolute yields.Weexpectthese trends to

continueatleastintothefirstfewmonthsof2011.

Credit markets: not all markets open for issuance



35/68

Mixed outlook

Inanormalcreditcycle,weusuallyseecorporationsconsolidatetheirbalancesheet

firstandforemost,before looking toexpand.Althoughthereis someevidenceof

mergersandacquisitions,itmustbeacknowledgedthatshareholdershavetaken

quitesomepaininrecentyears.Forthisreason,companiescouldbemoreinclined

totiptheirpolicyinfavourofshareholdersandtothedetrimentofbondholders.

Thiscouldbeachieved,forinstancebysharebuybacksorbymeansofacquisitions

onthebasisofavailablecashresources.InEurope,anytendencytowardsexpansion

islikelytobefairlysubduedforthetimebeing,giventheasyetfreshmemoriesofthecrisis.

Webelievethereispotentialforanupsetin2011,butmostlikelyatamacro,or

sovereignlevel.Theescalationofthesimmeringcurrencywarswouldbeafactor,

particularlyifinternationaltradeweretobecurtailedasaresult.Themoreobvious

variablethoughrelatestoEUsovereigndebt,especiallyontheperiphery.Butifthese

risksdonotmaterialise,thenweexpectthebankstoseecreditspreadsmaintainthe

currentbandwidths.Thereis uncertainty asto thefeaturesof newsubordinated

bonds,butwiththeemphasismoreonequitythenewbondsshouldhaveararity

value.Until we are further into the expansion cycle, technical and fundamental

supportspointtotighternon-financialcorporatespreads.

1. Exceptintheprotectedpolicyareasofhealthcareanddevelopmentcooperation,the

ministriesaretoreducespendinginrealtermsby19%.

2. Foramoredetailedanalysis,seethechapterGlobaleconomicchallengesbeyond2011:an

historicperspectiveelsewhereinthispublication.

3. Thefactthatonly4.3millionEuropeanjobswerelost,comparedtoover8millionintheUS

appearstobedueto(traditionally)lessaggressivedismissalpolicyandarelativelyinflexible

labourmarketintheeurozone.

4. Therealtradeweightedexchangeratemeasurestheexchangeratiobetweendomesticgoods

andservicesandabasketofimportedgoodsandservices,linkingthecompositionofthe

importedbaskettothedestinationoftheexportbasket.Thisexchangeratiocanfluctuate,

evenifcountrieskeeptheirexchangerateunchanged(asisthecasebetweencountriesintheeurozone).

5. FormoreonthisseeRabobankSpecialReport2010/14,Deflation,herewecome?.

Outlook2011 35


36/68

2010 has been a year of picking up the pieces. The economy is

emerging from a deep recession. After an economic contraction of

almost 4% in 2009, real GDP is expected to increase by an average

of 1% in 2010. This is not enough to bring production back to

pre-crisis levels. The Dutch economy has benefited in 2010 from

export growth and from the government stimulus memasures. For

the time being, consumers remain cautious, while on the

investment front, activity is limited. For the coming years, real GDP

growth - which is expected to average 1% - will be lower than in

2010. Factors to blame include the levelling off of world trade

growth and the austerity measures implemented by the

government. Because the proposed cuts will also affect consumer

spending, a resurgence of growth is not expected during the

2012-2016 period.

The Netherlands:becoming accustomed

to a lower growth

path



37/68

Ruth van de Belt

Anke Struijs

Authors

Economic recovery losing momentum

Inthewakeoftheflatteninggrowthinworldtrade,theeconomicrecoveryinthe

Netherlandslikewiseenteredasoftpatchafterthesecondquarter.Whilesecond

quartergrowthin2010wasup0.9%onthepreviousquarter,theeconomycontracted

by0.1%onaquarterlybasisinthethirdquarter(figure 29).However,thiscontrac-

tiondoesnotmeanthatweareabouttoenteranewrecession.Recoveryaftera

financialcrisistypicallyprogressesinfitsandstarts.Thequarter-on-quarternegative

growthislargelyduetocompanieshavingreducedtheirinvestmentininventories.

Inventorieshadfirstbeensharplyrundownduringthecrisis.Thiswasfollowedby

aperiodofinventoryrebuildingduringthefirsthalfof2010,creatingapositive

stimulusfordemandandboostingeconomicgrowth.Withouttheeffectofinventory

rebuilding,thegrowthfiguresforthesecondandthirdquarterswouldhavelooked

quitedifferent(figure 29).Inthethirdquarter,thevolumeofGDPwouldhaveincre-

asedbyalmost2%onthesecondquarterwhereastherewouldhavebeenalmostno

GDPincreaseinthesecondquarter.

Figure 29: Economic recovery slows

Source: Statistics Netherlands (CBS)

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Outlook2011 37


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Theordinarypersonwillnotreallybeawareofthenegativeinventoryeffectinthe

thirdquarter. Infact,consumersspentmorein thethirdquarter,particularlyon

durableconsumergoods,suchascarsandelectronics.Thusthevolumeofconsump-

tiongrewby0.1%comparedtothesecondquarter.Bycontrast,corporateinvest-

mentwasdownbyover2%,onthepreviousquarter,whileithadincreasedsignifi-

cantlyinthesecondquarter.

Theslackeninggrowthinthesecondhalfof2010hadbeenforecastbytheRabobank

economic growth indicator on the basis of leading indicators such as lending,

consumerconfidence, long-term interestrates, industrialorders andtheGerman

IFO index (figure 30). For the comingmonths, the indicator points to a further

slowdownintheeconomicrecovery,forecastingthatbytheendof2010,economicgrowthintheNetherlandswillbebelowtrendandwillremainatthatlevelin2011.

ItisestimatedthatrealGDPgrowthin2011willaverageat1%,lowerthanthe

averagefor2010(1%).

Theeconomiccontraction in thethirdquarter hasheightenedanxiety about the

dreadeddoubledip. Inkeepingwith theeconomic definitionof a recession, we

alreadyhaveonefootinasecondrecession,asevidencedbyonequarterofnegative

growth.Twosuchquartersinsuccessionwouldmeetthecriteriaforthedefinitionof

arecession.However,itmustbesaid,thatwithgrowthpercentagesaroundthezero

mark,thereislittledifferencebetweenapercentagemarginallyaboveormarginally

belowthatlevel.Italsomeansthatthelikelihoodofanotherquarterofnegative

q-o-qgrowthisslim.Inanycase,ourbasecaseisformodest,butpositivequarterly

growth.

ThescarsfromtheGreatRecessionwillalsoremainvisibleintheyearsafter2011.

Globally,governmentsarebattlingwithlargebudgetdeficits,andtheresultingcost-

cuttingmeasuresaremakingconsumersfeelthepinch,thusdampeningthevolume

Figure 30: Economic growth indicator shows slowdown

Source: Rabobank

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ofworldtrade.Afteraseverecontractionofaverageinvestmentspendingin2009

and2010,littlepent-upgrowthisexpectedfor2011andbeyond.Consequently,it

willtakequitesometimebeforethegroundlostin2009and2010hasbeenmadeup

(see also box 5).AverageannualgrowthintheDutcheconomyfortheperiod2012to

2016 isexpected tobemuch lower than inpre-crisis years, andisestimated to

average1%.

Trade motor gears down a notch

Sincethesecondhalfof2009,exportshavebeenthedrivingforceoftheeconomicrecovery.Thevolumeofexportsincreasedbyover10%duringthefirsthalfofthis

yearcomparedtoayearearlier,thankstoaglobalriseindemand.Dutchexporters

alsoprofitedfromthedeclineof theeurorelative tothecurrenciesof theirtrade

partners.Inthefirstsixmonthsofthisyear,therealeffectiveexchangerate(corrected

for inflation differences) declined byover6%,afterwhich it rose again slightly

(figure 32).Duringthecomingperiod,thepaceofworldtradegrowthisexpectedto

slacken,whichwillpushdownthegrowthofexports.Nonethelessexportvolume

growthwillbestrongin2010,andisexpectedtoreach9%comparedto2009.In

2011theincreaseisexpectedtobelower,averagingsome4%.Importsalsorose

stronglythisyear.Owingtoinventoryrebuildinginthefirsthalfoftheyearandthe

sharprisein there-exportingbusiness,therisein importvolumesisexpectedto

average10%for2010.In2011importvolumegrowthwillbealotslower,andwill

TheGreatRecessionof2009hasleftitsmark,evenlongaftera

returntogrowth.Duringtheyearofthecrisis,theeconomy

groundtoanabrupthalt,buttheriseinunemploymentwas

limited.Thisresultedinasharpdeclineinlabourproductivity

(figure 31).Productionwasconsiderablylower,yettherewere

still lots of people at work. Because the economy is now

recoveringandunemploymentappearstobestabilisingatthe

currentlevel,labourproductivityisimprovingagain.However,

productivitygrowthremainslow,andthe lowlevelofinvest-

mentisoneofthereasonsforthis.Inrecentyears,technolo-

gicalinnovationbroughtaboutasubstantialincreaseinlabour

productivity. In some cases, this was the fruit of sizeableinvestment.

Theincreaseinlabourproductivityisoneofthefactorsthat

determine how much the Netherlands as a country can

produceinthefuture:potentialgrowth.Anotherdetermining

factoristhesizeofthe(potential)workforce.Ifallotherfactors

remainunchanged - such asworkforce participationlevel -

then growth of the workforce numbers will slow due to

populationageingandwillevendeclineinthefuture.Together

with a limited rise in labour productivity, this means that

futurepotentialgrowthwillbelower than theratewehave

beenaccustomedto.However,thisisnottosaythattherewill

belessaffluenceperpersoninthefuture,sincethepopulation

willalsobeshrinkinginthelongerterm.However,thepaceof

economicgrowthingeneralwillbereduced.

Figure 31: Contribution of employment and labourproductivity to GDP growth

Source: Rabobank

Box 5: Fewer people, less growth

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Outlook2011 39


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bebelowthatofexports,at3%.Thisputsthegrowthofimportsandexportsat

slightlybelowthelong-termaverage.Therewillbelittlechangeinthisscenariofor

theperiod2012-2016.Duringtheseyears,realexportsareexpectedtoshowaverage

annualgrowthofaround4%,whileimportvolumeswillincreaseattheslightly

lowerrateof4%.

Little reason for new investment

Onthebackofgrowingworlddemandsincethespringof2009,industrialoutput

wascrankedupagain.Machinerythathadbeenswitchedoffduringtherecession

wasturnedonagaintomeetthegrowingdemand.Yetalargeproportionofproduc-

tion capacity remains unused (figure 33). In September a little over80% of theavailableproductioncapacityintheindustrialsectorwasinuse;whilethiswasa

majorimprovementonthelevelofApril2009(75%),itisstillbelowthelongterm

average.Consequentlythereislittleneedforinvestmentinexpansion.Thissituation

isfurtherexacerbatedbytheslackeningpaceofworldtradegrowthandthecautious

attitudeofconsumers(seebelow).Thismeanstheoutlookforfutureproductionis

onlymoderatelypositive.Despitea favourableinvestmentclimate(withrelatively

low interest rates), thevolumeof investmentin 2010will declinefurtherby an

averageof5%comparedtolastyear.In2011theinvestmentvolumeisexpectedto

growby2%onaverage.Andwithanaverageprojectedannualgrowthof3%in

theperiod2012-2016,thelevelofinvestmentby2016willstillbefarfromthat

attainedbeforethecrisis.

Cabinet takes a step in the right direction

Therecessionhasthrownthegovernmentfinancesoffbalance;butevenwithoutthe

crisis,thestateofgovernmentfinanceswouldnothavebeensustainableinthelong

term. Because of population ageing and increased life expectancy, some public

Figure 33: Capacity utilisation remains low

Source: Statistics Netherlands (CBS)

Figure 32: Cheaper euro drives exports

Source: BIS

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servicesintheircurrentformweredestinedtobecomeunaffordableinthefuture.

Financial consolidationis thereforenecessary,particularly forsolidaritybetween

thegenerations.

ThismessagehasalsohithomeinTheHague.Thebudgetthatwaspresentedbythe

outgoinggovernment,aswellasthecoalitionagreementsignedbythenewcabinet

showthatgovernmentspendingwillbecurbedduringthecomingyears.For the

period2011-2015aplanned18billionwillbesaved.Themaincutbackswillbe

madeinpublicadministration(2.5billion),socialsecurity(4.3billion)andinter-

nationalcooperation(1.9bn) (figure 34).Theproposedsavingsareexpectedto

reducethegovernmentsbudgetdeficitfrom6%ofGDPin2010to%GDPbylate2016.Andgovernmentdebtduringthesameperiodistobereducedfrom66%to

65%GDP,asaresultofanincreaseinGDP.Ontheotherhand,thequestionremains

astowhether thecabinetwillindeedsucceedin implementingtheplannedcost-

cutting measures during the coming period of government. As a rule, cutbacks

deliver lesssavings than initiallyhopedfor.Previousgovernmentshave triedfor

instance to reduce thenumberof civil servants; however, they have oftenbeen

unsuccessfuloronlypartlysuccessfulintheirattempts.WithregardtoEUcontribu-

tions,thesecanonlybereducediftheothermemberstatesareinagreement,which

isveryquestionable.Ontheotherhand,therepaymentofsupporttothebankshas

notbeenfactoredin;assumingthebankscanrepaytheloans,thiscouldreducethe

Outlook 2011 ENG - Robobank

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