Global Economic Outlook1st Quarter 2013

Ira Kalish, DeloitteResearch in theUnited States,Deloitte Services LP

2012 was, if nothing else, a year of pronounced economic uncertainty for many countries around the world, and for most of them, this trend will linger into 2013. In Europe, a fiscal

crisis continues to kindle doubt about the survival of the euro, creating uncertainty that is casting a shadow on real economic performance in the new year. The United States may have already entered recessionary territory. Likewise, China, India, and Japan are treading uncertain economic waters and scrambling to establish or maintain economic growth.

This first-quarter edition of the Global Economic Outlook begins with Alexander Börsch’s assess-ment of the Eurozone, where uncertainty remains a recurring theme. Concerns about the future of the shared currency are giving way to worries about the real economy, which may take their toll on growth prospects in the coming year.

Next, Carl Steidtmann suggests that the United States, like Europe, is already in a recession. He offers his rationale for a negative GDP forecast that may pull the United States into recessionary ter-ritory in early 2013. He suggests that the depth and duration of this recession will differ according to the speed of the resolution.

My assessment of China’s economic outlook is comparatively optimistic. Chinese economic growth is accelerating after slowing down for most of 2012. Improving exports, industrial produc-tion, retail sales growth, and declining consumer price inflation suggest that China is, in fact, on the mend. However, the country will need to navigate significant challenges, including ebbing foreign direct investment, a transition in political leadership, and the country’s ongoing need to shift away

Global Economic OutlookQ1 2013

2

from export-led growth in favor of its consumer-driven counterpart, all of which raise questions about China’s ability to stay its course.

Next, my outlook for Japan, entitled “Back into Recession,” suggests that Japan did not end 2012 on the optimistic note it enjoyed a year ago. The country’s exports have been hampered by a recession in Europe, declining automobile sales, waning government spending, aggressive monetary policy that hasn’t offset the country’s formidable deflationary pressures, and a high-valued yen that continues to compromise the competitiveness of Japanese exports.

Finally, Pralhad Burli writes that growth in India may improve over the next two quarters after experiencing a period of deceleration. Economic challenges, including a bur-geoning fiscal deficit, low investments, elevated inflation, and high interest rates are looming over India’s outlook.

Dr. Ira KalishDirector of Global EconomicsDeloitte Research

Global Economic Outlook published quarterly by Deloitte Research

Editor-in-chiefIra Kalish

Managing editorRyan Alvanos

Contributors Pralhad Burli Alexander BörschCarl SteidtmannIan Stewart

Editorial address350 South Grand StreetLos Angeles, CA 90013Tel: +1 213 688 4765ikalish@deloitte.com

Preface

3

Geographies

Eurozone: Greater Trust and Greater Uncertainty | 6

Concerns about the future of the euro are giving way to uncertainty pertaining to the region’s economic health.

United States: Peering Over the Fiscal Cliff and Into the Weeds | 12

Negative GDP growth in the fourth quarter and the likely outcomes of the fiscal cliff suggest that the US economy will find itself in recession-ary territory in early 2013.

China: Turning the Corner? | 20Economic growth is accelerating in China after slowing down for most of 2012. However, the country will need to navigate significant chal-lenges in order to stay its course.

Japan: Back into Recession | 24Japanese exports have been hampered by a recession in Europe, declining automobile sales, waning government spending, aggressive monetary policy that hasn’t offset the country’s formidable deflation-ary pressures, and a high-valued yen that continues to compromise the competitiveness of its exports.

India: Cautious Optimism Part Deux | 28Growth in India may improve over the next two quarters after experi-encing a period of deceleration. However, a burgeoning fiscal deficit, low investments, elevated inflation, and high interest rates are looming over India’s outlook.

Contents

6

12

20

24

28

4

Appendix

Charts and Tables | 32GDP growth rates, inflation rates, major currencies vs. the US dollar, yield curves, composite median GDP forecasts, composite median cur-rency forecasts, OECD composite leading indicators

36

30

38

42

5

2012 was considered the decisive year for the survival of the Eurozone. It became the

year of the European Central Bank. The ECB came to the rescue of the euro each time it was seriously endangered. This relief came either in the form of flooding the markets with liquid-ity—the long-term financing operations—or in the form of guarantees for the survival of the euro such as Mario Draghi’s “whatever it takes” announcement.1

While the ECB successfully increased trust in the future of the euro itself, the key chal-lenge for the Eurozone pertains to reducing uncertainty. Uncertainty in the Eurozone

remains at almost unprecedented levels, but its roots are changing. While uncertainty about the future of the euro itself dominated the European economy in 2012, uncertainty about the growth outlook clouds the economic pros-pects for Europe for 2013 and beyond.

The growing trust in the euro itself …

Although risks have not entirely disap-peared, the ECB’s announcement of guar-anteeing the existence of the euro was a game-changer that built trust among investors.

EUROZONE

Dr. Alexander Börsch is head of research, Deloitte Germany

Eurozone: Greater Trust and Greater Uncertaintyby Dr. Alexander BÖrsch

6

GeographiesEurozone

7

The difference the announcement made is vis-ible in the results of Deloitte Germany’s CFO survey,2 which was undertaken in April and October, before and after the ECB announce-ment (see figure 1).

While there is still a sizable portion of German CFOs who think that the Eurozone will shrink within the next five years, there is a clear trend: Considerably more CFOs think that the Eurozone will have the same members in five years’ time. And even more importantly,

the number of CFOs who assume a large-scale disintegration of the Eurozone shrank substan-tially; only 3 percent consider this the most likely scenario. This indicates that the funda-mental doubts about the future of the euro are receding.

… is not matched by decreasing uncertainty in Europe

In the wake of the financial crisis, the economic environment has changed drasti-cally. The main change concerns much higher volatility and greater tail risks, not only in the

financial markets but also in the real economy. The possibility of a breakup of the Eurozone, for example, is one of the previously unthink-able tail risks. In other words, the range of possible futures has increased massively.

Contrary to the financial crisis, which came as a complete surprise for most people, today’s uncertainties are known, but it is largely impossible to estimate their probability. The result is much greater uncertainty about the future state of the economy.

Despite greater trust in the future exis-tence of the euro—the core component of uncertainty in Europe over the last three years—overall uncertainty in Europe remained high throughout 2012. Figure 2 displays an uncertainty indicator that combines economic forecasts with content analysis of leading newspapers to arrive at a measurable concept of uncertainty. It shows that despite the ECB’s action, uncertainty in Europe is still at an exceptionally high level. The uncertainty peak was reached shortly before the ECB started its long-term refinancing operations at the end of 2011, but it still stands at a level that

Global Economic Outlook: 1st Quarter 2013

8

GeographiesEurozone

is similar to the peak of the financial crisis in 2008—2009.

This is confirmed by other indicators. Deloitte Germany’s CFO Survey suggests that the level of uncertainty that German companies feel they are exposed to has actu-ally increased between the second and fourth quarters (see figure 3).3

This is paradoxical, given the greater con-fidence in the euro. The roots of uncertainty must have changed; worries about the real economy have joined worries about the euro. Among the top three risk factors the German CFOs cited in the survey, sinking domestic and foreign demand came immediately after the risk of instability in the financial system. The remaining risks stemming from the euro crisis and the growing fears of recession thus create a new uncertainty cocktail.

The effects of uncertainty

While uncertainty is a principal ingredient of the business environment, an overdose of it is damaging in macroeconomic as well as microeconomic terms. Uncertainty has become the main drag on eco-nomic growth in Europe and elsewhere. The International Monetary Fund (IMF) has found that economic growth is strongly negatively correlated with uncertainty. Recessions associated with uncertainty are gen-erally more severe than normal recessions, and they tend to be deeper and longer. The output losses in such recessions are nearly twice as high as those resulting from other recessions.4

The main reason for these negative effects is obvious. While the impact differs between

sectors, firms tend to postpone investment, hiring, and project decisions. They tend to wait for less uncertain times to make important decisions that are potentially hard to reverse. The same is true for consumers who are hesitant to make bigger purchases, especially durable goods. Thus, uncertainty generates a wait-and-see attitude in the economy, with all ensuing negative consequences.

The growth outlook for the Eurozone

Ongoing uncertainty will continue to be a drag on the Eurozone’s growth in 2013. While the fundamentals in the crisis countries, such as unit labor costs and current account balances are beginning to improve,5 growth in 2012 was weak. At the time of writing in

December 2012, production in the Eurozone has been shrinking since autumn 2012, the Eurozone’s GDP is on the level of 2006, and unemployment has reached a record level.

The Eurozone’s GDP shrank in 2012 by 0.4 percent (see figure 4). The fastest-growing countries (Germany and Austria) reached 0.9 percent, while the crisis countries shrank

9

between 1.5 percent (Spain) and 6 percent (Greece). Currently, there are some posi-tive signs from early indicators. While the economic sentiment index continues to be negative overall, it rose in November. Increases could be registered for industry and retail trade. The increase in economic sentiment in the EU as a whole was even stronger.

These are positive signs, but the case for strong growth in 2013 is weak. The most likely scenario for the Eurozone is a stabilization of production in the first half of 2013, followed by a slow and sluggish recovery.6 For the whole year 2013, the Eurozone is likely to achieve a growth rate hardly above zero (0.2 percent), and the Eurozone’s crisis countries will still have negative growth even if it is expected to be less negative than in 2012.

The scenario of stabilization and a fol-lowing recovery is based on the assumption that uncertainty will slowly decrease. The key variable for all current growth predic-tions is, in fact, uncertainty. Most upside and downside risks are associated with it. If the Eurozone manages to decrease uncertainty in the markets—whether through greater investor

confidence in the reforms of the crisis coun-tries or reforms of the Eurozone’s governance structure—growth could be considerably higher. Unfortunately, the reverse is also true.

Which growth policy for Europe?The key challenge for the Eurozone in

2013—finding a way to grow and consolidate budgets at the same time—remains largely unchanged. Traditional Keynesian recipes and the insights of modern growth theory target completely different levels in that regard. The Keynesians assume that higher public spend-ing, financed with higher debt, will jump-start the economy in the short run thanks to multiplier effects. Growth theory argues that sustainable growth is a supply-side matter and is fostered by investments in innovation and the infrastructure that supports it, such as education and R&D.

Public investments in growth-enhancing areas can be instrumental to bridge this ten-sion and contribute to higher growth and higher growth potential. While they gener-ate demand and stabilize the economy, they also contribute to a higher growth potential.

Global Economic Outlook: 1st Quarter 2013

10

GeographiesEurozone

Investments in higher education and training, as well as in R&D, have positive short- and long-term effects.

Investing in the levers of growth and redesigning public investments and budgets

toward growth should therefore be the natural complement and part of structural reforms. Only in this way could the euro crisis have a positive effect; namely, it could help build the foundations of stronger growth.

1. On July 26 2012, the president of the European Central Bank announced that; “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” This suggested that the ECB is ready to buy government bonds of the crisis countries to lower their yields

2. Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft “Controlled Defensive.” CFO Survey Germany 2/2012.

3. Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft “Controlled Defensive.” CFO Survey Germany 2/2012.

4. International Monetary Fund. “Coping with High Debt and Sluggish Growth.” World Economic Outlook October 2012.

5. See Deloitte Global Economic Outlook 4th Quarter 2012.

6. German Economic Research Institute. Joint Economic Forecast Autumn 2012

11

AS 2013 begins, the issue of the moment is the next stage in the fiscal policy negotia-

tions, especially the issue of raising the debt ceiling. But regardless of what happens with the fiscal cliff, the United States is already in a recession. The outcome of the remaining bud-get negotiations will determine whether it will be a mild recession or something more serious.

Let’s start this recession by looking at the composition of Q3 GDP (see table 1). It is the mix of growth in that quarter coupled with the consequences of the fiscal cliff that puts the US economy at risk for another recession.

USA

Dr. Carl Steidtmann is chief economist at Deloitte Research, Deloitte Services LP

United States: Peering Over the Fiscal Cliff and Into the Weedsby Dr. Carl Steidtmann

Table 1:Contributions to GDP growth by segment

Real GDP 2.70%

Consumer spending 0.99 %

Business investment -0.23 %

Business inventories 1.16 %

Farm inventories -0.39 %

Housing 0.32 %

Trade 0.14 %

Federal government 0.71 %

State government -0.04 %

Source: US Bureau of Economic Analysis

12

GeographiesUnited States

United States: Peering Over the Fiscal Cliff and Into the Weedsby Dr. Carl Steidtmann

13

Consumer spending

Consumer spending grew 1.4 percent in Q3 and made up 0.99 percent of the 2.7 percent growth in Q3 GDP.

The October consumer spending data showed a 0.3 percent decline in real consumer spending. If the impact of Hurricane Sandy is anything like that of Katrina, there could be a similar decline in the November figures. That, in turn, will likely result in a decline in real consumer spending in Q4. The fiscal cliff nego-tiations could also have a negative impact on spending. Consumer confidence has already fallen sharply, as it did in the summer of 2011 during the last debt ceiling debate. With 70 percent of GDP coming from consumer spend-ing, that raises the risk that Q4 GDP could be negative.

Real disposable incomes (incomes after taxes and adjusted for inflation) posted mod-est growth at the start of the year (see figure

1), largely due to falling energy prices due to mild weather. Since May, incomes are down slightly despite very modest employment growth (737,000 jobs, 0.55 percent). Since June, the savings rate has fallen 0.7 percent to 3.4 percent.

The number-one factor driving down income growth is a decline in real hourly wages. Real hourly wages for non-supervisory workers peaked in August 2010 at $8.95 in real 1982 inflation-adjusted dollars. Over the past two and half years, real wages have declined modestly, dropping by just over 3 percent (see figure 2). The beginning of the decline coin-cides with the initiation of the second round of quantitative easing by the Federal Reserve. During that time, gasoline prices rose by 36.2 percent, while food prices were up a more modest 7.1 percent.

The tax agreement signed at the start of the year will drag down income growth even

Global Economic Outlook: 1st Quarter 2013

14

further. The end of the Social Security tax holiday will cost $95 billion. That will shave another 0.8 percent of disposable income. The increased taxes on upper-income households will also remove some spending.

With no income growth, it’s going to be hard to sustain spend-ing growth into the new year in the face of tax increases that will further reduce real disposable income.

HousingThere were significant downward

revisions in the new home sales data published in October. The numbers show a flattening out of new home sales that began in February, with sales turning downward in May (see figure 3). With a pickup in building activity, there is a risk that invento-ries of new homes are greater than the demand, potentially resulting in a pullback in building next year. New home completions include homes built for rental purposes and owner-built units that are not included in new home sales, and as such, will always be greater than new home sales.

GeographiesUnited States

15

The weakness in home sales will undermine home construction going forward. What has been a modest positive for the economy will go back to being neutral or slightly negative.

Business investmentBusiness investment fell in the third

quarter. New orders for non-defense capital goods less aircraft orders, a proxy for future capital goods spending, rose 1.7 percent in October, but are still down 8.1 percent from a year ago and have declined in seven of the past 12 months (see figure 4). New orders for computers fell 9.3 percent in October and are down 25.7 percent from a year ago. Given the declines in new orders, business investment is going to remain negative for several quarters to come.

Business investment is being hurt by a decline in CEO confidence. As measured by

Chief Executive magazine, CEO confidence fell 2.3 percent in November and has been down in five of the past six months.1 The magazine’s CEO confidence index fell from 5.11 in October to 4.99 in December. CEOs cited uncertainty over the fiscal cliff, tax policy, and regulatory change as the reasons for their growing pessimism. At the small-business level, future expectations of small business owners plummeted from +2 in October to -35 in November, according to a survey conducted by the National Federation of Independent Businesses (a rating above zero is a sign of optimism).2 The collapse in future expectations for small businesses was due to uncertainty over the fiscal cliff coupled with worries about escalating health care costs and a tsunami of new financial, health care, and energy regulations.

Global Economic Outlook: 1st Quarter 2013

16

GeographiesUnited States

Inventories

In an era of just-in-time inventory man-agement, no increase in inventories in excess of sales is ever wanted or warranted. When it happens, it is quickly reversed. Non-farm inventories rose sharply in Q3, accounting for 1.16 percent of the 2.7 percent increase in GDP growth. In drawing down inventories in Q4, real GDP growth will give back some of the Q3 growth.

TradeGlobal trade is slowing. The Baltic Dry

Index, a proxy for global trade, peaked in late October at 1109 and fell to 826 in

mid-December. The weakness in the Baltic Dry Index was reflected in the US trade data for October. US exports of goods and services fell 3.6 percent in October, the largest month-to-month decline since January 2009. The economic problems in both Europe and Japan are beginning to take a toll on US exporters. Imports were also down, although not by as much. The net result was a $2 billion month-to-month increase in the trade deficit. Unless reversed in November and December, which seems unlikely given the fall in the Baltic Dry Index, the decline in exports and the rise in the trade deficit will reduce Q4 growth.

Table 2:Projected contributions to Q4 GDP

Real GDP -1.05 %

Consumer spending 0.00 %

Business investment -0.23 %

Business inventories -0.58 %

Farm inventories 0.00 %

Housing 0.16 %

Trade 0.00 %

Federal government -0.36 %

State government -0.04 %

Source: US Bureau of Economic Analysis

17

Global Economic Outlook: 1st Quarter 2013

Q4 GDP: The start of a recessionPutting these different developments

together, one can roll up an estimate for Q4 GDP. What the confluence of factors add up to—Sandy, the fiscal cliff, the weakness in global trade, and the givebacks from one-time developments that boosted Q3 growth—is a negative forecast for Q4 GDP.

The projection for a negative fourth quarter uses the following assumptions:

• Consumer spending is flat on the quarter due to uncertainty over the fiscal cliff and the impact of Sandy.

• Business investment continues to decline as it did in Q3 due to fiscal cliff worries and weakness in European demand, taking -0.23 percent off of GDP.

• Half of the build-up in business inventories is reversed, taking -0.58 percent off of GDP.

• The pace of housing investment is halved by rising inventories and the impact of Sandy.

• Trade makes no contribution to GDP in the fourth quarter.

• Half of the surge in government spending is reversed, taking 0.36 percent off of GDP.

• State and local government spending continues to contract as it did in the third quarter.

The result: Q4 real GDP contracts by a little more than 1 percent.

Conclusion

Higher taxes and less government spend-ing next year are likely. A recession seems likely, albeit the depth and duration of the recession will differ depending on the speed of the resolution.

1. “CEO Evaluations of Current and Expected Future Business Conditions Even-Out at a Middle Mark.” Chief Executive.net. December 18, 2012. http://chiefexecutive.net/ceo-evaluations-of-current-and-expected-future-business-conditions-even-out-at-a-middle-mark

2. “December Report: Small-Business Owner Confidence Plunges More than Five Points One of the lowest optimism readings in survey history” National Federation of Independent Business. Accessed January 4, 2013 http://www.nfib.com/research-foundation/surveys/small-business-economic-trends

18

GeographiesUnited States

19

AfteR slowing substantially over the past year, China’s economy is showing signs

of reverting to faster growth. A rise in govern-ment-funded investment has helped to offset the considerable weakness in China’s exports to Europe. Interestingly, exports to other geog-raphies have actually improved. In October, overall exports were up 11 percent from a year earlier, far better than had been expected. This, in turn, contributed to a 9.6 percent increase in industrial production in October, offering the prospect of stronger GDP growth in the fourth quarter. In November, a private sector purchas-ing manager’s index for manufacturing moved into positive territory for the first time since July, indicating the fastest rate of growth in the sector in more than a year. Retail sales growth also accelerated in October, suggesting that the consumer sector is improving as well. Thus, it appears that China is on the mend.

CHINA

China: Turning the Corner?by Dr. Ira Kalish

20

GeographiesChina

21

Global Economic Outlook: 1st Quarter 2013

Moreover, consumer price inflation in China has decelerated substantially, with prices up a mere 1.7 percent in October versus a year earlier. Indeed, this was the lowest rate of infla-tion in 33 months. This means that the central bank has considerable wiggle room should it choose to further ease monetary policy in order to stimulate the economy.

However, although growth is showing signs of revival, China still faces some challenges. For example, foreign direct investment (FDI) into China declined in October for the 11th time in the last 12 months. Slowing growth, global economic weak-ness, a rising currency, rising wages, and politi-cal uncertainty are all likely reasons for the deceleration of inbound investment. For the first 10 months of 2012, inbound FDI was down 3.5 percent from 2011. Outbound investment from China, however, increased substantially. In the first 10 months of 2012, outbound FDI was up 25.8 percent from 2011. This suggests that Chinese companies are actively searching for resources and new opportunities around the world. The higher value of China’s currency means that foreign assets are becoming rela-tively cheaper. In addition, the recent weakness in commodity prices has probably made com-modity production resources cheaper as well.

Challenges for a new leadership

There has been a transition in China’s political leadership, raising questions about the likely path of government policy and the new leadership’s approach to tackling longer-term economic challenges. Interestingly, outgoing Chinese president Hu Jintao recently said that China should plan to double per-capita GDP from 2010 to 2020; this goal may be realistic if Chinese economic growth doesn’t slow down. This will likely require significant reforms aimed at maintaining long-term growth in the face of challenging demographics. Hu hinted

at such reforms by call-ing for the private sector to have “equal access to factors of production.” He also called for China to improve its ability to innovate and for a boost in domestic demand.

For the private sector, “equal access” to produc-tion factors is significant.

Today, state-run businesses enjoy favorable terms of credit, which often limit the amount of credit available to private-sector busi-nesses—especially smaller ones, which must pay very high interest rates in the informal credit sector. Reformers want to free up market interest rates that are now set by the central bank and to allow all borrowers to compete freely for credit. Hu’s evident support for this measure could presage considerable reform of

For the private sector, “equal access” to production factors is significant.

22

China’s credit markets. Yet doing so will likely have the effect of reducing the profit margins of state-run businesses.

Another issue is the need to shift away from export-led growth toward consumer-led growth. Rising wages are already helping to make this happen. For example, in the past three years, the wages of China’s migrant workers increased by 56 percent. Yet export-ers have mostly failed to pass on the increase in their costs to customers; the prices of US

imports from China rose only 4 percent over the last three years. Absent huge productivity gains, this pattern cannot be sustained indefi-nitely because it would ultimately cause profit margins to disappear. Rather, export growth will likely decline, and provided wages con-tinue to increase, consumer spending in China should grow faster. Market-opening reforms could help accelerate this change in China’s economic structure.

GeographiesChina

23

The year 2012 began with moderately positive prospects for Japan. While other large economies were expected to decelerate, Japan’s was expected to grow faster than in 2011 due to massive reconstruction spending. And indeed, growth was reasonably good in the first half of the year. Yet it now appears that Japan fell into yet another recession during the second half of the year.

The current recession has several culprits:

• Japan’s exports have been hurt by the recession in Europe, weakness in the United States, and the slowdown in China. In the third quarter of 2012, real exports declined at an annualized rate of 22 percent. Moreover, the political dispute between Japan and China over a group of islands claimed by both has poisoned the economic relationship between the two countries. Sales of Japanese-branded products in China have plummeted. Japanese auto companies are now planning on a weak sales environment in a country that had

been seen as an important growth market. Further, in Japan’s upcoming (December 2012) election, the opposition Liberal Democratic Party (LDP) is expected to win—and LDP leader Shinto Abe has taken a more nationalistic stance on foreign policy issues than the current Japanese leadership. This could have a further chilling effect on relations between Japan and China.

• Some of the economic strength Japan dis-played in the first half of the year was due to government incentives that support the sale of fuel-efficient automobiles. These incen-tives have now been eliminated, leading to a deceleration in car sales.

• Government investment spending in Japan is weakening as the reconstruction bud-get runs out, and no other forms of fiscal economic stimulus are taking place. Thus, fiscal policy is not providing an impetus for growth.

Japan: Back into Recessionby Ira Kalish

JAPAN

24

GeographiesJapan

25

• Although Japan’s monetary policy has become more aggressive, it has not been successful in ending the country’s ruinous deflation. Declining prices mean that real interest rates are relatively high. Plus, the expectation that prices will decrease leads consumers to delay purchases. Indeed, consumer confidence remains low, and consumer spending is declining.

• The value of the yen has remained relatively high, thus hurting the competitiveness of exports.

A debate is raging about the future direc-tion of Japan’s monetary policy. The Bank of Japan (BoJ) has implemented a program

of asset purchases, which was accelerated in October. The BoJ set an explicit target of 1.0 percent inflation. Yet deflation has continued, so the monetary policy has yet to produce the desired result. Political leaders are urging the BoJ to take a more aggressive stance and purchase assets until inflation returns. Abe, the leader of the LDP opposition party, is calling for a target of 2 percent inflation and wants to require the BoJ to finance government stimulus spending. In line with this view, Abe is calling for the government to limit the BoJ’s indepen-dence. While such a measure is unlikely to pass in Parliament, the fact that politicians are so angry at the central bank could have an impact on policy in the future.

Global Economic Outlook: 1st Quarter 2013

26

Outlook

The outlook for Japan is poor. Several fac-tors are likely to inhibit a strong recovery. First, Europe is expected to remain in recession until at least the second half of 2013, which will have a negative impact on Japanese exports. Second, the situation with China is not likely to improve any time soon. Third, Japan’s current government policy is not support-ive of growth. (That said, the LDP has indicated that it will support more fiscal stimulus spending if it wins the election. Hence, there is some uncertainty about the direction of policy.)

The weakness in exports has seriously damaged the eco-nomic health of Japan’s corporate sector, especially export-oriented electronics and automotive companies. For example, a large private-sector employer in Japan says it faces significant losses. The struggles of Japan’s electronics companies stem not only from economic weakness, but from competitive challenges as well. The rise of

Korean and Chinese competitors has damaged the brand equity of Japanese electronics com-panies. On the other hand, Japanese companies play a significant role in their supply chains.

Another challenge for Japan is the contin-ued strength of the yen. This strength puzzles many observers, given that Japan has a mas-sive sovereign debt (in excess of 200 percent of

GDP) and a weaken-ing trade balance. Under such circum-stances, a country would normally experience a weaken-ing of its currency. Yet Japan’s debt is not seen as problematic, given the country’s high rate of saving and very low interest rates. Moreover, the country’s economic stability, affluence, and low level of inflation create the impression

of safety. As such, investors in search of safe havens flock to Japan—even if the return on their investment is quite low. This, in turn, boosts the value of the yen. Although the loosening of monetary policy has helped to ease upward pressure on the yen, it has not been enough.

GeographiesJapan

The weakness in exports has seriously damaged the economic health of Japan’s corporate sector, especially export-oriented electronics and automotive companies.

27

The Indian economy appears to be stuck in low-level equilibrium. The country’s

GDP grew 5.3 percent in the second quarter of the 2012–2013 fiscal year—one of its low-est quarterly growth rates in the last decade. Investments have been lackluster, but the gov-ernment hopes that its recent push for reforms will help trigger investments and jumpstart the economy. Meanwhile, the central bank remains jittery about elevated inflation and may be wary of prematurely slashing its policy rate. Although the economy is expecting the government to provide the necessary boost, the government is unable to increase its spending due to a widening budget deficit. Nonetheless,

the economy is expected to perform better over the next two quarters, which is a positive sign amid a host of macroeconomic challenges.

Jumping political hurdles

The motion against the decision to allow foreign direct investment (FDI) in the coun-try’s multi-brand retail sector took center stage at the onset of parliament’s winter session. The government announced that it would open six sectors to foreign investment, and politically, multi-brand retail was the trickiest. Following several rounds of debates, the United Progressive Alliance, the ruling

INDIA

Pralhad Burli is senior analyst at Deloitte Re-search, India

India: Cautious Optimism Part Deuxby Pralhad Burli

28

GeographiesIndia Geographies

coalition, emerged victorious in both houses of parliament. This is a big boost for the govern-ment because it managed to garner the support of smaller regional parties who voted in their favor. The government will likely face less political pressure in the future, but farmer and trader unions could up the ante in the coming months. However, the central government’s worries are limited because the responsibility of implementation lies largely with individual state governments.

The policy allows foreign players to invest up to 51 percent in multi-brand retail, sub-ject to certain restrictions. Retail stores can be opened only in cities with a population of

more than 1 million. In addition, the mini-mum investment must be $100 million, and at least 50 percent of the investment must be in back-end infrastructure within three years. International retail chains deferred their India plans amid political uncertainty and wide-spread protests. However, the outcome of the parliamentary vote may hasten their entry into states that have already announced their support for FDI in the retail sector. Moreover, foreign investors looking to invest in aviation, insurance, pensions, and the utilities sectors could become more optimistic about prospects for those sectors.

29

Has growth bottomed out?According to the seasonally adjusted

HSBC Services Purchasing Managers Index, India’s services sector growth declined to 52.1 in November—its slowest pace in 13 months—from 53.8 in the previous month. Yet, the index has remained above the 50 mark since November 2011, which suggests an expansion. Moreover, service providers are optimistic about the short-term business outlook. Meanwhile, in November, the HSBC Manufacturing Purchasing Managers Index expanded at its fastest rate in five months. The index rose to 53.7 in November from 52.9 in October because of an uptick in new orders. The index provides evidence of an uptick in manufacturing activ-ity, and the recent performance of the infrastructure sec-tor provides hope for higher growth in the coming months. In addition, the sub-index for new export orders rose to a six-month high of 55.9 in November, suggesting a recovery in exports and broad-based factory output.

Overall, the Indian economy is showing early signs of a recovery, suggesting that the deceleration may have bottomed out. Auto sales and production of consumer goods have stabilized over the past two months. The Index of Industrial Production grew 8.2 percent in October, its fastest pace in more than a year. Economic activity, supported by an improve-ment in the industry and services segments, is expected to improve. Furthermore, a decline in crude oil prices could further boost GDP growth. Moreover, the global recovery may pick up in near future provided none of the economies face major set-backs in their

recovery. Positive economic data from China, improved manufacturing activity in the United Kingdom, a modest GDP acceleration in the United States, and structural reforms in Greece all suggest an improving outlook for the global economy, which augurs well for India’s growth.

Looking at the central bank for help

The Reserve Bank of India (RBI) cut its pol-icy rate by 50 basis points in April, but it has not tinkered with the policy rate since. Instead, the RBI has reduced the cash reserve ratio (CRR) by a cumulative 75 basis points in 2012. A CRR cut adds liquidity and enhances credit

availability, which could impact both deposit and lending rates. But, financial markets and industries have not been satisfied with the RBI’s monetary stance, consistently demanding a policy rate cut.

The Wholesale Price Index-based inflation stood at 7.45 percent in October, slightly lower than 7.81 in the previ-ous month. During

the current fiscal year, headline inflation has hovered between 7 and 8 percent. Meanwhile, retail inflation surged 9.9 percent in November following readings of 9.75 percent in October and 9.73 percent in September. The hawks would argue that, at its current level, inflation remains uncomfortably high. Furthermore, the government has not made significant headway in terms of fiscal consolidation. The government’s budgeted growth estimate of 7.6 percent is a far cry from the current growth rate of 5.3–5.5 percent. As a result, projected tax revenues will be very difficult to achieve. Moreover, the telecom spectrum auction left

The Indian economy is trapped between a burgeoning fiscal deficit, low investments, elevated inflation, and high interest rates.

Global Economic Outlook: 1st Quarter 2013

30

GeographiesIndia

a gaping hole in the government’s collection target. Spectrum sale proceeds came in at approximately $1.7 billion against the govern-ment’s estimate of $5.5 billion. Finally, little progress has been made on disinvestment in public-sector undertakings. As a result, move-ment toward fiscal consolidation is unlikely to be a trigger for cutting policy rates.

On the other hand, the doves would make a case for a rate cut given India’s high interest rate environment and decelerating growth. However, the RBI governor has resisted a policy rate cut since the inflation rate is still beyond the central bank’s comfort zone. Clearly, the RBI’s focus remains on inflation containment and it believes that its current policy stance will likely anchor inflation expec-tations. The RBI is caught between a rock and a hard place, and its policy stance will once again come under the spotlight in its next policy meeting. It is likely that the RBI may once again choose to lower the CRR and hold back on a policy rate cut until inflation recedes to manageable levels.

A rush toward external borrowing

Following the central bank’s decision to raise the limit for external commercial borrow-ing, Indian companies are increasingly turning to overseas markets to raise funds—a trend likely to continue over the next few months. According to the new regulation, a company can borrow offshore funds to the tune of 75 percent of the average foreign exchange earn-ings in the immediate past or 50 percent of the highest foreign exchange earnings realized in the past three years, whichever is higher. The previous limit was 50 percent. This measure will likely serve twin benefits. It could bring some stability to the rupee’s movement against the US dollar. Furthermore, Indian compa-nies can save on interest costs by borrowing at cheaper rates in overseas markets. Therefore,

companies with significant overseas presence could benefit through overseas borrowing for new investments or for paying-off costly domestic debt. On the other hand, loose mon-etary policies in western markets have resulted in a low interest environment, and banks’ are sitting on massive cash reserves. As a result, foreign banks are happy to lend to Indian companies as they have relatively favorable growth prospects.

The Indian economy is trapped between a burgeoning fiscal deficit, low investments, elevated inflation, and high interest rates. It is difficult to ascertain how the country will break out of this vicious cycle. While the global economy is recovering, downside risks loom large. India’s GDP has grown at an average rate of 5.4 percent during the first half of the current fiscal year, and the economy may end the year at a slightly higher growth level. A push for reforms is certainly encouraging, but successful implementation of these reforms is vital, and it may take a while before growth returns to its pre-crisis level.

31

Appendix

75

80

85

90

95

100

1

1.1

1.2

1.3

1.4

1.5

1.6

1.7

1.8

Jan 09

May 09

Sep 09

Jan 10

May 10

Sep 10

Jan 11

May 11

Sep 11

May 12

Sep 12

Nov 12

Jan 12

-4

-2

0

2

4

6

8

10

12

14

16

Jan 09

May 09

Sep 09

Jan 10

May 10

Sep 10

Jan 11

May 11

Sep 11

Jan 12

Mar 12

Jun12

Nov12

-3

-2

-1

0

1

2

3

4

5

6

Jan 09

May 09

Sep 09

Jan 10

May 10

Sep 10

Jan 11

May 11

Sep 11

Jan 12

Mar 12

May 12

Jul 12

Oct12

-15

-10

-5

0

5

10

15

20

Q1 07

Q2 07

Q3 07

Q4 07

Q1 08

Q2 08

Q3 08

Q4 08

Q1 09

Q2 09

Q3 09

Q4 09

Q1 10

Q2 10

Q3 10

Q4 10

Q1 11

Q2 11

Q3 11

Q4 11

Q1 Q2 12 12

Q3 12

-12

-10

-8

-6

-4

-2

0

2

4

6

8

Q1 07

Q2 07

Q3 07

Q4 07

Q1 08

Q2 08

Q3 08

Q4 08

Q1 09

Q2 09

Q3 09

Q4 09

Q1 10

Q2 10

Q3 10

Q4 10

Q1 11

Q2 11

Q3 11

Q4 11

Q1 Q2 12 12

Q3 12

US JapanUK Eurozone Brazil RussiaChina India

Brazil RussiaChina IndiaUS JapanUK Eurozone

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

USD-Yen

*Source: Bloomberg

GDP growth rates (YoY %)*

Major currencies vs. the US dollar*

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

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

Global Economic Outlook: 1st Quarter 2013

32

Appendix

Yield curves (as of December 18, 2012)*

US Treasury bonds & notes

UK gilts

Eurozone govt. benchmark

Japan sovereign

Brazil govt. benchmark

China sovereign

India govt. actives Russia‡

3 Months 0.02 0.32 0.02 0.10 7.11 2.72 8.14 6.14

1 Year 0.13 0.38 0.03 0.10 7.09 2.87 8.10 6.19

5 Years 0.73 0.90 0.36 0.20 8.54 3.25 8.10 6.54

10 Years 1.77 1.92 1.38 0.76 9.18 3.59 8.15 7.01

Composite median GDP forecasts (as of December 18, 2012)*

US UK Eurozone Japan Brazil China Russia

2012 2.2 -0.1 -0.5 1.7 1.5 7.7 3.6

2013 2 1.1 0 0.65 3.8 8.1 3.45

2014 2.8 1.6 1.2 1 4 7.9 3.8

Composite median currency forecasts (as of December 18, 2012)*

Q1 13 Q2 13 Q3 13 Q4 13 2012 2013 2014

GBP-USD 1.6 1.6 1.58 1.6 1.6 1.6 1.58

euro-USD 1.28 1.27 1.26 1.27 1.28 1.27 1.28

USD-Yen 82 83 84 85 80 85 88

USD-Brazilian Real 2.05 2.02 2.01 1.99 2.02 1.99 2.05

USD-Chinese Yuan 6.21 6.18 6.15 6.13 6.25 6.13 6.04

USD-Indian Rupee 53.75 53.3 52.9 52.4 54.01 52.4 50

USD-Russian Ruble 30.78 31.01 31.29 31.33 31.37 31.33 32.1

OECD composite leading indicators (amplitude adjusted)†

US UK Eurozone Japan Brazil China India Russia

Dec 10 100.46 101.56 101.61 100.49 101.43 101.72 101.33 102.74

Jan 11 100.65 101.57 101.70 100.61 101.37 101.69 101.12 102.90

feb 11 100.77 101.54 101.73 100.66 101.21 101.56 100.83 102.93

Mar 11 100.80 101.48 101.69 100.64 101.00 101.39 100.47 102.80

Apr 11 100.72 101.34 101.58 100.56 100.72 101.20 100.07 102.58

May 11 100.57 101.12 101.41 100.47 100.35 101.04 99.70 102.34

Jun 11 100.35 100.81 101.19 100.39 99.90 100.90 99.42 102.16

Jul 11 100.13 100.43 100.92 100.34 99.42 100.77 99.24 102.01

Aug 11 99.95 100.02 100.64 100.30 98.99 100.64 99.13 101.94

Sep 11 99.89 99.65 100.39 100.30 98.64 100.51 99.08 101.93

Oct 11 99.97 99.37 100.19 100.35 98.39 100.37 99.11 101.99

Nov 11 100.17 99.22 100.05 100.45 98.23 100.23 99.19 102.08

Dec 11 100.42 99.20 99.98 100.57 98.23 100.07 99.23 102.15

Jan 12 100.65 99.26 99.95 100.69 98.37 99.94 99.17 102.16

feb 12 100.81 99.35 99.92 100.76 98.62 99.85 99.01 102.05

Mar 12 100.88 99.44 99.89 100.77 98.87 99.74 98.76 101.72

Apr 12 100.88 99.52 99.83 100.71 99.07 99.62 98.46 101.15

May 12 100.82 99.59 99.74 100.61 99.21 99.55 98.13 100.47

Jun 12 100.76 99.71 99.64 100.48 99.33 99.52 97.80 99.85

Jul 12 100.73 99.87 99.53 100.36 99.41 99.51 97.50 99.44

Aug 12 100.75 100.06 99.43 100.27 99.43 99.53 97.29 99.23

Sep 12 100.84 100.28 99.36 100.20 99.39 99.53 97.24 99.14

Oct 12 100.93 100.50 99.31 100.17 99.28 99.56 97.26 99.09

*Source: Bloomberg ‡MICeX rates †Source: OCeD

Note: A rising CLI reading points to an economic expansion if the index is above 100 and a recovery if it is below 100. A CLI which is declining points to an economic downturn if it is above 100 and a slowdown if it is below 100.

33

Global Economic Outlook: 1st Quarter 2013

Additional resources

Deloitte Research Thought Leadership

Deloitte Review Issue 12

Asia Pacific Economic Outlook: China, Japan, Malaysia, and Thailand.

Please visit www.deloitte.com/research for the latest Deloitte Research thought leadership or contact Deloitte Services LP at: research@deloitte.com.

For more information about Deloitte Research, please contact John Shumadine, Director, Deloitte Research, part of Deloitte Services LP, at +1 703.251.1800 or via e-mail at jshumadine@deloitte.com.

34

Appendix

Contact informationGlobal Economics TeamRyan AlvanosDeloitte ResearchDeloitte Services LPUSAtel: +1.617.437.3009e-mail: ralvanos@deloitte.com

Pralhad BurliDeloitte ResearchDeloitte Services LPIndiatel : +91.40.6670.1886e-mail: pburli@deloitte.com

Dr. Alexander Börsch Deloitte ResearchGermanytel: +49 (0)89 29036 8689aboersch@deloitte.de

Dr. Ira KalishDeloitte ResearchDeloitte Services LPUSAtel: +1.213.688.4765e-mail: ikalish@deloitte.com

Dr. Carl SteidtmannDeloitte ResearchDeloitte Services LPUSAtel : +1.303.298.6725e-mail: csteidtmann@deloitte.com

Ian StewartDeloitte ResearchDeloitte & touche LLPUKtel: +44.20.7007.9386e-mail: istewart@deloitte.co.uk

U.S. Industry LeadersBanking & Securities and Financial Services

Robert ContriDeloitte LLPtel: +1 212 436 2043e-mail: rcontri@deloitte.com

Consumer & Industrial ProductsCraig GiffiDeloitte LLPtel: +1.216.830.6604e-mail: cgiffi@deloitte.com

Life Sciences & health CareBill CopelandDeloitte Consulting LLPtel: +1.215.446.3440e-mail: bcopeland@deloitte.com

Power & Utilities and energy & Resources

John McCueDeloitte LLPtel: +216 830 6606e-mail: jmccue@deloitte.com

Public Sector (federal)Robin LinebergerDeloitte Consulting LLPtel: +1.517.882.7100e-mail: rlineberger@deloitte.com

Public Sector (State)Jessica BlumeDeloitte LLPtel: +1.813.273.8320e-mail: jblume@deloitte.com

telecommunications, Media & technology

eric OpenshawDeloitte LLPtel: +1 714 913 1370e-mail: eopenshaw@deloitte.com

Global Industry LeadersConsumer BusinessAntoine de RiedmattenDeloitte touche tohmatsu Limitedfrancetel: +33.1.55.61.21.97e-mail: aderiedmatten@deloitte.fr

Energy & ResourcesCarl HughesDeloitte touche tohmatsu LimitedUKtel: +44.20.7007.0858e-mail: cdhughes@deloitte.co.uk

Financial ServicesChris HarveyDeloitte LLPUK tel: +44.20.7007.1829e-mail: caharvey@deloitte.co.uk

Life Sciences & Health CarePete MooneyDeloitte touche tohmatsu LimitedUSAtel: +1.617.437.2933e-mail: pmooney@deloitte.com

ManufacturingTim HanleyDeloitte touche tohmatsu LimitedUSAtel: +1.414.977.2520e-mail: thanley@deloitte.com

Public SectorPaul MacmillanDeloitte touch tohmatsu LimitedCanadatel: +1.416.874.4203e-mail: pmacmillan@deloitte.ca

Telecommunications, Media & Technology

Jolyon BarkerDeloitte & touche LLP UKtel: +44 20 7007 1818e-mail: jrbarker@deloitte.co.uk

35

About Deloitte University Press Deloitte University Press publishes original articles, reports and periodicals that provide insights for businesses, the public sector and NGOs. Our goal is to draw upon research and experience from throughout our professional services organization, and that of coauthors in academia and business, to advance the conversation on a broad spectrum of topics of interest to executives and government leaders.

Deloitte University Press is an imprint of Deloitte Development LLC.

This publication contains general information only, and none of Deloitte Touche Tohmatsu Limited, its member firms, or its and their affiliates are, by means of this publication, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This publication is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your finances or your business. Before making any decision or taking any action that may affect your finances or your business, you should consult a qualified professional adviser.

None of Deloitte Touche Tohmatsu Limited, its member firms, or its and their respective affiliates shall be responsible for any loss whatsoever sustained by any person who relies on this publication.

About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting.

Copyright © 2013 Deloitte Development LLC. All rights reserved. Member of Deloitte Touche Tohmatsu Limited

Follow @DU_Press

Sign up for Deloitte University Press updates at www.dupress.com.