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    A Deloitte Researc publication | 4th Quarter 2011

    Stressful Times

    Eurozone

    A crucial time or action

    United States

    The coming recession

    Meico

    Looking north

    Gold prices: deying gravity?

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    Last quarter, we began by stating that the biggest issues acing the global economy are

    the crisis in the Eurozone and uncertainty about the path o U.S. monetary and scal

    policy. Well, nothing seems to have changed. These remain the big issues. And yet, much

    has indeed changed. Since we published our last report at the end o July 2011, there has

    been one crisis ater another.

    In Europe, the members o the Eurozone agreed on a new package or assisting Greece,

    only to nd that nancial market stress kept getting worse as market participants doubted

    the package would be sucient. Hence, as o this writing, discussions are under way

    to nd a larger solution, and markets evidently have much lower expectations that the

    problem will actually be resolved.

    In the United States, August witnessed a stressul round o negotiations on the budget,

    the results o which have been questioned by many. Then, U.S. government debt was

    downgraded or the rst time in history, equity markets ell rapidly, the economy appeared

    to stall, and businesses were let wondering whether another recession was imminent. In

    emerging markets, concerns about rising infation and rising currencies have been replaced

    by ear o a global slowdown and rapid currency depreciation.

    In this issue o the Global Economic Outlook, we address all o these issues. First, ElisabethDenison oers a cautiously hopeul assessment about the prospects or preserving the

    euro. She discusses what must happen in order or the Eurozone to have a chance o

    long-term success. On the other hand, she recognizes the considerable risk o ailure and

    the high risk o recession i the Eurozone ails. For now, she sees recession taking hold

    principally in the peripheral nations o the EU rather than Germany and France.

    Next, Carl Steidtmann oers a ar more pessimistic view in his assessment o U.S.

    economic prospects. His argument is that the serious problems in Europe, which have

    a high probability o getting worse, are already having a negative impact on the U.S.

    economy and are likely to push the United States into another recession. He notes that,

    even absent the European crisis, the U.S. economy is already teetering on the edge with

    extremely slow growth and a dormant job market. Add to this the nancial contagion

    rom Europe, and the result is nancial market stress causing a slowdown in creditcreation.

    In our next article, I provide some thoughts on the outlook or China. In particular, I note

    that China appears to be decelerating due to the negative impact o a global slowdown

    Global Economic OutlookQ4 2011

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    Global Economic Outlook

    publised quarterly by

    Deloitte Researc

    Editor-in-cie

    Ira Kalish

    Managing editor

    Ryan Alvanos

    Contributors

    Pralhad Burli

    Elisabeth Denison

    Neha Jain

    Satish Raghavendran

    Siddharth Ramalingam

    Carl Steidtmann

    Ian Stewart

    Editorial address

    350 South Grand Street

    Los Angeles, CA 90013

    Tel: +1 213 688 4765

    [email protected]

    and the lagged eect o tightening monetary policy. I

    also look ahead at potential troubles coming rom the

    debts accumulated by local governments to und invest-

    ment in xed assets. The end result could be a substantial

    slowdown in growth.

    Following China, I look at the Japanese economy, which

    actually oers one o the ew bright spots in the global

    landscape. Due to spending on reconstruction, the

    Japanese economy is likely to grow aster next year than

    this year. On the other hand, Japan still aces considerable

    obstacles to a return to sustained growth.

    Ian Stewart then provides his prognostications or the UK.

    He says that the outlook or the UK economy is deterio-

    rating, not only because o weaker domestic undamen-

    tals, but more importantly, because o headwinds rom

    the neighboring Eurozone. Ian also discusses how the

    uncertain business environment has moved corporate

    strategies toward a more deensive posture, as evidencedby Deloitte UKs CFO survey.

    Next, Siddharth Ramalingam presents his outlook or India.

    Like Europe and the United States, India aces a slowdown

    in growth. But unlike those countries, the problem in India

    is that growth has been too rapid, thus leading to uncom-

    ortably high infation. The challenge or policymakers is to

    balance the ght against infation with a desire to retain

    sucient growth.

    In my outlook or Russia, I discuss how recent political

    announcements oer clarity regarding Russias political

    uture but ail to provide clarity about the economicpolicy environment. I also discuss how a combination o

    monetary policy tightening and headwinds rom Western

    Europe will likely lead to slower growth in Russia.

    As or Brazil, I note the recent reversal in monetary policy

    as the central bank switches rom ghting infation to

    preventing a recession. I also discuss how the crisis in the

    West led to a dramatic shit in the direction o Brazils

    currency, causing the authorities to change the direction o

    currency market intervention.

    In our eature article on Mexico, Pralhad Burli discusses

    Mexicos considerable challenges as well as its great

    potential. He notes that Mexico has ailed to grow at the

    rate o the BRICs and has thus been let behind. He also

    notes, however, that there are a number o actors that

    could boost uture growth or Mexico.

    Finally, Satish Raghavendran and Neha Jain provide some

    perspective on the actors that infuence the price o gold.

    Given the roller coaster path that gold has lately experi-

    enced, this issue should be o considerable interest to our

    readers.

    Dr. Ira Kalish

    Director o Global Economics

    Deloitte Research

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    Contents186 24

    6

    12

    18

    22

    24

    28

    Geograpies

    Eurozone: A crucial time or action Deteriorating sentiment and speculation about the monetary zones uture

    continue to unsettle markets. There is a case, however, or cautious optimism about the euros longer-term

    prospects. At the same time, dwindling global demand and a yet-to-be-solved sovereign debt crisis are posing

    signicant recessionary pressures, especially in the peripheral nations o the EU.

    United States: The coming recession A recession o European origins could wash back into the U.S. economy by

    hampering trade, industrial production, corporate protability, and banking. History never repeats itsel perectly,

    but the current nancial situation has some striking similarities to 2008.

    China: Slower growth, longer-term risks Chinas economic growth is decelerating because o the weakening

    global economy and tightened monetary policy. Overall debt has nearly tripled in the last ve years, and signicant

    investments in xed assets may loom heavily over Chinas longer term.

    Japan: On the bright side The Japanese economy is one o the ew economic bright spots in a world that

    is experiencing slower growth. Japan is recovering rom a natural disaster, and additional spending will likely

    accelerate the Japanese economy next year. However, slower overseas growth, a high-valued yen, and slower-

    than-expected reconstruction spending are introducing obstacles to the countrys economic prospects.

    United Kingdom: Waiting or a policy response Economic growth in the UK is deteriorating at the hands o

    declining domestic undamentals and downward economic pressures rom abroad. The countrys outlook hinges

    on policy responses, both at home and within the Eurozone. Additionally, an uncertain business environment is

    putting corporate strategies on the deensive.

    India: Trudging along, or now Indian policymakers are trying to curb rapidly rising infation and simultaneously

    sustain growth, despite a weakening global economy. GDP growth may continue to hover around 7.5 percent orthe current scal year.

    28

    Global Economic Outlook 4th Quarter 2011

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    42

    Geograpies (continued)

    Russia: Political clarity, policy uncertainty The announcement that Prime Minister Putin will return as president, exchanging

    jobs with President Medvedev, adds a needed note o political clarity, but uncertainty abounds pertaining to Russias economic

    policy outlook. A combination o monetary policy tightening and troubles in Western Europe may decelerate growth in Russia.

    Brazil: Changing direction The central bank in Brazil recently reversed its monetary policy rom infation ghting to recession

    prevention. In the wake o a decelerating global economy, authorities decided to rethink their currency market intervention.

    Mexico: Looking north Mexico aces signicant challenges. However, its ormidable economic potential cannot be

    overlooked. The country has ailed to keep pace with the BRICs, but possibilities abound or boosting uture growth.

    Topics

    Gold prices: deying gravity? Golds prowess as a monetary asset, a nancial asset, and as jewelry has contributed to its

    decade-long ascent. The price o gold will likely stabilize as the Eurozone crisis is resolved, the U.S. economy is revitalized, and

    infation in the emerging markets is tamed.

    Appendi

    Charts and tables GDP growth rates, infation rates, major currencies vs. the U.S. dollar, yield curves, composite median GDP

    orecasts, composite median currency orecasts, OECD composite leading indicators

    32

    36

    38

    42

    46

    3836

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    EUROZONE

    Eurozone: A crucial time

    or actionby Dr. Elisabet Denison

    Ideology versus Eecution

    The ortune o the Eurozone depends crucially on whether

    and how ast a convincing solution to the debt crisis

    can be ound and implemented. Fears o a Greek deault

    and its contagion eect, including the possibility o an

    ensuing banking crisis, hang over the economy like the

    sword o Damocles. Leaders are currently trying to solve

    three key issues:

    dealing decisively with Greece while rewalling other,

    less-aected ringe nations

    establishing a mechanism or a unctioning European

    bond market by giving the European Financial Stability

    Facility (EFSF) more money and more power

    putting the announced plans on scal and macroeco-

    nomic surveillance and enorcement into action

    On July 21, European heads o state, together with EU

    institutions and the International Monetary Fund, reached

    an agreement on securing the uture o the Eurozone

    with a 16-point action plan. It was a big achievement, but

    or it to be put into action, all 17 nations have to ratiy

    the agreement, and the delay in getting this done has led

    to renewed turmoil in nancial markets. Execution does

    not seem to be keeping up with ideology in Europe.

    (1) Dealing with Greece

    Opinions still vary widely on the necessity o restruc-

    turing Greek debt not only between nations, but also

    between dierent groups o stakeholders. The main

    concern is the unpredictable eect a Greek deault

    might have on European bond markets and, as a conse-

    quence, on the nancial sector, which holds much o the

    Eurozones sovereign debt. There is a stronger consensuson the obligation o rewalling other ringe nations with

    better undamentals (especially Italy and Spain) rom

    being sucked into a downward spiral o rising borrowing

    costs and increasing debt, but the mechanisms or doing

    so are ar rom being agreed upon.

    (2) Giving the EFSF more power

    Approving extra unding or the EFSF is a signicant

    hurdle. Some crucial votes have taken place in recent

    weeks, clearing the way or implementation. However,

    disagreement about the mechanism o delivery abounds.

    Dr. Elisabeth Denison is

    Senior Economist and

    Director o Corporate

    Development & Strategy,

    Deloitte Germany

    Eurozone growth is slowing. Sentiment has deteriorated over the summer amid signs o weakening global

    demand and disappointed hopes o solving the sovereign debt crisis. This is a crucial time or Europe. I

    Eurozone leaders now act decisively to stabilize fnancial markets and turn their plans or closer cooperation

    into action, it could halt the downward spiral o deteriorating confdence and weakening activity. Real economic

    indicators are not yet indicating a recession, but markets remain unsettled by deteriorating sentiment and

    speculation about the uture o the monetary union.

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    Geographies

    7

    Eurozone

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    Global Economic Outlook 4th Quarter 2011

    The EFSF could nance itsel through unding on capital

    markets by leveraging the guarantees o the Eurozonemember states (seemingly the preerred option) or

    through renancing at the ECB, which would, in act, not

    be much dierent than i the ECB steps into markets and

    purchases bonds rom member states.

    Waiting or approval o the July 21 agreements, the

    ECB has already stepped in to buy Italian and Spanish

    government bonds to drive down borrowing costs and

    avoid these two economies rom being orced to request

    bailouts like Greece, Ireland, and Portugal. Worried about

    its independence, the ECB stresses it does not plan to

    continue to intervene in bond markets. It expects the EFSF

    to be in a position to take over soon.

    (3) Fiscal and macroeconomic coordination

    With markets ocused on the immediate concerns o

    solving the debt crisis and establishing a credible bailout

    und, it has not been widely noted that the European

    Parliament has given its nal agreement and voted to

    adopt a package known as six-pack in the last week

    o September. The six legislative proposals or enhanced

    surveillance o scal discipline and coordination o macro-

    economic policies also include new enorcement mecha-

    nisms or non-compliant member states. The legislative

    package is expected to be in place by the beginning o

    2012, in time or the next semester o Eurozone economicpolicy coordination.

    In his state o the union address, EU President Barroso

    stressed the EUs commitment or action: The time or

    piecemeal solutions is over. It is about political will. It is

    the test or our whole generation.

    A recession in te cards?

    Unortunately, the process has been neither orderly

    nor decisive. Disappointed expectations have unsettled

    nancial markets, and negative sentiment is now

    spreading to the business and private sector. The Io

    Surveys Eurozone sentiment index ell or the secondquarter in a row in Q2 and is down 30 percent rom its

    peak at the beginning o 2010, even i the measure o

    current activity is holding up or now (see gure 1).

    The business-cycle tracer o the European Commissions

    Sentiment Index (ESI) conrms the threat o a recession in

    the Eurozone. This indicator graphs the level o economic

    sentiment (standardized index) on the vertical axis and

    its change (growth momentum) on the horizontal axis.

    Having held in expansionary territory or much o the

    past year, the indicator started to turn negative in spring

    1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 201160

    70

    80

    90

    100

    110

    120

    130

    Eurozone Sentiment Index Germany Sentiment Index

    Figure 1: IFO survey Eurozone

    (Index 100 = historic average)

    Source: IFO Institute

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    GeographiesEurozone

    o 2011, entered the downswing quadrant in April, and

    moved into contractionary territory in August. The latest

    reading in September points to urther deterioration (see

    gure 2).

    However, talk about a Eurozone recession should dieren-

    tiate between countries. The danger o recession is particu-

    larly high in ringe nations where austerity packages aresapping growth and hurting condence. Industrial nations

    like Germany and France are closely interconnected with

    their neighbors, but they are also depending on demand

    or their goods rom emerging markets, especially the

    BRICs. As long as growth in emerging markets does

    not all o a cli, growth in these countries will likely

    decelerate without turning negative. Given their relative

    weight in the Eurozone, the possibility o a recession in

    the Euro area this winter will hinge on how deeply the

    ringe nations decline. Germany and France account or

    48 percent o Eurozone GDP (see gure 3).

    -4.0

    -3.0

    -2.0

    -1.0

    0.0

    1.0

    2.0

    -8.0% -6.0% -4.0% -2.0% 0.0% 2.0% 4.0% 6.0%

    ESIIndex

    (Standardized

    level)

    ESI Index (%MoM, 3 month average)

    DOWNSWING

    UPSWING

    EXPANSION

    CONTRACTION

    Feb 11Sep 07

    Jul 08

    Dec 08

    Mar 09

    May 09

    Sep 09

    Mar 10

    Sep 10

    Sep 11

    May 11

    Figure 2: Business cycle tracer ESI

    Source: European Commission

    Growt estimates revised down

    The latest ocial orecast rom the European Commission

    still anticipates 1.6 percent GDP growth or the Euro area

    in 2011, with German growth revised rom 2.6 percent

    to 2.9 percent or the year. Current economic indicators

    support this view, with the economy still benetting

    rom strong momentum in the rst hal o 2011. Industry

    orders or the Eurozone are still up 8 percent rom a yearago and well above 2009 levels despite declines in

    August and September (see gure 4).

    Judging by leading indicators, however, a deceleration

    is likely in the second hal o the year. The negative

    momentum is expected to carry over into 2012 and

    weigh on growth prospects or next year. Forecasts or

    German growth have been revised to 1.0 percent or

    lower or 2012 based on recent data, and a recession or

    the Eurozone overall cannot be ruled out. This is due to a

    combination o several actors:

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    Global Economic Outlook 4th Quarter 2011

    $2,477

    $1,933

    $1,549

    $1,063

    $588

    $354

    $286

    $230

    $180

    $173

    $156

    $66

    $42

    $35

    $17

    $14

    $6

    $2,061

    $1,579

    $1,843

    $639

    $369

    $343

    $207

    $329

    $87

    $161

    $150

    $27

    $8

    $13

    $11

    $1

    $4

    Germany

    France

    Italy

    Spain

    Netherlands

    Belgium

    Austria

    Greece

    Finland

    Portugal

    Ireland

    Slovakia

    Luxembourgh

    Slovenia

    Cyprus

    Estonia

    Malta

    GDP (2010 bn)

    Public Debt (2010 bn)

    PublicDebt

    % GDP

    Growthforecast

    (2011)

    +2.9%

    +1.6%

    +0.7%

    +0.8%

    +1.7%

    +2.4%

    +1.6%

    -3.5%

    +3.7%

    +0.7%

    +0.6%

    +2.9%

    +3.4%

    +1.9%

    +1.5%

    +4.9%

    +2.0%

    83%

    82%

    119%

    60%

    63%

    97%

    72%

    143%

    48%

    93%

    96%

    41%

    18%

    38%

    61%

    7%

    68%

    igure 3: Eurozone country overview

    Source: Eurostat

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    GeographiesEurozone

    Decelerating export demand as global growth

    slows: Emerging markets will provide less stimulus with

    growth slowing as a result o their countermeasures

    to overheating; in the United States, there is ear o a

    renewed recession amid attempted debt reduction and

    persistently high unemployment.

    Weakening domestic demand due to deteriorating

    business and consumer sentiment: Uncertainty about

    the uture o the Eurozone is having a negative eect

    on condence, which will impact the spending behavior

    o corporations and private households.

    Investment costs are rising amid nancial market

    stress due to the sovereign debt crisis

    Te bigger picture

    The current crisis is rooted in rising global imbalances.

    The United States and many nations o the European

    Union ran unsustainable decits, which were nanced

    by surpluses and emerging economies, particularly Asia.

    Along the way, these trade partners rst among them,

    China accumulated huge nancial interests in the West

    Reerences and Research

    Sources:

    BIS Quarterly Review -

    International banking and

    nancial market developments,

    September 2011

    The 6-pack: tools or a stronger

    Economic Governance, European

    Commission 22/09/2011

    2011 State o the Union address,

    President o the European

    Commission, 28/09/2011

    EU interim orecast: recovery

    stalls amid nancial market

    crisis, European Commission,

    15/09/2011

    80

    85

    90

    95

    100

    105

    110

    115

    120

    125

    130

    2005 2006 2007 2008 2009 2010 2011

    Figure 4: Eurozone new industry orders

    (Index 2005 = 100)

    Source: Eurostat

    (currency reserves, sovereign debt, and other nancial and

    direct investments). So an orderly, long-term solution to

    dealing with the debt overhang o Western nations is in

    everyones interest (see Chinas oer to European leaders

    to buy Eurobonds i they are issued; however, the oer

    came attached to some unpopular conditions on easing

    trade barriers and taris).

    To stabilize long-term world growth, Western industrial-

    ized nations will need to nd a solution or a sustainable

    equilibrium in their relationship with the East. In a tri-polar

    world, Europe will have to nd its place, and it will only

    be able to do that i it manages to speak with one voice.

    President Barroso summed up the sentiment in his state

    o the union address: Populist responses are putting into

    question the Union's greatest achievements, the euro, the

    single market and ree movement o people. Yet there

    are solutions to the crisis. We can restore condence and

    trust through united action. I we do not go or urther

    integration, we risk ragmentation.

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    USA

    United States:The coming recessionby Dr. Carl Steidtmann

    Dr. Carl Steidtmann is

    Chie Economist at

    Deloitte Research

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    GeographiesUSA

    While the U.S. economy is not currently in a recession,

    the probability that it will slide into one beore the end

    o the year is high and growing. The second-hal uptick

    that so many, including ourselves, once expected was

    lost this spring in Europe as the rst Greek bailout began

    to unravel. When the contagion spread to other ringe

    countries, the issue shited rom Greece to the over-lever-

    aged European banks that hold 2 trillion euros in distressed

    sovereign debt, which is rapidly depreciating and cannotpossibly be serviced, much less repaid. The endgame will

    play out shortly, but the results a credit contraction and

    a severe recession or Europe are the likely outcome.

    In the United States, it is likely that job growth ailed

    to materialize, in part, because the private sector aced

    increased costs associated with regulatory oversight in

    health care, nancial services, and energy. Add to this the

    increase in government spending that was used to und

    short-term consumption, shiting wealth rom the uture

    into the present. And nally, the Federal Reserves high-risk

    but ultimately unsuccessul second round o quantita-

    tive easing increased oil and ood prices but did little tostimulate real growth.

    Q2 GDP points to recession

    The rst piece o hard data that argues in avor o a

    recession can be ound in the most recent readings on

    U.S. Gross Domestic Product (GDP). While the 20072009

    recession was more severe than previously advertised,

    the new data also showed that real GDP growth in the

    second quarter was up just 1.5 percent rom a year ago.

    Since 1947, there have been 14 occasions when real GDP

    growth slowed below 2 percent. In 11 o those cases, the

    economy ell into a recession, which puts the historical

    probability at 78 percent.

    Te European debt crisis

    The second development that raises the risk o a recession

    in the United States is the European debt crisis and a corre-

    sponding recession that would ollow it. A recession in

    Europe would wash back into the U.S. economy in several

    ways, including trade, industrial production, corporate

    protability, and banking.

    Trade: The European Union is a major trading partner or

    the United States, accounting or $259 billion in exports,

    which is roughly 12 percent o the $1.9 trillion in total U.S.

    exports. During the 20082009 recession, exports to the

    EU ell sharply rom a peak o $272 billion to $220 billion,

    a peak-to-trough decline o 19.1 percent over a teen

    month period. Even with a recovery, U.S. exports to the EU

    are still 4.9 percent below their mid-2008 peak.

    Another recession in Europe would have a comparable

    drag on U.S. exports. A comparable decline to whathappened in 20082009 would bring U.S. exports down

    to $210 billion. Since Europe would not be the only place

    rom which U.S. exports would decline, the trade sector

    would become a drag on growth.

    Industrial production: Manuacturing plummeted 15

    percent during the 20082009 recession, its sharpest

    contraction since World War II. Beginning in the summer

    o 2009, industrial production posted a solid recovery,

    but it began to ade in the rst quarter o 2011 due

    to problems in Japan and weaker growth in domestic

    demand. Production is up just 3.3 percent rom a year

    ago while regional Federal Reserve indices point to uture

    weakness.

    While manuacturing as a share o GDP shrank over the

    years, it is still an important source o exports, prots, and

    -25

    -20

    -15

    -10

    -5

    0

    5

    10

    15

    20

    25

    2001 2003 2005 2007 2009 2011

    Figure 1: U.S. exports to the European Union

    (YoY % change)

    Source: U.S. Census Bureau

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    Global Economic Outlook 4th Quarter 2011

    employment. With new orders or actory goods on the

    decline, weakness in exports to Europe may push manu-

    acturing back into a recession.

    Corporate profts: Ater collapsing during the 20082009

    recession, prots have posted their strongest and astest

    recovery in more than 50 years. As a share o GDP, prots

    are at a level not seen since the early-1950s. Prots hit

    a low o 6.9 percent in Q4 2008 as a share o GDP only

    to rocket up to 12.9 percent in Q2 2011. U.S. businesses

    have been able to post record prots, in part, due to the

    strength o their overseas operations. A recession in Europe

    will undermine the perormance o those operations and

    bring down corporate protability in the United States.

    Corporate prots are a key leading indicator or businessinvestment. When prot growth is strong, businesses

    tend to invest in that growth. Thereore, a contraction in

    corporate prots will lead to weaker business investment.

    Banking: In August 2007, commercial paper (CP)

    outstanding peaked at $2.2 trillion. As the credit crunch

    deepened, CP contracted by more than 50 percent over

    the ollowing year. The Federal Reserves purchases o

    commercial paper in the all o 2008 may have staved o

    an even deeper contraction.

    Uncertainty over the degree o exposure on the part o

    U.S. banks to European debt and the counterparty risk

    exposure to European banks has led to a liquidity squeeze

    in the United States that can be seen in the commercial

    paper market. Ater peaking at $1.2 trillion in July 2011,

    commercial paper outstanding has contracted by $200

    14

    -20

    -15

    -10

    -5

    0

    5

    10

    15

    1981 1986 1991 1996 2001 2006 2011

    Figure 2: Industrial production

    (YoY change)

    Source: Federal Reserve Board

    6%

    7%

    8%

    9%

    10%

    11%

    12%

    13%

    19611967 1973 19791986 1992 1998 2004 2011

    Figure 3: Corporate profits as a share of GDP

    Source: Bureau of Economic Analysis

    0

    50

    100

    150

    200

    250

    300

    2008 July 2009 July 2010 July 2011 July

    Figure 4: Commercial paper outstanding in the United

    States foreign financial institutions(In billions of $)

    Source: Federal Reserve Board

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    GeographiesUSA

    billion an annualized rate o decline in excess o 50

    percent.

    U.S. banks are not the only nancial institutions acing

    a liquidity crunch. Commercial paper issued by oreign

    nancial institutions has also been on the decline. The

    contraction in dollar-denominated commercial paper is

    creating a liquidity crisis or some European banks that

    depend heavily on short-term nancing. The FederalReserve responded to this dollar liquidity squeeze by

    opening dollar swap lines with the European Central Bank,

    the Bank o England, and the Swiss National Bank.

    Dj vu and downturn signals

    The current nancial situation has an eerie dj-vu sense

    to it. History never repeats itsel perectly, but there are

    enough parallels between the nancial crisis o 2008 and

    the early developments in the current nancial crisis in

    Europe to raise concern. While one or two o the events

    could be dismissed as a coincidence, they collectively make

    a strong case or a return to recession.

    1. Federal tax collections all: Tax collections began

    to sputter in the spring o 2008, posting small declines

    in the summer beore plunging ater the Lehman crisis

    in September. Tax collections peaked in late-July 2011.

    Through September, they have allen 5.1 percent rom

    that level, and they are fat rom a year ago. Declining tax

    collections is a symptom o a declining economy.

    2. M2 money supply growth: In the all o 2008, M2

    money supply growth exploded to the upside, rising nearly

    25 percent quarter-to-quarter on an annualized basis.

    Rapid money supply growth, coupled with fagging real

    growth, is one o the characteristic signs o a liquidity trap

    where the demand or money rises sharply in the ace o

    uncertainty. It is also a refection o the rush to saety as

    some o the increase was driven by businesses shiting

    deposits rom oreign to U.S. banks.

    M2 money supply at the end o September was growing at

    a 26.4 percent clip. The growth in money supply repre-

    sents a rush o European liquidity into the saety o U.S.

    banks.

    3. Commodity prices: Prices or gold, oil, ood, and

    eed all rose sharply rom 2005 to early-2008. Prices

    then traded in a narrow range beore plummeting in the

    summer o 2008, a decline that continued into early-2009.

    Gold prices ell 30 percent. Oil prices went rom a peak o

    $147 a barrel down to $38. The peak-to-trough decline in

    all commodities was 34.7 percent.

    -5

    0

    5

    10

    15

    20

    25

    30

    2007 2008 2009 2010 2011

    Figure 5: M2 money supply

    (YoY percentage change)

    Source: Federal Reserve Board

    200

    250

    300

    350

    400

    450

    500

    550

    600

    2001 2003 2005 2007 2009 2011

    Figure 6: Spot market price index

    (1967 = 100)

    Source: Commodity Research Bureau

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    Global Economic Outlook 4th Quarter 2011

    Commodity prices peaked in March 2011 and have

    declined 10.6 percent. Ater peaking at $114 a barrel

    in late-April, oil prices are down more than 30 percent.

    Copper prices have allen by roughly the same percentage.

    Wheat prices that reached $8.80 a bushel have allen to

    $6.60. Declining commodity prices are generally associated

    with a decline in the global economy.

    4. Credit spreads: Credit deaults rise during recessions.Fear o deault drives increases in credit spreads. During

    the 2008 credit crisis, credit spreads hit levels we have not

    seen at any other time in the post-World-War-II economic

    era. While nowhere near those levels, credit spreads are

    again on the rise. The TED spread, the dierence between

    interbank lending rates and U.S. Treasury bill rates, have

    more than doubled rom a low o 16 in late-July to 36

    more recently. Corporate risk spreads have risen rom a low

    o 255 in April to 333 more recently.

    In Europe, the expansion o risk spreads has been even

    more dramatic; spreads between Greek and German

    debt rose rom a ew hundred basis points to a ewthousand. Italian and German spreads have gone rom a

    low o 120 basis points to just under 400 basis points in

    late-September.

    5. The dollar: Ater a decade o steady declines, the dollar

    was bid up on oreign exchange markets beginning in the

    summer o 2008. The rush into the dollar was a sae-

    haven move that showed up in an increase in U.S. money

    supply and price and a decline in the interest rates on U.S.

    Treasury bonds. From trough to peak, the dollar gained

    20.4 percent over a nine month period in 20082009.

    Ater peaking in March 2009, the dollar again moved

    lower as it did over the course o the previous decade. By

    in July 2011, it was back at its pre-crisis levels. The dollar is

    again on the rise. In the six weeks since recording its low

    in late-July, the dollar rose 3.4 percent as global investors

    sought the saety o dollar-denominated assets.

    6. U.S. Treasuries: The global rush to saety that increased

    the value o the U.S. dollar also ound its way into the

    price or U.S. Treasuries. During the all o 2008, yields on

    10 year U.S. Treasury bonds ell just over 200 basis points

    rom 4.2 to 2.2 during the second hal o 2008.

    Since March 2011, interest rates on U.S. Treasury bonds

    have ollowed a similar, downward path. Despite a

    downgrade in U.S. debt ratings, rates o the 10 year U.S.

    Treasury bond have allen rom a high o 3.7 to 1.9 and

    was as low as 1.7 a drop o nearly 200 basis points over

    90

    95

    100

    105

    110

    115

    2008 2009 2010 2011

    Figure 7: U.S. dollar, trade weighted

    (1973 = 100)

    Source: St. Louis Federal Reserve

    1.5

    2.0

    2.5

    3.0

    3.5

    4.0

    4.5

    2008 2009 2010 2011

    Figure 8: 10 year U.S. Treasury bond yields

    (Percentage)

    Source: St. Louis Federal Reserve

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    Geographies

    a period o seven months. The Federal Reserves "Operation

    Twist" seeks to drive long-term rates even lower.

    7. Collapsing consumer confdence: As the nancial

    crisis began to build in 2007, consumer condence began

    to slide. From a peak value o 96.9 in January 2007, con-

    dence slipped steadily lower beore hitting a low o 55.3 in

    November 2008 a drop o more than 40 points.

    Ater peaking in February 2011 at 77.5, consumer con-

    dence, as measured by the University o Michigan survey,

    ell to a low o 55.7 in August 2011, a drop o nearly 22

    points. In past business cycles, a decline in consumer con-

    dence below 80 was a consistent sign o recession.

    8. Short selling ban: In all 2008, the Securities and

    Exchange Commission issued a ban on the short sale o

    bank stocks, but the ban ailed to stem the decline in the

    share values o stocks. In August 2011, nancial market

    regulators across Europe banned short selling o bank

    stocks, but the ban has ailed to stop the decline in bank

    shares.

    Wat is dierent now?

    U.S. businesses are going into this recession with much

    stronger balance sheets and much leaner operations than

    in 2008. Cash levels and productivity are substantially

    USA

    50

    55

    60

    65

    70

    75

    80

    85

    90

    95

    100

    2007 2008 2009 2010 2011

    Figure 9: Univ. of Michigan consumer sentiment index(1966 = 100)

    Source: University of Michigan

    higher. With leaner operations, layos and inventory

    reduction will not create the kind o downdrat or the

    broader macro economy that they did in 2008.

    On the downside, the policy options available to address

    the recession are much more limited today than they were

    in 2008. Back-to-back stimulus programs in 2009 and

    2010 in excess o $800 billion are unthinkable today. A

    third round o quantitative easing is possible, but it will becontroversial and given the eectiveness o the previous

    round, may be o limited value.

    While a recession has probably already started in Europe,

    expect the U.S. recession to begin beore the end o the

    year. Weaker exports, a decline in business investment, and

    contracting manuacturing will likely combine to push an

    economy that is operating at stall speed into a recession.

    The sharp cuts in inventories and employment that char-

    acterized the 20082009 recession should be limited in

    this downturn. Still, the United States starts this recession

    with an unemployment rate o 9.1 percent, a number that

    undoubtedly will go higher.

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    Global Economic Outlook 4th Quarter 2011

    ChINA

    Chinas economy is decelerating. In September, the

    purchasing managers indices or output and exports

    were below 50 or a third month in a row, which hasnt

    happened since 2009. Still, the indices barely slipped

    below 50, indicating that the decline in manuacturing is

    moderate. Moreover, Chinas central bank has stopped

    tightening policy given the latest global slowdown.

    Thereore, although Chinas economy will slow down,

    deceleration will likely be less-than-dramatic.

    On the other hand, it is notable that a senior Chineseocial recently predicted that growth in 2012 would be

    below 9 percent. I this prediction materializes, it would be

    the rst year since 2001 that growth alls below 9 percent.

    These comments refect a belie that a combination o

    monetary policy tightening and reduced global growth will

    cause the Chinese economy to grow more slowly.

    Interestingly, there is evidence that the economic

    slowdown is being experienced principally by small- to

    medium-sized private businesses (especially those that

    export) and not by the large, state-run enterprises that

    retain avorable access to credit. Ater all, imports o oil

    and iron ore rose signicantly in August. The biggestsource o recent growth has been xed asset investment,

    especially construction. The importation o iron ore, used

    to make steel, indicates ongoing strength in construc-

    tion. Meanwhile, a deceleration in exports is the prime

    cause o the economic slowdown. While the strength o

    construction is good in the short term, it means that China

    continues to over-build.

    Ecessive debt poses risk or Cina

    Chinas ocials have complained about the rapid

    expansion o U.S. government debt. This refects ear

    China: Slower growth,longer-term risksby Dr. Ira Kalis

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    19

    China

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    Global Economic Outlook 4th Quarter 2011

    that the massive stock o oreign currency reserves held

    by Chinas government could lose value. Less attention,

    however, has been paid to the big increase in overall debt

    in China itsel. Yet, that is likely to change soon, given the

    act that overall debt has nearly tripled in the past ve

    years. Notably, a top Chinese ocial recently said that the

    debt o Chinas local governments is our version o the

    U.S. subprime crisis. The $1.7 trillion in debts issued by

    local governments to und inrastructure building has been

    a concern or some time, but ocials have downplayed

    the danger until now. The ear is that multiple deaults

    could damage the health o Chinas banks without a

    bailout rom the central government.

    how did it come to tis?

    When the global economic crisis began in 2008 and

    Chinas exports suddenly dropped, the governmentimplemented a vast stimulus program to boost domestic

    demand and oset the drop in exports. Part o this

    involved extending credit to provincial and local govern-

    ments to engage in inrastructure development. In the

    short run, this policy was successul in boosting growth

    and preventing a general recession. The problem, however,

    is that many such investments have ailed to generate

    adequate returns. The Chinese government estimates that

    little more than one quarter o local government invest-

    ment has produced a return adequate to service the debts.

    Furthermore, local government borrowing is not the

    20

    entire problem. During the global crisis, the government

    injected capital into state-run banks so that they could

    lend to state-run companies. The result was an investment

    boom. Yet this also involved many investments that are not

    producing an adequate return.

    The result was that investment in xed assets surged,

    reaching almost 50 percent o GDP last year. Meanwhile,

    consumer spending declined to about 35 percent o GDP.

    Now that the Chinese economy is slowing, the risk exists

    that Chinas debtors may soon ace greater diculties in

    servicing their debts.

    Wat eactly is te risk?

    Is China at risk o having a nancial crisis? On one hand,

    there is a danger that a new round o deaults will damage

    the solvency o Chinas state-run banking system. Yet, it islikely that the government would bail out such banks and

    thereby prevent a larger nancial crisis. Moreover, due to

    capital controls, Chinas nancial system is not integrated

    into the global economy. Thereore, a problem in Chinas

    banks would not lead to problems outside o China.

    On the other hand, China does ace a risk. Specically,

    i the government were compelled to bail out troubled

    nancial institutions, it would probably not support

    continued lending or the purpose o poorly conceived

    investments. Consequently, investment would likely

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    GeographiesChina

    all considerably. Given that investment is now close

    to 50 percent o GDP, such a all could have serious

    consequences or GDP without an osetting increase in

    something else. What could that something else be?

    Exports are not likely to take up the slack. With a rising

    currency, slower growth overseas, and rising wages at

    Chinas actories, it seems likely that export growth will be

    slow in the next ew years. In this scenario, China will likely

    look toward a boost in consumer spending to oset a

    decline in investment, but it would have to grow rapidly to

    make a dierence and avoid a signicant slowdown, given

    that consumer spending is now only 35 percent o GDP.

    Wat could go rigt?

    There are some positive signs concerning the prospect

    or boosting consumer spending. First, wages have beenrising, adding to real, disposable incomes. This refects a

    shortage o labor as demographic trends limit the labor

    orces growth and as internal migration slows. In add ition,

    provincial and local governments have been increasing

    their minimum wages. Second, the government intends

    to have state-run companies pay higher dividends to

    shareholders (mainly the government). In so doing, this

    will reduce retained earnings and thereore, the impetus to

    invest. Third, higher infation will help to reduce some o

    the real value o the debts in question. On the other hand,

    high infation means that real interest rates are largely

    negative, thereby ueling continued borrowing. Also,

    high infation means that the real value o the currency is

    rising quickly, thereby hurting export competitiveness. So a

    slowdown in exports could become more pronounced.

    Wat appens net?

    It is sae to say that China is slowing down. In addition,

    it is probably sae to say that the excessive debt-nanced

    investment o recent years will likely lead to challenges

    somewhere down the road. In that situation, economic

    growth will decelerate. How much it slows will depend

    on a variety o actors, including how the government

    responds to such an event.

    In any event, an economic slowdown in China will have

    global ramications. A Chinese slowdown will remove

    pressure on global commodity prices and reduce exportgrowth or Chinas major trading partners. Domestically,

    slower growth could remove some o the upward pressure

    on wages and prices. It could also potentially lead to social

    unrest.

    It is sae to say that China is slowing down. In addition, itis probably sae to say that the excessive debt-nancedinvestment o recent years will likely lead to challengessomewhere down the road.

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    Global Economic Outlook 4th Quarter 2011

    Japan: On the bright sideby Dr. Ira Kalis

    In a world o slowing economic growth, Japan is the

    exception. In act, the country can reasonably expect that

    growth will soon accelerate at least or awhile. The

    silver lining o a natural disaster is the extra spending that

    boosts economic growth, but the positive impact o recon-

    struction spending has not met expectations. Challenges

    remain or the Japanese economy.

    In the second quarter o 2011, the economy contracted

    at a rate o 2 percent. This third consecutive quarter o

    declining GDP was, in part, due to the negative impact o

    the earthquake and tsunami. While many analysts antici-

    pated a strong boost to economic growth in the second

    hal o 2011, the latest numbers suggest slower growth

    than expected. The Tankan index o sentiment at large

    manuacturing companies rose rom -9 in the second

    quarter to +2 in the third quarter. A positive reading means

    that there are more optimists than pessimists among the

    surveyed executives. The current reading is still lower than

    in March, just beore the earthquake. Japan is recovering,

    but the pace is underwhelming. This is likely due to slower

    overseas growth, a high-valued yen, and slower-than-

    expected reconstruction spending.

    The rising value o the yen is taking its toll on the industrial

    sector. While the automotive sector is recovering rom

    damage to its supply chain, the major players are planning

    to shit production capacity oshore in order to avoid the

    impact o an overvalued currency. The strong yen refects

    several actors, including the repatriation o overseas unds

    or the purpose o reconstruction. It is also due to the

    perception o Japan as a sae haven or nancial assets in

    a time o global turmoil. Although the return on Japanese

    assets is very low, global investors do not perceive them to

    be at risk o outright ailure.

    Still, despite troubles in Japans export sector, the country

    will probably grow aster in 2012 than either Europe or

    the United States. This would not be the case absent the

    earthquake and tsunami; reconstruction spending will

    make a signicant dierence.

    In September, the Japanese government proposed its

    third reconstruction budget o 12 trillion yen roughly

    $160 billion, which is about twice what has already been

    budgeted. This brings the total to about $240 billion. The

    big debate has been over how to nance this expenditure.

    The current government has indicated a preerence or tax

    increases so as not to substantially increase the already-

    large debt. As such, it is likely that there will be an increase

    in the consumption tax. This will have some negative

    impact on consumer spending. In addition to increasing

    the consumption tax, the government plans to sell assets

    such as shares in Japan Tobacco to und reconstruction.

    Interestingly, the governments decit was already

    projected to be 8 percent o GDP even beore the earth-

    quake. Reconstruction costs, by adding an estimated 4

    percent o GDP, will not have a big impact on overall debt,

    even i it is nanced by borrowing.

    Meanwhile, despite the governments plans or scal

    rectitude, Moodys has again downgraded Japans

    sovereign debt. This action had little impact on the market

    or Japanese government bonds, which continue to oer

    among the lowest rates o return in the world. While

    Moodys was evidently concerned about the act that

    government debt has reached 200 percent o GDP, there

    are other mitigating actors. For example, 95 percent o

    that debt is held domestically. In addition, Japan continues

    to have a very high rate o savings, so nancing govern-ment decits is not a problem.

    Interestingly, Japanese monetary policy has been relatively

    aggressive this year; the Bank o Japan engaged in quan-

    titative easing on a surprisingly large scale, but perhaps

    it has not been large enough. The currency continues to

    rise, and infation continues to be very low. One o the

    purposes o a round o quantitative easing is to boost

    expectations o infation. Higher infation can have the

    eect o boosting spending, reducing real interest rates,

    and reducing the real value o debts. However, retail

    sales are declining, business investment ell in the second

    quarter, and infation remains close to zero. Thus, the reallevel o debt has not improved.

    Going orward, Japan continues to ace several downside

    risks despite the anticipated boost rom reconstruction

    spending. The global economic slowdown is rst among

    these risks as it will have a negative impact on export

    growth. Domestically, major challenges include a s lower-

    than-expected revival o electricity generating capacity,

    uncertainty about the uture o Japans nuclear program,

    political uncertainty, a continued high rate o savings, and

    long-term problems related to demographics.

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    United Kingdom: Waitingor a Policy Responseby Ian Stewart

    UK

    TheUKgrowthoutlookhasdeteriorated

    CFOsareshiftingtomoredefensivestrategies

    TheoutlookhingesonthepolicyresponsefromUKandinternational policymakers

    What looked like a global sot patch in activity has turned

    into something much more serious. Consistent with the

    other large industrialized countries, UK growth slowed

    sharply in the second quarter (although, in the case o the

    UK, activity was somewhat depressed by timing eects

    and by the impact o Japans tsunami and earthquake).

    UK domestic undamentals have weakened, but the big

    change has been in the global environment. The Eurozone

    debt crisis created ears o a vicious spiral o sovereign

    and bank deaults. One consequence has been the virtual

    closure o corporate bond and bank term unding markets

    to new issuance. Our own measure o nancial stress isnow showing the highest readings in 2 years (see gure 1).

    Condence about global growth has waned. Consensus

    orecasts or GDP growth have declined across the indus-

    trialized world (see gure 2).

    The UK consumer sector remains weak with spending

    under pressure rom a severe squeeze on real incomes.

    Over the last year, real personal disposable incomes have

    allen by almost 3 percent, the astest rate o decline in

    this indicator o consumer spending power since 1976.

    With consumer borrowing growing at single-digit rates,

    Ian Stewart is Chie

    Economist at Deloitte

    Research in the United

    Kingdom

    80

    130

    180

    230

    280

    Jan-06 Dec-06 Nov-07 Nov-08 Oct-09 Oct-10 Sep-11

    Figure 1: Deloitte financial stress index

    Source: Economics & Markets, Deloitte Research, London

    The Deloitte Financial Stress index is an arithmetic average of the ratio of 3 month LIBOR tobase rates, the ratio of yield on high yield bonds to yield on government bonds, the VIX index,the ratio of total market return to banking stocks return and the ratio of yield on long termgovernment bonds to yield on short term bonds.

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    Global Economic Outlook 4th Quarter 2011

    credit has been unable to ll the gap. Over the last year,

    retail spending has hardly increased, and house prices have

    allen. Mortgage approvals, a key leading indicator or

    housing activity, remain at historically low levels.

    Deloitte UKs third quarter survey o chie nancial

    ocers testies to the impact o recent macroeconomic

    and nancial uncertainty on corporate sentiment and on

    1.5%

    2.0%

    2.5%

    3.0%

    3.5%

    Mar-11 Apr-11 May-11 Jun-11 Jul-11 Aug-11 Sep-11

    US

    Japan

    Germany

    Britain

    Figure 2: Consensus GDP growth forecasts for 2012

    Source: The Economist

    0%

    10%

    20%

    30%

    40%

    50%

    2007Q3

    2008Q1

    2008Q3

    2009Q1

    2009Q3

    2010Q1

    2010Q3

    2011Q1

    2011Q3

    Figure 3: Deloitte CFO risk appetite survey

    % of CFOs who think now is a good time to take greater risk onto their companys balance sheet

    Source: Economics & Markets, Deloitte Research, London

    business strategy. Optimism among UK CFOs has allen or

    the third consecutive quarter and is now at levels last seen

    in early-2009 when the UK economy was in a recession.

    The world has become riskier and more uncertain or

    corporates. The proportion o CFOs who say external

    nancial and macroeconomic uncertainty is high or very

    high has almost doubled to 46 percent, and on average,

    CFOs now see a 43 percent chance that the UK economy

    will all back into recession.

    A weaker and more uncertain economic backdrop has

    also dented CFOs appetites or risk (see gure 3), and

    this, in turn, has expressed itsel in a continuing tilt in the

    balance sheet strategies employed by CFOs. For the rst

    time in a year, cost control is the top priority or CFOs.

    Capital expenditure and making acquisitions are tumbling

    down the list o priorities. Most think that a period o

    rapid margin expansion is drawing to an end. CFOs

    are responding with a renewed ocus on cost control.

    Expectations o a revival in corporate capital spending and

    hiring are ading. For UK corporates, deensive strategies

    are, once again, to the ore.

    The ndings rom the CFO Survey suggest that, at leastor now, corporate activity is likely to weaken. This repre-

    sents a setback or a recovery that was always going to

    be heavily reliant on the private corporate sector to grow

    capital spending, exports, and hiring.

    With sentiment sagging across the household and

    corporate sectors (see gure 4), policymakers have

    responded with urther monetary ease. In October, the

    Bank o England announced a round o urther quantita-

    tive easing worth 75bn, much higher than what the

    markets had expected. At the Conservative Partys coner-

    ence on October 3rd, the chancellor surprised markets

    by announcing a program o credit easing designedto support the fow o nance to the corporate sector

    through government purchases o corporate bonds. The

    details have yet to be worked out, but the act that the

    government has dusted o a policy response that was last

    employed in the rst quarter o 2009 testies to growing

    concerns about the outlook.

    Much will hinge on the speed and eectiveness o the

    response rom European policymakers to the crisis in

    the Euro area. The IMF summed up the problem neatly

    in its latest Financial Stability Report: Until a suciently

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    GeographiesUK

    A combination o monetary ease in the UK and abroadshould help bolster growth next year. So, too, will sharplylower infation; UK infation is widely expected to almosthalve over the next 12 months, and this will supportconsumer spending power.

    -70

    -60

    -50

    -40

    -30

    -20

    -10

    0

    10

    20

    30

    -45

    -40

    -35

    -30

    -25

    -20

    -15

    -10

    -5

    0

    Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11

    Consumer confidence (LHS)

    Business confidence (RHS)

    Figure 4: Consumer and business confidence indices

    Source: Confederation of British Industry and GfK NOP

    comprehensive strategy is in place to address sovereign

    contagion, bolster the resilience o the nancial system,

    and reassure market participants o policymakers' commit-

    ment to preserving stability in the Euro area, markets are

    likely to remain volatile."

    A combination o monetary ease in the UK and abroad

    should help bolster growth next year. So, too, will sharply

    lower infation; UK infation is widely expected to almost

    halve over the next 12 months, and this will support

    consumer spending power. But the UKs ortunes are

    heavily dependent on events in the Euro area. Financial

    stress, as Lehmans ailure demonstrated, can spread

    contagiously. Disruption to demand in the Euro area would

    hit the UKs largest export market. Introducing another

    round o quantitative easing in the UK is politically and

    technically straightorward, but nding a solution to the

    problems o the Euro area is precisely the opposite.

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    India: Trudging along,or nowby Siddart Ramalingam

    INDIA

    Over the past two years, India has experienced one o

    the highest infation rates in major emerging markets.

    High ood infation and ears o a lack o meaningul

    scal intervention have compelled the central bank toincrease interest rates in order to pursue lower prices at

    the expense o growth. The central bank's latest tightening

    in September, the twelth since March 2010, comes in

    the wake o ears o a global recession and the possibility

    o debt deaults in some Eurozone countries. While some

    critics o the central bank say that the bank has been too

    slow in reacting to infation and has not been bold enough

    with its rate increases, several others lament the rising cost

    o capital and alling domestic demand. While the debate

    regarding Indias monetary policy rages on, it is becoming

    increasingly likely that the Indian government will not meet

    its scal decit target or the year. While policymakers

    tinker with policy tools, the Indian economy is on courseto achieve over 7 percent growth this scal year.

    Ination stays ig

    Infation continues to be the key issue or Indian poli-

    cymakers. In a bold move to curb infation, the central

    bank raised interest rates by 50 basis points in July and by

    another 25 basis points in September. Despite recent rate

    increases, infation came in at over 9 percent in July and hit

    a 13-month high o 9.8 percent in August. Food infation,

    despite hitting a 20-month low o 7.3 percent in July,

    settled at 9.1 percent in September. That ood infation

    continues to be an issue, despite a good harvest in the

    20102011 season and normal rainall this year, is a clear

    indication that structural issues and supply-side bottlenecks

    that plague the Indian agricultural sector will remain orsome time to come.

    Fuel infation is beginning to exert upward pressure on

    headline infation as well. In order to ease the burden o

    uel subsidies on its purse, the central government decided

    to deregulate the price o petrol in 2010. Since this dereg-

    ulation, prices have risen sharply, with two increases just

    in the last ve months. This has pushed uel infation to

    about 15 percent or the year until September. While the

    infationary impact o the rise in uel prices is worrisome,

    what is interesting is the act that the latest price increase

    was the result o the depreciating rupee against the dollar

    on imports o crude oil.

    Te eternal sector

    With policymakers wrestling to control infation and sustain

    growth in the context o a weak global economy, the

    rupee hit new lows as global unds chase better prospects

    or growth. The alling rupee is a serious cause o conster-

    nation or importers, oil companies included. At the same

    time, while one would normally expect a weaker rupee to

    benet exporters, a shaky global recovery means exporters

    may not be able to take advantage o the opportunity or

    cost arbitrage in the coming months.

    Siddharth Ramalingam is

    a Senior Analyst at

    Deloitte Research, India

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    India's merchandise exports grew by 82 percent in July

    to $29 billion, while imports or the month climbed by

    52 percent to $40 billion. India's exports maintained

    their growth momentum in August, rising 44 percent to

    $24 billion. Imports grew by 41 percent to $38 billion in

    August. Although exports seem to be doing well despite

    the economic woes in traditional Western markets, this

    is unlikely to be the case going orward. With the global

    economy in a sticky patch, exports could start to decel-

    erate despite an increasing share o trade with emerging

    economies.

    At 14 billion rupees, oreign direct investment (FDI) or therst quarter o the current scal year has almost tripled

    compared to last year. The commerce minister estimates

    that FDI will touch $30 billion during the current scal

    year. With much o the world still in recession, it is likely

    that global investors will invest in India. The government is

    exploring FDI in the retail and pharmaceutical sectors, and

    it has relaxed investment norms over the last ew months.

    The government has also pledged to support the inra-

    structure sector and is setting up investment zones in order

    to attract investors. This is expected to pave the way or

    sustained growth over the next ew years.

    Consumption is bad, but industry is worse

    Interest rate hikes have nally begun to put the brakes

    on GDP growth in India. GDP growth or the rst three

    months o 2011 came in at 7.8 percent, compared to

    a growth o 9.4 percent in the corresponding quarter

    o 2010. Figures or the quarter that ended July urther

    corroborate the slowdown in growth. GDP grew at 7.7

    percent compared to 8.8 percent the previous year. What

    is surprising about data rom the recent quarter is that

    investment increased almost 8 percent ater foundering

    around zero percent during the previous quarter.

    High interest rates, combined with a potential liquiditychallenge in the second hal o the year, could ensure that

    investment drops o once again as the year progresses.

    The central government recently announced that it will

    need to borrow 13 percent more than what it budgeted

    or the current scal year primarily due to a reduction

    in unds available through national savings accounts;

    there has been an exodus o unds rom national saving

    accounts toward accounts in banks as they oer higher

    interest rates. This mopping up o unds rom the market,

    although unlikely to add to the scal decit, could crowd

    out investment rom the private sector and increase the

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    GeographiesIndia

    cost o borrowing or both government and private sector

    borrowers. However, the central bank is likely to be called

    upon to buy government bonds rom the market in order

    to inuse liquidity, and this could, in turn, add to infation.

    Consumer demand has taken a hit, and growth in rate-

    sensitive sectors has been weak in the last two quarters.

    Still, relatively speaking, domestic consumption is robust

    and is likely to act as a buer or the economy in the event

    o urther global economic turbulence. However, it is

    important to note that policymakers are currently grappling

    with high infation. Both the nance minister and the heado the central bank believe that current levels o ood

    infation are a matter o grave concern, and another hike in

    interest rates is a possibility. That being said, we could also

    be very close to the end o the rate increases.

    Until there is a clear indication that interest rates will

    stabilize, business condence is likely to continue to drop.

    Private investment is expected to slow down in the coming

    months as well. Indias manuacturing output slowed to

    its lowest pace in 30 months in September according to

    the HSBC purchasing managers index (PMI). The PMI slid

    to 50.4, which is just a touch above the level that divides

    contraction o manuacturing activity rom expansion. Any

    reading above 50 indicates expansion. Also, the services

    sector grew at its slowest pace in two years in August,

    according to the HSBC Markit Business Activity Index.

    A look aead

    The challenges that ace Indian policymakers are, to a

    large extent, the same as they were a year ago. Infation

    shows no signs o abating, and another interest rate hike

    is a possibility, but the end o the cycle o rate increases is

    probably very close. Consumer demand is likely to continueto slow down as monetary policy kicks in with some lag.

    Consequently, GDP growth may slow down urther and

    may hover around 7.5 percent or the current scal year.

    The scal decit is unlikely to meet the target level o 4.6

    percent o GDP. Since a signicant portion o the decit

    is unded through unds rom the central bank, money

    supply in the economy will continue to increase and exert

    upward pressure on infation

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    RUSSIA

    At long last, the political situation in Russia has clarity. It

    was announced that Prime Minister Putin will return as

    president in March 2012, exchanging jobs with President

    Medvedev. This means that, in theory, Putin could be

    president or the next 12 years since the constitution

    would allow this. Yet, clarity about who occupies which

    chair does not imply clarity about the policy outlook,

    which remains uncertain. And it could be that uncertainty

    pertaining to policy has contributed to a declining valueo the ruble. In the past ew years, Russia has experienced

    almost $250 billion in capital fight, given the weak global

    economy and a perception o poor investment opportuni-

    ties at home. Such fight puts downward pressure on the

    currency.

    The recent political announcement was greeted by an

    acceleration o currency depreciation as it let many

    questions about the uture unanswered. In the past year,

    President Medvedev spoke about creating a more diverse

    and transparent economy, promoting more oreign invest-

    ment, privatizing state-run companies, and improving the

    nances o the state-run pension program. Meanwhile,

    Prime Minister Putin has evidently avored greater stability

    and predictability through state control o important

    sectors, particularly energy. Now that the two men are

    exchanging jobs, the conventional wisdom is that Putin is

    the more powerul gure. But does this exchange o jobs

    presage a shit in policy or more o the same? No one can

    say or sure. The countrys nance minister, Alexei Kudrin,

    however, said he that couldnt work under the new regime

    and was promptly dismissed. Highly regarded or his

    scal management, Kudrins exit added to the sense o

    uncertainty.

    Russia: Political clarity,policy uncertaintyby Dr. Ira Kalis

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    Clarity about who occupies which chair does not implyclarity about the policy outlook, which remains uncertain.

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    Global Economic Outlook 4th Quarter 2011

    Modest growt aead

    Meanwhile, the Russian economy appears headed or

    growth in 2011 o about 4 percent. This is a disappoint-

    ment, given the Russian economy grew ar aster prior to

    the global crisis. Unortunately, a slowing global economy

    and dampening oil prices will not be helpul. Instead, the

    economy will mostly have to rely on domestic demand.

    While consumer spending is doing well, xed asset

    investment is not growing at a speed that would oset a

    slowdown in exports.

    On the positive side, consumer spending continues to rise,

    given rising real wages and greater access to consumer

    credit. Also, it is widely expected that scal policy will be

    more expansive in the months leading up to the election

    in March. This expectation is based on the act that similar

    policy shits have taken place in the past. Fiscal expansion

    will likely have a positive impact on economic activity.

    Also on the positive side is the act that infation is notaccelerating. The central bank tightened monetary policy

    during the rst hal o 2011, but it let policy unchanged

    since May. This tightening, combined with declining global

    ood and energy prices, has caused infation to peak below

    10 percent. In addition, it is expected that infation will

    gradually decline in the coming year. However, a steep

    drop in the value o the ruble could have an infationary

    impact.

    As or monetary policy, the deceleration o infation

    provides the central bank room or engaging in more

    aggressive policy, should the economic slowdown become

    onerous. On the other hand, while the central bank does

    not explicitly target the exchange rate, a declining ruble

    could restrain the bank rom cutting interest rates.

    Energy investment

    One o Russias problems in recent years was insucient

    investment and declining production in the energy sector.

    This was partly due to poor relations between the govern-

    ment and oreign investors. Now, a state-controlled

    oil company has entered into a joint venture with an

    American company to develop energy under Russias Artic

    coastline. This multi-billion dollar endeavor, in which Prime

    Minister Putin was present or the signing, suggests a new

    attitude toward oreign investment and a recognition that

    oreign technology will be needed to tap into oil in the

    most hostile conditions. It also suggests that several years

    down the line, energy output could start to grow again.

    The deal is big and is expected to involve tens o billions

    o dollars over time. The Arctic region is estimated to holdabout one quarter o the worlds recoverable oil and gas.

    European troubles

    Perhaps the biggest short-term risk to the Russian

    economy is the sovereign debt crisis in Western Europe.

    This has two potential implications or Russia. First, slower

    growth in Europe will hurt Russian exports o energy and

    manuactured goods. Indeed, this is already happening.

    Second, problems in Europes credit markets could make

    it dicult or Russian debtors to roll over their external

    debts.

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    Brazils central bank has chosen a new path. Ater a two

    year period o raising interest rates in order to ght rising

    infation, the bank suddenly and unexpectedly cut the

    critical Selic rate in August. The changing ortunes o the

    global economy have caused the central bank to rethink its

    policy in light o a new outlook.

    First, lets look at what has happened recently. When the

    United States implemented its QE2 policy o purchasing

    government bonds, which had the eect o keeping U.S.

    interest rates historically low, many investors sought higher

    returns in emerging markets such as Brazil. Not only did

    Brazil have relatively high interest rates, but investors

    also anticipated that the real would appreciate. Thus, the

    potential returns rom putting money into Brazil were

    considerable. The problem was that the inward fow o

    portolio investment had the eect o boosting the value

    o the currency. From December 2008 to August 2011,

    the currency rose 43 percent against the dollar. The resultwas damage to the competitiveness o Brazils manuac-

    tured exports. The problem was exacerbated as Brazil

    raised interest rates during the past two years in order to

    ght rising infation. Brazils economy was on re, and the

    government attempted to pour water on this overheated

    economy.

    To deal with the problem o currency appreciation, the

    Brazilian government imposed taxes on inward investment

    in order to limit the fow o money. This did not work.

    Instead, the government nally decided that, given the

    choice o ghting infation or ghting currency apprecia-

    tion, it would ocus on the ormer. It continued to raise

    interest rates in order to ght infation. By the summer o

    2011, the economy was showing signs o decelerating.

    In the period April through August, industrial production

    declined in three o the ve months. By August, it was

    up only 1.8 percent rom a year earlier. In September, the

    purchasing managers index (PMI) was down to its lowest

    level since April 2009. Moreover, as asset prices in Europe

    and the United States ell rapidly, investors shited unds

    out o Brazil in order to cover their losses elsewhere. The

    result was that, rom the end o August to late-September,

    the Brazilian real ell 16 percent against the dollar.

    Brazil: Changing

    directionby Dr. Ira Kalis

    ZIL

    With this very new situation, the Brazilian central bank

    decided that it no longer needed to worry about infation.

    Instead, it needed to worry about a signicant economic

    slowdown. So in August, it cut the Selic rate by 50 basis

    points and is widely expected to cut the rate again in the

    near uture. In addition, the central bank decided that toorapid a decline in the real could be disruptive and infa-

    tionary. In recent weeks, it has intervened in the currency

    markets by selling oreign currency reserves in order to

    stem the drop in the currency. The problem, however, is

    that propping up the currency has the eect o stemming

    money supply growth, which osets the positive impact

    o cutting interest rates. Again, the government will have

    to make a choice. Does it want to stabilize the currency,

    or does it want to ght the eects o a global economic

    slowdown?

    Going orward, it seems likely that interest rates will be

    cut urther. Ater all, the infation-adjusted interest rateremains airly high by global standards. A lower rate will

    help maintain a satisactory level o business investment.

    In addition, the rate o infation is expected to decline as

    the economy slows and, especially, as commodity prices

    stabilize. Thus, a looser monetary policy is likely to be

    benecial.

    The Brazilian economy will probably grow more slowly

    in the coming year than it did recently. The lagged eect

    o tight monetary policy and a high valued currency will

    take its toll on growth. Yet the new policy o lower rates,

    combined with a declining currency, will help boost invest-

    ment and exports. Foreign direct investment is likely to be

    strong given expectations about Brazils long-term uture.

    The big uncertainty concerns the impact o the global

    economy on Brazil. A severe recession in Europe emanating

    rom a partial collapse o the Eurozone would certainly

    have a negative impact on Brazil. Moreover, a global

    slowdown could have a signicantly negative impact on

    commodity prices, which in turn, would hurt Brazils export

    revenue.

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    Brazil

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    Mexico: Looking northby Pralad Burli

    MExICO

    At the turn o this century, Mexico was Latin Americas

    largest economy. Its prospects were akin to those o the

    BRIC nations. However, as the BRICs marched ahead,

    Mexico, it seems, lost its way. Despite being an upper-

    middle-income nation, Mexico continues to grapple with

    widespread income inequality and poverty. Between 2000

    and 2010, Brazils economy grew at an average rate o 3.7

    percent compared to Mexicos 2 percent. Today, Brazils

    economy is larger than Mexico and growing at a aster

    pace. While the outlook or China, India, and Russia ismuch more avorable, Mexico nds itsel caught in the

    crossre o violent drug cartels and the prospect o an

    economic slowdown or its major trading partner, the

    United States. Yet, Mexico has tremendous potential and i

    policymakers tackle the countrys challenges eectively, the

    economy could blossom once again.

    A bump in te road

    In Latin America, Mexico was among those hit hardest by

    the nancial crisis. Job losses, actory shutdowns, closed

    shops, and demand s lumps were the order o the day. As

    a result, the economy shrank by 6.1 percent in 2009. The

    economy bounced back rapidly thereater. GDP growth

    was up at 5.4 percent in 2010. Industrial production grew

    6 percent in 2010, reversing a majority o the decline seen

    during the previous year. The recovery was supported

    largely by consumer spending.

    The rst two quarters o 2011 have been avorable

    too. Economic activity picked up as domestic demand

    and exports experienced robust growth. Remittances,

    the second largest source o oreign currency, declined

    sharply since the onset o the recession, but they are once

    again on the rise. Despite a marked slowdown in the

    U.S. construction sector, an industry that employs many

    migrant workers, remittances between January and July

    2011 grew 4.2 percent over the same period last year.

    Furthermore, manuacturing and industrial production

    have maintained an upward trajectory. As a result, Mexico

    has been able to close the output gap quite signicantly.

    Despite staging a strong recovery, the economy still aces

    some challenges. The gloomy economic outlook or

    the United States does not augur well. In act, Mexicosgrowth orecasts have been lowered on dwindling growth

    prospects or the U.S. economy. Recent estimates peg

    Mexicos GDP growth rate between 3.5 and 4 percent in

    2011, slightly lower than previous orecasts. Furthermore,

    unemployment continues to play catch-up and is well

    above the pre-crisis level o under 4 percent. Mexicos

    unemployment rate rose throughout the second quarter

    o 2011. In July, unemployment reached 5.6 percent

    ater achieving a low o 4.6 percent earlier in March.

    Furthermore, in case the U.S. economy stalls, the grim

    unemployment situation in Mexico may worsen urther. In

    that scenario, Mexicos growth orecasts may be revised

    downward.

    Pusing or eport diversifcation

    Under the aegis o the North American Free Trade

    Agreement (NAFTA), the European Union Trade

    Agreement, and a slew o other bilateral arrangements,

    Mexicos nominal exports grew nearly 30 percent in 2010.

    The economy carried this momentum into 2011. During

    the rst two quarters o this year, nominal exports grew

    22.8 and 19.9 percent, respectively. Robust export sector

    growth will likely continue ollowing an agreement to

    allow Mexican trucks to make deliveries in America. The

    Pralhad Burli is a

    Senior Analyst at

    Deloitte Research, India

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    Global Economic Outlook 4th Quarter 2011

    agreement will likely result in substantial cost savings or

    companies and give Mexico another opportunity to make

    the most o its proximity to the United States.

    However, Mexicos dependence on demand rom the

    United States makes it vulnerable to an external shock.

    For an economy that relies heavily on the export sector,

    Mexico is poorly diversied. The United States alone

    absorbs nearly 80 percent o Mexicos exports. Less than 5

    percent o Mexicos exports go to the much-aster-growing

    BRIC nations. O late, Mexico has taken signicant strides

    to diversiy its economy. Mexico, along with Peru, Chile,and Columbia signed a trade agreement toward creating

    one o the largest trading blocs in the region. As a result,

    exports to other countries within the region and to Asia

    are growing rapidly.

    Meanwhile, higher wages in China, coupled with a rising

    yuan are avorable to Mexicos export sector. Moreover,

    the manuacturing sector contributes over 75 percent to

    Mexicos exports. Mexicos strong manuacturing base

    and rising wages in China may infuence U.S. companies

    to source manuactured goods rom Mexico. As a result,

    Mexico could potentially increase its market share in manu-

    acturing exports both to the United States and globally. Atthe same time, stronger manuacturing exports will likely

    stabilize export revenues because the economy will be less

    dependent on volatile oil and commodity prices. Exports o

    uel and mining products contribute around 16 percent to

    Mexicos total exports. However, a sharp decline in prices

    could potentially hurt Mexicos terms o trade.

    Wait and watc

    Unlike several countries in the region, infation in Mexico

    is relatively benign. Moreover, going orward, Mexicos

    growth rate is expected to be lower than other Latin

    American countries. As a result, the infation rate is likely to

    remain subdued. In 2011, infation is orecasted to hover

    within the 3.43.6 percent range, close to the ocial

    target o 3 (+/- 1) percent. Moreover, the central bank may

    need to shelve any plans o monetary tightening due to

    uncertainty in the U.S. economy. Thus, it is likely that the

    policy rate will be maintained at 4.5 percent until the end

    o 2011.

    An era o reorms

    Mexican consumers reel under the weight o monopo-

    lies in several sectors o the economy. From telecom to

    aviation, Mexicans are orced to pay high premiums on

    services or lack o adequate competition. Only two banks

    control more than hal o the market or deposit accounts.

    But all that is likely to change. Mexico seems to have

    begun what may become an era o anti-trust reorms. The

    government aspires to bring Mexicos anti-trust laws in

    line with best global practices. Furthermore, the political

    system is committed to ushering in reorms that allow rms

    a level playing eld. The Mexican Senate approved an anti-

    trust law to establish greater penalties and nes or rms

    engaging in monopolistic practices. The legislature and the

    judiciary have also played a part in ostering competition

    and transitioning toward reer markets.

    Such reorms could be potential game changers or

    Mexicos economy. One o the major beneciaries could

    be the petroleum industry, which until now, has been

    closed to oreign investment. Oil revenues contribute in

    excess o 50 percent o all government revenues. However,

    despite soaring oil prices, revenues have not kept pace.

    Inadequate investments in the petroleum industry over the

    past decade will likely hurt this sector in the uture. Output

    rom the oil sector has been declining. As a consequence,

    Brazil may soon become the leading oil producer among

    the Latin American nations. On the other hand, structural

    reorms that acilitate more investment, both domesticand oreign, may prop up Mexicos oil economy. While

    President Calderon has laid out a plan to raise additional

    capital or the state-owned oil manuacturer, it is unclear

    whether th


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