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Deloitte University Press Global Economic Outlook 1st Quarter 2014

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SEVERAL countries have passed significant hurdles lately. In China, the government finally announced long-awaited reforms that are intended to change the structure of the Chinese economy and allow growth to continue at a rapid pace. In the United States, a severe crisis was averted, but a government shutdown did have a negative impact on economic activity. In Japan, inflation has returned, and there continue to be signs that Abenomics is having a positive impact. The Eurozone has exited from a long and deep recession. Finally, a number of major emerging markets have quickly gone from an environment of optimism about future growth to one of uncertainty. Clearly, the world is once again at a turning point, and it is the job of economists to figure out which direction things are moving. In this issue of the Global Economic Outlook, Deloitte examines the state of the global economy as 2014 begins.
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    Global

    EconomicOutlook 1st Quarter 2014

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    Contents

    1st Quarter 2014

    China: Stepping into the unknown | 6By Dr. Ira Kalish

    Chinas government recently announced ambitious plans that could make the Chinese economy moremarket driven, consumer driven, transparent, and prone to profitable investing. Implementation remainsa significant challenge, but it is crucial to rectiying the countrys currently unbalanced system.

    United States: Breaking the holiday traditionringing in the New Year withless fiscal stress | 12By Dr. Patricia Buckley

    Te United States celebrated the New Year with economic pain rather than champagne as it coped, onceagain, with the fiscal crisis that never was. However, undamentals remain strong, and growth enginesshould begin to pick up steam by the second hal o 2014.

    Eurozone: Three areas to watch in 2014 | 20By Alexander Brsch

    Tree interrelated actors are critical to the Eurozones growth perormance in 2014 and beyond: acceler-ating business investments, stabilizing credit conditions, and decreasing uncertainty.

    Japan: Inflation returns | 26By Dr. Ira Kalish

    With inflation accelerating consumer spending and a declining yen boosting exports, Abenomics seemsto be working. However, uncertainties about an anticipated tax increase and the degree to which thegovernment will engage in deregulation continue to cloud the countrys growth projections.

    India: Can India overcome adversities and bounce back? | 30By Dr. Rumki Majumdar

    Despite a period o slow growth, high inflation, fiscal deficits, external imbalances, political uncertainty,and poor business confidence, India has an opportunity to restore growth by implementing policies thatmake better use o its considerable assets.

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    644430206

    Russia: No quick fix | 38By Akrur Barua

    Subdued investment, weak export markets, rising household debt, declining confidence, and deteriorat-ing demographics continue to weigh on Russias economy.

    United Kingdom: Gaining momentum | 44By Ian Stewart

    Britain is expected to have the astest growing economy in Europe in 2014, but growth remains histori-cally modest. Te United Kingdom will need a strong rebound in capital spending and in consumerincomes to maintain its improving prospects.

    Brazil: Festive season blues | 48By Navya Kumar

    Deteriorating fiscal balances, an increasing external deficit, high inflation, poor business investment, andcurrency troubles continue to hamper Brazils economy.

    Special topics

    The boom and beyond: Managing commodity price cycles | 52By Navya Kumar and Akrur Barua

    Te end o the commodity price boom is leaving many countries scrambling or ways to diversiytheir economies accordingly.

    Are emerging markets losing their brand appeal? | 64By Dr. Rumki Majumdar

    Many emerging markets aced financial volatility in the wake o the US Federal Reserves discussion

    about tapering. Countries with poor undamentals and weak policies have been hardest hit duringthis period o uncertainty, and sustaining growth will require a renewed ocus on undamentals.

    Economic indices | 74GDP growth rates, inflation rates, major currencies versus the US dollar, yield curves, composite median

    GDP orecasts, composite median currency orecasts, OECD composite leading indicators

    Additional resources | 78

    Contact information | 79

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    Dr. Ira Kalish is chief globaleconomist, Deloitte ToucheTohmatsu Limited

    PREFACE

    Global Economic Outlook1st Quarter 2014

    SEVERAL countries have passed significant hurdles lately. In China, the government finally announcedlong-awaited reorms that are intended to change the structure o the Chinese economy and allowgrowth to continue at a rapid pace. In the United States, a severe crisis was averted, but a government

    shutdown did have a negative impact on economic activity. In Japan, inflation has returned, and there

    continue to be signs that Abenomics is having a positive impact. Te Eurozone has exited rom a long

    and deep recession. Finally, a number o major emerging markets have quickly gone rom an environ-ment o optimism about uture growth to one o uncertainty. Clearly, the world is once again at a turning

    point, and it is the job o economists to figure out which direction things are moving. In this issue o the

    Global Economic Outlook, we examine the state o the global economy as 2014 begins.

    We start with China. I provide a discussion about the proposed reorms and the potential impact they

    could have on economic perormance and structure. I note that there remains uncertainty as to when

    or how these reorms will be implemented, or whether the government will generate sufficient internal

    support to make these reorms happen. Still, I conclude that China could become more market driven,

    more consumer driven, more transparent, and more prone to invest in projects with a positive return.

    Next, we turn to the United States. Patricia Buckley writes about the crisis that never was, but the

    considerable impact that the government shutdown had. Moreover, Patricia notes the potential allout i

    other budget crises emerge. Patricia also notes that while unemployment is declining, underlying weak-ness persists in the job market, and it may influence decisions by the Federal Reserve.

    In our third article, Alexander Brsch notes that the Eurozone has come out o recession only to

    experience disappointing growth. He says that growing at this speed will not be enough to heal the

    wounds o the recession. Alexander goes on to discuss the three things needed to generate more robust

    growth: accelerating business investment, stabilized credit conditions, and less uncertainty.

    Next, I review Japans economic situation. With inflation finally returning, it appears that Abenomics

    is having the desired impact. Indeed, a lower yen has boosted exports, and consumer spending has

    accelerated. However, that spending may be due to an anticipated tax increase. In addition, uncertainties

    about the potential impact o that tax increase as well as the degree to which the government will engage

    in deregulation are weighing on the countrys growth projections.

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    In our fifh article, Rumki Majumdar examines the Indian economy. She

    notes that India has lately experienced a period o slow growth, high inflation,

    fiscal deficits, external imbalances, and poor business confidence. In addition,

    political uncertainty has only added to such woes. Despite these problems,

    Rumki suggests that India has considerable assets, including human capitaland a strong financial sector, which can be utilized to restore strong growth.

    She discusses policies that could effectively utilize these assets in the uture.

    Next, Akrur Barua discusses the disappointing growth o the Russian econ-

    omy. He points to subdued investment, weak export markets, rising house-

    hold debt, and declining confidence as contributors to the weak perormance.

    Government stimulus spending, however, might alleviate some o the slow-

    down. Going orward, Akrur notes several challenges to aster growth, includ-

    ing increased global competition in the energy market, declining availability o

    cheap hydrocarbons, weak investment, and deteriorating demographics.

    In our seventh article, Ian Stewart discusses the surprisingly robust recov-

    ery o the UK economy. Indeed, Britain is expected to have the astest growingeconomy in Europe in 2014. Nevertheless, Ian notes that celebration may not

    be warranted, considering that growth remains low by historic standards and

    is only now about to exceed the modest growth experienced in 2007. In his

    article, Ian explains the reasons behind the recovery and discusses what must

    happen or growth to be sustained.

    In our last geographic article, Navya Kumar examines the considerable

    weakness in the Brazilian economy. She notes the causes o the slowdown and

    suggests that the situation will not be turned around quickly. A combination

    o troubling actors is hurting Brazil, including deteriorating fiscal balances,

    an increasing external deficit, high inflation, poor business investment, and

    currency troubles.

    In our first topical article, Navya Kumar and Akrur Barua consider the

    plight o commodity-exporting countries that now ace a likely end to the

    commodity price boom o recent years. Tey discuss the experience o such

    countries, the causes or the reversal, and the implications or commodity-

    exporting countries. In addition, they offer some suggestions or how such

    countries might shif ocus and diversiy away rom commodity dependence.

    Finally, in our last article Rumki Majumdar asks i emerging markets

    are losing their brand appeal. She discusses the financial market volatility in

    emerging markets that ollowed the US Federal Reserves discussion about

    tapering. She then examines how countries responded to this period o uncer-tainty and why some countries have recovered more quickly than others. She

    suggests that countries with poor undamentals and weak policies have ared

    worse than others. Clearly, this has implications or the types o policies that

    emerging nations ought to ollow going orward.

    Dr. Ira KalishChie Global Economist o

    Deloitte ouch ohmatsu Limited

    Global Economic Outlook

    published quarterly by

    Deloitte Research

    Editor-in-chief

    Dr. Ira Kalish

    Managing editor

    Ryan Alvanos

    Contributors

    Dr. Patricia Buckley

    Dr. Alexander Brsch

    Ian Stewart

    Dr. Rumki Majumdar

    Akrur Barua

    Navya Kumar

    Editorial address

    350 South Grand Street

    Los Angeles, CA 90013

    Tel: +1 213 688 4765

    [email protected]

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    China: Stepping intothe unknownBy Dr. Ira Kalish

    CHINAS leaders have finally provided somedetails about the nature o the reorms theyintend to implement. Tey havent said when

    or how these reorms will take place, nor is it

    known to which degree Chinese leaders will

    generate the internal support necessary or the

    reorms. But what we do know is that the plans

    are ambitious and, i ully undertaken, couldlead to a very different Chinese economy. China

    could become more market driven, consumer

    driven, transparent, and prone to investing in

    projects with a positive return. Tis is all or the

    better. Te real question, however, is whether

    China can implement its plans in time to avoid

    the problems that might arise rom the currently

    unbalanced system.

    For now, Chinas economy is growing rela-

    tively slowly compared to the past. oo much

    o its growth is coming rom actors that

    contribute to imbalances and set the

    stage or uture problems, such as fixed

    asset investment, especially in construction.

    Conversely, not enough growth is coming rom

    actors that ought to be sustained in the long run,

    such as consumer spending. Additionally, the

    critical export sector is providing mixed signals.

    However, a recent purchasing managers indexsuggested a slowdown in exports.2

    Reform intentions

    Te reorm program proposed by the Chinese

    government is radical yet cautious. It proposes

    increased competition or state-owned enter-

    prises (SOEs), yet ails to propose privatization o

    SOEs. It proposes the protection o private prop-

    erty rights, yet ails to give up state ownership

    o land. It does much to decentralize economic

    CHINA

    Its about cutting power, its a self-imposedrevolution. It will be very painful and evenfeel like cutting ones wrist.

    Premier Li Keqiang speaking in March 2013 on what reform will entail1

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    power by empowering the private sector, yet it

    pulls more power into the hands o the central

    government, ofen at the expense o local and

    regional governments. As such, it is a mixed bag

    o reorms.

    Despite this ambiguity, it is clear what the

    government generally hopes to achieve. Te

    reorms, i implemented successully, should

    lead to aster economic growth, less financial

    risk to the economy, and a shif in growth away

    rom investment in fixed assets. In addition, the

    reorms tackle a variety o social issuespro-

    moting more income equality as well as a more

    powerul and less corrupt judiciary. Finally, the

    reorms are somewhat conservative in that they

    aim to stabilize the economy and society by

    engendering greater predictability. Tere should

    be more transparency o financial markets and

    SOE finances, more proessional management o

    SOEs, less reliance on the decisions o fickle local

    officials, and more reliance on market orces to

    determine the allocation o resources.

    As to the potential impact o the reorms, this

    depends on how ast and the degree to which

    they are implemented. Many reorms will only

    bear ruit over a relatively long period o time.

    Reorm o the financial system, on the other

    hand, might have more immediate implications

    or the unctioning o financial markets. Given

    the problems in the banking system that have

    already been discussed in past editions o this

    publication, the aster China improves the effi-

    ciency o its financial services industry, the better.

    CHINA

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    Reform details

    Here are some details released by

    the government:

    China will change the governments relation-

    ship with SOEs. Going orward, SOEs will be

    required to return 30 percent o their profitsto the government. Currently, they return

    between 0 and 15 percent. Te added income

    to the government will be used to und

    improvements in public services. Moreover,

    some state-owned capital will be transerred

    to state-run pension plans. All o this is

    meant to partially address the issue o income

    inequality. In addition, China will allow pri-

    vate investors to take equity stakes in projects

    unded by SOEs. Tis will create more o a

    mixed economy, one not as dominated by

    SOEs. However, the government did not dis-

    cuss urther privatization o SOEsalthough

    this could come later.

    Meanwhile, the government said that it wants

    to introduce more competition to break up

    the monopolist practices o SOEs. Some SOEs

    will be broken up in order to create competi-

    tion. Others that are natural monopolies will

    be more closely monitored by the govern-

    ment, with government responsibilitiesseparated rom commercial responsibilities.

    In addition, the government will encourage

    hiring o proessional managers rom outside

    SOEs to run these enterprises, rather than

    relying on Communist Party officials. Te

    idea is to engender proessional manage-

    ment. Finally, the government pledged to

    strengthen SOEs' investment accountability

    and explore ways to publicize important

    inormation.

    Te government will try to promote a more

    competitive market with market-determined

    prices. Specifically, the government said that

    any price that can be affected by the market

    must be lef to the market. Areas in which

    the government sets prices will be confined

    to public utilities, public service, and areas

    that are naturally monopolized. In addition,the government pledged to erase regional

    protection, illegitimate avorable policies,

    and monopoly. It will perect the market

    exit mechanism to promote the survival o

    the fittest.3In other words, businesses will be

    permitted to ail. It is not clear i this includes

    state-owned businesses.

    China will allow private investors to estab-

    lish commercial banks in competition withstate-run banks. In addition, the government

    will build a deposit insurance system and

    complete the market-based exit system or

    financial institutions.4Tese actions could

    potentially create a more competitive market

    or bank deposits and commercial lending.

    Deposit insurance will set the stage or easing

    control o deposit interest rates and allow

    banks to ail or shrink without substantial

    risk to depositors. Still, more financial market

    reorms will be needed to curtail the risksassociated with the financial system.

    China will promote the protection o private

    property. It said that armers will be given

    more property rights and that they should

    have the right o succession. Moreover, a

    rural property rights trading market will be

    established. Tis means that armers will be

    able to bequeath or sell their land rights. As

    such, they will have an incentive to invest in

    boosting arm productivity. Te results should

    Te reorms, i implemented successully, should lead to

    aster economic growth, less financial risk to the economy,

    and a shif in growth away rom investment in fixed assets.

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    CHINA

    be higher ood production, lower ood prices,

    greater arm productivity, more rural-urban

    migration, and less income inequality. Beyond

    the rights o armers, the government said

    the property rights o the public economyare inviolable, as are the property rights o

    the non-public economy. Te government

    protects the property rights and legitimate

    interests o all kinds o ownership by ensur-

    ing that various ownerships have equal access

    to production actors, open and air market

    competition, and the same legal protection

    and supervision.5Tus, while there is no talk

    about urther privatization o state-owned

    assets, there is implicit recognition that

    the rights o private property owners mustbe protected.

    China will relax the system o residency

    permits known as the hukousystem. Rural

    residents will be ree to migrate to small

    and medium-sized towns and have access to

    public services in such towns (unlike the cur-

    rent situation in which migrants are treated

    as second-class citizens without access to ser-

    vices). However, restrictions on migration to

    megacities will remain. Evidently, the leader-

    ship wants to encourage rural-urban migra-

    tion, but not to the biggest cities. Tis means

    that labor shortages in big cities may persist.

    In addition, by providing public services to

    migrants in other cities, the government is

    implicitly pledging to boost spending on

    such services. As discussed earlier, taxing

    the profits o SOEs will be intended to und

    such services.

    Te government pledged to establish a

    special court to handle disputes concerning

    intellectual property. While it is too early to

    know how serious this pledge is, it suggests

    a desire to deal with this estering issue. Te

    statement specifically alluded to an intention

    to stimulate innovation. Without protec-

    tion o intellectual property, innovation will

    clearly stagnate.

    Te government will change the one-childpolicy. Currently, i neither spouse in a mar-

    ried couple has siblings, the couple is per-

    mitted to have more than one child. Going

    orward, they will be permitted more than

    one child i only one parent is an only child.

    Tis is clearly aimed at correcting the labor

    shortage that the old policy created. However,

    it will take another generation to have a

    real impact.

    Te government will address problems in

    the health care system. Specifically, it will

    encourage private investment in the medi-

    cal sector and prioritize supporting nonprofit

    hospitals run by private investors.6

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    Currency reform

    One o the notable areas or reorm not

    covered in the governments statement relates

    to the currency. However, the government hasseparately addressed this issue in recent weeks.

    Indeed, Chinas government continues to set

    the stage or eventual flotation o the currency.

    For years, the central bank has purchased

    oreign currency reserves in order to suppress

    the value o the renminbi, thereby maintain-

    ing the competitiveness o Chinese exports. Te

    deputy governor o the Peoples Bank o China

    (PBOC) recently said that it is no longer in

    Chinas avor to accumulate oreign-exchange

    reserves. He said, We will increase the role o

    market exchange rates, and the central bank willbasically exit rom normal oreign-exchange

    market intervention.7He also said that apprecia-

    tion o the currency would benefit more people

    than it hurts. He is right. Afer years o currency

    market intervention, China has accumulated

    $3.6 trillion in reserves. One way to look at

    this is to say that China has sold $3.6 trillion in

    I China stops intervening, the currency will rise

    in value, boosting consumer spending, suppressing

    inflation, and helping China shif toward a

    consumer-driven economy.

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    CHINA

    Endnotes

    1. Emma Rowley, Chinas new premier Li Keqiang to cut state control over economy, elegraph, March 17,2013, http://www.telegraph.co.uk/finance/china-business/9936059/Chinas-new-premier-Li-Keqiang-to-cut-state-control-over-economy.html.

    2. Markit Economics, press releases, http://www.markiteconomics.com/Public/Page.mvc/PressReleases,accessed December 17, 2013.

    3. Te decision on major issues concerning comprehensively deepening reorms in brie, China Daily,November 16, 2013, http://www.china.org.cn/china/third_plenary_session/2013-11/16/content_30620736.htm.

    4. Ibid.5. Ibid.6. Ibid.7. Ibid.

    8. James Regan, PBOC will basically end normal yuan intervention, Bloomberg News, November 19, 2013,http://www.bloomberg.com/news/2013-11-19/pboc-will-basically-exit-normal-yuan-intervention-zhou-

    says.html.

    apparel and electronics to US consumers in

    exchange or US government securities, the

    value o which is bound to decrease. While this

    has kept Chinese workers employed, it has hurt

    Chinese consumer purchasing power and causeda substantial distortion o the Chinese economy.

    Te act that the government is now willing to

    address this issue is good news.

    I China stops intervening, the currency will

    rise in value, boosting consumer spending, sup-

    pressing inflation, and helping China shif toward

    a consumer-driven economy. For the rest o the

    world, a higher-valued renminbi means that

    exports to China will be more competitive. Still,

    the PBOC gave no indication about the timing

    o a shif in policy. Meanwhile, it is likely thatspeculative capital will flow into China in antici-

    pation o this policy shif. Until the new policy

    is implemented, this could mean even more

    currency intervention will have to take place to

    avoid currency appreciation.

    All o this is highly significant because it

    moves China closer to its ultimate goal o mak-

    ing the renminbi a convertible currency thatis widely traded and used as a global asset. Yet

    exchange rate flexibility is only one part o this

    move. Te deputy governor o the central bank

    also said that the bank will no longer restrict the

    volume o oreign investment.8It will also gradu-

    ally end caps on deposit interest rates. Te latter

    would be the most significant action because it

    would go a long way toward fixing what is wrong

    with the banking system. However, no time

    rame was given or the latter reorm, and so a

    degree o uncertainty remains. Still, it is clear thatthe leadership intends to move the country in a

    ar more market-oriented direction.

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    United States: Breakingthe holiday traditionringing in the New Yearwith less fiscal stressBy Dr. Patricia Buckley

    Dr. Patricia Buckley isdirector of Economic Policy andAnalysis at Deloitte Research,Deloitte Services LP

    2013 began with a last-minute deal to mitigate some o the impact o the fiscal cliff and concluded with a budget deal that sets overall spending levels or the remain-der o fiscal year 2014 and all o fiscal year 2015. Tis is significant; these cliff hangers

    have been costly to the US economy. Beyond the direct impacts resulting rom what has

    evolved into an austerity agenda, these crises and near-crises have damaged consumer

    and business confidence, thereby serving as a urther constraint on growth. However,

    ambiguity as to what path the Fed will ollow as it scales back on its current course o

    monetary easing still remains.

    USA

    Te United States has narrowly avoided

    beginning the New Year with another

    budgetary stalemate, setting the stage or

    almost two years o relative budget calm.

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    From fiscal cliff to governmentshutdown and beyond:Tracking the course

    Te United States came perilously close to

    deault in the summer o 2011 and only avoided

    this unprecedented event when the president

    and Congress agreed to the Budget Control Act

    (BCA) o 2011. Tis act provided an increase in

    the debt ceiling in exchange or caps on ederal

    spending or the next 10 years, to be enorced by

    the threat o sequestrationacross-the-board

    cuts in most discretionary programs. Since

    Congress ailed to pass a spending bill that met

    the BCAs criteria by January 15, 2012, sequestra-

    tion was set to begin on January 2, 2013.1

    A broadseries o tax cuts were also scheduled to expire

    at the start o 2013, including the Bush income

    tax cuts, the 2 percent payroll tax holiday, capital

    gains tax, the estate tax, and the R&D tax credit.

    Adding to the uncertainty was the act that the

    country was, once again, bumping up against the

    debt ceiling.

    Te resolution o the fiscal cliff on January

    1, 2013 was a modest deal that allowed only a

    small number o the scheduled tax expirations to

    occur (the income tax on high earners and thepayroll tax holiday) and delayed the sequesters

    deep spending cuts or two months in hopes that

    a budget could be developed that honored the

    BCAs spending caps without making the across-

    the-board cuts. Tat effort was unsuccessul, so

    ederal agencies had to reduce spending or the

    remainder o fiscal year 2013. According to the

    White House Office o Management and Budget,

    the effective reductions were approximately 13

    percent or nonexempt deense spending and 9

    percent or nonexempt nondeense spending.2

    In February 2013, Congress suspended the

    debt ceiling until mid-May. As a result o some

    very large repayments to the reasury rom the

    government-sponsored housing agencies (Fannie

    Mae and Freddie Mac) and by using extraordi-

    nary measures to move unds between govern-

    ment accounts, the reasury was able to keep

    the debt below the ceiling until mid-October.

    Meanwhile, Congress did not produce a budget

    to und fiscal year 2014, and the ederal govern-ment went into a partial shutdown on October 1.3

    Afer a 16-day shutdown and with a govern-

    ment deault looming, Congress passed another

    temporary fix, unding the ederal government

    through January 15. In a rare but welcome move,

    a bipartisan budget plan was passed in advance

    o that deadline, providing a spending ramework

    through September 2015. However, the debt ceil-

    ing, which has been suspended through February

    7, was not addressed, and it remains a source o

    uncertainty on the horizon.

    UNITED STATES

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    According to the

    Congressional Budget

    Office (CBO), these

    fiscal impasses and their

    ongoing, partial resolu-tions have negatively

    impacted the US econ-

    omy. CBO estimates

    that economic growth

    in fiscal year 2013 (Q4

    o calendar year 2012

    to Q4 o calendar year

    2013) would be roughly

    1.5 percent higher, i not

    or the fiscal tightening

    required by the BCA.4More recently, the CBO

    estimated that, i the

    spending limits mandated by the BCA had been

    eliminated starting August 1, 2013, real GDP

    would be 0.7 percent higher, and employment

    would increase by 900,000 in Q3 o calendar year

    2014 (the end o fiscal year 2014) relative to the

    levels projected under current law.5

    Impact on confidence

    However, it is not only the actual resolutions

    that become law that are negatively affecting the

    US economy. It is the process through whichthese results are achieved. Both the brinksman-

    ship over the debt ceiling in 2011 and 2013 and

    the government shutdown in October 2013

    affected consumer and business confidence. As

    the country approached deault during the sum-

    mer o 2011, consumer confidence ell sharply,

    and it took months to recover. With the govern-

    ment shutdown and another threat o imminent

    deault, consumer confidence again dropped

    abruptly this past October, with a urther decline

    in November.Business confidence also was adversely

    impacted (see figure 1). Deloittes quarterly

    survey o chie financial officers o major North

    American companies illustrates how execu-

    tives perceptions o their businesses outlook are

    affected by actions in Washington.6Clear dips

    occurred at the debt ceiling showdown in 2011,

    the fiscal cliff debate at the end o 2012, and

    Tese fiscal

    impasses

    and theirongoing, partial

    resolutions

    have negatively

    impacted the

    US economy.

    Source: CFO Signals, What North Americas top finance executives are thinkingand doing, Q3 2013, Deloitte.

    Graphic: Deloitte University Press | DUPress.com

    Figure 1. Own company optimism: CFO optimism relative to previous quarter

    S&P 500 price at surveyperiod midpoint

    More optimistic Less optimistic Net optimisim (% moreoptimistic minus % lessoptimistic)

    500

    700

    900

    1,100

    1,900

    1,300

    1,500

    1,700

    80%

    -40%

    -20%

    0%

    20%

    40%

    60%

    Q22010

    Q32010

    Q42010

    Q12011

    Q22011

    Q32011

    Q42011

    Q12012

    Q22012

    Q32012

    Q42012

    Q12013

    Q22013

    Q32013

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    the approach o the government shutdown in

    October 2013.7

    One maniestation o the damage these

    actions do to confidence is visible in the recent

    relationship between job openings and hires, as

    measured by the Bureau o Labor Statistics Job

    Openings and Labor urnover survey (see figure

    2). In recent months, the job opening rate has

    increased much more quickly than the rate o

    hiring. Tis implies that companies are seeing the

    need to increase employment and are thereore

    posting job openings and conducting interviews,

    but that uncertainty is making them reluctant to

    actually make job offers. Additionally, employeeuncertainty about other job prospects is keeping

    the quit rate low.8

    Implications for the outlook

    However, even with the uncertainty being

    generated by Washington, the US economys

    undamentals continue to improve. Growth

    accelerated during 2013 and averaged 2.6 percent

    through the third quarter (annualized basis),

    unemployment continues to all, and inflation

    remains in check. With the unemployment rate

    reaching 7 percent, the Fed decided to make a

    slight downward adjustment to its current pro-

    gram o quantitative easing.

    However, many aspects o employment point

    to a labor market that may be weaker than the

    top-line unemployment rate suggests. Tese

    include high numbers o people who have been

    unemployed or extended periods or are work-

    ing part-time because they cannot find ull-

    time work.

    Another actor that suggests that the labor

    market is sofer than apparent at first glance is the

    decline in the labor orce participation rate. Aferpeaking in 2000, the United States labor orce

    participation rate declined slowly, then stabilized

    between 2004 and the onset o the recession

    (December 2007). However, during the recession

    and through the current recovery, the labor orce

    participation rate has been declining at a airly

    rapid paceand it is now 5 percent lower

    than it was prior to the onset o the recession (see

    figure 3).9

    Te proportion o people in the economy who

    are working or looking or work can change over

    UNITED STATES

    Source: Bureau of Labor Statistics,Job openings and labor turnover survey, November 22, 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 2. Total private job openings, hires, and quits

    Seasonally adjusted in thousands

    QuitsOpeningsHires

    Dec2000

    Jul2001

    Feb2002

    Sep2002

    Apr2003

    Jun2004

    Jan2005

    Aug2005

    Mar2006

    Oct2006

    May2007

    Dec2007

    Jul2008

    Feb2009

    Sep2009

    Arp2010

    Nov2010

    Jun2011

    Jan2012

    Aug2012

    Mar2013

    6,000

    0

    1,000

    2,000

    3,000

    4,000

    5,000

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    time or many reasons. For example, much o the

    growth in labor orce participation beginning

    in the mid-1960s reflected the large number o

    women entering the labor orce. Contributing to

    the current periods decline is a higher propor-

    tion o young people choosing to go to college

    and the retirement o the Baby Boomers. But

    these actors account or only part o the reduc-

    tion. Te decline in labor orce participation or

    those between the ages o 16 and 24, or instance,

    does reflect an increase in the collegiate popula-

    tion, both at the graduate and undergraduate

    levels (see figure 4). However, the decline in labor

    orce participation rates or this group halted in2010 and has been airly stable over the past three

    years. Meanwhile, the labor orce participation

    rate o those 55 and over actually continued to

    increase during the recession beore stabilizing

    at around 40 percent (see figure 5). With this

    groups average participation rate so much lower

    than that o the other age groups, the greater

    the proportion o people in this age group, the

    lower the overall labor market participation rate

    will be.

    While there are many explanations or the

    shifs in labor orce participation rates among

    1624-year-olds and those aged 55 and over

    ranging rom the benign or positive (e.g.,

    attending college or having sufficient resources

    to retire) to the negative (e.g., dropping out o

    the labor market because job prospects are very

    poor)the change in the labor orce participa-

    tion rate among 2554-year-olds is more likely to

    have been caused by poor labor market condi-

    tions (see figure 6). While certainly some in this

    group returned to school or retired, poor jobprospects seem to be a more likely explanation,

    given the magnitude o the shif.

    Te big question or policymakers at the

    Fed as they ponder urther reductions to their

    monthly purchases o bonds and mortgage back

    securities is, what proportion o those who lef

    the labor orce in recent years will decide to

    reenter the market and look or a job when they

    Source: Bureau of Labor Statistics, Current Population Survey, 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 3. Labor force participation rate

    Ages 16 and above

    Jan2

    00

    0

    Jul200

    0

    Jan2

    00

    2

    Jul200

    2

    Jan2

    00

    1

    Jul200

    1

    Jan2

    00

    3

    Jul200

    3

    Jan2

    00

    4

    Jul200

    4

    Jan2

    00

    6

    Jul200

    6

    Jan2

    00

    5

    Jul200

    5

    Jan2

    00

    7

    Jul200

    7

    Jan2

    00

    8

    Jul200

    8

    Jan2

    01

    0

    Jul201

    0

    Jan2

    00

    9

    Jul200

    9

    Jan2

    01

    1

    Jul201

    1

    Jan2

    01

    2

    Jul201

    2

    Jan2

    01

    3

    Jul201

    3

    68.0

    60.0

    61.0

    62.0

    63.0

    64.0

    65.0

    66.0

    67.0

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    UNITED STATES

    Source: Bureau of Labor Statistics, Current Population Survey, 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 4. Labor force participation rate

    Ages 1624

    Jan

    2000

    Jul2000

    Jan

    2002

    Jul2002

    Jan

    2001

    Jul2001

    Jan

    2003

    Jul2003

    Jan

    2004

    Jul2004

    Jan

    2006

    Jul2006

    Jan

    2005

    Jul2005

    Jan

    2007

    Jul2007

    Jan

    2008

    Jul2008

    Jan

    2010

    Jul2010

    Jan

    2009

    Jul2009

    Jan

    2011

    Jul2011

    Jan

    2012

    Jul2012

    Jan

    2013

    Jul2013

    68.0

    50.0

    52.0

    54.0

    56.0

    58.0

    60.0

    62.0

    64.0

    66.0

    Source: Bureau of Labor Statistics, Current Population Survey, 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 5. Labor force participation rate

    Ages 55 and over

    Jan

    2000

    Jul2000

    42.0

    30.0

    32.0

    34.0

    36.0

    38.0

    40.0

    Jan

    2002

    Jul2002

    Jan

    2001

    Jul2001

    Jan

    2003

    Jul2003

    Jan

    2004

    Jul2004

    Jan

    2006

    Jul2006

    Jan

    2005

    Jul2005

    Jan

    2007

    Jul2007

    Jan

    2008

    Jul2008

    Jan

    2010

    Jul2010

    Jan

    2009

    Jul2009

    Jan

    2011

    Jul2011

    Jan

    2012

    Jul2012

    Jan

    2013

    Jul2013

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    think that the market has sufficiently improved?

    Te actual size o the labor orce between the ages

    o 25 and 54 is 4.5 million below its prerecession

    peak, but the total population in this age group

    only decreased by 1.5 million over the sameperiod. Tis creates a pool o approximately 3

    million people that could move rom outside the

    labor orce into the ranks o either the employed

    or the unemployedwhich, in turn, could move

    a 7 percent unemployment rate upward very

    quickly. Tis analysis suggests that the Fed will

    move more slowly than some observers expect.

    But irrespective o the exact path that the

    tapering o the current round o quantitative eas-

    ing will take, the United States growth enginesshould begin to pick up steam during 2014. Near-

    term growth prospects improved since Congress

    and the Administration made a New Years reso-

    lution, o sorts, to provide or relative budgetary

    calmat least or the next two years.

    But irrespective o exactly when the current round o

    quantitative easing will start to taper off, the UnitedStates growth engines should begin to pick up steam

    during 2014.

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    UNITED STATES

    Endnotes

    1. Bill Heniff Jr., Elizabeth Rybicki, and Shannon M. Mahan, Te Budget Control Act o 2011, Congres-

    sional Research Service, August 19, 2011, http://www.as.org/sgp/crs/misc/R41965.pd.2. Karen Spar, Budget sequestration and selected program exemptions and special rules, Congressional

    Research Service, June 13, 2013, http://www.as.org/sgp/crs/misc/R42050.pd.

    3. Approximately one-third o the civilian ederal workorce (approximately 800,000 workers) was urloughedthe first week o the shutdown (uesday, October 1 through Friday, October 4). Workers deemed es-sential, defined as those who provide or the national security" or or the "saety o lie and property,"remained on the job. At the start o the second week o the shutdown, the Secretary o Deense declaredalmost all civilian Department o Deense employees to be essential. Tereore, as o Monday, October7, an additional 350,000 ederal workers were back on the job, reducing the total number o urloughedworkers to 450,000.

    4. Wendy Edelberg, Automatic reductions in government spendingaka sequestration, CongressionalBudget Office blog post, February 28, 2013, http://www.cbo.gov/publication/43961.

    5. Congressional Budget Office, letter to Congressman Christopher Van Hollen, Eliminating the automaticspending reductions specified by the Budget Control Act would affect the US economy in 2014, July 25,2013, http://www.cbo.gov/sites/deault/files/cbofiles/attachments/44445-SpendReductions_1.pd.

    6. CFO Signals, What North Americas top finance executives are thinkingand doing, Q3 2013, http://www.deloitte.com/assets/Dcom-UnitedStates/Local%20Assets/Documents/CFO_Center_F/us_CFO_Signals_3Q13_HighLevelReport_091913.pd, accessed December 17, 2013.

    7. Ibid.

    8. Bureau o Labor Statistics,Job openings and labor turnover survey, November 22, 2013.

    9. Bureau o Labor Statistics,Labor force statistics from the current population survey, United States Depart-ment o Labor, http://www.bls.gov/cps/, accessed December 17, 2013.

    Source: Bureau of Labor Statistics, Current Population Survey, 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 6. Labor force participation rate

    Ages 25-54

    Jan2

    000

    Jul2000

    85.0

    80.0

    80.5

    81.0

    81.5

    83.0

    84.0

    Jan2

    002

    Jul2002

    Jan2

    001

    Jul2001

    Jan2

    003

    Jul2003

    Jan2

    004

    Jul2004

    Jan2

    006

    Jul2006

    Jan2

    005

    Jul2005

    Jan2

    007

    Jul2007

    Jan2

    008

    Jul2008

    Jan2

    010

    Jul2010

    Jan2

    009

    Jul2009

    Jan2

    011

    Jul2011

    Jan2

    012

    Jul2012

    Jan2

    013

    Jul2013

    84.5

    83.5

    82.0

    82.5

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    Eurozone: Three areasto watch in 2014By Alexander Brsch

    2013 was a year o transition or theEurozone. On the positive side, a seeminglyendless recession came to an end, and tepidgrowth set in. Moreover, the main early busi-

    ness cycle indicators have been showing a clear

    and intact upward trend since the middle o the

    year. On the negative side, the overall growth rate

    or 2013 was still negative (0.4 percent). Going

    orward, most orecasts or 2014 oresee a growth

    rate in the region o around 1 percent.

    Growing at this speed will not be enough

    to heal the wounds o the recession. Eurozone

    citizens are poorer than they were beore the

    financial crisis. Between 2008 and 2013, GDP

    per capita ell by 3.5 percent. By comparison,

    US GDP per capita rose by 1.2 percent over

    the same period. While some members o the

    larger European Union, especially Poland, could

    substantially increase their

    GDP per capita over the same

    period, o the Eurozone mem-bers only Slovakia experienced

    an increase o more than 5

    percent. Countries such as the

    Netherlands, Spain, and Italy

    saw their wealth decreasing between 5 and 9

    percent over the last five years.1

    Several well-known actors, such as ongoing

    deleveraging and fiscal

    consolidation, are still a

    drag on the recovery in

    the Eurozone. However,looking ahead, things

    could also play out more

    positively than projected.

    Te strength o recoveries is rarely accurately

    predicted. Te remainder o this article consid-

    ers what would need to happen or growth in the

    Eurozone to exceed expectations. Tree interre-

    lated actors are critical or the Eurozones growth

    perormance in 2014 and beyond: accelerating

    business investments, stabilizing credit condi-

    tions, and decreasing uncertainty.

    EUROZONEDr. Alexander Brsch ishead of research, DeloitteGermany

    Growing at this speed will not be enough toheal the wounds o the recession.

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    Business investments

    So ar, the Eurozone recovery has been almost

    exclusively export-based (see the second quarter

    edition o Global Economic Outlook).2Higher

    competitiveness in the tradables sector helped

    the crisis countries to substantially improve their

    current account balances. Te resulting higher

    independence rom oreign capital contributed

    considerably to the relative calm on the financial

    markets in 2013. At the same time, increasing

    exports drove growth in Northern European

    countries, but they resulted in heightened depen-

    dency on emerging markets.

    A prooundly low rate o business investments

    has the biggest potential or positive surprises.

    Compared to the pre-crisis year 2007, invest-

    ments as a share o GDP ell rom 21.8 percent

    to 17.2 percent in 2013. Behind that decrease are

    actors like declining construction investments

    in countries such as Spain, which have experi-

    enced a real estate bubble. However, investment

    in equipment, which is decisive or economic

    growth potential and productivity, continues to

    all in the Eurozone (see figure 1).

    Weak investment rates are not limited to the

    crisis countries. Despite a period o economic

    strength, Germanys investment rate, overall

    and in equipment, has been much lower than

    the Eurozone average over the last decade. For

    the most part, Germanys substantial savings

    have been invested abroad rather than domesti-

    cally. Given the ongoing investment weakness in

    Germany, there is the danger that the low interest

    rates, currently at 0.25 percent afer the latest

    interest rate decrease in November, are mainly

    EUROZONE

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    used to finance construction investments, thereby

    possibly eeding a new real estate bubble.

    However, there are signs that investment

    weakness in Germany could be coming to

    an end, which would considerably help theEurozone recovery as a whole. Te investment

    plans o German CFOs or 2014 reached clearly

    positive territory and are accelerating or the

    first time, according to the Deloitte CFO Survey

    taken at the end o the third quarter (see figure

    2). Te results, reveal that investment propensity

    doubled and CFOs plan to use their high capital

    reserves to und investment at home and abroad.3

    Te crisis countries are also at a critical juncture

    in terms o investments. Higher competitive-

    ness in their tradable sectors could increase their

    exports and improve their current accounts. In

    a second step, improved export perormance

    should stimulate investments, which contributes

    to the upside potential o the Eurozone economy.

    Credit conditions

    Te ragility o the Eurozone banking

    system has significantly obstructed growth.

    Te Eurozone has been severely affected by thefinancial and banking crises because European

    corporates rely on credit to a much higher degree

    than, or example, US firms. Investment, there-

    ore, has been held back by difficult financing

    conditions in the crisis countries and the rag-

    mentation o European financial markets during

    the euro crisis.

    Te process o restructuring banks in the

    Eurozone and increasing systemic financial

    stability is ar rom

    finished. Te ragmenta-tion o bank unding

    markets continues,

    bank restructuring

    remains incomplete,

    and discussions about

    the orm o a banking

    union are ongoing. 2014 will see the European

    Central Bank assume responsibility or supervis-

    ing banks and reviewing asset quality. Te goal o

    the review is to increase transparency about bank

    balance sheets and repair them when needed.

    Nevertheless, while the Eurozones banking

    sector is still vulnerable and financial ragmenta-

    tion and differing financing conditions pose a

    very serious problem, several areas are improv-

    ing. Te European Central Bank notes positive

    developments in systemic banking sector stress

    as well as in banking unding challenges in

    stressed countries. Te indicator that measures

    systemic banking sector stress has been decreas-

    ing substantially. At the end o 2013, it reachedits lowest level since mid-2011, when the crisis

    intensified. Similarly, average bank unding

    costs reached their lowest level or more than

    three years, implying a normalization o bank

    unding conditions.4

    At the same time, credit conditions in the

    Eurozone as a whole are improving, thereby

    supporting higher investment activity. According

    to the Bank Lending Survey o the European

    Central Bank, banks expected an easing o credit

    standards on loans to enterprises in the ourthquarter or the first time since 2009.5In other

    Te process o restructuring banks in theEurozone and increasing systemic financial

    stability is ar rom finished.

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    EUROZONE

    Source: EU Commission, Euro area data for 2011 is not available.

    Graphic: Deloitte University Press | DUPress.com

    Figure 1. Investments in equipment as % of GDP

    Germany Spain Italy Euro areaFrance

    10%

    4%

    5%

    6%

    7%

    8%

    9%

    2003 20132004 2005 2006 2007 2008 2009 2010 2011 2012

    Source: Deloitte CFO Survey Germany.

    Gra hic: Deloitte Universit Press DUPress.com

    Figure 2. Investment propensity of German corporates Question: How will investments of your company change over the next 12 months

    Net balance of investment propensity (Percentage of CFOs who plan to increase investmentsminus the percentage of CFOs who plan to decrease investments

    20%

    -60%

    -50%

    -40%

    -30%

    -20%

    10%

    Q2 2012 Q4 2013

    0%

    -10%

    Q4 2012 Q2 2013

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    words, credit conditions and credit supply are

    stabilizing. Loan demand, on the other hand,

    is still weak. Nevertheless, i there is urther

    progress on both dimensions, systemic stability,

    and credit conditions, a stable basis or a strongerrecovery would be established.

    Uncertainty

    Te length and the depth o the Eurozone

    recession was, to a high degree, due to uncer-

    tainty regarding the uture shape o the Eurozone

    and the tail risks associated with it. Tis uncer-

    tainty affected consumers, corporates, and

    financial market participants alike, holding back

    consumption and investments and endangeringfinancial stability. It also reinorced the effects o

    credit constraints and weak balance sheets.

    Current developments suggest that uncer-

    tainty is on the decline. At the end o 2013, it

    is much lower than in the beginning. In the

    financial markets, the spreads o the Eurozones

    crisis countries vis-a-vis German bunds havenarrowed substantially since the beginning o the

    year. For example, the spread o Spanish 10-year

    bonds over German bunds shrank by around

    30 percent.

    Te same mechanism is visible in the real

    economy. Te degree o uncertainty that German

    CFOs see themselves exposed to decreased in a

    remarkable way. Between late 2012 and late 2013,

    those who elt that uncertainty in the economic

    and financial environment was high or very high

    ell to 18 percent rom 49 percent. Compared toearly 2012, the decrease is even more dramatic

    (see figure 3).

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    EUROZONE

    Endnotes

    1. Economic growth in the European Union, Lisbon Council 2013, http://www.lisboncouncil.net/publication/

    publication/100-economic-growth-in-the-european-union.html.

    2. Alexander Brsch, Eurozone: A silver lining on the growth horizon, Global Economic Outlook, April 15,2013, accessed December 16, 2013, http://dupress.com/articles/ eurozone-a-silver-lining-on-the-growth-horizon, accessed December 16, 2013.

    3. CFO Survey 2/2013, Unternehmen erhhen die Schlagzahl, Deloitte, http://www.deloitte.com/assets/Dcom-Germany/Local%20Assets/Documents/18_Growth%20Platorms/CFO-Services/CFO_2-2013.pd.

    4. European Central Bank, Financial Stability Review, November 2013.

    5. European Central Bank, Te Euro Area Bank Lending Survey, 3rd quarter, October 2013.

    Source: Deloitte CFO Survey Germany.

    Graphic: Deloitte University Press | DUPress.com

    Figure 3. Level of uncertainty Question: How do you rate the level of uncertainty in the financial and economic environment?

    NormalLow Very HighIncreased High

    100%

    0%

    10%

    30%

    40%

    50%

    90%

    H1 2012 H2 2013

    70%

    60%

    H2 2012 H1 2013

    80%

    3%

    17%

    0%

    73%

    6%

    2%

    7%

    43%

    43%

    6% 1%

    31%

    55%

    0%

    12%

    1%

    17%

    61%

    0%

    21%

    I this trend continues, reduced macro

    uncertainty and greater stability could help the

    Eurozones growth in 2014. By releasing catch-up

    and pent-up growth dynamics, it could lif the

    Eurozones growth above current orecasts.Investments, credit conditions, and uncer-

    tainty are closely interrelated. Tis opens up the

    possibility o positive eedback loops among

    them. For example, i political uncertainty

    urther decreases and credit conditions improve,

    a rise in investments is set to ollow. For growth

    in the Eurozone to exceed expectations in 2014,urther positive changes in each o these three

    areas would be valuable signposts.

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    Japan: Inflation returnsBy Dr. Ira Kalish

    AFTER growing at a rate o about 4 percentin the first hal o the year, the Japaneseeconomy grew at an annualized rate o 1.9

    percent in the third quarter. Surprisingly, there

    was a decline in exports and very weak growth in

    consumer spend-

    ing. Business

    investment slowed

    down as well. On

    the other hand,residential invest-

    ment significantly

    accelerated. Most

    o the economys

    growth could

    be attributed to

    inventory accu-

    mulationnot a

    sustainable way to

    grow in the longer

    run. On the posi-

    tive side, this was

    the ourth consecu-

    tive quarter o posi-

    tive GDP growth,

    the first time this has happened in three years.

    Looking toward the ourth quarter, there

    are some indications o improvement. For

    example, inflation has evidently returned to

    Japan. Excluding volatile energy and ood prices,

    the consumer price index was up 0.3 percent in

    October rom a year ago. Tis was

    the first time since October 2008

    that this indicator had risen year

    over year. Moreover, it was the

    astest rate o increase since 1998.

    When energy prices are included,

    the CPI was up 0.9 percent rom a

    year ago. Tis was the highest rate

    o inflation in five years. Clearly,

    the new central bank policy ounlimited asset purchases is hav-

    ing the desired effect. Te drop in

    the yen is boosting import prices,

    especially o energy products. Tat,

    in turn, is eeding through to other

    prices in the economy.

    Japanese consumers are also

    responding to the new economic

    policy. In October, household

    spending, adjusted or inflation,

    was up 0.9 percent rom a year

    earlier. Tere was a sizable increase

    in spending on homes, home-

    related products, and automo-

    biles. It is likely that some o this

    increased spending was in anticipa-

    tion o the sales tax increase that

    will take place in April. As such,

    it is not necessarily indicative o

    an underlying improvement in

    consumer spending. In act, there

    JAPAN

    Most o the

    economys growthcould be attributed

    to inventory

    accumulation

    not a sustainable

    way to grow in the

    longer run.

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    is reason to worry. Afer adjusting or inflation,

    household incomes continue to decline. Te

    average real income o wage earning households

    ell 1.3 percent rom a year ago. Tis reflects the

    act that, despite rising prices, businesses are notresponding with wage increases. I this trend

    persists, there could be negative implications or

    household spending. Moreover, a lack o wage

    inflation means that the positive inflation Japan is

    now experiencing could be ephemeral. Inflation

    cannot rely on a declining yen to be sustained.

    Tere needs to be wage pressure as well. Te

    government has pressured businesses to increase

    wages and has promised to enact legislation that

    will offer incentives or wage increases. It remains

    to be seen whether such efforts will bear ruit.

    One positive impact o the declining yen hasbeen an improvement in export perormance.

    Japanese exports grew in October at their ast-

    est pace in three years. Exports were up 18.6

    percent rom a year earlier, ar aster than the

    11.5 percent increase in September. As exports

    are generally priced in dollars, the increase in the

    yen value o exports was largely due to the impact

    o a weaker yen. However, even the volume o

    exports was up 4.4 percent rom a year earlier,

    suggesting that the declining yen is starting to

    have an impact on overseas demand. It meansthat exporters are offering oreigners lower

    prices in order to move goods. It also means

    that Abenomics is having the desired effect on

    trade. Te volume o exports to the United States

    increased 5.3 percent while the volume to Europe

    increased 8.0 percent. Volume to Asia, however,

    increased only 2.0 percent. Interestingly, despite

    the rapid rise in exports, imports grew even

    aster as Japan continued to import more uel to

    offset the shutdown o nuclear power plants. As

    such, the trade deficit expanded in October to

    a record level. Te main reason to worry about

    a trade deficit is that Japans government runs a

    large deficit and has a large stock o debt. Until

    now, this has mainly been unded domestically

    by tapping into Japans vast pool o savings. Yet a

    trade deficit will ultimately lead to net external

    borrowing. In other words, Japan will have to

    borrow rom oreigners to meet its obligations. I

    Japan must rely on borrowing rom abroad, this

    could lead to an increase in the cost o borrow-ing, thereby exacerbating the deficit.

    JAPAN

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    Deregulation

    Tere is growing concern that the third

    arrow o Abenomics (deregulation and reorm)

    will not be as aggressive or as urgent as manypeople hope. Indeed, the government has

    postponed details about many o the reorms

    that it intends to implement until June o 2014.

    Nonetheless, there are positive signs. Japans

    government said it will end subsidies or small

    rice armers by the end o the decade. Why is

    this important? Tere are two reasons. First, this

    action will lead to consolidation o rice arm-

    ing rom the current situation where 72 percent

    o rice arms are one hectare or less. Tis will

    boost productivity, expand production, reduce

    ood prices, and render a considerable amount o

    agricultural land useless. Tat, in turn, could lead

    to a reduction in land prices in urban areas. Tis

    is because land that previously was used or rice

    arming will be converted to other uses. Tere isa surprising amount o urban and suburban land

    currently used or rice arming. Second, the act

    that Japan announced such a significant reorm

    indicates a willingness to take on vested interests.

    Tis bodes well or urther important reorms as

    part o Abenomics. Nonetheless, the government

    did not announce any change to import tariffs

    on rice and other oods. Currently, there is a 778

    percent tariff on imported rice. Tis ensures that

    Japan will maintain a domestic rice industry.

    Te main reason to worry about a trade deficit is that

    Japans government runs a large deficit and has a large

    stock o debt.

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    JAPAN

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    India: Can Indiaovercome adversitiesand bounce back?By Dr. Rumki Majumdar

    FISCAL year 2013 has been tumultuous orIndia. For the first time in a decade, Indias

    economic growth ell below 5 percent, growing

    4.6 percent year over year in the first hal o

    FY 20132014 relative to

    last year.1Unortunately,

    growth is not Indias only

    challenge. Te economy

    is burdened with per-

    sistently high inflation,

    rising fiscal deficit, and

    excessive imbalance in its

    current account, expos-

    ing internal challenges

    that are affecting inves-

    tors confidence in the

    economys ability to grow. Political challenges are

    creating more conusion and skepticism, with

    India just a ew months away rom its general

    government election. Global economic uncer-

    tainties are aggravating Indias internal troubles:

    India was among the worst hit o the emergingeconomies whose currency, stock, and bond

    markets experienced extremevolatility this past summer due

    to the US Federal Reserves

    (Feds) tapering signal. Its cur-

    rency depreciated more than

    20 percent, while stock markets ell 10 percent

    during MaySeptember 2013 because o heavy

    capital outflows.

    Economic and political challenges rom all

    ronts are making it difficult or policy mak-

    ers to promote growth and ensure stability. Te

    question is, how prepared is the economy to ace

    its challenges head-on and bounce back? Will

    India be able to regain its lost position as one

    o the astest-growing nations? Indias ability

    to overcome its adversities lies in its inherent

    strengths and potential. India has gone through

    difficult times beore, which makes it resilient

    and better able to overcome economic chal-

    lenges. It is no surprise, then, that it is one o the

    ew major emerging economies to make a strong

    comeback afer the Fed announced that it wasdeerring tapering.2

    Dr. Rumki Majumdar is amacroeconomist and amanager at Deloitte Research,Deloitte Services LP

    INDIA

    Unortunately,

    growth is

    not Indiasonly challenge.

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    Economy muddledwith challenges

    Te growth in Q2 FY 20132014 improved

    slightly, to 4.8 percent, relative to the previous

    quarters low growth. Tis improvement was due

    to stronger growth in the agricultural and con-struction sectors, but domestic activities in most

    o the real sectors continue to underperorm, as

    seen in figure 1. Growth in the industrial sector

    remains sluggish due to poor growth in the man-

    uacturing, mining, and quarrying sectors, while

    growth in the services sector is also showing

    signs o weaknesses. Industrial sector growth has

    been hit by poor growth in consumer durables

    and basic goods, which account or 54 percent

    o Indias industrial products, while the capital

    goods sector has been highly volatile. Te onlyrelie is that a avorable monsoon has improved

    the scope or a good agricultural output, which

    will probably continue to boost the economys

    growth in the coming quarters as well. Real

    growth has been alling continually, and accord-

    ing to the IMF, which recently revised down its

    GDP orecast or India, the growth outlook is not

    very positive.

    According to the latest figures, wholesale price

    inflation (WPI) touched 7 percent in October,

    while consumer price inflation (CPI) continued

    to remain in double digits at 11.6 percent (see

    figure 2). Inflation is expected to rise urther, as

    suggested by a survey conducted by the Reserve

    Bank o India (RBI).3According to the survey,

    92.5 percent o respondents expect prices to

    increase in the next year.4Te meteoric rise o

    ood prices is the biggest reason or the rise in

    prices in India, which is likely to ease, owingto better agricultural output. Te RBIs newly

    INDIA

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    Source: Handbook of Statistics on Indian Economy, RBI, Ministry of Statistics and ProgrammeImplementation, and Deloitte Services LP economic analysis, December 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 1. Domestic activities slowing down

    GDP (RHS)Industrial production (LHS)

    15

    -15

    -5

    0

    5

    3.0

    3.5

    4.0

    4.5

    5.0

    5.5

    Jan 2012 Apr 2012 Oct 2012 Jul 2013 Oct 2013Jan 2013

    -10

    10

    Jul 2012 Apr 2013

    %, YoY %, YoY

    Source: Labour Bureau of India, Government of India, Deloitte Services LP economic analysis, December 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 2. Rising inflation is a worry

    WPICPI industrial worker

    14

    4

    6

    8

    10

    12

    Jan 2012 Apr 2012 Oct 2012 Jul 2013 Oct 2013Jan 2013Jul 2012 Apr 2013

    %, YoY

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    elected governor Raghuram Rajan has clearly

    signaled in the last ew monetary policy state-

    ments that he will ocus on price stability, which

    implies that policy rates are likely to remain high.

    Te industrial sector is already reeling rom thehigh cost o capital and low availability in a tight

    liquidity situation, and high rates will only hurt

    growth urther.

    Te rising fiscal and current account imbal-

    ances have been among the greatest macroeco-

    nomic worries or India (see figure 3). Indias

    fiscal gap widened sharply in the first six months

    o FY 20132014, and was estimated to be 76percent o the budget estimate and approximately

    8.3 percent o GDP in the first hal o FY 2013

    2014. Tis implies that the government has to

    spend less in the run-up to national elections or

    risk missing its stated aim o cutting the budget

    deficit to 4.8 percentwith the latter seeming

    more probable.

    Te current account deficit also widened in

    Q1 FY 20132014 relative to the previous quar-

    ter, and it remains close to its historically high

    levels. Te good news is that it is likely to ease,going by recent signs o correction in the trade

    account deficit (see figure 4). Policy measures by

    the RBI to curb gold imports and actors such as

    slowing domestic demand and lower oil prices

    due to reduced external risks have helped contain

    import bill growth. At the same time, exportshave grown aster in the first hal o the current

    fiscal year relative to FY 20122013 due to cur-

    rency depreciation and improved global demand.

    Remittance flows to India have surged as the

    countrys overseas population took advantage o

    the weaker domestic currency.

    Te high current account deficit is one o

    the biggest reasons or the increased vulner-ability in the capital outflow witnessed in recent

    months. Net portolio investment accounts or

    the majority o capital flow in the economy, o

    which 98 percent is oreign institutional invest-

    ment (see figure 5). Due to the inherent nature o

    institutional investments, capital flows in India

    are highly vulnerable to global liquidity and

    international investors sentiments. On the other

    hand, the proportion o direct capital invest-

    ment is a mere raction o GDP, which implies

    a very small proportion o the capital account is

    INDIA

    Source: RBI, Press Information Bureau, Government of India, Oxford Economics andDeloitte Services LP economic analysis, December 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 3. Twin deficits are a challenge

    Current account balanceFiscal balance

    0.0

    -12.0

    -10.0

    -8.0

    -6.0

    -4.0

    Sep 2008 Sep 2009 Sep 2010 Sep 2012 Sep 2013Sep 2011

    -2.0

    % of GDP

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    Source: RBI, Press Information Bureau, Government of India, Oxford Economics andDeloitte Services LP economic analysis, December 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 4. Trade deficit is narrowing

    Trade balance

    60

    -60

    -40

    -20

    20

    40

    Apr 2012 Oct 2012 Apr 2013 Oct 2013

    0

    %, YoY

    Source: RBI Bulletin, Press Information Bureau, Government of India, Bloomberg and DeloitteServices LP economic analysis, December 2013.

    Graphic: Deloitte University Press | DUPress.com

    Figure 5. High proportion of portfolio investment affecting currency stability

    Net FPI (LHS)Net FDI (LHS) Exchange rate (RHS)

    10

    -10

    -5

    0

    5

    45

    50

    55

    60

    65

    70

    Jan 2012 Apr 2012 Oct 2012 Jul 2013Jan 2013Jul 2012 Apr 2013

    USD billion INR/USD

    Dec

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    INDIA

    being invested in production and building long-

    term assets.

    Te recent capital outflow resulted in a sharp

    depreciation in Indias currency22.5 percent

    this year. Te Indian rupee hit a record low onAugust 28, 2013, although it has recovered some

    o its lost ground since then. However, as long

    as the current account and proportion o oreign

    institutional investments in total capital flow

    are high, the currency will remain vulnerable to

    external shocks; any events similar to the Feds

    hint o tapering, or actual tapering by the Fed,

    can upset the currencys stability.

    Impact on sentiments

    Poor growth and economic challenges are

    affecting consumer and business sentiments.

    According to an RBI survey, consumer confi-

    dence diminished in September, with around 60

    percent o respondents expecting that economic

    conditions will worsen.5Te consumer confi-

    dence measured by the current situation index

    declined due to the worsening perception o

    household circumstances, income, spending, and

    employment (see figure 6). On the other hand,

    the industrial outlook or the overall business

    situation is at its lowest level since 2005 due to

    the pessimistic assessment o and expectations

    or exports, imports, and the overall financialsituation. Te Business Expectation Index ell

    below the threshold level o 100 to 97.3 or the

    first time since 2008, indicating that businesses

    are highly pessimistic about the economic out-

    look and investment prospects.6Rising interest

    rates and the perceived rise in external finance

    costs are impacting investment decisions, while

    the perception o profit margins continues to

    remain negative. All these actors have led topoor production and employment outlooks.

    Simple strategies withgreater benefits

    Tough overwhelming, these challenges

    must be fixed i India wants strong and stable

    growth. Some must be addressed immediately,

    while others require more ocused attention and

    structural intervention.

    Source: RBI survey and Deloitte Services LP economic analysis, December 2013.

    Figure 6. Consumer and business confidence fell but are expected to improve

    Business expectation indexCurrent situation index

    115

    85

    95

    105

    Mar 2012 Jun 2012 Sep 2012 Jun 2013 Sep 2013Dec 2012 Mar 2013 Dec 2013

    Index

    Expected

    Expected

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    The immediate tasks

    For the most part, resolving Indias slow-

    ing growth, high inflation, and widening fiscal

    and current account deficits requires immediate

    initiatives beyond the measures already taken.

    Tese include promptly removing bottlenecks

    to the existing inrastruc-

    ture and manuacturing

    investments, improving

    the allocation o subsi-

    dies, and curbing external

    deficits by improving

    export competitiveness

    and reducing imports.

    Measures should be takento curb gold imports by

    imposing restrictions

    and promoting alternate

    investment options among

    retail investors. In addi-

    tion, uel imports should

    be contained by removing

    subsidies on uel products

    and encouraging the use

    o alternate and environ-

    mentally riendly sourceso energy. Monetary and

    fiscal policies should be

    coordinated so that i mon-

    etary actions provide the

    first line o deense, they

    are ollowed by immediate

    and credible government

    action. Te government

    needs to communicate its

    policies effectively to con-

    tain the current account

    deficit and inflation, as

    well as ocus on quick implementation o reorms

    without watering down the reorm process.

    Strategies for the long run

    With the rising population and a growing

    market potential, improved inrastructure and

    connectivity are a must. While large inrastruc-

    ture projects are being undertaken currently, thequality and scale is not enough considering the

    size o the population. Despite reorms being

    introduced, Indias system o acquiring land and

    allocating natural resources remains suboptimal,

    and bureaucracy and corruption prevent new

    laws rom being unctional. While the govern-ment has recently created institutions to acceler-

    ate decision making and implement transparent

    processes, the effort in this direction has to be

    more assertive.

    One important concern is that a large propor-

    tion o Indias national income comes rom the

    inormation technology and sofware industry,

    while contributions rom the manuacturing and

    services sectors remain low. India cannot sustain

    growth i its growth model continues to ocus

    on only a ew sectors that employ a small part othe population. A majority o Indias population

    lives in rural areas and does not have access to

    basic health acilities and primary education. o

    ensure stable, sustainable, and equitable growth,

    the country needs to employ its growing popu-

    lation, which means that it has to develop its

    manuacturing and services sector to diversiy its

    growth model.

    One important solution lies in encouraging

    small-scale industries, which have been gen-

    erating employment and promoting balanced

    regional development. Indias industrial policy

    resolution has, rom time to time, encouraged

    the growth o small-scale industries. However,

    to oster growth, the country must now ocus on

    technologies that are flexible and can be adopted

    to different mass production processes, as well as

    improve productivity in manuacturing, agricul-

    ture, and agro-based industries.

    India can learn a great deal rom policies

    in other countries. For instance, Japan recentlyput in place a policy to end subsidies to some

    sections o armers, which is expected to help

    consolidate arming, boost productivity, expand

    production, and reduce ood prices.7Tis policy

    is likely to ree a considerable amount o unpro-

    ductive agricultural land or better alternate use,

    thus reducing land prices in urban areas, which is

    a big concern in India as well. At the same time,

    the government o Japan is also providing protec-

    tion to armers through import tariffs and other

    measures. India can benefit a great deal rom

    For the most

    part, resolving

    Indias slowing

    growth, highinflation, and

    widening fiscal

    and current

    account deficits

    requires

    immediate

    initiatives

    beyond the

    measures

    already taken.

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    implementing, with necessary adaptations, some

    eatures o Japans policy.

    Building on its strength

    A countrys most important resource is its

    people, and India has this resource in abundance.

    Indias young and diverse population, with a

    quickly growing middle-income group, pro-

    vides the economy with a big potential market,

    as well as productive resources to serve this

    market. I this population is tapped effectively,

    India has the ability to develop a sel-sustaining

    growth model and reduce its dependence on the

    global market. Te availability o quality edu-

    cation, labor reorms, and financial inclusioncan help the economy reap the advantages o a

    growing population.

    Indias healthy financial and banking sec-

    tor is its other strength. Tis sector has shown

    immense resilience in the ace o the global finan-

    cial crisis, and the RBI has played an important

    role in preserving financial stability through a

    unique combination o monetary policies and

    macro-prudential regulations. While the banking

    sector has experienced an increase in bad loans

    in recent years, it is not cause or concern yet.

    However, with rising global policy uncertainties

    and Indias strong linkage to the global finan-

    cial system, India should keep a close check on

    liquidity and the stability o the banking system.

    Appropriate measures such as increased competi-

    tion and supervision can improve banks effi-ciency and access to markets, as well as contain

    the contagion risk o any global financial crises.

    Indias finances are relatively stronger than its

    peers. Te countrys overall public debt to GDP

    has been declining since 2006 and is currently

    66 percent o GDP, o which only 46 percent is

    held by the central government. Moreover, the

    debt is denominated in rupees and has an average

    maturity o more than nine years. Indias external

    debt burden is also low, with only 5.2 percent o

    the debt being short term. Indias strong oreigncurrency reserve implies that its sovereign risk

    rating is stable, and the economy has the abil-

    ity to borrow without a significant rise in risk

    premium. However, India should improve its

    fiscal balance to improve investors perceptions o

    sovereign risks.

    Tere is no doubt that the Indian economy

    is challenged. However, i the economy can

    strengthen its inherent potency and plan effec-

    tively to close the gap between the potential and

    actual, India can get out o the trough and back

    on to its high-growth path.

    Endnotes

    1. Hereafer, all growth percentages mentioned in the article are measured as year over year unless otherwisespecified.

    2. Reer to Are emerging markets losing their brand appeal? in this edition o Global Economic Outlook.

    3. Reserve Bank o India, Inflation Expectations Survey o Households, round 3, September 2013, http://

    rbidocs.rbi.org.in/rdocs/Publications/PDFs/05IEHR281013.pd.

    4. Te RBIs Inflation Expectations Survey o Households or the JulySeptember 2013 quarter (33rd round)captures the inflation expectations o 4,960 urban households across 16 cities or both the ollowing threemonths as well as the ollowing year.

    5. Te consumer confidence survey is conducted by the RBI, and the business sentiment survey is conductedby Federation o Indian Chambers o Commerce and Industry. Both the surveys were last published inJune 2013; also see Reserve Bank o India, Industrial outlook survey: Q2: 20132014 (round 68), October28, 2013, http://rbidocs.rbi.org.in/rdocs/Publications/PDFs/03IOS281013.pd.

    6. An index below the threshold o 100 signifies contraction.

    7. Economist, Rice arming in Japan: Political staple, November 30, 2013, http://www.economist.com/news/finance-and-economics/21590947-government-abolishes-previously-sacrosanct-agricultural-subsidies-

    political.

    INDIA

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    Russia: No quick fixBy Akrur Barua

    RUSSIAS economy continues to ace short-and long-term challenges, so it was notsurprising when growth disappointed in the third


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