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Global Economic Outlook3rd Quarter 2016

Global Economic Outlook

CONTENTS

Introduction | 2By Ira KalishOur team of global economists offer their views on the United Kingdom, Eurozone, United States, China, Japan, Brazil, Mexico, South Africa, India, and the economic implications of oil price fluctua-tions.

United Kingdom: After Brexit, what lies ahead? | 6By Ian StewartAfter Brexit, the final shape of Britain’s economic and political relationship with the European Union and the rest of the world may take years to fully emerge. Right now, the most useful response would be for the UK government to signal the direction of its negotiations with the European Union.

Eurozone: Life after Brexit | 12By Alexander BörschWhile the Eurozone’s economic recovery has con-tinued and even gained momentum, the outlook is shaped by Brexit. Key among the questions now are how to structure the future relationship with the United Kingdom as well as how to manage political risks.

United States: Businesses take a (hopefully) temporary breather | 18By Patricia BuckleyWhat effect will the first-quarter contraction in business investment and slower employment growth have on the outlook for US economy? Going by recent trends, annual GDP growth may not slow down overall. However, unless business investment picks up, longer-term growth might be at risk.

China: The deceleration continues | 26By Ira KalishData related to industrial production, manufactur-ing, electricity output, and retail sales all indicate that the Chinese economy continues to decelerate. Growing debt is also a cause for concern. There are warnings that unless China takes up serious reforms, the expansion of debt could lead to a finan-cial crisis, low economic growth, or both.

Japan: Will households oblige by spending more? | 30By Akrur Barua Private consumption holds the key to growth at a time of slowing exports—so how can Japan’s poli-cymakers create incentives for consumers to spend? The Bank of Japan actually may already be doing that, by both lowering borrowing costs and reduc-ing the government’s debt burden.

Brazil: A glimmer of hope | 38By Akrur Barua Brazil’s new government, though temporary, has its task cut out. GDP contracted for the fifth straight quarter, fiscal deficit is in double digits, and infla-tion is way above target. However, the president has started on the right note by putting in place a credible economic team.


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Mexico: Embracing the advantage of its northern neighbor | 46By Daniel BachmanPreviously, Mexico attempted to keep its distance from the United States. Since the resolution of the 1980s’ debt crisis, however, Mexico has instead embraced the advantages of its large neighbor. There are signs that this strategy may be starting to pay off.

South Africa: In search of an economic foothold | 52By Lester GunnionSouth Africa’s economic challenges have intensified. The economy contracted in the first quarter of 2016; and weak growth, political unrest, and deteriorating fundamentals have resulted in the currency slipping and inflation climbing. Policymakers will likely face difficulty in navigating internal and external chal-lenges.

India: Slow and steady may not be enough to win the race | 62By Rumki MajumdarTwo years into the new Indian government, how has the economy fared? It has been a mixed bag so far: Much-needed reforms have been initiated, but their progress has been slow. Uncertainty in the tax environment, poor implementation of structural reforms, and the lack of an assertive stance to im-prove trade are among the problem areas.

The oil mighty: The economic impact of oil price fluctuations | 70By Rumki MajumdarWide fluctuations in oil prices have played an important role in driving recessions and even regimes collapsing—which is why oil price move-ments are closely watched by economists, investors, and policymakers. The two recent cycles of historic highs and lows suggest that the world economy is in unchartered territory.

Economic indices | 78

Additional resources | 81

About the authors | 82

Contact information | 83

Illustrations by Stephanie Dalton Cowan

CONTENTS

III


IntroductionBy Ira Kalish

IN the summer of 2016, suddenly, there are new uncertainties concerning the global economy, not the least of which is the British referendum

in which a majority voted to exit the European Union. This raises questions about the short- and long-term outlooks for Britain, the future of the Eurozone, and the future of globalization and eco-nomic integration. Other current issues of concern include surprisingly weak job numbers in the Unit-ed States in May, continued deflationary pressures in the Eurozone economy, and rising corporate debt in China. These issues are affecting the decisions of policymakers and, as a consequence, the outlook for the global economy. Other issues that had been top of mind only a few months ago seem to have disap-peared from the headlines: oil prices, the Chinese currency, emerging-market debt, and the recession in Russia.

In this issue of the Global Economic Outlook, we begin with Ian Stewart’s assessment of the poten-tial impact of the British referendum. Ian explains the various possible scenarios that might take place, noting that the uncertainty itself is likely to have a negative impact on the economy. He says that although Brexit will likely cause a slowdown in growth, he believes that the United Kingdom will be able to avoid a recession. Moreover, he points out that, aside from the impact of Brexit, the UK econo-my continues to retain many positive attributes that should serve it well. Finally, Ian looks at the poten-tial impact of Brexit on the rest of Europe.

Next, Alexander Börsch looks at the Eurozone. He notes that economic growth has accelerated recent-ly, with real GDP up 0.6 percent in the first quarter. Yet he worries that a British exit from the European Union could have a negative impact on the Euro-zone countries, especially those with sizable trading relations with the United Kingdom such as Ireland, the Netherlands, and Belgium. Alexander also dis-cusses the impact of Brexit on business sentiment, noting that a recent survey found that German busi-ness managers are worried that Brexit could lead to other country exits and a weakening of the Euro-pean Union.

In our article on the US economy, Patricia Buck-ley says that, although she continues to believe the United States will have moderate growth in 2016,

“downside risk has definitely increased.” While she is not spooked by the slow growth in the first quar-ter, Patricia is especially concerned that business investment has now declined for two consecutive quarters, the first time this has happened since 2009. She also notes that the drop in investment was accompanied by a slowdown in job growth. While she expects the economy to have rebounded in the second quarter and that the job slowdown might be temporary, she says that a further drop in investment could put longer-term growth at risk.

In my article on China’s economy, I discuss the lat-est data indicating that the economy continues to decelerate, led by weaker exports and weaker in-

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vestment. I also examine the growing debate about the consequences of China’s big increase in private sector debt, especially corporate debt. I note the cri-tique of China’s policy response posed by the Inter-national Monetary Fund and others, as well as the Chinese government’s reaction to its critics. I con-clude that the debt situation poses a risk to future economic growth, especially if China doesn’t allow weak businesses to fail or restructure.

In his article on the Japanese economy, Akrur Ba-rua offers an interesting view on the relationship between monetary policy and the large amount of debt issued by the central government. The central bank’s program of bond purchases means that the volume of debt held by the public will rapidly de-cline. The result could be that, with a reduced debt burden, the government can contemplate fewer tax increases and more spending. That, in turn, might help to boost inflation at a time of continued defla-tionary pressures.

Akrur Barua also wrote this quarter’s article on Bra-zil. Akrur says that, while the economy remained in recession in the first quarter, there are signs that the worst is over. Notably, exports have begun to respond to a weak currency. Moreover, Akrur dis-cusses the current and potential impact of the new regime, which is considered to be focused on re-forms. Markets have responded well, with increased equity prices, an appreciated currency, and lower bond yields. The new government has appointed


published quarterly by Deloitte Research

Editor-in-chiefDr. Ira Kalish

Managing editorAditi Rao

Contributors Akrur Barua Dr. Alexander BörschDr. Patricia BuckleyDr. Daniel BachmanLester Gunnion Dr. Rumki Majumdar Ian Stewart

Editorial address350 South Grand Street Los Angeles, CA 90013 Tel: +1 213 688 4765 [email protected]

INTRODUCTION

3


a credible economics team and intends to consoli-date fiscal policy, reform pensions and the tax code, privatize state-run companies, and boost private sector participation in infrastructure investment.

In our next article, Danny Bachman offers his thoughts on the Mexican economy. He notes that, despite implementing many favorable poli-cies, growth remains low compared with other big emerging markets. On the other hand, Danny notes that a sensible monetary policy has lowered infla-tion. Plus, a flexible exchange rate has enabled the country to weather various storms. Danny is opti-mistic that the government’s reform agenda will ul-timately pay off in terms of stronger growth.

South Africa faces considerable headwinds, accord-ing to our next article by Lester Gunnion. Real GDP fell in the first quarter. Moreover, as Lester points out, South Africa faces “subdued commodity prices, weak external demand, a strong dollar, and sluggish global trade. Furthermore, weak growth, political unrest, and deteriorating fundamentals have seen the rand slip and inflation climb.” The country’s government also just barely avoided a ratings down-grade. Lester concludes that the short-term outlook is “rather dim.”

In her article on India, Rumki Majumdar notes that India’s economic performance has been reasonably good, assisted by low commodity prices and better governance. Yet, she says, economic reforms, which are needed to boost the future rate of growth, have been slow in such areas as regulation, financial market rules, relations between the center and the states, and trade relationships.

In our last article, Rumki Majumdar looks at the global oil market. Specifically, she reviews the his-tory of the last 50 years of oil price movements and provides thoughts on the factors that tend to drive prices. She then examines the current situation and concludes that, on balance, it is likely that oil prices will remain relatively low in a fairly narrow corridor. Finally, Rumki examines the likely winners and los-ers stemming from the likely path of oil prices.

Dr. Ira Kalish Chief global economist of Deloitte Touche Tohmatsu Limited

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5


UNITED KINGDOM

After Brexit, what lies ahead? By Ian Stewart

It is possible that the United Kingdom will not leave the European Union at all. The referendum vote was only ad-visory, 70 percent of MPs favor Remain, and some Leave voters seem to be suffering from buyers’ remorse.

BY the late afternoon of June 23, the day of the United Kingdom’s EU referendum, the betting markets had priced an 84 percent

probability of a “Remain” vote; in the preceding week, equities and the sterling had rallied strongly on expectations that Remain would win. The unex-pected vote to leave the European Union triggered a bout of financial market, political, and economic uncertainty. The immediate effects were seen in risk assets, including, most graphically, the biggest-ever one-day decline, of 8.0 percent, in the value of the British pound against the US dollar on June 24.

The final shape of Britain’s economic and political relationship with the European Union and the rest of the world may take years to fully emerge. How-ever, uncertainty is likely to moderate as the shape

of the government’s ambitions for the European Union take form. The next main landmark is the election of a new leader of the Conservative Party, and the new prime minister, on September 9. In a surprise move, the front-runner and leading Brexit campaigner, Boris Johnson, dropped out of the leadership race on June 30; the new prime minister is Teresa May, the former home secretary and a low-key supporter of Remain during the campaign.

There are numerous possible permutations of out-comes for the United Kingdom. It is possible that the United Kingdom will not leave the European Union at all. The referendum vote was only advisory, 70 percent of MPs favor Remain, and some Leave voters seem to be suffering from buyers’ remorse. Against this backdrop, the United Kingdom could

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3rd Quarter 2016United Kingdom

7


conceivably hold a second referendum or a general election that might result in the United Kingdom deciding to remain in the European Union.

But at the time of writing, in the aftermath of the vote, the most likely outcome seems to be that the new prime minister will invoke Article 50 of the Lis-bon Treaty, which starts the process of withdrawal, and that the United Kingdom will leave the union.

A central issue in negotiations will be the United Kingdom’s ability to retain access to the European Single Market while limiting the right of EU citizens to work in the United Kingdom. UK business wants to access the Single Market and overwhelmingly favors free movement of peo-ple, yet David Cameron told European leaders that it was concerns about immigration and free movement of peo-ple that caused UK vot-ers to vote Leave.1

The United Kingdom may try to square the circle by negotiating for somewhat reduced ac-cess to the Single Market and tighter constraints on EU migration. So far, the European Union sounds unyielding on its insistence on free move-ment of people, one of the four key principles of the union. Indeed, Angela Merkel warned the United Kingdom that it would not be able to “cherry-pick” the parts of the European Union it likes, such as the Single Market, without accepting its core prin-ciples.2

If the European Union maintains this line and the United Kingdom insists on taking control of EU mi-gration, the United Kingdom might find itself in a more distant economic relationship with the Euro-pean Union, perhaps operating under the rules of the World Trade Organization without trade deals

with the European Union, as countries such as Australia do. Under such a scenario, exports from the United Kingdom to the European Union—and vice versa—might be subject to customs controls and tariffs. Crucially, the access of the United King-dom’s highly successful financial service sector to the lucrative Single Market could be severely con-strained. While such a regime would create a new barrier to trade, especially in services, and would have pronounced sectoral effects, many successful exporters to the European Union, including China,

do cope with it.

As a shock, Brexit has some elements in com-mon with the 2008 fi-nancial crisis. But while that was an economic shock that threatened the solvency of the bank-ing system and triggered a credit crunch, Brexit is a political shock. Its impact on the economy is more indirect, at least in the short term, and manifests via financial markets and the knock-on effects on business and consumer confi-dence.

A declining financial-market risk appetite tends to weaken the cor-porate sector’s risk ap-

petite. Companies react by battening down hatches, paring investment, and sharpening their focus on cost control. Foreign investors could also take fright and hold back on investing in the United Kingdom. Since the United Kingdom needs overseas capital to cover its yawning current account deficit, such a buyers’ strike would further weaken the pound.

To generate a full-blown recession, consumers, who account for two-thirds of GDP, would need to stop consuming, as they did in 2009–10. The transmis-sion mechanism would come through rising uncer-tainty and a squeeze on spending power from high

As a shock, Brexit has some elements in common with the 2008 financial crisis.

But while that was an economic shock that threatened the sol-

vency of the banking system and triggered a credit crunch, Brexit

is a political shock.

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inflation and weak earnings. But for now, this does not seem to be the most likely outcome.

There are two lessons from economic history about the effect of external shocks. One is that the impact reduces over time; economies are resilient, and activity, in time, bounces back. The second is that shocks that threaten growth prompt a countervail-ing policy response. Authorities don’t sit on their hands and do nothing.

Today, the most useful response would be for the government to signal the direction for the United Kingdom in its negotiations with the European Union. In markets and business, as in life, intent matters. The usual policy levers could also be pulled. The Bank of England may well undertake more quantitative easing, stepping up the volume and the range of assets purchased to boost liquidity and as-set prices as well as drive down long-term interest rates. Agreed, inflation may head higher as a weak-er pound pushes up import prices. But as a one-off phenomenon in an economy facing great uncertain-ty, such temporary inflation would not justify inter-est rate rises. Fiscal policy may need to play a role, too. The chancellor previously suggested that Brexit would lead to an austerity budget in order to balance the books. That would dent growth and might well

be politically unviable in the face of opposition from many MPs. In today’s exceptional circumstances, the government could put deficit reduction on the back burner and use public spending and tax cuts to bolster growth. Such an approach has particular appeal to those who believe that monetary policy is a spent force. Thus it seems that the United King-dom faces slower growth with Brexit, but it should be able to skate around recession.

But what about the effects on the European Union?Last Thursday’s vote is as much a shock for the Eu-ropean Union as the United Kingdom. The sharp decline in Continental European equity markets on hearing the news testifies to concerns about the knock-on effects. A British exit would represent the greatest political setback to the European Union in its 65-year history. This comes at a time when the European Union is coping with a migration crisis and is trying to strengthen the euro area against fu-ture shocks. After a period of rapid economic and political integration in the ’90s and ’00s, Europe is seeing slower, more divergent growth and a loss of political momentum. Figure 1 shows some of the possible Brexit effects on the union.

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Deloitte UK Economics and Markets team.

Figure 1. The future of the European Union

Muddle through?

Multispeed Europe?

Step up integration?Brexit, further secessions

Challenges Response

Slow growth

Migration, borders

Fixing the euro

1.

2.

3.

4.

United Kingdom

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More extreme, anti-establishment political parties such as the Freedom Party in Austria, the Five Star Movement in Italy, the Front National in France, and the Freedom Party in the Netherlands are gain-ing ground. The immediate concern is the risk of a domino effect as Eurosceptic parties elsewhere in the European Union demand their own referenda. Recent research conducted by Deloitte and the Ger-man employers’ organization BDI found that 66 percent of German businesses believe a British exit would lead to further such votes in the European Union.3

A complicating factor for any UK negotiations with the European Union is a series of national elections, most crucially in the Netherlands (March 2017), France (April–May 2017), and Germany (August–October 2017; dates to be confirmed later). It is pos-sible that Europe’s de facto leaders, Angela Merkel and Francois Hollande, will leave office in 2017.

The United Kingdom’s departure from the European Union also raises questions about the future direc-tion of the trade bloc. Without the United Kingdom, the European Union loses a significant supporter of free-trade and free-market policies. Analysis by the think tank Open Europe suggests that the United Kingdom’s exit will tilt the balance of power in the European Union under qualified majority voting significantly toward a more protectionist, less free-market, approach.4

Faced with the risk of further secessions across Eu-rope and seeking to avoid political drift, EU lead-ers may seek to “double down” on ever-closer union.

Press reports have suggested that European leaders have already been drawing up plans for a future union without the United Kingdom, developing a so-called “Plan B” focused on closer security and defense cooperation.5

Yet the integration that the European Union sees as necessary to strengthen the European project could run into resistance from national electorates. The Pew Research Center recently reported a decline in support for the European Union across 10 major member states. The research also found that those European voters who favored the transfer of power from nations to the European Union were outnum-bered two to one by those who wanted to see pow-ers returned from the European Union to national governments.6

At times of great uncertainty, marginal new infor-mation, both important and trivial, is subject to great scrutiny. Dramatic but unrepresentative or er-ratic events are sometimes given more significance than they deserve. Fundamentals can get drowned in a torrent of speculation and news flow. In terms of the fundamentals, based on international mea-sures of competitiveness, the United Kingdom looks in decent shape. The World Bank, the World Eco-nomic Forum, and the Heritage Foundation rank the United Kingdom in the top tier of their league tables of competitiveness, up there with countries such as the Netherlands, Denmark, and Australia (figure 2). This ranking speaks of a flexibility and resilience that will be vital to the United Kingdom as it navigates what lies ahead.

In terms of the fundamentals, based on international measures of competitiveness, the United Kingdom looks in decent shape.

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Endnotes

1. Gabriela Baczynska and Elizabeth Piper, “At last EU summit, Cameron voices regret for Brexit,” Reuters, June 29, 2016, http://in.reuters.com/article/britain-eu-summit-idINKCN0ZE23E.

2. Ian Wishart, John Follain, and Jonathan Stearns, “Merkel tells Cameron before EU summit: Don’t delude yourself,” Bloomberg, June 28, 2016, http://www.bloomberg.com/news/articles/2016-06-28/merkel-tells-cameron-before-eu-summit-don-t-delude-yourself.

3. Deloitte Germany, EU referendum: Brexit und die Folgen für deutsche Unternehmen, June 2016, http://www2.deloitte.com/content/dam/De-loitte/de/Documents/financial-services/Deloitte-Deutschland-BDI-Brexit-2016.pdf.

4. Open Europe, http://openeurope.org.uk/.

5. Alex Barker, Stefan Wagstyl, and Anne-Sylvaine Chassany, “Paris and Berlin ready ‘Plan B’ for life after Brexit,” Financial Times, May 26, 2016, https://next.ft.com/content/09668b3e-2357-11e6-9d4d-c11776a5124d.

6. Bruce Stokes, “Euroskepticism beyond Brexit: Significant opposition in key European countries to an ever closer EU,” Pew Research Center, June 7, 2016, http://www.pewglobal.org/2016/06/07/euroskepticism-beyond-brexit/.

United Kingdom

Figure 2. United Kingdom ranks as competitiveGlobal competitiveness rankings

Note: Higher rankings indicate better, usually simpler, regulations for businesses; greater ease of doing business; stronger protections of property rights; and lower corruption.

Source: Business Index and Heritage Foundation Index of Economic Freedom; Deloitte UK Economics & Markets team.

Heritage Foundation World Bank World Economic Forum

#1 Hong Kong Singapore Switzerland

#2 Singapore New Zealand Singapore

#3 New Zealand Denmark United States

#4 Switzerland South Korea Germany

#5 Australia Hong Kong Netherlands

United Kingdom 10 6 10

Sweden 26 8 9

Poland 39 25 41

Spain 43 33 33

France 75 27 22

Italy 86 45 43

Greece 138 60 81

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EUROZONE

Life after Brexit By Alexander Börsch

WHILE the economic recovery in the Eu-rozone has continued and even gained some momentum, the Eurozone’s out-

look is shaped by the decision of the United King-dom to leave the European Union. The first exit of an EU member (besides Greenland, then part of Denmark in the mid-1980s) poses a variety of ques-tions for the European Union, in the political as well as economic spheres. Key among them are how to structure the future relationship with the United Kingdom as well as how to manage political risks in the European Union.

Some good news on the recoveryThe Eurozone’s economic recovery gained some mo-mentum in the first quarter. This was not necessar-ily expected: After the financial market turbulences in the beginning of the year and the various external risk factors, a weakening dynamic was more likely. Nevertheless, the growth rate of 0.6 percent in the first quarter was the strongest since Q1 2015.

External uncertainties did not scare the Eurozone’s consumers, who have continued to drive the recov-ery. Wages are growing, unemployment is slowly

shrinking, and low energy prices do their part to en-courage private consumption. At the same time, the net effect of external trade is negative, as imports have grown stronger than exports, even in the case of Germany, the Eurozone’s main exporter. The key reasons behind this are the waning tailwinds of a weak euro and weaker demand from emerging mar-kets.

The arguably most important component for a self-sustaining recovery, corporate investments, has been the weak spot of the Eurozone’s recovery since it started in 2013. Overall, the level of capital invest-ments in the Eurozone is still hardly higher than it was in 2010. But finally investments in the Euro-zone show some signs of life: Overall investments have grown robustly, at 0.8 percent, for the second quarter in a row.

Whether these encouraging developments indicate higher growth dynamics is not clear. In any case, they have been overshadowed by the June-end de-cision of the UK electorate to leave the European Union. While the possibility of Brexit was widely seen as one of the key tail risks for Europe and the world economy and was widely discussed, the likeli-hood of its occurrence was seriously underestimat-ed, not least in the financial markets.

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How does Brexit affect European business?At first glance, the main economic and political ef-fects of leaving the European Union should fall on the United Kingdom, the second-biggest EU econo-my. However, this is only partly true. Interestingly, the stock markets in Germany and France dropped more than the UK market did on the day after the referendum. To some degree, this is because Brexit comes at a very unfavorable time for the European Union.

The European Union has a host of challenges to solve, ranging from migration policy to the stabili-zation of the Eurozone and pressure from the rise of anti-EU and populist parties. In addition, Brexit has happened just when the recovery gained some momentum.

Interestingly, the stock mar-kets in Germany and France dropped more than the UK market did on the day after the referendum. To some de-gree, this is because Brexit comes at a very unfavorable time for the European Union.

Eurozone

13


While the immediate effects of Brexit play out in the financial markets, the effects on the real economy in the Eurozone will depend on Brexit’s impact on consumer and corporate confidence. Forecasts proj-ect the likely GDP losses in 2017 for the Eurozone to be 0.3 percent—not enormous, but sizable given the growth trend of around 1.5 percent. Given that there are no historical precedents, the effects will ultimately hinge upon the degree of political and financial market uncertainty surrounding Brexit in the coming months.

What kind of divorce?The political challenges for the European Union play out in two dimensions: the European Union’s position in upcoming UK exit negotiations, and the region’s future. According to the EU treaties, the EU-UK negotiations are supposed to be concluded within two years, starting from the date the United Kingdom formally gives notice of its wish to leave the European Union. This period can be extended if both parties agree.

The political challenges for the European Union play out in two dimensions: the European Union’s position in up-coming UK exit negotiations, and the region’s future.

Graphic: Deloitte University Press | DUPress.com

Source: International Monetary Fund, 2016.

Ireland 11.2

Malta 8.4

Cyprus 7.6

UK exports to EU(percentage of UK GDP)

12.5

Belgium 7.5

Netherlands 6.7

Luxembourg 5

Spain 3.1

EU27 3.1

Germany 3

Poland

France

Italy

2.9

2.2

1.7

Figure 1. EU member exports to United Kingdom (2014)

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Given that the negotiations need to disentangle legal relations that have developed over 40 years and set up a new trade regime, it is doubtful that two years of negotiations will be enough. The EU-Canada ne-gotiations over a free trade agreement just entered their seventh year. Some EU countries are likely to be more affected by a disruption of trade relations. On average, the export volume of EU countries to the United Kingdom is around 3 percent of their GDP, but this number is 6–11 percent for countries such as the Nether-lands, Belgium, and Ireland (figure 1).

Best and worst casesIn a best-case sce-nario, the divorce develops smoothly. Both sides realize that erecting trade barriers will lead to a lose-lose situa-tion. From an eco-nomic standpoint, both sides are inter-ested in a mutually beneficial outcome and minimal trade restrictions. However, the Brexit decision itself is evidence that economic considerations do not necessarily prevail. The European Union might be tempted to block

agreement to deter secessionist movements in other EU countries or set other priorities than Brexit.

On the other hand, from the European Union’s per-spective, a smooth divorce with a liberal trade re-gime inevitably requires the free movement of peo-ple. The models under discussion with no or limited disruption of trade relations (the United Kingdom

as member of the European economic area, or a Swiss-style negotiated access to the Single Market) include open borders for employees. This might be hard to ac-cept for a new British government that is committed to real-izing the anti-immi-gration demands of the Brexit movement.

In this sense, a best-case scenario with minimal trade re-strictions faces con-siderable hurdles on both sides and is far from automatic. A worst-case scenar-io, with disruption

of trade relations and major economic damages in terms of lower trade volume and foregone eco-nomic growth, is equally possible. The expectations of which scenario will prevail is very likely to move financial markets and investment decisions during the coming years of negotiations.

From an economic stand-point, both sides are interested in a mutu-

ally beneficial outcome and minimal trade re-

strictions. However, the Brexit decision itself is

evidence that economic considerations do not

necessarily prevail.

Eurozone

15


A best-case scenario with minimal trade re-

strictions faces consid-erable hurdles on both

sides and is far from automatic. A worst-case

scenario, with disruption of trade relations and major economic dam-ages in terms of lower

trade volume and fore-gone economic growth,

is equally possible.

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Source: Deloitte Germany, EU referendum: Brexit und die Folgen für deutsche Unternehmen, June 2016, http://www2.deloitte.com/-content/dam/Deloitte/de/Documents/financial-services/Deloitte-Deutschland-BDI-Brexit-2016.pdf.

High risk of further exits from the EU 66%

Stronger political fragmentation of the EU 42%

Weakening of market-oriented economic policies 40%

Regression of the EU to a pure free-trading zone 39%

Higher willingness of the remaining EU membersto cooperate in order to solve joint problems

12%

Stronger integration of the remaining EU members 9%

I do not expect any significant consequences 5%

I cannot estimate it 3%

0% 10% 20% 30% 40% 50% 60% 70%

Figure 2. German managers’ expectations regarding the consequences of Brexit on the European Union

Which consequences would a Brexit have, in your opinion, for the future of the EU?

What kind of future European Union?The second (political) factor involves the future of the European Union itself. Given the emergence of populist parties in many European countries, Brexit has already led to calls for similar referenda else-where, as well as to fears that Brexit could be the beginning of a wider disintegration of the European Union.

Enterprises also recognize this risk. In a joint survey conducted by Deloitte Germany and the Confedera-tion of German Industry shortly before the Brexit decision, two-thirds of the 215 polled German man-agers saw the risk of further exits in the aftermath of Brexit, and many fear political fragmentation of the European Union. Only a few see Brexit as a catalyst for deeper integration (figure 2).

In this sense, Brexit creates a variety of political risks for the European Union, and an intense dis-cussion about its goals and future governance struc-ture will likely emerge. Quite a few scenarios are plausible. They range from deeper integration and the emergence of a more state-like European Union to the return to a free-trade area with more politi-cal powers at the member-state level. As always in uncertain times, more extreme scenarios are also imaginable.

From an economic perspective, the crucial factor is how open and market oriented the future European Union will be. Consequently, political decisions are likely to shape the Eurozone’s economic outlook to an unusually high degree.

Eurozone

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UNITED STATES

Businesses take a (hopefully) temporary breather By Patricia Buckley

BUSINESS investment contracted in the first quarter, and employment growth slowed over the first half. Although it is too soon to walk

away from our previous outlook that 2016 will be a year of moderate growth, downside risk has defi-nitely increased.1 This is particularly true in light of the recent Brexit vote, which may well translate into slower world growth. The fact that first-quarter GDP growth was only 1.1 percent (annualized) is not in itself a big concern. The United States has had a string of weak first quarters followed by stronger growth later in the year. For example, first-quarter 2014 GDP growth was -0.9 percent and first-quarter 2015, 0.6 percent, and each of those years achieved overall growth of 2.4 percent.2 However, the fact that a contraction in business investment played such a large role in the low topline number, and that this was the second contraction in a row, is worri-some, particularly when considered in combination with slowing employment growth.3

Figure 1 shows the contributions of the various cat-egories of GDP to overall growth for the most recent five quarters.

• The contribution from personal consump-tion was almost the same in the first quarter of 2015 as in the first quarter of 2016, at 1.2 and 1.0 percentage points, respectively. In the later quarters of 2015, the contribution from personal consumption was higher on strong employment growth and some increase in real wages.

• The drag from business investment was 0.6 per-centage points in the first quarter of 2016, fol-lowing the 0.3-percentage-point subtraction in the fourth quarter of 2015. This is the first time that business investment has fallen for two consecutive quarters since 2009, the year the recession ended.

The United States has had a string of weak first quarters followed by stronger growth later

in the year.

18

3rd Quarter 2016

• Residential investment was the one bright spot in the first quarter of 2016, as its contribution rose to 0.5 percentage points from the 0.3-per-centage-point contribution in each of the prior four quarters.

• Private inventory investment declined in the first quarter, as it did in the preceding three quarters.

• The contribution from exports was near zero, weighted down by a relatively high dollar and slower global growth.

• The slight positive contribution from imports in the most recent two quarters indicates falling imports, as the slowdown in business invest-ment and change in consumers’ purchasing pat-

terns outweighed the high dollar impact (which makes imports cheaper).

• Government spending made a positive contri-bution to first-quarter GDP, which was more than accounted for by state and local spending. Spending at the federal level contracted.

The decline in business investment is even more notable because it is driven by negative contribu-tions from two of its components: structures and equipment. The third component, intellectual prop-erty (IP), made a positive contribution in the first quarter of 2016 after making no contribution in the fourth quarter of 2015. As shown in figure 2, it is not unusual for any individual component to decline in a particular quarter, but the last time that two of

United States

19


Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Bureau of Economic Analysis.

Q1 2015: 0.6% Q4 2015: 1.4%

Q2 2015: 3.9% Q1 2016: 1.1%

Q3 2015: 2.0%

-1.5

-1.0

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Residentialinvestment

Change in privateinventories

Exports Imports Governmentspending

Personalconsumption

Figure 1. Disaggregation of GDP growthPercentage point contribution to GDPPercentage point contribution to GDP


Structures Equipment Intellectual propertyproducts

Businessinvestment

-1.0

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Q1 Q2 Q3 Q4

2014

Q1 Q2 Q3 Q4

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Q1 Q2 Q3 Q4

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Q1

Figure 2. Contribution of business investment to GDP growth by typePercentage point contributionPercentage point contribution

20

3rd Quarter 2016

the components contracted in the same quarter be-fore the two most recent quarters was in the second quarter of 2013.

Looking now at the individual components of busi-ness investment, it is clear that the investment de-cline in structures is concentrated in the mining sector (figure 3). Real dollar investment in mining, which includes mining exploration, shafts, and wells, has fallen 70 percent from its peak investment of $137.3 billion in the fourth quarter of 2014 to only $41 billion in the first quarter of 2016. Investment in manufacturing structures registered strong growth between mid-2014 and mid-2015 before leveling off at the same investment dollar amount as power and communication structures. Investment in commer-cial and health care structures has continued to rise.


Mining exploration, shafts, and wells

Manufacturing

Power and communication

Commercial and health care

0

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2014

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Figure 3. Investment in structures by typeBillions of chained (2009) dollarsBillions of chained (2009) dollars

Although industry details are not available for soft-ware, the major funders of R&D investment are manu-facturers, who currently ac-count for 83 percent of all business R&D spending.

United States

21



Other equipment

Industrial equipment

Transportation equipment

Information processing equipment

150

200

250

350

300

2013

Q1 Q2 Q3 Q4

2014

Q1 Q2 Q3 Q4

2015

Q1 Q2 Q3 Q4

2016

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Figure 4. Business equipment investment by typeBillions of chained (2009) dollars, seasonally adjusted at annual ratesBillions of chained (2009) dollars, seasonally adjusted at annual rates


Research and developmentSoftware

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2014

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Figure 5. Private fixed investment in IP products by major typeBillions of chained (2009) dollars, seasonally adjusted at annual ratesBillions of chained (2009) dollars, seasonally adjusted at annual rates

22

3rd Quarter 2016

Unlike the decline in structures, the slowdown in equipment investment is more widespread, but even in this category, the sharp slowdown in mining has been a contributor, although it is not possible to gauge its exact contribution. As shown in figure 4, most of the decline in equipment investment has been in transportation equipment and the “other” category. Although the data are not broken down by users of transportation equipment, it is reasonable to assume that some of the decline, particularly in heavy trucks, is tied to the oil and gas industry. Also, mining and oilfield machinery make up around 13 percent of the “other” category. However, the weak-ness in equipment investment that has been evident across all categories must be more widespread than can be accounted for in a sector that currently con-tributes only 1.4 percent of value to the economy.

The two primary categories of IP investment are shown in figure 5. The other, much smaller cat-egory of investment in entertainment, literary, and artistic originals, with current real annual invest-ment of around $80 billion, is not shown. With both investment in software (own account, custom, and prepackaged) and research and development (R&D), the decline in mining activity has probably played a minor role in the change in trend. In both of these IP categories, investment sentiment seems to have shifted in the second quarter of 2015—a year after the price of oil began its steep slide. Software investment picked up in the first quarter, even as investment in R&D has remained flat. Although in-dustry details are not available for software, the ma-jor funders of R&D investment are manufacturers, who currently account for 83 percent of all business R&D spending. The largest sectors include phar-maceutical and medicine manufacturers, electronic and electronic component manufacturers (includ-ing semiconductors), and motor vehicle and parts manufacturers.

Concurrent with the decline in business investment, there has been a slowdown in employment growth. During the first five months of 2016, total non-farm employment increased by only 150,000 jobs per month on average. The comparable number

Manufacturing em-ployment has actually contracted so far in

2016, while the rate of employment growth slowed substantially in professional and business services,

construction, and lei-sure and hospitality.

United States

23


for 2015 was 229,000 jobs per month. Should this slowdown persist, the United States would see job growth of only 1.8 million this year—a substantially lower increase than the 2.7 million jobs created in 2015. Although unemployment is at a very low 4.7 percent, labor force participation (people working or looking for work as a percentage of the popula-tion) and wage growth are also low, making it un-likely that the job growth rate is slowing because of lack of potential employees.4

Since peaking in September 2014, mining employ-ment has fallen by almost 25 percent, and figure 6 shows that the pace of decline has not begun to de-crease. However, this is not the only sector where employment conditions have deteriorated. Manu-

facturing employment has actually contracted so far in 2016, while the rate of employment growth slowed substantially in professional and business services, construction, and leisure and hospitality.

Most of the currently available economic data are pointing to a substantially stronger second-quarter GDP growth rate, so the low employment increases seen so far in 2016 might just be a temporary pause. However, unless business investment, particularly in equipment and IP, picks up, longer-term growth might be at risk. These are the investments that cre-ate and incorporate innovation into production pro-cesses, which in turn drive productivity increases, and productivity growth has been sadly disappoint-ing so far in this recovery.

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Bureau of Labor Statistics.

2015 2016

-20

-10

0

10

50

40

60

20

30Le

isure

and

hosp

italit

y

Heal

th ca

re

Prof

essio

nal a

nd

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ess s

ervic

es

Fina

ncia

l act

ivitie

s

Reta

il

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ufac

turin

g

Cons

truct

ion

Gove

rnm

ent

Min

ing

Figure 6. Average monthly employment growth by sectorThousandsThousands

24

3rd Quarter 2016

Endnotes

1. Patricia Buckley, “United States: Moderate growth to continue, but when will wages begin rising?” Global Economic Outlook, Q2 2016, Deloitte University Press, April 29, 2016, http://dupress.com/articles/global-economic-outlook-q2-2016-united-states/.

2. There is a strong likelihood that there are technical issues with the seasonal adjustment to the data underlying the first-quarter GDP estimates. For example, researchers at the Federal Reserve Bank of San Francisco applied a second round of seasonal adjustment to the published real GDP data and found that first-quarter GDP has been underestimated since the late 1990s, and that the underestimation has risen in recent years to about 1.5 percentage points. For details, see Glenn D. Rudebusch, Daniel Wilson, and Tim Mahedy, “The puzzle of weak first-quarter GDP growth,” Federal Reserve Bank of San Francisco, May 18, 2015, http://www.frbsf.org/economic-research/publications/economic-letter/2015/may/weak-first-quarter-gdp-residual-seasonality-adjustment/.

3. Unless otherwise noted, the data in this chapter are from the Bureau of Economic Analysis’s National Income and Product Accounts.

4. Bureau of Labor Statistics.

United States

25


CHINA

The deceleration continues By Ira Kalish

THE latest data indicate that the Chinese econ-omy continues to decelerate.1 Data on Chinese trade indicate continued weakness in exports

but a slower pace of decline for imports. First, dol-lar-denominated ex-ports fell 4.1 percent in May versus a year ear-lier, sharper than the 1.8 percent drop in the previous month. This reflected weak demand in both Europe and the United States. In local currency terms, exports were actually up slightly. The difference between dollar- and renminbi-denominated exports reflects the deprecia-tion of the renminbi over the past year. Part of the problem for Chi-na, however, is that, al-though its currency has fallen in value, it has fallen far less than that of other emerging coun-tries. Thus China’s exports have lost competitive-ness versus other countries. Indeed some manufac-turing capacity has departed from China, heading to

other low-wage emerging markets. Meanwhile, the Chinese central bank continues to sell foreign cur-rency reserves in order to stabilize the currency and prevent a sharper depreciation.

Imports, which have been consistently fall-ing for some time, fell only 0.4 percent in May versus a year earlier. This was a far smaller decline than the 10.9 percent drop in April. There were some special circumstances, how-ever. First, the rise in commodity prices has boosted the import bill. Second, imports from Hong Kong increased 242.6 percent from a year earlier, possibly meaning that investors engaged in fake invoic-ing in order to move funds out of the country. Specifically, importers can invoice amounts far

larger than the actual cost of the imported goods. This makes it appear that imports were much

Part of the problem for China, however, is that, although its currency has fallen

in value, it has fallen far less than that of

other emerging coun-tries. Thus China’s exports have lost

competitiveness ver-sus other countries.

26

3rd Quarter 2016China

27


greater than was actually the case. Yet it enables the importer to send money out of the country without appearing to violate the government’s controls on capital movements. Thus underlying imports were likely quite weak, probably reflecting weak domes-tic demand. Moreover, many Chinese exports rely on imported inputs. Weakening exports have the ef-fect of weakening imports as well.

Fixed asset investment in China was up 9.6 percent in the first five months of 2016 compared with a year earlier. This was the slowest rate of investment growth in 16 years. Interestingly, private sector in-vestment was up only 3.9 percent, while investment by state-owned enterprises (SOEs) was up 23.3 per-cent. The latter figure might be of concern, given that there is considerable excess capacity in the state-run sector, producer prices for SOEs are de-clining, and SOEs are disproportionately laden with debt. The significant slowdown in private sector in-vestment might also be alarming, and could bode poorly for growth. Finally, investment in real estate was up 6.6 percent from a year earlier, a consider-able slowdown from before. Excessive investment in property has been one of the hallmarks of China’s economy lately. Thus slower growth of property in-vestment is surely welcome. The challenge for China will be to shift away from investment-led growth and toward consumer-led growth. In addition, it would be helpful if investment by the private sector increases as a share of the total. This is clearly not happening now.

Chinese industrial production increased 6.0 per-cent in May versus a year earlier. This was in line with growth over the past year. Manufacturing out-put was up 7.2 percent, while that of electricity, gas, and water was up only 2.4 percent. Mining output declined 2.3 percent. The weak growth of electric-ity output will be seen by some as a proxy for the state of the overall economy. In addition, output of cement and steel rose modestly, and that of coal dropped sharply. Meanwhile, Chinese retail sales were up 10.0 percent in May versus a year earlier. This was the slowest rate of expansion in quite some time. All of these data suggest an economy that con-tinues to decelerate.

Consumer price inflation in China decelerated in May. Prices were up 2.0 percent from a year ear-lier, less than the 2.3 percent inflation recorded in April. The central bank’s target rate of inflation is 3.0 percent. The weakening of inflation, despite a modest depreciation of the currency in the past year, suggests weakness of domestic demand. As such, it may presage further efforts by the government to stimulate the economy, either through monetary or fiscal policy. Meanwhile, the producer price index fell 2.8 percent in May versus a year earlier. This is less than the 3.4 percent decline in April. Producer prices have been consistently falling for a long time, driven by excess capacity. The fact that producer price deflation has abated may have to do with the recent rise in commodity prices. Still, as producer prices continue to fall, it will exacerbate the diffi-culties some companies may face in servicing their large debts.

In May, foreign direct investment (FDI) into China was down 1.0 percent from a year earlier. For the first five months of 2016, FDI was up 3.8 percent from the same period a year earlier. In that five-month period, investment in manufacturing was down 3.2 percent, while investment in service in-dustries was up 7.0 percent. Investment in services accounted for 70 percent of the total.

Debating debtThe International Monetary Fund (IMF) has entered into the debate about China’s growing debt. The deputy managing director of the IMF, David Lipton, said that “corporate debt remains a serious—and growing—problem that must be addressed imme-diately and with a commitment to serious reforms.” He pointed out that corporate debt is now about 145 percent of GDP, which is “very high by any mea-sure.” He warned that, if unchecked, the expansion of debt could lead to a financial crisis, low economic growth, or both. He also said that the measures taken so far by Chinese authorities are inadequate. These include securitization of debt as well as debt-for-equity swaps. The problem with such measures is that they don’t address the underlying problem

28

3rd Quarter 2016

of poor performance of the debtor companies, espe-cially SOEs. Lipton noted that, while SOEs account for about 22 percent of economic output, they ac-count for about 55 percent of corporate debt in Chi-na. Many of them are “essentially on life support.”2

Critics of China’s policies say that such enterprises must be reformed or shut down. Debt-for-equity swaps simply allow banks to own shares in these companies. Such measures do little to improve the performance of these companies. Banks are left with little incentive to force these companies to fail. Critics also say that it would make more sense for the Chinese authorities to simply allow banks to let companies default, and then establish a ve-hicle to clean up bank balance sheets. Such a policy would lead to the bankruptcy and possible closure of some unprofitable and highly inefficient compa-nies. While this might be painful in the short run, it would boost long-term productivity and enable the economy to restructure away from loss-making businesses.

Interestingly, the deputy governor of China’s cen-tral bank, Zhang Tao, says, “Any industry that lacks the mechanism to elevate winners and eliminate

losers can’t develop in a healthy and sustainable way.” This suggests a willingness to let failing com-panies fail—although this has not yet happened. He also addressed the issue of banks that hold bad debts, saying “We will permit financial institutions to go bankrupt in an orderly way, restructure those that need restructuring, shut those that need to be shut, and strengthen market discipline.”3 Mean-while, debt continues to expand. Lipton noted that

“in a setting of slower economic growth, the combi-nation of declining earnings and rising indebted-ness is undermining the ability of companies to pay suppliers or service their debts. Banks are holding more and more nonperforming loans, and the past year’s credit boom is just extending the problem.”4 Some observers have raised the specter of a crisis for China in which a large financial institution fails due to excessive bad assets. Yet this seems unlikely. Rather, China appears to face the risk of something akin to what happened in Japan in the 1990s, when banks rolled over bad loans to poorly performing companies. The result was a plethora of poorly per-forming companies being propped up by troubled banks. This led to limited credit creation, no eco-nomic growth, excess capacity, and deflation.

Endnotes

1. National Bureau of Statistics of China, “Homepage,” http://www.stats.gov.cn/english/, accessed June 29, 2016.

2. Shawn Donnan and Tom Mitchell, “IMF sounds warning on China’s corporate debt,” Financial Times, http://www.ft.com/cms/s/0/3f8dcf22-304c-11e6-bda0-04585c31b153.html#axzz4ChmrxqxF.

3. Ibid.

4. Ibid.

China appears to face the risk of something akin to what happened in Japan in the 1990s, when banks rolled over bad loans to poorly performing compa-nies. The result was a plethora of poorly performing companies being propped up by troubled banks.

China

29


JAPAN

Will households oblige by spending more? By Akrur Barua

OVER the past decade, there is an increas-ing sense among Japan’s policymakers that growth must be stimulated and deflation

countered. Arguably, the most spectacular of these measures has been aggressive monetary easing, es-pecially the use of negative interest rates this year.1 The verdict on some of these policies is mixed from a broad macroeconomic perspective. However, vari-ous components of the economy might throw pleas-ant surprises. Private consumption, which holds the key to growth at a time of slowing ex-ports, is one such exam-ple. While consumers obliged by increasing spending in Q1, they face strong headwinds in the medium to long term from an aging and declining workforce. So how can Japan’s poli-cymakers create incen-tives for consumers to spend? The Bank of Japan (BOJ) actually may already be doing that, not just by lowering borrowing costs but also by reducing the government’s debt burden.

Economic growth picked up in Q1 The economy grew at a seasonally adjusted annual rate (SAAR) of 1.9 percent in Q1, reversing from a 1.8 percent decline in Q4 2015 (figure 1). This was the second estimate for Q1, up from the 1.7 percent rise quoted in the first estimate. Private consump-

tion (2.6 percent) was a key growth driver in Q1, with households spend-ing more, especially on durable goods and services. Investments continued to disappoint, with both private resi-dential and nonresiden-tial investments declin-ing during the quarter. A deeper look at busi-ness investment reveals that spending on build-ings and structures as

well on machinery and equipment has been weak for the past year. This is not an encouraging sign for an economy eager to ramp up productivity in the face of disadvantageous demographics. Exports

It’s likely that the im-pact of aggressive

monetary easing on the Japanese yen

has run its course.

30

3rd Quarter 2016Japan

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Haver Analytics, Deloitte Services LP economic analysis.

GDP Private consumption

Government consumption Gross fixed capital formation

Exports

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Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 Q1-16Q1-14

Figure 1. GDP growth picked up in Q1, led by private consumptionPercentage, SAARPercentage, SAAR

31


provided much-needed succor to the economy in Q1, expanding 2.4 percent. However, the pace is lower than what Japan’s policymakers would want. It’s likely that the impact of aggressive monetary easing on the Japanese yen has run its course.

A key concern for private consumption is demographicsAnalysis of national accounts data reveals that while compensation of employees—both nominal and real—has gone up in the past year (figure 2), the share of household spending in GDP has con-tinued to decline (figure 3). This seems surprising,

given a strong labor market—unemployment is at a two-decade low—and real income gains due to low inflation. Japan’s low inflation, however, is due to deflationary pressures. So instead of spending more, consumers have held back, waiting for prices to stabilize. Moreover, as economic growth fluctuates, households appear pessimistic, with consumer con-fidence still in negative territory.2

Private consumption faces a deeper problem: de-teriorating demographics. In the last 10 years, Ja-pan’s population has fallen 0.6 percent, and its la-bor force, 0.7 percent (down 2.7 percent since 1996). This means that the number of earning individuals has declined. The burden of supporting welfare now rests on a shrinking workforce. Japan is also aging fast, which is evident in the composition of its labor


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Figure 2. In the last few years, employee compensation has slowedPercentage, year over yearPercentage, year over year

32

3rd Quarter 2016


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Share in GDP (nominal, left axis, percentage)

Growth (real, right axis, percentage)

Figure 3. Household consumption's share in the economy has gone down since Q1 2014

force (figure 4). So a rising share of the labor force has to focus more on savings for retirement than on current spending. (See the sidebar “Interview with Nobuhiro Hemmi” for more insights on this.)

Will the BOJ’s asset purchase program aid consumers?The BOJ, through its quantitative easing (QE) pro-gram, has eased the government’s debt burden—about 240 percent of GDP—by reducing the share of publicly held debt.3 For example, between January 2013 and May 2016, the BOJ’s holdings of govern-ment debt shot up 212.3 percent, while government debt increased just 12.1 percent. Consequently, the BOJ’s share in total government debt has increased

at the expense of others (figure 5). How does this help as total debt has not gone down? The BOJ now can easily convert this debt to perpetual-zero coupon bonds or, in the worst case, wipe it off its own balance sheet. Will this not increase risks and push yields up? Not really, because the level of pub-licly held debt has gone down due to the BOJ’s ris-ing share and hence has become more manageable. Moreover, the BOJ’s ultra-loose monetary policy and global financial volatility have driven borrow-ing costs to extremely low levels (figure 6).4 Inter-estingly, the government has more leeway now to introduce fiscal stimulus without spooking markets about rising debt.

The BOJ’s QE program aids consumers by mak-ing publicly held debt more manageable, allowing

Japan

33



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Jan-86 Jan-91 Jan-96 Jan-01 Jan-06 Jan-11 Jan-16Jan-81

Size of the labor force (left axis)

Share of the age group 15–44 years in the labor force (right axis)

Figure 4. The labor force and, within it, the share of relatively young people are decliningMillions, seasonally adjustedMillions, seasonally adjusted PercentagePercentage


700

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Central government debt (JPY trillion, left axis)

Share of BOJ’s holdings in central government debt (percentage, right axis)

Figure 5. BOJ is transferring a large share of government debt to its balance sheet

34

3rd Quarter 2016


Overnight call rate (uncollateralized) 10-year government bond yield

-0.5

0.0

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Jan-08 Jan-10 Jan-12 Jan-14 Jan-16Jan-06

Figure 6. 10-year government bond yields are now negative PercentagePercentage

the government more time to service that debt, in turn allowing consumers some breathing space. For example, it is possible that the second part of the two-part sales tax (first introduced in 2014) may be pushed beyond the revised date of 2017. Also, with a declining and aging population, the government may be hoping to partially shelter its working popu-lation—those who pay taxes and contribute to social welfare—from the burden of rising debt. In addi-tion, the BOJ’s move could help in the fight against deflation. This argument probably runs counter to

examples in Venezuela, Argentina, and Zimbabwe, where monetizing the government’s debt has led to hyperinflation. Japan, however, need not to worry about that. Increasing consumption through reduc-ing the debt burden might just help ease excess ca-pacity in the country, thereby reducing deflationary pressures, which, in turn, might benefit Japanese companies who are likely to face increasing head-winds from slowing global growth. The BOJ and the government must be hoping the plan works, bring-ing much-needed respite for the economy.

Japan

35


INTERVIEW WITH NOBUHIRO HEMMI

To understand more about recent policies and challenges ahead, I spoke with Nobuhiro Hemmi, partner and head of Global Business Intelligence at Deloitte Tohmatsu Consulting, Japan, and a member of the Deloitte Global Economist Council.

Akrur Barua (AB): The BOJ decided to keep rates on hold. Is it because BOJ thinks that monetary policy is not effective anymore? Or is it because the external environment is challenging, and the BOJ wants to wait and watch?

Nobuhiro Hemmi (NH): Both, I think. Officially, they seem to have announced a “wait and watch” policy as is evident from the BOJ governor’s interview.5 However, they introduced negative interest rates, which is not traditional monetary policy. This sort of contradiction reflects the new challenges that the BOJ faces.

AB: We have seen fiscal stimulus and strong monetary easing. The initial results were good, but they appear to be faltering now. When is the “third arrow” of Abenomics coming? What are the challenges? Which reforms do you think they should target?

NH: The market appears to have overestimated the impact of the “third arrow,” which has been the fundamental issue for Japan in the last two decades. So far, discussions around the “third arrow” have focused on growth strategies and easing regulations. However, the key issue is how to tackle the decrease in working population.

AB: The yen’s rise is opposite to what Japanese policymakers would want. How are exporters coping? Where do they see additional demand coming from? And which economies do they think will be the big markets over the next 5–10 years?

NH: Overall, from a macroeconomic point of view, the yen’s rise seems opposite to what policymakers would want. However, the impact (and implication) depends on industries and companies within these industries. Some companies have already shifted their operations outside of Japan, and others have hedged currency risk in the short term. Asia will still be a strong market for Japanese companies in the next 5–10 years. But there will be market segmentation, with a shift to a city-based approach from a country-based one.

AB: To stimulate domestic demand, Japanese corporates should invest more. Why have investments not picked up?

NH: If domestic demand is not positive in the near future, it will make sense for Japanese companies to be more conservative.

AB: With an aging society, what changes do you see in the next 5–10 years that will prop up domestic demand? More immigration or higher wages? Or longer working tenures?

NH: More than immigration, women’s participation in the labor market is an important issue for Japan. If policymakers cannot successfully implement a “womenomics” policy, they will introduce a further extension of the retirement age. Wages and tenures are not the key issues right now.

36

3rd Quarter 2016

Endnotes

1. Akrur Barua and Rumki Majumdar, “Impact of negative interest rates: Living in the unknown,” Global Economic Outlook, Q2 2016, Deloitte University Press, April 29, 2016, http://dupress.com/articles/impact-of-negative-interest-rates-controlling-inflation/.

2. Haver Analytics, June 2016.

3. Enda Curran and James Mayger, “Japan’s debt burden is quietly falling the most in the world,” Bloomberg, June 1, 2016, http://www.bloom-berg.com/news/articles/2016-06-01/japan-s-debt-burden-is-quietly-falling-by-the-most-in-the-world; Kevin Buckland and Shigeki Nozawa, “BOJ owning more debt than Japan banks is slow death for the markets,” Bloomberg, December 17, 2015, http://www.bloomberg.com/news/articles/2015-12-17/boj-owning-more-debt-than-japan-banks-is-slow-death-for-market.


5. Leika Kihara and Stanley White, “BOJ holds off on easing despite weak inflation, sparks yen spike,” Reuters, June 16, 2016, http://www.reuters.com/article/us-japan-economy-boj-idUSKCN0Z12SN; “BOJ to wait a few months to see effect of stimulus: Kuroda,” Reuters, May 11, 2016, http://www.reuters.com/article/us-boj-policy-kuroda-idUSKCN0Y21YA.

Japan

37


BRAZIL

A glimmer of hope By Akrur Barua

BRAZIL will soon host the Summer Olympics. When Brazil won the race to host two ma-jor events—the 2014 Soccer World Cup and

the 2016 Olympics—it was a proud moment for a country that was emerging as a strong contender on the global stage. However, much water has flowed down the Amazon since then. The economy is in bad shape. Political acrimony is high. Indeed, doubts have also emerged about Olympic host city Rio de Janeiro’s ability to complete facilities on time.1

Things seem to be improving though. The new government appears determined to restore fiscal health and reform the economy. Mar-kets have responded positively. There is good news for the Olympics, too. The World Health Organization has given its consent to the games despite the Zika virus threat.2 And the federal government has stepped in with financial support for Rio de Janeiro.3 As in the Olympics, however, victory—in this case for the economy—hinges on continuing the momentum of economic reforms, if not increasing it.

The economy contracted yet again in Q1There was not much respite for the economy in Q1 as real GDP contracted 0.3 percent quarter over quarter. This was, however, an improvement from the 1.3 percent decline in Q4 2015. Domestic de-mand faltered yet again, with gross fixed capital for-mation (-2.7 percent) and private consumption (-1.7

percent) contracting in Q1. Even though government con-sumption expanded 1.1 percent, any sup-port to the economy from the fiscal side will be temporary, given the dire need to get government fi-nances back on track.

The big standout for the quarter was exports, which expanded 6.5 per-cent (figure 1). Exports are benefitting from a rise in competitiveness due to a weak real—both nominal and trade weighted.4 With imports declining in Q1, net exports contributed positively to GDP growth, thereby providing much-needed relief to the econ-omy.

The new government appears determined to restore fiscal health and

reform the economy.

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3rd Quarter 2016


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Figure 1. Exports were a rare bright spot for the economy in Q1Percentage, quarter over quarterPercentage, quarter over quarter

Brazil

39


The new government means businesses The new government has its work cut out. GDP con-tracted for the fifth straight quarter and for the sev-enth time in eight quarters. The fiscal deficit is in double digits. Inflation is way above Banco Central do Brasil’s (BCB’s) 2.5–6.5 percent target. Worse, confidence in politicians is at an all-time low.5

Thankfully, President Michel Temer appears to have started on the right note by putting in place a cred-ible economic team. The finance minister, Henrique Meirelles, headed BCB during 2003–11 and was at the forefront of the fight against inflation in the last decade. Ilan Goldfajn, the new BCB governor, has reiterated his commitment to tackle inflation. Most importantly, both of them agree on the need to im-prove the government’s finances.

The government’s first step has been to improve transparency in fiscal management. In May, law-makers approved a primary deficit of 170.5 billion Brazilian reals (2.8 percent of GDP) instead of a sur-plus as projected in the initial budget. Without this approval, the government would have ground to a halt. Clarity on budget figures is also likely to boost credibility among rating agencies and investors.

In its efforts to cap spending, the government in-tends to amend the constitution to index budget spending to inflation for the next 20 years.6 If rev-enues go up due to any economic recovery, the ex-cess amount will be used solely to narrow the deficit. Interestingly, curbs on spending will extend to two key sectors—education and health—that have often remained outside the ambit of budget cuts. The gov-ernment has also asked the public sector develop-ment bank BNDES to repay its treasury debt.7


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Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Haver Analytics, Bloomberg, Deloitte Services LP economic analysis.

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The new administration has also talked about pen-sion reforms, a key component of government spending. According to the Wall Street Journal, about 41 percent of Brazil’s federal budget spending is directed toward pensions; the comparative figure for the United States is 24 percent.8 Temer’s team has started consultations with labor unions in a bid to prepare a proposal for pension reforms soon.9

The government is also mulling other reforms such as scrapping the sovereign wealth fund, greater par-ticipation of private companies in the oil and gas sector, increased privatization, more infrastructure concessions to the private sector, and tax reforms.10 If carried out, these measures will likely help Brazil gain competitiveness in the medium to long term.

The markets are loving it—for the momentMarkets seem to approve of the changes. Equities, for example, have bounced back this year, although much of the change was priced in earlier. The Ibovespa stock index is up 17.3 percent this year, while the financial index—a key forward indicator of macroeconomic movements—is up 24.4 per-cent. Given Brazil’s relatively open capital markets, rebounding equities will help stem capital flows. Confidence will be further strengthened if the gov-ernment passes key reforms. The real has already benefitted (figure 2) and is one of the strongest emerging-market currencies this year. This, in turn,

Brazil

41


has helped curb imported inflation; import prices of both consumer goods have been contracting (year over year) since last year.11

Arguably, the best news is the decline in long-term interest rates. Yields for 10-year government bonds have fallen about 3.7 percentage points so far in 2016 (figure 3). This will bring down the cost of servicing government debt. If this trend of falling yields persists, the BCB will find it easier to cut rates when inflationary pressures retreat.

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.com

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Source: Haver Analytics, Deloitte Services LP economic analysis.

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Falling bond yields and a return of confidence

have mitigated the threat of fiscal domi-

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PercentagePercentage

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Figure 5. It will be some time before BCB eases monetary policy

The threat of fiscal dominance abates furtherFalling bond yields and a return of confidence have mitigated the threat of fiscal dominance to a large extent. The government’s borrowing requirement is now at about 10.1 percent of GDP, while inter-est payments amount to 7.8 percent, lower than at the beginning of the year (figure 4).12 Inflation has eased partially to 9.3 percent in May from 10.7 per-cent in January. It is likely that the lagged impact of monetary policy and the base effect have come into play.

Despite these improvements, restoring confidence in monetary policy will not be easy—at least, not un-til inflation falls back to the target range of 2.5–6.5 percent (figure 5). Without that, BCB will not be able to cut the policy rate, which, at 14.25 percent, is the highest among prominent emerging econo-mies. In June, BCB kept its policy rate unchanged yet again, waiting for more improvements on the fiscal front. In a sign that market participants are still unsure about price pressures, inflation expecta-tions for the next 12 months have gone down by just one percentage point this year.13

Brazil

43


The way forward won’t be easy The key hurdle for Brazil’s economy is political un-certainty. Trouble has already started for the new government—although it is a temporary one, at least until former president Dilma Rousseff’s impeach-ment process is completed. Three ministers have re-signed so far.14 Also, while the proposed reforms are encouraging, the passage of these reforms faces dif-ferent hurdles. Pension reforms, for example, will face opposition from labor unions, especially those aligned with the previous government. Unions re-sent the proposal to raise the retirement age and want to make any changes to pensions applicable to just new job market entrants.15 Other reforms, such as the one on inflation-indexed budget spending, will have to be passed in the legislature with a two-thirds majority. For now though, the government appears to have the numbers.16

External problems also abound. Brexit will weigh on global markets, and emerging economies such as Brazil will be no exception to this volatility. That could, in turn, put pressure on Brazil’s currency and push bond yields up. A global shock could also dent exports, a key source of sustenance for Brazil’s economy of late. And while markets have given the benefit of doubt to the new administration, they can be unforgiving if the administration fails to deliver on reforms. Latin American economies, including Brazil, have learnt this the hard way. The govern-ment will do well to keep that in mind.

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3rd Quarter 2016

Endnotes

1. Andrew Downie, “Venues ready, but many challenges remain for Rio Games,” Reuters, April 27, 2016, http://www.reuters.com/article/us-olympics-rio-100days-idUSKCN0XN2CP.

2. BBC, “Zika crisis: WHO rejects ‘move Rio Olympics’ call,” May 28, 2016, http://www.bbc.com/news/world-latin-america-36401150.

3. Marcela Ayres and Lisandra Paraguassu, “Brazil agrees to $15 billion in state debt relief through 2018,” Reuters, June 20, 2016, http://www.reuters.com/article/us-brazil-politics-idUSKCN0Z7053.

4. Akrur Barua, “Brazil: Yearning for the good times,” Global Economic Outlook, Q2 2016, Deloitte University Press, April 29, 2016, http://dupress.com/articles/global-economic-outlook-q2-2016-brazil/.

5. Joe Leahy and Samantha Pearson, “Brazil: Tales of everyday agony,” Financial Times, May 15, 2016, http://www.ft.com/cms/s/0/1c067b52-1829-11e6-bb7d-ee563a5a1cc1.html#axzz4CIp0blBO.

6. Alonso Soto, “Brazil mulls time limit on spending ceiling: Sources,” Reuters, June 14, 2016, http://www.reuters.com/article/us-brazil-economy-spending-idUSKCN0Z02Q9.

7. “Brazil court to assess legality of BNDES’s Treasury loan repayment,” Reuters, June 1, 2016, http://www.reuters.com/article/brazil-budget-accounts-idUSL1N18T26M.

8. Paulo Trevisani, “Brazil’s acting president Michel Temer vows to tackle insolvent pension system,” Wall Street Journal, May 24, 2016, http://www.wsj.com/articles/brazils-acting-president-michel-temer-vows-to-tackle-insolvent-pension-system-1464132981.

9. Lisandra Paraguassu and Alonso Soto, “Brazil’s Temer wants proposal for pension reform within 30 days,” Reuters, May 16, 2016, http://www.reuters.com/article/us-brazil-politics-idUSKCN0Y72CG.

10. Anthony Boadle and Lisandra Paraguassu, “Brazil recovery on track despite political turmoil: Top Temer aide,” Reuters, June 2, 2016, http://www.reuters.com/article/us-brazil-politics-padilha-idUSKCN0YO23F.


12. Ibid.

13. Ibid.

14. BBC, “Brazil tourism minister resigns over graft scandal,” June 16, 2016, http://www.bbc.com/news/world-latin-america-36556214.

15. Trevisani, “Brazil’s acting president Michel Temer vows to tackle insolvent pension system”; Paraguassu and Soto, “Brazil’s Temer wants proposal for pension reform within 30 days.”

16. Anna Edgerton and Mario Sergio Lima, “Temer proposes spending cap in effort to fix Brazil’s budget,” Bloomberg, June 15, 2016, http://www.bloomberg.com/news/articles/2016-06-15/temer-proposes-spending-cap-in-attempt-to-fix-brazil-budget.

Brazil

45


MEXICO

Embracing the advantage of its northern neighbor By Danny Bachman

THAT the Mexican economy is very closely tied to its northern neighbor is not news. Lately, this “not-news” has been both good and bad:

bad because disappointing growth in the United States has translated into disappointing growth in Mexico; good because Mexico still has an advantage over other emerging economies. Similar economies that are more closely tied to Europe have had to cope with European stagnation, and many other resource-dependent economies—including other countries in Latin America—have felt the recent Chinese slow-down. In contrast, the United States has re-mained a relatively sta-ble source of economic growth for Mexico.

Before the 1990s, Mex-ico attempted to keep its distance from its neighbor. That was per-haps understandable given the past history of the two countries. But the attempt to “go it alone” in economic growth yielded little beyond some finan-cial crises and an infamous political business cycle. Since the resolution of the 1980s’ debt crisis, Mexi-co has instead embraced the advantages of its large

neighbor. There are some signs that this strategy may be starting to pay off.

Follow the leaderThe close connection between the two most popu-lous North American economies can be seen starkly in figure 1. Although the common business cycle originates in the United States, Mexican GDP is

more volatile than US GDP. It fell more dur-ing the two US reces-sions since 1995 and grew faster during the post 2008–09 recovery. This reflects Mexico’s integration with the US manufacturing sec-tor, which itself is more cyclical than the rest of the US economy.

The common cycle is new. Before the 1990s, the government ramped up spending in the year before each election, and the new president (Mexican presidents serve only one term of six years) then would spend two or three years tamping down spending and trying to get the budget under control. This resulted in a six-year

Since the 1990s, Mexico has traded that cycle for coor-dination with the

US business cycle.

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3rd Quarter 2016Mexico

boom-bust cycle patterned after the presidential term, which was completely unconnected to busi-ness cycles in the United States.1 Since the 1990s, Mexico has traded that cycle for coordination with the US business cycle.

This makes it seem like Mexico’s relationship with the United States is a choice. In reality, it is a fact of geography that post–World War II Mexican policy-makers attempted to ignore for several decades. But Mexicans have finally realized that their fate—like that of the other North American Free Trade Agree-ment (NAFTA) partner, Canada—is closely connect-ed to that of the United States.

Taking medicineThis eventually resulted in Mexico’s adopting a “take your medicine” approach to economic policymaking. Even before the 1994 peso crash (and the US-orga-nized rescue), Mexico had taken a number of steps to move away from its earlier attempt to decouple

Vietnam and India—neither of which has the geographical advantage of Mexico—have seen growth take off (not to even mention China). What is the secret sauce that allowed those countries—with surely just as many fundamental is-sues as Mexico—to reach such high rates of growth?

47


Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: IMF/Haver Analytics.

Mexico United States

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Mexico’s flexible exchange rate helped to miti-gate the impact of the US financial crisis and re-cession. As economists predicted, some of the impact of lower demand in the United States was absorbed by improved Mexican competi-

tiveness as the exchange rate depreciated.

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3rd Quarter 2016


ChinaVietnamIndiaIndonesiaArgentinaMexicoSouth AfricaBrazil0

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Figure 2. Growth in selected emerging markets20-year average per capita GDP growth rate20-year average per capita GDP growth rate

from the global economy (and the United States). After the passage of NAFTA, Mexican authorities generally attempted to follow the Washington Con-sensus, although domestic political opposition has slowed reform. This approach stressed liberalizing financial and product markets, making labor mar-kets more flexible, and adopting floating exchange rates. As part of the approach, Mexican authorities considered the country’s proximity to the United States as an opportunity rather than a curse. They began pushing back against the entrenched inter-ests that preferred an isolated, less dynamic coun-try that protected some of its citizens—unionized workers and politically connected businesses, for example—against outside competition.2

Figure 2 shows the disappointing results of Mexico’s reform attempts so far. Mexico is not alone, as Latin American economies in general have done poorly compared with East Asia. Mexicans might wonder why they haven’t seen better results. Vietnam and India—neither of which has the geographical advan-tage of Mexico—have seen growth take off (not to even mention China). What is the secret sauce that

allowed those countries—with surely just as many fundamental issues as Mexico—to reach such high rates of growth? The answer is not clear.

Despite such concerns, Mexican policymakers continue to believe that market-friendly structural changes are the key to long-term prosperity. In 2012, Mexico’s political leaders doubled down. The main political parties agreed on an ambitious framework for modernizing the Mexican economy (the Pacto de México), and Congress has indeed passed a num-ber of broad reforms in areas such as education and telecom.3

Mexican authorities have also adopted responsible monetary and exchange rate policy. Before the re-forming spirit took hold in response to the 1980s’ debt crisis, Mexico attempted to maintain a fixed exchange rate. That was to the advantage of Mexi-can consumers (especially those wealthy enough to afford imported goods), but high inflation in Mexico created a series of currency crises. The 1994 crisis was the last straw. Mexico let the peso float in early 1995. Not long before, the government had given

Mexico

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the Bank of Mexico autonomy and a single mandate of keeping inflation in check.

The results of the new monetary policy speak for themselves (figure 3). The exchange rate became more volatile, and the trend has been toward de-preciation, as the average dollar/peso rate has more than doubled. But the inflation rate has become less volatile—and much lower. Even better, Mex-ico’s flexible exchange rate helped to mitigate the impact of the US financial crisis and recession. As economists predicted, some of the impact of lower demand in the United States was absorbed by im-proved Mexican competitiveness as the exchange rate depreciated.

So it would be wrong to say that the Mexican au-thorities’ willingness to stick to the path of reform

has been fruitless. The turn to an independent mon-etary policy has been a huge success in eliminating the previous pattern of exchange rate crises and in keeping inflation under control. With luck, the harder-to-implement structural reforms will suc-ceed as well.

Moderate growth continuesMexico’s GDP growth accelerated a bit in the first quarter, to 0.8 percent for the quarter. That kept up Mexico’s record of consistent economic growth (between 2 and 3 percent) since the second quarter of 2014. It’s an enviable record given the volatility of global financial markets and the changing risks in the global economy over that period. Mexican growth continued at moderate rates even as US

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3rd Quarter 2016

growth slowed in Q4 and Q1—although some may say that this supports the hypothesis that US GDP figures suffer from seasonality problems.4 At the same time, Mexico’s inflation remains restrained (also between 2 and 3 percent per year).

Mexicans would, of course, prefer to see higher growth. The one-two punch of lower oil prices in 2014–15 plus the recent slowdown in US manufac-turing has been a formidable drag on the Mexican economy. Domestic demand has remained strong enough to keep GDP growing, although the Q1 fig-ures show slower growth in domestic demand as well. Absent a pickup in US growth (and, even bet-

ter, global growth), Mexico’s economy will eventu-ally slow even more.

Mexico’s long-term problems remain. Productivity growth is slow: The Bank of Mexico estimates that output per worker in manufacturing was virtually unchanged over the past three years. And Mexico’s headlines are still all too often dominated by vio-lence, whether related to teachers’ unions (as hap-pened in June in Oaxaca5) or drug cartels. But the Mexican economy remains vibrant, and Mexican authorities remain committed to market-based re-forms.

Endnotes

1. See, for example, Maria de Los Angeles Gonzalez, “Do changes in democracy affect the political budget cycle? Evidence from Mexico,” Review of Development Economics 6, no. 2 (2002): pp 204–24.

2. For a more complete history of Mexico’s post–World War II economy and reforms, see Timothy J. Kehoe and Felipe Meza, “Catch-up growth followed by stagnation: Mexico, 1950–2010,” Federal Reserve Bank of Minneapolis Research Department working paper 693, November 2012.

3. See Organization for Economic Development, Economic surveys: Mexico, January 2015, for a description of some of the specific reforms from the pact and an analysis of their impact on the Mexican economy.

4. Patricia Buckley, “United States: Another negative start—or was it?” Global Economic Outlook, Q3 2015, Deloitte University Press, July 23, 2015, http://dupress.com/articles/global-economic-outlook-q3-2015-united-states/.

5. Associated Press, “Clashes between police, teachers leave 6 dead in Mexico,” New York Times, June 20, 2016, http://www.nytimes.com/aponline/2016/06/19/world/americas/ap-lt-mexico-teacher-protests.html?_r=0.

The one-two punch of lower oil prices in 2014–15 plus the recent slowdown in US manufacturing has been a formidable drag on the Mexican economy.

Mexico

51


SOUTH AFRICA

In search of an economic foothold By Lester Gunnion

SOUTH Africa’s economic challenges have in-tensified. The economy contracted in the first quarter of 2016, as mining production and ex-

ports came under pressure from subdued commod-ity prices, weak external demand, a strong US dol-lar, and sluggish global trade. Furthermore, weak growth, political unrest, and deteriorating funda-mentals have resulted in the South African rand slipping and inflation climbing. In June, South Af-rica narrowly escaped a rating downgrade to below investment status.1 Even though the economy has some time to mend before it comes under the scru-tiny of ratings agencies again, the route to growth is unclear, especially as monetary and fiscal policy is tightened. Furthermore, the United Kingdom’s de-cision to exit the European Union is likely to add to global uncertainty, which in turn will add to South Africa’s burden. Policymakers are likely to face sev-eral difficulties in navigating internal and external challenges. The short-term outlook is therefore like-ly to be rather dim.

A grim picture for growth, mining, and exportsEconomic growth slipped into negative territory in Q1 2016. Real GDP, measured from a production standpoint, contracted at a seasonally adjusted an-nualized rate of 1.2 percent in Q1, down from growth of 0.4 percent in the previous quarter.2

Mining was the major drag on overall growth. The sector shrank 18.1 percent, resulting in a 1.5-per-centage-point subtraction from growth in real GDP (figure 1). In Q1, the mining sector was hit by lower production of iron ore and platinum group metals. The drop in production is linked to a downward trend in global commodity prices, stemming from weak global demand, growing uncertainty, and an appreciation of the US dollar. Production has also been hit by rising costs of inputs and labor. The Q1 decline in mining production also caused a contrac-tion in both the electricity and transport sectors due to weak demand.

Analyzed from an expenditure-on-GDP standpoint, the South African economy shrank at a seasonally adjusted annualized rate of 0.7 percent in Q1. This is the first time that South Africa has included an ex-penditure-on-GDP statistic in its quarterly release. The expenditure lens, which puts overall demand in focus, paints an equally grim picture. Household spending, net investment, and trade registered de-clines, while government consumption grew, albeit at a slower pace than the previous quarter. Trade was hit the hardest, with both exports and imports declining at an annualized rate of 7.1 percent. The decline in exports shaved off 2.2 percentage points from overall growth in expenditure on GDP in Q1. A decline in exports, particularly exports from South Africa’s mining sector, links back to the overarching trends of weak external demand, global uncertainty,

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Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Statistics South Africa, Deloitte Services LP economic analysis.

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South Africa

53


a strong dollar, and sluggish global trade, catalyzed by a slowdown in China. The decline in GDP from both a production as well as an expenditure per-spective indicates that South Africa faces both inter-nal supply-side challenges as well as weak internal and external demand.

Different factors likely to keep exports under pressureSouth Africa’s exports, which constitute nearly a third (30 percent) of all expenditure on GDP, are likely to remain under duress given the current global economic backdrop. In particular, economic developments in South Africa’s major export desti-nations are likely to work against exporters. China, which is South Africa’s single-largest export desti-nation (accounting for roughly 10 percent of all ex-ports in 2015), is slowing as it attempts to transition away from fixed investment as the primary driver of economic growth. As a result, Chinese demand for commodities has declined. This is pertinent for

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: China Customs/Haver Analytics, Deloitte Services LP economic analysis.

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Figure 2. China’s imports of South Africa’s major commodities (USD million)

A decline in exports, par-ticularly exports from South Africa’s mining sector, links

back to the overarching trends of weak external de-

mand, global uncertainty, a strong dollar, and slug-

gish global trade, catalyzed by a slowdown in China.

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3rd Quarter 2016

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: International Monetary Fund, Deloitte Services LP economic analysis.

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Figure 3. Indices of primary commodity prices

South Africa because 84 percent of all South Afri-ca’s exports to China are either mineral products or base metals. In fact, South Africa is, on the whole, a commodity-exporting nation: Mineral products, precious stones and metals, and base metals consti-tuted more than half (54 percent) of the country’s total exports in 2015.3

Figure 2 shows that China’s imports of minerals and metals from South Africa have declined in dol-lar terms, while figure 3 shows a decline in the price of industrial inputs and metals. Commodities are priced in US dollars, so a strong dollar means that commodities cost fewer dollars than before. This re-sults in commodity exporters such as South Africa earning fewer dollars for their exports. Another fac-tor influencing South Africa’s exports to China is the devaluation of the renminbi. China’s currency is at a five-year low against the dollar, with further de-valuation a possibility. A weak yuan makes Chinese imports of commodities, priced in dollars, compar-atively more expensive, increasing downward pres-sure on demand.

Apart from China, South Africa’s large single-coun-try export destinations include the United States (9 percent of exports) and Japan (6 percent of exports). However, despite the strong dollar and appreciat-ing Japanese yen, the value of imports (in dollars and yen respectively) from South Africa to both of these destinations has declined (figure 4). Addi-tionally, the Eurozone, an important export market for South Africa (the European Union as a whole accounted for 24 percent of South Africa’s exports in 2015), has also displayed tepid demand.4 As a result, the Eurozone’s imports from South Africa have remained flat, as seen in figure 5. Moreover, Brexit is likely to have repercussions on South Af-rica’s trade with both the United Kingdom and the European Union, particularly due to the uncertainty surrounding the renegotiation of trade deals in the short term.

Besides a drop in the value of South Africa’s exports, export volumes have also flattened over the last four quarters, as shown in figure 6. The recent dip in vol-ume stems from weak global trade (figures 7 and 8).

South Africa

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Source: Census Bureau/Ministry of Finance Japan/Japan TariffAssociation/Haver Analytics, Deloitte Services LP economic analysis.

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Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: International Monetary Fund/Haver Analytics, Deloitte Services LP economic analysis.

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South Africa

57


Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: World Trade Organization, Deloitte Services LP economic analysis.

-12

-10

-8

0

-2

2

4

6

-6

-4

2007Q1

2008Q1

2009Q1

2010Q1

2011Q1

2012Q1

2013Q1

2014Q1

2015Q1

2016Q1

2006Q1

World trade in volumes, seasonally adjusted, quarterly percentage changeWorld trade in volumes, seasonally adjusted, quarterly percentage change

Figure 8. Global trade in terms of volume

Not only has the value of global trade dipped, the volume of trade has also been suppressed.

The interplay of all these factors is likely to keep ex-ports under pressure. This is likely to contribute to South Africa’s current account deficit.

External and internal challenges likely to make policy formulation difficultSouth Africa’s current account deficit has been in negative territory since Q2 2003. The trade deficit contributes a fifth (an average of 22 percent over the last three quarters) to the total current account deficit. However, net foreign investment income payments account for 60 percent of the country’s current account deficit.5 Furthermore, since Q4 2014, net foreign nondirect investment income pay-ments have become more prominent (figure 9). As a result, net foreign investment income payments

are no longer dominated by net payments to direct investors. The risk associated with the rising share of payments to nondirect investors is that short-term foreign portfolio investments, or hot money, could flow out of the South African economy quickly if better risk returns are available elsewhere or if South Africa’s economy deteriorates further.

Brexit poses a threat in the short term because Brit-ish banks’ claims on South African entities stand at 178 percent of South Africa’s foreign currency reserves.6 In the medium term, the US Federal Re-serve’s (Fed’s) normalization of monetary policy also poses a threat. For the time being, the Fed’s gradual, cautious approach is likely to be advanta-geous to South Africa as well as to other emerging markets.

A further complication is that South Africa also runs a budget deficit. In fact, the budget has been in deficit every year since 2008.7 Alongside weak eco-nomic growth and political unrest, a budget deficit

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3rd Quarter 2016


Source: South African Reserve Bank/Haver Analytics, Deloitte Services LP economic analysis.

0

10,000

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,000

2013Q1

2014Q1

2015Q1

2016Q1

2012Q1

Foreign direct investment net income paymentsForeign nondirect investment net income payments

ZAR millionZAR million

Figure 9. South Africa net income payments, current account balance

The conundrum that the central bank faces is that the price rise and subse-quent tightening of mon-

etary policy come at a time when the economy is at risk of entering a technical re-

cession. However, arresting inflation and supporting the rand also remain key con-cerns for the central bank.

South Africa

59


and a trade deficit have resulted in downward pres-sure on the rand, which is further complicated by Brexit. As a result, despite recovering some ground between mid-January and the beginning of May, the rand has depreciated roughly 33 percent against the dollar since the beginning of 2015 (as of June 24, 2016). A weak rand, coupled with the fact that the country is in the grip of severe drought, has resulted in consumer prices rising above the central bank’s upper limit of 6 percent. The consumer price index rose 6.5 percent in May from a year ago. Food prices, in particular, are a cause for concern, rising 12.3 percent in May.8 In response, the South African Reserve Bank (SARB) has been tightening monetary policy: The policy in-terest rate has edged up from 5.0 percent at the start of 2014 to 7.0 percent as of May 2016. The conundrum that the central bank faces is that the price rise and subsequent tighten-ing of monetary policy come at a time when the economy is at risk of entering a technical recession. However, arresting inflation and sup-porting the rand also remain key concerns for the central bank. Furthermore, real interest rates need to be kept attractive, especially because South Af-rica’s current account deficit is funded (and in part fueled) by foreign investment.

Fiscal policy is also likely to remain tight. The bud-get for the fiscal year 2016–17, released in February, outlined measures to curb spending and increase taxation in order to rein in the budget deficit. This is crucial if South Africa is to avoid a rating down-grade to below investment status. Equally impor-

tant is achieving economic growth. However, in an environment marked by weak internal and external demand, declining confidence among consumers and businesses alike, and tight monetary and fiscal policy, growth will be hard to come by. In such a situation, South Africa’s persistent weaknesses are underscored. Unemployment, for instance, climbed to an astounding 26.7 percent in Q1, up from 24.5 percent in the previous quarter. Low labor force participation (58.7 percent in Q1 2016, of which 73

percent are employed) means that just above 40 percent of South Af-rica’s total population is employed.9

Productivity also has been a problem: Real output per employee has declined year over year for the last five quarters. As productiv-ity declines, labor costs continue to rise. Unit la-bor cost in the nonagri-cultural sector climbed an average of 5 percent year over year over four quarters in 2015.10 An economic environment of rising prices and low growth could mean that business owners will

not be able to meet the demands of trade unions, therefore leaving room for labor strikes that disrupt production and hamper economic growth.

A positive sliver in South Africa’s otherwise gloomy economic situation is the relative absence of roll-ing power cuts in 2016 compared with 2015, mainly due to the renewal of aging coal-powered plants. In similar fashion, South Africa will probably have to make the best use of all the resources at hand. In such a scenario, policy formulation is likely to re-main extremely challenging.

Continued economic weakness could also put South Africa un-

der the lens of ratings agencies later in the year. A downgrade

to below investment status would make

an already uphill jour-ney a lot steeper.

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3rd Quarter 2016

GDP growth likely to remain weak in the short termSouth Africa’s economy runs the risk of entering a technical recession, its first since 2009. The myriad internal challenges and external headwinds facing the economy are likely to keep growth subdued. The International Monetary Fund and the SARB both forecast a growth rate of just 0.6 percent in 2016.11 However, global developments stemming from Brexit are likely to lower forecasts. Continued economic weakness could also put South Africa un-der the lens of ratings agencies later in the year. A downgrade to below investment status would make an already uphill journey a lot steeper. South Africa desperately needs to find an economic foothold if it is to escape such a plight.

Endnotes

1. “South Africa escapes S&P downgrade to junk,” Financial Times, June 3, 2016, http://www.ft.com/fastft/2016/06/03/south-africa-escapes- sp-downgrade-to-junk/.

2. Statistics South Africa, “Gross domestic product: First quarter 2016,” June 8, 2016, http://www.statssa.gov.za/publications/P0441/P04411st-Quarter2016.pdf. All statistics in this section are from this source unless otherwise stated.

3. Department of Trade and Industry, South African Revenue Service/Haver Analytics, “South Africa international trade and BOP: Trade in goods by country and commodity, millions of rand, monthly, NSA,” accessed June 24, 2016; Deloitte Services LP economic analysis.

4. Ibid.

5. South African Reserve Bank/Haver Analytics, “South Africa: Balance of payments, including trade with BLNS countries in Q1 2010, balance on current account, SAAR, millions of rand, quarterly,” accessed June 24, 2016; Deloitte Services LP economic analysis.

6. Natasha Doff, “Rand snared and ruble spared Brexit risk in U.K. finance web,” Washington Post with Bloomberg, June 16, 2016, http://washpost.bloomberg.com/Story?docId=1376-O8JV136KLVRN01-5AGFIM27KH58GA9K6GPL3K03QE.

7. National Treasury/Haver Analytics, “South Africa: Main budget framework budget balance, millions of rand, annual, fiscal year April 1 to March 31,” accessed June 24, 2016; Deloitte Services LP economic analysis.

8. Statistics South Africa/Haver Analytics, “South Africa: Consumer price indexes, all areas (national), SA, December 2012=100, monthly, year-over-year percent change,” accessed June 24, 2016; Deloitte Services LP economic analysis.

9. Statistics South Africa/Haver Analytics, “South Africa: Employment and unemployment, quarterly, NSA,” accessed June 24, 2016; Deloitte Services LP economic analysis.

10. South African Reserve Bank/Haver Analytics, “South Africa: Productivity and costs, nominal unit labor cost, SA, quarterly, year-over-year percent change,” accessed June 24, 2016; Deloitte Services LP economic analysis.

11. International Monetary Fund, “South Africa and the IMF,” https://www.imf.org/external/country/ZAF/, updated June 13, 2016; South African Reserve Bank, “Selected forecast results: MPC meeting May 2016,” May 19, 2016, http://www.resbank.co.za/Lists/News%20and%20Publica-tions/Attachments/7300/Forecast%20May%202016.pdf.

South Africa

61


INDIA

Slow and steady may not be enough to win the race By Dr. Rumki Majumdar

IT has been two years since the Narendra Modi government came to power with a historic win in the national elections. It was expected that the

new government would embark upon much-needed economic reforms and radically restructure the In-dian economy. The actual performance record of the government, however, has been a mixed bag.

Several macroeconomic fundamentals have im-proved in the past two years. Even if one sets aside the discrepancies in growth data, there is hardly any doubt that India is among the better-performing na-tions in terms of growth and stability. Inflation has come down, thanks to falling oil prices. Although food inflation has remained vulnerable and the re-cent firming of oil prices has pushed up consumer prices, the overall inflation expectation remains an-chored. The current account deficit has narrowed, and the government has pursued its commitment to adhere to fiscal consolidation.

While it can be argued that global conditions, by way of low oil prices, have helped improve the key economic fundamentals, the government deserves some credit for its efforts in ushering in transpar-ency in system and procedures; emphasizing good governance; undertaking initiatives to improve the investment climate; and taking a few bold initiatives, such as showing restraint in raising minimum sup-port prices, which play a key role in food inflation.

According to the 2016 Deloitte India CFO survey, business leaders continue to remain optimistic about the Indian economy: Not only did 90 percent of the CFOs express optimism about the mid-term economic outlook, 94 percent expressed long-term economic confidence. Close to 60 percent expressed satisfaction with the timeline and effectiveness of government initiatives.1

However, there are a few areas where the glass re-mains half empty. These include uncertainty in the tax environment, poor implementation of structural reforms and regulatory impediments, slow reforms in the banking sector, the failure to transform his-torically weak relations between the center and the states, and the lack of an assertive stance to improve India’s trade, especially exports.

Economic performanceGDP growth in Q4 of FY 2015–16 accelerated to 7.9 percent year over year.2 The full-year growth in FY 2015–16 (the year ending March 2016) accelerated to 7.6 percent from 7.2 percent in FY 2014–15. Al-though methodological concerns continue to cast doubts on the buoyant growth data, there is no doubt that the economy is growing at a steady pace despite global uncertainty.

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3rd Quarter 2016

Expenditure data show that the improvement in GDP growth in Q1 was largely driven by higher pri-vate consumption, indicating that domestic demand is holding up well. Lower inflation has also helped improve households’ purchasing power (table 1).

However, investment declined for the first time since Q1 of FY 2013–14. Growth momentum had started to slow in Q3 of FY 2015–16, and growth contracted by 2.4 percent in the following quarter, primarily due to a reduction in fixed investments (-1.9 percent). This probably reflects the slowdown in capital expenditure by the center and the state governments as they try to adhere to the targeted fiscal consolidation. That said, growth in invento-ries slowed in Q4 of FY 2015–16, which bodes well

for investment in the coming quarters. Government spending on infrastructure (roads and railways) and a revival of private investment in response to rising domestic demand will likely be the key deter-minants of investment growth. While exports con-tinued to contract for the fifth consecutive quarter, the drag on GDP from net exports was relatively small due to falling imports as oil prices remained low. Slowing global growth and poor demand in an uncertain global economic environment have adversely impacted Indian exports. Consequently, the manufacturing sector, which accounts for 60 percent of the export basket, has failed to take off despite the government’s efforts to push the sector through various initiatives.3

India

63


The current account deficit fell 1.1 percent of GDP this fiscal year to the lowest level in nine years, pri-marily because of falling oil prices.4 There has been a significant improvement in foreign direct invest-ment (FDI) inflows, which grew 31 percent in FY 2015–16. However, the overall capital account more than halved from $90 billion to $41 billion due to negative net portfolio investments, which reversed from an inflow of $41 billion in FY 2014–15 to an outflow of $4 billion in FY 2015–16 (figures 1 and 2).

The government is expected to meet the fiscal defi-cit target of 3.9 percent of GDP in FY 2015–16, and has pledged to reduce it further to 3.5 percent in the next year.5 By adhering strictly to the fiscal road-map, the government has sent out a clear message that the goals are to accelerate growth and ensure macroeconomic stability.

Government spending on infrastructure (roads

and railways) and a revival of private investment in

response to rising do-mestic demand will likely be the key determinants

of investment growth.

Table 1. GDP and the expenditure side

Source: Central Statistical Organization, May 2016.

FY 2015–16

Q1 Q2 Q3 Q4

GDP 7.5 7.6 7.2 7.9

Consumption 5.7 5.7 7.4 7.6

Private 6.9 6.3 8.2 8.3

Government -0.2 3.3 3.0 2.9

Investments 6.6 9.6 2.0 -2.4

Fixed 7.1 9.7 1.2 -1.9

Inventories 3.6 5.4 7.7 5.6

Valuables 0.6 12.4 13.5 -17.2

Exports -5.7 -4.3 -8.9 -1.9

Imports -2.4 -0.6 -6.4 -1.6

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3rd Quarter 2016

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Ministry of Finance, Government of India, May 2016.

FDI inflow in India Net FPI investment Businessinvestment

-20,000

20,000

0

40,000

100,000

60,000

80,000

2012 2013 2014 2015

USD millionUSD million

Figure 1. Capital account balance: FDI grew while foreign portfolio investment (FPI) turned negative

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Reserve Bank of India, Ministry of Finance, Government of India, May 2016.

Central government gross fiscal deficitCurrent account balance

0

1

2

3

4

5

6

7

2008–09 2009–10 2010–11 2011–12 2012–13 2013–14 2014–15 2015–16

Percentage of GDPPercentage of GDP

Figure 2. Fiscal and current account balance

India

65


Glass half full: Major initiatives and reformsThe government has undertaken several initiatives and reforms in order to propel India to a higher growth path. Various programs and schemes such as “Make in India,”

“Digital India,” “Smart Cities,” “Startup In-dia,” and “Skill India,” among others, were launched with the in-tention of improving the manufacturing abil-ity of the country, pro-moting innovation and entrepreneurship, cre-ating job opportunities, and improving infra-structure and skills.

The government also undertook several diffi-cult structural reforms, such as the passage of the bankruptcy code and bills to foster fair play and transpar-ency in the allocation of natural resources.6

Rationalizing existing laws, encouraging FDI, increasing governance efficiency, and, most importantly, the gov-ernment’s willingness to seek feedback from industries on challenges in doing business have improved the overall business environment. According to the World Bank’s Doing Business report, India moved up four spots and now ranks at 130 out of 189 countries in ease of doing business.7 Although moderate, the improvement in the investment climate is reflected in the rise in FDI in the past year (figure 1).

The Indian government has taken advantage of the oil price windfall to reduce subsidies by deregulat-ing fuel prices and increasing excise taxes, which have improved the fiscal balance. The government

is also exploring how to ensure subsidies go to only those who need them, and thereby checking waste and leakages. Total subsidies are now less than 2 percent of GDP.8

The government has also started initiating labor market reforms in a prudent manner. Instead of in-

troducing the reforms at the center, the govern-ment has encouraged states to implement these reforms. The pos-sible logic may be that once states start imple-menting reforms and see the benefits, there will be little resistance to accepting reforms at the center. Some states such as Rajasthan, Mad-hya Pradesh, and Ma-harashtra have already started amending labor laws.

According to the 2016 Deloitte India CFO sur-vey, business leaders are highly optimistic about the economic outlook (figure 3). The survey suggest that many CFOs support these initia-tives and reforms, and are upbeat about the expected outcomes, al-though they agree that

the effectiveness of these can fully be assessed only after a while.9

Glass half emptyHowever, the survey has pointed to several chal-lenges that are impacting CFOs’ risk-taking ability and investment growth. Regulatory impediments, concerns over uncertainty in the tax environment, and delays in clearing goods and services tax (GST) bills and land acquisition bills are eroding business confidence. Structural reform progress in three

Instead of introduc-ing the reforms at the

center, the govern-ment has encouraged states to implement these reforms. The possible logic may be that once states start implementing

reforms and see the benefits, there will be little resistance

to accepting re-forms at the center.

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3rd Quarter 2016


Source: Deloitte, Still reluctant to spend: 2016 Q1 Global CFO Signals, 2016, http://www2.deloitte.com/us/en/pages/advisory/articles/global-cfo-signals.html.

Very optimistic Neutral Optimistic Not optimistic

0%

10%

20%

30%

70%

60%

40%

50%

Next 1 year 2–3 years 4–5 years

2%

38%

47%

13%

22%

68%

8%

2%

47% 47%

5%1%

Figure 3. Deloitte CFO Survey: Economic outlook

areas—GST, banking, and trade—has been signifi-cantly delayed.

Goods and services tax: Different Indian states have different and complicated regulations, licens-ing schemes, and tax systems, which has impacted investment decisions and the business environment across India. The GST bill is expected to streamline the process of taxation and make it more effective. The bill, which was supposed to be functional this fiscal year, still needs to be passed in the upper house, where the government lacks majority. The government is expecting to bring the GST bill for consideration during the monsoon session in July–August 2016. If passed, it will likely boost business sentiments.

The banking sector: Reforms in the banking sec-tor have remained unimpressive. The sector contin-ues to be dominated by public sector banks (PSBs), which account for over 70 percent of the total bank-ing system assets. This is not consistent with the modern banking system and the growth model for India.

While the lack of coop-eration between the two houses of parliament has been an important rea-son for the delay, the lack of assertion and inter-nal political conflicts are also impeding the abil-ity of the government to take up bold reforms.

India

67


Gradual reforms in the banking sector is one of the primary reasons for the decline of banking and poor credit growth in recent years (figure 4). Despite rel-atively high real interest rates, growth in aggregate deposits for all scheduled commercial banks fell to a historic low of 9.9 percent in FY 2015–16. Growth was 19.5 percent in FY 2009–10 and has steadi-ly declined since then. On the other hand, bank credit growth, which was as high as 25 percent in FY 2009–10, declined to 9 percent in the past fiscal year. While loan growth in all sectors has declined after the 2008 global financial crisis, the industry and services sectors have suffered the most due to rising corporate leverage and the concentration of risks in a few stressed sectors, such as iron, steel, power, and communication.10 This is reflected in the increase in nonperforming assets in banks’ balance sheets.

When the Modi government came to power two years ago, banking conditions were still good, and a move to privatize the PSBs might have gone a long

way in overhauling the entire banking system. That window of opportunity is probably gone now, given the high proportion of nonperforming assets, banks’ low profitability, and poor operating environment. The valuation of these banks is currently low, and there are not many investors interested in these PSBs.

Trade: India has been signing trade agreements at a blistering pace in recent years. However, the pur-pose of these agreements is not being met. Rising trade agreements have resulted in a stronger pres-ence of enterprises from partner countries in the Indian market. Consequently, India has witnessed a sharp rise in imports following these agreements. On the other hand, exports have failed to gain mo-mentum. Poor export competitiveness, a weak man-ufacturing sector, infrastructure bottlenecks, spe-cial economic zones not reaching their full potential, and India’s poor link to global value chains are hurt-ing India’s export ability. Moreover, poor domestic infrastructure and lack of awareness among indus-

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Reserve Bank of India, May 2016.

Aggregate deposit growthOutstanding credit growth

5

10

15

20

25

2008–09 2010–11 2012–13 2014–15

Figure 4. Banking business and poor credit growthYear-over-year percentageYear-over-year percentage

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3rd Quarter 2016

tries and exporters, especially those in the medium and small-scale enterprises, have limited the ben-efits of trade agreements. In addition, India’s delay in taking firm action in participating in new forms of trading arrangements and deciding on the pace and extent of such participation is hurting trade prospects.

In the right direction, but lacking paceThe Modi government has undertaken a few land-mark reforms since it came to power two years ago. However, the pace of reforms remains slow. Systemic infrastructure bottlenecks, lack of trans-

parency, and uncertainty in corporate governance rules continue to impact the environment for doing business and business sentiments. While the lack of cooperation between the two houses of parliament has been an important reason for the delay, the lack of assertion and internal political conflicts are also impeding the ability of the government to take up bold reforms. The modernization of India that Modi promised during the 2014 election is mired in chal-lenges. If the government wants to fulfill its election promises, it has to be more assertive in speeding up reforms. The government has three more years, and only time will tell if it can make a meaningful change in its stance to drive the economy on the path that Modi had promised.

Endnotes

1. Deloitte, Still reluctant to spend: 2016 Q1 Global CFO Signals, 2016, http://www2.deloitte.com/us/en/pages/advisory/articles/global-cfo-signals.html.

2. Growth is measured in year-over-year terms, unless specified otherwise.

3. Prachi Priya and Anuj Agarwal, “Exports need a Make-in-India push,” Financial Express, March 16, 2015, http://www.financialexpress.com/article/fe-columnist/exports-need-a-make-in-india-push/53963/.

4. Reserve Bank of India, May 2016.

5. Ministry of Finance, Government of India, Key features of Budget 2016–2017, 2016, http://indiabudget.nic.in/ub2016-17/bh/bh1.pdf.

6. Mines and Minerals (Development and Regulation) Amendment Bill, 2015; Coal Mines (Special Provisions) Bill, 2015.

7. World Bank Group, Doing business 2016: Measuring regulatory quality and efficiency: Economy profile—India, http://www.doingbusiness.org/reports/global-reports/~/media/giawb/doing%20business/documents/profiles/country/IND.pdf.

8. Ministry of Finance, Government of India, “Chapter 2: Public finance,” Economic Survey 2016–17, 2016, http://indiabudget.nic.in/es2015-16/echapvol2-02.pdf.

9. Deloitte, Still reluctant to spend.

10. Reserve Bank of India, May 2016.

India

69


SPECIAL TOPIC

The oil mighty: The economic impact of oil price fluctuations By Dr. Rumki Majumdar

IN 1973, Egypt and Syria waged a surprise war on Israel, which soon divided many countries into supporters of either side. Subsequently, several

oil-exporting Arab nations curtailed oil production (known as “the oil embargo”), quadrupling oil pric-es within a quarter. This oil crisis was one of the big-gest factors that pushed some oil-consuming, indus-trialized nations such as the United States and the United Kingdom into an economic recession that lasted over a year.1 History repeated itself when dis-ruptions in Iran’s oil production during the Iranian revolution, followed by the Iraq-Iran war, caused oil prices to skyrocket in 1979–80. This time, in addi-tion to a supply shock, increased inventory demand in anticipation of supply shortages and rising global demand contributed to the oil price rise. The price shocks had a substantial impact on US GDP, and the US economy went into a recession.2

The timeline of the Soviet Union collapse can be traced to Saudi Arabia deciding to stop protecting oil prices and increasing production fourfold in 1985. The sudden fall in oil prices was one of the key factors that weakened economic fundamentals of the Soviet Union. The region lost approximately $20 billion per year due to lower revenues from oil exports, which resulted in huge government bor-rowing in the following years. By 1989, the Soviet economy had stalled.3

Wide fluctuations in oil prices have played an im-portant role in driving economies into recession and even regimes collapsing—which is why movements in oil prices are closely watched by economists, in-vestors, and policymakers globally. Since 2008, oil prices have seen two cycles of highs and lows, with no indication of a steady path in the near future. The historic high values of oil prices during 2010–13 and the following prolonged downturn during 2014–16 (the longest since the 1980s) suggest that the world economy is in unchartered territory (figure 1).

In recent months, oil prices have shown signs of a recovery, after touching a low of $26 per barrel in January 2016.4 While many forecasters are optimis-tic about the recent price rise and are predicting that the oil glut may be over, some are concerned that there is a lot of uncertainty surrounding the current rebound. The direct influence of the Organization of Petroleum Exporting Countries (OPEC) on oil pric-es has changed due to rising competition from US shale oil producers. Instead of defending price lev-els, OPEC has changed its strategy to defend market share rather than price, by producing more at low prices. This supply strategy has been a critical fac-tor in the current oil price trajectory. On the other hand, uncertainty in global demand poses downside risks to oil prices. The question everyone is asking is,

70

3rd Quarter 2016Special topic


Note: Monthly average imported crude oil price, nominal deflated by the US consumer price index. The grey bars refer to the economic recessions in the United States.Source: Energy Information Administration, June 2016.

Monthly imported real crude oil price (USD per barrel)Monthly imported real crude oil price (USD per barrel)

20

0

40

60

100

80

120

140

1979 1984 1989 1994 1999 2004 2009 20141974

Arab Oilembargo

Iranian revolution and Iraq-Iran war

Saudi Arabiaincreasesproduction

The fall of Soviet Union

Asianeconomiccrisis

Dot-com bubble,9/11 attack

2008 financialcrisis

Unrest inMiddle Eastcountries

US shale revolution

Figure 1. Real oil price movements since 1970 mapped to global events

71


“By how much and how soon will oil prices go up?” While oil prices are expected to rebound to $58 per barrel in the next couple of years, they are unlikely to reach the previous high of $100 per barrel any-time soon.5

Explaining the past decade’s demand-supply conundrum Historically, volatility in oil prices is often explained by shocks to demand and supply of oil arising from any combination of business cycles, geopolitical factors, the discovery of new fields, or technologi-cal changes. The past one-and-a-half decades have witnessed an interplay of all these factors, resulting in extreme oil price fluctuations (figure 2).

Oil prices surged during 2003–08 due to an unex-pected global economic boom, especially in emerg-ing Asian economies such as China and India, while oil producers failed to keep up with the rising de-

mand. Post May 2007, rising inventories in antici-pation of increasing demand added to the existing demand pressures. Within a year, oil prices nearly doubled, reaching $113 dollars in May 2008.

After a brief fall in oil prices during the 2008 finan-cial crisis, prices quickly picked up by mid-2009 on the back of strong growth in some of the emerging nations. The political uprising and civil wars in a few Middle Eastern countries resulted in intermit-tent oil supply disruptions. Oil prices reached $100 per barrel in 2010 and remained steady at $90–120 per barrel during 2011–14.

All this changed, however, when oil prices dropped over 70 percent between June 2014 and January 2016, as supply outstripped demand. New oil fields and advancing technologies in the United States enabled US oil producers to increase production (figure 3). Post 2014, Libya and Iraq’s faster-than-expected resumption of oil production; US energy companies’ resilience in continuing supply despite


Note: The oil in the figure comprises crude oil, condensates, NGLs, and oil from nonconventional and other sources of supply.Source: Energy Information Administration, June 2016.

82

87

92

97

102

-2

0

-1

1

2

3

2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 20152004

Oil supply (left axis)

Implied stock change (right axis)

Oil demand (left axis)

Demand outgrowingsupply

Strongdemand amidrising supply

Global economicslowdown andgeopoliticaluncertainty

Oil glut

Figure 2. Oil demand-supply balance (million barrels per day)

72

3rd Quarter 2016Special Topic

Graphic: Deloitte University Press | DUPress.comGraphic: Deloitte University Press | DUPress.comSource: Energy Information Administration, June 2016.

4,000

6,000

5,000

7,000

8,000

9,000

10,000

Mar-2008 Mar-2010 Mar-2012 Mar-2014 Mar-2016Mar-2006

Figure 3. US crude oil production (thousand barrels per day)

falling prices; and increased production by Canada, Russia, and, lately, Iran after sanctions were lifted led to a sustained increase in oil supply.

However, the biggest contributor has been Saudi Arabia’s (the biggest oil producer within OPEC) un-willingness to not counter the increasing supply but instead maintain the production at historically high levels despite the perceived glut. Its intention might have been to preserve market share at the expense of Iran and the United States, even if that meant lower prices.

Meanwhile, global growth slowed because of the economic slowdown in China; modest growth in most of the advanced economies, including the United States; and increasing uncertainty in the Eu-rozone—leading to a steady fall in oil consumption growth by these big oil importers. Slowing demand growth amid rising supply resulted in a sharp in-crease in inventories during 2014–15. By the end of January 2016, oil prices slid to $26 per barrel—the lowest level since 2003.6

The magnitude and the duration of the fall in oil prices gradually started impacting revenues and in-vestments made by the US energy companies that

had borrowed heavily. Rising yields on the bonds (most of them non-investment grade) issued by these companies led to impending defaults. Conse-quently, crude oil production in the United States has started declining. While Iran, Saudi Arabia, and Russia have continued to boost oil production, un-planned supply disruptions due to production out-ages in a few countries, such as Nigeria, Canada, and Venezuela, have impacted the overall oil sup-ply, and thereby prices. At the time of this writing, benchmark oil prices are close to $50 per barrel.

Much has been made of the alleged role of specula-tive trading in oil futures markets and hedging in determining oil prices, especially when oil prices touched record-high levels in 2008 or when they were in free fall post 2014. However, there is no sig-nificant evidence justifying this argument.7

Where are oil prices headed?As we move past mid-2016, there is substantial un-certainty around how demand and supply dynamics will evolve in the future. The proven ability of US oil producers to generate growth even at low break-even prices, the unwillingness of OPEC members to

73


cut production, and the rising tension among OPEC members due to geopolitical reasons could lead to two possibilities in the short run.

If OPEC makes any attempt to curtail production—either because of limited spare capacity (except in Saudi Arabia), low investment ability, high pro-duction cost, or a combination of any of these—oil prices will likely move up too quickly. Given that there remains plenty of known shale available, pro-duction in the United States is more likely to revive as price signals become more appropriate.8 If that happens, OPEC may run the risk of losing market share to the US oil-producing companies.

On the other hand, in a bid to retain their market share, OPEC members, in particular Saudi Arabia, may prefer to keep prices low to prevent US shale companies from resuming production. That would imply that OPEC may choose to continue produc-tion rapidly in the future to maintain downward pressure on oil prices. If past behavior is any indica-tion of future conduct, this will be the most prob-able event in the near term.

In either of these possibilities, oil prices are expect-ed to remain low relative to past levels and bounce

around in a relatively narrow corridor in the near term. Moreover, several indications—such as OPEC continuing oil production and large volumes of existing, shut-in production in Nigeria, Venezuela, and Libya waiting to enter the market—point to more downside risks for oil prices. Oil prices are likely to increase to $58 per barrel in the next cou-ple of years, but not return to $100 per barrel.9

However, the steep decline in oil prices in 2015 and the “new reality” of low prices for a prolonged period have led to many high-cost projects being deferred, which may create a shortfall in future production. According to Deloitte MarketPoint, production will likely see a production fall of 2 million barrels per day from 2018 to 2020.10 Consequently, prices might increase further in the medium term.

However, the pace of the oil price rise will likely depend on the revival of global demand. Given the modest outlook for the US economy, rising post-Brexit uncertainty in the Eurozone and the rest of the world, and considerable downside risks to China’s economy, the demand for oil may grow only moderately between 2018 and 2020.11 Thus, the tight demand-supply balance will likely push prices up further, but the rise may not be significant.

74

3rd Quarter 2016

The winners and the losersLower oil prices will result in a redistribution of resources. Gains will likely be spread across many economies, while losses may be concentrated among a few.

Oil importers: The beneficiaries of persistently low oil prices are likely to be the oil-importing na-tions, because of improved household consumption spending, business investment as production costs fall and profits increase, and external accounts. Low oil prices also provide these nations an opportunity to cut down energy subsidies, which improves fiscal balance overall but reduces the benefits accrued to households and businesses.

Within oil importers, nations that are experiencing high inflation (primarily emerging nations) are like-ly to benefit from falling import prices, which put downward pressure on both core and headline infla-tion. On the other hand, persistently falling oil pric-es do not bode well for nations that are battling de-flationary pressures (primarily advanced nations). Major advanced nations, such as Japan, the United States, and those in Europe, have implemented unconventional monetary policies, and falling oil prices may complicate the conduct of such policies. These economies are constrained by interest rates that are either near zero or negative, so they cannot offset the deflationary impact of falling oil prices by reducing interest rates further, as they could have done in normal times. In order to anchor deflation, these economies may have to rely on forward guid-ance by monetary authorities for the medium term, extending the duration of the unconventional mon-

etary policies, or both. However, prolonged imple-mentation of unconventional policies may lead to greater economic and financial uncertainty in the long run.12

Oil exporters: Oil-exporting nations will likely be adversely impacted as real income goes down and profit margins for oil producers get stressed. Energy companies’ weak financial positions may deterio-rate the balance sheets of the financial institutions that lend to these companies and thus may threaten the financial stability of these economies. At the same time, the governments will likely take in less revenue, and their budgets and external balances are expected to come under pressure.

That said, the impact of falling prices on oil export-ers will differ depending on the contribution of oil exports to each country’s GDP and revenue. Growth in economies such as Venezuela and Angola is high-ly dependent on oil exports (relative to Russia and Saudi Arabia), and any vulnerability in oil prices is likely to have a severe impact on their economic activity. Similarly, in many countries, oil revenues account for more than 50 percent of total govern-ment revenues—for a few countries such as Iraq and Qatar, the share is as high as 90 percent.13

The International Monetary Fund (IMF) estimates the break-even prices at which Middle Eastern and Central Asian countries can balance their fis-cal and external accounts (figure 4). Prices below these break-even levels may result in severe fiscal and external account deficits, which may affect the valuation of the local currency, inflation, and exist-ing debt.

Much has been made of the alleged role of speculative trading in oil futures markets and hedging in determining oil prices, especially when oil prices touched record-high levels in 2008 or when they were in free fall post 2014.

Special Topic

75


Alternate policies and diversification might counter price instability Price instability intensifies economic uncertainty, and this impact is generally more pronounced in nations highly dependent on oil exports. The tight demand-supply balance for oil (discussed in the previous section) along with external shocks, such as political and policy shifts in the United States and Europe, may result in sustained pressure on oil price stability.

Given the uncertainty, oil exporters such as Brazil and Russia might benefit from undertaking struc-

tural reforms as well as adjusting fiscal and mon-etary policies, with the speed of adjustment deter-mined by the extent of vulnerabilities. Reforms in the financial sector and strengthening the private non-commodity sector could help boost non-oil growth.

In the long term, diversifying the economy away from oil can help cushion the impact of low oil prices and ensure economic stability in the face of extreme oil price fluctuations. Saudi Arabia has already an-nounced a “Vision 2030” reform program that aims to lessen the country’s dependence on the public sector to foster private sector entrepreneurship. The government is also taking steps toward improv-ing the educational system to enhance skills that


Note: These are the IMF’s estimated projections as of January 2015. Yemen has been a net oil importer in 2015 and 2016.Source: IMF database, 2015.

Yemen

Libya

Bahrain

Algeria

Oman

United ArabEmirates

Saudi Arabia

Iran

Iraq

Qatar

Kuwait

0 50 100 150 200 250 300 350 400

External breakeven Fiscal breakeven

Figure 4. Oil prices required to balance twin accounts (USD per barrel, 2016)

76

3rd Quarter 2016

could promote diversification.14 These measures, if successful, may help Saudi Arabia reduce its depen-dence on oil. This, in turn, may enable the country to regain its influence over the global oil market, be-cause then hard decisions to continue pumping oil at low prices may not come at the cost of economic deceleration. Similarly, Nigeria has also announced

a “zero oil” plan to help the country increase non-oil exports over the next decade.15 However, the pace and scale of these diversification efforts and their success will depend on a number of factors, includ-ing empowerment of the private sector and workers. Only time will tell whether these measures bear the fruit the respective governments expect.

Special Topic

Endnotes

1. The beginning and ending points of recessions are set by the National Bureau of Economic Research, a private, nonprofit, nonpartisan organization. See http://www.nber.org/cycles/sept2010.html.

2. Christiane Baumeister and Lutz Kilian, “Forty years of oil price fluctuations: Why the price of oil may still surprise us,” Journal of Economic Perspectives 30, no. 1 (2016), https://www.aeaweb.org/articles?id=10.1257/jep.30.1.139

3. Yegor Gaidar, The Soviet collapse: Grain and oil, American Enterprise Institute for Public Policy Research, April 2007, http://www.aei.org/wp-content/uploads/2011/10/20070419_Gaidar.pdf.

4. Europe Brent spot price FOB, Energy Information Administration, January 20, 2016.

5. George Given and Jeff Suchadoll, “The balancing act: A look at oil market fundamentals over the next five years,” Deloitte MarketPoint, 2016, http://www2.deloitte.com/us/en/pages/energy-and-resources/articles/future-of-oil-markets-next-five-years-marketpoint.html.

6. Europe Brent spot price FOB, Energy Information Administration, January 20, 2016.

7. Lutz Kilian, “Recent oil price fluctuations linked to world economy,” University of Michigan working paper, http://www.lsa.umich.edu/UMICH/econ/Home/Research/Economics%20Research%20in%20the%20Department/Kilian%20Oil%20Price%20Fluctuations.pdf, accessed June 30, 2016; Baumeister and Kilian, “Forty years of oil price fluctuations”; Rabah Arezki and Olivier Blanchard, “Seven questions about the recent oil price slump,” iMFdirect, December 2014, https://blog-imfdirect.imf.org/2014/12/22/seven-questions-about-the-recent-oil-price-slump/#_ftn3.

8. Given and Suchadoll, “The balancing act.”

9. Ibid.

10. Ibid.

11. Daniel Bachman, United States Economic Forecast, Q2 2016, Deloitte University Press, June 15, 2016, http://dupress.com/articles/us-economic-forecast-2016-q2/.

12. Aasim M. Husain et al., Global implications of lower prices, IMF, July 2015, https://www.imf.org/external/pubs/ft/sdn/2015/sdn1515.pdf.

13. Arezki and Blanchard, “Seven questions about the recent oil price slump.”

14. Margherita Stancati and Ahmed Al Omran, “Saudi Arabia approves economic reform program,” Wall Street Journal, April 25, 2016, http://www.wsj.com/articles/saudi-arabia-approves-economic-reform-program-1461588979

15. Olusegun Awolowo, “‘Zero oil’ plan and an export revolution,” Guardian, March 20, 2016, http://guardian.ng/opinion/zero-oil-plan-and-an-export-revolution/.

AcknowledgementsThe author would like to thank Andrew Slaughter, managing director, Center for Energy Solutions, De-loitte Services LP; and Anshu Mittal, executive manager, Research & Eminence, Deloitte Services India Pvt. Ltd. for their contributions.

77



Source: Bloomberg, Haver Analytics.

US UK Eurozone Japan Canada

Q110

Q210

Q310

Q410

Q111

Q211

Q311

Q411

Q112

Q212

Q312

Q412

Q113

Q213

Q313

Q413

Q114

Q214

Q314

Q414

Q115

Q215

Q315

Q415

Q116

-2

-1

0

1

2

3

4

5

6

7GDP growth rates (percentage, year over year)



Brazil China India South Africa Russia

Q110

Q210

Q310

Q410

Q111

Q211

Q311

Q411

Q112

Q212

Q312

Q412

Q113

Q213

Q313

Q413

Q114

Q214

Q314

Q414

Q115

Q215

Q315

Q415

Q116

-10

-5

0

5

10

15

GDP growth rates (percentage, year over year)



GBP-USD EUR-USD USD-JPY (right axis)

May 12 Nov 12 May 13 Nov 13 May 14 Nov 14 May 15 Nov 15 May 161

1.1

1.2

1.4

1.3

1.7

1.6

1.5

1.8

75

90

85

80

95

105

100

120

115

110

125Major currencies versus the US dollar



US UK Eurozone Japan Canada

May 12 Jan 13 Sep 13 May 14 Jan 15 Sep 15 May 16-2

0

2

4Inflation rates (percentage, year over year)



Brazil China India South Africa Russia

May 12 Jan 13 Sep 13 May 14 Jan 15 Sep 15 May 16

-5

0

5

10

15

20

Inflation rates (percentage, year over year)

Economic indices

78

3rd Quarter 2016

Yield curves (as of June 27, 2016)*

US Treasury Bonds &

NotesUK Gilts

Eurozone Govt.

Benchmark

Japan Sovereign

Canada Sovereign

3 Months 0.25 0.45 -0.54 -0.27 0.50

1 Year 0.47 0.30 -0.53 -0.31 0.52

5 Years 1.07 0.57 -0.53 -0.27 0.64

10 Years 1.56 1.09 -0.05 -0.17 1.16

Brazil Govt. Benchmark

China Sovereign

India Govt. Bonds

South Africa Sovereign Russia*‡

3 Months 14.16 2.30 6.71 8.00 10.53

1 Year 13.33 2.42 6.98 - 9.88

5 Years 12.45 2.87 7.41 8.89 8.79

10 Years 12.42 2.91 7.46 9.09 8.60 Composite median GDP forecasts (as of June 27, 2016)*

US UK Eurozone Japan Canada Brazil China India SouthAfrica Russia

2016 1.9 1.8 1.6 0.6 1.4 -3.5 6.5 7.5 0.5 -0.9

2017 2.3 2.1 1.6 0.8 2 0.9 6.2 7.6 1.3 1.2

2018 2.1 2.2 1.6 0.6 2.2 1.8 6.2 7.8 1.9 1.5

Composite median currency forecasts (as of June 27, 2016)*

Q3 16 Q4 16 Q1 17 Q2 17 2016 2017 2018

GBP-USD 1.47 1.48 1.48 1.49 1.48 1.52 1.55

Euro-USD 1.11 1.1 1.1 1.11 1.1 1.11 1.15

USD-Yen 110 112 111.5 112 112 114.5 113

USD-Canadian Dollar 1.3 1.31 1.31 1.3 1.31 1.25 1.3

USD-Brazilian Real 3.7 3.75 3.8 3.96 3.75 3.95 4.1

USD-Chinese Yuan 6.6 6.7 6.73 6.75 6.7 6.8 6.9

USD-Indian Rupee 67.83 68.5 68.57 68.5 68.5 68.82 67.59

USD-SA Rand 15.7 16 16.07 16.2 16 15.42 14.68

USD-Russian Ruble 66.67 68 66.42 66.75 68 65.75 63

*Source: Bloomberg ‡MICEX rates †Source: OECD

79


OECD composite leading indicators (Amplitude adjusted)†

UnitedStates

United Kingdom

Euroarea Japan Canada Brazil China India South

AfricaRussian

Federation

Jan 13 100.0 99.9 98.7 99.7 99.6 100.5 100.7 99.4 100.7 99.5Feb 13 100.1 99.9 98.8 99.9 99.5 100.3 100.8 99.3 100.7 99.5Mar 13 100.2 100.0 98.9 100.1 99.5 100.1 100.8 99.2 100.7 99.4Apr 13 100.3 100.0 99.0 100.4 99.5 99.9 100.9 99.1 100.7 99.4May 13 100.4 100.1 99.2 100.6 99.6 99.7 100.9 99.0 100.6 99.4Jun 13 100.5 100.3 99.3 100.8 99.6 99.5 101.0 98.9 100.6 99.5Jul 13 100.5 100.5 99.5 100.9 99.7 99.2 101.0 98.8 100.6 99.6Aug 13 100.5 100.8 99.7 101.1 99.8 99.1 101.0 98.7 100.6 99.8Sep 13 100.5 101.0 99.9 101.2 100.0 98.9 101.0 98.6 100.6 100.0Oct 13 100.5 101.2 100.1 101.4 100.0 98.8 101.0 98.6 100.5 100.2Nov 13 100.6 101.3 100.3 101.4 100.1 98.7 100.9 98.5 100.5 100.4Dec 13 100.6 101.4 100.4 101.5 100.1 98.6 100.9 98.5 100.4 100.6Jan 14 100.6 101.4 100.4 101.4 100.1 98.4 100.8 98.5 100.3 100.8Feb 14 100.6 101.4 100.5 101.2 100.2 98.4 100.7 98.5 100.2 101.0Mar 14 100.7 101.5 100.5 101.0 100.2 98.4 100.6 98.6 100.1 101.2Apr 14 100.7 101.5 100.4 100.8 100.3 98.5 100.5 98.6 100.0 101.5May 14 100.8 101.5 100.4 100.6 100.3 98.6 100.4 98.7 100.0 101.7Jun 14 100.8 101.5 100.3 100.3 100.4 98.7 100.3 98.8 100.1 101.9Jul 14 100.8 101.4 100.2 100.2 100.4 98.8 100.2 98.9 100.2 101.9Aug 14 100.8 101.3 100.1 100.1 100.5 98.8 100.0 98.9 100.3 101.9Sep 14 100.8 101.2 100.1 100.0 100.4 98.8 99.9 99.0 100.3 101.6Oct 14 100.8 101.1 100.1 100.0 100.4 98.7 99.7 99.1 100.4 101.3Nov 14 100.7 101.0 100.1 100.0 100.3 98.5 99.6 99.1 100.4 101.0Dec 14 100.7 100.9 100.2 100.1 100.3 98.3 99.4 99.2 100.3 100.6Jan 15 100.6 100.9 100.3 100.1 100.2 98.1 99.2 99.3 100.2 100.3Feb 15 100.5 100.8 100.4 100.2 100.1 97.9 99.0 99.3 100.2 100.2Mar 15 100.4 100.7 100.5 100.2 100.0 97.8 98.9 99.4 100.1 100.2Apr 15 100.3 100.6 100.5 100.2 99.9 97.8 98.8 99.5 100.1 100.3May 15 100.2 100.5 100.5 100.2 99.9 97.8 98.7 99.6 100.1 100.3Jun 15 100.0 100.3 100.5 100.2 99.9 97.8 98.5 99.6 100.0 100.2Jul 15 99.9 100.1 100.5 100.2 99.8 97.8 98.3 99.7 99.9 100.0Aug 15 99.7 99.9 100.5 100.1 99.7 97.8 98.1 99.8 99.7 99.8Sep 15 99.5 99.7 100.6 100.0 99.6 97.9 97.9 99.9 99.6 99.5Oct 15 99.3 99.5 100.6 99.9 99.5 97.9 97.8 99.9 99.6 99.1Nov 15 99.2 99.3 100.6 99.8 99.3 97.8 97.8 100.0 99.5 98.7Dec 15 99.0 99.2 100.6 99.6 99.2 97.8 97.7 100.0 99.5 98.4Jan 16 98.9 99.1 100.5 99.5 99.1 97.7 97.6 100.1 99.5 98.0Feb 16 98.9 99.2 100.5 99.6 99.3 98.0 98.4 100.2 99.5 98.3Mar 16 98.9 99.2 100.4 99.6 99.4 98.3 98.4 100.3 99.5 98.6Apr 16 98.9 99.1 100.4 99.6 99.5 98.8 98.4 100.4 99.4 99.2

Note: A rising composite leading indicator (CLI) reading points to an economic expansion if the index is above 100 and a recovery if it is below 100. A CLI that is declining points to an economic downturn if it is above 100 and a slowdown if it is below 100.

Source: OECD.

80

3rd Quarter 2016

Deloitte Research thought leadership

Asia Pacific Economic Outlook, Q3 2016: Australia, Indonesia, Singapore, and South Korea

United States Economic Forecast, Q2 2016

Issue by the Numbers, June 2016: In whose interest? Examining the impact of an interest rate hike

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

For more information about Deloitte Research, please contact John Shumadine, Director, Deloitte Research, part of Deloitte Services LP, at +1.703.251.1800 or via e-mail at [email protected].

Additional resources

81


Dr. Ira Kalish is chief global economist of Deloitte Touche Tohmatsu Limited.

Dr. Alexander Börsch is director of research, Deloitte Germany, Deloitte & Touche GmbH.

Dr. Patricia Buckley is director of Economic Policy and Analysis at Deloitte Research, Deloitte Services LP.

Ian Stewart is chief economist, Deloitte UK.

Dr. Rumki Majumdar is a macroeconomist and a manager at Deloitte Research, Deloitte Services LP.

Lester Gunnion is an economist and a senior analyst at Deloitte Research, Deloitte Services LP.

Akrur Barua is an economist and a manager at Deloitte Research, Deloitte Services LP.

Dr. Daniel Bachman is a senior manager for US macroeconomics at Deloitte Services LP.

About the authors

82

3rd Quarter 2016

Global Economics TeamDr. Daniel BachmanDeloitte ResearchDeloitte Services LPUSATel: +1.202.220.2053E-mail: [email protected]

Akrur BaruaDeloitte Research Deloitte Services LP IndiaTel: +1.678.299.9766E-mail: [email protected]

Dr. Alexander Börsch Deloitte ResearchGermanyTel: +49.(0)89.29036.8689E-mail: [email protected]

Dr. Patricia Buckley Deloitte ResearchDeloitte Services LPUSATel: +1.517.814.6508E-mail: [email protected]

Lester Gunnion Deloitte Research Deloitte Services LPIndiaTel: +1.615.718.8559 E-mail: [email protected]

Dr. Ira KalishDeloitte Touche Tohmatsu LimitedUSATel: +1.213.688.4765E-mail: [email protected]

Dr. Rumki MajumdarDeloitte Research Deloitte Services LPIndiaTel: +1.470.434.4090E-mail: [email protected]

Aditi RaoDeloitte ResearchDeloitte Services LPIndiaTel: +1.470.434.3941E-mail: [email protected]

Ian Stewart Deloitte ResearchDeloitte & Touche LLPUKTel: +44.20.7007.9386E-mail: [email protected]

Global Industry LeadersConsumer BusinessAntoine de RiedmattenDeloitte Touche Tohmatsu LimitedFranceTel: +33.1.55.61.21.97E-mail: [email protected]

Energy & ResourcesCarl HughesDeloitte Touche Tohmatsu LimitedUKTel: +44.20.7007.0858E-mail: [email protected]

Financial ServicesChris HarveyDeloitte LLPUK Tel: +44.20.7007.1829E-mail: [email protected]

Life Sciences & Health CarePete MooneyDeloitte Touche Tohmatsu LimitedUSATel: +1.617.437.2933E-mail: [email protected]

ManufacturingTim HanleyDeloitte Touche Tohmatsu LimitedUSATel: +1.414.977.2520E-mail: [email protected]

Public SectorPaul MacmillanDeloitte Touch Tohmatsu LimitedCanadaTel: +1.416.874.4203E-mail: [email protected]

Telecommunications, Media & TechnologyJolyon BarkerDeloitte & Touche LLP UKTel: +44 20 7007 1818E-mail: [email protected]

US Industry LeadersBanking & Securities and Financial ServicesKenny SmithDeloitte Consulting LLPTel +1.415.783.6148Email: [email protected]

Consumer & Industrial ProductsSeema PajulaDeloitte & Touche LLPTel: +1.312.486.1662E-mail: [email protected]

Life Sciences & Health CareBill CopelandDeloitte Consulting LLPTel: +1.215.446.3440E-mail: [email protected]

Power & Utilities and Energy & ResourcesJohn McCueDeloitte LLPTel: +216 830 6606E-mail: [email protected]

Public Sector (Federal)Daniel HelfrichDeloitte Consulting LLPTel: +1.571.882.8308E-mail: [email protected]

Public Sector (State)Mark PriceDeloitte Consulting LLPTel: +1.617.585.5984E-mail: [email protected]

Telecommunications, Media & TechnologySandra ShiraiDeloitte Consulting LLPTel: [email protected]: +1.415.783.5515

Contact information

83


84

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