Global

Economic
Outlook
A Deloitte Research publication | 4th Quarter 2009

The shape of the

recovery in 2010

What Happened to
Bank Credit?
What to expect in the
coming year

The United States

The economy turns the
corner

China
Promise and peril of
recovery

Eurozone
Emerging from recession

Japan
On an uncertain recovery
path
 Global Economic Outlook
Q4 2009
The year 2009 is coming to a close and all one can say is good riddance. It was the worst
year for economic performance in recent memory. The year began on the heels of a near
breakdown of the financial sector. At the start of the year, economists found themselves
opining on the probability of another Great Depression. Thankfully, the year is ending on
a more positive note with economists offering their views on the potential strength of the
all but certain recovery.

In this issue of the Global Economic Outlook, our economists look at the shape of the
imminent recovery across the globe. We begin with Ian Stewart offering his take on how
the credit markets are likely to behave in the coming year. This is a critical issue because
weak credit markets could substantially offset the otherwise positive impact of aggressive
monetary policy. Ian suggests that, while bank credit is likely to decline further before
bottoming out, there are signs of improvement. Surveys conducted by three major central
banks indicate an easing of lending standards on the part of banks. This reflects better
liquidity and capital positions and bodes well for the future. Ian predicts that overall
bank lending will start to grow in the latter part of 2010. In the interim, equity and bond
finance will expand.

In his survey of the U.S. economic outlook, Carl Steidtmann predicts that the U.S. recovery
will be stronger than most analysts now expect. He says that this is due to a combina-
tion of stimulatory factors. Moreover, despite the foreboding of some analysts, a strong
rebound is the norm following a deep recession. Yet Carl also predicts that the recovery
will be different in nature from past recoveries. Rather than being driven by the consumer,
this recovery will be largely dependent on government spending and exports. Finally, Carl
suggests that the coming rebound is laden with serious risks. These include continued
troubles for housing, banks, commercial property, and consumer balance sheets. He also
Global Economic Outlook takes aim at the risk of serious inflation.
Published quarterly by Deloitte Research
In our discussion of Asian economies, I point to the very positive signs for China’s
Editor-in-chief unfolding recovery. I discuss how the strong recovery is being generated by massive fiscal
Ira Kalish and monetary expansion. While this is boosting growth quickly, it is also setting the stage
Contributors for potential problems down the road. These include inflation, excess capacity, insufficient
Elisabeth Denison domestic demand, and financial problems for banks. While the authorities have begun
Shalabh Kumar Singh the process of withdrawing monetary stimulus, a smooth transition to market generated
Carl Steidtmann growth remains uncertain.
Ian Stewart
Editorial address
350 South Grand Street
Los Angeles, CA 90013
Tel: +1 213 688 4765
ikalish@deloitte.com

In his maiden contribution to our quarterly report, Shalabh
Kumar Singh offers an optimistic assessment of the outlook
for India. He attributes this to the potential for strong
exports destined for a growing world economy as well as
the effects of a fiscal stimulus.
Shalabh also provides our outlook for the Japanese
Info below needs
economy. His assessment is that growth, which has
already begun, will be modest at best. The ability of the
to be edited or
new government to effect a shift toward consumer driven
growth is uncertain, both in terms of the extent of the shift
filled in
and the method of financing such reforms.
Elisabeth Denison, in her discussion of the Eurozone, notes
the surprisingly robust and early economic recovery already
underway. Her outlook is for relatively strong growth next
year fueled by improvements in consumer spending and
strong growth of exports, the latter owing to strength in
Asia. Although she cautions that investment spending
will be late to revive, it will not be due to the lingering
effects of the credit crunch. The latter, she says, appears
to be over. The expansive monetary policy of the past
year should ultimately have a positive impact on capital
spending next year, especially as businesses have shed
inventories.
Ian Stewart offers a more sober assessment of the
economic prospects for the United Kingdom. He says that
the lingering effects of massive consumer debt will restrain
consumer spending as the rebuilding of balance sheets
takes place. Instead, as in the United States, growth will
come from a boost to exports and investment.
Executive summary
Finally, in an analysis of the Russian economy, I predict
that the economy will grow next year. Yet the strength
of recovery will depend on many uncertain factors. These
include the price of oil, the state of global capital markets,
the fiscal and monetary stance of policymakers, and the
degree to which global investors have confidence in
Russian economic management.
The common thread of all our analyses seems to be a
better than expected economic performance. Most of
the world’s major economies are now growing and some,
like Japan and the Eurozone, are growing sooner than
most analysts expected. The global crisis was notable for
the near synchronicity of the downturn. Likewise, the
upturn appears to be happening everywhere at once —
something that is not usually the case. The good thing
about this is that strengthening global demand is self-
reinforcing, especially as it boosts global trade flows and
export oriented production. The mostly synchronous policy
response to the crisis (fiscal and monetary expansion)
probably played a key role in the global recovery. Likewise,
the risks of the recovery are similar in most places. These
include the lingering effects of financial market stress as
well as the possibility of future inflation.
As always, we welcome comments and questions from our
readers.
Dr. Ira Kalish
Director of Global Economics
Deloitte Research
Global Economic Outlook 4th quarter, 2009

Contents
1 14

Topics

1 What happened to bank credit? Despite the recent improvement in economic and
financial conditions, growth in bank lending has collapsed in the last six months.
Improving financial conditions point to an upturn in credit growth in the latter part of
2010.

Geographies

5 The United States: The economy turns the corner Financial indicators suggest a
stronger than generally expected recovery. But instead of domestic consumers, the
biggest drivers of growth will be government spending, foreign consumers, and business
investment. Yet, the rebound is laden with risks.

11 China: Promise and peril of recovery No other major country in the world has
performed as well as China during the global crisis due to massive fiscal and monetary
expansion. Still, risks remain: inflation, excess capacity, among others.

15 India: On the upswing Despite the deficient summer monsoon, the economy is expected
to accelerate due to strong recovery in industrial production. The next financial year
promises to be much better, helped by the potential for a rebound in exports destined for
a growing world economy.

17 Japan: On an uncertain recovery path The recovery appears fragile, and record
unemployment, falling wages, and a decline in business investment have kept the mood
somber. In spite of myriad uncertainties, the economy will likely continue to register
positive growth, but the momentum could decline.

19 Eurozone: Emerging from recession The region is staging a surprising recovery, thanks
to stable consumer spending and a revival of demand from trading partners in Asia.
15 21 25 27

Geographies (continued)

23 The United Kingdom: Consumer rebalancing arrives A slow recovery is the likely price
the United Kingdom will pay to rebalance its economy. Growth in consumer spending will
remain subdued into 2011 and possibly beyond. The early recovery stages will be driven,
not by the consumer, but by exports and investment.

27 Russia: An uncertain outlook The Russian economy will grow next year. Yet the strength
of recovery will depend on many uncertain factors, including the price of oil, the state of
global capital markets, the fiscal and monetary stance of policymakers, and global investor
confidence.

Appendix

29 Charts for developed countries GDP growth rates; inflation rates; major currencies
vs. the U.S. dollar; yield curves; composite median currency forecasts; composite GDP
forecasts; OECD composite leading indicators.
 What
Ian Stewart is a Director
at Deloitte Research

happened
to bank
credit?
The credit crunch has
demonstrated to the wider
economy the importance of a
healthy banking system that is
willing and able to create
credit. Yet, despite the recent
improvement in economic and
financial conditions, growth in
bank lending has collapsed in
the last six months. This
article draws on credit data and
central banks’ own surveys of
banks to paint a picture of
what is happening to the credit
creation mechanism in the
industrialized world.
1
 Topics

nesses, property, or fixed assets for corporates. If asset

• Growth in bank lending in the big industrial
economies has collapsed, even as signs of recovery
mount.
• History suggests that bank credit is likely to contract
further as banks rebuild their balance sheets.
• Improving financial conditions point to an upturn in
credit growth in the latter part of 2010.
Borrowing by corporates is highly cyclical, with recessions
often driving corporates to repay bank loans. This pattern
has repeated in the current cycle, and bank lending to U.K.
and U.S. corporates is now contracting after a period of
strong growth (see figure 1). Lending to consumers is less
prices decline, as they often do in a downturn, a rational
consumer or corporate faces strong incentives to delay
purchases. In a recession, banks reduce the availability of
credit and tighten lending terms to reduce their exposure
to the downturn. On the demand side, corporates
and households, confronted by uncertainty and falling
incomes, are less likely to want to take the risks associ-
ated with borrowing and thus less likely to use credit to
finance major purchases. These are all normal features of a
standard economic cycle.
Figure 1: Outstanding bank lending to corporates
(% change, year-on-year)
30

volatile than lending to corporates, but here, too, credit 25

growth has slowed sharply (see figure 2). In the United 20
States, year-on-year growth in household credit is now
15
declining for the first time since records began in the early
10
1950s.
5
Given the highly cyclical pattern of credit growth over 0
the economic cycle, it would be wrong to automatically -5
attribute the recent decline in bank lending solely to -10
the credit crunch. As economies slow, both the supply 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
of and the demand for credit slows. The majority of
U.K. U.S. Euro area
borrowing is undertaken to finance asset purchases: house
purchases for consumers and acquisitions of other busi- Source: Datastream

Figure 2: Outstanding bank lending to households (% change, year-on-year)

16

14

12

10

-2

-4 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
2000 2000 2001 2001 2002 2002 2003 2003 2004 2004 2005 2005 2006 2006 2007 2007 2008 2008 2009 2009

U.K. U.S. Euro area

Source: Datastream

2
Global Economic Outlook 4th quarter, 2009

The bank lending surveys conducted by the Federal

Reserve, the European Central Bank, and the Bank
of England show that banks have become somewhat
more willing to lend to corporates and consumers.

3

Yet this has not been a normal cycle. The origins of this
downturn lie in the banking system, in excessive risk taking
and excessive leverage. The fact that vast government
intervention was required to save the global banking
system from collapse makes clear the source of the crisis.
While demand for credit has fallen away sharply in this
cycle, supply has been badly hit by stress in the financial
system.
Topics
Corporates, especially larger, high-quality names, are
finding it far easier to raise equity and bond finance. A
major improvement in the availability of bank credit will
take longer. Overall bank lending to the private sector in
the United States, United Kingdom, and Euro area may
start to expand in the latter part of 2010.
Figure 3: Private sector credit growth in advanced economies
(% change, over 12 months*)

History suggests that credit growth, while weak, is likely 14

12
to get weaker still. Past financial crises have generally
10
been followed by prolonged periods of contracting
8 Forecasts
credit growth, as banks seek to derisk and deleverage
6
their balance sheets. The Swedish and Finnish banking
4
crises of the early 1990s were, for instance, followed by
2
lengthy periods of shrinking credit supply. Today the IMF
0
is forecasting a sharp deterioration in credit growth in the
-2
major industrial nations over the next year (see figure 3).
-4
Even when damage to the financial system is much more 1999 2001 2003 2005 2007 2009 2011 2013
limited than it is today, credit growth can remain weak for
some time. America’s last major recession ended in 1991, *Average of U.S., U.K., and Euro area
yet corporate borrowing continued to contract for another
Source: IMF
three years.

Despite these rather bleak precedents we do see some Figure 4: Net percent of banks tightening credit standards to
positive signs. The bank lending surveys conducted by the corporates
Federal Reserve, the European Central Bank, and the Bank
100
of England show that banks have become somewhat more
willing to lend to corporates and consumers. The balance 80
of banks tightening lending standards — a key measure 60
of the credit conditions — has fallen from last year’s peak
40
(see figure 4). This shift seems to reflect a better liquidity
and capital position for the banks and improvements in 20
wholesale financial markets. Stronger financial markets 0
seem to have made banks a little more willing to lend —
-20
albeit on far more restrictive terms than were available
in 2006–2007. It will take time for this shift in sentiment -40
to feed through to an increased supply of credit. In the 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
meantime, credit conditions remain difficult. In September,
U.S. Euro area
80 percent of U.K. CFOs responding to the Deloitte CFO
Survey* rated credit as “costly” and 75 percent said it was Source: ECB and Federal Reserve bank lending/loan officers’ surveys
“hard to get.”

Figure 5: Outstanding bank lending to U.S. corporates

History shows that bank credit is a lagging indicator. (12 month % change) vs. net percent of banks tightening
Coupled with the severity of the crisis in the financial credit (lag by 3 quarters) moving averages
system, this suggests that bank credit is likely to shrink
further. But the evidence from the bank lending surveys 25 -30

is that banks in the United States, Euro area, and United 20 -10
Kingdom are starting, gradually, to ease lending terms.
15
Using the longest-running survey, the Federal Reserve’s 10
10
Loan Officers’ Survey, we find that the lag between
5 30
changes in sentiment or attitudes on the part of bankers
and changes in credit growth is about 18 months (see 0 50
figure 5).
-5
70
-10
0
1
3
4
6
7
9
0
2
3
5
6
8
9
1
199
199
199
199
199
199
199
200
200
200
200
200
200
200
201
Q3
Q1
Q1
Q3
Q1
Q3
Q1

Q3
Q1
Q3
Q1
Q3
Q1
Q3
Q1

*The Deloitte CFO Survey was conducted by Deloitte LLP, the U.K.
member firm of DTT.
U.S. Euro area

Source: Datastream 4
 The United States:
Dr. Carl Steidtmann The economy
turns the corner
is Chief Economist at
Deloitte Research

usa

5

While far from the picture of health, the U.S. economy
has shown impressive signs of healing over the past three
months. As the billions in monetary and fiscal stimulus
slowly work their way into the economy, continued
improvement can be expected. Housing prices have stabi-
lized and with heavy government incentives, sales have
risen. Auto sales have soared on government subsidies
aimed at improving sales and fleet mileage. Manufacturing
is showing signs of renewed strength. Bank profitability
has rebounded sharply.
The recovery, however, is likely to look very different
from the traditional economic rebound. While domestic
consumers will play their part, they are not likely to be the
biggest driver of growth. Instead, government spending,
foreign consumers, and business investment will likely lead
the U.S. economy to a stronger-than-expected recovery.
With the recession over or nearly over, the U.S. economy
still faces many challenges. Rarely have the risks to the
forecast been as great as they are now.
A different kind of recovery
Traditionally, U.S. economic recoveries have been
consumer-led. While the consumer will make a modest
contribution to the expansion, the mix of growth going
forward will likely be very different and more balanced
than in previous recoveries. The recovery will likely feature:
Massive government spending
Not since the buildup to World War II has the U.S. federal
government increased the rate of spending at such a pace.
From a year ago, federal government outlays are up nearly
30 percent, driven by increased spending from the stimulus
and bailout money for the banks and insurance and auto
companies from the Troubled Asset Relief Program (TARP).
Figure 1: Federal government outlays
(% change, year-on-year)
30.0
25.0
20.0
15.0
10.0
5.0
0 recession was intense.
-5.0
1984 1989 1994 1999 2004 2009
Source: U.S. Department of Treasury
Geographies
With less than 20 percent of the $787 billion stimulus
bill spent so far, the pace of government spending can
be expected to remain high for the foreseeable future.
The passage of health-care reform coupled with rising
demands on entitlement programs from an aging popula-
tion may put government spending on a sustained high-
growth path.
Improving exports and trade balance
Economic growth overseas is rebounding faster than it is
in the United States. Europe, Japan, and Brazil have already
experienced rebounds in real growth. That, coupled with
a steadily declining U.S. dollar, has produced a sizable
improvement in the U.S. trade deficit. While the pace of
deficit improvement is likely to slow, a rise in exports to the
rest of the world will give the U.S. economy a boost.
Figure 2: Monthly U.S. exports
(in billions of $)
180
160
140
120
100
80
60
40
20
0
1993 1997 2001 2005 2009
Source: U.S. Census Bureau
The big risks to trade are the increasingly protectionist
policy actions of the U.S. government. The stimulus bill
passed back in February had a “Buy American” clause.
More recently, the U.S. administration has imposed tariffs
on the import of Chinese-made tires.
Rebuilding inventories
As the economy headed into the recession, inventories
were extremely lean. The economy wide inventory-to-
sales ratio was near record lows, due in large part to the
billions invested by retailers and their suppliers on supply
chain management technology. Despite those lean
inventories, the pace of inventory liquidation during the
6
Global Economic Outlook 4th quarter, 2009

Increased business investment

Business investment fell sharply during the recession.
Faced with liquidity issues and a cutoff of lending from
the banks, most businesses slashed investment budgets.
Projects were scaled back or put on hold; business invest-
ment in equipment and software fell sharply. A shift in
the fundamentals for manufacturing will have a significant
and positive impact on business investment going forward.
There are three factors that will collectively work to give
a boost to both business investment and U.S.-based
manufacturing:

First, a weaker dollar has made U.S.-based manufacturing

more globally competitive. Since peaking in early March,
the dollar is down 12.9 percent against its major competi-
tors. From its decade high in early January 2002, the dollar
is down 33.8 percent. With high budget deficits that
will require foreign financing, the decline in the dollar is
expected to continue.

Faced with limited access to capital and worried about
working capital, businesses cut inventories to the bone.
They did the same thing with employment and for the
same reasons. They needed the cash. This working
capital driven inventory liquidation contributed to the
sharper than expected decline in the broader economy. As
customer demand begins to pick up, inventory reduction
will slow and then reverse. The process of rebuilding
inventories will add to overall economic growth in
the early stages of the recovery and contribute to its
robustness.
Figure 3: Quarter-to-quarter change in inventories
(in billions of $)
150
Second, rising energy prices increase the cost of transpor-
tation and create an incentive to shorten supply chains and
build products closer to the point of consumption. The
heavier the good produced, the greater the incentive to
move production back to the United States.
And finally, the United States is growing more protectionist.
The tariffs on imported Chinese tires is but the most
recent example of a growing list of protectionist moves
by the United States. Fear of getting closed out of the U.S.
market might induce both U.S. and foreign manufacturers
to move production facilities into the United States.
Figure 4: Construction put in place: Manufacturing
(% change, year-on-year)

100 100

80
50
60
0
40
-50
20

-100 0

-20
-150
-40
-200
-60
1979 1984 1989 1994 1999 2004 2009
1994 1997 2000 2003 2006 2009
Source: U.S. Bureau of Economic Research
Source: U.S. Bureau of Census

7
 Geographies

The shift in the economic landscape in favor of manu-

facturing is showing up in a boom in new construction
spending for manufacturing facilities. Even as most of
the construction industry is suffering from the economic
recession, construction for new manufacturing facilities
has grown robustly over the past two years as many
manufacturers are positioning themselves for the recovery.
Powering up
A second industrial sector that might lead the
U.S. economy out of the recession will be energy produc-
tion. Non- traditional forms of energy production got a
boost from the February stimulus bill, which included $50
billion in subsidies and incentives for the production of
alternative energy.
Figure 5: New construction put in place: Energy
(% change, year-on-year)
90
75
As has been the case with manufacturing,
the construction of new energy facilities
has experienced a boom despite the
recession.
The fundamentals for consumer spending have improved
sharply over the past three months. Real consumer
purchasing power is soaring. Real hourly wages grew
this summer at their strongest pace in more than 40
years. At the same time, household net worth, which
took a pounding over the past two years, is beginning to
rebound.
Figure 6: Real hourly wages
(% change, year-on-year)
6.0

60
4.0
45
30
2.0
15
0 0
-15
-30 -2.0

-45
-4.0
1994 1997 2000 2003 2006 2009

Source: U.S. Bureau of Census -6.0

1969 1974 1979 1984 1989 1994 1999 2004 2009

Even without the government incentives, energy produc-
tion was destined to be an industry that would lead the
economy out of the recession. Higher conventional
energy prices create real market incentives to search for
more cost-effective alternatives. These alternatives include
nontraditional energy sources in addition to the develop-
ment of more efficient uses of existing energy sources.
As has been the case with manufacturing, the construction
of new energy facilities has experienced a boom despite
the recession. In sharp contrast to past recessions, the
expectations for higher energy prices will continue to push
the development of new traditional and nontraditional
energy resources.
Consumer spending: The Pigou Effect
While consumers will not lead the economy out of
recession, they will play their part. High debt levels and
rising unemployment have led many to write off any
potential contribution to future growth from consumer
spending. The consumer only looks dead: the reality is
much better than it first appears.
Source: U.S. Department of Labor
What is driving the gain in real wages is the fall in
prices. Deflation creates what economists refer to as the
Pigou effect, named after British economist A.C. Pigou.
Deflation gives a boost not only to the purchasing power
of wages but to the real value of assets. The wealth effect
from deflation-driven gains, particularly in financial assets,
results in a rise in consumer spending.
Improvements in purchasing power and the labor market
(which are showing up in the sharp drop in first-time
unemployment claims) coupled with the sharp reduction
in tax revenue have significantly improved household cash
flow. Improved household cash flow has traditionally been
followed by an improvement in consumer spending.

8
Global Economic Outlook 4th quarter, 2009

Five reasons to worry those who go through bankruptcy, limiting consumer-

While every recovery climbs a wall of worry, this recovery spending growth. As bankruptcy continues to grow,
has its own special brand of misery that will keep the the size of that credit-constrained population will likely
pessimists happy for many days to come. grow with it.

Figure 8: Quarterly bankruptcy filings

1. Oil prices are rising. Despite slack demand and rising
(in thousands)
inventories, energy prices are rising. After falling to less
than $40 a barrel, oil prices have bounced back sharply. 3,000
A rebound in global growth and a weak U.S. dollar
coupled with increased interest in oil as an investment 2,500

asset class have increased demand and pushed up

2,000
prices.
1,500
A rising price for oil is a mixed curse. On the plus side,
it gives a boost to investment in energy development, 1,000
alternatives, and productivity. On the down side, rising
energy prices act as a tax on both consumers and 500
businesses, increasing costs and reducing spending on
0
other non-energy related items.
1982 1985 1988 1991 1994 1997 2000 2003 2006 2009

Figure 7: Spot oil price

Source: U.S. Department of Justice
(in $ per barrel)

160
3. Bank deleveraging continues. Under pressure from
140 both the market and regulators, banks are putting
120 the ample market liquidity to work by reducing their
balance sheet leverage. While stronger balance sheets
100 for the banks will be a long-term positive for both the
80 banks and the economy, in the short run the process
of bank deleveraging limits lending to small businesses.
60 Without access to credit, small businesses, which are a
40
primary source of employment growth, may be limited
in their ability to expand.
20

0
4. Commercial real estate delinquencies rise. With
the housing market on the mend, credit concerns are
1999 2001 2003 2005 2007 2009
now turning to the commercial side of the real estate
Source: St. Louis Federal Reserve business. Commercial banks hold roughly $1 trillion
in commercial real estate loans. As credit remains
2. Mortgage foreclosures and bankruptcy continue tight, more commercial properties find themselves
to rise. Bankruptcy tends to be a lagging indicator underwater on their current loans, making it difficult
of the economy but the rise in bankruptcy this time to roll over existing debt as it comes due. Commercial
seems to be well ahead of the business cycle. What is real estate loan defaults at commercial banks are rising.
surprising is that this increase in bankruptcy is coming Much of the commercial real estate debt is held by
despite a significant tightening of the bankruptcy laws regional banks.
back in 2005. The mass wave of mortgage foreclo-
sures has coincided with more bankruptcy. After
spiking just prior to the change in the law, bankrupt-
cies fell sharply in 2006, only to steadily rise back to
pre-change levels.

The new bankruptcy law is less lenient in its treatment

of debtors than the old law. Walking away from
unsecured debt is not as easy as it once was. Getting
credit post-bankruptcy will be much more difficult for

9

Figure 9: Delinquency rate on commercial real estate loans
(% of total loans outstanding)
14
12
10
8
6 Alfred Cecil Pigou
4
2
0 20
1991 1994 1997 2000 2003 2006 2009
Source: U.S. Federal Reserve
Another leg down in the credit crisis could emerge
from the problems faced by the regional banks.
While none of these banks falls in the “too-big-to-fail”
category, widespread regional bank failure would
likely stretch the capabilities and the resources of the
Federal Deposit Insurance Corporation (FDIC) to deal
with these problems.
5. Inflation risk is growing. The credit crisis of a year
ago set off a vicious deflationary cycle. Producer,
consumer, and commodity prices fell around the
world. In the United States, the producer price
index went from a year-on-year rise of 9.8 percent
in August 2008 (which represented the highest rate
of producer inflation in more than 25 years) to a
declining 6.8 percent a year later, the steepest decline
in producer prices in over sixty years. Prices at the
consumer level have experienced a similar whiplash.
In response to this dramatic deflationary contrac-
tion, the U.S. government has massively increased
government spending while aggressively expanding
the nation’s money supply. Couple these inflationary
policies with the stealth protectionism of “Buy
American” provisions in government stimulus bills
and increased regulatory oversight and you get a
potent policy mix for higher inflation.
Geographies
The error of optimism dies in the crisis,
but in dying it gives birth to an error of
pessimism. This new error is born not an
infant, but a giant.
Figure 10: Producer price index
(year-on-year change)
15
10
5
0
-5
-10
1949 1959 1969 1979 1989 1999 2009
Source: U.S. Bureau of Labor Statistics
Conclusions and observations
Financial indicators suggest a stronger than generally
expected recovery. A steep yield curve, compressed risk
spreads, and a rising stock market are all consistent with
this view. The strength of that recovery will come from
business investment, government spending, and exports
to foreign consumers.
During the Great Depression, British economist A.C. Pigou
argued that many of the government efforts to revive
the economy were misdirected and were actually making
matters worse. Pigou felt that the natural forces of the
business cycle would bring the economy back. Falling
prices would give consumers and businesses increased
purchasing power while the need to rebuild inventories
would add to aggregate demand.
We will get a real test of Pigou’s theory in the months
ahead. Despite massive government spending the
consensus forecast still sees sluggish growth ahead. Both
consumer and business sentiment remain muted. If Pigou
is right, we should see a much stronger than expected
economic recovery over the next 12 to 18 months.
10
Global Economic Outlook 3rd quarter, 2009

China: Promise and

peril of recovery
by Dr. Ira Kalish

china

11
 Geographies

Given China’s significant role as an exporter, there was

widespread expectation that China would suffer
considerably. Yet the drop in net exports, which everyone
feared would cause a serious recession, was more than
offset by the strength of consumer spending, business
investment, and especially government investment.
China is the toast of global economic policymakers. No Consider the details. In the first half of 2009, exports were
other major country in the world has performed as well down 22 percent. At the same time, overall fixed invest-
as China during the global crisis. Economic growth for ment was up 41.2 percent over the previous year. Yet
2009 will likely come in at around 8 percent and most while investment in industry was up 29.0 percent, invest-
analysts have revised their forecasts for 2010 to growth of ment in agriculture was up 68.9 percent and investment in
about 9 percent. This exemplary performance is a bit of infrastructure 50.3 percent. These massive numbers were
a surprise given the collapse of global trade that followed the result of both fiscal and monetary expansion. The
the onset of the credit crunch in late 2008. Given China’s increased government spending contributed to the infra-
significant role as an exporter, there was widespread structure investment. Monetary expansion led to increased
expectation that China would suffer considerably. Yet the bank lending, especially to state-owned enterprises and
drop in net exports, which everyone feared would cause a those involved in agriculture and infrastructure. Indeed the
serious recession, was more than offset by the strength of broad money supply was up 28.4 percent in the first half
consumer spending, business investment, and especially of 2009.
government investment. Indeed investment alone
contributed six percentage points to economic growth in
the first half of 2009. That strength, of course, was due
to massive monetary and fiscal stimulus on the part of the
Chinese government.

12
Global Economic Outlook 4th quarter, 2009
China and the world
When the crisis began a year ago, China shifted its
exchange rate policy and stopped allowing the renminbi
to appreciate in value. This was due to concern that
further appreciation would exacerbate an already bad
situation for China’s exports. Consequently, the dollar
exchange rate remained flat while China’s currency actually
depreciated against a basket of currencies. This slightly
improved the competitiveness of China’s exports and
probably prevented it from falling even further. It also
provided China with an opportunity to acquire and hoard
large quantities of commodities. When the global crisis
deepened in late 2008, global commodity prices dropped
precipitously. China took advantage of this by engaging in
massive purchases, the effect of which was to raise global
commodity prices.
By keeping the exchange rate flat, China’s authorities
created an expectation in financial markets that apprecia-
tion would eventually resume. Hence, speculative capital
flowed into China in anticipation of a future currency reval-
uation. The result was a big increase in foreign currency
reserves, which contributed significantly to money supply
growth. So although China’s authorities have complained
about the possibility of capital losses on their foreign
currency reserves, their continued accumulation of reserves
exposes them to even greater capital losses in the future.
13
Concerns about all that money
Should China be worried about all that money creation?
In the short term, the answer is no. China is currently
experiencing deflation. Monetary expansion is necessary
to avoid the potentially ruinous effects of deflation. Yet
as China’s economy starts to accelerate, there is fear that
inflation will be ignited and that efforts to remove the
extra liquidity will come too late. On the other hand, there
are two major reasons why inflation might not become a
problem.
First, the massive investment of late has created consider-
able excess capacity in industry. At the same time, there
remain large numbers of unemployed workers, the result
of massive dismissals from export-oriented factories. This
excess capacity in industry and employment will help to
keep the lid on wages and prices as the economy recovers.
Second, it is widely expected that China will resume
currency appreciation as the economy recovers. This
would result in declining import prices, which would be
disinflationary.
Hence, strong money supply growth may not neces-
sarily lead to serious consumer price inflation. Instead, it
could result in big increases in the prices of assets such as
property and equities. Indeed, the strong performance
of China’s equity markets in 2009 might be explained by
rapid money supply growth. And there is growing concern
about a money-fueled property price bubble.
The reason for concern has to do with the nature of the
money expansion. The central bank has increased the
reserves of state-controlled banks, which in turn have
dramatically increased lending not only to state-run enter-
prises but to households as well. Total bank lending in the
first half of 2009 was up 34 percent. New loans equaled
about 25 percent of GDP. Moreover, by the summer of
2009, roughly two-thirds of new loans were to house-
holds, mainly for mortgages and some for automotive
purchases. This probably accounts for the big increase in
housing and automotive purchases — as well as the frothy
nature of retail sales, which were up 16.2 percent in the
first half. And strong housing purchases, in turn, account
for the turnaround in property prices. As of late 2009,
property prices have risen to a level higher than their high
in 2007.
 Geographies

The problem with money-fueled increases in equity and

property prices is that when the central bank starts to
tighten monetary policy (which has just started to happen), The policy stance of the past year has had
it could result in a sharp drop in asset prices. That, in turn,
would have a negative impact on consumer spending and
the positive effect of moving China along
on the performance of bank loans. the road toward domestically driven
Performance anxiety growth.
That brings us to the next potential issue: non-performing
loans (NPLs). The massive increase in bank lending,
especially to state-owned enterprises, has led to excess
capacity and to substantial fears that these loans will not
perform well in the future. The fear is that banks have
not been especially careful. The result could be future
financial problems for the banks if their portfolios of NPLs
increase dramatically. That is probably why the govern-
ment recently told banks to increase their reserves to 150
percent of NPLs, up from 135 percent.

On the other hand, many analysts believe that the NPL

problem will not be as onerous as was the case in the past
decade. That is because a sizable share of the increased
bank lending went not to state-run enterprises, but to
local governments engaged in infrastructure spending.
While these governments may face future fiscal constraints
as a result of this borrowing, they are unlikely to default.
Instead, they may require assistance from the central
government in Beijing.

The bottom line

The authorities in China have begun the process of shifting
monetary policy to a tighter stance. As usual, timing is
everything. By starting now, when the economy is not yet
fully recovered, the authorities may be able to navigate
China toward strong growth without inflation and without
ruinous and destabilizing asset price bubbles. Still, risks
remain. China’s history of credit policy is one of blunt
instruments leading to volatility in asset prices. That may
recur. Yet the policy stance of the past year has had the
positive effect of moving China along the road toward
domestically driven growth. This is helping to lessen the
negative effects of lower export growth.

14
 India:
Shalabh Kumar Singh is
a Manager at Deloitte
On the upswing
Research, contributing
Asia Pacific perspectives
from India
india
Economists in India have had a busy year revising their
growth forecasts. 2009 started on a bleak note with the
economy expected to slow down further from last year,
with predictions hovering around the 5.5 percent mark.
Increased industrial production in May and June created a
sense of euphoria, prompting everyone, including the IMF
and the Reserve Bank of India (RBI), to revise their growth
forecasts upward. The consensus estimate was a 6.5
percent growth. Then, drought hit India, reducing the area
sown, which made everyone shave off 0.5 to 1 percentage
point from their growth forecasts.
The impact of the weak monsoon on agriculture sector
GDP and on overall growth is still uncertain. By itself, the
percentage deficiency in monsoon is not enough to decide
the impact on agriculture — the critical factors are distribu-
tion of rainfall geographically and over time. The thin silver
lining to the mostly non-existent clouds is that the shortfall
in rainfall is most acute in areas that are irrigated. The
worst-case scenario could be around a 7 percent decline
in agriculture sector GDP, about the same as in FY03
(April 2002–March 2003), a drought year of almost equal
15
proportion. The decline, however, is likely to be far less —
the Department of Agriculture and Cooperation suggests
only a 10–15 percent decline in food grains output
compared to 18 percent decline in FY03.
There are other factors that could sustain income from
agriculture. The decline in food grains output, primarily
rice, will likely be offset to some extent by the bumper
cotton crop expected this year due to both a rise in area
under cultivation and an increase in yield due to greater
adoption of the improved Bt variety of cotton. The big hike
in the minimum support price (price at which farmers can
sell to government agencies) means that farm incomes
will likely fall much less than the decline in output. Finally,
better post-monsoon rainfall could increase productivity in
the Rabi season, helping lessen the impact of the drought
further.
Despite the deficient summer monsoon, the economy
may still grow at close to or above 6 percent. Between
April and June of 2009, the economy grew at 6.1 percent,
better than in the last two quarters of FY09 (see figure 1).
 Geographies

Services are expected to continue to grow at a healthy
pace, though some sub-sectors such as hospitality have
suffered a demand compression. A heartening feature is
the much improved industrial performance of 8.2 percent
in June that was somewhat sustained in July at 6.8 percent
(see figure 2). With the “festival season” — the period
between October and November — coming up, demand
for consumer durables is likely to perk up. The consumer
durables sector has already seen a whopping 19.8 percent
growth in June, a sign that the worst may be over.
of 10-year yields on government bonds rising to 8.5–9
percent. With the possibility of fiscal consolidation starting
early next year, it appears likely that 10-year yields will not
rise beyond 7.5 percent. With the RBI likely to start raising
short-term rates early next year, the yield curve gap will
start normalizing over the next one year.
Inflation, however, is the biggest source of worry. After
remaining in the negative zone for the past three months,
Figure 2: Growth in industrial production (month-on-month)

25
Figure 1: Quarterly growth (financial year)
20
16
15
14
12 10
10
5
8
6 0
4
-5
2
0 -10
-2 July Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul
-4 ‘08 ‘08 ‘08 ‘08 ‘08 ‘08 ‘09 ‘09 ‘09 ‘09 ‘09 ‘09 ‘09
7

0
200

200

200

200

200

200

200

200

200

201
Industrial production Consumer durable Capital goods
Q4

Q1

Q2

Q3

Q4

Q1

Q2

Q3

Q4

Q1

Trade, transport, communication Finance, insurance, real estate
GDP Manufacturing
Source: Bloomberg
The real question is whether industrial growth will be
sustained to offset the expected decline in agriculture.
The forecast seems optimistic. It is expected that the
urban demand will pick up due to the fiscal stimulus,
hike in wages of government employees, and increased
investment in infrastructure. Rural demand will likely be
sustained because non-farm activities contribute nearly
half of the rural income. The National Rural Employment
Guarantee Scheme (a massive government program that
promises 100 days of unskilled manual employment to
every household), as well as government initiatives that
ensure farmers have adequate access to credit in the next
cropping season, will help. As the world economy revives,
exports — contributing a fifth of India’s GDP — will
start to improve. There are signs of revival in the textiles
sector, one of the worst hit in the recent economic slump,
while sectors such as automobiles and engineering are
showing positive growth. As financial markets stabilize and
economic sentiments improve, foreign direct investment
(FDI) will likely rise. In July, FDI surged to $3.5 billion, a 56
percent rise over the same month last year.
Better than expected advance tax collections in September
have raised hopes of an early recovery. The finance
minister expects the economy to recover in the January–
March 2010 quarter and has stated that the government is
likely to initiate the exit strategy in the next fiscal year. This
is good news for investors worried about the possibility
Source: Bloomberg
the Wholesale Price Index has slid into positive territory
in the week ending September 5. The RBI has raised its
inflation forecast for the year from 4 to 5 percent, and
is likely to raise it further to 6 percent. This means that
the RBI is caught between the proverbial rock and a hard
place. Inflation is mainly being driven by rising food prices
— a consequence of both supply side shock and rising
minimum support prices. Monetary policy is a blunt instru-
ment to tackle food price inflation and monetary tight-
ening could threaten the nascent industrial sector recovery.
The RBI governor has stated that India will likely be one of
the first countries to reverse its monetary stimulus, though
he does not want to raise interest rates sharply. This
probably means that the reversal is likely to come in stages,
starting in the January–March quarter.
The next financial year promises to be much better. A
lower base this year, especially in agriculture, will mean
a sharper recovery next year. Industry is already showing
signs of a revival, while services sector growth was never
in question. Exports too will likely support the economic
recovery — the Export-Import Bank of India expects
exports to grow at 10 percent next year. The economy is
likely to accelerate to around 7.5 percent in FY11, barring
a quick and early reversal in fiscal and monetary stimulus.

16
Global Economic Outlook 4th quarter, 2009

Japan:
On an uncertain
recovery path
by Shalabh Kumar Singh

japan

Japan appears to have come out of the worst postwar recession — the third G7 country
to do so — with a growth of 0.6 percent in the second quarter (April–June). This trans-
lates to an annualized growth of 2.3 percent. The recovery appears fragile, bringing back
memories of the “lost decade” when the economy showed signs of recovery only to falter
again. Record unemployment, falling wages, and a decline in business investment have
kept the mood somber. The accelerated decline in the “core-core” index of consumer
prices (excluding food and energy) in the month of July increased fears of the economy
being caught in a deflationary spiral. The Bank of Japan in its monetary policy statement of
September 2009 stated that “the year-on-year rate of decline in the CPI will likely accel-
erate somewhat for the time being,” though price stability may return in the “longer run.”
Machinery orders declined in July and core private sector machinery orders are at their
lowest since 1987, suggesting that business investment is not picking up.

The massive fiscal stimulus coupled with an almost zero interest rate policy is nearly the
same that fueled the recovery between the period 2000 and 2007. Consumer spending
rose by 0.7 percent for the first time in three quarters and there is a continued increase
in consumer confidence to 40.1 in August — the highest in nearly two years, despite the
worsening job outlook. Both suggest that the policy response has been effective in holding
up domestic demand. The current recovery, however, is being led by exports, a pattern

17

similar to the period 2002–07. Exports grew for the first
time in five quarters, and at a solid 6.4 percent, thanks
to the massive stimulus spending programs launched by
governments across the world, especially China.
Industrial production accelerated in the April–June
quarter, and inventory restocking is expected to continue
to fuel growth until the end of this year. The purchasing
managers index (PMI) rose to 50.4 in July and further to
53.6 in August, the highest level in the last three years,
which suggests continued expansion in the near term.
The decline in the ratio of inventory to actual shipments
suggests an improvement in the operating conditions of
manufacturing firms, though there is still significant excess
capacity to keep business investment from picking up
anytime soon.
A short-term euphoria may be created by the landslide
victory of the main opposition party, the Democratic
Party of Japan (DPJ). However, there is some uncertainty
regarding the policies the DPJ is likely to adopt and
their impact on economic growth in the medium and
long term. The DPJ has indicated that it will try to boost
domestic consumption through reduction in taxes and
fees and through provision of a social safety net (which
includes a monthly pension of ¥70,000, increase in
unemployment benefits, monthly support of ¥26,000 to
families for every child, removal of tuition fees in public
schools, and improved health care). The idea is to increase
household income and reduce precautionary savings, and
thereby, boost household spending. Skeptics, however,
are worried that households may divert the increased
Geographies
is also likely to hurt most big manufacturing companies.
With no plans to review the rigid labor laws or eliminate
protection for the services sector, these steps could
work against boosting domestic demand and benefiting
businesses.
The real hope for the economy is that exports, which
have been growing month-on-month since February,
are likely to continue to expand. The recent strength-
ening of the yen against the dollar, however, has worried
exporters. A stronger yen erodes earnings by reducing
the amount exporters repatriate to cover their costs.
Further, the yuan being closely tied to the dollar means
that earnings of Japanese exporters from China, a price-
sensitive market, could also get hurt. China has emerged
as the single biggest market for Japanese exports and the
current growth in exports is mainly being fueled by China
and other Asian economies (see figure 1). The yen may
continue to strengthen to reach ¥85-to-a-dollar by the end
of this year, given that the finance minister has ruled out
an intervention.
Figure 1: Monthly exports (trillions yen)
8
7
6
5
4
3
2
1
0
8

9
09

09

9
200

200

200

200

200

200

200

200

200

200
r 20

y 20
income to savings rather than increase consumption.
Aug

Sep

Oct

Nov

Dec

Jan

Feb

Apr

Jun

Jul
Ma

Ma

Reduced government consumption may further dip

domestic demand. Big corporations may benefit, however, Total exports Exports to Asia Exports to North America
by reducing their expenditure on pension and other forms
of social safety for their employees. Source: Statistics Bureau, Japan

A big worry is how the DPJ will fund these policy
measures. It plans to raise the money by eliminating waste
in government and reevaluating public works projects. The
suspension of dam construction projects has already been
announced. But what if these steps are not enough to
raise the required resources? For instance, Prime Minister
Yukio Hatoyama expects that the plan to provide child
care, eliminate highway tolls and tuition fees, and increase
unemployment benefits will cost the government around
¥7 trillion. Even if the government withholds the entire
public works spending, it will likely get only around half
this amount. An option is increased borrowings; however,
the gross debt-to-GDP ratio is more than 180 percent.
Big businesses are worried that the government may
increase their tax rates given that the DPJ has promised to
reduce the tax rate for small businesses from 18 percent
to 11 percent and not to increase the consumption tax for
the next four years. The promise to hike minimum wages
by nearly 60 percent, reverse the policy to hire temporary
workers and reduce carbon emissions, if implemented,
A stronger yen by itself, however, does not mean that
revenues for exporters will decrease. The net impact also
depends on the export volumes and domestic economic
conditions. A strong revival in world demand, which
appears likely, may offset the impact of a stronger yen.
China, which is expected to grow at 8 percent or more,
will likely continue to provide a lucrative market for
Japanese exporters. Meanwhile, demand in the United
States will likely rise due to both inventory replenishment
and the fiscal stimulus kicking-in in the fourth quarter.
Looking ahead, Japan’s fiscal stimulus is expected to start
slowing down by the end of this year. It is, therefore, to
Japan’s advantage that the recovery in the United States
is trailing the recovery in Japan, and that the U.S. fiscal
stimulus is likely to play out in 2010. Both these factors
will help sustain demand for Japanese exports at a time
when domestic measures to prop up demand start to fizzle
out. In short, though there are myriad uncertainties, the
economy will likely continue to register positive growth,
but the momentum could decline.

18
Dr. Elisabeth Denison
is Senior Economist
at Deloitte Research,
Eurozone:
Emerging from
contributing Eurozone
perspectives from
Germany

recession

EUROZONE

Eurozone economic activity contracted

sharply in late 2008 and early 2009, as
export-oriented economies like Germany
reeled from the global loss of confidence.
But the region is staging a surprising
recovery, thanks to stable consumer
spending and a revival of demand from
trading partners in Asia. Investment
spending will take some time to rebound,
but inventory rebuilding is likely to boost
production over the next couple of
quarters as new orders pick up. With
interest rates low, corporations are
positioning for the upswing.

19
 Geographies

In Spain, the recovery is hampered by high unemployment

(at 18.5 percent, the highest in the region) and continuing
retrenchment in the housing sector, which is depressing asset
prices and wealth.
In the second quarter of 2009, Eurozone GDP contracted
just -0.1 percent, following a drop of almost -2.0 percent
in Q1. Compared to a year ago, the rate of decline
moderated to -4.1 percent from -7.3 percent. The main
reason for the improvement was a pickup in net exports
and a boost from consumer spending, helped along by
timely government stimuli. However, the picture is still
uneven across the region. While GDP surprised on the
upside in both Germany and France (+0.3 percent quarter-
on-quarter), the contractions in Italy (-0.5 percent) and
Spain (-0.9 percent) were worse than expected.
In Spain, the recovery is hampered by high unemploy-
ment (at 18.5 percent, the highest in the region) and
continuing retrenchment in the housing sector, which is
depressing asset prices and wealth. In Italy, the export
sector with its heavy focus on consumer goods is slower
to recover than the more capital goods focused industries
of France and Germany, weighing on business sentiment.
For the Eurozone overall, however, indicators point to
continued stabilization in the second half of the year. In
the three months ending June, new orders for manufac-
tured goods in the region rose 1.0 percent on average,
which compares to a -1.0 percent average monthly drop
in the first three months of the year. With the improve-
ment already reported for July, the growth rate in orders is
likely to average around 2.0 percent in Q3 (see figure 1).
Figure 1: European economic activity in on the rebound
8%
6%
4%
Q3 ‘09
2%
0%
-2%
-4%
-6%
-8%
-10%
Little evidence of a credit crunch, but investment
spending is still weak
The corporate response to the uncertainty faced at the
end of 2008 was to slash inventories and freeze invest-
ments. In the combined first and second quarters of 2009,
inventories subtracted about 1.5 percentage points from
GDP growth in the Euro area — the largest negative
inventory contribution on record. However, with manufac-
turing orders picking up, companies are expected to start
rebuilding inventory over the next few months, aiding the
rebound in industrial production and contributing positively
to GDP growth.
Capital spending, meanwhile, continues to decline due
to low capacity utilization (currently around 70 percent
in manufacturing) and weak profitability. Corporate
profits declined sharply in the first quarter (more than 30
percent year-on-year in the industry sector) and are likely
to remain under pressure even through the first stages of
the recovery due to elevated unit labor costs and lack of
pricing power. But if the recovery in global demand can
be sustained and capacity utilization rises, companies will
likely take advantage of the low interest rate environment
to initiate some investment spending. For now at least, the
rate of contraction in capital spending seems to be slowing
(see figure 2).
Figure 2: Capital spending is still contracting in the
Euro area, albeit at a slower pace
3%
2%
1%
0%
-1%
-2%
-3%
-4%
-5%
-6%
2002 2003 2004 2005 2006 2007 2008 2009

2002 2003 2004 2005 2006 2007 2008 2009 2010 Eurozone fixed capital formation, qoq % change

Real GDP growth (QQ% annual) Source: Eurostat

New orders (3m average % change end-of-quarter), 1 quarter lead

Source: Eurostat
20
Global Economic Outlook 4th quarter, 2009

As part of the financial

rescue plan, and in the hope
that it would rebuild banks’
confidence in lending to the
real economy, the European
Central Bank (ECB) has
flooded the banking system
with liquidity in recent
months.

If investment spending is slow to pick up, it is not for lack
of money. As part of the financial rescue plan, and in the
hope that it would rebuild banks’ confidence in lending
to the real economy, the European Central Bank (ECB)
has flooded the banking system with liquidity in recent
months. In June, for example, it pumped €442 billion in
one-year loans into the market.
Some of this liquidity is seeping through to the corporate
sector. In a development that might suggest that balance-
sheet consolidation is coming to an end, about €2 billion
extra was borrowed by non-financial corporations in
August (seasonally adjusted), compared with a repayment
of €25 billion in July (see figure 3).
Figure 3: Corporate credit has stopped contracting
Overall, however, corporate lending remains at an
extremely low level. And surveys suggest this is not due
to an issue with the supply of but rather with the demand
for money. Even the ECB accepts that business borrowing
to fund investment will likely pick up only slowly as the
recovery unfolds.
Consumer demand remains stable; sentiment
improves
While the clampdown on spending by corporates has been
a drag on growth in recent quarters, consumer spending
has held up better than expected during the recession —
not least because of government incentives such as the
“cash for clunkers” schemes. But now there are fears that
Eurozone consumers could tighten their purse strings as
unemployment rises.

80 bn The impact might be less severe than feared, though.

60 bn Lower wage income is partly compensated by higher
40 bn social transfers (unemployment benefits), which in Europe
20 bn
can run up to two-thirds of the last income for a year
or longer. Also, the savings ratio (currently at about 15
0 bn
percent in the Eurozone, slightly above its longer-term
-20 bn
average of 14 percent) has room to decline as unemploy-
-40 bn ment rises, acting as a buffer for spending.
-60 bn
2003 2004 2005 2006 2007 2008 2009

Eurozone loans to non-financial corporations (mm change €bn)

Source: ECB, Statistical Data Warehouse

21
 Geographies

Consumers, at least, do not seem too worried. The latest Figure 4: Improving business sentiment
survey by the European Commission showed the consumer
sentiment improving 3 points to -19 in August, the highest 4500 120

reading since September 2008. Business sentiment is also 4000 110

improving across the region. The European Commission’s
3500 100
economic sentiment index (ESI) — although still well
below its long-term average of 100 — has risen 28 3000 90
percent in the six months since March 2009, reaching
2500 80
82.8 in September. Stock markets also reflect optimism,
with the Dow Jones STOXX 50 Index (a representation of 2000 70
supersector leaders in Europe) up 37 percent from March
1500 60
to September (see figure 4).
Jan Jul Jan Jul Jan Jul Jan Jul Jan Jul
‘05 ‘05 ‘06 ‘06 ‘07 ‘07 ‘08 ‘08 ‘09 ‘09
A look at the business-cycle tracer confirms that the
DJ STOXX 50, l.s. Eurozone Sentiment Index, r.s.
upswing has arrived. This indicator graphs the level of
economic sentiment (standardized index) on the vertical Source: European Commission, Bloomberg
axis and its change (growth momentum) on the horizontal
axis. Having been deep in contractionary territory for
several months, the indicator started to turn at the end Figure 5: The business cycle is turning
of 2008, entering into the upswing quadrant early this
summer. However, it also suggests that a solid expansion is 2.0
downswing expansion
still some way off (see figure 5).
1.0
Sep 07
ESI Index (standardized level)

May 06
Jan 05
Until the recovery is fully entrenched, the European Central 0
Bank is expected to stay put (the refinancing rate currently Jul 08
stands at a record low of 1 percent). ECB President Jean- -1.0
Claude Trichet has made clear that the central bank has an Sep 09 Aug 09
-2.0
"exit strategy" to unwind the exceptional measures it has May 09
Dec 08
taken during the crisis. However, a move in interest rates is -3.0
not expected until well into 2010 (if at all). In an interview Mar 09
contraction upswing
with the Financial Times on September 18, Erkki Liikanen, -4.0

governor of Finland's central bank, summed it up: "We are -10.0% -8.0% -6.0% -4.0% -2.0% 0% 2.0% 4.0% 6.0%

not in a hurry now. If you look at growth in Europe, it is

ESI Index (% mm, 3m avg)
about to recover — but clearly from a lower level."
Source: European Commission, Deloitte

References and Research Sources:

European Commission (EC), DG for economic and financial affairs, Interim forecast, September 2009.
European Central Bank (ECB), Monthly Bulletin, September 2009.
European Central Bank (ECB), Monetary Developments in the Euro Area, August 2009.
FT interview transcript: Erkki Liikanen, published September 24, 2009, <http://www.ft.com/>.

22
Global Economic Outlook 4th quarter, 2009

The United Kingdom:

Consumer rebalancing arrives
by Ian Stewart

U.K.

The overwhelming expectation is that the U.K. recovery

will be sluggish. The average economist does not expect
the annual rate of GDP growth to return to trend or
normal rates until 2012 at the earliest.

23
 Geographies

• The U.K. economy is starting to recover; growth

should pick up in coming quarters

• The scale of the balance sheet rebuilding

required in the consumer sector points to weak
consumption growth for some time

• The early stages of the U.K. recovery are likely to

be driven by exports and investment, not by the
consumer

Like most advanced economies, the United Kingdom has
seen a marked improvement in its economic prospects
in recent months. Financial markets have continued to
stabilize and this has been reflected in the continued rally
in equities and corporate bonds, in narrowing corporate
bond spreads and falling inter-bank interest rates. Most
lead indicators of economic activity signal recovery.
Business and consumer sentiment (see figure 1) have
improved markedly. But the overwhelming expectation
is that the U.K. recovery will be sluggish. The average
economist does not expect the annual rate of GDP growth
to return to trend or normal rates until 2012 at the earliest.

Figure 1: U.K. Consumer confidence

10

-5

-10

-15

-20

-25

-30

-35

-40
1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Source: Datastream

24
Global Economic Outlook 4th quarter, 2009

A slow recovery is the price the United Kingdom is likely

to pay to rebalance its economy. Consumers entered the
downturn with low savings and relatively high levels of
debt. Household debt as a proportion of income increased
from 100 percent to 165 percent in the 10 years to 2007
while the savings ratio dropped from 4.5 percent to -0.5
percent (see figure 2). Financial innovation had enabled
more consumers to access credit more readily, and this
helped fuel house prices and consumption. In recent
years, U.K. consumers have been making progressively less
provision for the future.

Figure 2: U.K. savings ratio

16
14
12
10
8
6
4
2
0
-2
71
73
75
77
79
81
83
85
87
89
91
93
95
97
99
01
03
05
07
09
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
20
20
20
20
20
Source: Datastream

Since 2007, lower house prices have eroded consumers’

collateral and, therefore, their ability to raise credit. At
the same time, banks have become more cautious about
lending. With unemployment on the rise, consumption has
taken a major knock, falling for the past five consecutive
quarters — the first time this has happened since records
began in 1955.

25
 Geographies

A process of balance sheet rebuilding is clearly well

underway. The savings ratio has risen sharply and U.K.
consumers have switched from being net users of capital With unemployment on the rise,
to net providers of capital to the rest of the economy (see
figure 3). consumption has taken a major knock,
Figure 3: U.K. household sector financial balance, £mn falling for the past five consecutive
15000 quarters — the first time this has
10000

5000
happened since records began in 1955.
0

-5000
slowed in recent months. Moreover, while earnings have
-10000
been squeezed by the downturn, inflation and taxes have
-15000
fallen faster. As a result, real earnings are showing strong
-20000 growth.
-25000
87

89

91

93

95

97

99

01

03

05

07

09

U.K. consumer balance sheets are certainly stretched, but

19

19

19

19

19

19

19

20

20

20

20

20

the problems may be less acute than they appear at first.

Source: Datastream
The pace of consumption growth depends largely on the
pace of rebalancing in the economy. The general view,
with which it is hard to disagree, is that this will be a slow
process. The corollary is that growth in consumer spending
will remain subdued into 2011 and possibly beyond.
But the news for the U.K. consumer is not all bleak. A
necessary and inevitable adjustment in balance sheets is
well underway. Unemployment is likely to rise for some
time, but the pace of deterioration in the labor market has
Borrowing has risen sharply, but so too has the overall
value of consumers’ financial assets. This is because part
of what has been driving the housing market is older
homeowners selling large homes, buying smaller ones,
and putting the extra cash into financial assets. U.K.
households accumulated an additional £1 trillion of debt
between 2000 and 2008 but also acquired over £750
billion of financial assets over the same period. And while
lower house prices are generally seen as an economic
depressant, more affordable housing provides a boost for
those planning to trade up or buy their first house. Finally,
consumers’ future incomes are not fixed. Consumers may
in future choose to work longer to increase their incomes,
in this way accelerating the pace at which they build up
reserves.

But for now it looks as if the process of strengthening

consumer balance sheets will take time. The United
Kingdom’s economic recovery over the coming quarters
is unlikely to come from the consumer. Rather, the main
drivers are likely to be investment, exports, and a switch in
demand from foreign to U.K. producers.

26
Global Economic Outlook 4th quarter, 2009

Russia:
An uncertain outlook
by Dr. Ira Kalish

There are several things clear about Russia. It had a very

Russia bad 2009, it will have a better 2010, and its longer-term
outlook depends heavily on the price of oil. The big
question then is whether Russia, even with higher oil
prices, is capable of returning to the high growth of the
past decade. The answer depends on several factors. These
include the policy response of Russia’s authorities, the
health of global credit markets, the degree of confidence
in Russia on the part of foreign investors, and, of course,
just how high oil prices go.

The short-term situation

For all of 2009, Russia’s GDP is expected to decline roughly
7 to 9 percent depending on whose forecast you read.
However, in August of 2009, GDP was down 3.9 percent,
easing from the drop of 10.9 percent in the second
quarter. Clearly, things are going from very bad to not so
bad.

The sharp recession, the worst for the BRIC and G20
economies, was due to several factors. First, the sharp
drop in the price of oil in 2008 wreaked havoc with
Russia’s economy. It reduced export revenue and hurt
Russia’s ability to service its large foreign debts.

Second, the global credit crunch meant that Russia’s

debtors were no longer in a position to roll over debts that
they could no longer service. Hence, Russia’s own financial
sector became troubled and ultimately required govern-
ment assistance. A collapse of credit within Russia was a
consequence and it is not over yet.
Third, when Russians faced problems with their foreign
debts, foreigners started shifting funds out of Russia,
putting downward pressure on the currency. To prevent a
collapse in the value of the ruble, the central bank inter-
vened heavily and raised interest rates. This tightening
of monetary policy exacerbated an already bad situation
and harmed already weak credit markets. Moreover, the
intervention left Russia with considerably smaller foreign
currency reserves.
Today, Russia’s economy remains in recession, but is
starting to show some positive signs. During 2009, the
government enacted a large fiscal stimulus that caused the
budget deficit to increase to roughly 9 percent of GDP. At
the same time, monetary policy has been loosened now
that the currency has stabilized. The benchmark interest
rate set by the central bank has been cut by over 200
basis points since April. This reflects strengthening in the
value of the ruble. On the other hand, inflation remains in
double digits. This means that there may be limited scope
for further monetary easing.

27

What's next?
The outlook for the coming year depends on a number of
factors. First and foremost, the price of oil will have a big
impact. When oil was close to $150 per barrel, Russia was
doing very well. Yet when the price fell to $60 per barrel,
the situation became troubling. However, the price of oil
throughout the past decade was lower than this. And yet
Russia’s economic performance was quite good. Export
revenue in 2009, while considerably lower than last year,
will probably be roughly comparable to that of 2006.
The problem is that during the past decade, Russia took
advantage of the relatively high price of oil and low capital
costs to borrow heavily from abroad. Today, external debt
is much higher than three years ago. Given this and the
state of global credit conditions, Russia requires an even
higher level of export revenue in order to restore economic
credibility. A significantly higher price of oil would be very
good for Russia, but whether this happens will depend on
the performance of the global economy.
That brings us to the second important factor: global
growth, especially growth in Western Europe. Roughly 65
percent of Russia’s export revenue is oil and gas related,
and the biggest export market for Russia is Germany,
followed by the Netherlands, Turkey, and Italy. The degree
to which Germany recovers (and Germany’s performance
will influence the rest of Europe) will have a big impact
on demand for Russia’s gas and the revenues Russia can
expect to receive.
Third, the ability of Russia to service its debts and obtain
capital in global markets will depend, in part, on the state
of global finance. Today, the banks of Western Europe
remain challenged by the situation in Central Europe and,
therefore, are apt to hold excess reserves. Credit market
conditions remain problematic. This may change next year,
but probably only slowly.
Finally, Russia’s performance next year will depend heavily
on the stance and flexibility of government policy. Fiscal
policy has been highly expansive, the effect of which has
been widely debated. But there is almost no debate as to
what comes next. Russia will ultimately have to remove
fiscal stimulus, something it seems determined to do in
a credible way. Indeed, the government is making very
pessimistic assumptions about the price of oil and the rate
of economic growth in forecasting its budget deficit of 7.5
percent of GDP for next year. The IMF, on the other hand,
sees a deficit of only 5.5 percent of GDP. In that case, there
will be greater flexibility to engage in stimulatory measures
if needed. Failure to do so may impede stronger growth.
Monetary policy will matter as well. It has lately been
relaxed, aimed at providing liquidity to the financial sector.
Yet inflation remains stubbornly high, possibly necessitating
another tightening of monetary policy in the near future.
Geographies
Finally, longer-term prospects will depend on other aspects
of economic policy such as regulation, investment in
infrastructure, efforts to stave corruption, and respect
for private property rights. Such issues have been an
impediment to economic diversification. Russia’s excessive
dependence on the resource sector is a concern for poli-
cymakers and diversification will require a new business
environment.
Risks to the Russian forecast
There are a number of issues that could threaten a strong
recovery for the Russian economy. First, Russian banks’
portfolios of non-performing loans (NPLs) are growing.
This means that an increasing share of Russian income
might be required for resolving the toxic assets of Russian
banks. That is money that would otherwise go to invest-
ment. The process of resolution impedes the normal
functioning of credit markets. Doing it quickly would be
better than delaying.
When Russians faced problems with their
foreign debts, foreigners started shifting
funds out of Russia, putting downward
pressure on the currency. To prevent a
collapse in the value of the ruble, the
central bank intervened heavily and raised
interest rates.
Second, Russia is already suffering from double digit
inflation. If oil prices rise rapidly, and if there is a renewed
flow of foreign investment into Russia, even higher
inflation could be the result. If the central bank must
consequently tighten monetary policy, growth will be
stifled.
Finally, a combination of corruption, poor governance,
government interference in the private sector, and insuf-
ficient investment in the oil and gas sector remain a
problem. These issues, under the common heading of
economic structure, will stymie longer-term economic
growth. Despite President Medvedev’s call for a more
balanced economy, Russia is excessively dependent on
the resource sector. Yet it fails to adequately invest in that
sector. Unless there are high oil and gas prices, growth will
not be strong.
28
Global Economic Outlook 4th quarter, 2009

Appendix
GDP growth rates (YoY%) GDP growth rates (YoY%)

6 15

4 10

2 5

0 0

-2 -5

-4 -10

-6 -15
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2
-8 07 07 07 07 08 08 08 08 09 09

-10
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Brazil India China Russia
07 07 07 07 08 08 08 08 09 09
Note: India's fiscal year is April – March
U.S. Eurozone U.K. Japan Source: Bloomberg

Source: Bloomberg

Inflation rates (YoY%) Inflation rates (YoY%)

6 20
5
4 15
3
10
2
1
5
0
-1 0
-2
-3 -5
Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug
08 08 08 08 08 08 09 09 09 09 09 09 09 09 08 08 08 08 08 08 09 09 09 09 09 09 09 09

U.S. Eurozone U.K. Japan Brazil India China Russia

Source: Bloomberg Source: Bloomberg

Major currencies vs. the U.S. dollar

2.2 115

2 110

105
1.8
100
1.6
95
1.4
90
1.2 85

1 80
8
08
8
8
08
08
9
9
09
9
09
9
9
09
9
Jul 0

Sep 0
Oct 0

Jan 0
Feb 0

Apr 0

Jun 0
Jul 0

Sep 0
Aug

Nov
Dec

Mar

May

Aug

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

Source: Bloomberg

29
 Appendix

Yield curves (as of October 1, 2009)

Eurozone
U.S. Treasury Government
Bonds & Notes U.K. Gifts Benchmark Japan Sovereign
3 Months 0.13 0.33 0.32 0.15
1 Year 0.40 0.58 0.69 0.17
5 Years 2.36 2.70 2.50 0.58
10 Years 3.35 3.69 3.43 1.29

Source: Bloomberg

Yield curves (as of October 1, 2009)

Brazil Govt. India Govt.

Benchmark China Sovereign Actives Russia Sovereign
3 Months 8.71 1.35 4.15 6.74
1 Year 10.24 1.45 4.55 7.76
5 Years 12.41 2.91 7.18 10.87
10 Years 12.80 (7 years) 3.51 7.23 13.11

Source: Bloomberg

Composite median currency forecasts (as of October 1, 2009)

Q4 09 Q1 10 Q2 10 Q3 10 2010
GBP-USD 1.65 1.65 1.67 1.65 1.66
Euro-USD 1.45 1.44 1.45 1.43 1.41
USD-Yen 95 96 98 100 101
USD-Brazilian Real 1.8 1.8 1.8 1.8 1.78
USD-Chinese Yuan 6.82 6.8 6.75 6.65 6.66
USD-Indian Rupee 47.25 46.5 46.25 45.5 45.5
USD-Russian Ruble 31.5 31.6 31.83 31.6 31.63

Source: Bloomberg

30
Global Economic Outlook 4th quarter, 2009

Composite GDP forecasts (as of October 1, 2009)

U.S. U.K. Eurozone Japan Brazil China India Russia

2009 -2.6 -4.25 -3.85 -5.95 -0.4 8.3 5.8 -7.9
2010 2.4 1.25 0.95 0.8 3.8 9.4 7.8 2.3

Source: Bloomberg, Citigroup

OECD Composite leading indicators

U.S. U.K. Euro area Japan Brazil China India Russia

July ‘08 98.68 96.87 100.16 99.91 105.54 99.62 98.80 103.82
August ‘08 98.19 96.04 98.27 98.99 105.05 98.02 97.88 101.86
September ‘08 97.64 95.24 95.91 97.75 103.92 96.04 96.81 99.14
October ‘08 97.15 94.50 93.33 96.20 102.14 93.82 95.61 95.89
November ‘08 94.50 96.50 94.10 95.10 101.00 93.50 95.30 93.60
December ‘08 92.60 96.20 94.30 92.60 98.80 92.50 94.40 90.70
January ‘09 91.50 96.10 94.00 91.30 96.70 92.20 93.80 88.40
February ‘09 90.90 96.30 94.00 90.20 95.00 92.60 93.60 87.00
March ‘09 90.70 96.70 94.50 89.40 93.60 93.40 93.50 86.20
April ‘09 90.90 97.40 95.30 89.50 92.90 94.30 93.90 85.90

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

Source: OECD

31
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Global Economic Outlook 4th quarter, 2009

Additional resources

issue 5 | 2009

What Next? Business Asia Pacific

in 2010 and beyond economic outlook
A review of perspectives and viewpoints
on possible scenarios

Platforms
and the
Open Door
High stakes in
platform leadership
may rewrite
the rules for
value capture in
wireless –
and beyond
China’s consumer market:
What next?
The Great
Transformation

How Profitable
Are Your
Customers
...Really?

October 2009
A Deloitte Research report A Deloitte Research Study

Global Economic Thought Leadership

Deloitte Review, Issue 5:
• The Great Transformation
• What Next? Business in 2010 and Beyond
• China: Still Manufacturing’s Shining Star?

Asia Pacific Economic Outlook

China's Consumer Market: What Next?

If We Can Put a Man on the Moon: Getting Big Things Done

in Government

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