Simultaneous Recovery and Risk: Forecast for the Global Economy, 2012

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1 Simultaneous Recovery and Risk: Forecast for the Global Economy, 2012 A brief scan of the world s leading economies highlights the near- and long-term prospects for a return to healthy growth. 1

While this year may ultimately be regarded as a period of significant correction for the world economy, the euphemism masks the painful dislocation and subsequent risks associated with the

2 Hopes for a dramatic upswing from the Great Recession have been replaced with more realistic expectations of a fitful recovery. Christine Lagarde, managing director of the International Monetary Fund (IMF), has called 2012 the year of healing. While this year may ultimately be regarded as a period of significant correction for the world economy, the euphemism masks the painful dislocation and subsequent risks associated with the consolidation of government fiscal positions and closely interrelated financial institution exposure. Indeed, the post-recession recovery has lost much of its momentum. As a result, global growth will likely slow to 4.4 percent in 2012, from 5 percent in 2011 (expressed in constant terms). The January 2012 update of the IMF World Economic Outlook summarizes the short-term outlook as global recovery stalls, downside risks intensify. The IMF downgraded its projections for world output growth this year from 4.0 percent to 3.3 percent, and lowered its forecast for 2013 from 4.5 percent to 3.9 percent (see figure 1). According to the World Bank, the operative words are uncertainties and vulnerabilities. For its part, the World Bank is projecting a decline in real GDP growth from 2.7 percent last year to 2.5 percent this year (37 percent to 3.4 percent in purchasing power parity). We expect the decline in global output for this year to be somewhat more tempered perhaps at 3.5 percent, compared with 3.8 percent last year. Still, there s every good reason to be cautious, especially when the potential downsides are taken into account. Three major economic futures are in simultaneous flux. First, although the eurozone has managed to persevere through the financial, fiscal, and political stürm und drang since the crisis erupted, the mild recession, the rise in sovereign yields, and the continued banking consolidation all suggest a stalled recovery. For the eurozone, the IMF is projecting a 2012 decline of -0.5 percent, while the European Commission is forecasting a drop of -0.3 percent. The European Union as a whole is expected to be close to flat at -0.1 percent. Figure 1 World economy gross product growth, (percent, constant prices) Advanced economies 2 Developing economies 4 World Sources: IMF World Economic Outlook Database ( ), IMF World Economic Outlook, January 2012 ( ); A.T. Kearney projections 2

3 Second, the United States remains weak from its ongoing housing crisis and hamstrung by persistently high unemployment, but it nevertheless has the potential for marginal short-term growth at least through the November presidential election. Many of the current forecasts anticipate a flat rate of growth at 1.8 percent, but our view is somewhat more positive with a growth rate above 2 percent. Finally, Europe s slowdown in Europe and the U.S. s continued fiscal challenges have translated into declining growth in the developing world. China s yearly growth has fallen sharply from 9.2 percent in 2011 to a projected 8.2 percent in Likewise, the pace of India s growth has slowed from 7.4 percent in 2011 to 7.0 percent in Nevertheless, China, India, and other high-growth developing countries will continue to be the center of global economic dynamism. These countries emerged relatively unscathed from the recession, and despite slower growth this year brought about by their own consolidation, they are continuing to retool their respective economic systems successfully. As always, however, wildcards issues or events that have the potential to dramatically alter the expected path are in play (see sidebar: Watching for Wildcards). Watching for Wildcards Wildcard events have the potential to derail even the most certain predictions. If or how they affect the recovery remains to be seen, but any one of the following could dramatically influence both short- and long-term prospects: Unemployment. Joblessness has grown sharply on both sides of the Atlantic. The challenge of unemployment is a major factor in the political debate in countries undergoing government transitions. Politicians are under significant pressure to alleviate short-term pressures while at the same time addressing the structural consolidation necessary to stabilize their economies. A related wildcard challenge is the unprecedented level of youth unemployment. In the aftermath of the joblessness that contributed to the Arab Spring phenomenon and the subsequent Occupy movement, both developing and developed economies must somehow simultaneously exercise fiscal constraint and address the unemployment challenge. Debt overhang. This has been on the GBPC watch list for quite some time. Above and beyond the immediate eurozone crisis, the urgent challenge for many developed economies is to restore economic growth in order to pay down high debt levels and revisit social contracts with rapidly aging populations. Geopolitical risk. This year, several prominent countries, including China, France, India, Mexico, Russia, South Korea, and the United States, will undergo major political transitions. In addition, there are significant residual concerns about the trajectories of Arab Spring countries, many of which have effectively removed unpopular and dysfunctional regimes but have not yet put lasting structures into place. The current escalating violence in Syria is a case in point of how domestic instability can spill over into neighboring countries. Finally, the uncertainty regarding the nuclear issue in Iran could extend for an indefinite period. Resource volatility. In the spring of 2008, immediately before the onset of the Great Recession, rapid global economic growth generated pronounced resource price volatility. This was merely a dress rehearsal. Four years later, we see the resurgence of the same kind of volatility generated by geopolitical risk, namely the threat of a wider conflict with Iran and related threats against the security of the Strait of Hormuz. The immediate concern is over energy prices ballooning because of these geopolitical concerns. However, the longerrange concern is that resource prices and constraints may abbreviate the limited recovery now underway by creating a ceiling for economic growth. 3

Combined, these uncertainties mean that business leaders must continuously assess economic trends and market-shifting conditions across the world.

4 Combined, these uncertainties mean that business leaders must continuously assess economic trends and market-shifting conditions across the world. Moreover, they must formulate and execute strategies based on both short-term developments and longer-range trends. What follows here is a brief world scan of the major economies to assess their performance and outlook for the coming year and beyond. Europe The eurozone financial crisis has stalled growth for both the core and periphery countries of Europe (see figure 2). The EU s aggregate growth rate is expected to fall from 1.6 percent in 2011 to -0.1 percent in 2012 in effect, flat-lining as core countries struggle with the magnitude of the challenges in the periphery countries with persistent weaknesses in their financial institutions. Similarly, the euro area is expected to see an output decline of more than 2 percent from 1.6 percent in 2011 to -0.5 percent this year. We believe that the impact of continued instability will be somewhat more muted at the 0 percent level as successive political efforts address vulnerabilities. Thus far, highly publicized bailouts have averted an even deeper crisis, but serious concerns remain over the debt burdens and growth prospects of Greece and other struggling peripheral countries. The situation, of course, is compounded by deteriorating social conditions including unemployment in the eurozone, which reached a record high of 10.8 percent in April. Even more striking is that youth unemployment (under 25 years old) is approaching 50 percent. The European Central Bank s (ECB) dramatic decision to implement the Long-Term Refinancing Operation in December 2011 and February 2012 may have alleviated short-term pressures by Figure 2 EU and euro zone GDP growth, (percent, constant prices) Euro area European Union Note: Euro area data start in 1992 Sources: IMF World Economic Outlook Database ( ), IMF World Economic Outlook, January 2012 ( ); A.T. Kearney projections 4

5 injecting more than 1 trillion ($1.27 trillion) in three-year lending into banks that need capital. However, the extent to which capital markets are returning to normalcy is unclear. They are on countdown. The operative question is whether they can exploit the current, more stable conditions to strengthen balance sheets and finances. Consequently, the European story in 2012 can be summarized as wait and see. Despite assurances from various sources that the euro area countries have turned the corner, prospects for recovery hinge on several major variables, including: The rate of stabilization of periphery economies The level of political coherence The activism of the ECB Strengthened governance in the euro area Resumption of credit operations and bank funding United States In the United States, economic indicators in early 2012 have been more positive than in Europe. Unemployment a politically charged issue has fallen to its lowest level since March Business indices are improving, consumer confidence and spending are strengthening, the devastating housing crisis may finally be turning a corner, and financial markets are rallying. Still, the prospects for a dramatic acceleration of the recovery are remote. While housing starts have reached a three-year high, reviving the market is still a significant challenge, with residential home prices across the United States only beginning to stabilize. Unemployment could inch below 8 percent by year s end, but concerns over stubbornly high long-term unemployment remain high as jobless workers struggle to regain skills or learn new ones. Federal Reserve Chairman Ben Bernanke recently noted that both the number of workers and the total number of hours worked are still below pre-crisis levels. In light of these issues, our view is that the annual growth rate for 2012 will be 2.2 percent a moderate rise from 1.8 percent last year. This amounts to a modest improvement but far from a dramatic shift (see figure 3 on page 6). Importantly, it leaves the economy vulnerable to a range of wildcards. The main variables in the U.S. economy s short-term outlook are: Whether the economy can restore growth levels in the 2 to 2.5 percent range, which is still substantially lower than other post-recession recoveries Continuing declines in unemployment and underemployment Recovery of the ailing housing market Long-range fiscal policy changes that fix structural deficits and long-term debt levels The capacity of policymakers to act decisively in the lead-up to November s presidential elections 5

6 Figure 3 United States GDP growth, (percent, constant prices) Sources: IMF World Economic Outlook Database ( ), IMF World Economic Outlook, January 2012 ( ); A.T. Kearney projections Japan The Japanese economy is expected to recover moderately this year, with year-over-year growth increasing from 0.9 percent to 1.7 percent in A number of global factors could act as headwinds for Japan s recovery, however, and could even undermine what limited progress is expected. Japan s internal economy is expected to recover, boosted by strong internal demand and fixed capital investment, which rose by 4.8 percent at the end of last year, thanks to rebuilding efforts in the wake of the March 2011 tsunami. Limited demand in main export markets such as the United States, Europe, and China will act as a counterbalance to the steep 10 percent weakening of the currency since the beginning of Moreover, Japan's industrial sector depends heavily on imported raw materials and fuels, especially since much of its nuclear capacity has been taken offline since last year. The country also imports nearly 60 percent of its food on a caloric basis. Given the dynamics, externally driven food and fuel price shocks could negatively affect Japanese growth over the short term. Over the longer term, Japan faces more stubborn challenges, such as adjusting to the global competition facing its post-world War II keiretsu structures, government debt in excess of 200 percent of GDP, and nearly 20 percent decline in working population by Primary issues to monitor this year include: The continued trajectory of recovery a year after the tsunami Price volatility in the international commodity markets on which Japan depends 1 Keiretsu structures are sets of companies with interlocking business and relationships and shareholding structures. 6

7 The exchange rate dynamics of the yen and Japan s external economy The capacity of the government to shore up weak institutions before demographic pressures, such as aging, become even more pronounced Vladimir Putin s new government faces the prospect of a moderate economic slowdown in Russia. Russia In the wake of the long-expected political transition that came with the March elections, the new government of Vladimir Putin faces the prospect of moderate economic contraction, from 4 percent in 2011 to a projected 2.5 percent in Inflation is expected to fall from 8 percent to 7 percent year-over-year. As figure 4 shows, the global recession interrupted Russia s high rate of growth prior to the crisis and the country has not yet fully recovered. This has hindered the leadership s efforts to modernize and diversify the Russian economy and sapped accumulated oil windfalls intended for critical inward investments. Vladimir Putin, the new prime minister, is a well-known entity, of course, and has signaled his intention to promote business-friendly policies. He will build on a range of reforms enacted last Figure 4 Russia GDP growth, (percent, constant prices) Sources: IMF World Economic Outlook Database ( ), IMF World Economic Outlook, January 2012 ( ); A.T. Kearney projections 7

8 year, including a relaxation of conditions on foreign direct investment (FDI) and incentives to strengthen innovation. Ultimately, the short-term outlook for his government is linked to the mild recession in Europe, the long-term vulnerabilities in the domestic financial sector, and whether or not Moscow can convince foreign investors who withdrew money prior to elections to return. In A.T. Kearney s latest FDI Confidence Index, a survey of global FDI volumes and patterns, Russia improved its position significantly from 18th to 12th place. 2 This suggests renewed interest on the part of international business leaders in Russia investment prospects. The country can continue to rely on its massive factor endowment its huge amount of land, people, and capital and its economy will benefit from volatility in global resources, particularly in terms of energy and agriculture. It is likely that the proceeds from resources will be channeled into the country s post-recession modernization process. In the aftermath of the joblessness that contributed to the Arab Spring, both developing and developed economies must simultaneously exercise fiscal constraint while increasing employment. High-Growth Developing Economies Figure 1 depicts the current and projected growth gap between developed and developing economies. The recession widened that gap, and in relative terms many of the resilient, high-growth developing countries are catching up rapidly. While there is considerable disparity among these countries, as a whole they represent the most significant source of economic dynamism in Indeed, China, India, and Brazil are particularly important to the short-term global economic outlook. China. As China s political transition approaches, Chinese Premier Wen Jiabao has downgraded the growth projections for 2012 to 7.5 percent (down from 9.2 percent last year), which would be the slowest growth rate since This anticipated drop in output reflects a decline in exports brought about by weakness in the global economy. Any deterioration of the European economy would mean further downside pressures on output. Still, assuming a mild recession in Europe and renewed growth in the United States, China s export economy may recover slightly over the remainder of the year. Inflation in China fell to 4.1 percent at the end of 2011, and it finished at 5.4 percent for the year. The IMF predicts that inflation will continue to fall through the first half of 2012 to 3.3 percent 2 To read the 2012 FDI Confidence Index, see Cautious Investors Feed a Tentative Recovery, at 8

9 and decline further to 3 percent in Price shocks in global food and energy markets could generate significant new inflationary pressures. Assuming a low inflation environment, it is likely, for both political and economic reasons that the government will seek to stimulate the economy in the lead-up to the political transition at the end of the year. While it would be premature to suggest that China is in for a hard landing, we anticipate that 2012 will be a consolidation year for the Chinese economy and growth will fall marginally below the target level of 7.5 percent. Still, as reflected in the FDI Confidence Index, there remains substantial support for China as a target for foreign investment flows. The country has been first in our rankings since India. After registering 9.9 percent growth in 2010, the Indian economy cooled to 7.4 percent last year, with a decline to 7 percent forecast for this year. Recent reports indicate that growth in the fourth quarter of 2011 fell to 6.1 percent. Part of this decline is the result of efforts by the central government to lower inflation by increasing interest rates. Successive tightening measures since 2010 have had a marginal impact on lowering inflation, but the economy remains highly susceptible to food inflation pressures. In the meantime, constraints on capital have slowed growth. Another important factor is the loss of momentum in economic and financial reforms. Political inertia or opposition has impeded progress in several significant areas, not least of which include the rule on foreign ownership of enterprises, physical infrastructure, and the elimination of state monopolies. A persistently high budget deficit has added fuel to the fire. Our research shows continued investment momentum for India. The country moved from third place to second in our investment survey this year. The outlook for India in the light of these factors is mixed. Growth rates have slowed substantially and the outlook for the remainder of the year is for more of the same. In the longer term, it remains to be seen whether the political coalition can succeed in implementing the next phase of bold economic reforms. Brazil. Brazil has experienced sharp declines over the past year. Its growth rate fell from 7.5 percent in 2010 to 2.9 percent in 2011, and the IMF is forecasting growth of 3 percent for this year. The Economist Intelligence Unit (EIU) is projecting real GDP growth of 4.3 percent from 2012 to We expect growth will be somewhat high in large part because of the massive resource base Brazil can exploit in the face of mounting global resource volatility. Inflation and imported inflation both remain serious concerns. The rate increased to 6.5 percent last year, although both the IMF and Organisation for Economic Co-operation and Development (OECD) both forecast declines for this year and next. Pressures are down for the time being, and monetary easing could spur rises in output growth. Another important issue is the tight labor market. Brazil continues to perform well in the FDI Confidence Index results. It placed 3rd this year, leapfrogging the United States, which fell from 2nd to 4th. The outlook, therefore, is for Brazil to experience modest improvement as it goes through major local elections that will continue to test the integrity of President Dilma Rousseff s ongoing political coalition. 9

A Correction Year Most observers agree that the global economic outlook is now substantially better than it was in the immediate aftermath of the financial crisis.

10 A Correction Year Most observers agree that the global economic outlook is now substantially better than it was in the immediate aftermath of the financial crisis. The fact is that a number of countries have implemented significant and, in some cases, politically difficult reforms aimed at addressing a wide range of structural vulnerabilities. Most observers would also acknowledge that this healing process is far from complete. Most of the wounds of may have been cauterized and bandaged, but the patient the world economy still requires close observation. A number of structural changes are still incomplete. Key vulnerabilities persist. It is also clear that multiple downside risks still loom large. Therefore, it is appropriate to suggest that 2012 will be a correction year and that the extent to which the current tepid recovery persists will depend on the capacity of policymakers around the world to address their different longer-range challenges. Author Erik R. Peterson, Managing Director of the Global Business Policy Council, Washington, D.C. erik.peterson@atkearney.com 10

11 A.T. Kearney is a global team of forward-thinking, collaborative partners that delivers immediate, meaningful results and long-term transformative advantage to clients. Since 1926, we have been trusted advisors on CEO-agenda issues to the world s leading organizations across all major industries and sectors. A.T. Kearney s offices are located in major business centers in 39 countries. Americas Atlanta Calgary Chicago Dallas Detroit Houston Mexico City New York San Francisco São Paulo Toronto Washington, D.C. Europe Amsterdam Berlin Brussels Bucharest Budapest Copenhagen Düsseldorf Frankfurt Helsinki Istanbul Kiev Lisbon Ljubljana London Madrid Milan Moscow Munich Oslo Paris Prague Rome Stockholm Stuttgart Vienna Warsaw Zurich Asia Pacific Bangkok Beijing Hong Kong Jakarta Kuala Lumpur Melbourne Mumbai New Delhi Seoul Shanghai Singapore Sydney Tokyo Middle East and Africa Abu Dhabi Dubai Johannesburg Manama Riyadh For more information, permission to reprint or translate this work, and all other correspondence, please insight@atkearney.com. A.T. Kearney Korea LLC is a separate and independent legal entity operating under the A.T. Kearney name in Korea. 2012, A.T. Kearney, Inc. All rights reserved. The signature of our namesake and founder, Andrew Thomas Kearney, on the cover of this document represents our pledge to live the values he instilled in our firm and uphold his commitment to ensuring essential rightness in all that we do.

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