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NS4053 Winter 2014

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  1. NS4053Winter 2014 Asia Assessment and Scenarios

  2. Outline • Current World Economic Situation • Overview, Patterns of Recovery, and Forecasts • Major Themes Over the Next Several Years • Areas of Uncertainty • Eurozone - Continued Stagnation? • Emerging Economies – Slowdown Ahead? • Asia Overview • Recent Capital Outflows and Financial Stress • Economic Prospects • Areas of Risk • Key Issues • China’s Rebalancing • Implications of Global Trends for Defense Expenditures

  3. Global Economy Overview I • Before the crisis the main feature of the global economy was its rapid integration – has continued at a slower pace since the crisis • Trade relative to GDP, capital flows relative to the global capital stock and so on are all rising • However, economic policies largely set at the national level to benefit domestic economy • These policies are increasingly affecting other economies • External effects particularly important in the financial sector due to potential for large and relatively abrupt changes in • Capital flows • Asset prices • Interest rates, exchange rates and • Credit availability.

  4. Global Economy Overview II • The 2008-09 global economic crisis and its aftermath illustrate this new reality • Characterized by defective growth models in advanced economies based on excess credit and domestic aggregate demand • Complicated by structural flaws and limited adjustment mechanisms in Europe leading to • Instability • A crisis • Large negative shock to the real economy • Emerging economies were immediately affected by • Credit tightening (including trade finance) • Rapid declines in exports • Resulting in similar shocks there

  5. Global Economy Overview III • This was followed by – extended version of the assisted growth model in the advanced countries • Unconventional monetary policy – United States • Lowered cost of credit for debtors and those seeking to borrow for business expansion • Came at the at expense of savers – lower interest rates • Did not work well because investment constrained by deficient domestic demand relative to capacity • Savers sought higher returns in emerging economies • Causing increases in credit and causing upward pressure on exchange rates and asset prices – responded with • Limits on capital inflows • Reserve accumulation and • Measures to restrict credit and restrain asset-price inflation

  6. Global Economy Overview IV • Situation changed in May 2013 when U.S. Federal reserve indicated it might taper its purchase of long-term assets • Asset prices shifted and in emerging economies • Capital rushed out, • Caused credit markets to tighten and • Exchange rates to fall • At a minimum a short-term growth slowdown is nearly certain • The reversals may have longer term adverse effects – although not clear at this point • While China’s output is affected by advanced country economic performance – financial system largely isolated • Capital account less open, foreign currency reserves of $2.5 trillion mean exchange rate is controllable

  7. Global Economy Overview V • Decentralized policy and growing externalities will result in a partial de-globalization • Not a good idea to run persistent current account deficits and become dependent on (temporarily) low-cost foreign capital • Open capital accounts may be replaced by rules-based constraints on financial capital flows • Lesson from crisis – substantial domestic ownership of banking sector is critical because multilateral resolution mechanisms in case of insolvency are largely non-existent • Pattern of accumulating reserves via current account surplus will be more pronounced in order to manage exchange rates • Public purchases of domestic assets to stabilize asset prices net capital flows will become increasingly common. • Successful countries will be those who learn to live with growing policy interdependency without much policy coordination

  8. Crisis Has Accelerated Changes in World GDP

  9. Decline of the G-8

  10. Patterns of Future Pubic Debt

  11. Debt Vulnerability

  12. Today’s Global Themes • Growth Prospects Weak • DMs accelerating from 1.2% -- high debt, austerity • EM GDP decelerating below 5% • Private Sector deleveraging, lack of investment, financial sector undercapitalization • Long period of massive capital inflows into Ems (since 2003) slowing or even partially reversing • Tail Risks Remain (probabilities 10-30%) • Hard Landing in China • Disorderly events in EZ (more likely to be long stagnation) • Military conflict with Iran leading to oil supply shock (low but increasing in 2014 • Geopolitical Risks (North Korea, China-Japan, Egypt, Syria, Iraq

  13. Industrial Recovery

  14. Patterns of Growth Recovery

  15. IMF Broad Forecast, April 2013

  16. IMF October 2013 Forecast I

  17. IMF Forecast October 2013 II

  18. RGE Forecasts October 2013

  19. Eurozone Slow-Down

  20. Unemployment in the EZ

  21. Eurozone Scenarios October 2013 • Base case (60%) • Muddle through in 2013 and beyond increasingly problematic as periphery governments under pressure to stop austerity/reform – incremental solutions found • Downside (30%) • Collapsing Italian government and doubts about ECB asset buying program • Member states fiscal and political resources further strained making future crises more difficult to resolve • Upside (10%) • Pro-reform governments are more resilient and world economy stronger • Progress towards true integration, banking union, common fiscal sharing inches forward

  22. Emerging Market Slowdown?

  23. EMs Face Hurdles I • Not a “BRIC wall” but a range of factors at play – Weak financing, currency overvaluation or policy missteps will take toll on economic • Policy Induced Slowdown -- after some overheating, many EMS tightened monetary policy in 2011 • Lack of Full Decoupling – from slow-growing DMs (EZ, US) • State Capitalism – distorting economic activity absorbing resources leading to fall in potential growth • Fallout from Chinese Slowdown – China is negatively affecting growth across Ems (especially in South-East Asia, Latin America, metal exporters. • End of Commodities Super-cycle – many Ems affected – Brazil, Russia, South Africa in particular

  24. EMs Face Hurdles II • Approaching end of US Federal Reserve QE and Easy Money – will slow if not reverse trillions of EM capital inflows • Increasing Frequency of Large Current Account Deficits –Many countries financing deficits in increasingly risky ways • Rising Political Risk in Many Ems – Busy electoral cycle in 2014 • Macro and Financial Fragilities in some Ems – handful of Ems have high and unsustainable debt rations that will require coercive debt restructurings, particularly if a sudden stop occurs. • The Risk of a Middle Income Trap – many Ems running out of easy sources of growth – have not laid a good foundation through improved governance for further growth

  25. EM Risk Rankings

  26. Next Big Emerging Economies?

  27. Asian Analysis • Asia Overview • Recent Capital Outflows and Financial Stress • Economic Prospects • Areas of Risk • Key Issues • China’s Rebalancing • Trans-Atlantic Partnership (TPP)

  28. Asia 2013: Overview • 2013: Asia as along with other emerging regions has encountered a wave of capital outflows • Overall impact manageable – but some countries have been subject to greater stress • Tighter global credit and domestic impediments in some countries – will dampen growth • This may be offset by gradual pickup in exports to advanced countries and resilient domestic demand • However conditions tighten further likely to see greater variation across region • Those with strong fundamentals and policy credibility will be able to offset external developments • Others that have delayed reforms, left fiscal vulnerabilities, or tolerated too-high inflation may be forced to respond with policy tightening – austerity.

  29. Asia: Recent Developments I • Since April, U.S. Federal Reserve tapering has ignited capital outflows from many emerging markets • Equity prices have fallen in some countries as well as exchange rates falling – Indonesia hard hit – to support currencies have had to increase interest rates and tighten credit thus slowing investment.

  30. Asia: Recent Developments II • While the reversal of capital flows has reflected increasing yields and more attractive investment opportunities in advanced countries – • Weaker growth prospects throughout Asia and country-specific vulnerabilities have played a role • Causes of weaker growth throughout emerging Asia • Weak external demand from advanced countries and a slowdown in China dampened industrial activity in region • Domestic demand has also softened • At same time a broader structural shift is underway with increasing supply bottlenecks in India and declining returns to investment in China • As a result, potential growth in the major emerging Asian economies has declined steadily

  31. Asia: Recent Developments III

  32. Asia: Vulnerabilities • Abundant global liquidity over last half-decade covered up some vulnerabilities that are now exposed • India and Indonesia are now running large current account deficits and facing high inflation (including food prices) • Some Indonesian inflation reinforced by a subsidized fuel price increase • Other concerns • Large fiscal deficits in Malaysia • Strong credit growth in recent years – Thailand, the Philippines and ASEAN more broadly • Overly simulative macroeconomic policies --Lao P.D.R, Mongolia

  33. Variation Across Asia Region I • Generalizations difficult with considerable growth differences across region in 2013 and into 2014 • China • China largely isolated from recent financial market volatilities • Continued measures to slow credit growth and the excesses of recent years should put economy on slower growth trajectory • Growth projected to decelerate to 7.6% in 2013 and 7.3% in 2014 • Excess capacity in a number of industries and stable food prices should mean inflation will remain under control

  34. Variation Across Asia II • Japan • Country’s growth upswing has been bright spot in region as Abenomics has reignited economy and is starting to lift country out of chronic deflation • Financial conditions have eased markedly as a result of exchange weakening and an asset price rally triggered by monetary easing • Inflation and inflation expectations have increased, but well below Bank of Japan’s target 2% • Growth likely to reach 3.5% a year by end of 2013 driven by weaker yean and recovering industrial demand • Growth forecast to decelerate to 1.2 percent in 2014 owing to waning reconstruction spending and the planned consumption tax increase • A new fiscal stimulus will be announced in December and may increase the growth forecast

  35. Japan: Regular Employment

  36. Variation Across Asia III • Korea • Economy spurred by fiscal and monetary stimulus is set for modest recovery • India • Fallout from recent financial stress has contributed to greater vulnerability of corporate and bank balance sheets • Further IMF downward revision of growth forecasts which were already very low in historical context • Reflects persistent supply constraints and slow progress on structural reforms • In most ASEAN countries growth should pick up somewhat • External demand will improve while domestic demand is likely to improve reflecting stronger pubic infrastructure spending (Thailand)

  37. Variation Across Asia IV • Indonesia • May be a slowing in first half of 2014 due to dampening domestic demand and weakness in external sector • Rapid IDR depreciation resulted in Bank of Indonesia raising interest rates – may slow down investment • Fuel price increases dampen private consumption • Growth forecast at 5.7% (2013), 5.5% (2014), and 5.9% (2015) • July 2014 elections critical in determining course of growth • Most likely high growth will return in the latter half of the decade

  38. Indonesian Inflation Forecast

  39. IMF October 2013 Asia Growth Forecasts

  40. IMF October 2013 Asia Inflation Forecasts

  41. Risk Assessments I • Asian Risk Assessment

  42. Risk Assessment II • Japan Risk Assessment

  43. Risk Assessments III • Indonesian Forecast Risk Analysis

  44. China’s Rebalancing I Overview: • China’s economy is currently going through a painful transition to a more consumption based economy • The days of double digit economic growth clearly over • In the short run, slower growth is generating concern about the nation’s near-and medium-term prospects • There is an up-side to the gradual slowdown over the past several years • Growth in the coming years will be both robust and more sustainable • The structural reforms that are central to the 12th Five Year Plan (2011-2015) will become somewhat easier to achieve • On balance it appears China’s economy is headed in the right direction, but still worrisome in the short-run • However, key economic and political risks – including corruption, social inequality and lack of progress in governance reforms – must be addressed in order to assure long-term economic growth.

  45. China: Quarterly GDP Growth

  46. Patterns of Growth Slowing I

  47. Patterns of Growth Slowing II

  48. China: Short-Run Concerns

  49. China: Rebalancing I

  50. China’s Rebalancing II China is making progress in other areas of rebalancing • Since the yuan was first unlinked from the dollar in July 2005, the nominal yuan-dollar exchange rate has appreciated by over 30% and the real rate by over 40% • China has recently widened the yuan’s trading band and has cautiously resumed many financial sector reforms that were stalled since 2004 • The country is also continuing to promote the international use of its currency for trade and investment purposes • China’s traditional east-west development gap is also shrinking as a result of the government’s “Go West” investment policies • In recent years, interior, not coastal provinces have grown most rapidly • Agriculture, main source of income for 30% population continued strong – per capita rural growth has exceeded urban growth • However, income and wealth inequality has increased.