International
Global Economy to slow in 2008 but rebound likely as year unfolds; US likely to avoid recession
By Finfacts Team
Jan 11, 2008, 06:59

Big US companies are increasingly dependent on overseas income.

Inflation seen as rising concern for central banks as year progresses - Capital flows to emerging markets set to remain robust.

A difficult environment featuring continual credit market tensions and highly elevated oil prices should contribute to a slowdown in the global economy this year. However, a recession in the United States is likely to be avoided, while emerging market growth is seen as remaining strong, according to 2008 global economic and capital market forecasts published on Thursday by the Institute of International Finance, the industry body for the world's leading financial firms.

Growth in the leading industrial economies is projected at 2.1 percent this year, down from 2.4 percent in 2007, while growth in emerging market economies is projected at 6.9 percent, following 7.3 percent last year. The IIF said economic activity in the United States in the next few months will be quite weak, with growth expected to average below one percent in the first half of the year. As the year progresses, however, the IIF expects a recovery, with average growth in excess of 3 percent in the second half of 2008. It anticipated that inflation will become a rising concern with the likelihood that in due course the U.S. Federal Reserve will turn its attention from supporting growth to countering possible inflation risks.

On Wednesday, US investment bank Goldman Sachs said that the US economy may already be in recession and forecast that the federal funds rate would fall to 2.5%.

The IIF is the leading global association of financial institutions with more than 370 members headquartered in over 65 countries. It estimated that the volume of net private capital flows to emerging markets in 2007 reached a record of $681 billion, compared to $560 billion in 2006. The high level in 2007 reflects sustained momentum in flows to emerging markets, despite the turmoil in mature credit markets in the second half of the year. The flow of equity capital remains robust, and diminution of commercial bank lending to emerging markets looks to have been remarkably limited to date. Net private capital flows to emerging markets are likely to be strong again in 2008 with a volume that could approach the level seen last year.

IIF Managing Director Charles Dallara said, “The continued deterioration in the U.S. housing market and persistent difficulties in the credit markets of the U.S. and Europe are obviously having a negative impact on economic growth in these areas. Nevertheless, there are important signs of economic resilience which suggest that recession can be avoided in the U.S., that global economic growth can hold up and that capital flows are likely to remain strong to emerging markets.”

First Deputy Managing Director and Chief Economist Yusuke Horiguchi told a press conference in Washington DC.: “The growth fallout in the United States from the continued housing slump and recent financial turmoil should persist through mid-year with fairly broad-based weakness. Growth performance in the Euro Area and Japan is also likely to be lackluster through much of the first half of the year. The combination of monetary policy easing by the U.S. Federal Reserve and the relatively healthy shape of the global corporate sector makes a second half global growth rebound quite likely. Further support may be provided by the expected persistence of strong demand growth in emerging economies.”

On the outlook for capital markets, Hung Q. Tran, IIF Senior Director, Capital Markets and Emerging Markets Policy, said that central banks in the mature economies face a more complicated policy environment. "They may have to continue easing monetary policy, but at the risk of rising inflation expectations at levels where monetary tightening typically followed in the past. With headline inflation trending upward, the impact of further substantial Fed easing risks being troublesome by late 2008 or beyond. In this context, a renewed surge in crude oil prices to $100 per barrel – if lasting - could slow economic activity while raising headline inflation to uncomfortable levels for policy makers. Slower-than-expected growth would then aggravate credit woes to the banks."

In considering other possible downsides to the global outlook, Philip Suttle, IIF Director of Global Macroeconomic Analysis, noted that among concerns not as yet widely discussed are house prices in many OECD countries that are higher than those in the United States. He added, “Another challenge that could develop in coming months in emerging markets, despite their resilience at this time, would be an excess of short-term capital inflows (both debt and equity), attracted by the prospect of higher growth and less risk. This would pose exchange rate policy concerns to some emerging markets while leaving others with large current account deficits vulnerable to a sharp decline of capital, especially as the global interest rate cycle turns up once again.”

With regard to the response of the financial industry to the events in the credit markets caused by the U.S. sub-prime mortgage crisis, Dallara noted, "The Board of Directors of the IIF has established a special Committee on Market Best Practices chaired by two experienced bankers, co-chaired by Richard Waugh, President and Chief Executive Officer of Scotiabank, and Cees Maas, former Vice Chairman and Chief Financial Officer of ING Group, NV. Under their leadership five working groups have been established that address the areas of Risk Management and Underwriting Practices, Liquidity Risk and Conduits, the Ratings Process, Valuation Issues, and Transparency and Disclosure issues.

The Committee, which has just met in Zurich and involves a wide range of leading global financial institutions, plans to submit preliminary proposals in the Spring and to issue a final report by June that will aim to include market best practices in each area. As we move forward we are engaged in informal dialogue with the official sector. We believe that this special initiative will yield pragmatic recommendations that can contribute to resilient markets and a stronger framework for risk management in the future."

Key forecasts in the new IIF report include:

• Global GDP growth is expected to be 3.1 percent, down from 3.5 percent in 2007 and 3.8 percent in 2006. In 2007, growth in mature markets slowed (led by the U.S. and Japan), but growth in emerging markets picked up. In 2008, however, the slowing is projected for both mature and emerging economies.

• U.S. - a relatively brief period of weak growth is just beginning, resulting partly from housing and particularly from spillovers from recent financial turmoil, especially as the major commercial banks respond to the constraints imposed by the combination of recent losses, as well as the need to rapidly expand their balance sheets. A more cautious spending pattern is likely on the part of both households and businesses. Positive factors include the impact of Fed easing, the basically healthy shape of the corporate sector and rising foreign demand. U.S. GDP is expected to rise by 2.1% (fourth quarter over fourth quarter) in the course of 2008 after expanding by 2.9 percent in the course of 2007.

• Euro Area and Japan – slower growth is expected in the next six months. In the Euro Area, the main negative is the damage to the region’s banks by their exposures to the U.S. CDO market. Compounding this effect are a likely home-grown slowing in housing and the lagged effects of European Central Bank tightening and a strong Euro. Euro Area real GDP growth is expected to be 2.1% in 2008 after 2.7% in 2007. For Japan, the IIF sees a continued downshift in growth, with GDP rising by 1.3% this year after a 1.9% gain in 2007.

• Emerging Markets - Aside from some impact of mature economies' slowdown, the main factor pushing growth (slightly) lower in 2008 is the effect of tighter monetary policies put in place by many emerging market central banks through 2007. For example, monetary tightening in China is likely to contribute to a slowdown in growth to 10.5 percent from 11.5 percent in 2007. Elsewhere in Asia, growth in India should be stable, and an acceleration is in prospect in Thailand and the Philippines. Latin America growth will be lower in 2008, especially in Argentina and Venezuela. Emerging European GDP will remain robust, although a slowing in Russia is in prospect.

• Inflation - Concerns may lead G7 central banks to begin to withdraw some of their recent accommodation in the second half of 2008. The Fed will likely spell out a steady reversal, while the European Central Bank seems intent on bringing inflation back within its target at a reasonable speed. More at issue is the Bank of Japan, which appears keen to “normalize” rates but is likely to face an economic situation not quite conducive to a significant policy stance change.

• Oil Prices - will be a critical factor on the inflation front that is expected to bring relief in the second half of 2008. The oil price is likely to average around $80 per barrel in the current quarter and continue to fall in the second quarter and then swing up again, before the impact of central bank monetary policy tightening starts to impact commodity prices. Oil is forecast to average around $77 per barrel in the final quarter.

• U.S. Dollar – After an initial respite, some further weakening of the U.S. currency is foreseen later in this quarter due to weaker U.S. economic data and a Fed rate cut at the end of January. The next leg in the dollar’s move down may come against emerging market currencies, especially Emerging Europe and Emerging Asia. The appreciation of Emerging European currencies has been a persistent feature of the convergence environment in recent years and shows no signs of stopping (although high external deficits raise caution flags). The pace of Emerging Asian real appreciation through 2008 will be driven primarily by China’s strategy, which has recently shown some signs of allowing a faster pace of currency appreciation.

• Capital Flows to Emerging Markets - in 2008 will remain heavily skewed to the private sector, with corporate borrowing expected to remain high, as in 2007 when corporates, for example, accounted for better than three-quarters of all bond issuance. Net short-term flows will remain high, although the projected pace of central bank reserve accumulation in 2008 will likely be down from 2007.