Global Economic Outlook - Deloitte Insights

Global Economic Outlook 3rd Quarter 2016

Global Economic Outlook

CONTENTS Introduction | 2

China: The deceleration continues | 26

By Ira Kalish Our team of global economists offer their views on the United Kingdom, Eurozone, United States, China, Japan, Brazil, Mexico, South Africa, India, and the economic implications of oil price fluctuations.

By Ira Kalish Data related to industrial production, manufacturing, electricity output, and retail sales all indicate that the Chinese economy continues to decelerate. Growing debt is also a cause for concern. There are warnings that unless China takes up serious reforms, the expansion of debt could lead to a financial crisis, low economic growth, or both.

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

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

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

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

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

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3rd Quarter 2016 CONTENTS

Mexico: Embracing the advantage of its northern neighbor | 46

The oil mighty: The economic impact of oil price fluctuations | 70

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

By Rumki Majumdar Wide fluctuations in oil prices have played an important role in driving recessions and even regimes collapsing—which is why oil price movements are closely watched by economists, investors, and policymakers. The two recent cycles of historic highs and lows suggest that the world economy is in unchartered territory.

South Africa: In search of an economic foothold | 52

Economic indices | 78

By Lester Gunnion South Africa’s economic challenges have intensified. The economy contracted in the first quarter of 2016; and weak growth, political unrest, and deteriorating fundamentals have resulted in the currency slipping and inflation climbing. Policymakers will likely face difficulty in navigating internal and external challenges.

Additional resources | 81 About the authors | 82 Contact information | 83

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

Illustrations by Stephanie Dalton Cowan

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Introduction By Ira Kalish

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N the summer of 2016, suddenly, there are new uncertainties concerning the global economy, not the least of which is the British referendum in which a majority voted to exit the European Union. This raises questions about the short- and long-term outlooks for Britain, the future of the Eurozone, and the future of globalization and economic integration. Other current issues of concern include surprisingly weak job numbers in the United States in May, continued deflationary pressures in the Eurozone economy, and rising corporate debt in China. These issues are affecting the decisions of policymakers and, as a consequence, the outlook for the global economy. Other issues that had been top of mind only a few months ago seem to have disappeared from the headlines: oil prices, the Chinese currency, emerging-market debt, and the recession in Russia.

Next, Alexander Börsch looks at the Eurozone. He notes that economic growth has accelerated recently, with real GDP up 0.6 percent in the first quarter. Yet he worries that a British exit from the European Union could have a negative impact on the Eurozone countries, especially those with sizable trading relations with the United Kingdom such as Ireland, the Netherlands, and Belgium. Alexander also discusses the impact of Brexit on business sentiment, noting that a recent survey found that German business managers are worried that Brexit could lead to other country exits and a weakening of the European Union. In our article on the US economy, Patricia Buckley says that, although she continues to believe the United States will have moderate growth in 2016, “downside risk has definitely increased.” While she is not spooked by the slow growth in the first quarter, Patricia is especially concerned that business investment has now declined for two consecutive quarters, the first time this has happened since 2009. She also notes that the drop in investment was accompanied by a slowdown in job growth. While she expects the economy to have rebounded in the second quarter and that the job slowdown might be temporary, she says that a further drop in investment could put longer-term growth at risk.

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

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

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3rd Quarter 2016 INTRODUCTION

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

published quarterly by Deloitte Research Editor-in-chief Dr. Ira Kalish

Managing editor

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

Aditi Rao

Contributors Akrur Barua Dr. Alexander Börsch Dr. Patricia Buckley Dr. Daniel Bachman Lester Gunnion Dr. Rumki Majumdar Ian Stewart

Editorial address

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

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

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

a credible economics team and intends to consolidate fiscal policy, reform pensions and the tax code, privatize state-run companies, and boost private sector participation in infrastructure investment. In our next article, Danny Bachman offers his thoughts on the Mexican economy. He notes that, despite implementing many favorable policies, growth remains low compared with other big emerging markets. On the other hand, Danny notes that a sensible monetary policy has lowered inflation. Plus, a flexible exchange rate has enabled the country to weather various storms. Danny is optimistic that the government’s reform agenda will ultimately pay off in terms of stronger growth.

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

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

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

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3rd Quarter 2016

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UNITED KINGDOM

After Brexit, what lies ahead? By Ian Stewart

B

Y the late afternoon of June 23, the day of the United Kingdom’s EU referendum, the betting markets had priced an 84 percent probability of a “Remain” vote; in the preceding week, equities and the sterling had rallied strongly on expectations that Remain would win. The unexpected vote to leave the European Union triggered a bout of financial market, political, and economic uncertainty. The immediate effects were seen in risk assets, including, most graphically, the biggest-ever one-day decline, of 8.0 percent, in the value of the British pound against the US dollar on June 24.

of the government’s ambitions for the European Union take form. The next main landmark is the election of a new leader of the Conservative Party, and the new prime minister, on September 9. In a surprise move, the front-runner and leading Brexit campaigner, Boris Johnson, dropped out of the leadership race on June 30; the new prime minister is Teresa May, the former home secretary and a lowkey supporter of Remain during the campaign. There are numerous possible permutations of outcomes for the United Kingdom. It is possible that the United Kingdom will not leave the European Union at all. The referendum vote was only advisory, 70 percent of MPs favor Remain, and some Leave voters seem to be suffering from buyers’ remorse. Against this backdrop, the United Kingdom could

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

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

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3rd Quarter 2016 United Kingdom

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

conceivably hold a second referendum or a general election that might result in the United Kingdom deciding to remain in the European Union. But at the time of writing, in the aftermath of the vote, the most likely outcome seems to be that the new prime minister will invoke Article 50 of the Lisbon Treaty, which starts the process of withdrawal, and that the United Kingdom will leave the union. A central issue in negotiations will be the United Kingdom’s ability to retain access to the European Single Market while limiting the right of EU citizens to work in the United Kingdom. UK business wants to access the Single Market and overwhelmingly favors free movement of people, yet David Cameron told European leaders that it was concerns about immigration and free movement of people that caused UK voters to vote Leave.1

As a shock, Brexit has some elements in common with the 2008 financial crisis. But while that was an economic shock that threatened the solvency of the banking system and triggered a credit crunch, Brexit is a political shock.

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

As a shock, Brexit has some elements in common with the 2008 financial crisis. But while that was an economic shock that threatened the solvency of the banking system and triggered a credit crunch, Brexit is a political shock. Its impact on the economy is more indirect, at least in the short term, and manifests via financial markets and the knockon effects on business and consumer confidence.

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

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

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

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

inflation and weak earnings. But for now, this does not seem to be the most likely outcome. There are two lessons from economic history about the effect of external shocks. One is that the impact reduces over time; economies are resilient, and activity, in time, bounces back. The second is that shocks that threaten growth prompt a countervailing policy response. Authorities don’t sit on their hands and do nothing. Today, the most useful response would be for the government to signal the direction for the United Kingdom in its negotiations with the European Union. In markets and business, as in life, intent matters. The usual policy levers could also be pulled. The Bank of England may well undertake more quantitative easing, stepping up the volume and the range of assets purchased to boost liquidity and asset prices as well as drive down long-term interest rates. Agreed, inflation may head higher as a weaker pound pushes up import prices. But as a one-off phenomenon in an economy facing great uncertainty, such temporary inflation would not justify interest rate rises. Fiscal policy may need to play a role, too. The chancellor previously suggested that Brexit would lead to an austerity budget in order to balance the books. That would dent growth and might well

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

Figure 1. The future of the European Union

Challenges 1.

Brexit, further secessions

2.

Slow growth

Response Step up integration?

Multispeed Europe?

3.

Migration, borders

4.

Fixing the euro

Muddle through?

Source: Deloitte UK Economics and Markets team. Graphic: Deloitte University Press | DUPress.com

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In terms of the fundamentals, based on international measures of competitiveness, the United Kingdom looks in decent shape. Press reports have suggested that European leaders have already been drawing up plans for a future union without the United Kingdom, developing a so-called “Plan B” focused on closer security and defense cooperation.5

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

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

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

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

The United Kingdom’s departure from the European Union also raises questions about the future direction of the trade bloc. Without the United Kingdom, the European Union loses a significant supporter of free-trade and free-market policies. Analysis by the think tank Open Europe suggests that the United Kingdom’s exit will tilt the balance of power in the European Union under qualified majority voting significantly toward a more protectionist, less freemarket, approach.4 Faced with the risk of further secessions across Europe and seeking to avoid political drift, EU leaders may seek to “double down” on ever-closer union.

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Figure 2. United Kingdom ranks as competitive Global competitiveness rankings Heritage Foundation

World Bank

World Economic Forum

#1

Hong Kong

Singapore

Switzerland

#2

Singapore

New Zealand

Singapore

#3

New Zealand

Denmark

United States

#4

Switzerland

South Korea

Germany

#5

Australia

Hong Kong

Netherlands

United Kingdom

10

6

10

Sweden

26

8

9

Poland

39

25

41

Spain

43

33

33

France

75

27

22

Italy

86

45

43

Greece

138

60

81

Note: Higher rankings indicate better, usually simpler, regulations for businesses; greater ease of doing business; stronger protections of property rights; and lower corruption. Source: Business Index and Heritage Foundation Index of Economic Freedom; Deloitte UK Economics & Markets team.

Endnotes 1.

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

2.

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

3.

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

4.

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

5.

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

6.

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

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EUROZONE

Life after Brexit By Alexander Börsch

W

HILE the economic recovery in the Eurozone has continued and even gained some momentum, the Eurozone’s outlook is shaped by the decision of the United Kingdom to leave the European Union. The first exit of an EU member (besides Greenland, then part of Denmark in the mid-1980s) poses a variety of questions for the European Union, in the political as well as economic spheres. Key among them are how to structure the future relationship with the United Kingdom as well as how to manage political risks in the European Union.

shrinking, and low energy prices do their part to encourage private consumption. At the same time, the net effect of external trade is negative, as imports have grown stronger than exports, even in the case of Germany, the Eurozone’s main exporter. The key reasons behind this are the waning tailwinds of a weak euro and weaker demand from emerging markets. The arguably most important component for a selfsustaining recovery, corporate investments, has been the weak spot of the Eurozone’s recovery since it started in 2013. Overall, the level of capital investments in the Eurozone is still hardly higher than it was in 2010. But finally investments in the Eurozone show some signs of life: Overall investments have grown robustly, at 0.8 percent, for the second quarter in a row.

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

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

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

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3rd Quarter 2016 Eurozone

How does Brexit affect European business?

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

At first glance, the main economic and political effects of leaving the European Union should fall on the United Kingdom, the second-biggest EU economy. However, this is only partly true. Interestingly, the stock markets in Germany and France dropped more than the UK market did on the day after the referendum. To some degree, this is because Brexit comes at a very unfavorable time for the European Union. The European Union has a host of challenges to solve, ranging from migration policy to the stabilization of the Eurozone and pressure from the rise of anti-EU and populist parties. In addition, Brexit has happened just when the recovery gained some momentum.

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The political challenges for the European Union play out in two dimensions: the European Union’s position in upcoming UK exit negotiations, and the region’s future. What kind of divorce?

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

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

Figure 1. EU member exports to United Kingdom (2014) UK exports to EU (percentage of UK GDP)

Ireland

11.2

Malta

8.4

Cyprus

7.6

Belgium

7.5

Netherlands

6.7

Luxembourg

5

Spain

3.1

EU27

3.1

Germany

3

Poland France Italy

12.5

2.9 2.2 1.7

Source: International Monetary Fund, 2016. Graphic: Deloitte University Press | DUPress.com

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

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

Best and worst cases

On the other hand, from the European Union’s perspective, a smooth divorce with a liberal trade regime inevitably requires the free movement of people. The models under discussion with no or limited disruption of trade relations (the United Kingdom as member of the European economic area, or a Swiss-style negotiated access to the Single Market) include open borders for employees. This might be hard to accept for a new British government that is committed to realizing the anti-immigration demands of the Brexit movement.

From an economic standpoint, both sides are interested in a mutually beneficial outcome and minimal trade restrictions. However, the Brexit decision itself is evidence that economic considerations do not necessarily prevail.

In a best-case scenario, the divorce develops smoothly. Both sides realize that erecting trade barriers will lead to a lose-lose situation. From an economic standpoint, both sides are interested in a mutually beneficial outcome and minimal trade restrictions. However, the Brexit decision itself is evidence that economic considerations do not necessarily prevail. The European Union might be tempted to block

In this sense, a bestcase scenario with minimal trade restrictions faces considerable hurdles on both sides and is far from automatic. A worst-case scenario, with disruption of trade relations and major economic damages in terms of lower trade volume and foregone economic growth, is equally possible. The expectations of which scenario will prevail is very likely to move financial markets and investment decisions during the coming years of negotiations.

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A best-case scenario with minimal trade restrictions faces considerable hurdles on both sides and is far from automatic. A worst-case scenario, with disruption of trade relations and major economic damages in terms of lower trade volume and foregone economic growth, is equally possible.

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

Which consequences would a Brexit have, in your opinion, for the future of the EU? High risk of further exits from the EU

66%

Stronger political fragmentation of the EU

42%

Weakening of market-oriented economic policies

40%

Regression of the EU to a pure free-trading zone

39%

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

12%

Stronger integration of the remaining EU members

9%

I do not expect any significant consequences

5%

I cannot estimate it

3% 0%

10%

20%

30%

40%

50%

60%

70%

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

What kind of future European Union?

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

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

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

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

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UNITED STATES

Businesses take a (hopefully) temporary breather By Patricia Buckley

B

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

Figure 1 shows the contributions of the various categories of GDP to overall growth for the most recent five quarters. • The contribution from personal consumption was almost the same in the first quarter of 2015 as in the first quarter of 2016, at 1.2 and 1.0 percentage points, respectively. In the later quarters of 2015, the contribution from personal consumption was higher on strong employment growth and some increase in real wages. • The drag from business investment was 0.6 percentage points in the first quarter of 2016, following the 0.3-percentage-point subtraction in the fourth quarter of 2015. This is the first time that business investment has fallen for two consecutive quarters since 2009, the year the recession ended.

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

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3rd Quarter 2016 United States

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

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

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

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

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

• The contribution from exports was near zero, weighted down by a relatively high dollar and slower global growth. • The slight positive contribution from imports in the most recent two quarters indicates falling imports, as the slowdown in business investment and change in consumers’ purchasing pat-

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Figure 1. Disaggregation of GDP growth Percentage point contribution to GDP

2.5 2.0 1.5 1.0 0.5 0.0 -0.5 -1.0 -1.5 Business investment

Personal consumption

Residential investment

Change in private inventories

Exports

Imports

Q1 2015: 0.6%

Q4 2015: 1.4%

Q2 2015: 3.9%

Q1 2016: 1.1%

Government spending

Q3 2015: 2.0% Source: Bureau of Economic Analysis. Graphic: Deloitte University Press | DUPress.com

Figure 2. Contribution of business investment to GDP growth by type Percentage point contribution

1.5 1.0 0.5 0.0 -0.5 -1.0 Q1

Q2

Q3

Q4

Q1

Q2

2013

Structures

Q3

Q4

Q1

Q2

2014

Q3 2015

Intellectual property products

Equipment

Q4

Q1 2016

Business investment

Source: Bureau of Economic Analysis. Graphic: Deloitte University Press | DUPress.com

20


the components contracted in the same quarter before the two most recent quarters was in the second quarter of 2013.

Although industry details are not available for software, the major funders of R&D investment are manufacturers, who currently account for 83 percent of all business R&D spending.

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

Figure 3. Investment in structures by type Billions of chained (2009) dollars

160 140 120 100 80 60 40 20 0 Q1

Q2

Q3

Q4

Q1

2013

Q2

Q3

Q4

Q1

Q2

2014

Q3

Q4

2015

Commercial and health care

Manufacturing

Power and communication

Mining exploration, shafts, and wells

Q1 2016


21


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

350

300

250

200

150 Q1

Q2

Q3

Q4

Q1

Q2

2013

Q3

Q4

Q1

Q2

2014

Q3

Q4

2015

Q1 2016

Information processing equipment

Industrial equipment

Transportation equipment

Other equipment


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

350 340 330 320 310 300 290 280 270 260 250 Q1

Q2

Q3

Q4

2013

Q1

Q2

Q3

Q4

2014

Software

Q1

Q2

Q3 2015

Q4

Q1 2016

Research and development


22


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

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

The two primary categories of IP investment are shown in figure 5. The other, much smaller category of investment in entertainment, literary, and artistic originals, with current real annual investment of around $80 billion, is not shown. With both investment in software (own account, custom, and prepackaged) and research and development (R&D), the decline in mining activity has probably played a minor role in the change in trend. In both of these IP categories, investment sentiment seems to have shifted in the second quarter of 2015—a year after the price of oil began its steep slide. Software investment picked up in the first quarter, even as investment in R&D has remained flat. Although industry details are not available for software, the major funders of R&D investment are manufacturers, who currently account for 83 percent of all business R&D spending. The largest sectors include pharmaceutical and medicine manufacturers, electronic and electronic component manufacturers (including semiconductors), and motor vehicle and parts manufacturers. Concurrent with the decline in business investment, there has been a slowdown in employment growth. During the first five months of 2016, total nonfarm employment increased by only 150,000 jobs per month on average. The comparable number

23


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

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

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

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

Figure 6. Average monthly employment growth by sector Thousands

60 50 40 30 20 10 0 -10

2015

nt me rn ve Go

Le is ho ure a sp ita nd lity

are hc alt He

vit cti la cia Fin

an

Ma n

Pr bu ofes sin sio es na ss la erv nd ice s

ies

l tai Re

ufa

ctu

rin

g

n tio uc str Co n

Mi

nin

g

-20

2016

Source: Bureau of Labor Statistics. Graphic: Deloitte University Press | DUPress.com

24


Endnotes 1.

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

2.

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

3.

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

4.

Bureau of Labor Statistics.

25


CHINA

The deceleration continues By Ira Kalish

T

HE latest data indicate that the Chinese economy continues to decelerate.1 Data on Chinese trade indicate continued weakness in exports but a slower pace of decline for imports. First, dollar-denominated exports fell 4.1 percent in May versus a year earlier, sharper than the 1.8 percent drop in the previous month. This reflected weak demand in both Europe and the United States. In local currency terms, exports were actually up slightly. The difference between dollar- and renminbidenominated exports reflects the depreciation of the renminbi over the past year. Part of the problem for China, however, is that, although its currency has fallen in value, it has fallen far less than that of other emerging countries. Thus China’s exports have lost competitiveness versus other countries. Indeed some manufacturing capacity has departed from China, heading to

other low-wage emerging markets. Meanwhile, the Chinese central bank continues to sell foreign currency reserves in order to stabilize the currency and prevent a sharper depreciation. Imports, which have been consistently falling for some time, fell only 0.4 percent in May versus a year earlier. This was a far smaller decline than the 10.9 percent drop in April. There were some special circumstances, however. First, the rise in commodity prices has boosted the import bill. Second, imports from Hong Kong increased 242.6 percent from a year earlier, possibly meaning that investors engaged in fake invoicing in order to move funds out of the country. Specifically, importers can invoice amounts far larger than the actual cost of the imported goods. This makes it appear that imports were much

Part of the problem for China, however, is that, although its currency has fallen in value, it has fallen far less than that of other emerging countries. Thus China’s exports have lost competitiveness versus other countries.

26

3rd Quarter 2016 China

27


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

greater than was actually the case. Yet it enables the importer to send money out of the country without appearing to violate the government’s controls on capital movements. Thus underlying imports were likely quite weak, probably reflecting weak domestic demand. Moreover, many Chinese exports rely on imported inputs. Weakening exports have the effect of weakening imports as well. Fixed asset investment in China was up 9.6 percent in the first five months of 2016 compared with a year earlier. This was the slowest rate of investment growth in 16 years. Interestingly, private sector investment was up only 3.9 percent, while investment by state-owned enterprises (SOEs) was up 23.3 percent. The latter figure might be of concern, given that there is considerable excess capacity in the state-run sector, producer prices for SOEs are declining, and SOEs are disproportionately laden with debt. The significant slowdown in private sector investment might also be alarming, and could bode poorly for growth. Finally, investment in real estate was up 6.6 percent from a year earlier, a considerable slowdown from before. Excessive investment in property has been one of the hallmarks of China’s economy lately. Thus slower growth of property investment is surely welcome. The challenge for China will be to shift away from investment-led growth and toward consumer-led growth. In addition, it would be helpful if investment by the private sector increases as a share of the total. This is clearly not happening now.

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

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

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

28

3rd Quarter 2016 China

China appears to face the risk of something akin to what happened in Japan in the 1990s, when banks rolled over bad loans to poorly performing companies. The result was a plethora of poorly performing companies being propped up by troubled banks. losers can’t develop in a healthy and sustainable way.” This suggests a willingness to let failing companies fail—although this has not yet happened. He also addressed the issue of banks that hold bad debts, saying “We will permit financial institutions to go bankrupt in an orderly way, restructure those that need restructuring, shut those that need to be shut, and strengthen market discipline.”3 Meanwhile, debt continues to expand. Lipton noted that “in a setting of slower economic growth, the combination of declining earnings and rising indebtedness is undermining the ability of companies to pay suppliers or service their debts. Banks are holding more and more nonperforming loans, and the past year’s credit boom is just extending the problem.”4 Some observers have raised the specter of a crisis for China in which a large financial institution fails due to excessive bad assets. Yet this seems unlikely. Rather, China appears to face the risk of something akin to what happened in Japan in the 1990s, when banks rolled over bad loans to poorly performing companies. The result was a plethora of poorly performing companies being propped up by troubled banks. This led to limited credit creation, no economic growth, excess capacity, and deflation.

of poor performance of the debtor companies, especially SOEs. Lipton noted that, while SOEs account for about 22 percent of economic output, they account for about 55 percent of corporate debt in China. Many of them are “essentially on life support.”2 Critics of China’s policies say that such enterprises must be reformed or shut down. Debt-for-equity swaps simply allow banks to own shares in these companies. Such measures do little to improve the performance of these companies. Banks are left with little incentive to force these companies to fail. Critics also say that it would make more sense for the Chinese authorities to simply allow banks to let companies default, and then establish a vehicle to clean up bank balance sheets. Such a policy would lead to the bankruptcy and possible closure of some unprofitable and highly inefficient companies. While this might be painful in the short run, it would boost long-term productivity and enable the economy to restructure away from loss-making businesses. Interestingly, the deputy governor of China’s central bank, Zhang Tao, says, “Any industry that lacks the mechanism to elevate winners and eliminate

Endnotes 1.

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

2.

Shawn Donnan and Tom Mitchell, “IMF sounds warning on China’s corporate debt,” Financial Times, http://www.ft.com/cms/s/0/3f8dcf22304c-11e6-bda0-04585c31b153.html#axzz4ChmrxqxF.

3.

Ibid.

4.

Ibid.

29


JAPAN

Will households oblige by spending more? By Akrur Barua

O

Economic growth picked up in Q1

VER the past decade, there is an increasing sense among Japan’s policymakers that growth must be stimulated and deflation countered. Arguably, the most spectacular of these measures has been aggressive monetary easing, especially the use of negative interest rates this year.1 The verdict on some of these policies is mixed from a broad macroeconomic perspective. However, various components of the economy might throw pleasant surprises. Private consumption, which holds the key to growth at a time of slowing exports, is one such example. While consumers obliged by increasing spending in Q1, they face strong headwinds in the medium to long term from an aging and declining workforce. So how can Japan’s policymakers create incentives for consumers to spend? The Bank of Japan (BOJ) actually may already be doing that, not just by lowering borrowing costs but also by reducing the government’s debt burden.

The economy grew at a seasonally adjusted annual rate (SAAR) of 1.9 percent in Q1, reversing from a 1.8 percent decline in Q4 2015 (figure 1). This was the second estimate for Q1, up from the 1.7 percent rise quoted in the first estimate. Private consumption (2.6 percent) was a key growth driver in Q1, with households spending more, especially on durable goods and services. Investments continued to disappoint, with both private residential and nonresidential investments declining during the quarter. A deeper look at business investment reveals that spending on buildings and structures as well on machinery and equipment has been weak for the past year. This is not an encouraging sign for an economy eager to ramp up productivity in the face of disadvantageous demographics. Exports

It’s likely that the impact of aggressive monetary easing on the Japanese yen has run its course.

30

3rd QuarterJapan 2016

Figure 1. GDP growth picked up in Q1, led by private consumption Percentage, SAAR

30 25 20 15 10 5 0 -5 -10 -15 -20 Q1-14

Q2-14

Q3-14

Q4-14

Q1-15

Q2-15

Q3-15

Q4-15

GDP

Private consumption

Government consumption

Gross fixed capital formation

Q1-16

Exports Source: Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

31


Figure 2. In the last few years, employee compensation has slowed Percentage, year over year

10 8 6 4 2 0 -2 -4 -6 Q1-81

Q1-86

Q1-91

Q1-96

Q1-01

Nominal

Q1-06

Q1-11

Q1-16

Real

Source: Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

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

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

A key concern for private consumption is demographics

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

Analysis of national accounts data reveals that while compensation of employees—both nominal and real—has gone up in the past year (figure 2), the share of household spending in GDP has continued to decline (figure 3). This seems surprising,

32


Figure 3. Household consumption's share in the economy has gone down since Q1 2014 61

10 8

59

6 4

57

2 55

0 -2

53

-4 51

-6 Q1-81

Q1-86

Q1-91

Q1-96

Q1-01

Q1-06

Q1-11

Q1-16

Share in GDP (nominal, left axis, percentage) Growth (real, right axis, percentage) Source: Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

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

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

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

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

33


Figure 4. The labor force and, within it, the share of relatively young people are declining Millions, seasonally adjusted

Percentage

70

63

68

61 59

66

57

64

55 62

53

60

51

58

49

56

47 Jan-81

Jan-86

Jan-91

Jan-96

Jan-01

Jan-06

Jan-11

Jan-16

Size of the labor force (left axis) Share of the age group 15–44 years in the labor force (right axis) Source: Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

Figure 5. BOJ is transferring a large share of government debt to its balance sheet 1,100

35

1,050

30

1,000

25

950

20

900 15

850

10

800 750

5

700

0 Q1-06

Q1-08

Q1-10

Q1-12

Q1-14

Q1-16

Central government debt (JPY trillion, left axis) Share of BOJ’s holdings in central government debt (percentage, right axis) Source: Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

34


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

2.0

1.5

1.0

0.5

0.0

-0.5 Jan-06

Jan-08

Jan-10

Jan-12

Overnight call rate (uncollateralized)

Jan-14

Jan-16

10-year government bond yield


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

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

35


INTERVIEW WITH NOBUHIRO HEMMI To understand more about recent policies and challenges ahead, I spoke with Nobuhiro Hemmi, partner and head of Global Business Intelligence at Deloitte Tohmatsu Consulting, Japan, and a member of the Deloitte Global Economist Council. Akrur Barua (AB): The BOJ decided to keep rates on hold. Is it because BOJ thinks that monetary policy is not effective anymore? Or is it because the external environment is challenging, and the BOJ wants to wait and watch? Nobuhiro Hemmi (NH): Both, I think. Officially, they seem to have announced a “wait and watch” policy as is evident from the BOJ governor’s interview.5 However, they introduced negative interest rates, which is not traditional monetary policy. This sort of contradiction reflects the new challenges that the BOJ faces. AB: We have seen fiscal stimulus and strong monetary easing. The initial results were good, but they appear to be faltering now. When is the “third arrow” of Abenomics coming? What are the challenges? Which reforms do you think they should target? NH: The market appears to have overestimated the impact of the “third arrow,” which has been the fundamental issue for Japan in the last two decades. So far, discussions around the “third arrow” have focused on growth strategies and easing regulations. However, the key issue is how to tackle the decrease in working population. AB: The yen’s rise is opposite to what Japanese policymakers would want. How are exporters coping? Where do they see additional demand coming from? And which economies do they think will be the big markets over the next 5–10 years? NH: Overall, from a macroeconomic point of view, the yen’s rise seems opposite to what policymakers would want. However, the impact (and implication) depends on industries and companies within these industries. Some companies have already shifted their operations outside of Japan, and others have hedged currency risk in the short term. Asia will still be a strong market for Japanese companies in the next 5–10 years. But there will be market segmentation, with a shift to a city-based approach from a country-based one. AB: To stimulate domestic demand, Japanese corporates should invest more. Why have investments not picked up? NH: If domestic demand is not positive in the near future, it will make sense for Japanese companies to be more conservative. AB: With an aging society, what changes do you see in the next 5–10 years that will prop up domestic demand? More immigration or higher wages? Or longer working tenures? NH: More than immigration, women’s participation in the labor market is an important issue for Japan. If policymakers cannot successfully implement a “womenomics” policy, they will introduce a further extension of the retirement age. Wages and tenures are not the key issues right now.

36


Endnotes 1.

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

2.

Haver Analytics, June 2016.

3.

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

4.

Haver Analytics, June 2016.

5.

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

37


BRAZIL

A glimmer of hope By Akrur Barua

B

The economy contracted yet again in Q1

RAZIL will soon host the Summer Olympics. When Brazil won the race to host two major events—the 2014 Soccer World Cup and the 2016 Olympics—it was a proud moment for a country that was emerging as a strong contender on the global stage. However, much water has flowed down the Amazon since then. The economy is in bad shape. Political acrimony is high. Indeed, doubts have also emerged about Olympic host city Rio de Janeiro’s ability to complete facilities on time.1

There was not much respite for the economy in Q1 as real GDP contracted 0.3 percent quarter over quarter. This was, however, an improvement from the 1.3 percent decline in Q4 2015. Domestic demand faltered yet again, with gross fixed capital formation (-2.7 percent) and private consumption (-1.7 percent) contracting in Q1. Even though government consumption expanded 1.1 percent, any support to the economy from the fiscal side will be temporary, given the dire need to get government finances back on track.

The new government appears determined to restore fiscal health and reform the economy.

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

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

38

3rd QuarterBrazil 2016

Figure 1. Exports were a rare bright spot for the economy in Q1 Percentage, quarter over quarter

12 9 6 3 0 -3 -6 -12 Q1-14

Q2-14

Q3-14

Q4-14

Q1-15

Q2-15

Q3-15

Q4-15

GDP

Private consumption

Government consumption

Gross fixed capital formation

Q1-16

Exports Source: Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

39


The new government means businesses

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

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

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

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

Figure 2. The real is recovering this year 5.0

4.5

4.0

3.5

3.0

2.5 Jan 15

May 15

Sep 15

USD/BRL

Jan 16

May 16

EUR/BRL


40


Figure 3. 10-year government bond yields have retreated from their highs Percentage

Basis points

18

600

17 16

500

15 14

400

13 12

300

11 10

200 Jan 15

May 15

Sep 15

Jan 16

May 16

10-year government bond yields (left axis) Brazil 10-year USD credit default swaps (right axis) Source: Haver Analytics, Bloomberg, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

The markets are loving it—for the moment

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

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

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

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Figure 4. Government’s borrowing requirements and interest payments have fallen Percentage (share of GDP)

12

10

8

6

4

2

0 Jan 14

Apr 14

Jul 14

Oct 14

Jan 15

Interest payments

Apr 15

Jul 15

Oct 15

Jan 16

Apr 16

Nominal deficit


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

Falling bond yields and a return of confidence have mitigated the threat of fiscal dominance to a large extent.

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

42


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

15

12

9

6

3

0 Jan 14

Apr 14

Jul 14

Oct 14

Jan 15

Apr 15

SELIC (policy rate)

Jul 15

Oct 15

Jan 16

Apr 16

Inflation


The threat of fiscal dominance abates further

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

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

43


The way forward won’t be easy The key hurdle for Brazil’s economy is political uncertainty. Trouble has already started for the new government—although it is a temporary one, at least until former president Dilma Rousseff’s impeachment process is completed. Three ministers have resigned so far.14 Also, while the proposed reforms are encouraging, the passage of these reforms faces different hurdles. Pension reforms, for example, will face opposition from labor unions, especially those aligned with the previous government. Unions resent the proposal to raise the retirement age and want to make any changes to pensions applicable to just new job market entrants.15 Other reforms, such as the one on inflation-indexed budget spending, will have to be passed in the legislature with a twothirds majority. For now though, the government appears to have the numbers.16 External problems also abound. Brexit will weigh on global markets, and emerging economies such as Brazil will be no exception to this volatility. That could, in turn, put pressure on Brazil’s currency and push bond yields up. A global shock could also dent exports, a key source of sustenance for Brazil’s economy of late. And while markets have given the benefit of doubt to the new administration, they can be unforgiving if the administration fails to deliver on reforms. Latin American economies, including Brazil, have learnt this the hard way. The government will do well to keep that in mind.

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Endnotes 1.

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

2.

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

3.

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

4.

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

5.

Joe Leahy and Samantha Pearson, “Brazil: Tales of everyday agony,” Financial Times, May 15, 2016, http://www.ft.com/cms/s/0/1c067b521829-11e6-bb7d-ee563a5a1cc1.html#axzz4CIp0blBO.

6.

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

7.

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

8.

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

9.

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

10. Anthony Boadle and Lisandra Paraguassu, “Brazil recovery on track despite political turmoil: Top Temer aide,” Reuters, June 2, 2016, http:// www.reuters.com/article/us-brazil-politics-padilha-idUSKCN0YO23F. 11. Haver Analytics, June 2016. 12. Ibid. 13. Ibid. 14. BBC, “Brazil tourism minister resigns over graft scandal,” June 16, 2016, http://www.bbc.com/news/world-latin-america-36556214. 15. Trevisani, “Brazil’s acting president Michel Temer vows to tackle insolvent pension system”; Paraguassu and Soto, “Brazil’s Temer wants proposal for pension reform within 30 days.” 16. Anna Edgerton and Mario Sergio Lima, “Temer proposes spending cap in effort to fix Brazil’s budget,” Bloomberg, June 15, 2016, http://www. bloomberg.com/news/articles/2016-06-15/temer-proposes-spending-cap-in-attempt-to-fix-brazil-budget.

45


MEXICO

Embracing the advantage of its northern neighbor By Danny Bachman

T

HAT the Mexican economy is very closely tied to its northern neighbor is not news. Lately, this “not-news” has been both good and bad: bad because disappointing growth in the United States has translated into disappointing growth in Mexico; good because Mexico still has an advantage over other emerging economies. Similar economies that are more closely tied to Europe have had to cope with European stagnation, and many other r e so u r c e - d e pe n d en t economies—including other countries in Latin America—have felt the recent Chinese slowdown. In contrast, the United States has remained a relatively stable source of economic growth for Mexico.

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

Follow the leader The close connection between the two most populous North American economies can be seen starkly in figure 1. Although the common business cycle originates in the United States, Mexican GDP is more volatile than US GDP. It fell more during the two US recessions since 1995 and grew faster during the post 2008–09 recovery. This reflects Mexico’s integration with the US manufacturing sector, which itself is more cyclical than the rest of the US economy.

Since the 1990s, Mexico has traded that cycle for coordination with the US business cycle.

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

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

46

3rd Quarter 2016 Mexico

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

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

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

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

47


Figure 1. Mexican and US GDP growth Year-over-year percentage change

10.0

7.5

5.0

2.5

0

-2.5

-5.0

-7.5

-10.0 98

00

02

04

06

Mexico

08

10

12

14

United States

Source: IMF/Haver Analytics. Graphic: Deloitte University Press | DUPress.com

Mexico’s flexible exchange rate helped to mitigate the impact of the US financial crisis and recession. As economists predicted, some of the impact of lower demand in the United States was absorbed by improved Mexican competitiveness as the exchange rate depreciated.

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Figure 2. Growth in selected emerging markets 20-year average per capita GDP growth rate

10

8

6

4

2

0

Brazil

South Africa

Mexico

Argentina

Indonesia

India

Vietnam

China

Source: IMF/Haver Analytics. Graphic: Deloitte University Press | DUPress.com

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

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

Despite such concerns, Mexican policymakers continue to believe that market-friendly structural changes are the key to long-term prosperity. In 2012, Mexico’s political leaders doubled down. The main political parties agreed on an ambitious framework for modernizing the Mexican economy (the Pacto de México), and Congress has indeed passed a number of broad reforms in areas such as education and telecom.3 Mexican authorities have also adopted responsible monetary and exchange rate policy. Before the reforming spirit took hold in response to the 1980s’ debt crisis, Mexico attempted to maintain a fixed exchange rate. That was to the advantage of Mexican consumers (especially those wealthy enough to afford imported goods), but high inflation in Mexico created a series of currency crises. The 1994 crisis was the last straw. Mexico let the peso float in early 1995. Not long before, the government had given

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

49


Figure 3. Inflation and the exchange rate Year-over-year percentage

Pesos/dollar

200

20

160

16

120

12

80

8

40

4

0

0 1975

1980

1985

1990

1995

2000

2005

2010

2015

Exchange rate (right axis)

CPI (left axis) Source: IMF/Haver Analytics.

Graphic: Deloitte University Press | DUPress.com

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

the Bank of Mexico autonomy and a single mandate of keeping inflation in check. The results of the new monetary policy speak for themselves (figure 3). The exchange rate became more volatile, and the trend has been toward depreciation, as the average dollar/peso rate has more than doubled. But the inflation rate has become less volatile—and much lower. Even better, Mexico’s flexible exchange rate helped to mitigate the impact of the US financial crisis and recession. As economists predicted, some of the impact of lower demand in the United States was absorbed by improved Mexican competitiveness as the exchange rate depreciated.

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

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

50


The one-two punch of lower oil prices in 2014–15 plus the recent slowdown in US manufacturing has been a formidable drag on the Mexican economy. ter, global growth), Mexico’s economy will eventually slow even more.

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

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

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

Endnotes 1.

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

2.

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

3.

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

4.

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

5.

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

51


SOUTH AFRICA

In search of an economic foothold By Lester Gunnion

S

OUTH Africa’s economic challenges have intensified. The economy contracted in the first quarter of 2016, as mining production and exports came under pressure from subdued commodity prices, weak external demand, a strong US dollar, and sluggish global trade. Furthermore, weak growth, political unrest, and deteriorating fundamentals have resulted in the South African rand slipping and inflation climbing. In June, South Africa narrowly escaped a rating downgrade to below investment status.1 Even though the economy has some time to mend before it comes under the scrutiny of ratings agencies again, the route to growth is unclear, especially as monetary and fiscal policy is tightened. Furthermore, the United Kingdom’s decision to exit the European Union is likely to add to global uncertainty, which in turn will add to South Africa’s burden. Policymakers are likely to face several difficulties in navigating internal and external challenges. The short-term outlook is therefore likely to be rather dim.

Mining was the major drag on overall growth. The sector shrank 18.1 percent, resulting in a 1.5-percentage-point subtraction from growth in real GDP (figure 1). In Q1, the mining sector was hit by lower production of iron ore and platinum group metals. The drop in production is linked to a downward trend in global commodity prices, stemming from weak global demand, growing uncertainty, and an appreciation of the US dollar. Production has also been hit by rising costs of inputs and labor. The Q1 decline in mining production also caused a contraction in both the electricity and transport sectors due to weak demand. Analyzed from an expenditure-on-GDP standpoint, the South African economy shrank at a seasonally adjusted annualized rate of 0.7 percent in Q1. This is the first time that South Africa has included an expenditure-on-GDP statistic in its quarterly release. The expenditure lens, which puts overall demand in focus, paints an equally grim picture. Household spending, net investment, and trade registered declines, while government consumption grew, albeit at a slower pace than the previous quarter. Trade was hit the hardest, with both exports and imports declining at an annualized rate of 7.1 percent. The decline in exports shaved off 2.2 percentage points from overall growth in expenditure on GDP in Q1. A decline in exports, particularly exports from South Africa’s mining sector, links back to the overarching trends of weak external demand, global uncertainty,

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

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3rdSouth QuarterAfrica 2016

Figure 1. Mining production volume 25% 20% 15% 10% 5% 0% -5% -10% -15% Apr-16

Jan-16

Mar-16

Nov-15

Jul-15

Sep-15

Mar-15

May-15

Jan-15

Sep-14

Nov-14

Jul-14

May-14

Jan-14

Mar-14

Nov-13

Jul-13

Sep-13

May-13

Jan-13

Mar-13

Sep-12

Nov-12

Jul-12

Mar-12

May-12

Jan-12

Nov-11

Jul-11

Sep-11

May-11

Jan-11

Mar-11

-20%

Physical volume of mining production index, 2010=100, year-over-year percentage change Source: Statistics South Africa, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

53


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

A decline in exports, particularly exports from South Africa’s mining sector, links back to the overarching trends of weak external demand, global uncertainty, a strong dollar, and sluggish global trade, catalyzed by a slowdown in China.

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

Figure 2. China’s imports of South Africa’s major commodities (USD million) 1,200

300

1,000

250

800

200

600

150

400

100

200

50 0

0 Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

China’s imports of mineral products from South Africa, non-seasonally adjusted (left axis) China’s imports of basic metals from South Africa, non-seasonally adjusted (right axis) Source: China Customs/Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

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

South Africa because 84 percent of all South Africa’s exports to China are either mineral products or base metals. In fact, South Africa is, on the whole, a commodity-exporting nation: Mineral products, precious stones and metals, and base metals constituted more than half (54 percent) of the country’s total exports in 2015.3 Figure 2 shows that China’s imports of minerals and metals from South Africa have declined in dollar terms, while figure 3 shows a decline in the price of industrial inputs and metals. Commodities are priced in US dollars, so a strong dollar means that commodities cost fewer dollars than before. This results in commodity exporters such as South Africa earning fewer dollars for their exports. Another factor influencing South Africa’s exports to China is the devaluation of the renminbi. China’s currency is at a five-year low against the dollar, with further devaluation a possibility. A weak yuan makes Chinese imports of commodities, priced in dollars, comparatively more expensive, increasing downward pressure on demand.

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

Figure 3. Indices of primary commodity prices 2005=100, in terms of USD

200 180 160 140 120 100 80 60 40 20 0 Jan-14

Apr-14

Jul-14

Oct -14

Jan-15

Apr-15

Industrial inputs

Jul-15

Oct-15

Jan-16

Apr-16

Metals

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

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Figure 4. US and Japanese imports from South Africa USD million

JPY billion

1,200

120

1,000

100

800

80

600

60

400

40

200

20 0

0 Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

US imports from South Africa, non-seasonally adjusted (left axis) Japan’s imports from South Africa, non-seasonally adjusted (right axis) Source: Census Bureau/Ministry of Finance Japan/Japan Tariff Association/Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

Figure 5. Eurozone imports from South Africa EUR million, non-seasonally adjusted

1,600

1,200

800

400

0 Jan-05

Jan-06

Jan-07

Jan-08

Jan-09

Jan-10

Jan-11

Jan-12

Jan-13

Jan-14

Jan-15

Jan-16

Source: Statistical Office of the European Communities/Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

56


Figure 6. South Africa’s volume of exports including gold, (seasonally adjusted, 2010=100) 120 115 110 105 100 95 90 85 80 2006 Q1

2007 Q1

2008 Q1

2009 Q1

2010 Q1

2011 Q1

2012 Q1

2013 Q1

2014 Q1

2015 Q1

2016 Q1

Source: South African Reserve Bank/Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

Figure 7. World trade, total imports (USD billion) 1,800 1,600 1,400 1,200 1,000 800 600 400 200 0 Jan-80

Jan-84

Jan-88

Jan-92

Jan-96

Jan-00

Jan-04

Jan-08

Jan-12

Jan-16

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

57


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

Not only has the value of global trade dipped, the volume of trade has also been suppressed. The interplay of all these factors is likely to keep exports under pressure. This is likely to contribute to South Africa’s current account deficit.

External and internal challenges likely to make policy formulation difficult

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

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

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

Figure 8. Global trade in terms of volume World trade in volumes, seasonally adjusted, quarterly percentage change

6 4 2 0 -2 -4 -6 -8 -10 -12 2006 Q1

2007 Q1

2008 Q1

2009 Q1

2010 Q1

2011 Q1

2012 Q1

2013 Q1

2014 Q1

2015 Q1

2016 Q1

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

58


The conundrum that the central bank faces is that the price rise and subsequent tightening of monetary policy come at a time when the economy is at risk of entering a technical recession. However, arresting inflation and supporting the rand also remain key concerns for the central bank.

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

100,000 90,000 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 2012 Q1

2013 Q1

2014 Q1

2015 Q1

2016 Q1

Foreign direct investment net income payments Foreign nondirect investment net income payments Source: South African Reserve Bank/Haver Analytics, Deloitte Services LP economic analysis. Graphic: Deloitte University Press | DUPress.com

59


tant is achieving economic growth. However, in an environment marked by weak internal and external demand, declining confidence among consumers and businesses alike, and tight monetary and fiscal policy, growth will be hard to come by. In such a situation, South Africa’s persistent weaknesses are underscored. Unemployment, for instance, climbed to an astounding 26.7 percent in Q1, up from 24.5 percent in the previous quarter. Low labor force participation (58.7 percent in Q1 2016, of which 73 percent are employed) means that just above 40 percent of South Africa’s total population is employed.9

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

Continued economic weakness could also put South Africa under the lens of ratings agencies later in the year. A downgrade to below investment status would make an already uphill journey a lot steeper.

Productivity also has been a problem: Real output per employee has declined year over year for the last five quarters. As productivity declines, labor costs continue to rise. Unit labor cost in the nonagricultural sector climbed an average of 5 percent year over year over four quarters in 2015.10 An economic environment of rising prices and low growth could mean that business owners will not be able to meet the demands of trade unions, therefore leaving room for labor strikes that disrupt production and hamper economic growth.

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

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

60


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

Endnotes 1.

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

2.

Statistics South Africa, “Gross domestic product: First quarter 2016,” June 8, 2016, http://www.statssa.gov.za/publications/P0441/P04411stQuarter2016.pdf. All statistics in this section are from this source unless otherwise stated.

3.

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

4.

Ibid.

5.

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

6.

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

7.

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

8.

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

9.

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

10. South African Reserve Bank/Haver Analytics, “South Africa: Productivity and costs, nominal unit labor cost, SA, quarterly, year-over-year percent change,” accessed June 24, 2016; Deloitte Services LP economic analysis. 11. International Monetary Fund, “South Africa and the IMF,” https://www.imf.org/external/country/ZAF/, updated June 13, 2016; South African Reserve Bank, “Selected forecast results: MPC meeting May 2016,” May 19, 2016, http://www.resbank.co.za/Lists/News%20and%20Publications/Attachments/7300/Forecast%20May%202016.pdf.

61


INDIA

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

I

T has been two years since the Narendra Modi government came to power with a historic win in the national elections. It was expected that the new government would embark upon much-needed economic reforms and radically restructure the Indian economy. The actual performance record of the government, however, has been a mixed bag.

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

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

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

Economic performance

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

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

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3rd QuarterIndia 2016

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

Expenditure data show that the improvement in GDP growth in Q1 was largely driven by higher private consumption, indicating that domestic demand is holding up well. Lower inflation has also helped improve households’ purchasing power (table 1). However, investment declined for the first time since Q1 of FY 2013–14. Growth momentum had started to slow in Q3 of FY 2015–16, and growth contracted by 2.4 percent in the following quarter, primarily due to a reduction in fixed investments (-1.9 percent). This probably reflects the slowdown in capital expenditure by the center and the state governments as they try to adhere to the targeted fiscal consolidation. That said, growth in inventories slowed in Q4 of FY 2015–16, which bodes well

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

Government spending on infrastructure (roads and railways) and a revival of private investment in response to rising domestic demand will likely be the key determinants of investment growth.

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

Table 1. GDP and the expenditure side

FY 2015–16 Q1

Q2

Q3

Q4

GDP

7.5

7.6

7.2

7.9

Consumption

5.7

5.7

7.4

7.6

6.9

6.3

8.2

8.3

-0.2

3.3

3.0

2.9

6.6

9.6

2.0

-2.4

Fixed

7.1

9.7

1.2

-1.9

Inventories

3.6

5.4

7.7

5.6

Valuables

0.6

12.4

13.5

-17.2

Exports

-5.7

-4.3

-8.9

-1.9

Imports

-2.4

-0.6

-6.4

-1.6

Private Government Investments

Source: Central Statistical Organization, May 2016.

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

100,000 80,000 60,000 40,000 20,000 0 -20,000 2012

2013

FDI inflow in India

2014

2015

Net FPI investment

Business investment

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

Figure 2. Fiscal and current account balance Percentage of GDP

7 6 5 4 3 2 1 0 2008–09

2009–10

2010–11

2011–12

2012–13

2013–14

2014–15

2015–16

Central government gross fiscal deficit

Current account balance

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

65


Glass half full: Major initiatives and reforms

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

The government has undertaken several initiatives and reforms in order to propel India to a higher growth path. Various programs and schemes such as “Make in India,” “Digital India,” “Smart Cities,” “Startup India,” and “Skill India,” among others, were launched with the intention of improving the manufacturing ability of the country, promoting innovation and entrepreneurship, creating job opportunities, and improving infrastructure and skills.

The government has also started initiating labor market reforms in a prudent manner. Instead of introducing the reforms at the center, the government has encouraged states to implement these reforms. The possible logic may be that once states start implementing reforms and see the benefits, there will be little resistance to accepting reforms at the center. Some states such as Rajasthan, Madhya Pradesh, and Maharashtra have already started amending labor laws.

Instead of introducing the reforms at the center, the government has encouraged states to implement these reforms. The possible logic may be that once states start implementing reforms and see the benefits, there will be little resistance to accepting reforms at the center.

The government also undertook several difficult structural reforms, such as the passage of the bankruptcy code and bills to foster fair play and transparency in the allocation of natural resources.6 Rationalizing existing laws, encouraging FDI, increasing governance efficiency, and, most importantly, the government’s willingness to seek feedback from industries on challenges in doing business have improved the overall business environment. According to the World Bank’s Doing Business report, India moved up four spots and now ranks at 130 out of 189 countries in ease of doing business.7 Although moderate, the improvement in the investment climate is reflected in the rise in FDI in the past year (figure 1).

According to the 2016 Deloitte India CFO survey, business leaders are highly optimistic about the economic outlook (figure 3). The survey suggest that many CFOs support these initiatives and reforms, and are upbeat about the expected outcomes, although they agree that the effectiveness of these can fully be assessed only after a while.9

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

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

66


Figure 3. Deloitte CFO Survey: Economic outlook 68%

70% 60% 50%

47%

40%

47%

47%

38%

30% 22%

20%

13% 8%

10% 0%

5%

2%

2% Next 1 year

Very optimistic

2–3 years

Neutral

Optimistic

1%

4–5 years

Not optimistic

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

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

While the lack of cooperation between the two houses of parliament has been an important reason for the delay, the lack of assertion and internal political conflicts are also impeding the ability of the government to take up bold reforms.

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

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Figure 4. Banking business and poor credit growth Year-over-year percentage

25

20

15

10

5 2008–09

2010–11

2012–13

2014–15

Aggregate deposit growth

Outstanding credit growth Source: Reserve Bank of India, May 2016.


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

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

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

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

68


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

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

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

Endnotes 1.

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

2.

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

3.

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

4.

Reserve Bank of India, May 2016.

5.

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

6.

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

7.

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

8.

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

9.

Deloitte, Still reluctant to spend.

10. Reserve Bank of India, May 2016.

69


SPECIAL TOPIC

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

I

N 1973, Egypt and Syria waged a surprise war on Israel, which soon divided many countries into supporters of either side. Subsequently, several oil-exporting Arab nations curtailed oil production (known as “the oil embargo”), quadrupling oil prices within a quarter. This oil crisis was one of the biggest factors that pushed some oil-consuming, industrialized nations such as the United States and the United Kingdom into an economic recession that lasted over a year.1 History repeated itself when disruptions in Iran’s oil production during the Iranian revolution, followed by the Iraq-Iran war, caused oil prices to skyrocket in 1979–80. This time, in addition to a supply shock, increased inventory demand in anticipation of supply shortages and rising global demand contributed to the oil price rise. The price shocks had a substantial impact on US GDP, and the US economy went into a recession.2

Wide fluctuations in oil prices have played an important role in driving economies into recession and even regimes collapsing—which is why movements in oil prices are closely watched by economists, investors, and policymakers globally. Since 2008, oil prices have seen two cycles of highs and lows, with no indication of a steady path in the near future. The historic high values of oil prices during 2010–13 and the following prolonged downturn during 2014–16 (the longest since the 1980s) suggest that the world economy is in unchartered territory (figure 1). In recent months, oil prices have shown signs of a recovery, after touching a low of $26 per barrel in January 2016.4 While many forecasters are optimistic about the recent price rise and are predicting that the oil glut may be over, some are concerned that there is a lot of uncertainty surrounding the current rebound. The direct influence of the Organization of Petroleum Exporting Countries (OPEC) on oil prices has changed due to rising competition from US shale oil producers. Instead of defending price levels, OPEC has changed its strategy to defend market share rather than price, by producing more at low prices. This supply strategy has been a critical factor in the current oil price trajectory. On the other hand, uncertainty in global demand poses downside risks to oil prices. The question everyone is asking is,

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

70

3rdSpecial Quarter topic 2016

Figure 1. Real oil price movements since 1970 mapped to global events Monthly imported real crude oil price (USD per barrel)

Unrest in Middle East countries

140 Iranian revolution and Iraq-Iran war

120

100

Arab Oil embargo

2008 financial crisis

Saudi Arabia The fall of increases Soviet Union production

80

Dot-com bubble, 9/11 attack

Asian economic crisis

60

40 US shale revolution

20

0 1974

1979

1984

1989

1994

1999

2004

2009

2014

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


71


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

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

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

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

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

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

Figure 2. Oil demand-supply balance (million barrels per day) 3

102 Strong demand amid rising supply

Demand outgrowing supply

2 Global economic slowdown and geopolitical uncertainty

97

1

92 0

87 Oil glut

82

-1

-2 2004

2005

2006

2007

2008

2009

2010

Oil supply (left axis)

2011

2012

2013

2014

2015

Oil demand (left axis)

Implied stock change (right axis) Note: The oil in the figure comprises crude oil, condensates, NGLs, and oil from nonconventional and other sources of supply. Source: Energy Information Administration, June 2016. Graphic: Deloitte University Press | DUPress.com

72

3rdSpecial QuarterTopic 2016

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

falling prices; and increased production by Canada, Russia, and, lately, Iran after sanctions were lifted led to a sustained increase in oil supply. However, the biggest contributor has been Saudi Arabia’s (the biggest oil producer within OPEC) unwillingness to not counter the increasing supply but instead maintain the production at historically high levels despite the perceived glut. Its intention might have been to preserve market share at the expense of Iran and the United States, even if that meant lower prices.

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

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

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

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

Figure 3. US crude oil production (thousand barrels per day) 10,000

9,000

8,000

7,000

6,000

5,000

4,000 Mar-2006

Mar-2008

Mar-2010

Mar-2012

Mar-2014

Mar-2016

Source: Energy Information Administration, June 2016. Graphic: Deloitte University Press | DUPress.com

73


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

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

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

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

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

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

74


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

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

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

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

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

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

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

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

75


Alternate policies and diversification might counter price instability

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

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

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

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

Figure 4. Oil prices required to balance twin accounts (USD per barrel, 2016) Yemen Libya Bahrain Algeria Oman United Arab Emirates Saudi Arabia Iran Iraq Qatar Kuwait 0

50

100

150

200

External breakeven

250

300

350

400

Fiscal breakeven

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

76


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

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

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

Endnotes 1.

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

2.

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

3.

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

4.

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

5.

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

6.

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

7.

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

8.

Given and Suchadoll, “The balancing act.”

9.

Ibid.

10. Ibid. 11. Daniel Bachman, United States Economic Forecast, Q2 2016, Deloitte University Press, June 15, 2016, http://dupress.com/articles/ us-economic-forecast-2016-q2/. 12. Aasim M. Husain et al., Global implications of lower prices, IMF, July 2015, https://www.imf.org/external/pubs/ft/sdn/2015/sdn1515.pdf. 13. Arezki and Blanchard, “Seven questions about the recent oil price slump.” 14. Margherita Stancati and Ahmed Al Omran, “Saudi Arabia approves economic reform program,” Wall Street Journal, April 25, 2016, http:// www.wsj.com/articles/saudi-arabia-approves-economic-reform-program-1461588979 15. Olusegun

Awolowo,

“‘Zero

oil’

plan

and

an

export

zero-oil-plan-and-an-export-revolution/.

77

revolution,”

Guardian,

March

20,

2016,

http://guardian.ng/opinion/


Economic indices GDP growth rates (percentage, year over year)

GDP growth rates (percentage, year over year)

7

15

6 10

5 4

5

3 2

0

1 0

-5

-1 -2 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 10 10 10 10 11 11 11 11 12 12 12 12 13 13 13 13 14 14 14 14 15 15 15 15 16 US

UK

Eurozone

Japan

-10

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 10 10 10 10 11 11 11 11 12 12 12 12 13 13 13 13 14 14 14 14 15 15 15 15 16

Canada

Brazil

Source: Bloomberg, Haver Analytics.

China

India

South Africa

Russia



Inflation rates (percentage, year over year)


Inflation rates (percentage, year over year)

4

20

15 2 10

5 0 0

-2

-5 May 12

Jan 13 US

Sep 13 UK

May 14 Eurozone

Jan 15

Sep 15

Japan

Canada

May 16

May 12

Brazil


125 120

1.7

115

1.6

110

1.5

105

1.4

100 95

1.3

90

1.2

85

1.1

80 75 May 12 Nov 12 May 13 Nov 13 May 14 Nov 14 May 15 Nov 15 May 16 EUR-USD

China

May 14 India

Jan 15 South Africa

Sep 15

May 16

Russia


Major currencies versus the US dollar 1.8

GBP-USD

Sep 13



1

Jan 13

USD-JPY (right axis)

Source: Bloomberg, Haver Analytics. Graphic: Deloitte University Press | DUPress.com

78

3rd Quarter 2016

Yield curves (as of June 27, 2016)*

US Treasury Bonds & Notes

UK Gilts

Eurozone Govt. Benchmark

Japan Sovereign

Canada Sovereign

3 Months

0.25

0.45

-0.54

-0.27

0.50

1 Year

0.47

0.30

-0.53

-0.31

0.52

5 Years

1.07

0.57

-0.53

-0.27

0.64

10 Years

1.56

1.09

-0.05

-0.17

1.16

Brazil Govt. Benchmark

China Sovereign

India Govt. Bonds

South Africa Sovereign

Russia*‡

3 Months

14.16

2.30

6.71

8.00

10.53

1 Year

13.33

2.42

6.98

-

9.88

5 Years

12.45

2.87

7.41

8.89

8.79

10 Years

12.42

2.91

7.46

9.09

8.60

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

UK

Eurozone

Japan

Canada

Brazil

China

India

South Africa

Russia

2016

1.9

1.8

1.6

0.6

1.4

-3.5

6.5

7.5

0.5

-0.9

2017

2.3

2.1

1.6

0.8

2

0.9

6.2

7.6

1.3

1.2

2018

2.1

2.2

1.6

0.6

2.2

1.8

6.2

7.8

1.9

1.5

Composite median currency forecasts (as of June 27, 2016)* Q3 16

Q4 16

Q1 17

Q2 17

2016

2017

2018

GBP-USD

1.47

1.48

1.48

1.49

1.48

1.52

1.55

Euro-USD

1.11

1.1

1.1

1.11

1.1

1.11

1.15

USD-Yen

110

112

111.5

112

112

114.5

113

USD-Canadian Dollar

1.3

1.31

1.31

1.3

1.31

1.25

1.3

USD-Brazilian Real

3.7

3.75

3.8

3.96

3.75

3.95

4.1

USD-Chinese Yuan

6.6

6.7

6.73

6.75

6.7

6.8

6.9

USD-Indian Rupee

67.83

68.5

68.57

68.5

68.5

68.82

67.59

15.7

16

16.07

16.2

16

15.42

14.68

66.67

68

66.42

66.75

68

65.75

63

USD-SA Rand USD-Russian Ruble *Source: Bloomberg

‡MICEX rates

†Source: OECD

79


OECD composite leading indicators (Amplitude adjusted)† United States

United Kingdom

Euro area

Japan

Canada

Brazil

China

India

South Africa

Russian Federation

Jan 13

100.0

99.9

98.7

99.7

99.6

100.5

100.7

99.4

100.7

99.5

Feb 13

100.1

99.9

98.8

99.9

99.5

100.3

100.8

99.3

100.7

99.5

Mar 13

100.2

100.0

98.9

100.1

99.5

100.1

100.8

99.2

100.7

99.4

Apr 13

100.3

100.0

99.0

100.4

99.5

99.9

100.9

99.1

100.7

99.4

May 13

100.4

100.1

99.2

100.6

99.6

99.7

100.9

99.0

100.6

99.4

Jun 13

100.5

100.3

99.3

100.8

99.6

99.5

101.0

98.9

100.6

99.5

Jul 13

100.5

100.5

99.5

100.9

99.7

99.2

101.0

98.8

100.6

99.6

Aug 13

100.5

100.8

99.7

101.1

99.8

99.1

101.0

98.7

100.6

99.8

Sep 13

100.5

101.0

99.9

101.2

100.0

98.9

101.0

98.6

100.6

100.0

Oct 13

100.5

101.2

100.1

101.4

100.0

98.8

101.0

98.6

100.5

100.2

Nov 13

100.6

101.3

100.3

101.4

100.1

98.7

100.9

98.5

100.5

100.4

Dec 13

100.6

101.4

100.4

101.5

100.1

98.6

100.9

98.5

100.4

100.6

Jan 14

100.6

101.4

100.4

101.4

100.1

98.4

100.8

98.5

100.3

100.8

Feb 14

100.6

101.4

100.5

101.2

100.2

98.4

100.7

98.5

100.2

101.0

Mar 14

100.7

101.5

100.5

101.0

100.2

98.4

100.6

98.6

100.1

101.2

Apr 14

100.7

101.5

100.4

100.8

100.3

98.5

100.5

98.6

100.0

101.5

May 14

100.8

101.5

100.4

100.6

100.3

98.6

100.4

98.7

100.0

101.7

Jun 14

100.8

101.5

100.3

100.3

100.4

98.7

100.3

98.8

100.1

101.9

Jul 14

100.8

101.4

100.2

100.2

100.4

98.8

100.2

98.9

100.2

101.9

Aug 14

100.8

101.3

100.1

100.1

100.5

98.8

100.0

98.9

100.3

101.9

Sep 14

100.8

101.2

100.1

100.0

100.4

98.8

99.9

99.0

100.3

101.6

Oct 14

100.8

101.1

100.1

100.0

100.4

98.7

99.7

99.1

100.4

101.3

Nov 14

100.7

101.0

100.1

100.0

100.3

98.5

99.6

99.1

100.4

101.0

Dec 14

100.7

100.9

100.2

100.1

100.3

98.3

99.4

99.2

100.3

100.6

Jan 15

100.6

100.9

100.3

100.1

100.2

98.1

99.2

99.3

100.2

100.3

Feb 15

100.5

100.8

100.4

100.2

100.1

97.9

99.0

99.3

100.2

100.2

Mar 15

100.4

100.7

100.5

100.2

100.0

97.8

98.9

99.4

100.1

100.2

Apr 15

100.3

100.6

100.5

100.2

99.9

97.8

98.8

99.5

100.1

100.3

May 15

100.2

100.5

100.5

100.2

99.9

97.8

98.7

99.6

100.1

100.3

Jun 15

100.0

100.3

100.5

100.2

99.9

97.8

98.5

99.6

100.0

100.2

Jul 15

99.9

100.1

100.5

100.2

99.8

97.8

98.3

99.7

99.9

100.0

Aug 15

99.7

99.9

100.5

100.1

99.7

97.8

98.1

99.8

99.7

99.8

Sep 15

99.5

99.7

100.6

100.0

99.6

97.9

97.9

99.9

99.6

99.5

Oct 15

99.3

99.5

100.6

99.9

99.5

97.9

97.8

99.9

99.6

99.1

Nov 15

99.2

99.3

100.6

99.8

99.3

97.8

97.8

100.0

99.5

98.7

Dec 15

99.0

99.2

100.6

99.6

99.2

97.8

97.7

100.0

99.5

98.4

Jan 16

98.9

99.1

100.5

99.5

99.1

97.7

97.6

100.1

99.5

98.0

Feb 16

98.9

99.2

100.5

99.6

99.3

98.0

98.4

100.2

99.5

98.3

Mar 16

98.9

99.2

100.4

99.6

99.4

98.3

98.4

100.3

99.5

98.6

Apr 16

98.9

99.1

100.4

99.6

99.5

98.8

98.4

100.4

99.4

99.2

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

80

3rd Quarter 2016

Additional resources

Deloitte Research thought leadership Asia Pacific Economic Outlook, Q3 2016: Australia, Indonesia, Singapore, and South Korea United States Economic Forecast, Q2 2016 Issue by the Numbers, June 2016: In whose interest? Examining the impact of an interest rate hike Please visit www.deloitte.com/research for the latest Deloitte Research thought leadership or contact Deloitte Services LP at: [email protected]. For more information about Deloitte Research, please contact John Shumadine, Director, Deloitte Research, part of Deloitte Services LP, at +1.703.251.1800 or via e-mail at [email protected].

81


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

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

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

Ian Stewart is chief economist, Deloitte UK.

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

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

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

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

82

3rd Quarter 2016

Contact information Global Economics Team

Global Industry Leaders

US Industry Leaders

Akrur Barua Deloitte Research Deloitte Services LP India Tel: +1.678.299.9766 E-mail: [email protected]

Energy & Resources Carl Hughes Deloitte Touche Tohmatsu Limited UK Tel: +44.20.7007.0858 E-mail: [email protected]

Consumer & Industrial Products Seema Pajula Deloitte & Touche LLP Tel: +1.312.486.1662 E-mail: [email protected]

Dr. Daniel Bachman Deloitte Research Deloitte Services LP USA Tel: +1.202.220.2053 E-mail: [email protected]

Dr. Alexander Börsch Deloitte Research Germany Tel: +49.(0)89.29036.8689 E-mail: [email protected] Dr. Patricia Buckley Deloitte Research Deloitte Services LP USA Tel: +1.517.814.6508 E-mail: [email protected] Lester Gunnion Deloitte Research Deloitte Services LP India Tel: +1.615.718.8559 E-mail: [email protected] Dr. Ira Kalish Deloitte Touche Tohmatsu Limited USA Tel: +1.213.688.4765 E-mail: [email protected] Dr. Rumki Majumdar Deloitte Research Deloitte Services LP India Tel: +1.470.434.4090 E-mail: [email protected] Aditi Rao Deloitte Research Deloitte Services LP India Tel: +1.470.434.3941 E-mail: [email protected]

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Financial Services Chris Harvey Deloitte LLP UK Tel: +44.20.7007.1829 E-mail: [email protected] Life Sciences & Health Care Pete Mooney Deloitte Touche Tohmatsu Limited USA Tel: +1.617.437.2933 E-mail: [email protected] Manufacturing Tim Hanley Deloitte Touche Tohmatsu Limited USA Tel: +1.414.977.2520 E-mail: [email protected] Public Sector Paul Macmillan Deloitte Touch Tohmatsu Limited Canada Tel: +1.416.874.4203 E-mail: [email protected] Telecommunications, Media & Technology Jolyon Barker Deloitte & Touche LLP UK Tel: +44 20 7007 1818 E-mail: [email protected]

Ian Stewart Deloitte Research Deloitte & Touche LLP UK Tel: +44.20.7007.9386 E-mail: [email protected]

83

Banking & Securities and Financial Services Kenny Smith Deloitte Consulting LLP Tel +1.415.783.6148 Email: [email protected]

Life Sciences & Health Care Bill Copeland Deloitte Consulting LLP Tel: +1.215.446.3440 E-mail: [email protected] Power & Utilities and Energy & Resources John McCue Deloitte LLP Tel: +216 830 6606 E-mail: [email protected] Public Sector (Federal) Daniel Helfrich Deloitte Consulting LLP Tel: +1.571.882.8308 E-mail: [email protected] Public Sector (State) Mark Price Deloitte Consulting LLP Tel: +1.617.585.5984 E-mail: [email protected] Telecommunications, Media & Technology Sandra Shirai Deloitte Consulting LLP Tel: [email protected] E-mail: +1.415.783.5515


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