The world economy exited recession in the third quarter of 2009 and is set to grow at a 3.8 per cent pace in 2010, based on consensus forecasts. Growth in the developed world is expected to exceed two per cent while in the emerging countries of Brazil, Russia, India and China, (the BRIC economies) growth is projected to average in excess of 7.5 per cent. The recovery in the industrialised nations is expected to be led by corporate spending on capital and inventory rebuilding, as both are very low now while profits and cash flows are very strong. Conversely, government and consumer spending should remain subdued.
Activity is expected to fade in the second half of the year, leading to a modest slowdown, once the impact from the rebuilding of inventories and government spending has passed. The picture is somewhat different in the emerging world, particularly Asia. Although hit by the financial crisis and global recession, these countries were still not at the "epicentre" of the turmoil. Having absorbed the demand shock, or having offset it with stimulatory macro policy, many of these economies can return more or less to pre-crisis growth rates.
United States
Within the developed world, the US is expected to lead the recovery, since economic fundamentals in Europe and the UK look weaker. However, since real GDP growth is still expected to be below that experienced in typical upswings, the US economy should continue to operate with a large margin of spare capacity and high levels of unemployment. The reasons for the sub-par rate of recovery can be traced back to the origins of the downturn, which have left a legacy of substantial headwinds for consumer spending, business equipment investment, housing and commercial property, as well as for credit conditions and employment prospects.
As such, while the near-term momentum in activity is strong, with growth driven mainly by fiscal infrastructure spending and the rebuilding of inventories, the problem is that once this support fades, other parts of the economy may not take up the slack. The silver lining is that inflation is expected to remain low, enabling the Federal funds rate to be held at its current 0-0.25 per cent level for a prolonged period while the recovery gains strength.
Eurozone
The Eurozone economy has continued to pick up since exiting recession in the third quarter of 2009, with growth remaining dependent on exports. Looking ahead, the upswing in the region seems likely to be gradual given that it is still affected by factors such as financial sector de-leveraging, tight credit, rising unemployment, and subdued growth in many of its trading partners. All this makes it likely that the current expansionary monetary and fiscal policies will be maintained until at least late 2010.
The major problem for the region appears to be the fiscal position of some of the peripheral economies such as Greece. This will intensify pressure on member states to consolidate their budgets, undermining the easy fiscal stance of eurozone governments, and potentially delaying recovery. These problems have abruptly weakened the euro relative to the US dollar over the past weeks.
United Kingdom
To date, the official data show that the UK's recovery has lagged behind the pace set by other economies. In many respects, the economic downturn ought to have been reversed quickly in the UK. The government was quick to address the problems of the banking system; the Bank of England, after an initial delay, was aggressive in cutting interest rates, and was early to adopt Quantitative Easing; while fiscal spending was expanded within weeks of the downturn commencing. In the meantime, the fall in sterling - particularly against the euro - should have enabled the manufacturing sector to recover promptly.
However, the problem is that the average British household and many UK financial institutions are more indebted than their American or European counterparts, and it is inevitably taking time for them to de-leverage their balance sheets. This coupled with the rapid deterioration of the government's fiscal position looks set to ensure that the UK's recovery remains the weakest of the G7 in 2010.
Japan
While the economic recovery is just gaining its footing in most of the developed world, in Asia the economic turnaround is approaching its first anniversary. This is also true for Japan where the recovery has been fuelled by positive net exports to the fast growing markets in the region, and surprisingly strong household consumption spending.
Renewed fears of a dip in inflationary expectations towards the end of last year prompted the government to announce a series of measures aimed at encouraging households to spend. Overall the Japanese economy is expected to stage a relatively impressive rebound this year, reflecting largely the fact that it also had one of the earliest and deepest recessions.
Asia excluding Japan
The non-Japan Asian economies have witnessed the most robust recoveries worldwide. To some extent this is due to government stimulus policies, but more fundamentally it is due to the fact that Asian economies have not been burdened with debt and therefore monetary and fiscal policies have been able to gain traction more quickly. However, given that these economies are so heavily dependent on exports, and because their trading partners in the west have been in recession, their normal export-led growth pattern is being forced to focus more on domestic spending.
The result is that their overall growth rates are not as rapid as they were in the pre-crisis days of export-led growth. By contrast, equity inflows to the region are expected to remain strong in 2010 and, along with the prospects of higher interest rates, will put further upward pressure on Asian currencies. In China, after preliminary data has shown that the economy expanded by 8.7 per cent for the whole of 2009, consensus now expects economic growth to accelerate to close to 10 per cent this year.
The problem that cannot be ignored is that, the rebound is increasingly triggering overheating fears. Hence, we have already seen this year the authorities moving to tighten policy by raising bank reserve requirements and curtailing bank lending.
Latin America
Aggressive policy measures, coupled with the global recovery, have ensured that the recession in Latin America has also been brief. Most economies posted strong quarter on quarter growth in the third quarter of last year. As commodity exporters, many countries in the region have benefited from the strength in global commodity prices.
Coupled with rising risk appetite, this ensured that capital inflows have recovered strongly. This is particularly true for Brazil, where equities and the currency have soared. The region should witness good growth rates in 2010, with inflation remaining subdued. However the overall outlook will be generally tied to the recovery of the region's main trading partners and the outlook for commodities.
Emerging Europe
While part of Emerging Europe is now expected to return to growth this year, the recovery in the region may still disappoint. In contrast to the rest of the developing world, domestic demand faces a number of significant headwinds. For a start, a fragile banking sector should keep credit conditions tight in much of the region. Moreover, in response to the deterioration in budget positions, fiscal policy looks set to tighten in pretty much every country next year. This will act as a brake on the recovery, even in the region's healthier economies. Accordingly, the near term growth will depend heavily on the strength of external demand.
This article has been compiled by the Research & Analysis Unit at Bank of Valletta's Wealth Management.
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