Outlook for the international economy
Table 1: International GDP growth forecasts(a)
(a) Calculations for World and euro area growth rates use GDP weights based on purchasing power parity (PPP).
Calculations for Major Trading Partners and Other East Asia use export trade weights.
(b) Other East Asia is: Korea, Taiwan, Hong Kong, Singapore, Indonesial Malaysia, Thailand, Vietnam and the Philippines
Source: National statistical publications, IMF and Treasury.
A stabilisation in financial markets, and better than expected economic data, suggest that the worst of the global recession may have passed. A number of economies returned to growth in the June quarter. In addition, partial indicators, including industrial production, trade and confidence have rebounded from their lows.
The upturn in activity in the June quarter varied across regions with the rebound in the emerging economies of Asia stronger than in the advanced economies. The outlook, however, remains uncertain and reliant on the ongoing implementation of extensive macroeconomic stimulus. An expected upturn in the inventory cycle is expected to support activity in 2010. Recovery in the longer term is contingent upon a sustained recovery in private demand supporting growth as the contribution from the public sector stimulus fades.
There has been a marked improvement in financial market conditions since early March 2009. Global equity markets have rebounded strongly, albeit from very depressed levels and credit spreads have narrowed significantly, reflecting both a perceived decline in system-wide risks and expectations of a global recovery.
Improved investor sentiment has seen wholesale funding markets reopen, allowing systemically-important financial institutions to raise significant amounts of new capital. Overall, the degree of stress in the world's key financial systems has fallen to the lowest levels since mid-2007.
Against this backdrop, world GDP is now estimated to contract by 1¼ per cent in 2009, a slight upward revision from the June forecast, but still the first annual contraction in six decades (Chart 1). Growth forecasts for 2009 have been upgraded across all economies (Table 1).
Chart 1: World GDP growth
Source: IMF and Treasury.
As a group, Australia's major trading partners are expected to contract by 1¼ per cent in 2009, a one percentage point upgrade from June largely reflecting the stronger outlook for key East Asian trading partners (Chart 2).
Chart 2: MTP GDP growth
Source: IMF and Treasury.
Deep contractions are forecast this year in the US, Euro area and Japan. Trade dependent economies of East Asia recorded the steepest declines in GDP as trade flows collapsed. Equally these same economies have bounced back the most rapidly. While China and India's growth has been revised up, they will still be at below-trend pace. In some other emerging economies, growth will be impeded by a combination of still weak external demand and the need for structural reforms to increase the contribution of domestic activity and decrease their reliance on external demand.
The massive macroeconomic stimulus, both monetary and fiscal, as well as measures to shore up bank balance sheets and restore credit flows should help the global economy continue to gradually recover in 2010.
However, any self-sustaining recovery is conditional on the continued stability of financial conditions, a restoration of global trade flows and improved confidence. Deleveraging by both firms and households will continue, which together with rising unemployment will act as a continued drag on economic growth.
A number of the upside risks identified in June - improved stability in financial markets and rapid response to fiscal stimulus, especially in Asia - have materialised, underpinning the near-term rebound. Over the medium to longer term a number of large risks remain around getting the global economy onto a sustainable growth path.
Much of the rebound in the first half of 2009 can be attributed to the large amount of stimulus around the world. However, over the longer term, fiscal constraints, especially in advanced economies, and the potential for a build up of inflationary pressures as output gaps narrow mean that fiscal stimulus needs to be withdrawn. The timing of fiscal consolidation will be a crucial factor affecting the outlook. If stimulus is withdrawn too early, before private sector demand becomes self-sustaining, this would provide a setback to the recovery. If it occurred too late, it would risk an even bigger public debt burden, the crowding out of private sector spending and inflation pressures.
An associated risk is that the high level of stimulus goes into speculative activity that leads to asset price bubbles, especially in Asia. Also as global growth recovers there is the risk of further sharp rises in commodity prices impacting on costs of production and public finances.
As deleveraging results in increased savings rates in advanced economies, the strength and sustainability of the global recovery depends on a successful rebalancing of demand between emerging and advanced economies. This is a key long term challenge facing the world economy and one on which the G20 has an important role to play by helping coordinate policy actions across the world's major economies.
Significant risks to financial stability remain over both the short and medium term. Most immediately, rising default rates amongst household and corporate borrowers combined with the ongoing likelihood of write-downs will continue to place pressure on bank balance sheets in the US and Europe.
There is still the downside risk of a possible re-intensification of the negative feedback loop between the real economy and the financial system that could undermine the recovery.
Looking further ahead, the means and speed with which the public interventions in financial markets are withdrawn entails significant risks to financial stability over the medium term. Financial systems remain susceptible to sharp reversals in sentiment, and a premature - or poorly coordinated - withdrawal of public support risks sparking a secondary crisis. Conversely, leaving support mechanisms in place for too long risks creating fertile conditions for future crises.
Evidence of drought in India and Southeast Asia has the potential to undermine the important agricultural sectors in these economies, and to impact negatively on consumption, detracting from growth in 2009 and 2010.
The improved outlook for the United States reflects the faster than expected stabilisation in financial and housing market conditions and a more moderate rate of decline in investment. Additionally, a turn in the inventory cycle is likely to provide support to growth in the near term, augmenting the boost provided by the fiscal stimulus package. Accordingly, forecasts for 2009 and 2010 have been revised up to -2¾ per cent and 1¼ per cent (up ¼ and 1 percentage point respectively).
Nevertheless, the recovery in the US economy is still expected to be sluggish and protracted compared to past recessions. In particular, the underlying weakness in consumer spending - by far the largest component of GDP - is likely to continue to weigh on growth. Household spending is expected to remain constrained in light of recent shocks to incom
es, confidence and wealth. Tight credit conditions and protracted labour market weakness are also likely to add to the frail outlook for consumption. However, consumer spending could be firmer than anticipated if the incipient recovery in house prices supplements the boost to confidence likely to flow from the policy-aided macroeconomic stabilisation.
The most significant downside risk is that private demand will not recover sufficiently to support the economy as the impact of the fiscal stimulus package wanes from mid-2010. The extent of the recovery in private demand, and the timeliness and success of the withdrawal of other extraordinary policy measures, including Federal Reserve interventions, will be a key determinant of the outlook in 2010 and beyond.
The outlook for China has improved considerably since June. A substantial boost to domestic demand, driven by aggressive monetary and fiscal stimulus, contributed to a very strong GDP outcome for the June quarter. The Chinese economy is now forecast to grow by 8 per cent in 2009 (up from 6¾ per cent in June), accelerating to 9¼ per cent in 2010 and 9½ per cent in 2011.
China's stimulus has boosted the economy both sooner and more strongly than expected. Record high loan growth has supported a substantial increase in fixed asset investment, particularly by state owned enterprises. Infrastructure related investment is expected to be the main driver of growth over the forecast period, with private sector investment expected to make a modest recovery as fiscal stimulus winds down in late 2010. Consumption growth has remained relatively stable and is expected to remain so over the forecast horizon, while export performance is expected to improve, but remain subdued, as the outlook for China's major trading partners gradually strengthens.
The loosening of monetary policy and the injection of liquidity into the financial sector has raised potential risks to China's growth: excess liquidity has increased the risk of unproductive investments, non performing loans and asset price bubbles; and there is concern that China's private sector will not recover sufficiently to sustain solid economic growth once stimulus winds down. Weaker than expected global demand also continues to be a downside risk to growth, with China's export growth likely to remain modest, even into 2011.
The Japanese economy is showing some signs of recovery. Industrial production and exports have continued to pick up, due in part to demand for Japanese exports from China and the Newly Industrialised Economies of East Asia. Production has also been supported somewhat by a boost to domestic sales from both the preferential tax treatment for environmentally-friendly cars and the government's ‘eco-points' system.
Despite these improvements, business investment is likely to remain depressed, as profits have plummeted and firms are saddled with excess capacity. Public investment, on the other hand, has increased as fiscal stimulus continues to be rolled out. These stimulus measures have provided some support to consumption, although consumption will be constrained by the unemployment rate reaching a record high and incomes being severely curtailed.
Forecasts for Japan have been revised upward. The economy is expected to contract by 5¾ per cent in 2009, before returning to growth of 1½ per cent in 2010 and 1 per cent in 2011, supported by sizeable fiscal stimulus and a modest increase in exports. Significant downside risks to the outlook remain, including the external environment, weak private demand amid negative wealth effects from a worsening employment situation and curtailed incomes, excess capacity, and deflation. Any recovery is from a very low base, and will be weak and prolonged.
Growth in the Newly Industrialised Economies (NIEs) weakened sharply over the second half of 2008. The contraction continued into the March quarter 2009, with Taiwan and Singapore reporting double digit declines in through the year GDP growth. While June quarter 2009 outturns were a significant improvement from the March quarter, there are a number of risks to the outlook.
Despite aggressive fiscal stimulus and monetary easing, weak export growth and a slow expansion in domestic demand will lead to GDP in the NIEs declining by a forecast 3 per cent in 2009, before accelerating to 3 per cent growth in 2010 and 4 per cent in 2011.
The recovery in the NIEs will be heavily influenced by China's performance, but will ultimately depend on the pace of recovery in private demand domestically and in the advanced economies, particularly the US and the Euro zone. Other obstacles to the recovery include the potential for oil prices to increase and the timing and design of government exit strategies that are adding uncertainty to the economic outlook.
The Indian economy remains resilient with growth of 5½ per cent forecast for 2009 and 6 per cent for 2010. Industrial production appears to have recovered as demand for India's manufacturing exports has stabilised. India's vast services sector, having provided strong support to growth in recent years, will also continue to put a floor under domestic demand. Agriculture, which accounts for around 20 per cent of GDP, remains the key risk to the outlook. With more than half of the country now in drought, agricultural output will be substantially lower in the second half of 2009 and possibly into 2010.
Although the authorities have so far responded to falling growth with timely and substantial expansionary fiscal and monetary policy, their capacity to provide further policy support remains very limited. Debt levels are high and renewed inflationary pressures resulting from food scarcity will limit further monetary policy loosening. India also continues to suffer from reduced foreign capital flows, a significant driver of investment growth in recent years. These factors will see India struggle to return to more rapid, pre-crisis rates of growth in the medium term. In 2011, growth is expected to continue at a relatively modest rate of 6¼ per cent.
Economic activity in the ASEAN-5 region has begun to show signs of stabilisation as improved consumption, supported by accommodative monetary policy and discretionary fiscal support, led to positive June quarter GDP outturns across the region.
GDP for the ASEAN-5 is forecast to decline by ¼ of a per cent in 2009, before rebounding to 4½ per cent in 2010 and 2011.
Despite encouraging signs that a recovery is underway, downside risks to the outlook remain. These risks reflect the region's reliance on trade and sustained higher commodity prices. On the upside, accommodative monetary policy and discretionary fiscal support should continue to provide impetus to growth in the second half of 2009 and the first half of 2010, while a recovery of capital inflows and easing of financial market constraints should lend support to investment.
The improved euro area economic outlook also reflects a rebound in confidence in most sectors and countries, and stabilisation in the manufacturing sector given increased global demand and trade. Accommodative monetary and fiscal policy combined with the progressive ending of the destocking process has also contributed to the improved short term outlook. As such, the 2009 forecast for the euro area has been revised up to a contraction of 4 per cent.
However, major headwinds to economic growth remain. Financial and monetary conditions remain tight and rising unemployment rates and negative wealth effects are likely to continue to depress private consumption, despite low price pressure supporting household incomes. Also, given necessary corporate balance sheet adjustments, record low capacity utilisation rates and still weak demand, investment is expected to continue to drag on growth in the near term. However, positive growth in emerging economies and fadin
g financial market tensions should support a modest recovery in 2010, with GDP growth of ½ per cent.
Growth prospects for the United Kingdom have also improved, with GDP expected to grow in the second half of 2009, largely due to a turn in the inventory cycle. However, the recovery is expected to be weak and protracted as growth is held back by tight credit conditions as banks repair their balance sheets. Past falls in asset prices, and high levels of public and private debt, along with the eventual need to unwind the large policy stimulus currently in place will also weigh on the recovery. GDP is forecast to contract by 4½ per cent in 2009, before recording modest growth of ¾ of a per cent in 2010.
The outlook for New Zealand has improved slightly in recent months. China is playing an important role with its strong demand for New Zealand's exports. The recent appreciation of the New Zealand dollar is however, a downside risk, as is increasing unemployment which will constrain private consumption.
Looking ahead to 2010, the resurgence in New Zealand's exports is going to be heavily influenced by the movement in dairy prices. Strong net migration to New Zealand in 2009 has boosted the underlying demand for housing and is likely to support a recovery in residential investment.