Research Dept. News
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Monthly Report, num 335 - May 2010
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International review
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IMF forecasts
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IMF forecasts: more recovery than expected
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The IMF expects 4.2% global growth for 2010, led by the emerging economies and the improved outlook in the United States...
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In its World Economic Outlook for April, the International Monetary Fund (IMF) upgraded its forecasts for 2010 and stated that recovery is stronger than expected. The reason for this lies in the improved financial conditions, although these are still worse than before the crisis. But the recovery will be at different speeds. Consequently, compared with January's forecast, the prospects have improved for Emerging Asia, which was already the main exponent of the global growth led by China in 2009. There are also improvements for Latin America and the United States. 3.1% growth is expected in 2010 and 2.6% in 2011 for the planet's leading economy, very similar to our own forecasts.
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...but Europe and Japan expect modest growth. Germany's expectations worsen while Spain undergoes a late recovery.
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In contrast with this upward tone, Europe and Japan seem to be exiting the recession less energetically. Japan's economy has improved its growth forecasts for 2010 but its prospects look worse for 2011. Albeit with the odd downgrade, the euro area maintains its modest growth expectations for 2010 and 2011, 1.0% and 1.5% respectively. By country, the main downgrade in forecasts has been for Germany that, according to the Fund, will grow by 1.2% in 2010 and by 1.7% in 2011. The forecasts are also worse for Italy and, to a lesser extent, for the United Kingdom. France, one of the countries that suffered least the repercussions of the crisis, is seeing some improvement in its expected rate of progress but this still does not exceed 2.0%. The Fund has also improved its forecasts for Spain, although still at the tail end of the recovery with an expected decline of 0.4% in 2010 and paltry growth of 0.9% for 2011.
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Stimuli must remain for 2010 but fiscal consolidation is necessary.
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In advanced economies, what still needs to be tackled in 2010 and 2011 is fiscal consolidation. Given the high deficits in government coffers, strategies will be required to make credible savings in the medium and long term. Notwithstanding these, and in the opinion of the IMF, the stimuli planned for 2010 in advanced economies should still be kept in place, as they have yet to make a full recovery. In this respect, moderate inflationary tensions give the central banks some room to manoeuvre in order to carry out adaptable monetary policies.
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The other risks are high unemployment and trade imbalances.
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The other risks to global recovery are high unemployment and trade imbalances. The excessively high proportion of long-term unemployed means that there is the danger of a large part of the unemployment generated during the crisis ending up as long-term. On the other hand, high trade imbalances had characterized the years before the crisis. In countries with a deficit, such as the United States and Spain, fiscal consolidation must be carried out, according to the IMF, in such a way as to limit the impact on growth and domestic demand. In countries with a surplus, such as China, Japan and Germany, the biggest challenge is to stimulate domestic demand.
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United States
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The United States: consumers take a step forward
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The United States is recovering thanks to consumption and capital goods investment.
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The US economy looked vigorous in the fourth quarter and this positive tone is expected to continue in the first quarter of 2010. The star of these first few months of 2010 is private consumption, which could be growing at a rate of around 3%. The expectation of robust growth is backed by optimistic business sentiment, suggesting that the advances made in capital goods investment will continue. However, there are still some elements of doubt. The upswing in consumption for the start of the year is due to a more moderate savings rate, as a result of a lower aversion to risk, rather than to higher income, which is conditioned by a labour market that is only very slowly moving towards recovery. The real estate market isn't very close to coming out of the tunnel either, while the deleveraging of household finances must continue. Household debt at the end of 2009 stood at 122.7% of disposable income, seven points below the record high of December 2007 but twenty above its long-term level. Consequently, although there may be vigorous growth in 2010, the medium-term outlook is still one of modestly-paced expansion.
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Retail sales speed up.
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The latest demand indicators are consistent with this recovery in private consumption. Retail sales, without cars or petrol, speeded up in March, up 4.4% year-on-year, the highest since the end of 2007. Consequently, after these three months of upswing, and having discounted the effect of price variations, retail consumption is close to its pre-crisis level of December 2007. Consumer confidence was still quite far from the rise experienced in consumption, affected by base variables such as high debt and the continued high unemployment. Consequently, in spite of its increase in March, the Conference Board index was still at a low level, confirming its role as a delayed indicator in recoveries.
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Entrepreneurs reinforce their increasingly optimistic view thanks to good corporate results.
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Business sentiment is still clearly more positive than consumer confidence. While, in principle, the fact that the non-financial sector is tackling the crisis with more moderate debt levels than that of banks and families has helped to boost business confidence, the good corporate results in the first quarter of the year have reinforced this optimistic perception. Consequently, the business sentiment index of the Institute for Supply Management for manufacturers in March rose to 59.6 points, a level befitting growth rates of more than 4% for the economy as a whole. For its part, industrial production continued to recover in March, although slowing down somewhat compared with its dynamism at the beginning of the year. With a similar trend, industrial capacity utilization was still a little above 73%. In spite of the good tone at the start of the year, both indicators are still 10% below the levels of December 2007.
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Housing is still weak due to excessive supply that is being swollen by mortgage foreclosures.
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The real estate market will continue to be weak for most of 2010. The key still lies in the large number of foreclosed mortgages, leading to an excessive supply of housing. The Case-Shiller index for housing prices fell by more than 30% between the middle of 2006 and April 2009. Since then, we can talk more of stabilization than recovery. With these drops, the price of many homes has fallen below the outstanding debt, an incentive to stop meeting the mortgage payments and give up the property. These are the so-called walkaways since, in the United States, any outstanding debt on an unpaid mortgage is totally written off once the property has been given over to the creditor. To stop this from happening, Obama's administration is working on legal provisions that reduce the outstanding capital in mortgages where this is more than 120% of the property's market value, but it is still not clear how these will be applied or the effect they'll have. The consequence is that activity continues to be below the minimum levels. The number of new homes started rose in March but these are still stuck at little more than a third of the average prior to the last real estate bubble.
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The labour market bottoms out but recovery will take some time yet.
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The labour market showed encouraging signs in March with the net creation of 162,000 jobs, the best figure for the last three years. However, the unemployment rate was still 9.7% and it doesn't look like improving significantly until the end of 2010. The problem is that the job losses caused by this recession have been the highest since 1945, and by a long chalk. It will be difficult for the unemployment figures to fall for two reasons. First, the proportion of long-term unemployed, the most difficult people to relocate, is double that of the 1983 recession, when the unemployment rate was at similar levels to today. The other difficulty lies in the large number of discouraged workers and involuntary part-time workers, who might absorb any growth in the demand for labour as the recovery progresses.
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The CPI rises 2.4% and the core CPI a moderate 1.2% due to the low utilization of production capacity and rent.
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The prolongation of the low utilization of production capacity for production is helping to keep prices stable, and substantial inflationary tensions are unlikely to appear in 2010. This gives the central banks some room for manoeuvre to maintain expansionary policies, even while draining the system of its liquidity. Consequently, the general consumer price index (CPI) rose 2.4% year-on-year in March, while the more significant core CPI, the general index without food or energy, continued to moderate its growth to 1.2% year-on-year. However, this slowdown is partly due to falling rental prices attributed to home owners. Without this component, core inflation rose by 2.4% year-on-year, somewhat more in line with the fundamental trend in prices.
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The February trade deficit for goods and services was 39,704 million dollars, 2,752 million more than the previous month. Almost the whole decline occurred in the balance that excludes oil and its derivates. The recovery in exports eased off while imports continued to advance thanks to lively domestic demand. If private consumption and investment continue to expand, the deficit should go on rising over the coming months, but without interrupting the slight corrective trend in the trade imbalance started at the end of 2006, which can be seen if we exclude the effects of oil.
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Japan
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Japan: cars and exports
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Japan recovers thanks to exports and state aid.
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Exports have been the stars of the Japanese recovery. Private consumption, however, still depends on government stimuli and is suffering from the effects of deflation. For its part, investment is starting to show signs of incipient reactivation.
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Industry and investment advance.
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The latest supply indicators continue to confirm that improvement is limited to the industrial and exporting sectors. In February, industrial production, which in Japan is closely related to how the economy performs overall, lost part of its energy of the last three months, although the general tone is still one of growth. Consequently, the general index has recovered three fifths of the 34.7% it lost during the crisis. The outlook for investment continued to improve in February, thanks to the upswing in machinery orders for foreign demand, although these were still 25% below the average for 2008. The other half, orders for domestic demand, remained at 23% below the level for 2008.
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Housing is still weak but unemployment remains at 4.9%.
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Retail sales for February were up 4.2% year-on-year, a very fast pace due to base effects, but the level remained close to that of 2003. The greatest recovery in consumption continued to be in automobile sales thanks to state aid. For its part, although the Tokyo housing market saw an upswing in March, new houses started in February were still 36% below the average for the last decade, already characterized by a low profile. On the positive side, the labour market maintained its gains, with an unemployment rate that remained unaltered in February at 4.9%.
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Core CPI falls 1.1%.
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Looking at prices, the underlying weaknesses in domestic demand will mean that deflationary trends will continue throughout 2010. January's CPI fell 1.1% year-on-year, as did core inflation, the general index without energy or food, already accumulating fourteen consecutive months of decreases. With regard to the foreign sector, the trade surplus continued in March. Exports maintained their strong upswing from the period October 2009-January 2010, although they have been practically stagnant for the last two months. For their part, imports dropped off due to weak domestic demand.
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China
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China: beating all expectations
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China grows by 11.9% in the first quarter...
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China grew by a spectacular 11.9% year-on-year in the first quarter of 2010, and although this was partly due to the lows of a year ago, this figure is higher than even the most optimistic forecasts. Although inflation remained at a modest 2.2% year-on-year for the quarter as a whole, the pace of expansion has revived the risk of the economy overheating. The rise in housing prices, 11.7% year-on-year in March, also means there's a risk of a real estate bubble emerging.
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...and the risk of overheating reappears.
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In order to alleviate the resurgent indications of reheating, the Chinese monetary authority seems willing to adopt a more flexible approach to its currency. This would be added to the various rises in the cash reserve ratio and the limitations imposed on granting credit. The words pronounced by the governor of the Chinese central bank during the National Popular Assembly, framing the exchange rate policy within a broader policy of a temporary nature aimed at combating the crisis, point to an imminent appreciation of the renminbi.
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Business indicators continue to show great vitality.
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Domestic demand continued its upward trend, both in consumption and investment. In particular, retail sales grew by 15.5% year-on-year in the first quarter in real terms. Similarly, investment in fixed assets rose by a substantial 26.2% year-on-year in March, although a little less than the 26.6% of January and February. In spite of this, the forecasts for the next few months point towards a slowdown in the investment component once the measures have been implemented to restrict the approval of new investment projects and given the credit limitations imposed for 2010. At present, new credit granted in March rose to 508 billion renminbi, compared with 702 billion with the moderation announced.
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On the supply side, industrial production in March grew by 18.1% year-on-year, lower than the 20.7% for January-February and coming close to the values of around 15% that were typical before the crisis. Meanwhile, the purchasing managers' index (PMI) rose to 55.1 points, a level indicative of strong expansion, after having weakened slightly for a couple of months.
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China's trade balance in March reveals a deficit after six years of surplus.
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Lastly, the data for international trade reveal a deficit of 7.2 billion dollars in March, the first monthly deficit in six years. This decline in the trade balance was caused by the large increase in imports, up 66% year-on-year, although exports were still strong and rose 24.3% year-on-year. Overall, the first quarter has ended with a trade surplus of 1.4 billion dollars, a surplus that might increase further thanks to the upswing in foreign demand and in spite of the more than likely appreciation of the renminbi.
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Once again, China shows itself to be a vigorous economy that, for the time being, is capable of controlling inflationary tensions. However, there's no doubt that the risk of overheating is hovering over the Asian giant and that a more restrictive monetary policy that includes a more flexible exchange rate must be part of the central bank's agenda.
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Brazil
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Brazil: an imminent rise
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Brazil's Central Bank makes its move to keep inflationary surges in check.
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As expected, Brazil's Monetary Policy Committee raised the reference rate at its meeting on 27 and 28 April. Although most analysts expected a rise of 50 basis points in the SELIC rate, it was actually raised by 75 points. In any case, the Brazilian monetary authority, led by Henrique Meirelles, who recently opted to remain at the head of the Central Bank, has earned e reputation of economic orthodoxy. This therefore augurs a firm reaction to the marked inflationary upswing.
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Temporary effects and the recovery push the rate of inflation up to 5.2% in March, much higher than the target set.
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Throughout 2009, inflation was contained thanks to the wide output gap and weak commodity prices, but the 2010 panorama is very different. Adverse weather conditions, the annual rise in public tariffs and the lively Brazilian recovery all pushed inflation up to 5.2% in March. Part of this increase is expected to be temporary: on the one hand, the smaller crops due to strong rains is seasonal; on the other, the annual rise in transport and education prices will dissipate over time. However, even after these effects have been adjusted for, the inflationary pressures are evident in some sectors such as construction and household goods and, although the rate of inflation may soon stabilize, it is expected to do so far above the target set (4.5%).
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The latest business data in Brazil support this suspicion, pointing to an economy in expansion that is very close to the full utilization of its production capacity. In March, the utilization of this capacity reached 83.5% and leading indicators suggest that this will go on rising. In spite of a moderate decline, the confidence of Brazilian consumers in their economy remained at historically high levels, as with credit, which continued to grow in February (1.5% year-on-year). This, and the good performance by the labour market with an unemployment rate that continues to fall (11.7% in January), explain the positive tone of retail sales that revealed surprising gains in February, up 12% year-on-year, once again confirming the strength of domestic spending. A strength that has been passed on to supply, with further rises year-on-year in double figures, both for industrial production (16% in February) and automobile sales (18% in March). The purchasing managers' index (PMI), in spite of a slight fall in March, continues to point towards strong expansion.
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Domestic demand continues firm and appears able to withstand the withdrawal of fiscal stimuli.
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While domestic demand remains strong, foreign demand has not been able to slow up the drop in the trade balance. The renewed upswing in the real over the last few weeks has not helped the adjustment. Overall, the main requirement is to avoid the excessive overheating of an economy that, moreover, is not considering any far-reaching fiscal adjustment until at least after the elections in October.
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Mexico
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Mexico: in the wake of the United States, a double-edged sword
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The recovery in Mexico continues to benefit from the US drive.
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As 2010 advances, the Mexican economy gains in pace and optimism. An optimism that has caught on among many analysts, leading to more than one reconsidering their growth forecasts for the Mexican economy. Among the latest to rate the country more highly is the OECD, whose new estimate places GDP growth for 2010 at around our forecast of 4.2% and above the growth expected for the rest of its member countries. Others, such as Miguel Messmacher, head of the Economic Planning Unit of the Mexican Treasury, even dare to predict higher advances if the foreign recovery is stronger than expected. And therein lies the key: «the foreign recovery». In other words: «the recovery of the United States».
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Although 2010 commemorates the bicentenary of Mexican independence and is therefore already a year of celebration in Mexico, this optimism comes from no other source than the surprising energy of the US economy. The consolidation of the United States' recovery has once again been the major driving force behind a Mexican recovery whose renewed upswing is fundamentally due to exports that, in February, were up 31% year-on-year and boosted industry, which continued its growth, up 4.4% compared with the same month in 2009.
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Unemployment and weak credit and remittances are still hindering a domestic upswing in Mexico.
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On the other hand, the still high unemployment (in historical terms), weak credit and the drop in remittances continue to hinder a domestic demand that is expected to recover much more cautiously. Nonetheless, leading indicators for economic activity still point towards a slow but gradual improvement. After the 1.8% year-on-year drop in retail sales in January, signs of improvement in employment have somewhat boosted the confidence of Mexican consumers in their economy, which should soon result in healthier domestic spending.
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Promoting reforms, essential for growth.
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Domestic spending that should gradually become the main driving force in the Mexican economy and thereby reduce its overdependence on the economic performance of its neighbour to the north of the Río Grande. In this respect, the fiscal reform, the recent proposal by Calderón's government to promote competition and reinforce anti-trust laws, or any other measure aimed at strengthening the internal pillars of growth, if fulfilled, will be highly positive and, in any case, will be essential to ensure growth sustainability in the long run.
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Raw materials
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Oil continues to rise and metals speed up
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Crude crosses the barrier of 85 dollars per barrel, boosted by the expected recovery.
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Oil prices are still on the up, at over 85 dollars in spite of the dollar remaining strong. Between 20 March 2010 and 20 April 2010, crude rose 6.9%, reaching 85.37 dollars per barrel (Brent quality, for one-month deliveries). This means that crude has gained 9.7% this year while the dollar has gained 7.7% compared with the euro.
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The recovery pushes up oil prices.
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The expected economic recovery, particularly that of emerging economies, has driven up oil prices and, in the short term, these are likely to exceed the top end of the reference band of 75-85 dollars per barrel. These rises might continue but no sharp changes are expected over the coming months, with a volatility that is very far from the levels of 2008.
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Metals continue to rise due to changes in how iron prices are set.
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With regard to the rest of commodities, the Economist index rose 4.2% between 20 March and 20 April due to metals, which continued to climb. Most of the gains were in base metals, influenced by the withdrawal of the annual reference system to set the price of iron and by the Chinese limiting imports of low grade iron ore. Iron and nickel were up 25% while aluminium and copper rose more moderately, after enjoying strong upswings in previous months. In precious metals, palladium was up 23.1% and platinum 9.4% due to the recovery in the car industry. Gold remained stable although hinting at an upswing, close to the barrier of 1,150 dollars an ounce. Foods performed more irregularly, with drops in the price of rice and sugar and rises in tea.
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Times of crisis - the chance for economic reform?
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Will the crisis trigger structural reforms?
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Are bad times (economic crises) opportunities to promote structural reforms? Indeed, it would seem that the more acute the crisis, the more urgent it is to reform the economy. However, the assumption of a direct relationship between economic crisis and carrying out reforms is not as immediate as we might think. The issue of structural reform, and its determining factors, also seems to largely depend on the political, social and even cultural context in which it occurs.
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Because of this, in order to improve our understanding of the keys to success, our starting point is to analyze three examples of structural reform carried out within the euro area: the labour market reforms undertaken by Germany between 2002 and 2005, the 2003 pension reform in France and the 1999-2007 reform of business hours, once again in Germany.(1)
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The so-called «Hartz reforms» led to the adoption of four labour acts in Germany in 2002-2005. Although the content of the reform is wide-ranging and diverse, the basic strategy was to change a culture that protected workers based on passive policies to one of active policies. Key aspects in this culture were the establishment of «Personnel Service Agencies», with the same functions as temporary employment firms, along with more traditional functions of public intermediation between job seekers and employers, the reform of the Federal Employment Office in order to improve job placement and the toughening up of conditions for receiving unemployment benefit.
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For their part, the French pension reforms in 2003 aimed to achieve three ambitious goals: to bring the pension systems of civil servants and salaried workers closer together, to improve the financial stability of both systems and to cut back on the generous incentives for early retirement. These reforms aroused strong opposition but the government ended up imposing a series of measures that toughened up the conditions for public employee pensions, increased the period required for social security contributions to access the maximum pension and encouraged people to go on working once they had reached retirement age.
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Lastly, the German reform of retail opening hours was carried out in two stages. The first, promoted by the federal government between 1999 and 2003, resulted in a modest reform, one of whose main innovations was the possibility to remain open until 8 pm on Saturdays. After a ruling by the constitutional court, the Länder were able regulate this issue, generally opting for a widely liberalized system that practically eliminated any restriction to business hours from Monday to Saturday.
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What general conclusions can be drawn from these three cases? As can be seen from the above table, one initial lesson is how successful reforms require a clear electoral mandate. This might be related to taking advantage of the initial years in a legislature to avoid any possible negative effects on future elections. The importance of this electoral factor would vary, however, depending on the issue in question. While it seems critical in areas perceived by citizens as central to their social charter (pensions and the labour market, for example), in those aspects perceived as more technical or sector-specific, such as reforms of product and service markets, the predominant role is played by pressure groups.
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Another relevant aspect concerns the macroeconomic cycle. In the case of the German reforms, there is a relationship between the cyclic position and the reform attempted, as both were launched at a time of economic weakness. The French pension reform, however, escapes this relationship, undoubtedly because the debate regarding its benefits and costs is projected over the long term due to its nature.
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However, it would be valid to ask to what extent these conclusions, based on just three cases, can be generalized. The answer is that, when the OECD studies 20 cases of reform in advanced countries in different areas, the general lesson remains that the labour market and product and service markets are more likely to be reformed at a time of crisis. Nevertheless, the issue of labour reform is packed with nuances. In line with the political economic literature on labour reform, the OECD states that a high unemployment rate tends to pressurize in favour of reform, although the most organized part of the market tends to oppose measures that involve reducing protection. This means that the most frequent outcome of labour reform in difficult times focuses on liberalizing less organized segments (newcomers to the market, the unemployed, etc.).
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A third conclusion of interest concerns the relationship of reforms with other similar initiatives or global trends. The evidence available suggests that reforms of product and service markets are more likely to succeed if they take place within international liberalization trends (e.g. related to the liberalization of the domestic market) or when there is greater international competition. Among the cases in question, that of liberalizing retail opening hours would reflect this influence, as the Länder were concerned about the growing phenomenon of cross-border shopping.
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Lastly, a fourth area of interest when studying the determining factors of reforms is how these are implemented. In this area, the main conclusion resulting from the above cases, and confirmed in other studies by the OECD devoted to other reforms, is that the processes involved in adopting structural reforms are long and require significant preparation, including notable effort dedicated to analysis, consultation and communication. For example, the preparation for the French pension reform took over one year and, in other similar cases, two years of work prior to launching the reform are not exceptional. Similarly, the communication policy was designed with care, including consultation processes with economic players. This strategy meant that the need for this reform was never in doubt, although it met with opposition in society.
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Another aspect of the process that leads to successful reform is what the OECD calls «government leadership». Although, as has already been mentioned, accord is key, the cases studied suggest that what is fundamental is strong government commitment to the reform (whose most typical exponent is the credible announcement that the government will act unilaterally if no agreement is reached). The German labour reforms and French pension reforms fall into this category.
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Given the experience of the abovementioned reforms, can we expect the current crisis to trigger new initiatives for structural change in the euro area? Studies by the OECD, both those mentioned above as well as other similar examples, highlight the fact that the political and procedural dimension is critical, and that the economic situation might actually play a less decisive role than sometimes publicly assumed. In particular, and taking up the conclusions of the OECD, only if the electoral mandates are clearly favourable to tackling structural reform, and if the governments apply their political capital to a process of slow preparation, complex agreement and strong leadership, are we likely to witness a new generation of structural reforms.
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(1) These reform processes have been the object of several studies by the OECD, among which we would particularly recommend the following publications: The Political Economy of Reform. Lessons from pensions, product markets and labour markets in ten OECD countries 2009 and Going for Growth, 2009 and 2010 editions.
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This box was prepared by Àlex Ruiz
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International Unit, "la Caixa" Research Department
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