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Economics Weekly - Developing economies lead the way out of recession; Weekly economic data preview - BoE MPC meeting and US payrolls dominate proceedings

Economics Weekly - 3 August 2009

 

Developing economies lead the way out of recession

Following the onset of the global credit crisis two years ago, it was generally believed that developing economies, particularly in Asia, would be better placed to weather the storm than some of the more advanced economies, such as the US and UK. It was reasoned that the export-orientated, savings-rich countries, with the support of China, faced little prospect of an external payments crisis and were one step removed from the bursting of the debt bubble created in western economies. De-coupling was the buzzword at that time. Yet, over the subsequent twelve to eighteen months, expectations that the developing world could distance itself from the global credit crisis faded amid a collapse in world trade.

 

Having risen by an annual average of 8% between 2003 and 2007, world trade volumes dropped by over 15% in 2008 - see chart a. Within the developed world, Germany and Japan bore the brunt of the downturn, with merchandise exports and industrial production in both countries falling sharply in 2008. But many of the newly-industrialising and developing economies, including China, Hong Kong, South Korea and Thailand were also badly affected.

 

The correlation between developing and advanced economy growth has risen sharply

Chart b shows the correlation of GDP growth between developing and advanced economies over the past two decades. Despite earlier expectations of de-coupling, their economic performances have become increasingly intertwined. In the early 1990s, the correlation coefficient was volatile around zero, implying little or no relationship in the average GDP growth rates of the two economic regions. Over the past decade, however, the correlation has risen strongly. While the high correlation suggests the average GDP growth rates in these two economic regions move in the same direction, it tells us nothing about the magnitude of these movements. Since the credit crisis erupted, not only have developing economies been dragged lower, but in many cases their over-reliance on external trade has left them exposed to far sharper downturns in growth - see chart c. For example, as a group, emerging market GDP dropped by 2.3 percentage points between 2007 and 2008, compared with a drop of 1.6 percentage points for the major advanced economies.

 

But developing economies have started to outperform in recent months

Over recent months, however, the tide appears to have turned. Just as the developing economies took the sharpest knock following the credit crisis, these economies now appear to be bouncing back the fastest – see chart c. The bounce-back is being led by China. In the second quarter, China’s annual rate of growth rose to 7.9% from 6.1%. It was the first acceleration in China’s growth rate in more than two years. Other developed economies also appear to have recovered some poise. For example, Singapore’s GDP grew by an annualised 20.4% in the second quarter, bringing an end to the economy’s worst recession in 45 years. South Korea also posted a robust 2.3% quarter-on-quarter increase in GDP during the second quarter.

 

How have developing economies managed to bounce back so sharply over recent months?

As in the advanced world, part of the improvement in growth in the developing economies reflects a moderation in the pace of inventory liquidation. More fundamentally, however, it also reflects an improvement in global trade. With the world economy over the worst of the credit crisis, global trade flows appear to have bottomed out. For example, the Baltic Dry Freight Index – an index of shipping costs – has risen more than four-fold since the end of 2008, one of a number of key indicators suggesting that global trade is now starting to turn higher. Since developing economies tend to derive a disproportionate share of their national income from exports, early signs of a recovery in world demand tend to show up first in improvements in developing world GDP.

 

It is not only inventories and the turn in the world trade cycle, however, that have boosted developing economies in recent months. There are also signs that domestic demand conditions in some of these economies are improving, underpinned by government stimulus – particularly in China. A 4trn yuan ($585bn) stimulus plan is currently being implemented by the Chinese government comprising infrastructure spending, tax cuts and various incentives to induce consumers to buy cars and electronic goods. Apart from the stimulus, the Chinese government is also exerting pressure on banks to lend more. The impact of these measures is clearly evident. Over the first half of this year, Chinese fixed investment spending surged almost 34%, the fastest growth in nearly five years. Over the same period, the annual rate of China’s money supply growth has doubled to 28%.

 

Recovery in developed economies raises hopes for stronger, more balanced growth ahead

There are hopes that the efforts taken by China, and other developing countries, to stimulate their domestic economies will help to support growth prospects elsewhere. If China can successfully wean itself of its dependence on exports, and develop a more efficient, market-based domestic economy, the prospects for China’s economy and, by extension, the world economy, would be that much stronger. For this to occur, however, China’s government needs to combine domestic stimulus with further substantial currency revaluations. Judging by the limited progress that has been made on this front over the past year, it remains to be seen whether the Chinese government has the political will to do so. Nonetheless, the recent signs of improvement in China and other developing economies provide cautious grounds for optimism that these countries may lead the world out of recession over the coming year.

Adam Chester, Senior UK Macroeconomist, Corporate Markets

 

Weekly economic data preview - 3 August 2009

 

BoE MPC meeting and US payrolls dominate proceedings

The key data releases and events this week are the monetary policy decisions by the BoE and ECB on Thursday and the US official employment report on Friday. Both the BoE and ECB are expected to keep interest rates on hold, but markets will be looking closely to see if the BoE decides to use the remaining £25bn of the potential £150bn of asset purchases currently authorised by the Treasury. The Reserve Bank of Australia is also expected to leave rates unchanged at 3% on Tuesday. All eyes will be on Friday’s US non-farm payrolls which is expected to show a less severe pace of decline in employment of around 370,000 versus 467,000 in June, while the jobless rate is forecast to increase. US ISM purchasing managers’ surveys and the ADP employment report in the first part of the week will give markets the opportunity to hone forecasts for Friday’s numbers. UK industrial production, producer prices and PMI surveys are also due, while German manufacturing orders and industrial output will also receive attention.

 

􀂄 We expect the Bank of England MPC to keep interest rates on hold at 1% and vote to use the remaining £25bn of the £150bn asset purchase facility (APF), having already purchased £125bn of assets, mainly gilts. It is possible that the MPC could ask the Chancellor to increase the APF beyond £150bn currently authorised, but there is also an outside chance that it decides to stop asset purchases, at least for now. Much will depend on the Bank’s new quarterly inflation forecasts which will be available to the MPC. Although Q2 GDP was weaker than expected, falling 0.8% on the quarter, recent business surveys suggest that modest growth could return in the second half of this year. In particular, the services sector, which is less susceptible to the stock cycle, has seen some more positive signs with the services PMI above the ‘neutral’ 50 level in May and June. We expect the services PMI to rise slightly to 51.7 in July from 51.6, while the manufacturing PMI is forecast to rise to 47.5 from 47.0. Nevertheless, these surveys do not tell us about the durability of any upturn, as rising unemployment and constrained credit growth are likely to cap growth and may even lead to a renewed downturn. Hence, the MPC may yet ask the Treasury to increase the current £150bn limit on asset purchases, if it does not do so next week. Moreover, producer price figures on Friday are forecast to show further falls on an annual basis, highlighting weak pipeline inflationary pressures.

 

􀂄 US non-farm payrolls on Friday are expected to show a fall of around 370,000 in July, while the jobless rate is anticipated to rise to 9.6% from 9.5%. Such an outturn would indicate a relative slowdown in the pace of deterioration in the labour market. Nevertheless, the pace of contraction in employment is still significant, which will weigh on prospects for consumer spending. Indeed, last week’s advance Q2 GDP release showed that personal consumption fell by more than expected by 1.2%  (annualised). Ahead of the official employment figures, markets will analyse the ISM purchasing managers’ surveys and the ADP employment for clues on upside or downside risks. Further, the ISM surveys will provide indications of whether GDP growth will return in the current quarter. We expect the manufacturing ISM to rise to 46.0 from 44.8 and the non-manufacturing ISM to rise to 48.0 from 47.0.

 

􀂄 The ECB is expected to keep benchmark interest rates unchanged at 1%. We expect it to leave the door open for further reductions, if economic circumstances warrant it, though our central view is for rates to remain at the current level until the second half of next year (when policy may start to be tightened). The ECB’s covered bond purchase programme only started in July, so we are not likely to see any major adjustments there. Last week saw further improvements in the advance releases of the eurozone PMI surveys, though they still signal contraction in overall GDP, albeit at a slower rate than in previous quarters. Final releases of the PMI surveys are due this week. We also saw the flash estimate of annual CPI inflation fall more than expected to -0.6% in July, indicating that inflationary pressures remain weak. Euro zone producer price inflation, due on Tuesday, is expected to show a fall to -6.6% on the year. German industrial orders on Thursday and industrial production and trade data on Friday will receive attention. Orders could record a fourth consecutive monthly rise in June, though they are still expected to be down sharply by about 26% compared with a year ago.

Hann-Ju Ho, Senior Sector Economist

 

Economic Research,
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