Eng 2015 03 annual global outlook

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Global View – 25 Nove ember 2015

Glob bal outloo ok - Cauttious opttimism w warranted Han de Jong Chie ef Economist Tel: +31 + 20 628 4201 han.d de.jong@nl.abnam mro.com

The glo obal econom my has disa appointed ag gain in 20155, growing le ess than expectted. In contrrast to previious years, emerging e ecconomies have h been th he main culprit, c while e Europe ha as performed d in line with h earlier exp pectations.

The US S and Japan n have fallen n modestly short s of earrlier expecta ations.

Inflatio on was, gene erally, not a problem, while w fears fo or deflation did not domina ate either.

The ou utlook for 20 016 and bey yond hinges on the answ wer to two questions. q First, can c emergin ng economie es deal with the challen nges they ha ave been struggling with in 2015? And second, can n advanced d economies s maintain their growth mom entum?

Our ans swer is a cauti ous 'yes' in to o both question ns. It must be said, though, that the risks of a less fa avourable devvelopment in emerging e econ nomies than w we are forecasting in our basse case are e relatively hig gh. To be clea ar, most other economists annd commentators take a mo ore negative e view on the outlook for em merging econo omies. So our cautiously optimistic view iss more po ositive than the e view of man ny others.

PMI and Eurozone e economic se entiment index

110

58 56

105

54 52

100

50

95

48

90

46 44

85 11

12

13

14 4

15

Devveloped economiees

E Emerging marketss

Braazil

E Eurozone econ. seentiment (rhs)

Datastream Source: Thomson Reuters D

Challen nges for emerrging econom mies It does not n do justice to the realities s of emerging countries to ssee them as a homogenouss group. Yet, Y they tend to have a num mber of challenges in comm mon that have plagued them m in 2015. Three in particu ular stand out:: •

The slowdown in C China

•

The sharp fall in ccommodity pric ces

•

The tightening of d domestic finan ncial condition ns

The slo owdown in Ch hina Chinese e economic grrowth has been slowing for several s years.. This will conttinue as the Chinese e economy be comes larger and richer and it is also thee result of the changed c grow wth strategy y with more em mphasis on co onsumption gro owth and servvices, rather th han on construc ction, investm ent and exporrts. While man ny question thee accuracy of Chinese econom mic data, we th hink that the Chinese economy has, so farr, gone throug gh a soft landin ng

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Global View – 25 Nove ember 2015

and we expect that prrocess to conttinue. Howeve er, the effects oon the rest of the world econom my are largely ffelt through what is happening to Chinesee imports. And d these importts have, as s far as we ca an read the data, been partic cularly weak inn 2015, falling g by some 5% or so in 20 015 in volume terms, much weaker w than one o would asssociate with a soft s landing off the overrall economy. It is probably fair to say tha at while China has experienc ced a soft landing, it has actuallyy felt quite hard for the rest of the world. W Why this has happened is not n entirely clear, particullarly in a year when the Chinese currencyy has apprecia ated against many otther currencie s, weakening Chinese competitiveness. IIt could be the e result of the shift tow wards servicess as an engine e of growth, bu ut that alone sseems an implausible and insufficie ent explanatio on for such import weakness s. It would apppear unlikely that t imports in China's economy can n continue to contract c in volu ume terms whhile the econom my continues to grow at a decent, albe eit somewhat slower pace. Looking into 22016, therefore, it is hard to see how w the impact o of China on the e rest of the world w economyy can get more e negative, unless itt experiences a real hard la anding. Instead d, we actually expect China a's impact on the rest of th he world to be e less negative e in 2016 and 2017 than it hhas been in 20 015.

China a: estimated i mport volum mes % yoy

60 50 40 30 20 10 0 -10 -20 -30 11

12

13

14

15 5

Datastream, Grou up Economics Source: Thomson Reuters D

The falll in commodi ty prices Commo odity prices havve been slidin ng down since 2011, but thee fall in prices accelerated sharply in the second d half of 2014, extending and d intensifying in 2015. Overr the last 18 months oil prices havve fallen some 60%. Other commodity c pricces have fallen less, but stilll by a significant amount. As commodity y producers and exporters aare mainly fou und in the grou up of emerging economie es, the fall of commodity c prices has beenn very negative e for these econom mies, while it ha as, with a couple of notable exceptions suuch as Austra alia and Canad da, been po ositive for adva anced econom mies. The typic cal response tto such big shocks is that th he winners take a while tto realise theirr windfall and adjust spendi ng patterns. In n contrast, the e losers are a usually qui ck to respond. Investment spending s in thhe commodity sectors is slashed rapidly and g governments seeing s their rev venues fall aree forced to implement austerity y.

Many co ommodity marrkets continue e to be plagued d by excess s upply. The dro op in Chinese imports,, the disappoin nting developm ment of the wo orld economy as a whole an nd the increassed productiive capacity in n recent years s have created d an imbalancee between sup pply and dema and that will take time to d disappear. It would w be too simplistic, howeever, to assum me downward pressure e on commod ity prices will persist as long g as excess suupply exists. Speculative S

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Global View – 25 Nove ember 2015

investorrs are importan nt players in these markets. Net short possitions by spe eculative playe ers have rea ached record levels in the oil o market. While these net sshort positions s could yet increase e, it would app pear much mo ore likely that they t will be cloosed on a one e year horizon, pushing oil prices high her, not lowerr. Meanwhile, high-cost oil pproducers are starting to cutt back pro oduction. Thiss would encourage holders of o short positioons to close th heir positions even if oil o production continues to exceed e global consumption.. Similar argum ments can be made co oncerning othe er commoditie es, in particula ar metals. We therefore believe that the commod dity markets a are going to be e less unfriend dly to emergingg economies in 2016 than in 2015, while w the benefficiaries of the e weakness of oil and other ccommodity prrices have not yet used up p their full adva antage.

Short positions Numberr of contracts in thhousands

350 300 250 200 150 100 50 0 10

11

12

13

14

15

Source: Thomson Reuters

A country experiencin ng a collapse in i its export prrices must adjjust to these changed c circumstances. Allowiing, or encourraging, a depreciation of thee currency would be an obvious strategy and in fact, inevita able. In the short term, a droop in one's currency exacerb bates the econ nomic difficultie es as it increa ases inflation aand encourage es capital outflows s. But in the ne ext phase thes se effects wea aken and the iimprovement in competitiveness startts to dominate e. The result is an improvem ment in foreign trade. Most emergin ng economies have seen the eir currencies weaken signifificantly agains st the US dolla ar during th he last 18 mon nths or so. Th he positive effe ects are now sstarting to com me through, for example e in a clear im mprovement in the trade bala ance of countrries such as Brazil B and Turkkey.

We wou uld expect thiss positive effec ct gradually to get stronger iin the course of o 2016.

Financiial conditions s Large amounts of cap pital have flow wed into emerg ging economiees in recent ye ears as their prospec cts seemed ve ery promising. This supporte ed the availabiility of credit in n these econom mies and, as a result, supporrted their econ nomic growth. As relative fo ortunes for emergin ng and advancced economies have now ch hanged and thhe dollar has appreciated a strongly y, capital has sstarted to leav ve emerging ec conomies. Thiis has tightene ed financial conditions, reduced th he availability of credit and has, as a resuult, been a dra ag on growth. We W reckon there t is still a lot of capital that could leav ve emerging ecconomies, posing a seriouss threat to o the 2016 outtlook. This pro ocess has to some extent a self-fulfilling character. c Man ny borrowe ers in emergin g economies borrow in dolla ars and leave their currency y exposure unhedge ed. A rise in th he dollar exchange rate puts s immediate ppressure on su uch entities ass their deb bt ratios deterriorate and the e availability off credit for theem is squeezed.

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Global View – 25 Nove ember 2015

It is tem mpting to argue e that this situa ation will get worse w before itt gets better and a it probablyy will. But some qualificcations are in order o here. First, many emeerging countrie es depend mo ore on Foreign Direct Inve estment (FDI)) flows than on n portfolio flow ws. Brazil is a good g example e.

These FDI F flows are m much more sta able than porttfolio flows. Seecond, many emerging e econom mies have sign ificant foreign exchange res serves which ccan act as a shock s absorbe er. e economies have drawn do Indeed, many of these own reserves in the last two o years. Third, one mus st also raise th he question why w foreign cap pital would conntinue to leave e these econom mies throughou ut 2016 and pe erhaps in 2017 7. The currenccies of these countries c have e fallen a lot, how much h more is there e to go? Inves stors who havee suffered significant curren ncy losses may m prefer to ssweat it out fro om here. In ad ddition, if our eexpectations for f commodityy prices tu urn out to be ccorrect, econo omic conditions s for commod ity exporters should s start to o stabilise e in the course e of 2016, furth her encouraging foreign cappital to stay. Clearly C this is an a assessm ment on a kniffe's edge. Cap pital flows can be volatile annd volatility can n be triggered d by the sma allest incident o or policy or co ommunication mistake. Monnetary tightening in the US would perhaps be the e most obvious s risk here.

Curren ncy depreciattion for selectted emerging g economies versus USD 1 June 20 014 – 19 Novembber 2015 Brazil

-42%

Turkey

-26%

South Afrrica

-25%

Mexico

-22%

Indonesia a

-15%

Source: ABN AMRO, Thom mson Reuters Data astream

Advanc ced economie es doing welll The eurrozone econom my has grown roughly in line e with what wa was expected at a the beginnin ng of 2015. That is positiive as the restt of the world has h disappoinnted and tensio on around arply over the summer. The e overall growtth rate of the eurozone e Greece increased sha econom my of around 1 .5% in 2015 on o average is low l by historicc standards, but falling unemplo oyment sugge ests that trend growth is eve en lower. The positive outco ome in 2015 suggestts that the tailw winds of lowerr oil prices, low w interest ratees, the healing of the credit channel, the weaker e euro and the end e to austeritty are doing thheir job. While some of thesse effects will w weaken in the course off 2016, others will remain. Inn addition, the e recovery hass, arguably y, become sellf-sustaining as a domestic de emand is finallly recovering and a overall growth is now broadlyy based. In ad ddition, the EC CB is set to inccrease its stimulus as it wan nts to preve ent the risk tha at financial ma arket volatility and a disappoinntments in the rest of the wo orld econom my hurt the eurrozone recove ery. The ECB is also keenly aware that it continues c to undersh hoot its inflatio on target and is s seeking way ys to bring inflaation closer to o its target.

The US economy hass entered its seventh year of recovery folllowing the 07//09 recession.

But the recovery has been unusuallly tepid. This is most likely tthe result of a fall in trend growth, but also in the e weakness elsewhere and the deleveragging process that t was needed after the e crisis. Some argue that recoveries do no ot, on averagee, last much lo onger than sevven years, so s a recession n must be in sight. We disag gree. The fact that the recov very has been so slow imp plies that bottllenecks, such as high inflatiion, falling corrporate profits, shortages in certain sectors s etc., th hat usually are e a reason for an economicc upturn to end d are not anywhere close. 2015 5 has seen de ecent economic growth in thhe US, albeit a little slower th han

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Global View – 25 Nove ember 2015

anticipated. Such an o observation co onceals the fa act that domesstic demand growth has accelera ated materiallyy and foreign trade t plus inve entories have become a sig gnificant drag on o US econ nomic growth in 2015. We see s little reaso on to assume tthat US econo omic performance will dete eriorate in 2016. We think th hat growth will remain rough hly unchanged d in 2016.

As unem mployment ha s fallen to wha at must be clo ose to the leveel consistent with w full employm ment, and officcial interest ra ates are still att crisis lows, thhe Fed has ev very reason to tighten monetary m policcy. But given the t lack of imm mediate inflatiion pressures,, given the stro ong dollar an nd the potentia al volatility hig gher US rates may cause inn financial marrkets after such an exten nded period off effectively ze ero interest rates, the Fed aalso has every y reason to actt cautious sly. We therefo fore expect the e slowest tighttening processs of the Federral Reserve's history.

Japan has, h strictly spe eaking, fallen back into rece ession as GDP P contracted in the second and the third quarterss of 2015. This s is, no doubt, a disappointm ment. Howeve er, one must be ear in mind that potential growth in Jap pan is very low w. The OECD, for example, estimates it att 0.4%. A modest unde ershoot of pote ential growth thus quickly puushes the eco onomy into a technica al recession. W We must cons sider whether this t definition oof recession is s useful for an n econom my such as Jap pan. Neverthe eless, we expe ect the Bank off Japan to increase its stimulus s in due cours e.

Overall encouraging g, risks are ob bvious Our cen ntral message is that the glo obal economy should grow a little faster in n 2016 and 20 017 than in 2015.

2 Key to tthat view is tha at emerging economies will be able to cope a little better with the challenges prresented to th hem in the cou urse of 2015. T The Chinese slowdown s will continue e, but its nega ative effects on n the rest of th he world econoomy will ease. Commodity markets s appear to ha ave undershot and some sta abilisation of pprices and perh haps even a modest recovery in prrices is our ma ain scenario fo or 2016. Final ly, financial co onditions in emergin ng economies have tightene ed, but as currrencies have aalready correc cted sharply, and a commod dity prices are e expected to at a least stabilis se, the worst m may be over.

Our exp pectations in a all these three areas are sub bject to risk. Thhe Chinese slowdown may intensify y and the conttraction of imp ports may conttinue. In additiion, sustained d excess supply in comm modity marketss may push co ommodity prices lower still aat least for a while w And debtt problem ms in emerging g economies, together t with a rise in US innterest rates and a the US dollar may lea ad to further tig ghtening of financial conditio ons in emerginng economies s. How high these risks are e, is obviouslyy difficult to ga auge, but we would w estimatee the chance of o our base ca ase scenario o materialising g at 65-70% and the risk sce enario at 30-335% We are (even) more cconfident abou ut the outlook for the eurozoone and the US. U The recoveriies in these ecconomies are now broad ba ased and theyy continue to benefit from tailwinds s.