Global Economic Outlook: Bottoming Out Now, Recovery by June 2009

Economics Research and Analytics January 2009

Executive Summary
1. Indicators point to a bottom 2. Fear Index is reaching a low-point

3. Rebound to start in June due to massive global response 4. Sustainability of up-swing driven by performance of emerging nations

Origin of Crisis

The Genesis: Sub Prime Story

Sub Prime Model
Home Buyer Loan Bank Payments Sub Prime Model: Consequences Repercussions of defaults in mortgage market Falling house prices Prime borrowers start to default Write-downs by holders of mortgages and other instruments Resulting credit crunch in the economy
* Note: CDS: Credit Default Swaps
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Defaults

Sub Prime Model: Actions Banks disperse risk of defaults Banks lend more New markets established for retail mortgages New market created for CDS (total CDS market estimated by BIS to be $57 trillion) Lax norms for housing credit as a result of low interest rates

Loan remains in the banks books

Mortgages are traded

Loss Due to Defaults

Mortgage Market Mortgages not in banks books

Genesis: From Financial Sector to Real Sector

Defaults Sub-Prime Mortgages Lack of Capital for Companies $ Tightening Credit Markets Financial Institutions Losses

Lack of Trust in Financial Institutions

Suspension of Interbank Lending

Banks Slow Lending Down $

Lack of Lending for Small Business

Slower Growth

Consumers Reduce Spending

Lack of Retail Credit

$
Economy Slows Down/Contracts

Internationalization of the Crisis

European Banks Lose Money on Sub Prime Mortgages

European Banks Withdraw Investments in Eastern Europe Unwinding of Yen Carry Trade and FII Withdrawals Lower Exports From Asia Due to Lower American and European Demand

Oil Prices Drop on Slower growth in Europe and USA

Withdrawal of FII Inflows: Currency Depreciation

How Fear Drove the Recession Fear is Now Bottoming Out

The only thing we have to fear is fear itself.

-- Franklin Roosevelt

Bottoming Out Now

Employment Creation Hits Bottom; Due for an Upswing

Beginning of great moderation; macroeconomic policies smooth business cycles Current employment levels the lowest of the Great Moderation Era, suggesting bottom-out

Non-Farm Payroll growth indicates increase in non-agricultural employment During the Era of Great Moderation, the business cycle was longer and smoother, and recessions were typically shallower than pre-1984.

Employment creation is currently at the lowest level of the Great Moderation Era (i.e., 1984 onwards); job creation will be positive for the foreseeable future, given the massive global fiscal stimulus.

Has Industrial Production Bottomed-Out?

Lowest since oil shock; that said, recent months output indicates recovery Recovery in industrial production despite lower automotive growth rates

Increased output despite the overhang of a recession illustrates the robust underlying conditions in American manufacturing

Industrial output showing a rebound from recent lows, suggesting the recovery of underlying fundamentals.
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Consumers Are Continuing to Buy

The decline in retail sales is not as steep as in the 2006 or 2001 recessions. Recovering consumer confidence should lead to positive growth in the near future.

Consumers activity, aided by the fiscal stimulus, will boost industrial production and ultimately aid recovery.
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The Good, The Bad, and the Ugly

The Good
Fear Index has peaked, indicating bottom-out Non-Farm Payroll growth has hit historic lows Industrial production has recovered and is much higher than during previous recessions Widely accepted that real estate is bottoming out now as well

The Bad
Credit markets still remain tight Interest rates are at historic lows, but lending has not restarted Crisis has gone global

The Ugly
Potential collapse of US automotive industry (though recent events indicate recovery to come soon) Clarity on the extent of sub prime losses and other securitized losses (no recent losses, suggesting the worst news is behind us)

The crisis is reaching a bottom

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Global Economy to Rebound by June 2009

Mega Drivers for Rebound

Positive economic news around the world; unprecedented focus worldwide on addressing the economic situation Fastest government response in history, primarily driven by massive government fiscal stimulus package New US Government/Obamas economic growth plan focuses on creating employment through investments in infrastructure, renewable energy, broadband, and medical technology; infrastructure alone will create 2 million jobs Decline in commodity and oil prices leading to a tax break stimulus Easing of inflationary and liquidity pressures Strong demand from emerging nations will be a factor in reviving the global economy Smart money is coming back to the market, with stock exchanges at historic low P/E ratios Fear fatigue and rebound in confidence
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Global Response: Massive Government Stimulus

USA: $700 Billion bailout rapid interest rate cuts $23 billion support for top 3 auto companies; plan to create 2.5 million jobs by 2011

UK: Germany: Belgium & Switzerland: ECB France

250 billion pound bailout $700 billion relief package Capital infusion Interest rate cuts $50 billion stimulus package

Russia Support for ruble; $20 billion stimulus package

China: Interest rate cuts and $586 billion stimulus (infrastructure, rural) India: Interest rate cuts $4 billion stimulus package (infrastructure, exports, textiles)

Japan: Interest rate cuts, 447 billion yen stimulus package South Korea: Interest rate cuts and efforts to keep currency stable, $11 billion stimulus package

Brazil Support to real, infrastructure development under PDP (more than $64billion injected to financial system)

Global Response
Governments infusing capital into financial institutions Globally coordinated interest rate cuts IMF offers bridge loan to meet foreign exchange requirements Discussions, coordinated efforts (G20 summit)
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Global Response Stimulus Packages

Country USA Stimulus Package and Policy Changes Job and growth fund- $25 billion 2.5 million jobs by 2011: 82.5% of losses (i.e., 1.6 million jobs) to be recovered within 6 months Every $1 billion spent on roads will create approximately 35,000 jobs Public buildings, schools, roads, energy efficiency, broadband and medical technology will be primary sources for employment growth in 2009 UK: 250 billion pound bailout Germany: $700 billion relief package Belgium & Switzerland: Capital Infusion Spain $14 billion infusion, 300 000 jobs to be added by next year EU Interest rate cuts permanent; reduced VAT for labor-intensive units; $250 billion (i.e., stability and growth pact). Job creation sources include energy efficiency, transportation, infrastructure, broadband connectivity, construction, automobiles Japan: South Korea: Interest rate cuts Interest rate cuts; battling to stabilize currency

European Union

Japan and South Korea

Emerging Markets

China: Interest rate cuts and $700 billion bailout; close to $88 billion for railway infrastructure with focus on 10 sectors including infrastructure, technological innovation, Healthcare, and low-income housing India: Interest rate and tax cuts totaling $4 billion in the next four months (March 2009); sector focus is on apparel, infrastructure, other export-oriented sectors

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Easing of Inflationary and Liquidity Pressures

12.0 10.0 8.0 %Y n Y .o 6.0 4.0 2.0 0.0 2002 - 2.0 USA Euro Area Advanced economies Japan Latin America 2003 2004 2005 2006 2007 2008 2009 F

Inflationary Pressures: Easing Worldwide

Increase in Real Income

Ensuring Liquidity

%
Y on Y

Policy Rate Reduction Leading to Addition in Liquidity

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Decline in Commodity and Oil Prices

300 250 Index 2005=100 200 150 100 50 0 1980M1

Commodity and energy prices have declined sharply in recent months. Oil prices have declined from $147 to $40 and will be a key stimulus for the 2009 rebound.

1982M1

1984M1

1986M1

1988M1

1990M1

1992M1

1994M1

1996M1

1998M1

2000M1

2002M1

2004M1

2006M1

2008M2

Industrial Inputs Price Index

Agricultural Raw Materials Index

Metals Price Index

Fuel/Energy Index

300 250 200 150 100 50 0

Index

7 -0 Ja n Ja n

-0

-9

-9

-9

-9

-9

-9

-9

-0

-0

-0

-0

-9

-0

Ja n

Ja n

Ja n

Ja n

Ja n

Ja n

Ja n

Ja n

-0

Ja n

Ja n

Com m odity Fuel (energy) Index, 2005 = 100, includes Crude oil (petroleum ), Natural Gas, and Coal Price Indices

Ja n

Ja n

Ja n

Ja n

Ja n

-0

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Emerging Markets - China

20 18 16 14 12 10 8 15.4 6 4 2 0

Industrial Output China (2008)

17.8

15.7

16.0

16.0

14.7

12.8

11.4

Fe br ua ry

Au gu st

Se pt em

Source: National Institute of Statistics

Month (Year 2008)

Oc t

China is Structurally Vulnerable to External Environment Export-driven economy Dependent on foreign capital inflows High level of migration 8.2 imperative to maintain high growth momentum US is main destination for Chinas exports

Growth Rate (%)

Ju ne

il

Ap r

ob er

ar c

Ju ly

be r

ay

Steps to Combat Crisis Announced a $586 billion bailout. Focus on developing infrastructure to create jobs and revive economy Government easing lending to stem fall in home prices Coordinated interest rate cuts to boost liquidity

Current Scenario
Small and medium manufacturers struggling to access credit Falling real estate prices could adversely affect the banking sector Facing struggling domestic demand, Chinas recovery will depend upon access to an alternative market for its exportsnamely India

Chinas present hard landing is expected to recover by the middle of 2009, when domestic consumption in China recovers as a result of effective use of stimulus package and growth in alternative market for its exports (i.e., India).
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Emerging Markets - India

Industrial Output India (2008)
September August M ths (Year 2008) on July June May April March February 0.00 1.00 2.00 3.00 4.00 5.00 6.00 7.00 8.00 9.00 5.47 9.52 10.00 4.37 6.22 5.53 1.42 7.37 4.80

Key Issues: Rupee; Real Estate Real estate boom for past few years, with prices now cooling off Rupee has depreciated considerably against the dollar, leading to loss of corporate profits

Source: CSO
Growth Rate % (YoY)

Steps to Combat Crisis Comprehensive cut in excise duties to facilitate consumption across the board Easing of norms for foreign investments in local economy. Small manufactures received sops manage rising costs. Exports, automotive, textiles industries have received stimulus

Current Scenario
Fall in consumption: especially consumer durables Increase in outsourcing activity (due to offshoring by US and European companies seeking to cut costs)

India is set to record lower but nonetheless significant growth of 7% in 2008. Public spending, investments in infrastructure and third wave of IT boom in India will make the economy even more buoyant by June 2009.
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World Economy - Composition and Growth

60.00 50.00 40.00 $ Trillio n 30.00 20.00 10.00 0.00 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Developing Econom ies Advanced Econom ies

Advanced Economies accounted for 67 percent of world GDP in 2007 and Developing Economies 33 percent in 2007. In terms of contribution to growth, the share of emerging countries has been increasing with major contributors being China, India, Russia, Brazil. These are also fastest expanding economies (Russia is now an exception) with large public sector contributions. Stimulus plans to result in more employment and growth. A quarter of growth was driven by these emerging markets; contributions from these economies will play a key role in global economic growth and recovery.

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Road to Recovery

US/European Stimulus Package

Increasing Government Consumption

Output Stabilizes-Aided by Capital Goods and Infrastructure

Increasing Demand for Capital Goods Increasing Consumption

$
Credit Market Stabilize

Resumption of Corporate Lending

Stemming Job Losses

$
$

Boom in Asia

Chinese Stimulus

$
Consumer Spending Gets Back on Track Restarting of Retail Credit

$
Recovery/End of Trough Asian Stimulus

Increasing capacity utilization and expansion

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