2011 Global Economic Outlook

NOMURA GLOBAL ECONOMICS

Rocky Road of Recovery
Emerging economies thrive, but risk mishandling rebalancing. Developed ones advance, but into post-crisis headwinds. Now the twain must meet.

Nomura Securities International Inc.

See Disclosure Appendix A1 for the Analyst Certification and Other Important Disclosures

2011 Global Economic Outlook

Contents
GLOBAL
Forecast summary Our view on 2011 in a nutshell Global Outlook 2011: A rocky road of recovery One year on: a 2010 forecast post-mortem QE: Back to basics, again GEMaRI: Brave new world Global imbalances: Putting the basic macro identity to work Global politics outlook 2011 3 4 6 5 7 8 10 12

NORTH AMERICA
US Outlook 2011: Debt hangover limits recovery Household deleveraging The output gap The new fiscal debate Fed policy in the crosshairs US Economic Outlook: Firmer turf on the recovery road Canada Economic Outlook: In need of a push from the neighbours 13 14 16 17 19 20 21

EURO AREA
Euro Area Outlook 2011: A slippery road lies ahead Turning now to credit House price prospects Are the periphery countries solvent? Liquidity withdrawal: When the time is right Euro Area Economic Outlook: Breaking up is hard to do European Countries Economic Outlook: Germany, France, Netherlands European Countries Economic Outlook: Italy, Spain, Switzerland Scandinavian Economic Outlook: Norway, Denmark, Sweden Periphery Europe Economic Outlook: Greece, Portugal, Ireland 22 23 24 26 28 29 30 31 32 33

UNITED KINGDOM
UK Outlook 2011: Rebalancing the books Counting the cost of fiscal consolidation Permanent impairment in productive potential UK Economic Outlook: Gale-force rebalancing 34 35 36 38

JAPAN
Japan Outlook 2011: Export-led recovery on the horizon Underlying growth in consumer spending The BOJ’s risk tolerance Japan’s deflation and the output gap Japan Economic Outlook: Emerging from the soft patch 39 40 42 43 45

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2011 Global Economic Outlook

ASIA
Asia Outlook 2011: Challenges of rebalancing China: Gearing up for further reforms Asia macro policy: Not enough to fight inflation Asia politics outlook 2011-2012 Australia Economic Outlook: Tiger taming New Zealand Economic Outlook: A patchy recovery China Economic Outlook: GDP growth of 9-10% to continue Hong Kong Economic Outlook: Robust growth continues India Economic Outlook: The consolidation year Indonesia Economic Outlook: Poised for take off Malaysia Economic Outlook: Reform awaits a mandate Philippines Economic Outlook: Making inroads Singapore Economic Outlook: Back to trend South Korea Economic Outlook: Twin imbalances Taiwan Economic Outlook: Balanced growth ahead Thailand Economic Outlook: Still all about political risks Vietnam Economic Outlook: Higher growth and inflation ahead 46 47 48 51 52 53 54 55 56 57 58 59 60 61 62 63 64

EMERGING EUROPE, MIDDLE EAST AND AFRICA
EEMEA Outlook 2011: Policy design for postmodern times Forecast sensitivity to oil prices Sovereign wealth funds: Repositioning post-crisis Politics across EEMEA Hungary Economic Outlook: Investor unfriendly policies dampen growth Poland Economic Outlook: Racing ahead, fiscal clouds Russia Economic Outlook: Lacking momentum South Africa Economic Outlook: Unexciting growth, policy more interesting Turkey Economic Outlook: Widening imbalances Rest of EEMEA Economic Outlook: Czech Republic, Romania, Israel Rest of EEMEA Economic Outlook: Ukraine, Kazakhstan, Egypt Rest of EEMEA Economic Outlook: Saudi Arabia, Qatar, United Arab Emirates 65 66 68 70 71 72 73 74 75 76 77 78

LATIN AMERICA
LatAm Outlook 2011: Too much of a good thing What drives inflation in Latin America Key elections in Latin America Brazil Economic Outlook: Inflation risks challenge outlook Mexico Economic Outlook: A stronger recovery on the way Rest of LatAm Economic Outlook: Argentina, Chile, Colombia 79 80 82 84 85 86

FOREIGN EXCHANGE
Foreign Exchange Outlook 2011: A global rebalancing act 88

EQUITY MARKET
Equity Market Outlook 2011: Reducing the risk premium 89

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3 2011 3.00 0.00 1.3 4.1 4.75 3.7 2.7 1.0 3.5 4.0 4.0 2.00 10.3 2011 4.05 5.75 5.3 2.0 Policy Rate (% end of period) 2010 2.6 4.00 7.9 1.5 5.00 0.50 1.50 Note: Aggregates calculated using purchasing power parity (PPP) adjusted shares of world GDP.4 7.1 1.0 2.8 5.8 3.6 -4.7 5.6 2012 4.96 0.31 0.9 7.0 3.7 25.1 1.50 6.13 1.25 3.2 3.63 3.4 5.5 3.3 6.0 6. ***For Hong Kong and † Singapore.75 2.6 5.8 4.8 2.71 12.5 3.5 3.1 3.5 2.8 2.00 10.8 16.40 2.00 7.94 0.75 10.3 6.25 10.40 3.1 -0.9 6.0 15.0 4. $89 and $96 respectively.7 6.3 9.7 1.00 1.6 12.5 3.50 8.6 14.00 9.5 2.8 3.50 1.56 0.0 6.6 1.8 2.5 5.0 4.5 1.50 1.05 2.5 -0.4 4.8 4.5 5.3 5.8 1.25 9.25 8.60 5.7 1.6 1.00 5.5 4.17 7.23 10.8 2.6 -0.2 2.5 -2.8 2.4 5.0 3.0 7.5 5.8 5.7 3.52 7.56 0.00 1.3 5.25 2.50 3. Nomura Global Economics 3 6 December 2010 .4 8.8 2.50 3.4 3.00 5.00 1.0 3.3 2.50 7.00 2. the policy rate refers to 3M Hibor and 3M Sibor.50 2.9 2.8 1.3 7.1 6.50 8.0 6.1 2.8 6.50 6.00 1.5 3.3 1.1 4.5 -0.7 3.8 7.3 8.00 6.00 7.9 4.47 0.7 2.25 4.0 9. after $62 in 2009.2 4.0 3.9 2.25 4.10% target unsecured overnight call rate range.8 2.4 4.5 4.75 6.13 2.8 1.75 5.3 2.25 0.50 2.4 8.1 3.13 3.50 6.0 2012 3.5 3.7 3.13 2.8 0.4 5.0 3.1 7.7 1.00 7.9 3.8 7.50 4.00 2.3 2.8 4.2011 Global Economic Outlook Forecast Summary Real GDP (% y-o-y) Global Developed Emerging Markets Americas United States* Canada Latin America Argentina Brazil Chile Colombia Mexico Asia/Pacific Japan† Australia New Zealand Asia ex Japan.05 5.43 0.0 4.50 5.0 1.0 4.5 10.7 2.5 2.00 7.5 1.5 5.7 2.40 7.8 9.1 1.3 1.40 7.1 3.6 3.6 1.8 2.1 2.3 5.5 3.1 4.3 2.1 1.5 6.6 9.9 5.00 2011 3.4 3. **Inflation refers to wholesale prices.40 3.7 1.5 3.9 5.7 1.5 5.3 5.2 5.00 5.75 2.0 3.50 0.00 3.6 9.7 5.4 4.7 7.7 4.8 4.2 10.00 1.00 2.0 2.00 4.9 4.0 1.6 1.2 2.6 5. Source: Nomura Global Economics.1 9.0 -3.82 11.3 5.75 7.50 1.0 7.5 4.2 3.2 2.5 2.9 5.2 7.0 0.00 2.50 1.3 4.25 7.2 2.3 5.75 3.8 3.00 2.2 3.0 3. *2010 and 2011 policy rate forecasts are midpoint of 0-0.5 2.5 6.00 2.3 2.00 2.9 1.8 1.5 7.8 5.4 6.3 2.9 7.00 1.00 4.3 1.55 2.0 1.9 9.5 1.75 2.1 2.9 3.2 6.50 1.5 2.0 7.4 1.8 3.0 3.00 6.50 2.7 2.11 2.9 2.50 1.50 1.1 3.50 8.9 4.50 1.8 4.00 5.5 0.46 0.25 7.3 6.7 8.6 3. Currently assumed average Brent oil prices for 2010.25 6.06 2.5 3.2 0.7 2.15 0.75 4. NZ China Hong Kong*** India** Indonesia Malaysia Philippines Singapore*** South Korea Taiw an Thailand Vietnam Western Europe Euro area France Germany Greece Ireland Italy Netherlands Portugal Spain United Kingdom Denmark Norw ay Sw eden Sw itzerland EEMEA Czech Republic Egypt Hungary Israel Kazakhstan Poland Qatar Romania Russia Saudi Arabia South Africa Turkey Ukraine United Arab Emirates 2010 4.63 2.7 1.75 2.3 8.2 3.2 5.41 2.5 2.9 1.75 2.95 1.4 9.00 1. Policy rate forecasts in 2010-2012 are midpoint of BOJ’s 00.75 6. consensus forecasts and Nomura in-house analysis.3 0.5 19.2 5.00 2.4 4. respectively.00 2012 4.05 5.7 3.7 2.05 3. Aust.6 7.2 2.92 6.2 1.3 3.25 6.5 Consum er Prices (% y-o-y) 2010 3.5 0.7 1.9 2.1 4.1 1.5 8.75 2.50 1.00 2.87 6.7 24.00 7.25% target federal funds rate range. 2011 and 2012 are $79.00 2.5 4.1 2.0 1.6 4.81 0.07 0.2 2.40 6.0 2.9 1.25 1.6 1.7 1.8 1.3 4.8 -1.00 0.0 1.5 5.0 3.6 1.00 1.50 1.00 9.4 4.0 5.3 2.3 2.0 2.25 5.35 1.1 2.00 1.8 0.3 3.6 7.0 10.2 1.7 5.0 6.00 8.1 6.00 1.25 7.4 4.82 2.2 5.75 8.49 1.2 0.0 11.2 6.9 1.3 1.7 2.25 3.25 2.25 3.0 5.50 1.1 2.6 3.00 7.0 6.2 3.25 2.00 1.0 5.25 5.7 2.6 1.4 3.9 7.0 4.00 7.50 7.50 7.0 1.75 8.9 6.4 1.73 1.7 5.6 3.0 4.7 2.5 2.7 4.5 2.8 2.4 5.4 3.3 3.50 4.5 4.00 0.5 2.7 2.9 1.50 1.00 4.00 2.7 3.0 -0.5 3.3 2.59 9.6 1.75 3.2 0.00 4.1 3.4 5.8 8.3 26.5 3.0 1.0 2.0 8.90 0.00 6.05 4.0 6.6 2.6 2.5 0.7 3.3 7.0 3.5 -0.7 5.3 9.8 1.8 5.5 1.4 1.8 2. Our forecasts incorporate assumptions on the future path of oil prices based on oil price futures.5 4.1 10.25 3.1 1.00 2.6 1.

• We expect no further QE with a first BOE rate hike in August 2011. Inflation is subdued. infrastructure development is likely to unleash growth of above 7% by 2012. bigger imbalances resulting in core inflation and current account deficit pressures. • We expect the BOJ to expand its asset purchase program from ¥5trn to ¥8-10trn if the yen strengthens and stocks fall again. • We expect the Fed’s $600bn Treasuries-buying program to be enough to boost growth and stabilize inflation expectations. EM overheating turns sour. • Turkey: We see domestic demand firming. • A gradual reduction in economic slack should help stabilize inflation but below the rate consistent with price stability. • Downside risks: euro area fiscal crisis escalates and spreads. • Middle East: Growth is picking up on higher oil prices and fiscal stimulus. the ECB’s in September 2011. and risks skewed to later. • We see inflationary pressures mounting in EM as funds keep flowing in and the authorities intervene to stem rising currencies.2011 Global Economic Outlook Our View on 2011 in a Nutshell Global • The developed world recovery is set to stay muted due to ongoing de-leveraging. • We expect a continued gradual recovery in UK growth despite the damping effect of deleveraging and fiscal consolidation. an investment pull-back in China. United States • We expect the heavy debt burden to restrain the pace of recovery consistent with the growth patterns after financial crises. much of the emerging world. Nomura Global Economics 4 6 December 2010 . Asia • Rising inflation is the big macro theme: it will be difficult to control if countries keep holding back appreciating exchange rates. • Korea: With growth slowing yet inflation high. the focus of fiscal policy will shift toward long-run reforms of taxes and entitlements. • We expect euro-area growth in 2011 to be sustained by stronger investment and net trade despite fiscal headwinds. • Developed-world inflation should stay contained. • Poland’s monetary policy normalisation with resume but there is complacency in fiscal policy ahead of elections in October. • With the output gap closed. fiscal restraint and other crisis legacies. but we see the ECB and BOE raising rates way ahead of the Fed and BOJ. led by Asia. except in Saudi Arabia. EEMEA (Emerging Europe. • Russia’s growth will probably be lacklustre even though pre-election spending should support consumption. • Improving confidence about the outlook should lead to rising employment and renewed capital spending. • Mexico stands to reap the most from a US recovery in 2011. but weakening against EM currencies. • China: We expect 9-10% growth in 2011-12 as the government implements structural policies to promote consumption. • Australia: We see GDP growth lifting sharply from mid-2011 on much stronger capex in the resource sector. • We anticipate the US dollar consolidating in 2011 against other major currencies. Middle East and Africa) and Latin America • South Africa: A fundamental policy shift is occurring with faster fiscal consolidation to allow more room for lower interest rates. • Inflation will likely stay above target during 2011 in the UK and hover around the 2% target ceiling in the euro area. which will allow policy rates to fall in H2 2011. even as growth consolidates in 2011. • With better fundamentals and fewer aftermath issues. is set to keep growing briskly. • An upside surprise?: animal spirits stir and crisis-calibrated monetary policies help release pent-up developed world demand. • Brazil’s economic growth will moderate next year due to fiscal tightening. • India: We expect supply constraints to keep inflationary pressures elevated. The pick-up in domestic demand will add momentum to growth. we expect policymakers to allow a stronger KRW but hike rates only modestly. • The main risks are greater-than-expected yen strength and political disruptions surrounding the FY11 budget. • Indonesia: Building on robust domestic demand. • Hungary’s anti-growth fiscal policy is concerning and with a more political MPC and pension changes markets will be volatile. • We project Japan to pull out of deflation around end-2012 on the back of a shrinking output gap and higher crude oil prices. • With the recovery on a firmer path. Japan • We see a more pronounced recovery from mid-2011 on government stimulus measures and overseas economic recovery. Argentina’s strong growth is likely to keep inflation high in 2011. Europe • We see the euro area staying intact and fiscal austerity backed by ongoing official financing helping prevent periphery default.

05 -0.6%.81 -0.6%).4% vs 6. qualitatively this view has been vindicated: the developed world looks set to grow by 2. Interestingly.05 1. Although we missed the details.3 2. it does not seem to have done euro area growth much harm (relative to expectation).4 2. particularly the first quarter. emerging markets look set for strong growth”. central banks kept rates lower. it is salutary to see how our 2010 forecasts fared. Inflation globally turned out to be a little higher than we expected. the outlook started to darken a bit. But the growth surprise was concentrated in the first half of the year.3 -0. interest and exchange rates are end of period.8 3.7 3.8 0.96 -0.00 3. with Germany providing the biggest upside surprise (3.4 3.2 1. The euro ended up being weaker and long-term interest rates (particularly in the core of the euro area) much lower than we expected. In our 2010 Global Economic Outlook.60 2. We did not see the EA fiscal crisis coming.7% (rather than the 1. particularly in LatAm and the UK.57 -19.20 $/£ 1.3 TRY/$ 1.8 UK 1.0 4.04 5.80 Euro area 1.9 1. as inventories and fiscal stimulus kicked in – growth was coming in and looking weaker than we had expected in the second half. we summarized our outlook for 2010 thus: “The aftermath of the crisis should constrain the developed world recovery.80 $/€ 16-Dec-09 Exchange rates 6-Dec-10 Error.40 ¥/$ 87. pp 16-Dec-09 CPI inflation (% y-o-y) 6-Dec-10 Error. from around about the end of Q2.7 -0. but.47 8.6 0.59 -1.1 0.4 -1.4 9.13 0.3 3.0 3.1% we expected).7 0.2 4.6 5.70 2. but our big picture forecast fared quite well.9 4.6 1. Figure 1.2 1.23 LatAm 4.1 6.0 80. pp Global 4. Notwithstanding that.40 EEMEA 3.9 8. pp 16-Dec-09 Official interest rates (%) 6-Dec-10 Error.2 0.30 -18.45 5. led by a booming China.55 1.3 0.3 Asia 8.3 5.75 0.7 2.60 1.4 1.00 -0.70 6.6 -0.8 0. with surprises (to us) coming in both the developed (2.6% vs 1. and the Chinese authorities were a little slower to start letting the renminbi exchange rate against the dollar rise again than we had penciled in.8 0.2% (Figure 1).50 -0.6 2.8 0.5 Japan 1.9 BRL/$ 1.6%). It looks like the euro area will grow by 1.80 3.00 -0.60 1.28 2.8% rather than 4.0 -8.5 0. official interest rates turned out to be a bit lower than we expected.0 RMB/$ 6. Nomura Global Economics 5 6 December 2010 .25 3.6 6. With three quarters worth of 2010 GDP in the bag.7 3.84 7. The other was the Fed feeling that it needed to launch a second round of balance sheet expansion (“QE2”). But we missed two signal events in 2010.13 0. the ECB and the Bank of England not making the first hikes we had penciled in for late in the year and EM central banks generally being less aggressive in their tightening than we foreshadowed. Nomura forecasts for 2010 at end-2009 and latest estimates for 2010 Forecast date 16-Dec-09 GDP grow th (% y-o-y) 6-Dec-10 Error. the yen strengthened more than we expected. much slower than it could have grown coming out of such a severe recession. Growth and inflation were a bit higher than expected. % 1.45 6.2% (close to its 30-year annual average growth rate).25 Note: GDP growth and CPI inflation forecasts/estimates are period averages.4 1. and the emerging world by 7.8 0.40 -1. Source: Nomura Global Economics. both helping Germany in particular.4 7.5 0.05 -0. One was the eruption of the euro area (EA) fiscal crisis early in the year – we had identified the financial crisis re-erupting as the key downside risk rather than its transmuting so quickly into a fiscal crisis. The main growth surprises came in Japan and Latin America (specifically Brazil and Argentina). as attention-grabbing as the euro area fiscal crisis was. Global growth has turned out to be quite a bit stronger than we expected. although the US (and EEMEA) bucked that trend. Our biggest forecast error was to expect long-term interest rates to end the year much higher than they look like doing.25 4.25 1. likely coming in at 4.10 0. the euro and sterling weakened against the dollar rather than strengthening as we expected.6 2. in the US in particular to the point where the Fed needed to reverse course from de facto tightening to quite an aggressive quantitative ease.1 1.95 1.7 2. On exchange rates. pp 16-Dec-09 10-year bond yields (%) 6-Dec-10 Error. we did forecast that the Bank of Japan was “likely to adopt additional easing measures”. So the numerical upward surprise belies the fact that.2 0.2011 Global Economic Outlook One year on: a 2010 forecast post-mortem Paul Sheard In previewing 2011.60 3.4%.90 -0. with China looking set to grow by 10.1 1.32 US 2.15 -0.6% vs 2.6 6.35 1.0%) and the emerging worlds (7.

looking for global growth of 4. and high growth in the former is likely to continue to attract strong global capital flows. Our global economic forecast for 2011 remains in this vein and reflects three key premises. particularly the US and Europe. or any of the major economies.3% in 2011. Q1 2008 = 100 140 135 130 125 120 115 110 105 100 95 90 Mar-08 Mar-09 Mar-10 Mar-11 Global US Euro area Japan Forecast China India Note: WE is Western Europe.2% after 2. some very small to begin with. Emerging economies look set to account for almost three-quarters of global growth in 2011 (on a purchasing power parity basis). we expect the global recovery to remain a two-track one (Figure 2).to mid-2009 after the 2008-09 crisis and Great Recession to continue (Figure 1). back into recession.3% in 2011. the post-crisis global economy is struggling to rebalance smoothly: the tensions and imbalances in the global economy are likely to remain sources of market volatility and downside risk to the economic outlook (Figure 4). GDP growth forecasts: 2011.2011 Global Economic Outlook Global ⏐ Outlook 2011 Paul Sheard A rocky road of recovery We forecast global growth of 4. Three premises underpin our 2011 forecast In our 2010 Global Economic Outlook. China will contribute three times as much as the US to global growth in 2011. The financial crisis of 2008 happened for a reason – various excesses and imbalances had built up over a long period of time – and the aftermath and their unwinding will continue to weigh on the economy and Figure 2. whereas developed economies. Path of GDP for selected countries/regions Figure 1. ROA is Rest of Asia.6%): emerging economies. we expect the economic expansion that began in early. This is always true but is particularly germane when the economy has been hit by major shocks. we forecast “a strong recovery in most of EM and a shallow one in the developed world”. We expect EM to drive the developed world to limp Global rebalancing is unlikely to be smooth Developed economy headwinds We live in historic times The concept of “path dependence” in economics says sensibly that where an economy has come from influences where it is likely going: history matters. key countries/regions % y-o-y 10 9 8 7 6 5 4 3 2 1 0 Japan WE US EEMEA LatAm ROA India China Index. On our forecasts.8%: it would take major shocks or policy errors to push the global economy.4%) than the developed world economies (2. Two-track recovery to continue We expect the economic expansion to continue First. Emerging economies are set to keep growing strongly but risk overheating while the developed world recovery faces continued stiff headwinds. complicating policy management and raising risks of overheating and policy errors. 6 6 December 2010 . Source: Nomura Global Economics. Third. have closed or are closing way ahead of those in developed economies. This is largely how things turned out (see Box: One year on: a 2010 forecast post-mortem). Nomura Global Economics Source: Nomura Global Economics estimates. continue to face headwinds to growth from the aftermath of the financial crisis. particularly those in emerging Asia. Output gaps in many emerging economies. generally have good domestic fundamentals. Second. positing that the financial crisis would cast a long shadow on the recovery in the latter but that EM would likely post strong domestic-demand-driven growth. after 2010’s likely 4. and India will contribute as much to global growth as Western Europe and Japan combined.6% after 2010’s likely 7. with the emerging economies growing much faster (6. with China and India alone accounting for almost half (Figure 3).

and therefore as neither a monetary silver bullet nor a monetary demon. Individual banks do not (and cannot) use reserves to directly lend to non-bank borrowers. In isolation the overnight rate is a pretty trivial interest rate. or by making a new loan. they are assets that the central bank supplies to the banking system in exchange for the ones it takes out. we tried to demystify QE (see “QE: back to basics”. and all other financial asset prices are linked to interest rates. having had the composition of their portfolios altered in a more liquid direction. The excess reserves created by QE are the balance sheet counterpart to the assets the central bank “sucks out of the system”. with a view to favorably influencing the public’s expectations. via substitution effects in investors’ portfolios. they can get rid of their reserves in only two ways: by lending them to other banks or using them to buy assets. But what happens when the central bank has cut the overnight interest rate to zero and still wants to ease monetary conditions? It cannot use the interest rate any more. it is the evil of all evils. So in normal times an interest-rate-setting central bank does not actively control the size of its balance sheet and the balance sheet is quite stable in size because its two main components on the liability side (reserves and currency) are.2011 Global Economic Outlook QE: Back to basics. that is QE. But precisely because it has this power and banks know it. whereas the banking system may not want to borrow from the central bank. This too changes only slowly and indirectly (via the impact on the demand for money) with changes in the overnight interest rate. securities purchases work by affecting the yields on the acquired securities and. and seeing their reserves drain when the borrower withdraws the money. which just shifts them around the banking system. but it is linked to all other rates out on the yield curve via the expectations of future overnight rates. so-called “central bank liquidity”). at least in the U. these basically reflect decisions taken by the public (how much money to hold on deposit and how much currency to hold. but (given the ratio set by the central bank) this level depends on the amount of deposits in the banking system. Individual portfolio holders. QE is little more than the monetary policy equivalent of a placebo. The central bank is able to set the overnight interest rate because it. it has to pay for them and it does this typically by creating reserves. This is often called “printing money” but the term is misleading because the reserves created are not money (banknotes) that anybody can spend. “Changing the quantity of bank reserves” is precisely the other side of the balance sheet coin to the asset purchases and is an integral part of the portfolio rebalance effect. in principle. central banks set an overnight interest rate (eg. and it alone. by signaling what its objectives are and how it intends to set the rate in the future to meet them. the central bank does not have to use it. respectively). A balance sheet has two sides and the Fed creates excess reserves when it purchases securities. the unfettered printing of money that can only lead to monetary ruin.” This is a spurious distinction. the use of the term ‘quantitative easing’ to refer to the Federal Reserve’s policies is inappropriate. thus creating a new deposit. This is quite different from the image conjured up by describing central banks as “pumping liquidity into the system” as if that liquidity was like water in a bucket waiting to “flow” to firms as credit and fuel inflation. on a wider range of assets. which changes only slowly over time. The other key liability is currency in circulation. Fed Chairman Ben Bernanke is not being very helpful when he says: “In my view. there is nothing. Quantitative easing typically refers to policies that seek to have effects by changing the quantity of bank reserves. Normally. But it can now start to do something that it was not actively doing before: expand the size of its balance sheet by purchasing assets or increasing its lending (the former is more powerful because.S. in the US the federal funds rate). can influence (loosen or tighten as the case may be) financial conditions in the economy. to stop the central bank from buying assets from either the banking system or from other holders of assets). There continues to be a great deal of misunderstanding surrounding what is referred to as “quantitative easing” (QE). will start to rebalance those portfolios. In this space last year. a channel which seems relatively weak. Reserves are a liability of the central bank. usually roughly the level corresponding to the required reserve ratio. 16 December 2009) and we have written a number of pieces on it since (see the Global Weekly Economic Monitor). and the communications of central bankers do not always help. and this process will have an impact on asset prices – and importantly on the public’s expectations – in a way not unlike normal monetary easing. When the central bank buys assets. context. To some. to others. QE is just another way of easing financial conditions. by setting the overnight rate and. All it needs to do is to announce its target interest rate and ensure that it is supplying enough but not too many reserves. the appropriate way to understand QE is to see it as a natural extension (at the zero interest rate bound) of what central banks normally do. Nomura Global Economics 7 6 December 2010 . So the central bank. if the central bank wants to push that interest rate up it can do so by draining reserves and if it wants to push it down it can flood the banking system with reserves. again Paul Sheard A central bank can keep easing monetary conditions at the zero bound by expanding its balance sheet. 2010 Global Economic Outlook. In contrast. In our view. controls the supply of reserves to the banking system (reserves are deposits of banks with the central bank. exchanging the assets it purchases for a very liquid asset – central bank reserves. So where does the monetary easing effect come from? Economists talk of the “portfolio rebalance effect”: when a central bank acquires a large amount of securities or other assets it is altering the relative supply of (imperfectly substitutable) assets residing in private sector portfolios. Central banks can do this because the overnight interest rate is the rate at which banks lend and borrow reserves among themselves.

which at 64. At such a juncture. will all be needed to prevent the build-up in imbalances and a rise in GEMaRI scores. only Iceland’s GEMaRI score has risen above the initial danger threshold of 73. fiscal deficits and other imbalances. These countries would almost certainly score at the very highest end of GEMaRI in view of significant external and public sector debt. Asia has the strongest growth prospects of any region in GEMaRI because of its loose macro policies. The one possible exception is Vietnam. burgeoning current account deficits and other imbalances monitored by GEMaRI. LatAm scores. GEMaRI. they cannot have balance of payments-related stresses. India’s GEMaRI score (43) is the second highest in Asia because it too has large current account and fiscal deficits and high inflation. Such “developed” market issues. sound economic fundamentals and positive spillover effects from the robust China. Asia’s GEMaRI scores fell on aggregate in Q3 as the strong recovery continued there. higher real rates. can provide pointers. this financial decoupling is unlikely to last and spreads could spring back to higher levels and again move more in step with developed market spreads. even if financial market recouping is the order of the day. A full version of the latest GEMaRI update can be found here: “Brave New World”. Such a move can be targeted by looking at individual country risks and imbalances (in other words. not based as much on country specifics. because of low FX reserves and twin trade and fiscal deficits. For the 37 countries that we cover. markets may well hone back in on fundamentals and on imbalances in particular. However. has now fallen back. the issue is more that a structural asset allocation shift is occurring within global portfolios to increase weight on EM given growth outperformance. then it risks a leveraging up of imbalances and so GEMaRI will still be of use in highlighting the risks building here. however. On the flip side. LatAm crisis and then from 2007 onwards globally with easy money again flowing in EM. However. Turkey. Aggregate regional scores fell back (indicating a reduced likelihood of a currency crisis) in Q3 for EEMEA and to a lesser extent Asia after falling in the previous quarter too. current account surpluses and low public debt suggest that full-blown exchange rate crises are highly unlikely. Hence markets could return to moving in step with GEMaRI risk indications. Figure 1. being within the euro. The moves in GEMaRI scores this quarter are eclipsed by the developments in periphery Europe. has Asia’s highest GEMaRI score. But. while a number of stressed CEE (Central and Eastern European) countries have increased their scores. where GEMaRI can be of some use). highlight a dissociation between risk and reward in many EM countries: the correlation between FX/CDS moves and GEMaRI has broken down as strong capital inflows have continued into EM. Nomura Global Economics 8 6 December 2010 . instead such stresses and imbalances are exposed through liquidity issues.2011 Global Economic Outlook GEMaRI: Brave new world Peter Attard Montalto The G20 has shifted its attention to imbalances and the potential effects of cash flowing into EM. we believe that some degree of economic decoupling can continue. Alternatively. Nomura’s Global Emerging Market’s risk index. the fastest riser in Q2. as well as macro-prudential policy on bank lending and fiscal discipline. GEMaRI provided an early warning of such previous inflow-led imbalances before the Asia crisis. Our GEMaRI scores as of Q3 continue to suggest that the emerging market (EM) macroeconomic and financial environment is relatively benign. if the shift is more indiscriminate. Offsetting policy with reserve accumulation and tighter rates. increased in aggregate given the strong recovery that is taking place in that region. EEMEA scores remain volatile as growth softened in Q3 on lower external demand. however. economic decoupling does risk a continued flow of liquidity entering EM and finding its way through the banking system to household leverage. Nomura’s GEMaRI index Scores 100 79 75 50 25 0 64 61 60 51 51 50 50 44 43 43 39 37 37 36 33 33 30 28 26 25 25 25 23 22 21 19 19 17 17 16 1-in-2 chance of a currency crisis 1-in-3 chance of a currency crisis 10 10 8 7 7 0 Source: Nomura Global Economics. published 2 December 2010. If further contagion occurs around the periphery. Our Global Emerging Market Risk Index (GEMaRI) measures the risk that a currency crisis will occur in the next 12 months. however. High and rising FX reserves.

and central banks needing and being able to keep monetary policy loose.2 3.6 0. after venting plenty of anger. real exchange rates should rise For the emerging economies. In Japan.2 0. back in deflation. and a crisis of confidence about the future of the euro (see Euro Area Outlook 2011: A slippery road lies ahead and UK Outlook 2011: Rebalancing the books). In the US.1 3. unsentimental as they are. where we forecast 2. In Europe. are prone to test policymakers’ mettle. the euro area is in reasonable macroeconomic shape (Figures 4 and 5) and at the end of the day we believe European policymakers will “do whatever it takes” to keep the European project on the rails and that electorates.5 0. create their own legacies and unintended consequences.7% in 2010. Policymakers again are having to take rear-guard action. The developed world is set for prolonged weak growth For the developed economies. chilling animal spirits.8 2011 4. The problem lies in an economic governance system whose deficiencies have been exposed by the financial crisis and whose institutional rules of the game remain work-in-progress.3 2012 4.rather than domestic-demand-led recovery (see Japan Outlook 2011: Export-led recovery on the horizon). how landmark health care reforms are going to be implemented. fiscal authorities eager to repair the damage to government finances (Figure 5). Contributions to global GDP growth 2010 Global growth (% y-o-y) Contributions to growth (pp): Developed World United States Western Europe Japan Emerging Markets China India 1. will support them. where we forecast growth of just 1. it is an entirely different kettle of fish.5 1. which we see as taking another 4-5 years to run its course (see US Outlook 2011: Debt hangover limits recovery). but constrained by low growth in their ability to do so. and associated earlier-than-expected headwinds from fiscal austerity. leaving unemployment stubbornly high. And the crisis.1% in 2011 after a base-effect-flattered likely 3. and set real estate prices tumbling again. the aftermath of the financial crisis is making its mark as a fiscal crisis. Source: Nomura Global Economics estimates.5 0.4 1. With growth so strong and so weak in the developed world. the key crisis-aftermath headwind is continued household debt deleveraging.6 0.5 % GDP 10 8 6 2008 2011 F 2012 F 1.5 4.4 0.5 4 2 0 -2 -4 -6 US Euro area Japan China Source: Nomura Global Economics estimates. the post-crisis/Great Recession world likely means prolonged anemic growth.8% in 2010. again). where we forecast 2. Taken as a whole. and emerging market (EM) risk appearing to be contained (see Box: GEMaRI: Brave new world). Figure 4.3 0. even if it does mean biting the hand that feeds them.2 1. capital is naturally flowing into EM in search of the higher potential returns on offer. and why we do not see it as sowing the seeds of future high inflation. Household debt deleveraging is crimping US growth In Europe there are fiscal crisis headwinds We think European policymakers will rise to the challenge Japan. Current account balances: 2008 vs 2011-12 forecast Figure 3.1 1. markets.8% growth in 2010.0% growth after likely 1. We are not in the doomsday camp on the outlook for the euro area. to close the output gap quickly. and for those deeply in unconventional territory.1 3.4 0.5% growth in 2011 after likely 2. is looking to exports Emerging worries In EM. Note: Contributions to growth are on a purchasing power parity (PPP) basis. and policy responses to it. Forecasting in this kind of environment is likely to continue to have a strong element of slow-motion watching of history in the making. In such circumstances. We look for the politicians eventually to regain the upper hand. for long (on the latter. Nomura Global Economics 9 6 December 2010 . the Great Recession pushed an economy that was finally emerging from deflation back into that state. see Box: QE: Back to basics.5 0. and whether a grid-locked government can come to grips with longer-term fiscal challenges is also likely damping animal spirits.5 0. relative to how far GDP has fallen. Growth is likely to be too slow. inflation pressures muted. Given their differential growth performance and outlooks (Figure 2).2011 Global Economic Outlook influence it in 2011 and beyond. Uncertainty about the financial regulatory regime. as most put their hopes in an export.4 0.5 0.

by running current account surpluses or deficits is how countries save or dis-save. Such government dis-saving provides the necessary offset to absorb the surge in private sector net savings. Paul Sheard One of the most useful and powerful analytic devices in macroeconomics is the savings-investment identity. an increase in the budget surplus (if private net savings do not change) causes the current account surplus to increase. the macro identity shows that in a global recession. denoted by the same Y. have been running such large current account surpluses given that low income developing economies might be expected to finance their investment and growth by drawing on the savings of more developed. it can be saved (accumulating as financial assets). in one of three ways: it can be used to finance consumption. as tempting as it may be to say things like. The output of a country. lest the economy otherwise spiral into a great depression.2011 Global Economic Outlook Global imbalances: Putting the basic macro identity to work Current account balances link the real and monetary activities of countries across time and space. which means that its private sector (household and/or corporate sector) must be running an even bigger net savings surplus. That said. they can do so only if others are willing to increase their net borrowing. investment. others must be dis-saving (in a two-country world. the identity part yields: C + I + G + X = C + S + T. that ‘somebody’ has to be foreigners. Third. That is. Too often observers speak of government budgets. and rearranging terms yields the result: (S – I) + (T – G) = (X – M). must find its way into one of the following: private consumption. the macro identity says nothing of the sort. There are a few important things to note about the macro identity. M. China being the notable example. which is also the increase (if positive) in the nation’s financial claims on foreigners. C. there is a useful role for governments to run large deficits. Income can be disposed off. together they represent the nation’s total net savings. Nomura Global Economics 10 6 December 2010 . S. it says nothing about causality. Y = C + S + T. T. and the associated stock of government debt. the macro identity reminds us that there is a big difference between government net savings and national net savings. so if some countries are saving. as if they were synonymous with the country’s net savings and stocks of indebtedness. all these expenditure categories being net of imports. think China and the US. Fourth. given that net savings can be deployed only by lending them to somebody – and for a whole country. G. its savings net of investment – must be equal to its current account surplus or equivalently to the increase in its net claims on the rest of the world. and exports X. But the output of a nation also accrues to the suppliers of the factors of production as income. it has puzzled many economists why many emerging market economies. C. respectively. also by virtual of being an identity. for instance. Putting the two together. The first pass at looking at current account surpluses and deficits should be through this spectrum rather than immediately labeling them as “imbalances”. or it can be taxed by the government. Third. falling victim to what Keynes called the “paradox of thrift”. to leave expenditure on domestically produced goods. a point too often lost on those who seem to think that only the manufacturing or production sector adds value and that the financial sector is purely parasitic. richer and often more mature. if some countries want to increase their net savings. Y = C + I + G + X – M. for the world as a whole. over time. The macro identity is easily derived from the basics of national output accounting (symbols below are all in real terms). consumption or investment by the government. So the macro savings-investment identity says that total national net savings equals the current account balance. In a world of autarky there would be no current account “imbalances”. That is. all the talk of the need for global coordination of the unwinding of current account imbalances under the aegis of such fora as the G20. Hence. respectively. current account balances sum to zero. Now. the macro identity holds ex post but it need not (in fact. First. Japan is a good example: it consistently runs a budget deficit and a current account surplus. denoted by Y. respectively). note five simple points: First. it shows that the monetary economy is intricately linked to the real economy. when the government deficit is just one half of the national savings equation. exhaustively. when desired private sector net savings are prone to spike (because savings rise and investment falls) in many if not all countries. aging economies. if positive). This means that. it is always true. It is the operation of the decentralized price system of the market for goods and services and financial claims that makes inconsistencies in planned savings and investment consistent after the fact. Second. Tell me that a country is running a current account deficit and a budget surplus and I will tell you that the private sector is running a deficit. Cancelling the common consumption term. to put the macro identity to some economic use. The first term is private sector net savings and the second term is the government’s net savings or budget surplus. and as current account balances necessarily sum to zero at the global level. I. Fifth. This simple but surprising little identity yields a number of important insights when thinking about global imbalances. But second. The government deficit says little about national indebtedness. generally does not) hold ex ante. but countries would be extremely impoverished by their inability to trade with the rest of the world and transfer consumption opportunities through time as a result. In words. this says that a country’s total net savings in each period – that is. being an identity. The term on the right-hand side is the current account balance (surplus.

% y-o-y 15 Investment pulling back in China is a serious risk EM overheating poses risks Politics aplenty DW pent-up demand being released is an upside risk Figure 5. is released. but the scope for inflation to overshoot on the upside. with the result that over time the real exchange rate appreciation will likely end up occurring via domestic overheating and inflation (see Asia Outlook 2011: Challenges of rebalancing. amid a busy election calendar.2011 Global Economic Outlook real exchange rates in emerging economies in general should be appreciating relative to the developed world and this is both indicated by. a slowdown in Chinese growth would ricochet around the global economy. which by their nature tend to be to the downside (see Box: Global politics outlook 2011). the global rebalancing of current accounts that needs to take place over time. anything that caused investment growth in China to slow markedly. is on the rise. There are also political risks. Figure 6. Commodities pose an inflation challenge Risks to the forecast The fiscal crisis spinning out of control is the key risk Given the long shadow that the 2008-09 crisis and recession is likely to cast. EEMEA Outlook 2011: Policy design for postmodern times. 11 6 December 2010 Nomura Global Economics . Given how investment-intensive its economy has become. Now that would be nice. and should contribute to. would have a dramatic downward impact on GDP growth (Figure 6).3% in 2010 to 5. and with monetary policy calibrated to deflation risks. with negative impacts for growth and market sentiment. let alone go negative. we continue to see the risks as more tilted to the downside. it is possible that animal spirits stir and “pent-up” demand. A third downside risk is that “currency war” tensions and capital control mania escalate and spill over into trade protectionism. There are signs of this starting to happen. Rising food and commodity prices. most recently accentuated by its investment surge response to the crisis. CEIC. If the euro area fiscal crisis subsides and none of the negative risk factors surface. the blowout in such imbalances having been part of the jig-saw of factors precipitating the crisis in the first place (Figure 4) (see Box: Global imbalances: Putting the basic macro identity to work). with demand weak in their developed world export markets. China’s 2011 GDP simulated growth: sensitivity to rate of investment growth Real GDP . A second is a pullback in investment in China. At the top of the list is that the fiscal crisis in Europe spins out of control and even spreads beyond Europe. and geopolitical risks. implicit in the above description of our baseline forecast. % y-o-y -20 Source: Nomura Global Economics estimates. We see three main downside risks. partly fuelled by strong EM growth. Source: China Statistical Yearbook. create particular challenges for emerging economies given the importance of food in CPI baskets. And given how important China has become in the global economy (Figure 3). Nomura Global Economics. The main upside risk to our baseline forecast is that developed world (DW) growth turns out to be stronger than we forecast. EM policymakers are prone to resist nominal exchange rate appreciation by stepping up foreign exchange intervention and imposing distortionary capital controls. precipitating too much fiscal austerity for economies to bear and triggering another round of financial system distress. We are bullish on the outlook for EM growth and are forecasting only a modest pick-up in inflation from 5. Fiscal balances. perhaps triggered by attempts to cool an overheating economy. more flexible exchange rates would also allow these economies to better absorb such price shocks. Resisting nominal appreciation risks overheating However. testing the inflation-targeting mettle of central banks.7% in 2011. 2008-2012F % GDP 0 -2 -4 -6 -8 -10 -12 US 2008 EA 2009 2010 UK 2011 Japan 2012 10 5 0 -5 20 15 10 5 0 -5 -10 -15 Real gross capital formation. particularly in the US. and LatAm Outlook 2011: Too much of a good thing).

We expect the coalition to survive the likely set-backs at the ballot box and to stay the course. We therefore expect tensions to remain high for the time being. • • • • • Korea: South Korea’s recent tougher stance towards North Korea in the wake of the latter’s most recent act of aggression may not be sufficient to deter Pyongyang from further malfeasance (e. missile launches and/or a third nuclear test). Lebanon – stand to fuel tensions locally and the regional and wider terrorism threat posed by al Qa’ida in Yemen may yet unsettle markets. Pakistan: Possible terrorism spillover into India. but do not rule out the parties involved in the six-party talks returning to the negotiating table in the foreseeable future. Egypt. Domestic politics in Portugal and Spain. Furthermore. include the management of capital inflows and food price inflation. bipartisan agreement may form on anti-China legislation (see below) and on enhancing political oversight of the Fed. However.g. we doubt that it will do so fast enough to satisfy some of China’s critics in Washington. perhaps especially in emerging markets.. Internationally. we see only a low probability of a global shock emanating from the region in the next 12 months (e.2011 Global Economic Outlook Global politics outlook 2011 Alastair Newton Politics and policy will continue to be key drivers of market sentiment in 2011 as governments pursue exit strategies from the financial crisis. rightly or wrongly. Eurozone: We continue to take the view that the Eurozone will probably manage to avoid another major crisis in 2011. we see little prospect of North Korea being prepared to abandon its nuclear programme. Russia: What will Mr Putin do next? Thailand: Still troubled. all give markets continued cause for concern.g. 24 November 2010). We expect the Republican Party to seek to minimize the additional burden on business of healthcare and financial market regulatory reform. Nigeria: Oil and troubled waters. Other top “issues” to follow (in alphabetical order): o o o o o o o o o o o Argentina: After Kirchner. an Israeli military strike on Iran). Turkey: A third term for AKP? Ukraine: Back in bed with the IMF? Venezuela: The Bolívar revolution presses on regardless. Generic issues where policy decisions stand to play a particularly important role. Vietnam: The next generation • • Note: A full assessment of all the issues noted above can be found in Issues Which Keep Me Awake at Night 2011 Forecast: Politics Remain Pivotal Even As Risk Aversion Recedes (Nomura International plc. while weak governance in both Belgium and Italy may further unsettle bond markets. especially with key local elections in Germany in March. Furthermore. th China: The rolling out of the 12 Five-Year Plan will be a key element in ensuring a smooth economic trajectory through the handover of power to the incoming Fifth Generation leadership between October 2012 and March 2013. investors remain to be convinced that Eurozone leaders will yet find the wherewithal to avert a re-run of the early 2010 crisis. regardless of whatever incentives the international community offers. However. The United Kingdom: The 5 May 2011 local elections and referendum on electoral reform stand to test the ruling coalition’s resilience as the impact of the government’s ambitious fiscal consolidation programme is increasingly felt by the electorate. as well as a now probable early general election in Ireland. Iraq. the recent deepening and broadening of sovereign debt worries looks set to continue into next year. Nomura Global Economics 12 6 December 2010 .g. decisions in the US stand to be the main focus of markets as the outcome of the 2010 mid-term elections points to legislative gridlock (often seen. Brazil: A change at the helm still points to policy continuity. However. Sino-US relations remain paramount and we look to President Hu Jintao’s proposed visit to Washington In January 2011 to help defuse tensions. We look for bipartisan agreement to extend the Bush-era tax cuts (hopefully before they expire at the end of 2010) but see little hope of progress on medium-term fiscal consolidation. The Middle East: Domestic politics in a number of economies – e. as a positive by markets). • The United States: Barring an out-of-left-field event. However. Peru: An unpredictable election. even though we expect RMB appreciation to accelerate.

although the quarterly pattern has been more erratic than we had envisioned (Figure 1). The debt reckoning continues Household debt remains excessive Although the recent contraction shared a number of elements common to all cyclical downturns. OECD. From 2001 to 2006.6% clip envisioned at the end of 2010. owing much more than their property is worth. The nature and severity of the Great Recession continues to shape the profile of recovery. Consequently. a large backlog of homes in foreclosure further delays the price Figure 2.3% rate in the fourth quarter. t = 100 120 115 110 OECD big five 105 100 95 Recovery to date t-4 t t+4 t+8 t+12 t+16 t+20 Quarters from peak Our forecast Start of recession or financial crisis Earlier US Mar-08 Mar-09 Mar-10 Mar-11 Sep-08 Sep-09 Sep-10 Sep-11 Mar-12 Source: Bureau of Economic Analysis. we expect 2. real output will end the year a tad softer than we forecast in Outlook 2010. government efforts to help homeowners modify mortgages have done little to improve mortgage market fundamentals. With three quarters of 2010 real GDP already known and available data tracking a 2. time. 13 6 December 2010 . Indeed. Unprecedented millions of homeowners are irrevocably insolvent.2011 Global Economic Outlook United States ⏐ Outlook 2011 David Resler Debt hangover limits recovery The recovery from the “Great Recession” is likely to remain a slow and arduous climb. Actual and forecasted growth in real GDP: 2008-2012 % q-o-q ar 6 4 2 0 -2 -4 -6 -8 Actual (black bars) Dec 2010 forecast (red bars) Dec 2009 forecast (red line) Index. Indeed. but the collapse in prices of the real estate financed by mortgages has shattered the incentive to meet those debt obligations. but the recovery so far has been as disappointingly slow as we had expected. Moreover. household balance sheets remain bloated with mortgage debt. Although record numbers of these debtors are in arrears and facing foreclosure. As with all previous slumps. Nomura Global Economics. owing to the lackluster growth during the middle two quarters of 2010. Historically low interest rates have eased the debt service burden. the end of a housing boom initiated the contraction and the subsequent downturn as rising interest rates triggered a supply/demand imbalance that required an inventory correction. they remain near record levels. with outstanding household mortgage debt now exceeding the remaining equity stake (Figure 3).2%. Nomura Global Economics. Recoveries from financial crises: now and then The wheels of debt resolution turn slowly Figure 1. Upwards of one-in-five homeowners owe more than their home is worth.5% year-on-year growth in 2011. As a result.7% growth during 2010 looks to have been about right. mortgage debt of households grew at an average annual rate of about 12. the heavily leveraged equity cushion collapsed. But this housing cycle has been unlike any other. down slightly from the 2. Growth in 2010 lived up to modest expectations The National Bureau of Economic Research (NBER) determined that the longest and deepest business contraction since the 1930s ended in June 2009. Initially. But when the bubble burst. it also left a legacy of unique and debilitating effects. We forecast growth to remain below its underlying potential for most of the coming year. Nomura Global Economics Sep-12 Source: BEA.9%). featuring a brutal debt-financed real estate price bubble. household debt relative to income remains extraordinarily high (see Figure 1 in Box: Household deleveraging). Although financial institutions seem to have largely dealt with the consequences of that leverage. the extra leverage seemed to be paying off as real estate values rose even faster (12. and although mortgage debt delinquencies and foreclosure starts have retreated a bit. the legal wheels of debt resolution – foreclosure proceedings and bankruptcy – have been turning too slowly to quickly resolve the crisis. However well-intended. our year-ago forecast of 2. the recovery is tracking the same sort of trajectory that has prevailed after other financial crises (Figure 2).

A second is lower expected income. However. Similarly. commercial banks have charged-off about $80bn in credit card debt. auto loans and related debt. For mortgages at least. lower debt ratios should make spending and the financial system less vulnerable to asset prices. Figure 1. Mortgage debt dominated the increase in household leverage – accounting for 94% of the increase in the debt-to-disposable income ratio since 1997 – and has also accounted for most of the decline. and we estimate that other mortgage holders wrote off about $375bn in US home mortgages (extrapolating the Fed’s commercial bank default rates to the broader mortgage universe). Lower expected income growth means lower targeted debt levels and perhaps the need for higher precautionary reserves of liquid assets (particularly if income uncertainty has also increased). The total amount of charged-off mortgages (around $465bn) is therefore almost exactly equal to the decline in mortgage debt.7%. this makes intuitive sense: households cannot realistically pay off their mortgage debt by trimming other expenditures. The household debt ratio declined after the 1969-70. Over that same period. In addition. The economic impact of deleveraging is one of short-term pain for longer-term gain. Nomura Global Economics Source: Univ. the ratio of credit market debt of US households to disposable personal income has fallen by 12 percentage points (pp): from 130% to 118% (Figure 1). Note: Shading indicates recessions. weighing on growth and real estate prices. It also cuts available collateral. and other debt by just 2pp. of Michigan. as of Q2 2010 home mortgage debt had declined by $463 billion from its peak in Q3 2008. Mortgage debt has fallen by 10pp as a share of disposable income. Zach Pandl Since the start of the 2008-09 recession. we estimate that the debt-todisposable income ratio averaged 91% in 1995. and especially if falling debt levels are caused mostly by defaults. The post-war average of this ratio is 74. Across the OECD. Sharply declining debt levels are a distinctive aspect of the current recovery. One is the decline in house prices. Over time. Ratio of household debt to disposable income Figure 2. A very large portion of the decline in the household debt-to-disposable income ratio is therefore not voluntary “belt tightening” but reflects the extinction of debt through default. On current trends this decline would take another four to five years. commercial banks charged-off about $90bn in defaulted mortgage debt. Surveys suggest households have turned quite pessimistic about their future income prospects (Figure 2). which is equal to about half of the decline in consumer credit from its peak. deleveraging will cause households to shed assets. 14 6 December 2010 . BEA. financial innovation and changes in consumer preferences may have increased the structural level of debt. depressing consumption relative to income. which is where it stood in the late 1990s before the housing boom over the last business cycle. presumably making the economy more stable. and the average since 1916 is 38. What accounts for this big decline in household debt? The single most important reason seems to be defaults. 1981-82 and 1990-91 recessions. and therefore the appropriate level of debt that households should carry. households targeting lower debt ratios will likely raise their savings rates. A drop in house prices reduces wealth and expected lifetime resources.2011 Global Economic Outlook Household deleveraging Household debt ratios should continue to fall in 2011. Over the near term. At the height of the financial crisis. surveys and other data indicated a severe tightening of credit supply. 107% in 2000 and 129% in 2005.6%. In addition to defaults. putting downward pressure on prices (particularly for real estate). a number of secondary factors likely contribute to falling debt-to-income ratios. A third is supply constraints. 1973-75. We expect the debt-to-disposable income ratio to continue to fall. We think these constraints have dissipated a lot – as indicated by the Fed’s Senior Loan Officer Surveys – but they likely helped cause some of the initial decline in debt levels. however. which may be particularly important for household debt tied to small businesses. but the average decline at this point in the recovery was just 1pp. but it is difficult to know where it will stop. debt levels actually rose. According to Federal Reserve data. Median income growth expectations for next 12m % 140 120 100 80 Mortgages 60 40 20 0 Mar-55 Consumer credit Other Mar-65 Mar-75 Mar-85 Mar-95 Mar-05 Total % 5 4 3 2 1 0 -1 -2 -3 -4 Mar-85 Mar-90 Mar-95 Mar-00 Mar-05 Mar-10 Real Nominal Source: Federal Reserve. Our working assumption is that the US debt-to-disposable income ratio will fall to 90%. During and after the other post-war US recessions.

has recovered part of the wealth lost when asset prices collapsed during 2008-09. Labor market conditions began to improve in 2010 and we expect them to continue to do so in 2011 and 2012. Even though capital spending declined by more than 20% from the Q1 2008 peak to the Q4 2009 low and businesses’ stock of real business equipment fell for Figure 4. As with our forecast of a year ago. While facing a protracted period of debt-constrained spending. Uncertainty impedes the housing recovery Meanwhile.5mn over the four quarters ending in Q4 2012. Private sector employment has risen by more than 1. solid earnings growth and ample cash flow make it likely that the equity markets will continue to recover. builders remain hesitant to construct new homes. With overall demand improving gradually. With about 14. is wage and salary income. Payroll employment relative to cycle peak Home-building and construction face a slow recovery Manufacturers have raised their capital/labor ratio Figure 3.3% (3. That extra wealth lift should complement the growth in personal incomes – the mainstay of consumer spending. Such a slow recovery in employment is unprecedented and reflects what are likely to be profound structural changes.5 trillion. Nomura Global Economics . with housing starts remaining below the lowest point of all previous recessions throughout 2011 and most of 2012. with some 14. home-building is forecast to recover only slowly so most of the lost 2.4% of the housing stock still vacant. many of the job cuts in manufacturing also reflect a widespread industrial “rightsizing” as industries substitute capital for labor. job growth The labor market should continue to improve. With the Fed likely to complete its QE program. Nomura Global Economics. the second quarter’s $1. but still slow. Nomura Global Economics. no industry has been hit harder than construction where about 2.2 million (in net terms) since its December 2009 low. But a QE2-assisted boost to equities is a welcome lift Improving.5mn jobs from Q4 2010 to Q4 2011 and about 2. of course. Still.2011 Global Economic Outlook realignment necessary to establish confidence that the “correction” has ended. this long-standing trend accelerated during the recession (Figure 5). we envision only a slow rebound in homebuilding.5% of the existing housing stock still unoccupied. the household sector. the combined net worth of all US households stood at about $53. Indeed. but slowly The key driver of income growth. we expect the jobs recovery to accelerate and forecast total payroll gains of some 1. The result has been an unusually protracted housing slump and a housing market that increasingly seems unlikely to bounce back soon. The Great Recession also accelerated the decades-long slide in manufacturing employment but that sector has grown so lean that some industries are likely to restore some of the jobs they have cut.2mn) below the previous peak (Figure 4). forecast employment remains about 2. Mortgage debt and home-owners’ equity $trn 14 12 10 8 6 4 Mortgage debt 2 0 1980 1985 1990 1995 2000 2005 2010 Equity in residential real estate Index (100 at time t) 108 106 104 102 100 98 96 94 t-4 t t+4 t+8 t+12 t+16 t+20 Quarters from peak Source: Bureau of Labor Statistics. Thanks in part to stock prices resurging in anticipation of the Fed’s latest phase of quantitative easing (QE2). 15 6 December 2010 Business cycle peak Post-war average Actual Forecast Source: Federal Reserve. It seems unlikely that employment will regain that peak before the end of 2013. nearly double the number added during the 200207 expansion. the growth in consumer spending is likely to be restrained.7trn higher than at the nadir of the recession when the cumulative loss stood at $17trn. which depends primarily on the state of the job market. Through Q2 2010.2trn drop in households’ equity and mutual fund balances was more than recovered in the third quarter. down somewhat from the first quarter but about $4. Arguably. as a result of rising stock prices. Still.1 million jobs have been eliminated. Until more households fully extinguish that debt.1 million construction jobs are likely to be permanent. five full years after the previous business cycle peak and some two and a half years after the trough.

during the 2008-09 recession. A further increase in this job mismatch could convert some cyclical unemployment into permanent unemployment and thereby reduce the economy’s potential GDP growth rate. the relationship between the unemployment rate and inflation has either become unstable. defined as the unemployment rate that is consistent with a stable rate of inflation. the jobless rate reached double-digits in Q4 2009 and has remained above 9% longer than at any time since the Great Depression. The CBO’s methodology relies on a number of assumptions and estimates of its component parts. the central tendency of FOMC members’ projections of the longer-run unemployment rate was revised up to 5.2%. The Congressional Budget Office (CBO) calculates perhaps the most frequently cited estimate of the output gap. including the labor input gap.8pp smaller than the CBO’s estimate of -6. there are several ways to measure economic slack. suggesting there is considerable deflationary pressure on inflation.0 6.5 4. Thus.0 3.0~5.5 percentage points (pp) below the current jobless rate. making it debatable just how big the output gap is. Thus.3%. The output gap is defined as the difference between actual GDP and potential GDP. oil price shocks and wage and price controls” in estimating the natural unemployment rate. 16 6 December 2010 . many economists argue that a mismatch between job seekers and employers has been widening. if a labor market mismatch has effectively narrowed the output gap. Nomura Global Economics -8 Mar-67 Mar-74 Mar-81 Mar-88 Mar-95 Mar-02 Mar-09 Source: CBO. Meanwhile. resulting in a higher natural unemployment rate than current estimates of NAIRU suggest. many argue that the slide in inflation can be attributed to the huge excess of productive capacity in the economy.5 natural unemployment rate based on the Beveridge curve CBO's estimate % 6 4 2 0 -2 -4 -6 output gap based on the Beveridge curve analysis CBO's estimate -3.5 6. Nomura Global Economics.0%. While the CBO took into account other factors such as “changes in productivity trends.0 5. we extracted a structural component from the unemployment rate (Figure1). Output gap: CBO and our alternative % 7. The “core” consumer price index – the CPI excluding food and energy – advanced by just 0. Figure 1. which relates the unemployment rate to the job vacancy rate. Federal Reserve Chairman Ben Bernanke recently noted that protracted episodes of joblessness “may also convert what might otherwise be temporary cyclical unemployment into much more intractable long-term structural unemployment.0% in November from June’s projections of 5. noting that its inter-temporal stability seems unreasonable.1 3. it is unclear how much slack exists in the system. inflation pressures could surface sooner than conventional estimates of the output gap may imply. The CBO currently pegs the NAIRU at 5. Although the economy continues to operate with a lot of slack.1% of GDP. The latter is defined as the level of output attained when labor and capital are used at a normal (economic-trend adjusted) level. Thus. However. The combination of a fairly high unemployment rate and a falling but still positive inflation rate. With most other inflation indicators tracking a disinflationary trend. some economists question the CBO’s estimate of NAIRU. about 2. the overall output gap depends on the level of the natural unemployment rate. its lowest reading since the series began in 1957. Nomura Global Economics.1% (Figure 2).7% to a record low of 68. which is primarily determined by the divergence between the actual rate of unemployment and its “natural rate”.” Reflecting this possibility. more than 4. we calculate an output gap of -3. To assess those arguments. We estimate that the persistently elevated job vacancy rate coinciding with a rising unemployment rate would effectively raise NAIRU to about 6. we derived an estimate of the natural unemployment rate to incorporate variation in job mismatches. For instance. its latest estimates put it at a sizable 6. which corresponds to the CBO’s NAIRU (non-accelerating inflation rate of unemployment). Incorporating this estimate into output gap accounting. which is similar to the CBO’s methodology. the capital utilization rate in the industrial sector plunged from an April 2007 peak of 81.5 5.2011 Global Economic Outlook The output gap Aichi Amemiya Although the output gap is a key determinant of inflation.3 -6. or there has been some structural shift in this relationship in recent years.3%. By removing the cyclical element from the so-called Beveridge curve.2% in June 2009.0 Mar-64 Jan-72 Nov-79 Sep-87 Jul-95 May-03 Source: CBO.0~6. Natural unemployment rate: CBO and our alternative Figure 2.59% in the 12 months ending October.0 4. suggests that the inflation rate has been boosted by some factor other than the unemployment rate or that the natural rate of unemployment may be temporarily elevated for some reason.

broadening the base.6%. never exceeding 20. and other defining tax regime characteristics. and simplifying the code could both boost output and secure a more stable source of income. and Erskine Bowles. Relative to GDP. The Bowles-Simpson plan would cap revenues “at or below” 21% of GDP and would cut spending to about 22% of GDP before eventually falling in line with the revenue cap. Complicating the task of setting policies to resolve these cyclical imbalances.9% or falling short of 16. thoughtful measures to address the long-run problems in Medicare and Social Security can no longer be blithely dismissed as politically impossible. has created a distorted and unstable revenue base in which most income tax revenues flow from those in the highest brackets (Figure 2). and would limit or cap various tax deductions including mortgage interest and charitable deductions. it would also simplify the tax code to just three marginal individual tax rates 8%. Figure 2. Figure 1. averaging 18. Even before the commission issued its report. Perhaps most importantly. The new Congress is likely to be receptive to such proposals. a former Republican senator. the Bowles-Simpson tax plan would repeal the alternative minimum tax and state and local income tax deductions. The Great Recession has left a legacy of depleted revenues and expanded outlays. Federal receipts and outlays: shares of GDP. the commission’s tax proposals hold particular promise and may find a warmer reception in the new supplyside-oriented Congress than the more controversial entitlement reforms. once President Clinton’s chief of staff. Encouragingly. Nomura Global Economics . policymakers also now face the consequences of procrastinating for decades over addressing the effects of an aging population on entitlement spending. the commission implicitly acknowledges that “comprehensive tax reform” can help promote growth. as Figure 1 illustrates. Whether the revenue and spending goals can be achieved. History sometimes creates its own imperative. the fiscal policy debate is rapidly shifting to concerns about the long-run budget outlook. the proposals themselves represent a watershed in the debate about fiscal priorities and the “guiding principles” behind the plan could serve as a template for informed debate on structuring a credible fiscal policy fix. co-chairs Alan Simpson. This remarkable stability has occurred despite a wide range of marginal tax rates. In the year ahead. Flattening the rate structure. Spending on the other hand has trended higher as recessions ratchet outlays up to levels that fall only grudgingly when the economy improves. outlined their own five-part plan.1% since 1951. This simple graphic encapsulating decades of diverse experience leaves little room to doubt that only structural reform of both spending and taxes can materially reduce the deficit. 17 6 December 2010 Decade/Years Source: Congressional Budget Office. with its seven marginal rates and complexity of deductions and exemptions totaling some $1. Notwithstanding the intense resistance to changing entitlements. revenues have never been lower nor outlays higher than in the past three fiscal years (Figure 1).2% to 18. The 1 December report from the president’s special bi-partisan deficit reduction commission has brought that debate to center stage. and 23% and a single corporate tax rate of 26%. Nomura. which will convene its two-year session in early January. Decade-long averages have fallen in an even narrower range: from 17. The commission recommends meaningful reforms both to sacrosanct entitlement programs as well as to the Byzantine tax code. some specific proposals within the plan could find their way into legislation sometime during the 112 Congress.2011 Global Economic Outlook The new fiscal debate David Resler In 2009 government policies focused on economic stimulus and in 2010 on sweeping health care and financial services reforms. revenues have been remarkably stable. Although enacting all the commission’s recommendations seems out of reach th in the near future. exemptions and deductions. Instead. 14%. Tax filings and yield by marginal rate. In our view. Although many insist that a still struggling economy requires more fiscal stimulus. the compelling case for long-run fiscal policy reforms takes center stage. Notably. Nomura Global Economics. 25 % 100 % Share of returns Outlays 20 Deficit 75 50 15 Receipts 25 10 Share of taxes paid 2000-07 2008 2009 1950s 1960s 1970s 1980s 1990s 2010 2010s 0 0 5 10 15 25 28 33 35 Marginal tax rate Source: US Treasury: Statistics of Income. However. Current law.1% until the current cycle.3 trillion in 2007. the perceived failure of nearly three years of stimulatory policies to secure a strong recovery has all but foreclosed consideration of new spending measures.

4% in 2011 and 11. we have not altered our long-standing forecast that inflation will remain below the Federal Reserve’s “mandate consistent inflation rate” – i. concerns about the US government’s long-run finances now seem likely to outweigh arguments for another short-term stimulus. The dollar’s sharp decline in advance of the Fed’s QE2 decision made it seem likely that a weaker dollar would generate a further lift to exports.0 1.e. barring an overwhelming reversal of the dollar’s weaker trend. Contributions to GDP growth by sector Booming Asia should boost exports Government spending will be a drag on growth Figure 5. Meanwhile. That capital downsizing undoubtedly reflects the effect of a net decline of nearly 200.5 1.. financial services. Nomura Global Economics.5 -1. Consequently.5pp to overall GDP growth in 2011. A lower level of potential output also implies the need for fewer workers (i. US exports are likely to grow at a considerably faster pace than imports. and manufacturing. With the lingering effects of the debt-financed housing bubble still restraining domestic demand.000 businesses in four key industries: construction. Nomura Global Economics Source: BEA. production growth will depend increasingly on demand from markets overseas. We expect trade to contribute about 0. shipping and transport.0 -0.0 0.2% in 2012. state and local governments will continue to trim spending. China. For instance. we expect the FOMC to maintain an unusually accommodative policy stance but we do not envision the need for a further expansion of the QE program already announced. 18 6 December 2010 Structures Govt . a higher unemployment rate) than in the past and policymakers seem to agree. economic policies are unlikely to provide much extra stimulus in the year ahead. The temporary boost from the 2008 and 2009 fiscal stimulus programs will likely turn to being a drag on growth. respectively. we expect increases in business investment in equipment and software to be quite robust: 11. it is likely to take many more years before the economy will require the number of workers that were employed at the peak of the last expansion. Nonetheless. ar 2. BLS: Nomura Global Economics. and Brazil have become increasingly important destinations for US exports.e.. the degree of “slack” that we expect to persist should limit any price pressures that might develop.0 Inventories Consumption Equipment Trade Housing 2009:3 to 2010:3 2010:4 to 2011:4 2012 Source: BEA. the real value of business capital per employed worker jumped to a record high. Nonetheless. India. new firms and the survivors that deferred or cancelled projects during the recession will need to invest in new equipment and hire more workers. higher in September than their comparable totals a year ago.5 0. Accordingly. Figure 6. a rate of about 2% in the PCE price index. but to play a much less important role in 2012 as the dollar begins to recover some of its recent decline (Figure 6). Owing to their exceptional growth over the past year. A lower level of potential output The Great Recession has cut potential output These observations suggest that the Great Recession has cut into the economy’s productive potential (see Box: The output gap). Although this also suggests that inflation pressures could begin to surface at a higher unemployment rate. With the new Congress likely to shift the fiscal policy debate toward long-run concerns (see Box: The new fiscal debate) and to intensify its scrutiny of monetary policy (see Box: Fed policy in the crosshairs). the 12-month cumulative total of US exports to China and to Brazil were about 35% and 25%. but the resurrection of sovereign debt concerns has heightened uncertainty in the foreign exchange markets. Consequently. Capital stock per private sector employee $ 000s 140 135 130 125 120 115 110 105 100 95 90 1980 1985 1990 1995 2000 2005 2010 Actual Estimated percentage points. virtually all levels of government are laden with debt and must limit spending. Like households. Long-range forecasts from Federal Open Market Committee participants show that more policymakers expect a higher unemployment rate than in the past. As these industries gradually recover. Without the temporary aid from the federal government.2011 Global Economic Outlook the first time.

By the time the Fed had completed its MBS purchase program early in 2010. In particular. over that six-month span. the Fed set a “strategy or rule” for systematically adjusting its interest rate target to achieve its goals and a ”procedure for adjusting the supply of bank reserves. an amount consistent with its long-term trend. Nonetheless. From August 2007 until the fall of Bear-Stearns in March 2008. Beginning in March 2008. the Federal Reserve has taken the lead in devising policies to minimize harm to the world economy. Mr Pence ignores the last of those three goals and directs his criticism at the first two – the so-called “dual mandate.339 trillion and most expected the Fed to gradually contract the portfolio. Representative Michael Pence (R. Initially. For instance. the invocation of the “exigent circumstances” clause in Section 13(3) of the Federal Reserve Act (FRA) began to raise questions about the Fed’s conduct.” An activist Congress is likely to give Professor Taylor’s proposal or others like it a serious hearing in the year ahead. Our forecast that inflation will stabilize and begin edging higher as the economy gradually strengthens implies the Fed will fulfill its stated plans. He links problems of monetary policy to the Federal Reserve Reform Act of 1977 that established the “goals of maximum employment. it began to use some of these standards tools in unconventional ways. single mandate – price stability. But from Bear-Stearns’ demise until the September 2008 bankruptcy filing by Lehman Brothers. the Fed largely offset the increase in dealer and bank lending with reductions in its holdings of US Treasury debt. the Fed once again provoked its long-time critics. targeting a path for the price level rather than the rate of inflation. his proposed legislation would “return the Fed to its original. Critics now seek to debate the proper role of the central bank. However.” In the tradition of most such discussions. but that no further operations will be needed. The Fed however does not necessarily see the dual mandate as an impediment but believes that it can best achieve both by pursuing a “mandate consistent inflation rate. stable prices and moderate long-term interest rates.” While Mr Pence is incorrect in his reading of the “original” mandate – the FRA of 1913 made no mention of such macroeconomic goals – his arguments for a single goal have a solid theoretic foundation. Critics’ concerns have ranged from the Fed’s mandated goals to the need for greater oversight and indeed for its very existence. perceiving an increasing threat of deflation.2011 Global Economic Outlook Fed policy in the crosshairs David Resler Policy innovations by the Federal Reserve since the onset of the financial crisis helped stabilize markets and pave the road to recovery. Others have focused on other aspects of Fed policy. the FOMC is contemplating “a number of possible strategies… including providing more detailed information about the rates of inflation the Committee considered consistent with its dual mandate. Nomura Global Economics 19 6 December 2010 . Indiana) has introduced legislation that would redefine the mission of the Fed. the Fed’s actions provoked little more than a few raised eyebrows among its critics as it stretched the interpretation of the powers granted it under section 13(3) of the FRA. critics zeroed in on the Fed’s creation of the Maiden Lane funds as an unauthorized intrusion into the market’s role of allocating credit. the Fed relied mainly on its conventional tools to address market dysfunction and illiquidity. the Fed decided that it must not allow any further contraction of its balance sheet. the Fed decided to expand its securities holdings to prevent the contraction of its balance sheet that would have resulted from the natural phase-out of the emergency lending programs.” To that end. Stanford Professor John Taylor (of Taylor-rule fame) has proposed that Congress reinstate “reporting and accountability” rules for the Fed that would modernize earlier oversight rules “to incorporate policy decisions about the interest rate. which had increased by more than 165% by the end of 2008.” Professor Taylor proposes that as part of its reporting requirements. by concentrating its purchases on mortgage backed securities (MBS). Judging that threat not to have diminished. the FOMC in November announced its intention to increase its US Treasury securities holdings at a pace of about $75 billion per month until it reaches a target of about $$600 billion at the end of Q2 2011. however. But in August.. The collapse of Lehman Brothers changed everything.” Accordingly. the Fed’s balance sheet increased by a modest $22 billon. Since the earliest signs of the financial crisis surfaced in the summer of 2007. Convinced that it would need to keep the size of its balance sheet elevated (a policy the Federal Open Market Committee (FOMC] announced in its 16 December 2008 statement). The evolution of those efforts reflects the shifting perceptions about the very nature of the crisis. including granting discount-window lending access to non-bank primary dealers. The FOMC has also made clear that the pace of implementing this policy will depend on evolving economic conditions. and targeting a path for the level of nominal GDP. its balance sheet had swelled to $2.” The Congressman contends that “this conflicting mandate has pitted short-term hopes for job gains against long-term costs to the economy [and that] QE2 is an example of what happens when the Fed involves itself too much in macroeconomic meddling.” The accountability provision must explain and account for “any revisions to or deviations from such objectives or plans. Opponents of this first phase of “quantitative easing” objected to the Fed’s “money printing” operations and to its singling out of a particular sector for credit injections.” Legislative initiatives by Mr Pence and others will likely sharpen the Fed’s focus on such reforms. These measures helped prevent a collapse of liquidity in the financial system but also resulted in a massive expansion of the Fed’s balance sheet. the Fed’s expansion of its balance sheet – and indeed the whole array of unconventional policies it has used to tackle the crisis – has triggered a growing wave of skepticism about the conduct of monetary policy. For instance. but have alarmed some. Nonetheless. Nonetheless.

0 0.9 0. Nonfarm payrolls are average monthly change during the period.42 1. In addition.4 9.64 2.8 -3.6 7.9 1.50 1. Inflation measures and calendar year GDP are year-over-year percent changes.30 0. Third.9 -3. Activity: Emerging from a mid-2010 “soft-patch.5 -2. 000 saar Consumer prices Core CPI Federal budget (% GDP) Current account balance (% GDP) Fed securities portfolio ($trn) Fed funds 3-month LIBOR TSY 2-year note TSY 5-year note TSY 10-year note 30-year mortgage 3Q10 2. Policy: We expect that QE2 will be “one and done” – that the Fed will complete.9 -1.4 125 637 1.0 0.5 4.5 2.4 -0. Risks: Risks are roughly balanced.00 3.1 9.85 4. sales volumes and home-building are likely to remain depressed compared to pre-recession levels. Inflation: We believe the four-year slide in core inflation will come to an end in 2011.6 7.2011 Global Economic Outlook United States ⏐ Economic Outlook David Resler ⏐ Zach Pandl ⏐ Aichi Amemiya Firmer turf on the recovery road We see modest growth.6 -1. The positive impulse from the 2009 Recovery Act has now turned into drag.7 4Q11 2.25 0-0.1 -3.6 9.7 0.10 3.2 9.3 0.4 7.00 2.3 0.85 4. Details of the forecast % Real GDP Personal consumption Non residential fixed invest Residential fixed invest Government expenditure Exports Imports Contributions to GDP: Domestic final sales Inventories Net trade Unemployment rate Non-farm payrolls.54 2.6 1Q11 2.5 6.1 1.0 -1.50 2.25 0.30 0.85 5.51 4.1 -2. with widespread spare capacity across many sectors (for background.25 0.40 4.64 2. Source: Nomura Global Economics.3 0.0 1.2 0.7 7.90 2. Housing starts are period averages.6 0.00 1.8 -7.25 0-0.0 0.5 4.6 0.5 2.4 -4. the sweeping reforms of the health care and financial services industries could impede hiring and investment.5 2. especially over the near-term.7 2.00 3. Nonetheless.25 0-0.0 0.00 1.6% y-o-y) for a few months.8 2.04 0-0.4 17.0 1.30 0. Finally.30 0. The unemployment rate is a quarterly average as a percentage of the labor force.5 0. most measures of inflation expectations look stable. but not add to.40 4. On the downside.8 1.1 0.3 9.65 4.25 0-0.25 0-0. Domestic fundamentals remain deflationary.1 8. If growth falls below trend. 000 Housing starts.6 2.3 150 659 1.2 6.75 1.25 3.00 0.25 3. First.29 0. while we see some improvement in the housing sector. Numbers in bold are actual values.25 0-0.9 11. The outlook for fiscal policy remains highly uncertain. the dollar has weakened.6 8.25 1. Alternatively. Interest rate forecasts are end of period.0 2Q12 2.26 3.7 7.24 2.7 5.3 9.8 9.25 0-0.6 0.3 16.0 0.25 0-0.5 -1.8 2.25 3.8 2. Nomura Global Economics 20 6 December 2010 .75 4.8 2.00 2.30 0.30 0.7 8.9 5.3 1.4 2.7 2.9 -9. Table reflects data available as of 6 December.2 3. The additional easing of monetary policy late in 2010 makes it unlikely that the FOMC will begin raising its interest rate targets before 2013.64 2.75 0.8 6. before rising very slowly to 1% by the end of 2011. consequences and cures).1 175 706 1.6 119 624 1.7 -1.6 2012 2. However.0 0.7 100 619 1.8 6.7 6.0 -3.75 4.1 3.1 -5. Putting it together.00 1.0 -1.25 0-0.1 7.8 7.9 2.7 75 542 1.0 7. or actual inflation fails to stabilize. A delay in extending Bush-era tax cuts could dent growth in early 2011.3 9.7 74 588 1.0 2. commodity prices have picked up.7 9.5 0.0 6.50 0.7 -3.9 4Q10 2.34 2.8 2.3 10.64 2.8 -7.7 0. fiscal policy is expected to be less favorable for growth.3 1.10 3.7 1.2 0.9 1Q12 2.00 3.8 2. while state and local government budget pressures should weigh on outlays and employment.15 4.7 8.25 1.3 13.4 -0.25 3.7 0.30 0.5 -0. and rent inflation has started to turn (rents make up a large share in US consumer price indexes).64 2.9 1. On the other hand. we do expect some modest tightening in the form of balance sheet contraction to begin in 2012. powerful headwinds are likely to keep the pace of growth quite moderate in 2011.3 -27. see our report Deflation: causes. we are concerned about a step down in real estate prices and its impact on consumer spending and the financial system.32 Notes: Quarterly real GDP and its contributions are seasonally adjusted annualized rates (saar).0 -1.3 2.8 5.7 2.9 213 769 1. the Fed could purchase more.30 0.7 9.6 3.1 -0. higher business confidence and better financial conditions could lead to faster growth.9 1. inflation expectations slip.54 2.30 0. household deleveraging should restrain consumption and put downward pressure on real estate prices.25 0-0.0 200 754 1.7 2.6 2.80 1. we forecast that core inflation will hold at current levels (0.6 -73 589 1.3 -1.5 2.9 7. Second.8 100 582 1. and the Fed on hold in 2011.0 8.8 2Q11 2.4 0.1 2010 2.75 0.50 0.75 1.” the US economy appears to be entering a more secure phase of recovery.6 1.7 3. the second round of quantitative easing.4 2.50 1.8 10.85 4.24 2.0 0.2 0.2 7.8 3Q11 2. low but stabilizing core inflation.4 2011 2.50 2.4 4.00 2.

0 3.50 1. inflationary pressures are expected to remain well contained.7 7.25 2.4 8.7 1.3 0.5 4.4 3.5 2.7 5. This is in sharp contrast to the growth rate of the Canadian economy during the recovery.7 7.9 0. Risks: We think that the risks to our scenario are balance. as households increase their saving rate to reduce their debt burden.7 78 2.87 2. while the gradually pickup in global and US growth should provide some much needed support for exports.3 -0.03 1.00 0. Source: Bank of Canada.0 -3.1 0.8 6.8 -5.2 7.8 2Q11 2. as the output gap narrows to zero.8 2.8 6.1 7. As the excess capacity gradually fades.0 0.5 19.1 70 2.2 3.5 4. 000 Consumer prices Core CPI Federal deficit (% GDP) Current account balance (% GDP) Overnight target rate 3-month T-Bill 10-year government bond USD/CAD 1.8 2.4 -1. especially for domestic demand. Most of the downside risk is linked to external factors.99 2011 2.90 3. On the positive side.1 7.2011 Global Economic Outlook Canada ⏐ Economic Outlook Charles St-Arnaud In need of a push from the neighbours Growth is expected to very gradually increase.5 8. as the housing market gradually return to more sustainable levels.6 1.75 1.5 3.8 1.20 3. Activity: We expect activity to gradually pickup in 2011 and to be slightly above the long term trend of 2.0 7.10 0.1 7.30 2.9 3.99 1.1 1.0 60 2.70 1.8 2.7 8.20 0.8 1.5 6. Interest rate forecasts are end of period.4 3. the strong domestic demand should continue to boost imports. The unemployment rate is a quarterly average as a percentage of the labour force.3 5.9 -2.8 2.6 4Q10 2. Policy: With considerable monetary stimulus in place.20 1. reversing some of the competitiveness lost due to the higher dollar.1 4.30 0.0 -1.00 0.0 2.2 90 1.9 60 2.7 -0. Consumer spending is expected to moderate gradually.0 0. we believe that the BoC will continue to gradually remove some of the monetary stimulus over the next years.9 -5.1 3.30 3. Headline inflation is expected to be slightly higher than the Bank of Canada’s 2% target in the first half of 2011. the gradual increase in commodity prices should boost Canada’s terms of trade and national income. Fiscal policy is expected to be neutral over the projection period.30 2.2 2.2 2.6 -3.9 6.7 6.1 1.4 5.2 4.4 90 1.4 0. However.0 0.8 7.5 2.9 9.25 2.3 6.0 0.8 3Q11 3.00 Notes: Quarterly real GDP and its contributions are seasonally adjusted annualized rates (saar).0%.3 -0.1 1.25% by year end. In addition.7 5. as the government unwinds the stimulus put in place during 2009. before declining below 2% in the second half as the effect from the July-2010 introduction of the Harmonized Sales Tax disappear.00 2012 2.0 2.75 1.5 2.8 2.4 2.0 1.6 80 1. Residential investment is expected to remain tame in 2010. With the output gap expected to close in 2012.7 13.00 0.0 2010 2. Table reflects data available as of 6 December 2010.25 3. growth could surprise on the upside and consumer spending and residential construction could prove more resilient than expected.9 2.40 3.75 3.75 3.0 4.9 6.00 2.2 8.1 -0. Core inflation is expected to remain below the BoC’s target in 2011 and then gradually converge to 2%.9 2.7 0.7 5.9 4Q11 2. but remains highly dependent on exports. Business investment in machinery and equipment is expected to remain robust over the forecast period supported by the need to rebuild capital after almost two years of weak investment.8 80 2.4 0.0 10. Statistics Canada.4 2.0 2Q12 2.0 3.9 0.0 -0.90 1.9 2. the growth outlook remaining fairly positive.9 -0.00 0.8 7. Details of the forecast % Real GDP Personal consumption Non residential fixed invest Residential fixed invest Government expenditure Exports Imports Contributions to GDP: Domestic final sales Inventories Net trade Unemployment rate Employment.5 5.7 0.0 7.50 1.7 0.1 6. Nomura Nomura Global Economics 21 6 December 2010 . Inflation measures and calendar year GDP are year-over-year percent changes.8 -4.97 1.00 3.00 0.8 1Q11 2.4 4.1 7.3 -0.9 -0.0 6.75 2.5 2. the BoC should resume tightening monetary policy.5 6.9 -3.90 3.97 1.0 1Q12 2.1 70 2.0 5.50 1.9 2. We expect the Bank of Canada to resume tightening at the end of 2011Q1 and to proceed very gradually reaching 2.25 1.2 -2.0 0.1 10.3 0.7 2.8 5.0 4.9 0.0 2.1 -0. In addition.90 4.0 -2.5 0.0 0.80 3.1 96 1. but uncertainty remains elevated.0 83 1.1 5. Employment is the average monthly change during the period.4 2. with the risk of a slower US and global economy at the forefront given the impact on exports and commodity prices.3 5.4 4. Numbers in bold are actual values.8 4.5 0. the strong Canadian dollar provides an incentive to invest by reducing the cost of imported capital goods.3 -0.99 2.2 1.8 4. Inflation: With significant spare capacity in the economy and growth not strong enough to close the output gap until 2012.00 3Q10 1.0 1.

fixed investment growth looks set to accelerate further over the forecast horizon: we expect it to rise by 1. while activity has stagnated in Spain and Portugal. and in Germany. Netherlands (58%) Semi-core .8 9. Ireland (17%) Euro area Real GDP grow th HICP inflation Unem ploym ent rate ECB policy rate 10-year Bund yield Fiscal balance 1.Spain. Investment.9% (from 1. and relatively broad-based. Several factors suggest that firms will continue to invest to add to their productive capacity. Furthermore. Nomura Global Economics . the level of uncertainty surrounding these projections is unusually high.10 -6. Source: Nomura Global Economics.4 Note: Annual averages.1 10.7 1.50 2. we revise up our 2011 outlook The upturn has gained more traction in 2010. a lower euro and better credit conditions should help support growth in the core countries.0 9.3 1. Belgium (24%) Periphery .6 Index. We expect the economic recovery to remain intact and growth to re-accelerate over the forecast horizon.00 1. Since our last major forecast write-up (European Economic Outlook: The Hazardous Journey. Source: Eurostat. Cross-country divergences look set to widen further in 2011. Unemployment rate is % of labour force and fiscal balance is % of GDP.6 -3.0 1. As a result. 1Q08 = 100 104 102 100 98 96 94 92 1Q08 1Q09 1Q10 1Q11 1Q12 Note: The numbers in parenthesis denotes share of EA GDP. broadening out from being purely export-driven. France. We have previously argued that the recovery will be kick-started by strong exports.7 1. Austria. lower bond yields.9% in 2011 and 3.3 -4. economic conditions in the “periphery” economies have weakened further: activity in Greece and Ireland has continued to contract.3% in July) in 2010. By contrast. 31 July 2010).2% (from 1. We have therefore revised up our euro-area GDP forecasts to 1. Encouragingly. consumption growth should regain speed as well. complicating the ECB’s exit path.2 2.9 2. Second. to 1. Nomura Global Economics.7% (from 1.1% in 2012. We forecast this trend to continue: stronger private and external demand should thus offset the headwinds from the fiscal tightening that is expected in 2011 and beyond.. the recent pick-up in bank lending is an early sign that the corporate deleveraging cycle is coming to end (see Box: Turning now to credit).00 3.4 -5.8%) in 2012 (Figure 1).80 -6.90 3. however.6 1. First.Germany.. Despite market turmoil.5 1. it finally increased in both Q2 and Q3.50 3.6 10.00 1. Euro area GDP levels: to date and forecast Figure 1.75 2.40 3.8 1. In view of the ongoing market turmoil.8 1. ECB. as the recovery should gradually trigger an improvement in labour market conditions. up.0 9.70 4. except interest rates which are end of period. the sustained increases in consumer confidence and business surveys – many are now at multi-year highs – suggest that capex will continue to contribute to GDP growth.9 forecast 10.6% in 2012. the euro-area recovery has turned out stronger and more resilient than we were expecting. while headwinds from deleveraging and fiscal austerity measures should continue to Figure 2. Main euro area forecast changes % July 2010 2011 2012 Decem ber 2010 2011 2012 1. and then consumption. in particular.9 2. Confidence effects and early signs of housing market stabilisation (see Box: House price prospects) should also induce households to increase their spending: we forecast growth of 0.. with private domestic demand growing in both Q2 and Q3.3 1. Greece.and should increasingly become broad-based Two-speed euro area to continue Euro-area aggregate growth has so far been mainly supported by a stronger-than-expected recovery in the so-called “core countries”.Italy. 22 6 December 2010 Core . Growth divergences will likely persist into 2011 We think these growth divergences will persist in 2011 and 2012: strong global demand.6 -4.00 2. . to be followed by investment picking up. Bloomberg.2011 Global Economic Outlook Euro area ⏐ Outlook 2011 Peter Westaway ⏐ Jens Sondergaard ⏐ Lavinia Santovetti A slippery road lies ahead We forecast the recovery to become more evenly driven by domestic and external demand. finally! There are signs that the recovery is.. investment seems to have responded earlier than expected: after eight consecutive quarterly declines. increasing to 1.8% in 2011. Portugal.5%) in 2011 and to 2. underpinned by the revival in domestic demand.

We also used our EONIA forecast. At the same time. To use the set of models for a credit growth projection. While we do not expect the ECB to sound the alarms with credit growth at those levels. At the height of the financial crisis in February 2009. This more upbeat assessment is consistent with the results in the September 2010 ECB Bank Lending Survey (BLS). But there are also signs that the deleveraging cycle by non-financial corporations is coming to an end. the ECB pointed to a “deceleration in the underlying pace of monetary expansion” as supporting evidence that inflationary pressures were diminishing. there are monetary hawks on the Governing Council that have repeatedly emphasised that keeping interest rates too low for too long may create a new credit bubble. Nomura Global Economics Note: Latest data point is Q3 2010. In addition. a substantial pick-up in lending growth in the euro area would be needed before money and credit growth would be a source of upside risk to price stability. Euro-area private sector credit growth Figure 2. mainly because of greater corporate demand for inventory and working capital financing (Figure 2). Source: ECB and Nomura Global Economics. First. which confirmed that credit conditions had improved in the euro area in Q3 and are expected to continue to do so in Q4. driven mainly by stronger lending to households. But after having fallen sharply during 2008-09. which is encouraging for the investment outlook. We used the suite of models to gauge what the current upbeat signals from the September BLS results suggest for euro-area credit growth in Q4 2010 and Q1 2011. particularly for house purchases in France and Italy (Figure 1).5% by the end of Q1 2011 with y-o-y household credit growth stabilising at 3. we think the ECB will become more concerned. net loosening -20 -10 0 10 20 30 40 50 60 70 1Q09 1Q10 Demand: future (lhs) Supply: future (rhs) 1Q02 1Q04 1Q06 1Q08 1Q10 Demand: present (lhs) Supply: present (rhs) Note: Horizontal dotted line represents 2000Q1-2010Q3 average. How much weight should be put on the results in the bank lending survey? A recent ECB Working Paper (The euro area Bank Lending Survey matters) showed that the BLS results are leading indicators for bank lending growth in the euro area.7% by the end of Q1 2011. Assuming that the sovereign debt crisis gradually abates in 2011. net loan demand for financing fixed investment may finally be turning a corner. stating explicitly that “a turning point” was reached in early 2010. we assume banks will report a further loosening in credit conditions over the next two quarters (with the size of the reported easing calibrated to match what was observed between Q2 and Q3 2010). Specifically. we assume that banks will continue to report a further gradual uptick in net demand for both household and corporate lending (again the size of the demand uptick every quarter calibrated as above). Figure 1. thus supporting the case for the ECB to begin raising interest rates in the second half of 2011 This assumes that the current tensions in the periphery are short-lived and do not have major negative implications for the banking sector’s ability to supply credit. with monthly lending flows to firms picking up and the annual growth rate of credit to firms becoming less negative in 2010. which has the main policy rate rising to 0.5%. ECB Bank Lending Survey: corporate sector % y-o-y 20 15 10 5 0 -5 1Q00 forecast Private sector lending Lending to non-financial corporations Loans to households % balance. But if credit growth continues to trend upwards throughout Q2 and Q3 2011.6% and non-financial credit growth increasing to 1. Money and credit developments play an important role in the ECB’s policy decision-making. we project a further rise in euro-area credit growth over the next two quarters. These levels suggest a fairly moderate credit expansion that is well below the monthly 2000-10 average. 23 6 December 2010 . The survey reported that net demand by firms for bank loans turned positive for the first time in more than two years. euro-area credit growth now appears to be picking up.2011 Global Economic Outlook Turning now to credit Jens Sondergaard There are early signs that the euro-area credit cycle is turning decisively. What does the recent pick-up in credit suggest for the ECB’s policy stance? The ECB has lately become cautiously more optimistic about the outlook for credit. the work – using an estimated suite of models – shows how an easing in credit conditions in a particular quarter is generally followed by an uptick in bank lending growth (both corporate and households) in the following quarters. we had to make assumptions on the results of the next two Bank Lending Surveys (the next one is in January 2011 and the one after in April 2011). In our view. increased demand 40 30 20 10 0 -10 -20 -30 -40 -50 1Q06 1Q07 1Q08 % balance. We calculate that the annual private sector credit growth will increase to 2. Source: ECB and Nomura Global Economics.

fiscal headwinds and political instability will probably adversely affect the Italian housing market in 2011. such as demographics and inflation. a rising population and decreasing user costs have lifted equilibrium levels. Spain (17%) and the Netherlands (4%). but rise by 3% in 2012. In France. so it is worth asking whether house prices in the euro area have really hit the bottom. The situation in Italy is similar: A conservative banking sector has protected the housing market from the credit crunch. we think an increase in line with inflation is likely because of the country’s low share of home ownership and tax deduction initiatives for home buyers. compared with per capita compensation. Importantly. with no signs of a revival by end-2012. In Spain. we expect a cumulative 2% increase in nominal house prices by end-2012. Nomura Global Economics 24 6 December 2010 . as well as valuations based on our models not being too far out of line.2011 Global Economic Outlook House price prospects Stella Wang The euro-area housing market should soften in 2011 and we expect prices to be 2% above their pre-crisis levels by end2012. • Our new model suggests that. mainly driven by the German housing market. as well as other key variables determining house prices. Euro-area housing markets have stabilised in 2010. Assuming no structural changes in tax and lending systems. A higher price-to-income ratio than its long-term average provides a standard first-pass measure of house price overvaluation and indicates the potential for house prices to decline (Figure 1). we think deficit cutting is likely to weigh on the housing market in the coming years. however. Source: Datastream and Nomura Global Economics. Italy (11%). Nominal house prices % y-o-y % deviation from long-term average 30 20 10 0 -10 -20 -30 1Q00 1Q02 1Q04 1Q06 1Q08 1Q10 GE SP FR NL IT 25 20 15 10 5 0 -5 -10 Big 5 FR SP GE IT NL Forecast -15 1Q00 3Q01 1Q03 3Q04 1Q06 3Q07 1Q09 3Q10 1Q12 Source: Datastream and Nomura Global Economics. Overall. In real terms. our model suggests that a further 7-9% drop is likely. But this model is rather crude as it excludes the possibility of a favourable evolution of fundamentals. The above results suggest that a double-dip in some euro-area housing markets may lie ahead. we think the large supply of unoccupied dwellings will delay its housing market recovery. We have therefore developed an advanced model that includes an inverted housing demand equation and incorporates the user cost of housing. we expect downward adjustments to last until the end of 2011 before house prices pick up in 2012. But concerns about a sizable decline linger. we expect divergence in house price developments across the euro area. the euro-area housing market should continue to recover but only moderately over the next two years. buoyed by strong economic and employment growth. although the high indebtedness of households constitutes a drag on the housing market. • • In summary. House price to income ratios Figure 2. we do not expect a major house price decline in four of the five major countries as we think that. the improving employment market and a gradual easing in credit conditions should provide firm support. And despite strong increases in the first three quarters of 2010. We look for nominal house prices to stall in 2011. with apparent overvaluation in the housing markets of France (13%). this metric suggests that there was a 9% undervaluation in Germany at the end of Q3 2010. We look for prices to increase by 2% in real terms and 5% in nominal terms through 2011-12. so current house prices are not significantly different from their equilibrium. converging to their long-term equilibrium (Figure 2). Note: The house price to income ratio is the average price of a 2 100m unit. Italy and Spain. Figure 1. the tepid growth of housing stock. In France. our new model suggests that the degree of overvaluation is not that significant. but high transaction costs. Meanwhile. the degree of undervaluation does not appear large because the oversupply of housing in the 1990s has pushed down the equilibrium level of house prices. In the Netherlands. house prices in the region having risen by 2% y-o-y. such as increasing income and population. house prices in Germany should rise. Interestingly. Of the five biggest euro-area countries.

1Q01 1Q03 1Q05 1Q07 1Q09 Note: Harmonized competitiveness indicator index (Unit Labour Costs based). however. This view is based on our analysis that the periphery economies are fundamentally solvent. Portugal has fared less well and may need to do more. So far. such financing from the EU and IMF has allowed Greece and Ireland to be financed until well into 2012. Looking beyond the acute need for periphery countries to correct fiscal imbalances. Belgium.2011 Global Economic Outlook weigh on activity in the periphery. 1Q99=100 Core . This can only happen if labour and product markets are sufficiently flexible. not least in Greece and Ireland. Divergences in euro area competitiveness Figure 3. Importantly too. this can only be corrected by a prolonged period of lower inflation. Source: ECB and Nomura Global Economics. we are confident that EU governments will stand behind the periphery despite some ambiguous statements. We are expecting these policies to be implemented despite the uncertainty surrounding politically weak governments in Spain.Germany. It is this prospect of slow growth in the periphery.Italy. albeit rather slowly (for more details.. again We view the periphery economies as basically solvent While the ongoing turmoil is worrying. a process that is slowly beginning (Figure 4). We consider that they have fiscal plans that will gradually stabilise their debt-to-GDP ratios. official financing is necessary and appropriate. Currently. 25 6 December 2010 Nomura Global Economics . Greece. see Box: Are the periphery countries solvent?). budget execution has been promising. hence the importance of implementing structural reforms in the periphery. it seems likely that Portugal may also need support. the interest rates at which they can borrow in the market would remain too high (Figure 3). In the absence of an independent interest rate or exchange rate. which had caused markets to doubt that commitment. the challenge remains as to how the same countries can regain lost competitiveness relative to the core owing to their relatively high rates of inflation during the first decade of EMU. In these circumstances. Finland (26%) 140 130 120 110 100 90 80 1Q99 Germany Greece France Ireland Spain Italy 2 Jan 07 Jul 07 Jan 08 Jul 08 Jan 09 Jul 09 Jan 10 Jul 10 Source: Datastream and Nomura Global Economics. at reasonable levels of interest rates. The food price shock looks set to be stronger than originally thought. so further austerity measures may yet need to be announced. Ireland (18%) Semi-core . subject to strict conditionality on fiscal austerity. combined with a challenging starting point for public finances. Austria. A credible last resort financing framework is crucial Competitiveness differences need to be closed Inflation above the 2% ceiling Inflation above 2% reflects higher commodity prices. EU policymakers have begun to provide clarification on the permanent crisis resolution mechanism to apply beyond 2013. which would further enhance their debt solvency. although it is unlikely in our view. In some cases (Spain and Ireland) we believe that official forecasts err on the optimistic side. we forecast that the core countries will have recovered to their pre-crisis GDP levels by mid-2011. Sovereign debt crisis. that has recently increased market concerns about sovereign debt sustainability in the periphery. productivity growth stands to be stimulated.. we expect the sovereign debt crisis to gradually abate in 2011. which tracks the euro-area HICP food component well and is Figure 4. If these reforms are successful. If Spain ultimately also requires support. If markets remain unconvinced of their credibility. However. Divergences in euro area bond yields % 8 7 6 5 4 3 Index. Portugal. As a result. We now forecast HICP inflation to hover around the ECB’s target ceiling over the forecast horizon as the ongoing acceleration in commodity prices and mild domestic price pressures should push up inflation. France. Netherlands (55%) Periphery . while the periphery economies will not have reached their pre-crisis GDP levels by the end of 2012 (Figure 2). this would put a strain on the capacity of the existing financing facilities. Our food commodity price index. These countries are only solvent.Spain. Portugal and Ireland. But so far.

Cross=2011. but overall these are not comparable to the Irish problems. then official financing is the right response in our view. we feel this provides a necessary “shock absorber” to stop the banking crisis from taking an even more negative turn. albeit to a lesser extent. with a much lower primary surplus requirement. Our baseline assumption is that Ireland can stabilise its debt-to-GDP ratio at a much lower level than Greece.0 -8.0 0. A common metric for evaluating fiscal sustainability is to analyse the fiscal scenarios and growth and financing cost scenarios that are necessary to deliver a stable debt-to-GDP ratio. has the most problematic debt dynamics. Even if official financing continues.0 Source: AMECO and Nomura Global Economics estimates. Not only does this emphasise the scale of the adjustment required. but also the difficulty of achieving a primary surplus (which was often not achieved in the last 10 years. Spain has a better starting point in its public indebtedness but is suffering from most of the problems mentioned above. Patience is needed. appropriately extended timeframes need to be given to allow these economies to adjust. Figure 2 shows the path that we forecast each country to follow in terms of its primary balance (x-axis) and interest rate growth differential (“snowball effect”) (y-axis) out to end-2012 (the dot is the starting point for both values and the arrow is the end point). Figure 1.2011 Global Economic Outlook Are the periphery countries solvent? Dimitris Drakopoulos ⏐ Peter Westaway Fiscal plans in the periphery should stabilise debt ratios. • The recently agreed official support package for Ireland increases the sovereign’s support to the banking sector considerably. However chronic low productivity growth makes it hard for Portugal to “grow out” of its indebtedness. Primary balance and snowball paths in 2010-12 % GDP 7 5 3 1 -1 -3 -5 -7 -9 Average 1990-1999 Average 2000-2009 2010 Max 2000-2009 Debt stabilizing primary balance in 2012 Spain Greece Portugal Ireland Snowball effect (pp GDP) 14 12 10 8 6 4 2 0 -2 -4 -10.0 6. our view is that in the face of these challenges. We see growth-enhancing reforms. As with Portugal.0 Primary balance (%GDP) 4. Portugal and Spain) with the primary balance they need to achieve in order to stabilize their debt ratios. 26 6 December 2010 Nomura Global Economics . but this is a slow process and downside risks abound.0 -2.0 Italy Greece Ireland Increasing debt ratio Spain Portugal Falling debt ratio -6.30) the tendency of the debt-to-GDP ratio to increase or decrease depends on the speed with which countries can eliminate their primary fiscal deficits (the deficit net of interest payments) and by the differential between the nominal growth rate and the average interest rate on existing debt (known as the “snowball effect”). As we previously explained in “The arithmetic of debt dynamics” (p. Fiscal consolidation efforts so far are unconvincing. Greece needs to maintain primary surpluses of close to 6% to return its debt ratio back to 2009 levels by 2020.0 2.0 -4. but should remain comfortably affordable (unlike Greece). In our baseline. but policies are moving in the right direction. Arrow = 2012 Source: Nomura Global Economics estimates. even during the boom years). • • • Overall. as we believe they currently are. However. a stronger commitment to consolidation and an average cost of debt that remains capped (potentially by using the European Financial Stability Facility/Stabilisation Mechanism) giving Portugal the best chance of stabilising its debt ratio ahead of others and of maintaining it at much lower levels. Primary balances in the periphery Figure 2. despite being closer to stabilising its debt ratio than Spain or Ireland. the average cost of debt will slowly drift up to 6%. Ireland. Debt will take a long time to stabilize. causing the debt ratio to almost quintuple from 2007 levels. Note: Dot = 2010 forecast level. Spain and Ireland start from the largest primary balances in the euro area and require the largest fiscal adjustments to reach the debt-stabilising point (the dotted line). it is most important that structural problems are addressed to enhance Spain’s long-run growth prospects. Banking sector uncertainties remain both in liquidity and solvency terms for the smaller savings banks. Figure 1 compares the prevailing primary balances in each of the four periphery countries (Greece. If markets are not prepared to give it. Greece. Portugal’s current debt and deficit figures are closer to the euro area average. with implementation risks stemming from the regional governments. however it will take about two years longer.

continued market turmoil into early 2011 is a source of downside risk both to our forecast and interest rate call.5 8.0 3.and hike in September Figure 5. Energy prices and the ongoing surge in the prices of raw materials should also contribute to higher inflation.0 8.5 10. which we expect in September 2011. 27 6 December 2010 1Q00 1Q02 1Q04 1Q06 1Q08 1Q10 1Q12 Compensation per employee (lhs) Unemployment rate (rhs) Source: Eurostat. Under our central assumption that periphery tensions gradually abate in 2011. The appointment is made by the European Council. grew by 18% y-o-y in October. We think domestically generated price pressures will mildly increase further in 2011 because of the expected improvement in labour market conditions.0 1.. Finally. preparing the markets for a first rate hike. due in particular to the robust recovery in the core countries. Nomura Global Economics .. reaching 9.0 % y-o-y 5 4 3 2 1 0 -1 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Source: Eurostat and Nomura Global Economics.5 9.5% by end-2012 (Figure 5).5pp to headline HICP inflation in 2011. ECB and Nomura Global Economics. Even so.2011 Global Economic Outlook based on agricultural prices in the European Union (for more. But at the time of writing. Euro area wages and unemployment Figure 6. This would push up labour costs: we expect compensation per employee to increase by 2. The sitting ECB President Trichet will chair his final Governing Council in October 2011 and a replacement has to be named beforehand (we think by June 2011). we expect the ECB to resume its liquidity withdrawal process and to complete it by Q3 2011 (see Box: Liquidity withdrawal: When the time is right).5 7.. We expect President Trichet to be more “vigilant” on inflation and to adopt an increasingly more hawkish tone throughout the first half of 2011.5 1. Looking at the ECB’s preferred measure (the compensation per employee series).1% in 2011 and 2. but it is possible that a noncouncil member candidate is appointed.5 3.. the ECB has repeatedly signalled throughout 2010 that it remains committed to completely withdrawing its liquidity support provided to the European banking system.. . The ECB will also have a new president in 2011. labour cost growth increased to 2% y-o-y in Q2. We forecast food price inflation to contribute around 0. but worryingly high as the euro-area unemployment rate was as elevated as 10% in Q2. we forecast HICP inflation to increase from 1. the ECB’s balancing act looks even more challenging as systemic risk remains a serious concern.but wage growth is picking up But there are also early signs that underlying inflationary pressures are increasing. should also drive inflation higher.0 7.0 % of labour force 10. exchange rate pass-through effects from the past and the expected depreciation of the euro (our FX team expects the trade-weighted index to drop by 5% between now and the end of 2012). The ECB has repeatedly stated that it sees no conflict between its price stability mandate and preserving financial stability as long as the interest rate tool targets the former and liquidity operations/ bond purchases the latter.7% in 2012 – above the 2. . This is still low by historical standards. The top candidates for the position include current ECB Governing Council Members Bundesbank President Axel Weber (probably the most likely to become the next ECB President) and Banca d’Italia Governor Mario Draghi. we think the ECB will likely become increasingly uncomfortable with a monetary policy stance that implies negative real interest rates. its highest level since May 2008.0% in both 2011 and 2012 (Figure 6). However. We expect the unemployment rate to start falling soon. coupled with potential further increases in indirect taxes. following a recommendation by the euro area finance ministers and is typically the outcome of a political deal-making process. Timing is everything The ECB will likely normalise liquidity by mid-2011.0 2. To sum up.3% average between 2000 and 2007..0 9. With headline inflation set to break the 2% ceiling and GDP growth close to trend in 2011.5 2. despite the ECB announcing a pause in its liquidity withdrawal policy and is stepping up its bond purchases.6% y-o-y in 2010 to 2. see Food price shock: estimating the pass-through). Euro area inflation: to date and forecast % y-o-y 4.

is a technical term and is defined as the sum of the banks’ reserve requirement + banknotes in circulation + government deposits in local central banks (the sum of the latter two is also called autonomous factors). supplied with ECB liquidity in excess of what they would 1 receive in normal circumstances. in effect.50 1. effectively fully normalising liquidity operations. We have previously described a roadmap for how we see the ECB completing its withdrawal of liquidity (see “Banking without liquidity support” in European Economic Outlook: The Hazardous Journey. Keeping a liquidity facility in place for too long may prevent a longer-term solution to the underlying problem: a weak and undercapitalised banking sector in several periphery economies. Back in July. 1 “Excess liquidity” means that liquidity supply exceeds liquidity demand. This capacity to get funding from the ECB is now disproportionately used by banks in the periphery: it is effectively one of the instruments that the ECB uses to ease specific tensions.50 0. an exceptionally generous liquidity facility has become an important. In short. Assuming that the sovereign debt crisis subsides from its current critical phase in Q1 2011. Excess liquidity in the Eurosystem Figure 2. the model projects that by Q3 2011 excess liquidity should have returned to its pre-crisis levels (Figure 1).00 0. At the same time. The next and final step. the ECB would be “over-allotting” those operations. the ECB introduced “fixed rate tenders with full allotment” longterm refinancing operations (LTROs). will need to request a similar financing package.00 1. or even Spain. rate hikes are another”). funding source. Our Interest Rates Strategy team has developed a model that projects the effects of liquidity normalisation on excess liquidity and the level of EONIA (see “Normalization is one thing.00 1Q10 3Q10 ECB main rate 1Q11 3Q11 EONIA 1Q12 3Q12 3mth Libor Source: ECB and Nomura Global Economics. This effectively means that the ECB has put on hold its already ongoing liquidity withdrawal policy until Q2 2011. Figure 1. would be to stop offering the full allotment at both 1-month and 1-week operations. we expect the ECB to announce at its March meeting that it is reverting back to 3-month LTROs fixed by generous amounts. “liquidity demand”. After Lehman Brothers collapsed in September 2008. 31 July 2010). we think the next step will involve the ECB eliminating the 3-month full allotment operations. But the governments in question do not have the financial resources to do this. Using the withdrawal roadmap outlined above. we expect EONIA to move above the main refinancing rate (Figure 2). The problem is that this has created a dependency relationship and. we expected the ECB to make this move by December 2010. banks need to access money markets less and EONIA is now below the ECB’s main rate. by announcing a very generous amount. however. Importantly. Because of the possible contagion risks to the semi-core countries. With “excess liquidity” in the banking system. while still keeping the full allotment for weekly and 1-month operations. in some cases. the ECB announced at its December meeting that it would continue offering 3-month LTRO operations at full allotment throughout Q1 2011. which we expect the ECB to take in Q3 2011. But following the intensification of the sovereign debt crisis. We expect that a forthcoming set of credible stress tests on the Greek and Irish banking systems will determine their capital needs and allow policymakers to start recapitalising the banks. if not overriding. Nomura Global Economics Source: Datastream and Nomura Global Economics. So this would still keep excess liquidity in the system and would allow EONIA to gradually drift up towards the main refinancing rate. The ECB has repeatedly made it clear that European governments need to take steps to reorganise and restructure the banking sector where necessary. banks are.50 2. We expect the ECB to announce that it will shift to 3-month fixed allotments at its March meeting. As a result of these operations. Interest rates forecasts €bn 450 400 350 300 250 200 150 100 50 0 Mar-10 Jul-10 Nov-10 Mar-11 Jul-11 Forecast Actual % 2. The IMF/EU financing packages for both Ireland and Greece contained financial assistance for substantial banking-sector recapitalisation.2011 Global Economic Outlook Liquidity withdrawal: When the time is right Jens Sondergaard The recent intensification of the European sovereign debt crisis caused the ECB to pause its liquidity withdrawal process until April 2011. and these have fully covered the liquidity needs of the European banking system as a whole. we think the ECB will engage in further sovereign debt purchases to avoid this outcome (although pressure will likely be on the Spanish government to inject more capital into its banks). 28 6 December 2010 . It remains to be seen whether Portugal.

6 2.05 3.6 1.6 1.9 1.1 2.0 0. exchange rate pass-through effects from the past and expected depreciation of the euro and potential further increases in indirect taxes should also drive inflation higher.34 1.4 6.9 -4.2 5.2 1.27 0.8 2.5 1.7% in 2012 – above the 2.1 0.0 2.2 0.2 2.0 0.4 -0.3 0.50 1.3 -1.3 0. the ECB will likely become increasingly uncomfortable with a monetary policy stance that implies negative real interest rates.50 2.0 1.8 1.1 -6.30 1.5 0.2 4Q10 1.80 3.30 1.9 2.1 0.3 6.1 1.00 1. Once the sovereign debt crisis gradually abates in 2011.50 1. but are now triggering a pick-up in domestic demand.26 $/euro 1.9 2.0 0.0 5.1 3Q11 2. Moreover.3 -3. but the euro area and its recovery should remain intact. labour productivity.3 2010 1.9 1.0 2. Compensation per employee.70 4.1 5.00 1.8 10.1 1.90 3.77 1.00 1.30 1. ECB. Moreover.7 2Q11 1.89 10-yr bund yields 2.1 0.77 1.30 1.7 3. DataStream and Nomura Global Economics.7 0.70 3.7 0.0 7.0 0.10 2.4 -0.5 4.77 1.1 1. unit labour costs and inflation are y-o-y percent changes. the recovery looks set to remain unbalanced.25 3.9 3Q10 1. as labour market conditions improve and the unemployment rate starts to decline from early 2011.9 9.1 0. we think that the core economies will prove strong enough to offset the weakness in the periphery.7 9.5 1Q11 1.6 10.0 1.34 1.0 0.1 1.3 2.5 1. Finally.4 1.1 2.8 4Q11 2.0 0.3 1.0 6.1 0.00 1.4 1.0 5.9 0.6 9.35 1.04 1. However.7 9.5 -0.9 1Q12 2. we remain convinced that the euro area will survive this crisis and that no countries will leave the monetary union. Numbers in bold are actual values. Source: Eurostat.5 -0.6 2.1 3.7 1.3 1.5 2.8 2.1 7. commodity price increases should continue to exert upward pressure on headline inflation.9 0.90 2.0 0.5 0.8 9.35 1.9 0.55 3.35 1.0 1. also aided by signs that the corporate deleveraging cycle is coming to an end.9 0.00 3-month rates 1.04 1.9 4.0 0.4 1. Unemployment rate is a quarterly average as a percentage of the labour force.8 7.00 1.7 10.0 2.25 1.1 1.6 0.4 1. we expect the ECB to continue its liquidity withdrawal policy and adopt a more hawkish tone preparing the markets for its first rate hike by September 2011. which is expected to gain momentum over the forecast horizon.77 2.2 6. consumer spending looks set to increase in 2011 and 2012.0 -0.9 1. others forecast.0 1.4 10.2 0.4 0.9 2.1 0.1 0. Exports kick-started the upturn in 2009. but the exacerbation of the sovereign debt crisis casts a shadow over on the recovery.1 2Q12 2.1% in 2011 and 2. The investment cycle should gain more strength in the second half of 2011 and beyond.0 2.7 9.4 1.6 1.3 1.90 3. However.1 1.3 9. Activity: The recovery has started to broaden out.7 2.3% recorded on average between 2000 and 2007).4 -0.6 1. Table reflects data available as of 6 December 2010. Details of the forecast % Real GDP Household consumption Fixed investment Government consumption Exports of goods and services Imports of goods and services Contributions to GDP: Domestic final sales Inventories Net trade Unemployment rate Compensation per employee Labour productivity Unit labour costs Fiscal balance (% GDP) Current account balance (% GDP) Consumer prices 1.0 -0.2 6.8 -0.52 1.3 1.31 Notes: Quarterly real GDP and its contributions are seasonally adjusted annualised rates.0 7.0 7. while deleveraging and fiscal tightening should keep growth subdued in the periphery. Overall.1 0.7 0.6 -0. Inflation: We expect inflation to hover around the ECB’s target of 2% in both 2011 and 2012.32 1.6 0.50 1.3 1.0 2012 2.8 1.1 1.1 10.2 4.05 1.6 2011 1.0 1.2 0. The improvement in labour market conditions should push up domestically generated price pressure (we expect compensation per employee to increase by 2. Interest rate and exchange rate forecasts are end of period levels.0 0.9 0.1 1.5 1.9 0.7 0.9 2.8 9.6 0. with the core countries providing the impetus to growth.6 -0. rate 1.2011 Global Economic Outlook Euro area ⏐ Economic Outlook Lavinia Santovetti ⏐ Jens Sondergaard Breaking up is hard to do We expect the sovereign crisis to linger and gradually abate in 2011.0 ECB main refi.1 1.7 2.6 0.5 7. Policy: With growth close to trend and headline inflation hovering around the 2% target in 2011. Nomura Global Economics 29 6 December 2010 .3 3.5 7.3 0.33 1.9 5. We expect full normalisation of liquidity by the third quarter of 2011. Risks: Domestic demand may surprise on the upside.6 -0.

Drakopoulos ⏐S.4 7. High export and import growth is likely over the next two years but their net contribution should be lower. However.9 9.9 4.7 7.1 14.8 10.9 1.8 7.2 -3. • • Note: Table reflects data available as of 6 December.0 2. steps have been taken towards achieving a credible consolidation strategy underpinned by pension reform.5 0. France’s recovery should slowly gain strength with GDP growth rising to 1.1 87.1 0.3 -5.1 9. and keep private consumption below pre-crisis growth rates.8 2011 1.1 9.7 -3.4 -2.4 0. which should lead to a sizable improvement in public finances in 2011.8 1. We view the 2011 targets as feasible.2 0.2 8.6 1.9 -2.7 76.6 7.6 3. initially driven by net exports and then by a pickup in investment and consumption.6 5.2 -1. Source: Datastream and Nomura Global Economics.2 1.6 -1.0 89. • • • Note: Table reflects data available as of 6 December. Source: Datastream and Nomura Global Economics.5 78.8 64.0 1.5 1. Economic expansion will again rely heavily on domestic demand. But we see upside risks to wages in 2011 and 2012. We expect the trend to continue but at a slow pace.5 2011 1.8 2010 1.5 -12.7 0.0 66.8 75.2 67.7 4.3 1.7 3.5 -7.8 9.7 6.2011 Global Economic Outlook European Countries ⏐ Economic Outlook J.3 10. the coalition government is vulnerable.0 -4.9 -8. The unemployment picture has been slowly improving since Q1 2010.9 9.0 73. we expect domestic demand to remain robust in 2011 and 2012.1 7.6 8. However.7 • The German economy rebounded strongly in 2010.8 14. subdued consumption points to moderate growth % GDP growth Private consumption Fixed investment Government consumption Exports Imports HICP inflation Unemployment (% of labour force) Fiscal balance (% GDP) Government debt (% GDP) 2009 -3. Netherlands: Moderate growth Although benefitting from its strong neighbour.1 2012 2. Price and wage inflation should remain moderate. The German labour market has performed impressively in 2010 with unemployment at an 18-year low.1 -10.8 -12.1 7.7 -7.0 5.3 6. Germany.7 1. Wang Germany: Impressive ongoing recovery Economy is on a strong footing with low levels of unemployment underpinning domestic demand % GDP growth Private consumption Fixed investment Government consumption Exports Imports HICP inflation Unemployment (% of labour force) Fiscal balance (% GDP) Government debt (% GDP) 2009 -4.4 60.5 1.0% in 2012. Overall.2 2.2 -10.6 0.7 1.5 -5.3 0.7 9.5 6.6 83.4 9.8 -3.3 6.7% in 2011 and to 2.2 -4.7 76.0 2.1 4.8 -7. We think that increasing hours and unit labour costs will hamper the improvement in employment and keep the unemployment rate above 5% until the end of 2011.5 1. Source: Datastream and Nomura Global Economics.0 2.8 1. France: Slowly gaining strength Economy is recovering well. • • Note: Table reflects data available as of 6 December.6 4. German trade unions have demanded fairly moderate wage rises and seem to prefer greater job security instead.8 7.8 8.3 • • • We expect Dutch economic growth to be gradual owing to slowly recovering household consumption.8 5.0 5.6 1.3 0.7 -0.6 0.9 -14.3 1.4 2010 3.8 0. combined with improving business sentiment.3 -9.4 2012 2. The new government has committed to a strong consolidation package.6 -7.7 0.4 1. The degree of spare capacity has declined rapidly in 2010 and we think investment can grow further in 2011. On the fiscal side.4 2011 3.5 -0. which adds more uncertainties to the Dutch outlook.6 2. the slowdown in public sector compensation along with small tax increases should weaken disposable income growth.0 1. makes us optimistic about fixed investment in 2011-12. Sondergaard ⏐ D. but further tough consolidation efforts will be left to the new government in 2012.6 1.7 2010 1.1 • Following a moderate slowing of activity in recent months. Given the low level of unemployment with business (Ifo) and consumer confidence (GfK) at multi-year highs.8 -5. The cut in the corporate tax rate. but stronger focus in restoring sound public finances and job creation is needed % GDP growth Private consumption Fixed investment Government consumption Exports Imports HICP inflation Unemployment (% of labour force) Fiscal balance (% GDP) Government debt (% GDP) 2009 -2. • Nomura Global Economics 30 6 December 2010 .2 1.5 -6.6 2012 2.0 4.

0 Fixed investment 3.50 Note: Table reflects data available as of 6 December. However.7 20. Source: Nomura Global Economics.6 Exports 7.34 1.1 -1.6 3.25 1.2 1. at 2. The ongoing fiscal consolidation is encouraging.00 0.8 -12.4 5. Thus we push forward SNB’s rate hike call to September 2011.4% and 2.2 -7.6 1.0 2010 1.9 70.25 Policy rate (3m LIBOR).0 0.0% for 2011.9 Government consumption 0.0 6.1 -0. % GDP growth Private consumption Fixed investment Government consumption Exports Imports HICP inflation 2009 -3. • • Nomura Global Economics 31 6 December 2010 . • • Unemployment (% of labour force) 18. We expect GDP to pick up by 0.0 1.8 -0.7 2. Structural weakness remains Italy’s Achilles’ heel and will likely continue to weigh on future economic performance: additional reforms are needed. • • We expect Switzerland to grow steadily.1 4.5% in 2011 and rise by 1% in 2012.6 -17.2 2012 1. Source: Nomura Global Economics.4 8. but more needs to be done to curb some of the structurally high expenditure components.0 -3.9 Policy rate (3m LIBOR).9 Private consumption 1.7 1. Weak household consumption and shrinking investment will remain a drag on activity. Switzerland: Currency appreciation contains inflation Healthy growth ahead underpinned by domestic demand. We expect the unemployment rate to average 8. There seems to be political determination to prevent Spain from having to access EU/IMF financing.1 2.1 -5.0 -4.6 11. we view Spain as fundamentally solvent. supported by domestic demand over the forecast horizon.00 0.44 1.9 18.1 9.0 0.2 5.5 -1. In its September monetary policy assessment report.6 8.25 EURCHF * 1.8 7.5% in 2012.2 10.5 6. 2009 2010 2011 2012 GDP growth % y-o-y 2.9 3.9 3.3 -5.8 1. We do not expect the debt-to-GDP ratio to stabilise until around 2015.0 • Spain’s macro fundamentals are weak and austerity measures should start to bite into growth soon.3 116. reforms and the banking sector is essential.42 1.1 -4. relative to 2010 growth looks set to moderate over the next two years: we forecast GDP growth at 2.5 2.0 -9.1 8.3 64.7 Imports 7.1 6.1 -1. In addition.3 120.1 0.2 2010 -0.7 1. Source: Federal statistics office and Nomura Global Economics.5 Unemployment rate 3. albeit significant.4 -0.6 -6.3 -0.5 0.7 -4.2 -11. We expect the deficit to narrow to 6. should remain above the euro-area average.2 0.1 • Italy will likely grow below the euro-area average.7 1.6 0.0 3.9% of GDP in 2011. We expect exports to be the most dynamic component and investment to recover only moderately.1 1. thus the government will likely need to announce more measures to hit the 6% deficit target. Elections in the spring look increasingly likely.6 0.2 7.3 2012 1.5 -5.8 -5.0 0.3 5. • • • • Note: Table reflects data available as of 6 December.6 120.5 0.25 2.2011 Global Economic Outlook European Countries ⏐ Economic Outlook Lavinia Santovetti ⏐ Takuma Ikeda Italy: Fragile ongoing recovery Fiscal challenges.2 -16.9 1. low % * 0.1 53.4 3. renewed turmoil over European periphery debt sustainability has ignited further CHF appreciation and could cause SNB’s concern over the possibility of deflation to increase. high % * 0.7 Current account 10.4 1.1 6.5 2.5 -0.1% for 2011 and 2012.3% in 2012.75 0.0 10. • Spain: Slow moving.3 1.2 2.9 3. However.7 2.9 -8.3 -1.1% in 2011 and 1.4 74.0 3.3 2011 0.0 Fiscal balance (% GDP) Government debt (% GDP) -11.2 • • Note: Table reflects data available as of 6 December.0 2011 1.7 2.0 119.7 3. The unemployment rate will likely remain high.1 0.75 1. at 1. Inflation.7 6.0 2.3 4.3% in 2010 and hover around 8.0% in 2011 and 2012. % GDP growth Private consumption Fixed investment Government consumption Exports Imports HICP inflation Unemployment (% of labour force) Fiscal balance (% GDP) Government debt (% GDP) 2009 -5.3% from 1. because of sluggish growth and the slower reaction of the labour market to activity growth.2% in 2011 followed by growth of 2.1 -14.6 -19. the Swiss National Bank (SNB) revised down its CPI inflation forecast to 0.2 19. reflecting the CHF’s strong appreciation. but solvent Political willingness to take determined action on fiscal policy.4 CPI 0. are of a considerably different order of magnitude than in the periphery.5 0.4 5.9 -0.

4 -0.9 0.7 3. • • * End of period.2 9.5 1.6 5.8 0.7 5.8 8.3 -0.2 -1.0 2.1 2. Low levels of capacity utilisation and low wage growth should continue to keep inflationary pressures low in the near term.70 • Declining household saving ratios from their highs combined with low levels of unemployment should support robust consumption growth in 2011.05 7.4 4. We also expect investment to bounce back in 2011 following falls in both 2009 and 2010. a pick-up in domestic demand should help GDP growth reaccelerate over the forecast horizon.0 2. As we expect the sovereign debt crisis to gradually abate in 2011.41 2010 5.8 5.3 0.8 1.8 -13.5 4.90 2011 2. But as growth accelerates.6 1.3 -13.2 8.3 5.3 -9.4 3.9 3. But increased competitiveness should help export prospects in 2011 and 2012.5 -14.3% by 2012.41 2010 1. the output gap to close and inflation to reach 2. increasing rates by 75bp in 2011 and a further 100bp in 2012.8 3.00 7. The high level of consumer confidence. • • * End of period Note: Table reflects data available as of 6 December.1 7.75 9.0 1.1 3.25 9. Sweden should reach its pre-crisis level of GDP in early 2011.0 1.4 2.7 2.5 3.0 3. Hence.75 7.2 3.8 1.1 -9.2011 Global Economic Outlook Scandinavia ⏐ Economic Outlook Jens Sondergaard Norway: Robust consumption ahead Low unemployment and interest rates support healthy consumption growth % GDP growth (Mainland) GDP growth (Total) Private consumption Fixed investment Government consumption Exports Imports CPI inflation Unemployment rate Policy rate* EURNOK* 2009 -1.7 5.00 2012 2.45 2011 2. Nomura Global Economics 32 6 December 2010 .4 3.4 3.3 0.7 4.05 7.2 -4.45 2012 2.0 2.6 1.0 2. The headwinds from the housing market slump together with a large supply of unsold houses continue to constrain residential investment and weigh on house prices.3 4.5 2.7 1.8 4.4 1. higher employment levels and rising disposable real household income should support consumption in 2011 and 2012.2 3.4 3. we expect a tightening in the labour market.1 2.6 6.9 -11.25 10.4 1. Faced with strong growth and inflationary pressures.55 7.3 9. Sweden: Strong rebound from crisis The challenge is normalising monetary policy % GDP growth Private consumption Fixed investment Government consumption Exports Imports CPI inflation Unemployment rate Policy rate* EURSEK* 2009 -5.0 1.4 -16.25% by end-2011 and by 3.4 2. Note: Table reflects data available as of 6 December.8 0.8 7. Source: Datastream and Nomura Global Economics.7 4. Source: Datastream and Nomura Global Economics.9 1.45 • The Danish recovery from its deepest post-war slump has been unimpressive and we expect continued subdued GDP growth in 2011 and 2012.3 2.0 2.3 3.00 2011 3.6 3.44 2010 2.75% by end-2012.25 9.8 2.7 1.1 -1.20 7.3 8.00 • The Swedish recovery’s momentum remains strong with low interest rates and robust credit growth fuelling domestic consumption.9 0.2 -7. Inflationary pressures should be building in 2011.3 2. with CPI inflation reaching 2.0 6. we think the Riksbank is keen to continue its rate hiking.2 5.5 1.0 12.4 4. Source: Datastream and Nomura Global Economics Denmark: Subdued growth ahead Robust consumption remains the bright spot % GDP growth Private consumption Fixed investment Government consumption Exports Imports CPI inflation Unemployment rate Policy rate* EURDKK* 2009 -5.7 -3.9 3. closing the output gap shortly thereafter.1 2.2 2. The weak export performance in 2010 is worrying particularly in view of the strong growth in Denmark’s largest trading partners – Germany and Sweden.0 2.0 -4. we expect the Norges Bank to assume its rate hiking.6 2.9 1.7 -12.1% by 2012.0 3.70 2012 3.75 7.1 1.3 7.1 1. We expect the Riksbank to raise rates to 2. • • * End of period Note: Table reflects data available as of 6 December.75 8. The high level of household indebtedness clouds the consumption outlook as interest rates rise further.2 1.7 11.3 3. The risk are tilted towards more hiking in the coming year.

1 -7.1 4.8 -13.2 -3.1 -1.8 -10.1 -14.1 1.2 -2.6 9.1 -22. with domestic demand acting as a drag on growth.9 -11.0 13.3 -1. Fiscal prospects might come weaker than expected particularly given large one-off revenues recorded in 2010. However.2 -4.1 89 2012 0.2 2.9 0. we feel this provides a necessary “shock absorber” to stop the banking crisis from taking an even more negative turn.4 -4.8 -11.0 -11. Households remain in a period of debt reduction with the saving rate well above its historical average.8 -4.0 -8.3 76 2010 1. however yields may remain too high for the sovereign to reduce its debt/GDP ratio.5 -9.5 -1.7 13.6 -5. making a support package necessary.4 9.8 Fiscal balance (% GDP) Government debt (% GDP) -14.9 0.6 11. • • Unemployment (% of labour force) 11. • Portugal: Triptych of problems and an unstable political situation Economy suffers from low productivity.5 -5. reflecting a drawnout adjustment process. • • Note: Table reflects data available as of 6 December.2 11. Households will continue their balance sheet repair amidst weak labour market environment. % GDP growth Private consumption Fixed investment Government consumption Exports Imports GDP deflator Unemployment (% of labour force) Fiscal balance (% GDP) Government debt (% GDP) 2009 -2.8 3.2 6.1 -1.7 -8.1 0.4 143 2011 -3. Recent revisions of debt and deficit figures make debt dynamics look more challenging and reinforce the need for a longer adjustment period (see “Greece extensions and revisions”).7 -0.6 -7.7 -11.7 99 2011 0.0 -24. Growth will resume in 2012 as external demand and wage moderation support exports and private investment.2 158 • We expect growth in 2010-12 to be in line with official forecasts.1 -6.4 109 2012 1. Exports will be the only driver of GDP growth.1 -5. and weaker than expected VAT-related tax revenues. Some potential for an increase domestic demand in 2012 remains as consumer bring forward planned expenditures before VAT hikes in 2013/2014.6 -4.1 6. however external imbalances are decreasing and competitiveness is recovering but at a slow pace. Source: Datastream and Nomura Global Economics.1 1. The high (tax driven) rates of inflation will continue in 2011.1 114 • Growth prospects remain weak.6 2.6 -1.7 14.6 4. weak competitiveness and high (mostly private until now) debt. as politics seem to be getting in the way % GDP growth Private consumption Fixed investment Government consumption Exports Imports GDP deflator 2009 -7.5 -0.2 9. Ireland: Maintaining credibility requires a clear plan for the banking sector Uncertainty about the plan for the banking sector remains. Reducing deficits in loss making public companies would be the main challenge.9 12.6 13.0 2010 -0.0 1.3 82 2011 -1. however they are strongly influenced by global demand and exchange rate developments.8 -7. After 12 consecutive negative quarters we expect GDP to start growing in the second half of 2011. besides weak tax receipts.2 1.0 0. Increases of the sovereign’s support to the banking sector will cause the debt ratio to almost quintuple from 2007 levels.6 -4.1 9.2 153 2012 0.0 5.6 66 • Note: Table reflects data available as of 6 December.2 1.9 10.2 -9.6 -1.4 -1.4 128 2010 -4.0 -4. Source: Datastream and Nomura Global Economics.5 -5.4 2.9 -7.6 6.6 -18. Source: Datastream and Nomura Global Economics.2 0.1 -3.0 91 • We expect the economy to contract in 2011 owing to austerity efforts.9 -1.9 -0.2 5.9 1.3 8. % GDP growth Private consumption Fixed investment Government consumption Exports Imports GDP deflator Unemployment (% of labour force) Fiscal balance (% GDP) Government debt (% GDP) 2009 -2.9 -3. Nomura Global Economics 33 6 December 2010 .5 -15.0 -6.4 -5.9 2.2011 Global Economic Outlook Periphery Europe ⏐ Economic Outlook Dimitris Drakopoulos Greece: Swimming against the tide Weak growth prospects owing to fiscal measures and a long road ahead until regaining competiveness.0 -11.8 -10. • • Note: Table reflects data available as of 6 December.6 -9.0 -3.5 -7.7 1. further risks will arise in 2011. We are less concerned about debt sustainability prospects compared to Ireland and Greece. Private consumption should decrease substantially in both 2011 and 2012.5 1.5 4.3 15.5 -9.3 -7. entirely driven by the external sector (mostly in services like tourism and merchant shipping) Despite having a credible fiscal consolidation program.

it has exacerbated them. 34 6 December 2010 . Inflation is stubbornly high but policy is on hold for now. up from its current low base. Imbalance between domestic and external demand opened a sizable current account surplus that has remained stubbornly large. we expect real terms cuts in both consumption and investment by the government to cause the real share of the public sector in GDP to shrink by over 2%. Developments in recent months have been consistent with the tentative unwind of these imbalances though. In the years ahead. Nomura Global Economics Source: ONS and Nomura Global Economics. we expect the share of private consumption in GDP to shrink slightly but for private investment’s share to rally by around 1% of GDP..3% between 2010 and 2011 and for this to pull the overall current account deficit in to 1. due to recovering demand growth in external markets. including in dwellings.9% of GDP to 2. we think that the extremely stimulative monetary policy setting will entice private investment. we forecast the UK to rebalance as these factors normalise toward a more sustainable state and policy appropriately moves away from its current crisis setting. this leaves the private sector as a whole to slightly increase its size relative to GDP. credit constraints and suppressed consumer confidence weigh on the outlook. Imbalances in the UK economy are multifaceted and have been persistent. a surplus has not been recorded on this measure since 1997 and we do not expect a return to this situation within our forecast horizon. While we expect both net trade and domestic final sales to drive growth in 2011 and 2012 (Figure 1). saar 6 4 2 0 -2 -4 -6 -8 -10 Forecast Change in employment. other industries have successfully capitalised on the persistent weakness of sterling. albeit with some modest appreciation in our forecast. is likely to rebalance the economy toward external demand.5%. As such. Nevertheless. 1000's 600 400 200 0 -200 Forecast Net trade Inventories Domestic final sales 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 1Q12 3Q12 -400 -600 -800 -1000 2000 Private sector Public sector 2002 2004 2006 2008 2010 2012 Source: ONS and Nomura Global Economics. Indeed. Picking winners External trade should improve as foreign demand recovers Partly because of the capital flows captured by the UK as a global financial centre. Figure 2. the domestic contribution contains a marked divergence between the private and public sectors. Employment growth We see private and investment demand gaining ground Figure 1. Contributions to GDP growth pp q-o-q.2011 Global Economic Outlook United Kingdom ⏐ Outlook 2011 Philip Rush Rebalancing the books Growth in net exports and investment will likely offset the fall in public spending and the impaired growth in private consumption. Indeed. especially with the expansion of the public sector. despite the persistent weakness in sterling. We expect the negativity of the real share of net external trade in GDP to halve between 2010 and 2012 to 1. Accommodating the improvement in the share of net trade to GDP is mainly the retrenchment in the public sector (see Box: Counting the cost of fiscal consolidation). Although excess productive capacity weighs on business investment. in no small part due to the financial industry. the persistent weakness of sterling. but we also expect some rebalancing of the UK economy within the private sector away from its previous reliance on private consumption where impaired growth in real incomes. Although the service sector has struggled to gain global market share. Underlying this likely positive development is an improvement in external demand for goods and services. Naturally.3%. the UK can sustain a structural deficit in its external trade in goods and services. In some respects the recession has helped the necessary rebalancing but in others. We forecast the trade in goods and services deficit to narrow by 0.

On this basis. This implies a 5.2 -1. Particular focus has been placed on the £81bn of spending cuts as part of a £110.0% of GDP over this period (Figure 1).8% of GDP consolidation in the current structural deficit from 2009-10 levels. the government is aiming to remove the part of the deficit that will not go away with the economic cycle without encouraging additional cuts to capital spending (investment). That is equivalent to an average burden of over £1k per UK citizen. the headline fiscal consolidation we expect by 2014-15 would be significantly less.0 -1. The impact costs of the fiscal consolidation programme are not necessarily the end of the story either. 35 6 December 2010 . With fiscal consolidation being so costly for the economy.2011 Global Economic Outlook Counting the cost of fiscal consolidation Philip Rush A painful. the economy is set to take a significant hit in 2011-12. monetary policy will need to remain more accommodative than it might otherwise have been. the government was able to revise up its capital expenditure budget without affecting its fiscal mandate.6 -0. the government is set to beat its target by achieving a small current structural budget surplus of 0.5% of GDP. we cannot believe markets would have accepted the prospect of a perpetually large fiscal deficit. we believe that the direct fiscal multiplier is likely to be small enough to keep the direct drag on GDP from fiscal consolidation (as in Figure 2) reasonably close to the total hit that the UK economy is likely to endure.9% of GDP (Figure 2). Despite this pain. By defining the fiscal target in this way. this is subject to the unrealistic caveat that such an unsustainable fiscal policy could have been pursued without inducing a sufficiently negative market reaction to force such action.8 07-08 08-09 09-10 10-11 11-12 12-13 13-14 14-15 Source: OBR. the simple counterfactual that we consider most illuminating is one where there are no discretionary tax changes and government spending is constant in real terms. Our interest in withdrawn expenditures causes us to exclude from the comparison expenditure on debt interest and net expenditure transfers to the EU. of which 40% would be through taxation. Under current plans. supportive growth tailwinds for the private sector should survive the headwind from retrenchment in the public sector. In the UK’s “emergency” budget. and the magnitude of the total structural fiscal tightening is even larger at 8. Nomura Global Economics 2010-11 2011-12 2012-13 2013-14 2014-15 Source: Nomura Global Economics.8% lower in 2014-15 because of the discretionary fiscal consolidation.2 -0. preventing contractions in terms of both total output and employment. We expect it to be quite some time before monetary policy can be described as “tight” again. Indeed. at £68bn. the government spelt out its total consolidation plans as it sought to balance the current structural deficit by the end of the parliamentary term in May 2015. Despite this emphasis.8% lower than it would have been had discretionary fiscal tightening not been pursued. poorly defined. in the Comprehensive Spending Review. Figure 1.4 -1. Although the government may have been able to avoid angering the markets with a slightly less onerous consolidation programme (see UK Fiscal Consolidation Programme – Assessment. Decomposition of the fiscal deficit Figure 2.6 -1. Regarding the impact of the fiscal consolidation programme on GDP. we think GDP will be 3. However. we still find it to be a useful benchmark against which to contrast budget plans.5% of GDP in 2014-15.8 -1. This then slows to a more manageable but non-negligible 0.3bn discretionary fiscal tightening by 2014-15. Although we believe that the drag on GDP growth is likely to be less than the headline statistics in the “emergency” budget imply. these cuts are still very considerable. versus 26% in the budget. in any case. which is worth about 1. the definition of the counterfactual fiscal policy against which this is applied is not necessarily useful for determining the hit to the economy and it is. as the effect of a Keynesian fiscal multiplier leans against the supportive factors that have elsewhere led to examples of expansionary fiscal contractions.0 -0. By front-loading the fiscal contraction and the tax increases in particular. On aggregate. front-loaded fiscal consolidation programme will be a significant drag on GDP growth throughout the parliamentary term. HM Treasury and Nomura Global Economics. Fiscal consolidation’s drag on GDP % of GDP 12 10 8 6 4 2 0 -2 Cyclical deficit Capital structural deficit Current structural deficit Combined= PSNB % GDP 0. Although this would constitute an unsustainable fiscal policy. because deviations from this scenario represent an expenditure drag on the economy. 25 October 2010 for details). Cumulatively. We believe GDP will be 3.4 -0. as we do not consider changes in this unavoidable expenditure to have direct implications for domestic GDP growth.

Nomura Global Economics 36 6 December 2010 . we estimate the level of potential GDP to have fallen by 5% relative to its pre-crisis trend (Figure 2). and demand recovers quickly enough. If so. But the impact of output gap uncertainty is ambiguous. there is also a respectable case for an activist increase in rates which pre-empts the risk of a deanchoring of inflation expectations. too. in our view. become unemployable or perhaps fall out of an industry experiencing a permanent structural decline. In particular. we are taking a fairly downbeat view of the ability of the UK’s productive potential to recover and the extent to which monetary policy can influence it. OECD and Nomura Global Economics. often the source of productive new ideas. Although so-called Brainard uncertainty about policy parameters might point towards a less activist approach. growth in total factor productivity may also be inhibited in firms that are concentrating on staying in business rather than looking for growth opportunities. but even so. Pre-existing capital stock may be scrapped in industries that have suffered a structural decline in demand. labour supply is diminished. But the experience of deep recessions can also influence the rate of growth of productive potential which. The situation is more complicated if productive capacity is temporarily shut down. Long term unemployment itself also limits growth in the productivity of labour as workers outside of active employment (or education) are not acquiring new skills. it may be difficult to distinguish between a one-off fall in potential and a protracted slow-down in its growth rate since many of the underlying causes are similar. given the forward-looking nature of monetary policy. Overall. which is earlier than the markets currently expect. So this means that the productive potential conditional on the current capital stock may fall short of its eventual long-run desired level once investment has been given time to recover. CBI. indicate considerably less spare capacity than those derived from empirical analysis based on a theoretical production function. When unemployed workers become disillusioned with the labour force. Source: BoE. small firms. debate the extent to which productive capacity has been destroyed by the recent financial crisis. we are more concerned about inflation and think that the BoE will need to start removing stimulus in August 2011. some productive potential may be brought back on stream and not be lost permanently. for example. which might explain the very low effective excess capacity reported in business surveys. And more generally. As such. Survey-based measures of excess productive capacity.2011 Global Economic Outlook Permanent impairment in productive potential Philip Rush⏐Peter Westaway The UK’s potential productive capacity was seriously impaired during the crisis and its growth is also likely to remain well below its previous trend rate for some time. This short-run measure of productive potential is the one that matters for inflationary pressure. can have an equally important influence on interest rate decisions. Productive potential will naturally fall if investment falls sharply during a recession since the capital stock will be lower than it otherwise would have been. As a result. Particular care needs to be exercised in interpreting these estimates at the current juncture. such as our own or the OECD’s (Figure 1). The combination of these levels and growth rate effects leaves potential some 7. The permanent loss of UK productive capacity Standardised capacity index 103 102 101 100 99 98 97 96 95 1Q98 Range of surveys (lhs) Nomura output gap (rhs) OECD output gap (rhs) % of potential GDP 4 3 2 1 0 -1 -2 -3 -4 -5 -6 -7 1Q08 1Q10 Index. Economists can. Measures of excess capacity Figure 2. and do. Pre-crisis trend Potential GDP GDP 1Q00 1Q02 1Q04 1Q06 Note: Index level of 100 corresponds to output at potential. This so-called “endogenous supply-side response” is even trickier to gauge. Falls in activity relative to pre-crisis trends may over-state the degree of spare capacity in the economy and therefore give too relaxed a view on the necessary pace of monetary tightening.4% below its pre-crisis trend by Q4 2012. In fact. But productive potential may have fallen for other reasons that are less likely to correct quickly. This matters greatly for monetary policy prospects. In practice. Figure 1. are likely to have been particularly badly constrained by a lack of funding from the banking sector. 1985Q1 = 100 210 205 200 195 190 185 180 175 170 165 160 1Q05 1Q06 1Q07 1Q08 1Q09 1Q10 1Q11 1Q12 Source: ONS and Nomura Global Economics. long-term unemployment and business liquidations have been lower in the UK than might have been expected given the falls in activity. underlying productive potential in the UK will grow below either trend or actual output until beyond 2012.

We see evidence that the recession permanently damaged the productive potential of the UK (see Box: Permanent impairment in productive potential). Under our forecasts. like financial services. even with rate hikes There is growing acknowledgement of the risk to inflation expectations on the MPC. this does not prevent rate hikes from the MPC which may seek to remove some stimulus. We expect the next move to be a 25bp rate hike in August 2011 but see it as more a case of appropriate accommodation rather than tightening per se. it would not be easy for output to expand without employment increasing and this makes us relatively optimistic about employment growth in the next few years. Nomura Global Economics Source: Bank of England. including the sectoral composition of the recession. when judged against what might have been expected under Okun’s law. We agree with the Bank of England that this is the result of a series of “one-off” shocks to the price level. While the real cuts in public sector spending in the ambitious fiscal consolidation programme make job cuts in the public sector highly likely. With inflation remaining above target for so long. As such. Inflation has remained stubbornly above target throughout 2010 and it will likely remain so until 2012 (Figure 3). surging commodity prices and the large depreciation of sterling. There are many potential reasons for this.2011 Global Economic Outlook To me. strong growth in the private sector should lead to decent gains in private sector employment. especially to consumers. Mervyn King will have to write eight consecutive letters explaining why inflation is so far above target. in our view. the economy will not be able to sustainably return to its pre-crisis output trend and thus the amount of effective excess productive capacity is probably smaller than what might otherwise have been thought. Underlying inflation is probably much lower than the headline inflation rate suggests. However. UK inflation % y-o-y 6 5 4 3 2 1 0 -1 -2 Jan 07 Jan 08 Jan 09 Jan 10 Jan 11 RPI CPI CPI target Jan 12 % 16 14 12 10 8 6 4 2 0 -2 -4 1Q90 1Q94 1Q98 1Q02 1Q06 1Q10 Nominal base rate Real base rate Source: ONS and Nomura Global Economics. Figure 4. monetary policy will need to remain loose to close the persistently large output gap. suffering to an unusually high degree. We see the level of productivity as being permanently impaired Raising the roof Productive potential in the UK has been permanently lost In our view. Bank of England base rate Figure 3. the appropriate policy stance will change if its credibility is threatened. If this fall in productivity reflected deliberate temporary labour hoarding. which involved high productivity industries. As a result. ONS and Nomura Global Economics. to you We expect the private sector to absorb the public sector job cuts Rebalancing in expenditure also requires a rebalancing in employment or to make some extreme assumptions in relative productivity growth. the disinflationary pressure in the economy would be smaller and fade more quickly. On balance. permanent hits relative to pre-crisis trends are not isolated to whole economy productivity. However. Assuming. While the MPC will likely continue to look through the current elevated inflation prints to its more subdued forecasts. we remain comfortable with our long-held view that private sector job creation will be more than sufficient to absorb the job cuts in the public sector (Figure 2). the level of whole economy productivity has fallen. as we do. “One-off” shocks boost inflation above underlying weakness Literate accommodation in the age of austerity Monetary policy is set to remain loose. If so. explained by the sectoral composition of the recession. On an economy-wide basis. there is a risk that inflation expectations begin to become unanchored to the upside and that would be costly for policymakers to correct at a later date. accommodating tight fiscal policy in the process. but it is not obvious how weak it is. we think that it mainly reflects a permanent hit. that this does not happen. then it might be expected to be reversed. the fall in employment during the recession was small relative to the fall in output. including VAT changes. If true. 37 6 December 2010 .

0 3.assessment. Activity: With another 2.73 1.0 0.8 2.3 0.5 0. we think that they lie to the upside of our inflation forecasts.50 3.4 7.5 6.0 7.8 2.4 -1.8 5.1 1.75 0.3 1.4 0.0 1.1 2Q12 2. We expect these factors to force CPI inflation back above 3.68 3. Risks: Although the risks to our growth forecasts lie to the downside.6 7. Details of the forecast 3Q10 Real GDP Private consumption Fixed investment Government consumption Exports of goods and services Imports of goods and services Contributions to GDP: Domestic final sales Inventories Net trade Unemployment rate Fiscal balance (% GDP) Current account balance (% GDP) Consumer prices (CPI) Retail prices (RPI) Official Bank rate 10-year gilt £ per euro $ per £ 3. others forecast.5% from GDP in fiscal year 2011-12.5 3. inflation will have been above target for more than two years and averaged 2.1 1.6 7.7 7.9 -1.9 7.5 0.7 7.3 -0. However.0 1.79 1.8 0.90 0.1 5.5 0.7 2.6 2.6 -0.72 3. Bank of England.4 3.50 4.30 0.90 0.6 5. Together. poor credit availability. However.50 3. Numbers in bold are actual values.3 7.5 2Q11 0.3 4.0 1.3 4.1 7. Annual figures are % y-o-y changes.6 1.1 0. Extremely loose monetary policy and the persistent weakness of sterling continue to provide considerable stimulus throughout our forecast horizon.8 7.40 0.56 3.80 1.00 3.5 2.3 6.3 0. Moreover.9% over the preceding five years.0 1.81 1.6 2.5 0. We expect this to subtract 1.1 0. continuing the slowdown started in H2 2010.5 1. Source: ONS.3 1.4 -1. We have consistently asserted that further easing is neither necessary nor likely to occur and we stand by that view.3 0.78 1.8 -10. Stubbornly high inflation will likely remain a common feature once again in 2011.3 2. Fiscal consolidation plans aiming to take the current structural deficit into surplus by 2014-15 engage in earnest at the start of 2011.83 1.10 0.2 -0.73 2012 2.3 1Q12 3. This would require eight consecutive letters from the BoE governor explaining why inflation is so far above the 2% target.8 -1.1 2.6 8.4 4.7 3.1 0.2 0.1 1.7 7.9 3.6 9.0 2.7 3.6 3.4 1.7 0. 2011 should mark a return toward more normal levels of fiscal changes. Interest rates and currencies are end-of-period levels. The fiscal deficit is based on the PSNB measure for the calendar year.2 0.9 0. Policy: The Bank of England is likely to leave monetary policy unchanged at its current extremely stimulative setting throughout the first half of 2011.0 0.75 3.1 0.4 -1.00 0. a deterioration of real wages and a shaky housing market.3 4Q11 3.4 -8.4 9.50 3.0 0. DataStream and Nomura Global Economics.40 0.2 2.6 2.5 4.5 4.6 7.4 1.57 2011 2.40 0.25 4.0 2.1 3.9 -0. 25 October).3 0.7 2.0 0.4 3.0 -0. the persistently large negative output gap and base effects will likely drag CPI inflation back below target. but we think the tailwinds will win out.45 0.1 2010 1.06 0. Nomura Global Economics 38 6 December 2010 .2 3. With the details now known (see Europe Special Report: UK fiscal consolidation .8 7.1 -0.5 -1.73 1.5 6.0 0. these considerable offsetting gales should provide an environment conducive to rebalancing toward external demand and private sector investment while moving away from public spending and to a lesser extent private consumption.4 1.9 0.7 -1.7 1.5% y-o-y by February 2011 and for it to remain above 3% until the end of 2011. The risks to our rate call are skewed toward a later increase.8 2.83 1. Headwinds come from the fiscal consolidation programme. Inflation is % y-o-y. Table reflects data available as of 6 December 2010.2011 Global Economic Outlook United Kingdom ⏐ Economic Outlook Philip Rush⏐Peter Westaway Gale-force rebalancing Fiscal austerity bites into GDP growth in H1 2011 but it should pick up in H2 while the economy rebalances.78 1.8 1.76 1.71 3.9 2.5 5. we expect the next move by the MPC to be the removal of some stimulus with an initial 25bp rate hike in August 2011.1 4.5 1. if realised. Inventories include statistical discrepancy. 2011 is likely to get off to a slow start.6 6. Beyond that. Inflation: Inflation has been and should continue to be boosted by “one-off” shocks such as changes to VAT and surging commodity prices.2 -2.3 3.2 4.78 1.4 1.9 5.7 4Q10 2.77 1.6 -0.4 -1.1 4.57 3.5 7.5 3Q11 2.7 0.00 4.71 Notes: Quarterly figures are % q-o-q changes at a seasonally adjusted annualised rate.84 1.0 1.63 3.0 -6.1 0.50 3. we expect Q1 to mark the trough and supportive tailwinds to maintain the economy’s momentum throughout.4 -0.0 2.7 1Q11 0.3 1.1 4. However. implementation risks and substantial structural changes in the public sector should keep the policy debate going at a brisk pace.9 1.3 1.50 3.5pp VAT hike booked to ring in the New Year.00 3.

Now that companies have completed their structural adjustments (eg. A full-blown recession should be averted Figure 1.3 1 .3 1 -20. However. Furthermore. Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 08 09 10 11 12 13 39 6 December 2010 Other General machinery Transportation equipment IT & digital Basic materials Mining and manufacturing -1 . Ministry of Economy. This is because of: (1) payback after the surge in lastminute demand for automobiles just before the eco-car subsidy scheme expired and after this summer's heat wave. annualized 11 9 7 5 3 1 -1 -3 -5 -7 -9 -11 -13 -15 -17 Estimates Consensus (ESP forecast survey) Nomura CY . For example. 2011 should see the economy emerge from its soft patch This year the Japanese economy entered a soft patch.8 -2. we expect it to avoid a full-blown recession. Source: Nomura Global Economics. We expect USD/JPY to enter a gentle uptrend after bottoming at 80 at the end of March 2011. The end of the yen's uptrend and a pick-up in external demand should boost the pick-up in exports we expect from Q3 2011. Trade & Industry Nomura Global Economics Note: Data for Q4 2010 and thereafter are Nomura estimates. Q3 industrial production declined (falling 1.8% in Q2. ESP Forecast Survey.9 7. by clearing their excess debts). We expect real consumer spending to decline by 0.0 % y-o-y. the latest statistics indicate that the domestic economy has been slowing.9% q-o-q annualized. Breakdown of industrial production by contributing sectors Figure 2. We think the Japanese economy has probably entered a soft patch within a longer-term recovery. company production forecasts point to production in Q4 also being likely to decline in q-o-q terms (Figure 1). Materials = steel + nonferrous metals + chemicals.5 5. and that this soft patch may continue until Q2 2011 (Figure 2).0 5.2 6. as well as: (2) the increase in the cigarette tax in October (See Box: Underlying growth in consumer spending). up from 1. Adjusted using realization and amendment ratios. wages and employment and trigger a full-fledged domestic recovery. The main risk to the economy in 2011 – on both the upside and the downside – is likely to be the yen. but we expect it to return to stronger growth in 2011 driven by exports. Source: Nomura Global Economics.3 -3. we think that the current slowdown is unlikely to turn into a full-blown recession because of the stimulus from measures taken by the government and the BOJ and the modest but sustained recovery in private demand. Economy in a soft patch The economy has slowed sharply In Q3 2010 Japan’s real GDP (first preliminary estimate) grew at an unexpectedly high rate of 3. Exports need to pick up if companies are to use their unprecedented surplus liquidity to boost domestic investment.6% q-o-q in Q4. an export-led recovery is more likely to feed through to a recovery in domestic demand. which has been caused by a slowdown in export growth and the fading impact of previous stimulus measures.2011 Global Economic Outlook Japan ⏐ Outlook 2011 Takahide Kiuchi Export-led recovery on the horizon The Japanese economy has slowed sharply. Political instability at home is also likely to be a wildcard factor.6 06 07 08 09 10 CY Note: Latest two months based on METI's Survey of Production Forecasts in Manufacturing. However. Our quarterly forecasts for the Japanese economy pp contribution to q-o-q chg 10 5 0 -5 -10 -15 -20 -25 05 -1 . We think that the recovery in 2011 will be led by a pick-up in exports. However. IT/digital = electrical machinery + IT/telecom equipment + electronic parts & devices.8% q-o-q) for the first time in six quarters.5 -1 .

these factors were transitory and spending could see a reactive decline in Q4. Ministry of Internal Affairs and Communications. auto sales qualifying for eco-car subsidies. consumer appliance sales under the eco-point scheme.6% q-o-q rise in nondurables spending reflected. followed by a decline in demand in Q2. As a result of government stimulus measures. tax changes and this summer’s heatwave. we look for spending to follow a more autonomous and stable recovery path.5 1. that were decided at the same time. supported by an upturn in personal incomes. Cabinet Office. A record hot summer caused spending on air conditioners and refrigerators to spike. A 0. But the underlying trend remains positive. Proposed tax system reforms affecting households Measures being considered Change of household income (JPY bn) Increase in new child benefit Limits on income and residents’ tax married couple’s allowance Reduction in adult (23-69 year-old) dependents’ income and residents’ tax allowance Limits on earned income allowance Reduction in basic inheritance tax allowance New gift tax rates Abolition of fixed-asset tax on new homes Abolition of reduced rates of tax on listed company dividends and share sales 250 Decrease Decrease Decrease Decrease Increase -154 Decrease Figure 2. Source: Tax Commission. may be needed to fund it. Furthermore. While we cannot rule out the possibility that employment growth may stall with the economy slowing as production declines. However. Although the government pans to raise child benefits in FY11. Spending on durable goods rose sharply (11. imposing limits on earned income allowances and reducing the basic inheritance tax allowance. we think this was probably outweighed by the negative substitution effect from special factors such as the surge in demand for automobiles. The government's outline for tax reforms. we think a boost to household income from government measures looks unlikely (Figure 1). we need to remember that the underlying trend in consumer spending has generally remained positive ever since Q2 2009 (Figure 2). Figure 1. other measures such as a possible limit on the married couple’s allowance. while the end of eco-car subsidies in early September sparked a last-minute surge in spending on automobiles. once the impact of these measures drops out of the picture. as indicated by three consecutive quarters of growth in real employee compensation so far in 2010. probably as a result of stimulus measures such as the eco-point scheme and the eco-car subsidy scheme. in FY11 they can expect to feel the negative effects of policies such as cuts in income and resident’s tax dependency allowances.0 -0.9pp and depress consumer spending in Q4.1% q-o-q.1% q-o-q).5 -2. consumer spending rose 1. contributing 0. we believe. The impact of this faded in Q3 and spending on TVs began to increase again. our view is that any adjustment to production activity is likely to be short-lived and that incomes will continue to grow steadily.5 0. However. firm sales of drinks and frozen desserts through the summer and a surge in demand ahead of the tobacco tax hike in October.0 08 09 Extraordinary factors Est Excluding extraordinary factors Real private-sector final consumption expenditure 10 CY Note: “Extraordinary factors” refers to the combined impact of and subsequent fallout from the disappearance of government stimulus measures directed at the household sector (such as the new child allowance and the abolition of fees for public senior high schools). but are likely to detract -0.0 0. Since measures to boost consumer spending can have a (negative) substitution effect on other goods and services. such as reducing allowances for adult dependents. Due to the narrowing in April of the range of products to which the eco-point scheme applied. we think the underlying component may have outweighed the impact of such measures. We estimate that special factors contributed 1.2011 Global Economic Outlook Underlying growth in consumer spending Mika Ikeda Consumer spending continues to be affected by temporary factors: government stimulus measures (and adverse reactions to their discontinuation). in Q1 2010 there was a last-minute surge in demand for TVs. Japan Meteorological Agency. Tobacco Institute Of Japan data and Nomura Global Economics. should also be positive for consumer spending. Ongoing improvement in incomes. In these circumstances. includes measures that would increase household tax bills.0 -1.7pp to real GDP growth. some are concerned that consumer spending could fall sharply. JADA. With the boost from existing measures fading. In Q3 2010.3pp to consumer spending in Q3. Underlying growth in consumer spending % y-o-y 1. which is being considered by the Tax Commission. Although the underlying component fell in Q3 2010. while households benefited in FY10 from policies such as the new child benefit scheme and the de facto abolition of fees at public senior high schools. consumer spending has risen ahead of any improvement in the employment situation. Nomura Global Economics 40 6 December 2010 .5 -1. the hot summer and last-minute demand ahead of a hike in cigarette tax. However.

In October. In November. (2) Cash flow = recurring profits / 2 + depreciation. and thereby to continue to bolster a gradual recovery in domestic demand. (3) Free cash flow = (cash flow) (capex). same hereafter) had reached an all-time high of ¥22. We expect this to bolster the economy. According to the latest data (on a four-quarter moving average basis). Source: Ministry of Finance. This equates to 4. We estimate that a 10% appreciation of the yen against the US dollar would depress Japan’s real GDP by about 0. the government intervened in the forex market for the first time in six-and-a-half years. As a result. have been the main cause of Japan’s prolonged deflation in terms of both supply and demand.6pp. Nomura Global Economics Note: (1) 4-Q mov avg. (4) Data for companies with a capital of ¥10mn or more (excluding financial and insurance) Source: Ministry of Finance. In September 2010. as the ratio of the corporate sector’s interest-bearing debt to cash flow indicates (Figure 3). (2) Cash flow = recurring profits / 2 + depreciation. As a result. we expect to see negative growth for only one quarter (namely. In particular.090bn. Figure 3. Assuming that the yen continues its ascent. the cash surplus – cash flow minus capital investment (free cash flow) – at companies with capital of at least ¥10mn (excluding the financial and insurance sectors. we expect the BOJ to carry out a further round of easing by expanding this asset purchase program (Box: The BOJ’s risk tolerance). annualized. companies are under increasingly less pressure to curb their employment costs and capital investment (See Box: Japan’s deflation and the output gap). Corporate sector’s surplus cash (free cash flow) x 13 12 11 10 9 8 7 6 5 4 1955 60 65 70 75 80 85 90 95 2000 05 CY 10 ¥trn 80 70 60 50 40 30 20 10 0 -10 -20 55 60 Cash flow Free cash flow Capex CY 65 70 75 80 85 90 95 00 05 10 Note: (1) Interest-bearing debt + borrowing from banks + other borrowings + bonds.5tn on an annualized basis as of June 2010 (Figure 4). mainly as a result of a slowdown in exports. (3) Data for companies with a capital of ¥10mn or more (excluding financial and insurance). At its core is a package of stimulus measures worth a total of about ¥5. Q4 2010). the BOJ announced a program of "comprehensive monetary easing" incorporating an asset purchase program. in our view. The economy is highly sensitive to USD/JPY We see a continuing decline in USD/JPY as the biggest downside risk to the Japanese economy in both the short and medium term. Interest-bearing debt/cash flow ratio Figure 4. now that it has cleared its excess debts from the bubble years. What we think will bolster the domestic economy is the corporate sector's unprecedented surplus funds. These excess debts. (4) 4-Q mov avg. we expect the public investment it contains to bolster real GDP in Q1–Q2 2011. 41 6 December 2010 .2011 Global Economic Outlook The government and the BOJ have been pulling out all stops The recent sharp economic slowdown and strength of the yen have forced the government and the BOJ to pull out all the stops on the policy front.3pp a year.7% of nominal GDP for FY10 (Nomura estimate). Unprecedented corporate surplus liquidity Companies have unprecedented surplus liquidity We expect private domestic demand to continue to pick up slowly despite the domestic economy's soft patch. We expect a portion of this unprecedented surplus corporate liquidity to find its way into domestic investment and wage increases. mainly by stabilizing the exchange rate. in an attempt to halt the yen's ascent. We expect it to boost GDP by about 0. the Diet passed a supplementary budget for FY10.

and (3) establishing a ¥35trn asset purchase program that includes fixed-rate fundsupplying operations (of about ¥30trn) against pooled collateral. Although the Japanese economy has recently shown signs of slowing. However. During this period we think the BOJ is unlikely to discontinue its de facto ZIRP. probably expanding its asset purchases from the current ¥5trn to ¥8-10trn.1 0 9. Source: BOJ. we assume that the BOJ will increase the size of the program to ¥8-10trn.05 Note: 1) Max purchase amounts are yardsticks.1%.2 12 10 8 6 4 1. Nomura Global Economics.2011 Global Economic Outlook The BOJ’s risk tolerance Shuichi Obata We expect the yen to strengthen again in Q1 2011 and the BOJ to further ease monetary policy. 2) Conventional method in which counterparties' bid yield spreads calculated by subtracting min yield of 0. Figure 1.0 0.5 2.6trn of J-REITs rated AA or higher. as the weighted-average risk would increase as a result.0 2 0. We therefore think that the increase for bonds and CP may be ¥1-2trn. We expect the yen to appreciate again in Q1 2011 and think USD/JPY is likely to break below 80. the level of the BOJ’s risk tolerance is the unknown factor. Assuming that purchases of both ETFs and J-REITs double. pressure on the BOJ to further ease monetary policy. respectively. Nomura Global Economics Nomura Global Economics Note: (1) We estimated risk as the daily return corresponding to the bottom 1%.0-0. More problematic is the BOJ’s tolerance of risk involved in purchasing ETFs and J-REITs.4trn per annum at a time. Overview of BOJ's new asset purchase program Eligible securities Maximum purchase amount ¥trn Long-term JGBs Treasury discount bonds Commercial paper. it has done so by ¥2. albeit briefly. we expect the BOJ to remain on the sidelines for the time being. We expect the BOJ to further ease monetary policy in Q1 2011. if anything. We expect this easing to take the form of an expansion of the asset purchase program that the BOJ announced in October. or buy less equity-related products to maintain the risk level. In the past. As there is only about ¥1. etc 1. (2) The sample period was form 1 October 2008 to 30 September 2010. the BOJ would have to either increase its JGB (and corporate bond) purchases.2 0. (2) clarifyin its definition of “price stability” (its condition for discontinuing its zero interest rate policy (ZIRP)). The BOJ has made it clear that it will only discontinue this policy if its definition of price stability is satisfied (i. As its aim then was to calm financial markets.. we see limited scope for the BOJ to increase purchases in this asset class. “in a positive range of 2% or lower”). As for ETFs. increasing purchases would expose the BOJ to considerably more risk (Figure 2). when the BOJ has increased its JGB purchases. etc ETFs J-REITs 0. the BOJ announced its Comprehensive Monetary Easing: (1) lowering its target for the uncollateralized overnight call rate to 0. we estimate a total purchase limit of about ¥8. 42 6 December 2010 TSE REIT Index 2-yr JGBs . As before. 3) The BOJ plans to continue making purchases for about 12 months after its first program purchase. One reason for this is that the Japanese stock market has held up quite well since the yen stopped appreciating. and as many within the BOJ want to see both the effectiveness and the side-effects of measures taken so far.5trn. while the size of the market may not be a problem. maximum purchase amounts of ¥3trn and ¥1trn. Assuming a core CPI rate of 0.e. Since the BOJ’s additional easing was in response to yen strength and stock market weakness. half that amount might be a more likely figure this time. Since the start of November.1 0. the BOJ has begun to use some of the ¥5trn that constitutes the new part of the program to buy JGBs and is due to start purchasing corporate bonds and commercial paper next month. On 5 October 2010.5 0.Source: Bloomberg. We think the BOJ is most likely to increase the size of the program from ¥5trn to ¥8-10trn and believe that if the BOJ wants to increase the size of the program while minimizing risk it will have to increase its weighting of JGBs. However. To allow for both possibilities.8 Corporate bonds. has eased. It is can be seen from Figure 1 how carefully the BOJ must have considered the size and risks to each market when it decided on the maximum purchase amounts for each asset class in the ¥5trn program.45 0. we see further bouts of yen strength and stock market weakness as conditions for any further monetary easing.1 0.5 Figure 2. For commercial paper and corporate bonds.1% from the yield at which counterparties wish to sell to the BOJ. Comparison of asset risks AA-rated corporate bonds 5-yr US Treasuries A-rated corporate bonds BBB-rated corporate bonds Nikkei Average Risk as a multiple of the risk of US Treasuries. We think the main considerations in trying to judge by how much the BOJ is likely to increase its purchases of individual assets are the size of each market and the BOJ’s risk tolerance.5% y-o-y is the trigger. x 11. we do not expect an end to the ZIRP until 2014. (3) All corporate bonds had a maturity of two years. were set in 2009.

it suggests that these aftereffects eased. Labour and Welfare and BOJ. as a result of stronger external demand. Elasticity of inflation with respect to the output gap Figure 2. We think that the sharp decline in the expected rate of growth during the recent recession is likely to have been temporary.potential GDP) / potential GDP. % y-o-y 6 5 Est 4 3 2 1 0 -1 -2 -3 -4 CY Scheduled cash earnings (rhs) Expected grow th rate (rhs) -0. this relationship is not necessarily stable. whereby it corrects forecasting errors that result from the difference between the previous year’s expected and actual growth rates. the Japanese economy entered another deflationary phase in 2009.3 Est 0. which excludes food and energy. (2) The expected growth rates for Q2 2010 and thereafter. employment. We believe this indicates that deflationary pressures have begun to ease as the output gap narrows. higher than the 0. Furthermore. However. resulting in the growth rate forecast by corporations to be lowered further (Figure 2). the elasticity of inflation with respect to the output gap has turned negative. Cabinet Office and Ministry of Internal Affairs and Communications. Naokazu Koshimizu Because of the large negative output gap. Reductions in excessive stock severely depressed growth. As a result. companies were eager to contain their employment costs by increasingly taking on temporary workers with relatively low wages. average wage growth per head in Japan trended lower. as the expected growth rate continued to rise during the last economic recovery. it has turned upwards this year. (2) Data for Q4 2010 and thereafter are Nomura forecasts.1% expected at the end of 2009. (3) To calculate the elasticity. and scheduled cash earnings for Q4 2010 and thereafter are Nomura forecasts. 43 6 December 2010 Nomura Global Economics . capital investment and debt increased in line with growth expectations. However. Source: Nomura Global Economics. as % of output gap 8 6 4 2 0 -2 -4 -6 -8 Output gap and price elasticity (rhs) Core CPI (lhs) Output gap (lagged by two quarters. even though there were several recovery periods from the 1990s onwards.0 % y-o-y 15 10 5 0 Corporate loans (lhs) annualized. From the late 1990s until the early 2000s the output gap failed to turn decisively upwards despite several economic recoveries. As reducing surplus stock is no longer a longterm deflationary factor in Japan. Ministry of Health. the benefits seem to have failed to feed through to domestic demand. as the benefits of the economic recovery of the late 2000s have begun to have a positive knock-on effect on domestic demand. Although Japan’s expected growth rate declined sharply during 2008’s recession. As the bubble inflated in the late 1980s and early 1990s.2011 Global Economic Outlook Japan’s deflation and the output gap The structural factors that have caused Japan’s deflationary pressures have now eased. we view this as a cyclical concomitant of the recession rather than a reduction from the excesses of the 1980s. Source: Nomura Global Economics.9%. the expected growth rate tends to follow a pattern. we think the economic recovery could feed through to domestic demand and expect deflationary pressures to ease as a result of a better supply-demand balance. as happened during the 1990s. and the relationship between the output gap and inflation has become more tenuous. core CPI inflation tends to gather upward momentum as the output gap turns positive. even during economic recovery periods. As Figure 1 shows. because the Japanese economy has been hit by the after-effects of the 1980s asset boom turning to burst in the 1990s. In terms of employment. This relationship suggests that the expected growth rate at the end of 2011 is likely to be (a four-quarter trailing average of) 0. deflationary pressures may start to ease. capital investment and debt. wages and lending % y-o-y . Although the Japanese economy experienced several cyclical recoveries. we have used the core CPI. Expected growth rate. Note: (1) The expected growth rate is the "industry demand real growth rate outlook (average for the next three years)" from the "Annual Survey of Corporate Behavior. Wages and lending began to pick up. The elasticity of inflation with respect to the output gap has turned positive again. Although wages and lending also declined substantially. lhs) pp 0. Cabinet Office. In addition. as it is likely to be a better reflection of supply-demand. after the bubble burst great efforts were made to halt and reverse the excessive growth in employment.2 -0. However.1 -0. We think that the output gap has failed to turn positive despite the economic recoveries.3 90 92 94 96 98 00 02 04 06 08 10 12 CY -5 -10 90 92 94 96 98 00 02 04 06 08 10 Note: (1) Output gap calculated: (actual GDP ." divided into quarters and plotted as a four-quarter trailing average.1 0. recently the economy has begun to recover rapidly and as a result the negative output gap has narrowed. Figure 1. However.2 0. Therefore. This shows that deflation increased despite the negative output gap narrowing.

A 5pp cut in the corporate income tax rate. thereby dampening domestic demand in general and consumer spending in particular. we think an increase in per capita wages or a rise in share prices would also give consumer spending quite a boost.. 49% of their export contracts are denominated in USD. Although Japanese exporters are now much less dependent on the US. possibly. the prospect of a further cut in the corporate income tax rate at some point in the future might persuade companies to refrain from transferring production overseas despite the strength of the yen and. would therefore be very significant. thereby threatening both production and jobs in Japan itself. a 10% appreciation of the yen against the dollar would depress their recurring profits by about 7%. action is needed on four fronts to reduce the pressure on companies to transfer production overseas: (1) more stable exchange rates.. Using the Cabinet Office's short-term economic model. According to our estimates for about 400 leading Japanese companies (NOMURA 400. This could eventually trigger a recovery in domestic demand. and if these policies are successful. As a result. . Similarly. ex-financials). we think the government is likely to include a 5pp cut in the basic rate of corporate income tax in its tax revisions for FY11.. The biggest boost to real GDP from a cut in the corporate income tax rate would come via capital investment. This would be the first cut in corporate income tax in 12 years. the cumulative result is a severe blow to the Japanese economy and a possible obstacle to overcoming deflation. We expect the Japanese economy to emerge from its soft patch around the middle of 2011 in an export-led recovery helped by an end to the yen's ascent and by strong demand overseas. We expect the government will implement policies which may help export-led recovery cause recovery in domestic demand that spells the end of deflation in the future. Action to boost Japanese exports We see a mediumterm risk of industry hollowing out In the medium term.3pp and real GDP by 0. squeezing their profit margins. we think that the prospect of continued export expansion could give companies the confidence to use their unprecedented surplus liquidity to invest in Japan and boost wages and employment. although quite modest. It is therefore the job of the government to try to counteract such moves. if the yen appreciates against the dollar. it might help to attract investment in Japan by foreign companies. (3) more support for new industries. and help unleash firms’ surplus liquidity We expect the soft patch to end by midyear Nomura Global Economics 44 6 December 2010 . While it may make perfectly good sense for individual companies to transfer their production overseas. This tendency for the yen to damage the Japanese economy via its impact on the stock market strikes us as Japan’s Achilles heel. In our view. in turn. even to transfer production back to Japan. considerably less than the peak figure of 40% in the early 1980s. only 41% is denominated in yen.2pp (annual average of quarterly impact).2011 Global Economic Outlook A stronger yen would also have a big negative impact on corporate earnings.. In contrast. (2) more competitive corporate tax rates. This. especially in the rest of Asia. Furthermore. Corporate taxes are set to be cut This should spur investment . we are concerned that the strength of the yen could lead Japanese companies to transfer production overseas faster than they would otherwise have done and eventually hollow out Japanese industry. Exports to the US now account for just under 15% of Japanese exports. due to be announced in midDecember. we estimate that a 5pp cut in the rate would boost real capital investment by 1. With regard to the second front. hits their share prices. If the government implements policies such as these that are aimed at making life easier for Japanese exporters and making them more competitive. Japanese companies’ export receipts decline in value in yen terms. and (4) more encouragement of free trade.

3 -8.1 -0.85 1.2 5.5 0. After an emergency package of around ¥920bn.1 2Q12 2.15 80.8 3.2 -0.8 3Q10 4. Table reflects data available as of 6 December 2010.8 -0. marking Japan’s exit from its deflationary phase.7 1Q11 1.2 4.7 4.1 -0. It would also almost certainly dent consumer spending via the negative impact on equity markets.6 6.0 1.25 82.5 2.6 3.9 4.3 3Q11 1.6 5.0 -9.50 85.0 -2. Unemployment rate is as a percentage of the labour force.9 4.8 24.90 1.2 4Q11 1.0 0-0.1 1.e. % GDP) Current account balance (% GDP) Unsecured overnight call rate JGB 5-year yield JGB 10-year yield JPY/USD 0.0 -0.10 0.2 -0.0 0.6 1.10 0.5 5. Interest rate forecasts are end of period.2 1.0 6.5 0.3 4.1 6.2 1.5 3. the Japanese economy has entered a soft patch.0 0-0.8 0.3 0-0.6 -1. Details of the forecast % Real GDP Private consumption Private non res fixed invest Residential fixed invest Government consumption Public investment Exports Imports Contributions to GDP: Domestic final sales Inventories Net trade Unemployment rate Consumer prices Core CPI Fiscal balance (fiscal yr. All forecasts are modal (i.45 1.4 0.0 6. exports pick up led by renewed momentum in overseas economies.10 0.55 86. However.1 0.10 0.6 4.6 0.0 0.3 5.2 3.1 0.55 86. Risks: There could be upside for the economy if emerging Asian economies continue to grow more strongly than expected. However.45 1. Further yen appreciation would harm the export environment as well as fuel deflation by causing import prices to drop.5 0.9 2.7 5.0 -0.0 2011 1.0 -0.7 2. characterized by a sharp loss of momentum in the pace of recovery.6 5.9 3.4 -0.0 6.2 1.1 4.2 0. Source: Cabinet Office.3 4.8 0.8 1.1 -0.93 83.00 1.4 10. Fiscal balances are for fiscal year and based on general account.5 0.10 0.1 8.6 -2.0 4Q10 -2.40 85.7 0-0.0 0.55 1. economic developments in the US and Europe and political turmoil sparked by budget deliberations in Japan.3 1. and aggressive fiscal and monetary stimulus measures take effect. others forecast. BOJ.3 4.6 11.5 -12.2011 Global Economic Outlook Japan ⏐ Economic Outlook Takahide Kiuchi Emerging from the soft patch We think that the Japanese economy will resume its recovery trend in mid-2011.5 -3.1 -0. as exports gather momentum again and government stimulus measures kick in.10 0.8 0.10 0.1 -2.5 0-0.5 -9.9 -0.90 1.5 0-0.60 87.8 1.9 6. The BOJ has carried out its "comprehensive easing" package of extraordinary monetary easing measures.3 1.1 0. Once expectations of a recovery start to grow.10 1.1 1. and Nomura Global Economics.4 6.9 6. Statistics Bureau. Fiscal and monetary policy: The Democratic Party of Japan (DPJ) administration has pulled out all the stops with its economic stimulus measures. deliberations are under way to reduce Japan's corporate tax rate for the first time in about 12 years.7 0.6 0.0 5.5 10. the negative output gap is likely to narrow.85 1.26 0. the single most likely outcome). we think it will resume its recovery in mid-2011. We look for CPI to turn positive at the end of 2012. Ministry of Finance. the plentiful funds amassed in the corporate sector will likely aid the recovery in corporate capital investment.60 88.70 1.4 4.4 3.4 0.8 0.3 2012 2.7 -4.2 1Q12 2. causing those economies to be plunged back into recession.8 4. Nomura Global Economics 45 6 December 2010 .0 5.0 0.7 2Q11 1.4 0.7 -5.0 -12.1 0.2 5.0 2010 3. If we were to see the renewed spectre of financial market turmoil sparked by fiscal restructuring efforts and concerns over fiscal deterioration in the US and Europe.15 80.0 Notes: Quarterly real GDP and its contributions are seasonally adjusted annualized rates.3 0.8 -6.1 0.0 4.0 2.3 4.0 -0.8 -1.4 0.2 0.1 0.1 -0.0 0.1 4.10 0.4 0. We expect Japan's central bank to implement additional monetary easing measures in response to a renewed upsurge of the yen. With real GDP growth continuing to outpace potential growth.1 0-0.7 1.8 6.1 -0. the Japanese economy would also be hit by the negative fallout.2 2. Inflation measures and CY GDP are year-on-year percent changes.3 4.6 0. Economy: Hit by the slowdown in overseas economies and the strong yen.5 0.3 0.8 4.3 4. Numbers in bold are actual values. For the FY11 budget.10 0.0 -1.10 0.70 90.4 2..4 5. as the negative impact of the strong yen runs its course.0 -0.4 4.3 0. resulting in an increase in the asset purchase program to ¥8–10trn.3 -0.5 0. the economy's performance could fall short of expectations in the event of sharp yen appreciation.1 6.1 -8.1 1.4 0.0 0.80 1.0 7.4 -2.3 0.0 0-0.0 11.5 0-0.9 3. Inflation: We expect a gradual slowdown in the pace of decline in the CPI on the back of the economic recovery.8 -1.4 2.7 0-0.6 5.1 6.9 1. the government has decided to implement a supplementary budget worth around ¥5trn in FY10.4 0.

000 12. . The bigger macro picture is Asia rebalancing: 1.2011 Global Economic Outlook Asia ⏐ Outlook 2011 Rob Subbaraman Challenges of rebalancing Asia’s economies are rebalancing. Asia will never fully decouple from the advanced economies – global financial markets are too integrated for that. Size of economies. Recently. In the first three quarters of 2010. We do feel strongly. the huge pipeline of new private-public infrastructure projects in India and Southeast Asia. China juggernaut. Domestic demand. in USD at market exchange rates USD trn 16 14 12 10 8 6 4 2 0 Rest of Asia Korea India China US Japan 0 1996 1998 2000 2002 2004 2006 2008 2010E 2012F Source: CEIC and Nomura Global Economics. only one-third of Asia’s total imports came from G3 economies. its high-growth phase of development is far from over (for details of our forecast. and China moving to unwind government subsidies that have long-favoured exporters/producers over workers/consumers (See Box: China: Gearing up for further reform). In 2011-12. and 3) emerging markets (EM) more generally.. see the China Economic Outlook: GDP growth of 9-10% to continue).000 4. Asia has been losing some growth momentum but we see this as temporary. actual and projected nominal GDP. If. Figure 2.000 2. however. China’s economy has reached a size where continued high growth rates mean the rest of Asia now has a large. another is the sheer size of Asia’s expanding middle class. on the other hand.000 8. The heat is on. China’s ordinary imports will exceed those of the US by 2016. we expect the economies of Asia ex-Japan to collectively grow by over 8%. and that this process is happening faster than most people realise.. The debate over Asia “decoupling” is too black and white for our liking. But in the past five years. Consider China’s so-called “ordinary” imports (goods catered to China’s own demand instead of exports). setbacks are likely. Latin America and Saudi Arabia will for the first time exceed its total imports from the US. since the 2008-09 crisis.. led by 9-10% growth in China.. these are on track to total USD0.000 10. domestic demand contributed 93% of GDP growth in China and 94% in the rest of Asia. 46 6 December 2010 . even with only 1-2% growth in the G3. but with GDP per capita of only USD4. 28 May 2010). but more important is the increased focus on strengthening social safety nets. Germany and France.000 Planned Under construction In operation … as policymakers look more inward for growth Asia now has a large. Asia is becoming less reliant on the G3 economies . Asian policymakers have grasped this and have switched their focus to generating domestic demand (Figure 1). 2) China. Asia is becoming less reliant on the G3 (US. 2. This year. One reason is the tepid G3 recovery. It is telling that this year China’s combined imports from Africa. and is rapidly diversifying to other emerging markets Figure 1. Nomura Global Economics Source: International Union of Railways. but unless macro policies also rebalance. At this pace. dynamic growth pool in its own backyard . Increased links with other EMs. A good example is high-speed rail: by the end of 2012. Asia is fast becoming too big a slice of the global economic pie to keep relying on export-led growth.. autonomous growth engine in its own region. China will have more track than the rest of the world combined (Figure 2). euro area and Japan) economies: it is well on the way to being able to achieve its full growth potential. that Asia’s economies are in the process of rebalancing toward: 1) domestic demand. Put simply. China is now the world’s second-largest economy. 3. wanting bigger homes and more consumer durables. there is another G3 recession (not our base case) Asia would be hit hard again. the materials and manufacturing of which are largely sourced from within Asia and other emerging markets and commodity producers. The amount of high-speed (>250km/hr) rail lines in the world as of May 2010 Km 14.75trn versus US imports of USD2trn..500. but its fiscal firepower and sound fundamentals would position it well to bounce back ahead of other regions (see our Special Report. China’s ordinary imports have grown on average by 24% per year versus 5% for US imports. Real policy interest rates are still negative in most Asian countries. In 2010. We believe that.000 6.

health care and education. CPI and 1-year deposit rate Figure 2. 3 Modernise agricultural sector to construct New Socialist Countryside 4 Modernise industrial structure 5 Enhance the coordinated regional development and urbanization 6 Construct a resource-saving. Macroeconomic policies.3% in 2011 and 1.0% in 2012 on stronger tax revenues and a slower rate of expansion in public investment. Summary of draft on China’s 12 Five-Year Plan Shift China's economic growth pattern and build new stage of scientific development 2 Expand domestic demand and maintain relatively fast economic growth. to mitigate the concerns about financing of local government projects.7% in 2009. heightening the need to raise rates from their current excessively low levels. environment-friendly society 7 Invigorate China through science and education and construct an innovation-oriented nation. so over the same period the one-year deposit rate should rise by a larger 225bp. we expect the government to conduct agricultural reform to raise farmers’ incomes. In our view.90 by the end of 2012). On monetary policy. we expect the central bank to raise the one-year benchmark lending rate by 175bp in 2011-12. by which the government now allows investment in projects that were previously restricted to private investment. resulting in a narrowing in banks’ currently wide interest rate margins. Also. internationalizing the RMB. 47 6 December 2010 1 th % 10 8 6 4 2 0 -2 Mar-01 CPI. But we expect the overall macro policy stance to stay mildly supportive of the economy. four 25bp increments in 2011 and three more in 2012 (for details of our forecast. sizable rate hiking cycle and the government to use the new five-year plan to accelerate reforms. to continue social welfare reform in such areas as social security. This would involve the phasing out of quantitative bank lending restrictions. Price deregulation for resources such as gas. China announced its intention to develop and promote the seven strategic industries (energy-saving. electricity and water should also encourage efficient use of natural resources. aiming for sustained.22 by the end of 2011 and 5. see the China Economic Outlook: GDP growth of 9-10% to continue). On fiscal policy. for 2011-15) (Figure 2). in order to raise consumers’ propensity to consume in the medium run. While the government is likely to strengthen its policy to consolidate heavy industries to remove inefficient facilities. we expect the so-called “New 36”. so real deposit rates should barely turn positive by late 2012 (Figure 1). y-o-y 1yr deposit rate F Mar-03 Mar-05 Mar-07 Mar-09 Mar-11 Source: CEIC and Nomura Global Economics. alternative-fuel cars. relativelyhigh medium-term growth. • • Figure 1. We expect China to implement an aggressive rate hiking cycle not only to contain inflation but also for the longer-run structural reason of making the financial system more market-oriented. With a very high investment-toGDP ratio of 47. to raise minimum wages with the aim of raising the income of low-income consumers. we expect the central government’s budget deficit to narrow from 2. We expect China to implement various structural measures in 2011. We expect less accommodative fiscal policy and tighter monetary conditions in 2011-12 to address rising inflation pressure.5% of GDP in 2010 to 1. We expect the rate hikes to be asymmetric. liberalizing the capital account and moving to a more flexible exchange rate regime (we forecast CNY/USD to appreciate to 6. and to encourage urbanization. Structural reforms. While we are forecasting significant interest rate hikes. we are also expect a large rise in inflation. the government intends to sustain relatively high growth by promoting private consumption. alternative energy. Rather than simply continuing its existing policy. new-generation information technology.087 companies to close energy-inefficient facilities. Promoting regional development. we expect China to encourage manufacturers and service providers to relocate from coastal regions to central and western regions by implementing policy favoring those regions. 8 Improve public service system 9 Promote China's culture and soft power 10 Perfect system of socialist market economy 11 Pursue the win-win opening-up strategy Source: Xinhua News Agency and Nomura Global Economics. Improving energy efficiency. Policy efforts to reduce energy usage per unit GDP accelerated in mid-2010 when the government ordered 2. Nomura Global Economics .2011 Global Economic Outlook China: Gearing up for further reform Tomo Kinoshita │ Chi Sun We expect a long. there are three key policy directions: • Shifting the pattern of growth from investment-driven to more consumption-oriented growth. although spending on social welfare and new strategic industries should accelerate. This topped the agenda in the draft of the 12th Five-Year Plan (FYP. with a focus on the central and western regions. All this means that interest rate policy should become China’s primary monetary policy tool over time. For that purpose. biotechnology and high-end equipment industries) with which the government is trying to encourage energy efficiency. advanced materials.

Risks from “growth over inflation” policymaking We forecast Asia ex-Japan CPI inflation to rise from 4.1 8.1 2. given our forecast of CPI inflation rising and remaining above central bank targets.2 -1. we use the 3-month interbank rate since the monetary authorities target the exchange rate. 48 6 December 2010 Note: In Singapore and Hong Kong. any of which could eventually result in a costly macro adjustment and be counterproductive. With inflation rising.7 -4. Australia. Greater China and Korea to keep monetary conditions loose The current account can be a useful barometer of whether an economy shows signs of overheating. Indonesia. Source: BIS. Source: CEIC and Nomura Global Economics estimates.2 -0. higher value suggests tighter monetary conditions and negative values suggest loose monetary conditions. even though these interventionist policies tend to lose effectiveness over time. Korea. excessive CPI inflation or worsening current account positions.1 -0. CEIC and Nomura Global Economics estimates. Malaysia) to 100bp (China. we expect the authorities.1 Real MCI 0. this pattern breaks down for Hong Kong. Policy rates in Asia ex-Japan.6% from 0. Combining real policy rates and exchange rates. given it hurts GDP growth. whereas countries with large current account surpluses (ASEAN) have allowed more of the tightening of monetary conditions to happen through real currency appreciation.7 15. including by using more capital controls.5% y-o-y in 2010 to 5. October 2010 China HK India Indonesia Korea Malaysia Philippines Singapore Taiwan Thailand Real policy rate -2. Figure 1. However. so their real monetary conditions indexes (MCI) were the loosest as of October 2010 (Figure 1). Figure 2.5 -1.5 -8. but have kept their real policy rates and real effective exchange rates (REER) well below their long-run averages. Korea and Taiwan. We believe the greater use of macro-prudential measures will be partly at the expense of rate hikes. for fear of attracting capital inflows.6 0.6 -3.3 -2. Current accounts and policy rates Figure 3. and for Asia we find a strong inverse relationship between the amount of rate hikes that have been implemented recently and are forecast for next year.5 0. we expect all Asian central banks to raise interest rates.5 16.0 7. particularly in Greater China and Korea.8 3. such that real policy rates rise to only 0. Philippines.3%. Vietnam).8 -0. overall monetary conditions are likely to remain relatively loose. The scope for monetary tightening to respond to commodity price-driven inflation is also limited. We would also add China to this group as its REER has hardly moved in recent years and bank loan growth has remained high. the two countries with large current account deficits (India and Vietnam) have hiked rates the most.7 -4. we used the 3-month interbank rate as a proxy for the policy rate.6 13. CEIC and Nomura Global Economics estimates. The longer-term consequences can be asset price bubbles. NZ % y-o-y 8 6 4 2 Real policy rates Nominal policy rates 20 15 10 Current account. we think Asia will not be able to escape significant real exchange rate appreciation. but not enough to significantly raise real policy rates. and the current account balance (Figure 2).8 -9. to resist rapid currency appreciation. These three have a large current account surplus and high inflation. % of GDP in 2010-11 Singapore Malaysia Taiwan HK Philippines Korea Indonesia China Thailand India 5 0 -5 -10 -15 -50 0 Vietnam -2 Cumulative rate hikes . In the end.2011 Global Economic Outlook Macro policy: Not enough to fight inflation Young Sun Kwon ⏐ Sonal Varma We expect real policy rates in Asia (GDP weighted) to remain low in 2011. bp in 2010-11 Dec-01 Dec-03 Dec-05 Dec-07 Dec-09 Dec-11 0 50 100 150 200 250 Note: Weighted by GDP (on a purchasing power parity basis). Such a loose monetary policy.0 REERs 8.8 1.5 -18. Real monetary conditions index (MCI). Source: IMF. too. far lower than the historical average of around 2% (Figure 3).3 Note: MCI estimated as weighed average of real effective exchange rate (deviation from long-run average since 2000) and real policy rates (deviation from long-run average since 2000). ranging from 50bp (Taiwan.0 -12.1% in 2011. MCI value of zero indicates neutral monetary conditions. In Hong Kong and Singapore. eager to support exporters. Nomura Global Economics . while allowing an undervalued currency to appreciate can help contain inflation. can be positive for domestic growth only in the short run. the rising risk is that a large part of this comes via higher domestic inflation.7 2.3 -4. Finally. India inflation refers to wholesale price index. Policymakers to miss their inflation targets In 2011.1 -7.3 2.

Taiwan and Thailand (Figure 4). on cue. Nomura Global Economics China Japan Rest of Asia % y-o-y 20 15 10 5 0 -5 -10 % of GDP Change in nominal effective exchange rate. While food prices comprise 14% of the US CPI basket.2011 Global Economic Outlook Myopic policy responses Excess net capital inflows pose a policy dilemma Asia’s rapid ascent is creating new policy challenges. If they want to manage the exchange rate while trying to regain control over domestic monetary policy. One is the attraction of massive net capital inflows because of Asia’s superior economic fundamentals and higher growth rates vis-à-vis the advanced economies. the biggest FX accumulators have been Hong Kong. Asia’s FX reserves are now more than adequate to insure against a crisis. but not all. and so rapidly rising food prices have a large impact on Asian inflation. Asia’s FX reserves have surged to USD5. an open capital account and monetary policy autonomy.0 0. Their rationale: after relying on an export-led growth model for decades. there has been a contagious shift in Asia this year to micro-manage the economy though capital controls and macro-prudential policies (see our Special Report. there have been 25 such measures imposed across the region this year. They also involve rising costs when the interest paid on sterilisation bonds is higher than the interest earned on FX reserves. Figure 4. Asian policymakers are willing to tolerate gradual currency appreciation. credit quotas and property taxes in lieu of raising interest rates may seem to work in the short term. in Asia that weighting is more than double. 12 months to Sept-2010 Figure 3. FX reserves in Asia USD trn 3.5 0. conditions that we expect to continue through 2011-12. The new trend in Asia is to micro-manage the economy The “impossible trinity” is starting to bite Inflation looms Inflation will be the macro story in 2011 Another challenge created by Asia’s ascent is rising commodity prices. given the imputed cost of housing feeds into Asian CPI with lags of 6-24 months and have hefty CPI weights in Hong Kong (29. on top of Asia’s large current account surpluses. CEIC and Nomura Global Economics. lhs Change in FX reserves. Singapore. of: a managed exchange rate. Asia has limited currency appreciation through FX intervention. FX reserves and currencies.2%). spanning nine of the 11 countries we cover. Heated property markets are another inflation driver. takes time.0%) and Taiwan (18. This trend can be understood as a manifestation of the so-called “impossible trinity”: a country can simultaneously choose any two. However. Herein lies the rub. On our count. As a result. The case for capital controls in Asia.0 1. because the economies are operating at nearfull capacity.0 2. and the deepening of local debt markets to absorb the capital inflows. These capital inflows rarely trickle in – they come in waves which. Singapore (20. using capital controls to slow currency appreciation and imposing higher mortgage downpayment ratios.5trn (Figure 3). In response. especially that of food. 8 September 2010). but scaled by GDP. the only thing they can do is to clamp down on capital flows. Unemployment rates have mostly fallen back to pre-crisis levels and. Inflation pressures are also percolating. which becomes inflationary. 49 6 December 2010 .5 2.0 Oct-98 Oct-00 Oct-02 Oct-04 Oct-06 Source: CEIC and Nomura Global Economics. the shifting of capital and labour from export-orientated industries to domestic industries. which we believe will continue to rise sharply (see our Special Report. wage inflation is rising and could accelerate in China as the supply of young rural workers willing to migrate to manufacturing jobs continues to dwindle. 1 November 2010).5 1. have placed significant appreciation pressure on Asian currencies.5%). China tends to grab all the attention. rhs 20 15 10 5 0 -5 -10 Oct-08 Oct-10 Source: BIS. The upshot is that many countries in Asia will be hard-pressed to avoid inflation problems in 2011-12 (See Box: Macro policy: not enough to fight inflation). The coming surge in food prices. but not at the speed that market forces would dictate. but the international experience is that these sorts of measures become less effective over time as investors find loopholes. Countries that attempt to manage the exchange rate when capital is flowing freely lose control of their domestic monetary policy – they end up having to keep interest rates too low so as not attract more capital inflows.

e. with such a high investment-GDP ratio. Productivity drive in China. China’s challenging GDP arithmetic. We are bullish on China. Korea is the region’s growth laggard in 2011. 50 6 December 2010 Nomura Global Economics . Seoul searching. Figure 6. Current account and fiscal balance forecasts. due to KRW/USD appreciation sapping export competitiveness. or cut import tariffs to boost local supply. if for whatever reason it were to stop growing. and promoting human capital. but with solid fundamentals. making banks more accountable for properly pricing credit risk. policies may need to as well China’s economy is very unbalanced HKD/USD peg. China aside. as it does not reflect fiscal deficits. having one of the few property markets with oversupply and a household sector constrained by debts exceeding 150% of disposable income. it could cut China’s GDP growth in half (in most Asian countries.2011 Global Economic Outlook Hence our 2011 CPI inflation forecasts are above-consensus in all Asian countries. In terms of continued surging net capital inflows. total factor productivity) is key for China to avoid a noticeable slowdown in its potential growth rate. Hong Kong is by far the most exposed to an asset price bubble that. by definition. it will be hard for capital to contribute more than it already is. The result: worsening fiscal and current account balances. promoting the private sector and service industries. where commodities comprise such a large share of the consumption basket. Using labour and capital more efficiently (i. The HKD/USD peg means Hong Kong is importing the Fed’s QE2 and experiencing deeply negative and falling short-term real interest rates. Asian investment-to-GDP ratios are too low. look most vulnerable to a “sudden stop” – when investors start to focus on sovereign risks (Figure 6). This would allow monetary conditions to be more in sync with an economy increasingly geared to China’s and is consistent with Hong Kong fast becoming the RMB offshore financing centre. Australia. expect a wave of publicprivate infrastructure projects. automation and a more efficient use of resources. low interest rates. Others may well follow China’s lead in introducing food and energy subsidies and price controls to shield lowincome households. From this perspective. Surprises and themes We highlight two possible out-of-the-blue surprises and three big picture macro themes: As economies transform. for different reasons So how does Asia fare in the face of the dual shocks of surging capital inflows and commodity prices? In terms of rising food and energy prices. a rising North Korea risk premium (see Box: Asia politics outlook 2011-12). Source: IMF and Nomura Global Economics. particularly in India and Southeast Asia. India and Hong Kong look most vulnerable. Net imports of food and energy-related items and their weighting in CPI baskets. we expect reforms to focus on: phasing out government subsidies to producers. New Zealand and possibly Malaysia could be net beneficiaries. fiscal space and strong capital inflows. Yet policy responses and economic fundamentals must also be considered. China’s one-child policy means the contribution from labour to potential output growth will soon dwindle to zero and. 2011 (circles = size of gross public debt as a % of GDP) % of GDP 20 Malay 15 Sing Taiwan 10 5 0 -5 -10 -15 -15 -10 -5 Fiscal balance 0 5 % of GDP Ireland Japan UK Phil China Thai Indo Brazil NZ Viet Aust HK Korea Policy is set to favour quality over quantity Korea is set to be the laggard in 2011 There could be an infrastructure boom Figure 5. It is not our base case. investment falls at least one year per decade – in China. but also aware that the economy is very unbalanced. will burst. from Taiwan to India and across Southeast Asia in between. it has not fallen since 1989). Investment is nearly half of GDP. the Philippines. Infrastructure boom. which is completely at odds with the stage of its economic cycle. Vietnam and most of all India. 2009 % weighting in CPI 65 60 Vietnam Malaysia China Singapore Thailand Taiwan Japan Korea HK Indonesia Philippines India 50 45 40 35 30 25 20 Current account balance Food and energy items 55 US India Greece NZ Australia -10 -5 Portugal 0 5 10 15 % of GDP Net imports of food and energy Source: CEIC and Nomura Global Economics. Note: Singapore’s public debt is excluded. In our forecasts. whereas India and the Philippines seem most exposed (Figure 5). but the HKD could be re-pegged to the RMB in 2011-12. In 2011-12.

if (as looks increasingly likely) the army elects to broaden its campaign against Islamic militants into North Waziristan. due no later than December 2011. South Korea: The 26 March sinking of the South Korean corvette Cheonan and the 23 November artillery assault on the South Korean island of Yeonpyeong (the first attack on South Korean soil since the Korean War) has returned brinkmanship to the peninsula. The deep-seated political divide is likely to continue to cast a cloud over the economic outlook. If elections are held in H1. but do not rule out a return to negotiations. We believe there could be greater scope after the CPC for tighter policies to avoid overheating and structural reforms. While this is a near-term risk to investment inflows. We believe closer ties with China (including the Economic Cooperation Framework Agreement effective September 2010). We expect tensions to remain high. It is one of the reasons why we have Korea’s GDP growing by only 3. Sino-US relations remain paramount and we look to President Hu Jintao’s proposed visit to Washington in January to help defuse tensions. will be a major positive for Taiwan’s medium-term growth outlook. which we think will focus on improving the quality and hence sustainability of economic growth. we doubt that it will do so fast enough to satisfy China’s critics in Washington. by lowering tariffs imposed on Taiwan’s electronics and other products and enhancing investment from China. In Pakistan. market sentiment and the economic outlook. 2011-2012 2011 January: China – President Hu Jintao’s state visit to Washington January: Vietnam – Communist Party 11th National Congress March: China – National People’s Congress (approval of FYP) 23 July: Malaysia – Last date for Sarawak state elections 26 December: Thailand – Last date for parliamentary elections 2012 January: Taiwan – Legislature elections February: Singapore – Deadline for parliamentary elections 15 Apr: North Korea – 100th anniversary of the birth of Kim Ilsung April: South Korea – Parliamentary elections September: Hong Kong – Legislative Council elections October: China – Chinese Communist Party 18th Congress December: South Korea – Presidential election Nomura Global Economics 51 6 December 2010 .5% in 2011. we think the government would boost fiscal policy and put reforms on hold until after the elections. we do not expect escalation of territorial disputes between China and its neighbours in 2011. even though we expect RMB appreciation to accelerate. making it the laggard in the region. Potential flashpoints include the ongoing trial of UDD leaders and the dismissal of the electoral fraud case against the Democrat Party. Renewed violence would likely hit domestic demand and tourism. We would expect the ruling coalition to achieve a sufficient mandate to move ahead with structural reforms. The direction of Sino-US relations and geopolitical tension between the two Koreas could fundamentally change Asia’s economic outlook. Despite continuing differences. Thailand: Despite recent relative calm. but we do not expect much political fallout beyond the near term. we believe that the risk of another major Pakistani terrorist attack on India could increase. Vietnam: The 11th Communist Party Congress (CPC) in January 2011 is expected to usher in a new generation of leaders. Taiwan: We expect China/Taiwan economic ties to continue to deepen and for the KMT to win the legislature and presidential elections due in early 2012. The negative sentiment could rumble on into the early months of 2011. Internationally. while at the country level we see elections in Thailand and possibly Malaysia as potential gamechangers. however. persistent political tensions could erupt again between now and the general election. with the opposition demanding that the prime minister resign. we do not place a high probability on the prime minister resigning. away from a “Sunshine policy”. in 2011 (and possibly as early as H1) as he seeks his own mandate and tries to leverage Malaysia’s strong economic recovery and opposition disarray. A key element in that process will be the 12th Five-Year Plan (to be unveiled in March 2011). • • • • • • Some important dates.2011 Global Economic Outlook Asia politics outlook 2011-12 Alastair Newton │ Asia economics team A particularly full political calendar in 2011-12 will shape policy direction. Here is how we see the main political events ahead: • China: We judge that in 2011 China’s leaders will be focused on ensuring a smooth economic trajectory through the handover of power to the incoming Fifth Generation leadership between October 2012 and March 2013. Malaysia: We expect Prime Minister Najib Razak to call a general election. Foreign investors are likely to demand a higher risk premium. due by April 2013. such as improving efficiency of public investment and strengthening of the financial sector – all of this should allow the country to attract stronger FDI and will be positive for its longer-run economic outlook. We judge that these events will push South Korea towards a “Sunset policy”. India: Corruption scandals have disrupted the Parliamentary session. but view a major escalation (major military confrontations) as a low probability – albeit high-risk – event for South Korea.

25 5.8 0.96 0.8 12.02 Note: Numbers in bold are actual values.7 3.0 7.50 3-year bond 4. 000 35.3 Unemployment rate 5.1 Trimmed mean 2.9 2.1 3. other measures are period average.7 5.10 5.8 -2.5 7.1 6.00 1. driven by a major increase in investment spending in the resources sector.3 3.50 5.9 8. Nomura Global Economics 52 6 December 2010 % y-o-y growth unless otherwise stated . Interest rate and currency forecasts are end of period.7 3.2011 Global Economic Outlook Australia ⏐ Economic Outlook Stephen Roberts ⏐ Tatiana Byrne Tiger taming Above-trend GDP growth later in 2011.0 3.7 2.3 7.3 2.30 6. Inflation: Economic spare capacity is limited.20 6.20 6. these should be complete by Q3 2011.4 -0.6 3.% y-o-y 2. The post-crisis fiscal spending boost to growth is likely to be allowed to run down as initially planned through 2011.3 3. Our forecast is that two more 25bp rate hikes to 5. keeping commodity prices elevated. % q-o-q.6 -0.5 -0.0 25.2 3.5 2.8 3.6 10.8 3.2 -2.98 1.50 5. especially in the labour market where we see the unemployment rate falling below 5% in 2011 – a level that in the past has been consistent with higher wage increases and rising inflation.8 3. We see policy to be set to partly offset this. providing 1.0 13. Details of the forecast 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP (sa.2 3.0 -1.1 2.1 0.0 1.96 0.% q-o-q.3 2. Any substantial setback in Asian growth. Source: Australian Bureau of Statistics.70 5.2 6.0 3.2 3.1 7.0 0. with very rapid growth in exports and business investment balanced by cautious household and government spending.7 2.8 11.6 .0 28.2 0.3 2.1 0.0 1.0 0. Forecast increases in export volumes and a record lift in spending on resource projects.25 5.8 3.0 imports 12.20 5.2 9.9 4.7 5.7 -1.90 6.0 3.1 Net trade -1.50 5.4 0.7 30.50%.9 5.9 0. would also present downside risk.8 4.3 3.0 28. particularly Chinese growth.9 0.5 2.8 2.3 2.0 25.1 3.1 -0.6 3. given that the RBA wants to establish the rate level ahead of accelerating business investment in mid-2011.9 3.3%).8 1.0 -0.2 -0.4 9.8 4.2 4. Activity: We expect persistently strong GDP growth from mid-2011 and in 2012.1 3.96 1.3 -1. making space by limiting growth in government and household spending. sa 0.4 5.8 2.8 -1.0 25.2 1.50 5. Reserve Bank of Australia and Nomura Global Economics.30 6. positive shock to national income and GDP growth from a once-in-a-century improvement in the terms of trade.10 AUD/USD 0.25% should suffice and.3 7.1 Weighted median 2.1 Federal deficit (% of GDP) FY end-June -4. about 1pp above their long-term average.9 2.25 5.60 5.3 percentage points (pp) less impetus to GDP growth than in 2010.10 6.2 5. especially China.3 6.0 0. In contrast.1 3. especially with borrowing interest rates pushing above the average of the past decade on further policy rate hikes.5 2.9 4.3 3.6 -1.2 3. We also see weaker government spending acting as a drag on growth through 2011.4 -0.25 5.4 2.0 Current account deficit (% GDP) -2.1 3.25 90-day bank bill 4.00 5.2 2.4 0.5 11.3 2.2 4.0 25.4 Government (total spending) 9.6 3.8 3. we see a high household debt burden weighing on household spending in 2011.8 7.75 5.0 4. annualized) 0. we still expect CPI inflation to move a little above the RBA’s 2-3% target band in 2011 and 2012.2 3. Policy: Policymakers will have to deal with the consequences of a massive.02 1.2 -2.0 30.0 3.5 2.0 4.9 3.7 9.25 5.9 3.0 0.2 0.6 -1.0 4.9 3.1 25.5 3.6 3.2 2.7 0. Risks: Worse global financial market conditions through the channel of higher Australian bank funding costs and borrowing interest rates could intensify deleveraging in the heavily indebted household sector.30 5.5 5.02 0.0 3..00 10-year bond 4.75 5.6 1. the single most likely outcome).75 5.5 2.50 4.0 -0.e.0 3.6 Household consumption 3.0 Consumer prices 2.5 4.1 2. A major improvement in sentiment on risk assets could lift growth.20 6.50 5.3 -0.4 0.0 28.3 Cash rate 4.0 2.25 5.02 1. We see the RBA working to establish a cash rate early in 2011 consistent with commercial banks’ standard variable mortgage interest rates of around 8.20 6.8 3.0 4.4 4.8 4.50 6.0 2. both derive from our view of robust growth in major Asian export markets.0 5. Table reflects data available as of 6 December 2010.50 5.00 5.7 Employment.9 Contributions to GDP growth (% points): Domestic final sales 4. above the long-term trend (3.2 8.2 7.90 6. While Australian dollar strength and forward-looking monetary policy tightening by the Reserve Bank (RBA) may limit how far inflation rises.00 5.97 0.30 6.0 Investment (private) 2.25 4.96 5.9 12.20 5.0 Exports 4.4 Inventories and statistical discrepancy 0.9 .97 5.9 4.2 9.2 2. will have policymakers trying to tame growth and limit inflationary pressure.2 4.50 5. others forecast.1 9.0 0.02 1.0 3.2 3. All forecasts are modal forecasts (i.6 2.

17 3.9 2.40 6.0 22.8 Employment.4 3.0 Consumer prices 1.00 3.6 3.0 4.8 5.5 -6. Both highlight periodically potential capital flight risk from a small.9 2.50 3. A still-wide negative output gap by our calculations at the end of 2011 should help contain inflation expectations and help lower annual inflation to the upper part of the target band in 2012.4 0.9 2.4 Investment (private and public) 1.4 .2 -0.75 4.4 2.5 3.0 18.5 4.84 Note: Numbers in bold are actual values.0 14.6 4.4 4.6 2.00 4.84 0. others forecast.1 0.6 2.00 6.9 5.80 0.9 Government consumption 2.77 0.% q-o-q saar 0.0 3.1 2.0 -5.75 4.1 4.00 4.2 0. Nomura Global Economics 53 6 December 2010 .40 6.9 Contributions to GDP growth (% points): Domestic final sales 1.6 5.e.0 0.8% y-o-y in 2011 and 3.9 3.7 2.0 2.4 2.9 0.2 -0.4 1.7 4.0 19.01 5.1 0. We expect a pro-saving theme in policy.4 2.1 5.20 6.80 4.2 4.00 10-year bond 5.4 4.5 5. relatively undiversified economy.50 3. but improving domestic spending should also drive imports higher too.82 0. Consumption is also likely to receive a boost through 2011 from higher farm incomes as soft commodity prices continue to rise.25 3.8 2.6 0.81 4.8 .1 0.9 5.4 5.2 0.75 4.00 5.9 1.6 Weighted median 1.10 5.2 4.1 6.8 2.60 5.4 4.4 4.2 percentage points to GDP growth in 2011-12 – we also expect a modest improvement in household consumption spending.9 1.0 4.0 1.5 2.8 2.2 -0.2 -2.3 3. Activity: We expect real GDP growth to lift to 2.5 2. Reserve Bank of New Zealand and Nomura Global Economics.5 Current account deficit (% GDP) -5.30 4.0 18.4 6.2 2. the single most likely outcome).6 3. 000 23. Risks: The biggest downside growth risk we see is weaker than expected spending by the heavily indebted farm and household sectors.9 2.8 2.5 4.0 20.5 Inventories and statistical discrepancy 1.5 2.3 -0.2 1. but with earthquake reconstruction spending masking patchier underlying improvement. All forecasts are modal forecasts (i. open. Thus. with household confidence improving as employment continues to grow through 2011.1 -0.75 0.9 1.1 3.3 Net trade -1.5 4.9 2.3 2.00 3.80 6.20 3.84 0.1 1.1 -0.1 4.5 Federal deficit (% of GDP) FY end-June -2.5 4.3 Unemployment rate 6.25 3.3 -0.5 2.9 1.40 5. We expect government budgets to be restrained. other measures are period average.% y-o-y Household consumption 2.2011 Global Economic Outlook New Zealand ⏐ Economic Outlook Stephen Roberts ⏐ Tatiana Byrne A patchy recovery We see GDP growth accelerating to its long-term trend through 2011. to the up/downside) is if economic growth in Australia and in Asia proves to be stronger/weaker than we forecast. although this may be tempered by a desire to reduce high debt levels in the household sector.9 3.0 3.6 3.0 20.% q-o-q.75%.0 5. Interest rate and currency forecasts are end of period.1 2.50 3. Comparatively strong growth in Australia and Asia should support strong growth in export volumes in 2011..3 1.5 3.8 5.3 3.5 3. An important two-way risk (ie.30 5.0 Imports 6. we see an erratic net export contribution to GDP growth through the year. 2010.60 5.5 4.9 2.84 0.6 5.50 3. but should fall back from Q4 as the 2.0 4.7 2.9 4.9 2.4 2.1 5.4 2.1 4. Source: Statistics New Zealand.2 0. with a market-driven exchange rate.2 2.50 90-day bank bill 3.3 4.4 5.3 4. Table reflects data available as of 6 December 2010.4 -0.4 5.5 4.4 2.1 2.1 2.7 6.60 6.5 -0.76 0.6 3. bar the earthquake recovery spending in 2011 and early 2012.4% in 2012. Apart from reconstruction spending – contributing on our estimates 2.6 3.7 4.9 6.6 4.50 5.2 Cash rate 3.1 0.4 -2.4 Exports 2.5 2. Details of the forecast % y-o-y growth unless otherwise stated 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP .40 6.9 4. We expect three well spread out 25bp RBNZ rate hikes in 2011 to 3. but much of the lift in 2011 is one-off investments related to reconstruction efforts in the wake of the Canterbury district earthquake on 4 September.7 5.0 20.3 5.8 3.84 0.0 -1.75 3.75 3-year bond 3.0 18.0 2.0 22.8 0.5pp lift in the goods and services tax falls out of the annual calculation.20 4.4 -0.40 6.20 NZD/USD 0.3 3. Policy: The Treasury and the RBNZ agree that the build-up of government and private debt has been excessive over the past decade and made worse by the economic downturn through 200809. sa 0.4 1.5 1.20 4.30 5.7 3.7 4.4 Trimmed mean (15% trim) 1.0 -0.6 2.5 3.2 2.7 4.5 1.2 3.75 0.8 0.9 3.00 3.6 4.8 1. Inflation: CPI inflation is set to spike above the top of the Reserve Bank of New Zealand’s (RBNZ) 1%-3% target band in 2011. We see the RBNZ moving gradually to normalise borrowing interest rates in 2011 and 2012 while taking into account higher spreads charged by commercial banks on their lending rates.00 4.

5 2. If.0 14.2011 Global Economic Outlook China ⏐ Economic Outlook Tomo Kinoshita ⏐Chi Sun GDP growth of 9-10% to continue We expect GDP growth to rise steadily through 2011. we forecast exports to grow at 12%.7 4.1pp in 2011. We expect the contribution from private consumption to GDP growth to rise from 3.0 13. Policy: In response to excess liquidity and rising inflation we expect interest rate hikes of 100bp.0 14. On the other hand.5 14. to be unveiled in March 2011.25 3.3 27.30 6. Inflation: We expect high producer price index (PPI) inflation of 6.56 5.5 32.0 59.1 23. Government consumption should contribute a smaller 1.0 8.60 6. Nomura Global Economics 54 6 December 2010 .9 22.5 15.4 1Q11 9.60 6.1 -1. including enforcing better working conditions.5 13.0 16.06 6.. we expect net trade to make a 0. As a result. in line with nominal GDP growth.4 19. Our 4Q10 forecast includes the temporary hike that expires 31 Dec 2010.50 2. Risks: Policymakers are walking a tightrope.50 20.0 53.0 2. translating to 16.81 6.14 6. Also at the back of our minds is China’s challenging GDP arithmetic: investment is approaching half of GDP. On trade.4 2.5 14.0 13.75 Reserve requirement ratio (%) 17.0 21.31 1-yr bank deposit rate (%) 2.31 6.0 16.81 7. The 12 Five-Year Plan. led by domestic demand.00 19. food & energy) Retail sales (nominal) Fixed-asset investment (nominal.6 3. but we expect stronger 13. we expect core CPI inflation to steadily rise through our forecast horizon.50 19. due to strengthening consumption.75 4. the single most likely outcome).4 5.e.70 6.31 5.9 2.40 6. Table reflects data available as of 6 December 2010.25 2. Of these two risks.8% import growth due to strengthening domestic demand and rising commodity prices. more sustainable economic growth.06 5.4 4.0 35.5 13.56 7.1 percentage points (pp) in 2010 to 3. We expect a net increase in loans of close to RMB8trn in 2011.50 6. We expect investment to remain the chief GDP driver – contributing 5.4 20. urbanisation and proactive government policies.5 12.8 18.25 2.50 20.3 2Q11 9.6 18.90 Notes: Numbers in bold are actual values.3pp contribution to 2011 growth.0 35.2 10. Interest rate and currency forecasts are end of period.50 3.7 17. due to strong investment demand for raw materials and the deregulation of natural-resource prices. Excluding food and energy prices.1 4Q11 10. ytd) Industrial production (real) Exports (value) Imports (value) Trade surplus (US$bn) Current account (% of GDP) Fiscal balance (% of GDP) 3Q10 9. If authorities over-react to inflation and implement a strict RMB6-7trn loan quota.2 4. All forecasts are modal forecasts (i.7 23.50 20.0 20.6 22. raising the risk of a hard landing.0 18. for whatever reason.0 12.0 22.5 35.5 20.1 17. such as keeping the real deposit rate deeply negative.0 8.8 4.4 1-yr bank lending rate (%) 5. we forecast real GDP growth to steadily rise over the next four quarters.5 14.5 5. other measures are period average.1 11.2pp in 2011 and 3.5 1.5 15.3 1.5 15.0% in 2011. excess liquidity and reduced overcapacity in the manufacturing sector. by definition.0 12. Policymakers will have their work cut out checking inflation and rebalancing the economy toward consumption.0 61. is likely to jump-start the reform effort to achieve higher quality. large minimum wage hikes and social welfare reform.2 12.50 20. could fuel asset price bubbles that.0 12.8 188 4.9pp in 2012 – as th strong pipeline projects and new projects under the 12 Five-Year Plan kick in. Stringent measures to counter property market th speculation are likely to continue.00 20. due to rapid income growth. too lax policy. others forecast.06 6. Some industries could face a squeeze in profit margins.0 16.3 20. Our RRR forecasts apply only to the large banks and where they cover more than half the banking sector’s deposits. low by Chinese standards due to subdued growth in the advanced economies.1 9. eventually burst.0 14.2 2Q12 9.3 20.9 4.0 2.56 6.50 18.3pp in 2012. to average 9. investment stopped growing one year it would halve China’s GDP growth rate.22 5.5% in 2011.50 4.5 2011 9.8% in 2011. Activity: After bottoming in Q4 2010.1 22.4 3Q11 9.7 4Q10 9.2pp in 2011 and 4.3 20.0 Net increase in RMB Loans (RMBtrn) 8. driven by rising input costs (raw materials and wages).6 189 5. we worry about the latter developing over several years.0 -2.1 2010 10.2 17.1 -1.5 1.1 18.1 65. We expect CPI inflation to rise to 4.0 5.2 19.56 6.5 21.5 2. investment could weaken sharply.3 2012 9.22 6.6 23.7% y-o-y loan growth.50 3.2 2.8 29.2 3.1 2.0 18. bank reserve requirement ratio hikes of 250bp and more macro-prudential measures in 2011.75 3.4 24.0 4.4 23.00 18. Source: CEIC and Nomura Global Economics. Details of the forecast % y-o-y growth unless otherwise stated Real GDP Consumer prices Core CPI (excl.00 20.9 1Q12 9.0 31.0 12.50 Exchange rate (CNY/USD) 6.00 3.0 147 3.

2 11.4 16. the single most likely outcome).7 0.2 2.9 5. As Hong Kong is one of the economies least likely to impose any capital control measures in Asia. Inflation: We believe a sharp rise in CPI inflation is likely.5 4.2 0. We expect the government to mitigate inflation pressures by reducing housing-related tax and public housing rental in FY11 (starting April 2011). Authorities have implemented numerous macro-prudential measures to try to contain the excessive rise in prices over the past several months but they may need to impose more if property prices continue to rise at such a pace.4 10.6 3.4 5. As a result.3 6.40 0.8 Fiscal balance (% of GDP) 3.1 3.5 4.9 12.4 -16.7 4.0 4.2 4.7 -1.4 -13.33 0.5 10.1 -14.3 16.9 Imports 23. especially tourist-related demand.2 11.9 1.9 4.7 8. Although authorities imposed strict tightening measures on the property sector on 19 November.5 3.4 2.6 16.0 -0.5 10.4 26.1 4.5 10.2011 Global Economic Outlook Hong Kong ⏐ Economic Outlook Tomo Kinoshita Robust growth continues We expect multiple factors to drive growth in 2011-12.5 4. Policy: As Hong Kong uses a currency board system with HKD pegged to USD. Risks: Being a small. other measures are period average.0 Real GDP 6.2 5.8 22.4 4.9 18.1 3.3 14.4 19.6 -0. Nonetheless.3 18. reflecting the lagged feed-through effects from rising rental price inflation.75 7.0 10. higher imported food prices from China and hikes in the minimum wage from May 2011.75 Notes: Numbers in bold are actual values.3 4.e.75 7. we expect private consumption to remain robust.3 4.2 17.3 4. up a cumulative 47. In fact.3 4.9 5. due mainly to improved employment conditions.7 6.75 7. %) 4.3 3.3 3.0 8.1 0. Robust growth in neighbouring economies. consumption has been quite strong in recent months even though post-crisis pent-up demand has waned.0 -1.4 Contributions to GDP: Domestic final sales 4.9 16.9 16.4 4. open economy and a major financial hub.5 3.40 0. Hong Kong is one of Asia’s most vulnerable economies to a double-dip in advanced economies.2 Gross fixed capital formation 0.9 5. we expect investment in both the public and private sectors to maintain strength.5 Current account (% GDP) 5.3 0.7 3.7 3.4 0.40 0.40 0.9 16.7 -9.2 0.2 17.1 4..9 -59. Source: CEIC and Nomura Global Economics.2 6.5 5.40 Exchange rate (HKD/USD) 7.3 2.6 3.8 13.8 5.4% since December 2009.8 5.9 5.7 16.5% in 2011 and 4. especially given that. we expect CPI inflation to accelerate to 4.8 3.3 15. Interest rate and currency forecasts are end of period.4 3. others forecast.8 4.4 3.7 8.0 19.8 11.1 3. is likely to contribute to an increase in tourist arrivals.8 4.1 4.2 4.3 2.3 10.0 6.9 3.1 -0.5 4. % q-o-q.0 6.40 0.9 17.1 1.2 3. because of the HKD-USD peg. the rising possibility of capital controls in other Asian economies might encourage further capital inflows in to Hong Kong.1 3-month Hibor (%) 0.9 1. Hong Kong cannot autonomously raise interest rates.75 7.8 6.8 6.40 0. including private consumption.4 Unemployment rate (sa.6 Exports (goods & services) 19.7% in 2011.3 Private consumption 5.0 24. Table reflects data available as of 6 December 2010.5 7.8 11.8 3. a very weak effective exchange rate.3 Consumer prices 2.9 3.1 -15.5 7.5 Trade balance (US$bn) -8.7 0.9 Exports 27.7 5. First.0 Current account (US$bn) 12. service-sector exports.0 10.0 0.5 4.4 0.6 8. Nomura Global Economics 55 6 December 2010 .5 4.9 5.6 -13. investment and service-sector exports.9 2.2 10.75 7.9 -0. residential property prices have risen sharply. Second.9 1. rising wages and wealth effects from higher property and stock prices. Third.3 0.75 7.0 10.3 18. Activity: We expect robust economic growth of 4.76 7.2 Imports (goods & services) 15.0 Net trade (goods & services) 7.0 4. the tight labour market and low borrowing costs should keep private consumption strong. especially China.40 0.40 0.1 12.9% in 2012.75 7.4 4. Details of the forecast % y-o-y growth unless otherwise stated 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 [sa.75 7.4 4. driven by three demand-side factors.6 4.5 -44.75 7.7 5.4 10. monetary policy easing in the US brought very accommodative monetary conditions to Hong Kong.7 -51.0 5.4 20.6 Government consumption 3.4 16.7 10.1 3. are likely to increase further.0 17.4 4. Public investment should be buoyed by large.5 7. thus raising the risk of bigger asset bubbles.6 4.4 Inventories -4.4 -14. All forecasts are modal forecasts (i.0 0. government-led infrastructure projects while private investment growth should rise steadily on a shrinking output gap.8 4.40 0. annualized] 2.5 3.

prompting 75bp of rate hikes through next year. First.0 8.90 7. CPI is for industrial workers.2 -4.2 14.8 2Q12 9.4 7. followed by a pause.0 15. Interest rate and currency forecasts are end of period.5 11.2 6.5 7.6 8.7 0. other measures are period average. averaging 7.50 5.0 -1.90 8.3 14. real estate and services-sector capex.6 7.4 7. On the fiscal front.2 0.00 5.9% in 2010.0 14.75 6. We forecast underlying private demand – both investment and private consumption – to remain strong.7 9.8 7.9 9.5 9. Fiscal deficit is for the central government and for fiscal year.8 -5.25 7.2 8.00 6.4 15.4 5.00 6.9 43.9 8.00 6.50 Cash reserve ratio (%) 6.00 6.10 7.25 7.2 44. with less scope for proceeds from asset sales and high subsidy burden.0-5.25 6.3 8.0 2. We expect inflation to bottom in Q1 2011 and start to climb from the 6%-handle in H1 2011 to above 7.6 7. prompting 75bp of rate hikes in 2011.6 0.0 2.1 10.00 6.25 6.50 5. Source: CEIC and Nomura Global Economics.5%.0 15.10 8.8 2010 8. Nomura Global Economics 56 6 December 2010 .3 6.50 5.6 43.0 2.0 0. This will come on top of the aggressive 150bp of hikes in 2010 shifting the monetary policy stance to modestly tight.0 2.1 -0.9 9.0 9.1 13.8% in 2010 due to three factors.0 13.00 6.8 1Q12 8.5 Repo rate (%) 6. others forecast.5 15.6 8.9 13.1 -0.50 6. compared with 11. which should result in greater demand-side inflation.1 -1. 2010 is for year ending March 2011.5 12.9 44.1 8.70 7. we expect net exports to be a larger drag on growth as imports pick up in line with improving domestic private demand.5 0. we expect the central government’s fiscal deficit to remain unchanged at 5.5 7.5 2. Second. We expect investment to be led by infrastructure.5 8.0 9.4 44.00 6.2 -4.0 8.1 8.20 8.7 0. Inflation is likely to remain above the comfort zone. eg.7 0.10 8.6 8.1 -1.0 14. we expect the RBI to deliver a 25bp rate hike in January 2011.1 43.50 6.5 7.2 6.00 10-year bond yield (%) 7.9 7.4 2Q11 8. A sharper-than-expected global rebound and falling commodity prices are an upside risk to our growth outlook.2 11.5 10.3 7. % q-o-q.3% y-o-y in 2011.1 -0.3 40.9 9.0 3.8 7.1 -0.00 6.10 8.0 15.75 7. Policy: We expect inflation to persistently exceed the Reserve Bank of India’s (RBI) comfort zone of 5.6 8.3 4Q10 4.3 9.0 9.4 44. Details of the forecast % y-o-y growth unless otherwise stated Real GDP (sa.00 6. In terms of profile.0 8.0 0. We expect private consumption to remain supported by rising wages and strong rural demand.3 8. We see inflation remaining sticky due to what we see as a structural rise in commodity prices (we build in a 15% rise in the CRB index) and a closing output gap.25 5.2% of GDP in FY12 (year ending March 2012).2 2011 8.0 15. Risks: A reversal in capital flows and lack of an investment revival are downside risks. Inflation: We expect headline WPI inflation to remain elevated.7 8. Activity: We expect real GDP growth to consolidate at 8% y-o-y in 2011 after a strong 8.25 6.7 6.00 6.00 7.5 8.0 1Q11 8.5 10.5 5.2011 Global Economic Outlook India ⏐ Economic Outlook Sonal Varma The consolidation year We expect economic growth to consolidate in 2011 after a strong rebound in 2010.2 11.1 6.00 6.0 4.9 -3.0 8.5 12.0 4.9 9.7 0.4 -3. Third.00 7.1 9.2 9.5% in H2 2011. Table reflects data available as of 6 December 2010.5 0.7 11.9 7.0 11. We expect CPI inflation to average 8.00 6.6 42.1 -0.6 44.0 12.00 6.0 9.1 10. 2011 should see growth consolidating before rising to 8.1 -1.5 17.5 -5.4% in 2011.7 9.90 8.4 14.5 13. annualized) Real GDP Private consumption Government consumption Fixed investment Exports (goods & services) Imports (goods & services) Contributions to GDP (% points): Domestic final sales Inventories Net trade (goods & services) Wholesale price index Consumer price index Current account balance (% GDP) Fiscal balance (% GDP) 3Q10 10.2 4Q11 8. despite favourable base effects.2 2012 8. we expect growth in government consumption to slow after the above-normal increases since the onset of the crisis.3 3Q11 8.7 9.8 8. Overall.1 0.25 8.8 9.2 0.3 Notes: Numbers in bold are actual values. before resuming with 25bp hikes each in Q3 and Q4 2011. we expect growth in agricultural output to normalise and yearon-year growth to be pulled lower by adverse base effects.1 0.50 6.6% in 2012.5 8.2 6.5 14.3 12.0 9.50 Reverse repo rate (%) 5.25 Exchange rate (INR/USD) 44.5 15.0 11.

1 6.9 Exports (goods & services) 11.9 6.g.1 9.0 6.0 0.6 6.0 0. Investment is likely to be driven by a robust consumption growth outlook. BI has taken measures to reduce foreign holdings of central bank bills (SBI).8 1.3 37.9 6.1 5.5 7.50 6.8 Exports 25.5 6.8 37.4 9.0 5. strong capital flows to Indonesia are expected to continue and we expect further capital control measures on short-term debt. We do not expect the first rate hike until Q2 2011 given BI’s inflation forecast and its concerns about excessive capital inflows. We believe the government’s aim of raising GDP growth to above 7% by 2014 will be achieved sooner given constraints to infrastructure development – land acquisition.2 37.4 Consumer prices index 6.7 0.50 6.3 10. booming commodity exports. financing.2 6.3 5.2 6.6 Inventories 0.8 6.7 -1.6 0.6 Imports 32.3 5.4 12.0 1.8 7.0 12.5 10. Interest rate and currency forecasts are end of period. conflicting regulations – are being addressed through a soon to be tabled land acquisition bill.2 Merchandise trade balance (US$bn) 9. Risks: Renewed global financial turmoil is a key external risk. IDR strength.2 0.0 0.4 10.4 6.7 11.50 7.9 9.1 6.6 0. Inflation and monetary policy: Bank Indonesia (BI) kept its policy rate on hold at 6.0 0.0 0.4 6.7 28.8 1.2 5.9 Gross fixed capital formation 8. Fiscal policy: The 2011 budget targets a pick-up in infrastructure spending to IDR122trn (10% of spending) and a modest fiscal deficit of 1.9 6. BI raised the primary reserve requirement (RR) for banks from 5% to 8% in November 2010 and from March 2011. political stability.2 6.3 4. In contrast.3 10.7 0.e.4 0.8 0. higher wages. likely further sovereign credit rating upgrades on sound economic fundamentals and fiscal space for accelerated infrastructure spending. A substantial and unexpected rise in international oil prices could trigger an administered fuel price increase and a stepped increase in inflation.0 9. sparked by EU debt problems).2 5.2 6.3 12.0 0.0 4. will re-link the RR to banks’ loan-to-deposit ratios outside a 78-100% range. but its form is still unclear.6 0.50 6.8 0.50% throughout 2010 as it expects inflation to remain within the 4-6% y-o-y target through 2011.0 Private consumption 5.4 0.3 0.9% in 2010 to 6.8 6.3 0.9 11.3 5.0 0.0 0.6 6.9 6.0 0.9 5.0 Net trade (goods & services) 1.1 0. and fast growing credit (from a low base) to keep consumption growth above 5%.4 37.0 7.5% in 2011 and 7% in 2012.1 12. infrastructure development is likely to unleash growth.1 Contributions to GDP (% points): Domestic final sales 5.2 6.8 5. and the March RR change.7 5.0 -2..3 Imports (goods & services) 11.1 11.6% of GDP in 2011 and 2012. Activity: We expect domestic demand driven growth to rise from a forecast 5. Nomura Global Economics 57 6 December 2010 % y-o-y growth unless otherwise stated .1 24.7 11. the single most likely outcome). creating regulatory uncertainty/risks which will likely spill over into 2011.2 12.3 0.9 5.7% of GDP (from our forecast of 1.6 5.7 7.8 9.1 13.4 0.50 7.2% in 2010). Source: CEIC and Nomura Global Economics.6 Fiscal Balance (% of GDP) -1.8 5.8 9.50 Exchange rate (IDR/USD) 8908 8970 8900 8800 8680 8520 8440 8360 8970 8520 8200 Notes: Numbers in bold are actual values.8 12.2 8. Better/worse than expected progress with infrastructure is a key up/downside risk to the outlook.5 10. With the government’s planned revisions to procurement regulations we also expect higher rates of expenditure realization in 2011. we forecast a pick-up in inflation to 6.75 7.50 6.0 6.5 7.50 7.8 12.2 5. We expect favourable demographics with a rapidly expanding middle class.1 0. Stronger import growth (associated with stronger consumption and investment) and higher net income outflows (associated with the increase in foreign holdings of Indonesian equity and debt) are expected to reduce the current account balance to 0.3 Government consumption 3.6 Current account balance (% of GDP) 0. respectively. The end-2010 deadline for establishing a consolidated financial supervisor (OJK) is approaching.8% and 0.2 5.2 5. other measures are period average. Details of the forecast 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP 5. and lead to an eventual deficit in the medium term.50 7.4 16.4 4.2011 Global Economic Outlook Indonesia ⏐ Economic Outlook Yougesh Khatri | Euben Paracuelles Poised for take off Building on robust domestic demand.2 6.9 6.8 5.7 0.0 5.2 5.5 5.3 12.6% and see upside risks relating to commodity and administered price increases and capacity constraints starting to bite.6 Bank Indonesia rate (%) 6.0 3.2 -1.1 6.1 9. a strengthening IDR.50 7.7 5.2 5..3 9.5 5.0 10.0 5.0 5.5 10.2 8. All forecasts are modal forecasts (i. Unless there is a prolonged pull back from risk (e. others forecast.2 12.3 4.5 9.8 8.6 5.4 6.0 6.2 5.7 13. an increased fiscal allocation for infrastructure and the donor-supported Indonesia Infrastructure Guarantee Fund.6 0. Table reflects data available as of 6 December 2010.2 5.7 1.8 4.8 6.8 5.0 5.

0 8.2 16.75 2.9 15.1 16.8 1.6% estimated for 2010.e.3 9.3 1.2 4.0 7. a key downside risk is insufficient reform momentum to escape the “middle-income trap”.7 Fiscal Balance (% of GDP) -5..6 1. other measures are period average. less than the 5.0 Gross fixed capital formation 9. likely in 2011.9 2.2 5.0 9. but is now targeted by the government to increase due to ambitious infrastructure plans under the Economic Transformation Program.3 0.72 Notes: Numbers in bold are actual values. Aware of this.7 11.3 3.5 15.5 5. supported by a growing “middle class”.3 3.0 Exports (goods & services) 6.3 11.4 4.0 5.5 6. Monetary conditions should also tighten through further MYR appreciation.08 2.2 -1. the authorities are aiming to increase productivity and competitiveness in their array of development plans.5 13.1 3.4 3. The 2011 budget targets a deficit of 5.7 9. Investment-to-GDP plummeted after the Asia crisis. Activity: With our real GDP growth forecast of 7% in 2010.5 3.1 0.7 6. We expect Bank Negara (BNM) to keep its monetary policy on hold in Q1 2011 until there is more clarity on the global picture and given its "moderate inflation" projection through 2011.3% in 2011.25 3.0 3.1 Imports (goods & services) 11.25 3. Nomura Global Economics 58 6 December 2010 % y-o-y growth unless otherwise stated .2 5.7 3.2 13.3 15.4 11.3 12. We are more concerned about CPI inflation. expecting it to rise to 3.0 5.1 16.1 Current account balance (% of GDP) 10.0 8.9 55.5 18.2 14.6 4. Politics and fiscal policy: We expect an election to be called in 2011 (as early as H1).6 15. can deliver a firm mandate for the prime minister.2 16.0 11.8 6.9 7.0 Consumer prices index 1. which could see further fiscal support for growth.8 5.2011 Global Economic Outlook Malaysia ⏐ Economic Outlook Yougesh Khatri ⏐ Euben Paracuelles Reform awaits a mandate Reforms may stall until elections.1 12.2 6.2 5.5 -3.0 9.9 12.2 Exports 23.3 Contributions to GDP (% points): Domestic final sales 4.5 -1. the single most likely outcome). others forecast.1 3. A medium-term upside risk is a rapid reform progress leading to an investment boom.3 12.0 3.3 13.1 3.0 14.00 3. given the large current account surplus and potential for larger capital inflows.6 4. This is consistent with the fading of temporary growth drivers such as inventory re-stocking.0 9. Execution is the key risk and this will in turn depend on the outcome of the next elections. All forecasts are modal forecasts (i.2 3.1 -1.8% by 2015.4 15. policy stimulus and pent-up demand for electronics.9 15.0 1.09 3.00 2. Reforms are likely to pause in the meantime.6 -0.0 8.1 Inventories 4.2 Overnight policy rate (%) 2.6 13. We expect private consumption to hold up in 2011.9 9.2 7.1 5.2 3.9 18.0 3.7 5. Inflation and monetary policy: Monetary conditions tightened in 2010 via real effective exchange rate appreciation and three 25bp rate hikes. with 25bp hikes each in Q2 and Q3 2011.75 2.0 -0. More macro-prudential measures are likely.6 15.0 7.4 1.2 11.4% of GDP.0 1.7 5.7 18.2% in 2011 to return to trend output levels (the government targets 5-6%).88 2. but we would expect to see them gain momentum after the elections – in our base case the ruling coalition maintains a majority providing Prime Minister Najib with a “legitimate” mandate.4 47.08 3.0 10.8 4.6 11. Interest rate and currency forecasts are end of period.25 2.2 9.25 Exchange rate (MYR/USD) 3.0 5.0 16. but these may mask an underlying deterioration in export competitiveness.0 7.0 11.6 6.25 3.75 3.2 12.75 3.2 5.93 2. a strong labour market and rising commodity prices.6 27. We expect buoyant commodity exports in 2011. Risks: The major downside risks relate to a relapse in the global recovery and lower commodity prices.3 -4.0 8.2 3.6 6.0 8.0 8.4 1.2 15.0 6.8 30.8 -1.9 Merchandise trade balance (US$bn) 7.5 5.9 11.84 2.5 Private consumption 7.3 Government consumption -10.0 3.5 5.1 2.6 5. This should impel BNM to resume raising rates.7 6.25 3.0 5.5 4.3% in 2011 and 2.6 -5.4 -1.88 2.3 16.2 7.80 3.7 4.7 5.1 Net trade (goods & services) -3. Table reflects data available as of 6 December 2010. The budget and the deferral of the goods and services tax (GST) may cast doubt on the government’s commitment to fiscal consolidation given the 10th Malaysia Plan targets a federal government fiscal deficit of 5. we estimate the output gap has turned positive.1 11.97 2.7 4.2 7. We thus expect below-trend growth of 5.0 38. Details of the forecast 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP 5. Source: CEIC and Nomura Global Economics.2 -1.5 Unemployment rate (%) 3.2 7.6 8. but higher than expectations.6 8. We do not expect Malaysia to impose controls on inflows in the near future – BNM recently further liberalized the capital account and set a 70% loan-to-valuation ratio cap on third mortgages in a bid to curb property market speculation.0 4.5 3.2 3.3 4.0 1.7 Imports 29.4 4.4 5.2 8.0 7.0 11.3 5.5 4.0 16.4 12.7 -4.4 3.

6 8.9 7.5 6.7 Private consumption 4.99 4.2 10.3 Fiscal balance (% of GDP) -3.8 6.9 43. Fiscal policy: Inroads have been made in narrowing the fiscal deficit.00 5.50 91-day T-Bill yield (%) 3. Inflation and monetary policy: We forecast CPI inflation of 4.1 13. Private investment.0 6.6 6.7 7.25 Exchange rate (PHP/USD) 44.0 6.8 6.3 0.1 -2. Table reflects data available as of 6 December 2010.8 -2.0 5.5 -1.9 -0.2 13.3 11. where.0 43. Testimony to all this was the larger-than-expected turnout by private investors at the November infrastructure summit.7 2.0 3.00 5. although in a measured way given an ambitious 7-8% GDP growth target for 2011.0 -2.4 39. could finally take off.0 22.4 7.0 5.6 -3. we expect it to rise due to global commodity prices and an already positive output gap.9 4.4% of GDP) of planned infrastructure projects were announced.0% in 2012.6 4.7 -1.2 5.3 -3.9 38. While inflation is likely to remain tame over the next few months.0 12.6 0.3 Reverse repo rate (%) 4.9 4.8 10.75 4.1 6. A key test is the large revenue-generating.2 0.8 6.8 2.50 6.2 0.3 5.9 17.3 -2.9 -1. respectively.2011 Global Economic Outlook Philippines ⏐ Economic Outlook Yougesh Khatri ⏐ Euben Paracuelles Making inroads Fiscal improvements are likely to continue in 2011 and the government is starting to address infrastructure deficiencies. Deployment is likely to rise further given demand for higher skilled workers.7 5.2 0.0 12. annualized] -1.8%.2 7.8 13. which should attract more private investment.0 0. PHP130bn (1.4 6. Interest rate and currency forecasts are end of period.4 6.8 0.1 6.4 11.2 0.2 42.0 0.4 6. Activity: In 2011 we forecast GDP growth of 5.4 2.9 7.6 -10.0 5.5 6. e. driven by strong overseas Filipino worker remittances which.8 7.0 25. and rising to 5.8 12.7 Inventories -0. will likely continue to see solid expansion.7 -2. Details of the forecast 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP [sa.8 5.0 2.9 3.3 7.7 Consumer prices 3. which reached a record high in Q3 2010.0 18.4 4.0 4.g.75 5.5 6.3 6.5 6.2 3.7 5.6 4.0 6.4 6.4 Gross fixed capital formation 13.4 2.1 1.4 2.4 16.6 8.7 -0. All forecasts are modal forecasts (i.3 3.2 40. which grew 22.8 -1.8 0.0 8. Given these tie in with the President’s anti-corruption platform.9 5.3 -6..7 14.2 2.0 Merchandise trade balance (US$bn) 0.25 6.5 5.4 9.3 7.4 5.6 1.00 5. Achieving tax-to-GDP targets will involve unpopular reforms to widen the tax base and the president breaking his electoral promise not to pass new tax measures – possibly at a time when his approval ratings start to decline (if history is any guide).2 8.9 41. via rationalization of expenditures and importantly.9 40.4 5.4 -6.0 12.2 Imports 21.8 6. medical workers to ageing developed economies.00 4. has benefitted from increased worker deployment earlier this year.4% and 2.4 7.9 -0.5 6.00 4.5 Government consumption -6.7 6. some improvement in revenue collections via tax administration measures.4 41.4 2.7 (% of GDP) 2. a successful and transparent tender process by mid-2011 could kick-start further implementation against a backdrop of an increasingly upbeat private sector.7% in 2012.8 4.3 -0.1 4.4 6.0 12.9 5.2 -2.8 5.4%. in turn.1 9. Some of the tightening is also likely to be done via currency appreciation. A surge in commodity prices. Nomura Global Economics 59 6 December 2010 % y-o-y growth unless otherwise stated .2 7.8 12.0 7.e.6 -10.0 5.1 Imports (goods & services) 18.2 5.5 6.8 3.4 6.9 Notes: Numbers in bold are actual values. We expect BSP to hike rates from Q2 2011. well above Bangko Sentral’s (BSP) forecasts of 2.9 1.2 6. coming early in the administration.4 -1.1 -5.6 0.00 6.00 4.25 7.9 1. But sustaining it into 2012 will be more challenging.0 -1.75 5.8 8.0 6.0 32.1 5.4 Unemployment rate (sa.6 -3.3 1.50 4.0 5.5% in 2008-09 despite the crisis. after stagnating since the mid-1990s. Risks: S&P’s credit ratings upgrade (with others likely soon).00 4. other measures are period average.7 -0. measures to be tabled in Congress by 2012.6 7.0 Real GDP 6. %) 6.8 3.8 13.4 40.1 6. are key downside risks to growth.0 Contribution to GDP growth (% points): Domestic final sales 5.00 5.9 3. The Aquino administration’s strong mandate.2 0.2% in 2011 and 5.1 -0.0 18.0 5. others forecast.0 -5.4 11. Source: CEIC and Nomura Global Economics.0 6.00 6.13 4. The business process outsourcing sector.9 17.0 3. in particular those of oil and rice.5 8. While 100% rollout of these projects is unlikely in the near-term.0 13.1 4. and limited fiscal space to support it. Consumption should remain a steady source of growth.00 4.7 Current account balance (US$bn) 1.4 Net trade (goods & services) 6.7 3.5 2. the perception of its firm commitment to improving governance and the recent credit ratings upgrade by S&P are bolstering business sentiment.6 Exports 39.2 8. % q-o-q. the single most likely outcome).4 3.3 7.7 Exports (goods & services) 29. but politically unpopular. we expect the momentum on fiscal consolidation to continue into 2011. could risk engendering government complacency in terms of the fiscal reform agenda.1 7.5 6.1 4.

Manufacturing will likely continue to diversify and move further up the value chain: the electronics sector has seen a resurgence in investment commitments in 2010.7 1.4 7.1 3.40 0.7 15.0 5.3 1.5 5.1 7.4 15.7 1.6 15.4 8.5 15. %) 2.4 7.4 3.2 5.9 4.4 Exports (goods & services) 20.2 0. As a hub for a fast growing Asia.0 7.5 4.2011 Global Economic Outlook Singapore ⏐ Economic Outlook Yougesh Khatri ⏐ Euben Paracuelles Back to trend After a stellar recovery.7 5.7 18.3 15.9 12.0 Government consumption 7. 2) a tight labour market. Interest rate and currency forecasts are end of period. is impressive.51 0.4 0.0 2.9 26.7 7.7 1.4 5.2 3.6 7. while the government targets 4-6%.7 Inventories -3.22 1.2 2.2 3.3 12. Potential large-scale capital inflows and low interest rates raise the risk of asset bubbles and disruptive corrections.2 5.40 0.9 5.0 Consumer prices index 3.8 8.8 6.5 17.9 12.0 2.5 11.2 3.7 2. others forecast.8 Private consumption 5. and 4) greater pass-through from rising commodity prices given buoyant domestic demand.2 0.2 7. such as a renewed slump in the global economy or an escalation of tensions on the Korean peninsula. We share this concern about increasing inflation – our estimates of a positive output gap suggest demand-side pressures could push inflation beyond the 2-3% MAS target in 2011 and so we could see further tightening in 2011. We expect policy continuity.3 Contributions to GDP (% points): Domestic final sales 4. led by electronics services and R&D activities.9 -1.27 1.29 1.6 0. and we expect a larger fiscal surplus to be run in 2011.4 10.5 5.8 17.0 7.9 8.7 18. annualized] -18. All forecasts are modal forecasts (i.0 12.2 5.0 5.40 0.9 3.25 1. Bio-med.0 7.40 0. Fiscal policy has appropriately shifted from counter-cyclical support towards structural measures to boost productivity. we believe Singapore can maintain growth rates of 5-6% into the medium term.4 15.0 15.4 Merchandise trade balance (US$bn) 11.2 11. is becoming increasingly important.5 Unemployment rate (sa.0 5. the government took various measures to cool the property market (e.7 21. Singapore’s ever more important but volatile biomed sector increases volatility and reduces the predictability of output.6 9.8 0.0 5.5 19.. Services are expected to continue to perform well.9 2.5% y-o-y.e.5 9.5 5. extending the holding period to impose the seller’s stamp duty and decreasing loan-to-valuation ratios to 70% for buyers with other mortgages). with rising tourism and new attractions such as the integrated resorts.6 11. 3) a diminishing cyclical productivity boost. with diversifying drivers of growth.2 5. Details of the forecast % y-o-y growth unless otherwise stated 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP [sa.3 -1.6 7.3 12. % q-o-q.9 4. The fiscal stance was contractionary in 2010.3% in 2011.0 4.8 16. Risks: Key downside risks are external.7 1.0 5.0 11.6 12.5 4.4 -15.29 1.4 3.6 22.3 Real GDP 10.40 Exchange rate (SGD/USD) 1.9 -1.1 1.9 5. Policies: The MAS move of targeting stronger SGD NEER appreciation has put further downward pressure on record-low SGD short-term rates. During 2010.1 12.9 0. which complements monetary policy in addressing overheating.3 Imports (goods & services) 17.5 2.5 5.8 3.40 0.0 5.2 9.0 4.7 5. other measures are period average.5 8.40 0.5 Gross fixed capital formation 5.4 0.9 5.2 0.0 0.3 14.6 5.5 4.2 6.0 7.9 18.4 20.1 34.7 Fiscal Balance (% of GDP) 0.0 5.8 8.9 3.5 8.5 14.6 7.1 3.3 5.4 6.8 0.0 9.8 -0.g. If these measures fail to cool prices.0 11.4 18.5 2.8 6.9 9.7 2. having contributed nearly a fifth of the remarkable 2010 growth.0 11.5 7.3 13.4 1. MAS indicated price pressures are building given: 1) high resource utilization levels.0 8. for an advanced economy.9 Net trade (goods & services) 11.1 1. Table reflects data available as of 6 December 2010.5 0.21 1.1 6. Source: CEIC and Nomura Global Economics.3 27.3 Imports 22.8 5. The government is likely to call elections in 2011 which will usher in the next generation of leaders.7 15. Nomura Global Economics 60 6 December 2010 .0 16.1 1.8 25. Singapore’s economy is likely operating at full potential and we expect growth to revert to the 5-6% medium-term trend which.6 0.2 7.2 15.2 4.5 8.17 Notes: Numbers in bold are actual values. Activity: Asia’s most open economy was also the fastest growing in 2010 at an estimated 15.24 1.5 4.4 12.2 1.40 0. Inflation and monetary policy: The Monetary Authority of Singapore (MAS) surprised markets again in October by increasing the slope and width of the SGD NEER band.6 5.20 1.9 10. We expect growth to slow to 5.2 Current account balance (% of GDP) 23. and is likely contributing to property price pressures (and bubble concerns).32 1.8 3 month SIBOR (%) 0.1 17.0 Exports 27. Financial and trade services are also well positioned to continue to grow as Asian growth in general expands and becomes more integrated.22 1.40 0.40 0. the single most likely outcome).5 0. we expect more macro-prudential and administrative measures in 2011.3 20.4 4.

we expect G3 (US. We forecast CPI inflation to rise from 2. Activity: We see growth momentum picking up modestly in 2011 after sequential GDP growth eased markedly in H2 2010.8 3.50 3.9 3. its external debt was equivalent to 48% of GDP and Korea was one of Asia’s largest net importers of oil (5.9 3.0 3.37 3.8 3.30 3.9 5.2 2.25 2.8 6.3 -2.5 4.8 4. Interest rate and currency forecasts are end of period.40 4.9 Fiscal balance (% of GDP) -1.0 -0.3 17.9 3. it may leave Korea’s twin imbalances unresolved.0% in 2012.2 0. credit markets and commodity prices. protracted low rates.7 3.020 by end-2011) should offset cost-push inflation from higher oil prices.0 3.1 -0.3 1.7 3.9 -0.1 6.3 3.4 Fiscal balance ex-social security (% of GDP) -2.3 3.6 8.7 4. Risks: The economy is heavily reliant externally: in 2009. Policy: With slowing growth and the twin imbalances of a large current account surplus and high inflation. All forecasts are modal forecasts (i.8 7.9 Construction investment -2.0 -1.3 6.2 3.4 8.6 Inventories 1.0 2.1 0.7 Unemployment rate (sa.40 3.3 -0.1 0.25%.9 Contributions to GDP growth (% points): Domestic final sales 3.4 4. In the next two years. if the BOK hikes rates without allowing KRW appreciation.0 10. Details of the forecast % y-o-y growth unless otherwise stated 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP (sa.4 2. annualized) 3.6 3.1 Money supply (M2) 9..20 3.4 1. we expect policymakers to allow KRW appreciation but hike policy rates only modestly.5 Government consumption 2.5 10.2 Consumer prices 2.5 -0.2 4. Nomura Global Economics 61 6 December 2010 .9 4.2 1.1 3.5 9.20 3.8% of GDP) in 2011 from USD35bn (3. In 2012.2 0.6 7.5 -0.4 9. As such.3 3.3 0.1 17.0 8. On the other hand.50 3. tightening macro-prudential measures further.0 0.2 6.1 11. we look for the current account surplus to narrow to USD21bn (1.2 3.30 3.0 Private consumption 3. the single most likely outcome).e. All in all.2 3.1 9.7% in 2011.1 4.7 -0. % q-o-q) 0.0 8.75 3.0 2.0 4.6 3. CEIC and Nomura Global Economics.1 4.3 4.1 6.60 3.2 3. the economy is vulnerable to sudden changes in global economic conditions.8 3.5% in 2011. others forecast.1 1.5 1.8 1.2011 Global Economic Outlook South Korea | Economic Outlook Young Sun Kwon Twin imbalances With slowing growth and the twin imbalances of a large current account surplus and high inflation. Source: Bank of Korea. supported by government policy designed to prevent a housing market slump.8% of GDP).5 3.2 1. allowing KRW appreciation and hiking policy rates slowly.4 3.9 -0. exports accounted for 50% of GDP.3 3.6 3.00 4.0 9. % q-o-q.1 25.50 2.3 4.0 3.1 5.50 3.0% in 2012.8 0. Low interest rates should also support consumption and business investment. failing to contain inflation.8 5.75 2. before rising to 5.8 7. the government’s stimulus measures ahead of the presidential election should help boost domestic demand. Despite recent events.0 5. We expect house prices to recover only gradually in 2011-12.7 Net trade (goods & services) -1. other measures are period average.4 -0.0 3.76 3.6 0.3 7. Domestically.2 7.6 4.1 1. Table reflects data available as of 6 December 2010.20 4.30 Exchange rate (KRW/USD) 1180 1110 1080 1060 1040 1020 1005 990 1110 1020 960 Notes: Numbers in bold are actual values.0 1.0 House prices (% q-o-q) -0.1 2.5%) in 2010.1 -1. %) 3.50 2.00 3. In addition to solid emerging market demand.4 0.0 4.1 5.8 6. mainly due to higher oil prices and a stronger KRW.30 4.9 3.0 1.5 9. but admittedly high-risk event.9 5.4 0.0 3.6 -4.2 3.6 0.4 Imports (goods & services) 14. we expect the BOK to raise rates three times in 25bp increments in Q2 and Q4 2011 and Q1 2012.3 0.0 1. euro area and Japan) demand to improve gradually.1 5.10 4.1 5.4 4.1 4.1 13. but construction investment is likely to suffer given elevated housing inventory.2 -0.0 11.20 4.9% in 2010 to 3.7 0.2 Real GDP 4.5 -2.0 0.90 4. we view a major escalation of geopolitical tensions on the Korean peninsula as a low probability.6 3.4 11.1 1.70 3.2 4.7 3. making the economy vulnerable to an inflation shock.90 3.4 1.0 9.4 Business investment 24.4 3.70 5-year T-bond yield (%) 3.6 -0. but rising nominal wages and housing rents are adding to inflation pressures.0 9.4 4.7 14. Meanwhile.1 0.25 3.9 4. lifting the terminal rate to 3.00 3.7 0. but KRW appreciation should erode some competitiveness. should risk adding to higher financial leverage. The positive feedback loop between strong corporate earnings and household income/job creation should gain more traction.9 -0.8 6.9 Real GDP (sa.2 -1. we expect GDP growth to slow from 5.0 8.0 BOK official base rate (%) 2.25 2.1 4.5 5.6 -2.0 Current account balance (% of GDP) 3.4 3.9% in 2010 to 3.5 1. before easing to 3.8 7.3 3. we expect policymakers to choose a compromise policy mix: implementing modest fiscal consolidation.3 0.6 4.4 3.3 19.0 2.7 Exports (goods & services) 11.8 0.2 1. in association with high competition in the banks.25 3-year T-bond yield (%) 3.5 4.30 3. Inflation: A stronger KRW (we forecast KRW/USD appreciating to 1.8 3.

2011 Global Economic Outlook

Taiwan ⏐ Economic Outlook

Tomo Kinoshita

Balanced growth ahead
We expect both domestic and external demand to drive robust growth in 2011-12. Activity: We expect the economy to maintain robust growth of 4.9% in 2011 and 5.3% in 2011. Although we expect growth to slow from 9.9% in 2010, this reflects the disappearance of one-off base effects that came with the economic rebound in 2010. We expect both domestic and external demand to support future growth. On domestic demand, steady growth in private consumption should be supported by improving labour market conditions and higher wages. The consumer confidence index in October recorded its highest level since 2004. Investment growth should remain strong as the output gap is likely to shrink further in domestic demand-oriented industries. We also expect exports to remain strong as the major electronics manufacturers have increased production capacity. ECFA: Under the Economic Cooperation Framework Agreement (ECFA) with China, which became effective in September 2010, China will start to reduce tariffs on 539 Taiwanese goods worth 16% of the island’s China-bound exports. Taiwan is also relaxing restrictions on visitor arrivals and investment from China. Strengthening economic ties with Asia’s largest and fastest growing economy stands to be a major boon for Taiwan’s economy. Monetary and fiscal policy: We expect CPI inflation to pick up to 2.5% in 2011 and to 3.1% in 2012, from 1.0% in 2010, due to higher commodity prices, limited spare economic capacity and accelerating import prices from China. We expect higher inflation to cause the Central Bank of China (CBC) to raise benchmark interest rates by 12.5bp every quarter until end-2012, with an eye on a gradual rise in inflation. On property, the central bank’s stricter loan-to-value ratio for new residential property lending in Taipei, implemented in June 2010, appears to have effectively reduced speculative activity for now – though we cannot rule out the possibility that further tightening measures will be introduced if property prices rise further. On fiscal policy, we expect overall government spending to increase moderately in 2011 to support growth. Risks: As Taiwan is a very open economy with a high exports-to-GDP ratio of 54% in 2009, the state of the advanced economies continues to be a major risk. We believe that the further increase in capital inflows through the banking sector and the resulting TWD appreciation may prompt authorities to limit such inflows by using capital controls. We believe that ECFA developments, which will be heavily influenced by the political situation, pose both up- and downside risks to the economy.

Details of the forecast
% y-o-y growth unless otherwise stated 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP [sa, % q-o-q, annualized] 0.1 -0.9 12.2 6.0 6.3 1.2 8.0 5.2 Real GDP 9.8 4.4 3.2 4.2 5.8 6.3 5.3 5.1 9.9 4.9 5.3 Private consumption 4.5 3.1 4.4 3.7 3.9 3.8 4.1 3.8 3.7 3.9 3.9 Government consumption 0.4 0.6 1.4 0.5 1.1 1.6 0.4 0.4 1.2 1.2 0.4 Gross fixed capital formation 23.7 12.0 8.2 6.4 8.0 9.0 8.4 8.9 23.1 7.9 8.8 Exports (goods & services) 20.1 15.5 13.1 9.1 9.2 9.3 10.7 10.7 25.7 10.1 11.0 Imports (goods & services) 22.8 19.0 15.9 10.5 9.1 8.9 10.9 11.3 29.7 11.0 11.4 Contributions to GDP: Domestic final sales 6.7 3.9 4.1 3.2 3.8 4.0 3.9 3.8 6.2 3.8 3.8 Inventories 1.6 -0.1 -0.9 0.4 0.6 0.7 0.2 0.1 2.1 0.2 0.1 Net trade (goods & services) 1.4 0.6 0.0 0.6 1.4 1.7 1.2 1.3 1.6 0.9 1.4 Exports 27.1 17.5 14.6 11.1 11.7 12.3 14.2 14.2 33.8 12.4 14.5 Imports 31.5 21.0 17.9 12.5 11.6 11.9 14.4 14.8 42.0 13.4 14.9 Merchandise trade balance (US$bn) 6.2 6.5 3.7 7.1 7.0 7.5 4.1 7.7 24.7 25.3 27.8 Current account balance (US$bn) 9.0 17.3 9.5 10.1 8.5 18.3 9.9 10.6 47.7 46.4 48.9 (% of GDP) 8.3 14.8 8.2 8.4 6.6 13.6 7.6 7.9 11.1 9.3 8.7 Fiscal balance (% of GDP) -1.2 -1.3 -1.0 Consumer prices index 0.4 1.1 2.0 2.5 1.8 1.9 1.9 1.9 1.0 2.5 3.1 Unemployment rate (%) 5.1 5.0 4.9 4.7 4.6 4.3 4.3 4.2 5.7 4.3 4.0 Discount rate (%) 1.50 1.63 1.75 1.88 2.00 2.13 2.25 2.38 1.63 2.13 2.63 Overnight call rate (%) 0.22 0.35 0.47 0.60 0.72 0.85 0.97 1.10 0.35 0.85 1.35 10-year T-bond (%) 1.20 1.32 1.45 1.57 1.82 2.30 2.43 2.55 1.32 2.30 2.80 Exchange rate (NTD/USD) 31.3 30.0 29.6 29.3 29.0 28.7 28.4 28.1 30.0 28.7 27.5 Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 6 December 2010. Source: CEIC and Nomura Global Economics. Nomura Global Economics 62 6 December 2010

2011 Global Economic Outlook

Thailand ⏐ Economic Outlook

Yougesh Khatri ⏐ Euben Paracuelles

Still all about political risks
The economy proved itself resilient in the face of a raft of negative political events in 2010, largely on a strong bounce-back in external demand. But a repeat in 2011 may be difficult. Activity: We expect GDP growth to ease to 4.8% in 2011 from an estimated 7.7% in 2010, driven mainly by the fading of the extraordinary contribution of the large inventory build-up in 2010, as well as weak net exports. In addition, consumer spending is also likely to slow as sentiment weakens again amid rising political uncertainty. This has been the case in the past four election cycles: private consumption has tended to be weak in the run-up to elections, and recover modestly afterwards. That said, investment spending is still likely to grow by a solid 7% in 2011, led by an acceleration in government-led infrastructure projects (under the second stimulus plan, SP2), particularly following recent floods and ahead of the elections. Funds for SP2 are already secured and with the slow progress in implementation so far, some of these funds may be put to use to repair infrastructure damaged by the floods in late October 2010. Politics: Despite leading a fragmented coalition, the ruling Democrat Party (DP) has stayed in power longer than most expected, surviving a series of violent protests and a legal case calling for its dissolution. Regardless, the bigger test still lies ahead: elections must be called before December 2011. The government is likely to push these out as far as possible to allow more time to implement populist policies, but even so we do not rule out a pro-Thaksin government returning to power. Parliament has approved a first reading to change a constitutional provision from multi-seat to single-seat constituency, which arguably could favour the opposition. Meanwhile, the dismissal of the electoral fraud case against the DP on a small technicality, along with the trial of jailed opposition leaders, could spur more anti-government protests, accusing the courts of applying double standards. Political uncertainty looks set to rise in 2011. Monetary and FX policy: We expect the Bank of Thailand (BoT) to hike rates again in Q2 2011, consistent with our forecast of CPI inflation rising to 4.2% in 2011 and 4.4% in 2012. The BoT likely sees real policy rates as too low, which explains the rhetoric that the normalization process is still incomplete. However, the pace of future hikes will also depend on capital inflows, THB movement and external conditions. Thailand re-imposed a withholding tax on government bond purchases by foreign investors. We believe capital controls, as well as continued sterilized FX intervention, capital outflow liberalization and macro-prudential measures are in store (but we do not expect draconian capital controls in the near term such as those imposed in 2006). Risks: Growth remains externally dependent, with large spill-over effects from the export and tourism sectors to domestic demand, so, politics aside, a renewed global downturn is a key downside risk. Higher global food prices are positive for Thai growth but oil prices are negative. Details of the forecast
% y-o-y growth unless otherwise stated
3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP [sa, % q-o-q, annualized] -2.7 2.4 20.1 -1.4 0.0 3.8 6.3 9.4 Real GDP 6.7 3.3 4.5 4.7 4.9 5.3 5.2 5.7 7.7 4.8 5.2 Private consumption 5.0 5.0 4.5 4.5 5.0 5.0 5.9 5.7 5.1 4.8 5.9 Public consumption 2.0 5.0 4.0 4.0 5.0 5.0 10.1 11.0 6.3 4.5 8.8 Gross fixed capital formation 8.0 8.1 6.2 6.5 7.4 7.6 11.1 7.5 9.8 6.9 8.9 Exports (goods & services) 11.7 8.8 8.0 8.0 9.0 10.0 7.1 9.2 14.5 8.8 10.1 Imports (goods & services) 21.2 11.1 10.0 10.0 12.0 12.0 12.3 14.3 21.7 11.0 13.0 Contribution to GDP (%points): Domestic final sales 4.7 4.6 3.7 4.3 4.8 4.6 5.9 5.8 5.3 4.3 5.8 Inventories 4.9 -1.3 0.2 0.2 0.2 0.2 0.0 2.3 3.2 0.2 -0.2 Net trade (goods & services) -2.6 0.3 0.5 0.2 -0.4 0.5 -1.3 -1.4 -0.7 0.2 -0.1 Exports 21.9 5.0 7.5 10.8 11.4 11.8 13.3 14.7 23.7 10.4 14.9 Imports 30.5 9.1 10.2 15.4 14.5 13.4 6.2 8.8 33.1 13.4 8.3 Merchandise trade balance (US$bn) 2.8 1.5 1.2 2.7 1.6 0.9 0.0 0.0 10.6 6.4 21.8 Current account balance (US$bn) 2.0 3.1 3.6 1.0 2.1 0.3 3.8 -0.1 13.2 7.0 5.1 (% of GDP) 2.6 3.8 3.8 1.1 2.1 0.3 3.5 -0.1 4.0 1.8 1.2 Fiscal balance (% of GDP, fiscal year basis) -1.3 -2.3 -2.6 Consumer prices 3.3 3.0 3.5 4.2 4.7 4.2 3.4 4.4 3.3 4.2 4.4 Unemployment rate (sa, %) 1.1 1.1 1.0 1.0 1.0 1.1 1.6 1.6 1.1 1.4 1.6 Overnight repo rate (%) 1.75 2.00 2.00 2.25 2.75 2.75 3.00 3.25 2.00 2.75 3.25 Exchange rate (THB/USD) 32.3 29.5 29.0 28.5 28.1 27.8 27.6 27.3 29.5 27.8 26.8 Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 6 December 2010. Source: CEIC and Nomura Global Economics. Nomura Global Economics 63 6 December 2010

2011 Global Economic Outlook

Vietnam ⏐ Economic Outlook

Yougesh Khatri ⏐Euben Paracuelles

Higher growth and inflation ahead
High inflation and VND devaluation are symptoms of weak fundamentals, but we are optimistic that policy and reforms are getting back on track, so the economy can grow at its full potential. Activity: Vietnam’s favourable demographics, size, location and natural resources underlie its huge potential and we think the 2011 GDP growth target of 7.0-7.5% is achievable. Vietnam’s impressive growth has been accompanied by large growth and inflation swings in recent years. The associated “stop-go” policies and “twin deficits” have made investors more cautious. With strong growth momentum in recent quarters, policymakers seem to have re-focused on stability, marked by rate hikes in October. Beyond the 11th Communist Party Congress in January 2011, we believe there is scope for tighter policies and reforms – such as improving the efficiency of public investment, further reforming state-owned enterprises/banks and strengthening the financial sector. Progress in delivering sounder fundamentals – which we expect in H1 – should attract foreign investment, boost competitiveness and be positive for the longer-term outlook. Inflation and monetary policy: Inflation is likely to exceed 9% in 2010 (versus the target of 8%) and is expected to pick up further with international food and commodity prices and minimum wage hikes expected in January. Upside inflation risks stem from demand-side pressures, more administrative (power and fuel) price hikes and more/larger VND devaluations. Benchmark interest rates were hiked 100bp on 5 November (given VND pressures and rising inflation) and we expect another 100bp hike and a VND devaluation in Q1 2011 (following two devaluations in 2010). We also expect the government to impose further price controls in 2011 as inflation rises. Fiscal and other policies: We forecast a fiscal deficit of 4.2% of GDP in 2010 and expect further consolidation into 2011, with a deficit of 3.6% versus a targeted 5.3%. Bank capital adequacy requirements were raised from 8% to 9% on 1 October and the loan-to-deposit ratio capped at 80% of deposits (after allowing a more liberal definition of deposits). The large trade deficit and a heavily managed exchange rate have eroded FX reserves (estimated to be USD13.5bn at end-June). There are signs that the trade deficit is beginning to narrow (on a 12month rolling basis) which could help rebuild FX reserves - a likely policy priority in 2011. Risks: Inconsistent macro policies could trigger further downgrades (after Fitch downgraded its long-term FX debt rating by one notch to B+ in July, citing external vulnerabilities, a weak banking system and inconsistent macro policy). Given still elevated vulnerabilities, a loss of investor confidence (triggered, for example, by another boom-bust policy cycle) could result in a vicious spiral which, in the worst case, could lead to a balance of payments crisis. Other key risks are external (such as spill-over effects from problems in Europe). Details of the forecast
% y-o-y growth unless otherwise stated 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11 1Q12 2Q12 2010 2011 2012 Real GDP [sa, % q-o-q, annualized] 8.2 5.7 5.0 8.3 10.2 7.1 3.8 7.3 Real GDP 7.2 7.2 6.9 6.4 7.5 7.9 7.1 6.9 6.7 7.2 7.5 Private consumption 8.0 8.0 8.2 Public consumption 5.0 6.0 6.5 Gross fixed capital formation 8.2 8.5 10.0 Contribution to GDP growth (% points): Domestic final sales 9.0 9.2 10.1 Inventories 0.5 0.5 0.0 Net trade (goods & services) -2.7 -2.7 -2.9 Exports 36.2 21.0 19.5 17.6 17.7 18.4 17.1 17.3 23.1 18.2 16.8 Imports 13.0 8.4 14.9 13.9 15.8 13.3 13.7 14.6 19.0 14.4 14.2 Merchandise trade balance (US$bn) -2.1 -4.5 -3.3 -2.6 -2.1 -4.2 -3.1 -2.4 -12.9 -12.1 -11.7 Current account balance (US$bn) -10.0 -9.2 -8.7 (% of GDP) -9.8 -8.0 -6.5 Fiscal balance (% of GDP) -4.2 -3.6 -3.3 Consumer prices 8.4 10.5 10.8 11.6 11.6 9.2 8.0 8.6 9.1 10.8 8.7 Unemployment rate (%) 5.5 5.0 4.5 Base rate (%) 8.00 9.00 10.00 10.00 10.00 10.00 10.00 10.00 9.00 10.00 10.00 Refinance rate (%) 8.00 9.00 10.00 10.00 10.00 10.00 10.00 10.00 9.00 10.00 10.00 Exchange rate (VND/USD) 19,490 19,500 20,000 20,000 20,000 20,000 20,000 20,000 19,500 20,000 20,000 Notes: Numbers in bold are actual values; others forecast. Interest rate and currency forecasts are end of period; other measures are period average. All forecasts are modal forecasts (i.e., the single most likely outcome). Table reflects data available as of 6 December 2010. Source: General Statistics Office of Vietnam, State Bank of Vietnam, World Bank, CEIC and Nomura Global Economics. Nomura Global Economics 64 6 December 2010

5 20 0 -20 -40 Sep-08 1. combined with the continued cyclical global recovery. combined with cyclical trends.2011 Global Economic Outlook EEMEA ⏐ Outlook 2011 Ann Wyman Policy design for postmodern times Structural changes. but flows into EEMEA fixed income markets have been more significant.5 % IL CZ 70 60 50 40 30 20 10 0 UA KZ CPI food weight CPI oil weight Oil&food weight RU HU EG ZA -8. and by the drawing of attention to conventions. Currency appreciation pressures in EEMEA are less pronounced than in other emerging market regions. This comes at a bad time for some countries whose current accounts (CAs) are widening. particularly in Asia. the continued growth of EM investment funds should still lead to capital flows into the region. global economic conditions remain fragile and a new set of realities are settling into the emerging world that still require less conventional policy responses. While investors may prefer to be modestly underweight EEMEA. We think that authorities will increasingly focus on less traditional monetary. impairing competitiveness. EM cumulative fund flows since Sept 2008 USD bn 100 80 60 40 6. flows to Asia have outstripped those into EEMEA and Latin America since the crisis.5 EEMEA bond flows(rhs) AEJ (equity + bond fund flows) EEMEA (equity + bond fund flows) LatAm (equity+ bond fund flows) 11.5 Currencies face appreciation pressure High commodity prices affect countries differently Figure 1. as global risk appetite pauses with deepening European concerns. a host of structural changes are under way—most a derivative of the continued adjustment towards a world where developing countries. Persistent growth differentials between developed and developing markets have led investment allocations to the emerging markets to grow at a record pace (Figure 1). resulting in long-term increases in commodity prices and more permanent shifts in investment flows.” Oxford English dictionary. given EEMEA’s importance many local currency benchmark indices. effectively supporting longer-term price increases. particularly where interest rates remain high. Postmodernism: “A style and concept characterised by distrust of theories and ideologies. are leading EEMEA policymakers to adopt new strategies to cope with shifting global growth. Policy in EEMEA is confronting changing economic dynamics. Ongoing strong capital inflows to EEMEA create conditions for many currencies to continue to appreciate. This view was often invoked by policymakers during the 2008-09 crisis. In 2010. Exceptional circumstances often require exceptional measures. are likely to result in new challenges for regional policymakers. drive economic activity.. 65 6 December 2010 . and many policymakers are contemplating how to calibrate their policy responses. In Emerging Europe. There are several implications of this for EEMEA: Rising fund flows to EM. These changes. Middle East and Africa (EEMEA). Weight of oil and food in EEMEA CPI baskets USD bn 21. Another repercussion of strong emerging markets growth is the pressure it places on the global demand for commodities. Nomura Global Economics.5 16. Nomura Global Economics. But even as the crisis fades into history.5 -3. which is progressing within EEMEA at a varied pace. High commodity prices—a mixed blessing for EEMEA.. Some of these approaches are likely to be successful and others less so. currency and fiscal tools to confront these challenges. Nomura Global Economics Source: CEIC. crude oil prices have already increased significantly and agricultural commodities prices have surged. In aggregate. Structural changes are afoot Shifting sources of global growth are an important influence Inflows into the region represent a key structural change Many of the important structural changes currently under way in EEMEA are a function of the ongoing shift of global growth away from the developed world and toward emerging markets. rising inflation and increased fiscal scrutiny. Politicization of decision-making remains a key risk factor.5 Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 PL TR Source: EPFR. we expect that prices Figure 2. The pace of inflows may consolidate (though remain firmly positive) at the start of 2011.

0 3. the negative fiscal implications are strongest of all the EEMEA.4 0.4 pp in Turkey and Poland.4 0. higher (lower) oil prices will result in lower (higher) CPI inflation in Russia because of their low weighting in the CPI basket and the likely influence of a stronger exchange rate reducing imported inflation.4 -0.1 0. while declines would not influence policy rates. Oil price changes have a surprisingly low impact on headline inflation in South Africa as inflation has been sticky in the past.5 -1. but not for Hungary and Egypt. For instance.2 0. Inflation sensitivity follows headline inflation levels: A 10% increase in oil prices pushes headline inflation up by as much as 0. For the surplus countries.4 0.3 -0.0 0. Further oil price increases beyond 10% could have an even larger negative impact as non-oil imports may also rise with projected increased capital inflows (around a 0.1pp extra burden for every 10% increase outlined in Figure 1).2 2. and because of the uncertain outlook for commodity prices.0 Note: pp – percentage points. For Russia every 10% gain in oil prices leads to the current account surplus widening by 2. a further 10% price increase causes the current account surplus to rise by just 0. Qatar and Kuwait.2 -0. Nomura’s oil price view: Nomura sees oil prices rising linearly to US$91/barrel by end-2011 and to US$98 by end-2012. there is around a 0. and in our base case narrow the surplus by 0.3 2. respectively.6 -0. Fiscally. large government subsidies limit pass-through. policy rates in countries that have persistent inflation.0 0.5 0. Russia and Saudi Arabia the positive effect is the largest. Because of substantial energy subsidies in Egypt.0 0. Every 10% increase adds about 0.2 0.4pp of GDP due to asymmetric effects on import demand. Current accounts are the most affected: For oil producers and importers the impact on current accounts from the trade channel is obvious. CPI inflation is another counter-intuitive case.1 0.3-0. Figure 1.0 -0. Policy rates do have some sensitivities to oil prices as well: While energy prices have been treated as exogenous variables by most central banks.4pp of GDP. Nomura Global Economics 66 6 December 2010 .0 0.1 -0. we are of the view that oil price increases (in contrast with declines) influence policy rate decisions.0 0. of note.5% increases.1 4. and to some extent.4pp of GDP.9 2. Deciphering some asymmetric shocks for Russia: Russia responds differently to different oil price shocks.3 0 0 0 0 0 0 0 0 0 0 -0.3 -0. while in Saudi Arabia the impact is well over 4pp of GDP. In our models. A 10% rise in oil prices has no influence on policy rates. we see value in providing a sensitivity analysis (Figure 1) which explores the expected impact of an additional 10% increase in energy prices in 2011. Because of the importance of global energy prices in the outlook for many EEMEA countries. However. representing 5% and 7. Lower oil prices have a more linear profile.2 -0.0 -0. especially through the inflation expectations channel.1 0. For Poland and Russia oil prices matter for monetary policy.3pp benefit to Turkey and South Africa – due to VAT on imports – which is probably the only aspect of the benefits of higher commodities to these two countries.3 3. the biggest beneficiaries are Saudi Arabia.3 2.2011 Global Economic Outlook EEMEA: Forecast sensitivity to oil prices Olgay Buyukkayali ⏐ Tatiana Orlova Energy prices affect current accounts and inflation.1 0.1 0.3 percentage points (pp) of GDP to the current account deficit. Turkey is the most sensitive among energy importers.4pp of GDP for every 10% fall. Growth in Russia and the Middle East are positively affected: a 10% rise causes growth to increase by more than 2pp in some cases. Source: Nomura Global Economics. a 10% increase in oil prices in Russia has the biggest impact on the current account.8 0. Sensitivity of EEMEA 2011 base case to 10% higher oil prices vs Nomura base case GDP (pp grow th) Current Account (pp of GDP) Inflation (pp.2 0.4 0.4 -0.2 0. Effects on growth and the fiscal impact are more relevant for oil exporters than importers. No major growth or fiscal implications for oil importers: A 10% rise in energy prices does not have much effect on oil importers.6 4.9 4. In our view.1 4.3 1.1 2. but the impact of further price increases decreases in magnitude.1 0. for a 20% rise in oil prices we expect 25bp hikes in South Africa and Turkey.0 0.0 0. widening its surplus by 2. However.4 0.1 0. In the Middle East. period average) Budget balance Policy rate Public debt (pp of GDP) (basis points) (pp of GDP) Turkey Russia South Africa Hungary Poland Egypt Kuwait Qatar Saudi Arabia UAE 0.2-0. Russia is moving towards an inflation-targeting regime and the Central Bank of Russia will likely allow more significant strengthening of RUB than previously should oil prices rise. particularly for smaller price swings.

Turkey’s output gap may have closed by end-2010. banking sector linkages with Europe’s periphery are relatively limited. and. Figure 4. government support policies (such as subsidies. (See the Box: Sovereign wealth funds: Repositioning post-crisis for a discussion of their evolving investment preferences). The spike in food prices has been particularly troublesome for the region. Oil prices also have an inflationary effect. or in those with generally poor policy. inflation is turning around from its cyclical base: In many countries. there are a number of cyclical factors that can amplify the need for less orthodox.. taxes and tariffs). while gaps should close in both South Africa and Poland in 2011. hedging/purchasing practices. As trade balances of oil exporters grow. High oil prices could further widen Turkey’s CA deficit A deeper Eurozone crisis can complicate EEEMEA policy Other cyclical developments under way Cyclical effects also contribute to a postmodern environment Against a backdrop of important structural shifts. contagion risks will increase considerably. The economic linkages between EEMEA and Europe’s periphery are limited. Hungary and the Czech Republic. effectively loosening fiscal policy. (As EEMEA’s exports to Europe are part of a supply chain with links to Asian demand. Fiscal accounts and balance of payments: Given the political importance of maintaining an affordable supply of food in countries with large poor populations. increasing the investment funds available for sovereign wealth funds. CDS spreads. Also. or postmodern. but the speed of the recovery is likely to accelerate in 2011 (Figure 4). While the dynamics of the sovereign crisis in Western Europe remain fluid. benefitting from price rises. the pricing power of local firms.3% of GDP (2008). the weight of commodities in countries’ consumer price indexes (Figure 2).2011 Global Economic Outlook will continue to drift higher still over 2011. even if less pronounced (see Box: EEMEA: Forecast sensitivity to oil prices). The first channel where this contagion is likely to emerge is through financial markets. Conversely. is likely to see most substantial negative impact on its currency account. policy responses. which is expected to remain strong. authorities sometimes use subsidies to smooth the impact of international food price changes.. their implications for countries in EEMEA should not be underestimated. The trade channel may also become an increasingly important link of contagion if the crisis spreads to the core. Nomura Global Economics Source: Nomura Global Economics. which have already widened. Changing European dynamics. especially in those EEMEA countries with troublesome fiscal deficits or balance of payments trends. importantly. 67 6 December 2010 . but if a more severe scenario were to emerge for core European banks. this effect may be offset somewhat). inflation bottomed during H2 2010 and is now starting climb. Egypt also has a significant food trade deficit of 3. Nomura Global Economics. including price changes in local currency terms. Turkey. Oil prices can also have a meaningful effect on trade and fiscal balances. Egypt is the EEMEA country most exposed to such fiscal risks. Ukraine stands out as a net food exporter. First. output gaps are closing: growth has recovered in many countries. Russia and the Gulf states are clear beneficiaries. but if the crisis spreads toward core Europe. Figure 3 highlights where some of the trade risks are greatest—namely in Bulgaria. could widen further. EEMEA economic growth 8 % growth GDP growth 2011 GDP growth 2010 Figure 3. This upward pressure on commodity prices will likely affect countries in EEMEA through several channels: . The region’s biggest oil importer. greater focus will likely emerge on the almost US$900bn in Western European bank claims on Eastern European institutions.but maintaining price stability will be a challenge for all Inflation: The spill-over from international commodity prices to domestic inflation can be influenced by many factors. given the high share of food in the composition of many consumer baskets. the accumulation of international reserves is reaccelerating. leaving it exposed to balance of payments (BoP) pressures from high commodity prices as well. Trade links: vulnerability to European uncertainty Exports to EU as % of Total 120 100 80 60 40 20 RS HR TR RU KZ ZA EG BG BH RO PL LV CZ HU more vulnerable 6 4 2 0 SA 40 60 Exports as % of GDP (5y avg) 80 UAE 100 less vulnerable 0 0 20 IL -2 -4 EG TR KZ UA SA PL IL RU ZA HU RO CZ Source: CEIC. Finally.

it also changes the long-term nature of the role of SWFs by altering their liability profile. Investment strategies are likely to be more diverse and leverage higher. but with large operations in EM. SWF investment activity has picked up in 2010 (Figure 2). Greater exposure to commodities. This trend is being driven by an expectation of high returns. SWF funding could play a role in support of the EFSF. and should increase further in 2011. But SWFs are also slowly coming into the frame as potential sources of stabilization funds for Europe. but increasing concerns about the euro have lessened its appeal as an “alternative.” In 2011. Nomura Global Economics. Rebolledo Sovereign wealth funds (SWFs) were hard hit by the 2008-09 crisis. Wyman │ I. as shown below: Increasing focus on emerging markets (EM). Norway’s SWF has made its first investment in commercial property. particularly energy and food.5% of total assets to 14. Nomura Global Economics Emerging markets' reserves Total reserves USD bn 250 200 150 100 50 0 2000 2002 2004 2006 2008 (H1) 2009 Number (rhs) Value.” via International Finance Corporation funds for development and infrastructure investments. SWFs emerged as important sources of funding for financial sector stabilization during the crisis. but their activity will likely pick up in 2011 as international reserves grow (Figure 1). 68 6 December 2010 . which may include greater EM exposure. in London’s Regent Street. Re-evaluation of dollar exposure. including Temasek (Singapore). SWFs are becoming much more attuned to the value of investing in EM and its expected growth outperformance versus the developed world. Nomura Global Economics. making significant investments in faltering western banks—many of which did not pay off. Retreating from financial services. Investments often take the form of exposure to companies based in the developed world. Given their heavy exposure to the sector and the poor performance that has in some cases increased domestic political pressure. SWFs are also expanding into socalled “frontier markets. some SWFs including Russia’s have forbidden the purchase of specific government bonds (Ireland and Spain). One of the most striking emerging trends is the increasing leverage being assumed by some SWFs. $Bn (lhs) # 250 200 150 100 50 0 (H1) 2010 Source: Monitor Group. acting as an incentive to improve efficiency and discipline. Figure 1. COFER. SWFs are taking an increased interest in commodities. while Australia’s Future Fund has indicated that it is targeting an increase in its property exposure from 9. As sovereign risk assessments of European countries deteriorate. Many. while others such as Norway’s have expressed pessimism about peripheral bonds. though the politics are admittedly daunting. as well as a strategic effort to help secure natural resources. SWFs as borrowers and lenders. SWFs have also provided funding for the recapitalization of their own banking sectors.7bn and Temasek purchased a 14% stake in Odebract Oleo and Gas for US$400mn. both. Longer-term global dynamics would argue for a gradual reduction of dollar exposure.5% in 2011. but developed world SWFs have more recently begun to increase their property exposure given distressed prices in many countries. Middle East SWFs are well-known for their taste for real estate. Nevertheless. Expanding real estate investments. Europe as a “risky” asset. process and trade them.2011 Global Economic Outlook Sovereign wealth funds: Repositioning post-crisis A. investing in both the hard assets and the companies that produce. have raised funding through the capital markets. Global reserves growth led by emerging markets Figure 2. especially LatAm. While accessing private capital can have beneficial effects. SWFs are likely to continue to explore options for further diversification. It is notoriously difficult to gauge the currency composition of SWF assets. Particularly notable transactions have been taking place in Brazil where Qatar Holding purchased a 5% stake in Banco Santander Brazil for US$2. SWF equity transactions by number and volume USD trn 10 9 8 7 6 5 4 3 2 1 0 1999 2001 2003 2005 2007 2009 2011f Source: IMF. Funds are employing “postmodern” strategies such as increasing exposure to emerging markets and taking on leverage. This is inevitably eliciting questions about the very nature and definition of SWFs. the US dollar currency pegs of the Middle East region together with the dollar pricing of their main exports suggest that their SWFs are highly exposed to the dollar. Mumtalakat (Bahrain) and Khazanah (Malaysia). Mubadala (UAE). SWFs are now shying away from direct equity stakes in financial services firms—though investments in private equity/alternatives are a notable exception. China has promised to buy Greek bonds and has indicated it may consider Portuguese debt investments.

Alternative monetary policy tools are being employed to tighten Stress on fiscal discipline requires effective action Are traditional politicians ready for postmodern policy? Postmodern policy in the wrong hands risks being misused While financial markets increasingly demand that policymakers cope cleverly with the difficult economic environment. Policy rates in post-modern economic times bp 150 125 100 75 50 25 0 IL (3. As the crisis in Europe intensifies. and sometimes unorthodox. Fiscal policy efforts: budget balance % of GDP 0 Figure 5.25%) (6. As the European crisis deepens. Meanwhile. have set off on a much slower consolidation track (Figure 6). from gauging likely changes in output potential. Finally.00%) (8.25%) -1 Change in policy rate in 2011 (Interest rate levels) -2 -3 -4 -5 -6 -7 -8 -9 CZ EG HU IL KZ PL RO RU ZA TR UA 2011 2010 TR PL EG HU ZA CZ RU KZ SA RO UA Source: Nomura Global Economics. The current environment provides regional central bankers with many challenges: from pressures surrounding increasing capital inflows and associated currency appreciation. And in Hungary. while at the same time raising reserve requirements is one of the best examples of this creative policy in practice. there is an increased risk of perversions of postmodern policy. and loose monetary policy could raise questions elsewhere. Fiscal policy—tighter. as it attempts to balance its concerns about the strength of the currency with stimulus being provided via looser fiscal policy. Although many have already set in motion consolidation plans to address the deterioration in their debt levels—with the Czech Republic.2011 Global Economic Outlook The closing of output gaps along with the recovery in some labour markets is feeding into this dynamic. With a heavy political calendar in EEMEA scheduled for 2011 (see Box: Politics across EEMEA). including Poland and Hungary. Nomura Global Economics Source: Nomura Global Economics. On balance. despite real rates approaching negative territory. Romania and Latvia some of the most aggressive—numerous other countries in the region. current account deficits are widening as the strengthening of domestic recoveries in some parts of EEMEA contributes to increased import demand.00%) (7. Where there is concern about capital inflows. 69 6 December 2010 . pressure to improve overall fiscal deficit and public debt ratios is leading to less orthodox policy choices in some countries: Hungary’s response through dismantling its reformed pension system and distorting sectoral taxes is a prime example. we see EEMEA central banks erring on the side of loose policy. warding off the potential drags in the west. In the end. faster.25%) (2. with the goal of gaining votes. Central bank independence is already suffering credibility blows in places such as Hungary.25%) (7. Moreover. Figure 6.75%) (6. where none would have been expected otherwise (see Figure 5 for our policy rate forecasts).25%) (6. Israel’s efforts to ensure that implied forward rates remain at least 100bp below policy rates.00%) (4. Postmodern policy implications 2011 has many challenges in store for EM central banks Monetary and exchange rate policy—a focus on the macro-prudential. countries in EEMEA are likely to feel increasing pressure to tighten their fiscal deficits more quickly than previously planned. the abandonment of necessary fiscal tightening and/or the use of less orthodox tightening measures may be invoked in the name of postmodern policy. to preparing for possible tail-risk events in peripheral (and even core) Europe. or the Central Bank of Romania’s operations in the basis swap market to minimise speculative capital flows are others.50%) (9. the need for risk premia to secure inflation expectations against government policy changes is now leading to rate hikes.00%) (1.25%) (8. to confronting commodity price increases that may be more structural. it is ultimately politicians who oversee the implementation of postmodern policy. various policy tools are being used to decrease the carry appeal while not easing monetary conditions as much as rate cuts (or postponed hikes): Turkey’s recent 400bp cut in the borrowing rate (and leaving the lending rate unchanged). the South African Reserve Bank appears to be maintaining an easing bias. even at the expense of higher inflation. the markets may well judge the efficacy of postmodern policy in EEMEA by its ability to help the regional economies face the rebalancing challenges emanating from the east while at the same time.

A switch of power to the opposition would cause a major slowdown in fiscal consolidation. but only in Poland and Romania could they cause major policy shifts. head of the Egyptian General Intelligence Directorate (EGID). EU Council Presidency: Although EU president van Rompuy will continue to chair the Council per se. but we expect he will. raising the profile of the region during key negotiations on possible Treaty changes and establishing a new EU Economic Governance Framework. should retain its dominant position. causing the local media to speculate about other possible candidates. presidential elections in September 2011: Current president Hosni Mubarak. in early H2: The long-standing political regime is unlikely to change. it should be tough for any other party to clear the required 7% threshold. after a cabinet reshuffle and new prime minister. local elections (likely Q2): These are important sub-provincial elections. The pro-government party. COPE has had leadership issues. which currently fully occupies the Majilis. There are no major differences in the opposition’s local. CEE will be in the driving seat for EU finance ministers’ meetings (Ecofin). his son. United Russia should be able to use its access to administrative resources and budget revenues to ensure high turnout and secure a majority of seats. Overall. foreign or economic policies to challenge the stability provided by the AKP governments of the past eight years. The continued decline in unemployment and the recent tax amnesty could generate some support for the AKP ahead of the elections. again while leftist it is seen as more pro-investor than the current coalition member. the parliamentary contest is likely to be close too. as will corruption and sentiment towards the ANC government. and the political climate should remain stable with the status quo maintained. The main question is who will be the candidates in the 2012 presidential elections. but locally it may do fairly well. the ANC may launch some policy moves in the February budget. who has been in poor health in recent years. are already disrupting fiscal policy and postponing fiscal consolidation. We believe that either Vladimir Putin or Dmitry Medvedev. H2 2011): The political landscape in Romania is very precarious. Hungary (H1) and Poland (H2). But his lack of military background has caused some commentators to question whether his candidature would command the support of the military. We expect the total proportion of control to drop from around 85% to closer to 70% thanks to the opposition DA (Democratic Alliance) maintaining its momentum of the past two years. is widely seen as a possible successor. we believe that. Nur Otan. The convergence theme and prospects for EMU (Economic and Monetary Union) may come to the fore again. Kazakhstan. Nomura Global Economics 70 6 December 2010 . which we think will take place in October. but it is also possible that there will be no announcement until after the Duma election. Of the opposition parties. but not both. Sejm elections (likely October): The 2011 parliamentary elections. Should Mubarak senior decide not to stand for re-election. The overwhelming victory of the ruling National Democratic Party in the November 2010 parliamentary elections has served to wrest representative power from the Muslim Brotherhood (which performed well in the 2005 elections) and should minimise uncertainty around presidential candidate selection and approval (by parliament).2011 Global Economic Outlook Politics across EEMEA Tatiana Orlova The 2011 calendar is rich in elections. PSL (Polish People’s Party). As fiscal austerity hits home and the coalition’s popularity falls further we see a meaningful risk that one of these no-confidence votes is passed. The PO could decide to form another coalition but with a different partner. It will be interesting to see how the newly resurgent SLD (Democratic Left Alliance) performs. The SLD is currently at 8% in the polls vs PSL’s 3%. Jobs will be a major issue. The PO (despite being more left wing than the conservative PiS) is seen as the more investor-friendly option. Gamal Mubarak. but we expect a series of no-confidence votes in the coming months from a more united opposition. Given different systems and seat allocations across the different elections. key will be proportion of control of municipalities and proportion of votes. mainly in H2. Egypt. Turkey. Current polls put the PO well ahead of PiS at 50% vs 35%. parliamentary elections at end-2011: The election season should begin in spring. The loose coalition government has a slim majority. While this would not necessarily cause an immediate collapse of the government. early elections would be unavoidable (brought forward from 2012). elections (risk of being called early. Once the elections are out of the way it should be possible to make necessarily expenditure-side fiscal reforms. only the Communists should easily overcome the 7% minimum threshold for obtaining seats in the Duma. has not yet stated whether he plans to stand for re-election. Putin is very likely to run again following his four-year break. elections for the Majilis (the parliamentary lower house). Russia. The presidential election in 2010 was very close: 53% for ruling PO (Civic Platform) and 47% for opposition PiS (Law and Justice). We would expect his candidacy to be announced early in the Duma election campaign to help United Russia secure a constitutional majority. That may allow for easier reforms in some areas. such as Omar Suleiman. Poland. South Africa. with no need for a coalition. parliamentary elections (July 2011 though possibly as early as April) and presidential elections in 2012: The events are unlikely to create major volatility in the markets. its alliance with the ID (Independent Democrats) and possible coalitions with COPE (Congress of the People) in some areas. As the incumbent. Romania. Our base case remains an AK Party (AKP) election victory once again. Worried about these elections. we think the vote share of the ANC (African National Congress) may fall from 65% at the 2009 parliamentary elections to close to 60%. and we expect no serious challenge to Putin’s United Russia party which currently holds more than two-thirds of the seats in parliament (the Duma). will participate in the presidential race.

6% of total issuance (HUF2. The ruling FIDESZ has a very strong mandate after winning the 2010 parliamentary and local elections.0 5.0 -2. Orban is current PM. particularly export demand from Germany for onward export to Asia.9% of GDP next year even under lower growth assumptions. resulting from the dismantling of the mandatory private pension savings system should mean that the government can meet its deficit target of 2.5 -3. We expect inflation to remain sticky and above target.84 9. such as a new flat personal tax system and the cutting of corporate tax. Nomura Global Economics Source: Nomura Global Economics.75 280 2011 1. Details of the forecast 2009 Real GDP % y-o-y Nominal GDP USD bn Current account % GDP Fiscal balance % GDP CPI % y-o-y * CPI % y-o-y ** Population mn Unemployment rate % Reserves USD bn *** External debt % GDP*** Public debt % GDP MNB policy rate %* EURHUF* -6. The party is both fiscally conservative.25 290 Figure 2. a hole of some HUF500bn remains in the budget in 2013 and beyond. Debt market dynamics will likely be complicated by structural changes including the removal of the private sector mandatory pension savings system.91 10.8 5.4 78. Risks: We think the market needs to decide if such unsustainable and growth-discouraging fiscal policy while meeting fiscal targets (and falling debt on the pension system changes) is correct.5 40. ending 2011 at 3. Whilst the current MPC may hike in December. Household consumption should stop contracting in Q1 2011 for the first time since the crisis with its growth averaging 1. Fiscal and Politics: The focus of next year’s outlook is the interplay between fiscal policy and politics. external risks are the ones to watch.4 74.8 9. this could well be reversed afterwards. the lack of credit growth given the banking tax should limit capital formation and household consumption growth for the year.2011 Global Economic Outlook Hungary ⏐ Economic Outlook Peter Attard Montalto Investor unfriendly policies dampen growth We believe the 2011 policy mix will not encourage growth and is investor unfriendly. The external sector should drive most of the recovery. **Period average. Debt dynamics 90 Pre-budget baseline Orban/ Baseline 81. while negative risks stem from the spill-over of fiscal policy. However.0 159. January and February. An external shock from periphery Europe.4 6.3 6.4 -1.7 4.6 4. The 2011 budget (and beyond) does not include expenditure reforms and the burden is placed on revenues. further downgrades or a reassessment of Hungarian growth prospects through 2011 could lead to funding problems and capital flight.0 91. but also because of reduced issuance of some HUF456bn the impact on rates is unlikely to be negative. Bold is actual data ***Includes IMF/EU funds 50 2003 2005 2007 2009 2011 2013 2015 Note: Table reflects data available as of 6 December 2010.2 -4.5 172.3% in 2011 after -2.25 270 2010 1. Note: Bajnai stands for policy under previous Prime Minister.5% in 2011 from 1. Upside risks to growth are mainly from the external sector.5 103.0 42. This should decrease debt demand by some 4.9 114.1 9.0 93. For 2011 these measures should offset other growth-boosting longer-term measures. but also deeply populist. Sectoral taxes should feed through to consumers and banking taxes (the toughest globally) will probably lead to the recovery in credit growth stalling as in H2 2010 and continue to act as a drag on growth. Source: Nomura Global Economics.4bn).88 10.0 172.8 40.86 10.0 3.0 -3.0% in 2010.3 170.7 0.2 4. Activity: We look for growth of 1.1 6. Currency and debt markets: Although we look for the forint to be weaker through 2011 because of a market reassessment of growth and fiscal policy. Hence its set of measures will hurt growth and are inflationary and investor unfriendly (both portfolio and FDI) over the medium run.3 75. However.25 285 2012 2. Overall these taxes combined with asset sales and additional contributions.2 9.7%. Figure 1.8 4.0 73.6 Bajnai 60 *End of period.1% in 2010.1 80 70 75.7 0.7 -2.4 3.9 3.5 35.5 79. Inflation and rates: There is considerable monetary policy uncertainty given the government wants to change both the inflation target and the MPC members in March. 71 6 December 2010 .8 9.

50 3.50 4. Risks: A broad-based recovery and more closed economy suggests there is insulation against any possible growth dip in the eurozone. fiscal clouds Investment. such that the trade balance only makes a small negative contribution to growth.1% in 2010 to +12. as credit expansion and a natural cyclical recovery in real wages and employment provide a boost to households.2 3. However. Fiscal and politics: Policy for the year will be focused solely on the Sejm elections. We see inflation rising to average 3. Inflation outlook 6 5 4 3 2 1 0 Jan-08 Nov-08 Sep-09 Target % y-o-y Net core Headline Jul-10 May-11 Mar-12 Note: Table reflects data available as of 6 December 2010.5 -1.7 51. Activity: Growth should accelerate to 4. Inflation and rates: Poland will be one of the only countries in the region with demand-side inflationary pressures in our view. Figure 1.9 85.1 9.7 635.9 54.1 3. The 2011 budget provides little policy change.1 3.50% by year-end.0 3.0 38.6% in 2010. Investment should be a new contributor with attractive valuations prompting additional capital inflows. with a concentration on revenue from a 1pp VAT increase and some other smaller measures.5 9. The government is unwilling to undertake difficult but necessary expenditure reforms before the elections. Rates may well rise at a slower pace if there is excessive PLN appreciation. which curbs inflation.0 90.5 635.50 3.5% during 2011 from 2. Interest rate rises through the year should act as a drag on growth.8 752.8 -2. but must do so in its 2012 budget to keep markets on side and be on a sustainable track towards euro adoption in 2015 (with ERM II entry we believe at 3.9 -3. with upside inflation risks from commodities and risks on the downside from a stronger currency. All in all.3 54. though it should principally get its boost from construction in preparation for the 2012 European Football Cup. but not meaningfully as policy will likely remain in loose territory overall.9 -7. **Period average. Details of the forecast 2009 Real GDP % y-o-y Nominal GDP USD bn Current account % GDP Fiscal balance % GDP CPI % y-o-y * CPI % y-o-y ** Population mn Unemployment rate % Reserves USD bn ** External debt % GDP Public debt % GDP NBP policy rate %* EURPLN* 2010 2011 2012 4.9 5. We expect the PO to cement its position. 72 6 December 2010 .5 -1. though it may swap coalition partners from the leftist PSL to the more centre-left SLD. this should take growth in investment from -3.10 *End of period.6 804.5 3. A credit rating downgrade post Sejm elections is possible.70 in H1 2012).4% growth in 2010 to 4. In 2011.50 4. Markets’ assessment of the fiscal situation and the government’s commitment to (eventual fiscal consolidation) will dictate the success of debt issuance.5% y-o-y in 2011 supported by a broad-based recovery.9 8.2011 Global Economic Outlook Poland ⏐ Economic Outlook Peter Attard Montalto Racing ahead. but a close Presidential election mid-2010 has kept the party on the edge and nervous of opposition PiS.6 -7.8 4. The ruling PO is still significantly ahead in the polls.8 -6. we expect the budget deficit to come in at a very large (considering growth) 6. external demand and strong domestic demand should see growth surge ahead. Source: Nomura Global Economics.0 69. We see the National Bank of Poland responding with a stop-start tightening policy (in response to currency strength fears) beginning in February.70 3.2% in 2011.0 38. compounded by the domestic recovery and credit growth.6 3.0 100. Equally expansionary fiscal policy should provide support for another year. which we expect to take place in October.0 3.6 3. we see export demand from Asia (both direct and indirect via Germany) offsetting increased import demand.9% of GDP.1% in 2011. The government has moved out its 3% of GDP deficit goal to 2013. Risks are broadly balanced. Nomura Global Economics Source: Nomura Global Economics.4 38. In particular. growth is unlikely to mask the fiscal policy fudge that is ongoing until after the elections.8 62. with rates reaching 4. Bold is actual data Figure 2.4 37.5 2.5 1. though Asia and global growth more generally are probably more significant drivers.0 11.4 65. Public debt levels will be watched closely and will likely be close to the key constitutional 55% of GDP debt limit. We see household consumption moving ahead from 3. though remains a tail risk.0 59.0 -5.8 64.8 4.0 3.5 54.

the government will need to place Eurobonds and increase domestic borrowing markedly to finance it.6 2.49 35.7 -3. Still. The consolidated budget. **Period average.5 1.6% of GDP in revenues. Activity: Unless oil prices rise sharply. The government accepts that the development of the economy is being hindered by the high level of state ownership. Official fiscal projections for 2010-13 8 6 4 2 0 -2 -4 -6 -8 -10 % of GDP $/bbl 90 80 70 60 50 40 *End of period. though there is a risk that policy will remain unchanged and focused on growth rather than inflation.5 7. he will probably do it during the parliamentary campaign to boost United Russia’s popularity. which should generate about $50bn in revenue. Table last revised 2009 Budget deficit Reserve Fund Welfare Fund Net domestic borrowing Net external borrowing Urals.0 -4. which we think is very likely.20 1.5 2012 3. Russia has nearly ironed out all differences with the EU and US.7 -6. which now balances at a Urals price of above $100/bbl following years of fiscal expansion. We forecast CPI inflation of 8-9% y-o-y for most of 2011.5 6. Details of the forecast 2009 Real GDP % y-o-y Contributions to GDP (pp) Consumption Gross investment Net exports CPI % y-o-y ** Federal budget % GDP Current account % GDP FX reserves.6 1.2 4. Nomura Global Economics Source: Russian Finance Ministry.3 2. The severe drought last summer dealt a blow to the still-fragile economy. Bold is actual data. we think growth will probably be lacklustre compared with the previous decade. and has therefore announced a large privatisation programme for 2011-15.25 30. This should support household consumption. This rise should bring in an extra 1. Inflation: The second-round effects of last summer’s drought are likely to persist until mid-2011. Although the 2011 budget includes certain tightening measures. the government has stopped channelling any windfall oil revenues into the sovereign wealth funds. Nomura Global Economics.50 2.2 0. and will likely use these revenues for pre-election handouts.75 30. end of period RUB Basket*** on 3 December 2010 ***45% EURRUB and 55% USDRUB -5. the most interesting political question next year will be the identity of the candidates for the presidential election expected in early 2012. Policy: The Central Bank of Russia may be forced to react to lingering high inflation with a rise in interest rates in Q1 2011. as companies will be hit by an increase in the effective rate of social tax from 26% to 34%. United Russia. the announcement of the candidates for the presidential race and the possibility of WTO accession in H2 2011. Other inflationary factors include the lagged effects of loose fiscal and monetary policies. and together with rises in the gas extraction tax and excise duties for alcohol and tobacco should help reduce the budget deficit from about 4% of GDP this year to the 3. Because of the weakness of the opposition and the high (7%) threshold for representation in the Duma.5% y-o-y.4 -0. has a good chance of retaining a constitutional majority (or two-thirds of the seats) in the Duma. will likely post a smaller deficit than in 2009. but fixed investment may remain anaemic.1 590 8. and WTO entry may take place in H2 2011.25 31.8 2011 3.6% pencilled in the 2011 budget.8 -4. it is not planning to sell a controlling stake in any of the state-owned flagship enterprises in 2011.75 30.0 11.74 -7. Rising inflation reversed the benign trend in real wage growth and dented consumer confidence.8 3.83 34. Politics: Although parliamentary elections are due at the end of 2011.9 -2.9 -2.8 505 7. way above the government’s target of 6. If Vladimir Putin puts himself forward as a presidential candidate.5 540 8.8 439 8.3 11.99 1.7 -1.27 36. given the near-depletion of the Reserve Fund. we think they will achieve little in trimming spending as the forthcoming elections will constrain tightening. this would provide a boost to market confidence.3 Figure 2. gross USD bn CRB policy rate %* USDRUB.9 2010 3.2011 Global Economic Outlook Russia ⏐ Economic Outlook Tatiana Orlova Lacking momentum Next year’s focus is likely to be on the year-end parliamentary elections. and the speed of recovery slowed in H2 2010.8 8. However. rhs 2010 2011 2012 2013 30 20 10 0 Source: Nomura Global Economics. Figure 1. 73 6 December 2010 . As the country approaches the elections.67 35. the ruling party. regulated tariff hikes in January and the likely rise in meat prices due to short supply.

2 -12. However.3 -4. led by Asian demand is trailing off.Private sector credit extentions Note: Table reflects data available as of 6 December 2010. Inflation and rates: There is significant uncertainty on whether the rate-cutting cycle has ended because of the MPC’s ability to accept such late.0 6.50 11.8 39.0 -0. The ability to sustain such consolidation is however unclear.5% growth until mid 2012. Overall.7 4. we see inflation remaining in its target for the whole year.8 6.3% in 2011 after 2.3 4. gross USD bn* CPI(X) % y-o-y * CPI(X) % y-o-y ** Manufacturing output % y-o-y Retail sales output % y-o-y SARB policy rate %* EURZAR* USDZAR* -1. Foreign debt issuance is also being reduced. We expect the ANC to lose some ground in terms of its control over the number of local authorities (dropping from around 80% to 65%) owing to the opposition DA-led coalition.0 -6. Rates should then stay on hold until the last meeting of the year (December).3 -5.0 -2.8 8. Questions remain over the role of monetary policy in the government’s New Growth Plan as it is meant to be doing more of the macroeconomic heavy lifting. However. pro-cyclical policy adjustment. even though this is not our baseline forecast. and become more sustainable.5 3. households will probably be constrained by the rise in employment taking much longer than the fall on the way down. According to our estimates the economy will not reach its potential of 3. with corporates still deleveraging through much of H1.00 10. policy more interesting Underlying growth should recover further.5 46.1 8. Very high real wage growth however will offset this to some extent when combined with asset price appreciation. we expect the government to go further. But given the global currency wars and yields in South Africa these measures are likely to only have a limited effect.9 11. Therefore.0 2.9 -3.3 -5.5 44.6 6.1 7. Bold is actual data PSCE.8 -5.9% of GDP next year (a touch higher than the budgeted -4.8% in 2010.0 0.90 2011 3. Currency: The government has taken actions to weaken the ZAR with outflow exchange control relaxation starting in 2011 and by providing the South African Reserve Bank with more funds to cover the sterilisation costs of more rapid reserve accumulation. An early growth spurt in exports during the past year. South Africa will probably only experience a sluggish recovery.5%. Real GDP growth and breakdown pp contribution 12 10 8 6 4 2 0 -2 -4 -6 -8 Trade Balance GFCF Government Consumption % q-o-q saar 8. Such a move should re-energise the debate within the ANC about the New Growth Plan.7 6. We believe there is a strong likelihood of a cut in rates in January. Nomura Global Economics Source: Nomura Global Economics. while the effects of a slowdown in demand outside Asia has been compounded by a currency overvalued by some 25% in our view.8 -3.0 -8. Although we think this means a dovish bias over a whole cycle.6 7.9 45.8 5.3 7. but it will be highly data dependent after the overly dovish MPC statement in November.6%. Politics and fiscal: The focus in the year ahead will be the interplay between policy and the locals elections (expected in Q2). ending at 5.00 2012 3.5 4.8 3. second-round effects and a weak ZAR.50 9. Details of the forecast 2009 Real GDP % y-o-y Current account % GDP PSCE % y-o-y* Fiscal balance % GDP FX reserves.50 Figure 2. Figure 1. Overall. 74 6 December 2010 .3 6.0 -4. especially its interaction with monetary policy.6 7.48 2010 2. **Period average. we expect the recovery to be achieved largely through a renewed spurt in infrastructure investment and household spending. Activity: Despite suffering only a mild recession during the crisis.2 5.9 -4. Source: Nomura Global Economics.0 4.2011 Global Economic Outlook South Africa ⏐ Economic Outlook Peter Attard Montalto Unexciting growth. where we see the MPC having to normalise rates owing to a worsening inflation outlook. state intervention in industry and other developmental state interventions on jobs and education.4 6. overall we expect a pretty rapid narrowing of the budget deficit to 4. the risks of an MPC mandate change are material. We look for growth of 3. though the outlook for 2012 looks more bearish with higher commodity prices.1 -6.3 4.6% given post election spending pressures).0 6. Fiscal policy is the area to watch.0 Other GDP (rhs) Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-11 Mar-12 *End of period. We therefore see inflation ending 2012 outside its target at 6. Risks are to rates on hold for longer. albeit slowly.7 8.5 10.6 6.00 10.8 -4.7 5.

1 7.1 5. the political climate looks extremely stable following the Constitutional Court referendum.7 5.5 8.4 4.8 10.6 12.0 6.7 9.2 -6.25 7.6 -6.5 3.2 9.6 11.8 4.5 -6. We think risks are on the upside owing to the strong policy response from construction and public investment ahead of the elections.1 -3.3 2.00 7. Our baseline is an overall 150bp rise through 2012.3 30.5 14.00 1.3 -0.5 -4.0 1. We think the risks of capital controls being implemented should the currency appreciate rapidly are extremely low.6 8.2 -5. We expect the TCMB to actively raise TRY and FX reserve requirements to stabilise corporate and individual credit growth.6 -0.9 1.3 -3.2 2.5 -3.1 2.2 5.9 6.0 -6.3 2.7 4Q10 2.8 13. driven largely by continued double-digit growth in private investment. Inflation: We expect food price disinflation and core inflation in 2011 that would still leave headline inflation above the 5.9 4.8 0.6 8.4 3. An AKP majority government is our base case in the elections. which is also an upside risk for our base case. and meat imports and base effects could bring some relief.1 0.0 1.00 TCMB policy rate % 1.5 0. looks low.2 3.2% in 2010.food (period end) CPI (period avg .1 3.2 1.8 8.2 1.0 2.0 4.2 -0.1 3.6 9.00 7.4 8.5 2. Nomura Global Economics 75 6 December 2010 .0 -1.2 -3.6 8.5 10.4 4.5 23. Leverage in the economy.3 15.3 -3. Activity: According to our forecasts Turkey has come out of the recession with relatively strong growth of 7.8 9.47 2011 5.2 31.4 2.9 20.3 3.2 1.25 1.2 32. Furthermore.3 6.1 2. despite rapid growth.2 5.4 7.0 7.6 3.1 3.1 30.0 8. real wages together with lower unemployment are all pointing to risks on the upside for core inflation.1 1.3 30. with 100bp taking place during 2011.3 30.8 4.5 3Q10 5. which is currently running above 15% yo-y.0 6.00 1.8 7.1 0.9 3.7 9.8 5. and highlight the case for an investment grade rating by 2011 (which is largely priced in by the markets).8 9.7 31.3 4. Fiscal policy does not help the monetary authorities as much as it could – due to elections in 2011 – with the government spending the cyclical revenue overshoots in the primary surplus during 2010 and 2011.1 -1.9 30.6 -6.6 9.4 7.4 1.0 2Q11 4.0 -6.6 1.3 22. Our calculations suggest the output gap probably closed during Q4 2010.3 4.3 6.0 -0. Private consumption contribution should moderate and this should reduce net import’s negative contributions to GDP.7 6.3 5.47 1.3 3.58 1.45 TRY/USD TCMB policy rate denotes O/N borrow ing rate until 1Q10 and 1-w eek repo rate thereafter Note: TCMB policy rate denotes O/N borrowing rate until 1Q10 and 1-week repo rate thereafter.0 10.3 -1.1 6.7 -6.00 1.9 2.0 4.5 1.5% target at around 7.9 0.2 1. The government is keen to address food price inflation.4 1.1 17.1 2.8 5.5 -3.8 8.8 2.3 1.4 -3.1 2.8 7. We expect the first hike in May because of core inflation pressures.5 8.5 7.7 0.1 5.0 -6 -3 30 8. Details of the forecast % y-o-y unless otherw ise Real GDP Personal consumption Private investment Government expenditure Exports Imports Contributions to GDP (pp): Personal consumption Private Investment Government expenditure Stocks Exports Imports CPI (period end) CPI -ex.0 2Q10 10.4 26.3 6.45 1.7 8.1 6. The authorities are aware of the widening imbalances and seem to be addressing the issue.4 -8.1 -3.50 1.9 11.7 31.5 6.3 0.2 1.2 3.2 7.4 2.9 5.7 -0.5 5.2 -6.6 30.44 2010 7.3 -0. We think success could bring an investment grade rating as early as Q3 2011 by at least one agency. The debt dynamics remain stable.7 1.9 6.40 2012 4.6 -1.7 11.12m) Current account (% GDP) Fiscal balance (% GDP) Net public debt (% GDP) 1Q10 11.6 8.1 1.8 2.7 6.4 6.6 6.5 2.0 1Q11 5.2 0. our scenarios do not assume aggressive stock building.5 4.5 14. Macro-prudential policy measures are unlikely to stop the widening of the current account deficit.9 6.6 4Q11 6.1 0. Source: Nomura Global Economics.5 7.1 13.9 2.4 9.3 -1.4 30. Even though parliamentary elections are set for July 2011 (we see significant risks of them taking place a few months earlier due to logistical reasons).75 6.3 1.7 31.2 1.2011 Global Economic Outlook Turkey ⏐ Economic Outlook Olgay Buyukkayali Widening imbalances Loose monetary and fiscal policy has supported the continuation in domestic demand-led growth.0 2.3 1.6 -3.7 3Q11 5.40 1.2 6.5 -2.47 1.9 8.0 6.7 6. We expect growth in 2011 to remain above-potential at 5.0 0.2 6.9 3.9 2.40 1Q12 3.4 5.5 1.0 13.4%.5 1.2 0.1 -4.0 3.4 1.4 -4.7 6.5 6. Table reflects data available as of 6 December 2010. With pricing power rising.2 2.7 16.00 7.51 1. Policy: Monetary and fiscal policy remains loose.2 8.50 7.4 -3.5 32.0% y-o-y.0 4. Risks: Overheating and terms-of-trade shocks (oil prices) are the main risks because the current account deficit is running above 6% of GDP.2 1.

0 38. Inflationary pressures should remain fairly high.8 -2.3 1. **Period average. currency pass-through and commodity price pressures suggest inflation should remain high and sticky throughout the year.0 36. but also shrinks the current account surplus.7 1.5 3.2 1.2 9. • Israel: Growth continues to advance Israel’s output gap has closed.2 3.3 2.5 -7.0 -4. early elections are possible. Strong domestic demand not only risks inflation moving above the upper band of the target.0 45.1 8.3 222.5 -4.3 28. • • *End of period.0 2.70 2011 4. as may sluggish growth in periphery Europe.0 45.5 3. **Period average.25 23.7 -5.9 -3.30 2011 1.5 -3.0 2. with increasing political instability owing to a more united opposition.79 2010 3.0 1.25 4.3 4.0 48. Nomura Global Economics. Source: CSO. CNB.0 2.7 5. though a loss in domestic competiveness needs to be watched.50 4. In our view.50 2012 4.25 3.8 4.8 4.0 3.9 45.0 70. but also because of a rise in real wages. Bold is actual data Note: table reflects data available as of 6 December 2010. but the VAT increase.3 3.3 -6.8 3.2 41. Bold is actual data Note: table reflects data available as of 6 December 2010.2 1.1 73.9 1. Romania: A challenging road ahead Twin deficits leave little room for supporting growth 2009 Real GDP % y-o-y Current account % GDP Fiscal balance % GDP CPI % y-o-y * CPI % y-o-y ** External debt % GDP Public debt % GDP NBR policy rate %* EURRON* -7.7 6.50 2012 2.5 • A strong rebound in 2010 owing to stronger external demand from the EU and Asia will probably dissipate in 2011 when fiscal austerity measures hit domestic demand.60 • Israel’s export-driven economy outperformed the region in the post-crisis environment thanks to an aggressive monetary policy response resulting in a healthy domestic demand. • • *End of period. Romania was one of the few countries to suffer three full years of contracting output and the expected rebound in headline growth in 2012 should be mainly due to base effects and FDI.5 -5. Fiscal consolidation may dampen household demand.0 3.9 2. While fiscal consolidation will drag on growth.0 -4. Bold is actual data Note: table reflects data available as of 6 December 2010. Core inflation should continue to ease given excess capacity and reduced wage pressures.6 10. which we expect to fall throughout the year.8 2.4 1.3 3.4 -1.5 223.4 -4.8 2.5 2012 2.3 -0.5 3.0 3. We see inflation hovering just above target on commodity price pressures throughout the year.0 45.7 41.0 -4.9 43.75 3.2 4.00 4.0 2.5 -4.0 7.5 2. Source: Ministry of Statistics.0 -5. it is an important boost to credibility.8 1.0 7.3 -3. inflation pressures are rising 2009 Real GDP % y-o-y Consumption % y-o-y Gross investment % y-o-y Exports % y-o-y Imports % y-o-y CPI % y-o-y * CPI % y-o-y ** Budget balance % GDP Current account % GDP Policy rate %* USDILS* 0.8 -7.4 253.8 69.0 70. fiscal challenges and heightening risk perceptions on periphery Europe.00 3.0 3.5 3.2 2010 2.6 255.4 44.8 -3.2 8.00 3.00 23. Monetary policy should continue to tighten in 2011: in our view with the BoI is likely to hike policy rates by 125bp in 2011.2 0.25 • The political background remains testing.0 2.0 45.7 -0.5 3.0 35 6. **Period average. there is reduced room for interest rate cuts and we see no hikes until 2012.25 4.2011 Global Economic Outlook Rest of EEMEA ⏐ Economic Outlook Peter Attard Montalto ⏐ Olgay Buyukkayali Czech Republic: Fiscal/growth trade-off The fiscally hawkish coalition will likely continue to correct the situation it inherited but growth will likely suffer 2009 Real GDP % y-o-y Nominal GDP USD bn Current account % GDP Fiscal balance % GDP CPI % y-o-y * CPI % y-o-y ** Population mn Unemployment rate % Reserves USD bn ** External debt % GDP Public debt % GDP CNB policy rate %* EURCZK* -4.5 -6. Source: BOI.0 2.3 35. • *End of period. Nomura Global Economics 76 6 December 2010 .9 3.0 3. Nomura Global Economics. though tempered by a strong currency.00 26.2 3.2 2010 -2.8 -5.0 7. The surprise victory of the centre-right coalition in the election suggests fiscal consolidation in 2011 should be impressive and put the economy on a more solid course after more than a year of policy stagnation. lower GDP growth probably means rate rises are unlikely before Q4 2011 and will be slow.5 2.0 3.1 10.1 8.5 3.3 2.75 25 2011 1.0 6. not only because of a housing market boom. With a plethora of no confidence votes.0 10.5 10.0 3. However.1 43.5 -5.4 -8.

The NBK intends to change the FX regime in March 2011.9 -8.7 9.1 6.5 2.6 4.75 7.0 12. gross USD bn NBU discount rate %* USDUAH* -15.0 4.25 7.0 37.2 3.3 3.5% of GDP in 2010.5 -3.4 -46.00 138 • Manufacturing.00 6.5% of GDP from 5. which propelled the economy in 2010.0 11.3 10. The Central Bank of Egypt (CBE) should resume rate hikes in 2011.0 2.8 4.0 7.2 -3.50 7.10 2012 5.1 1.0 -3. Bold is actual data. Growth is expected to remain above 5% in 2011. The government will have to balance the need to fulfil harsh conditions of the IMF stand-by programme with preserving political stability.0 7.50 2010 5.5 29.3 -6.2 -40.1 16. will likely retain some of its momentum in 2011.6 29. gross USD bn NBK official rate %* USDKZT* 1.9 28.2 20. Bold is actual data.0 38.1 8.5 11.4 16.9 7.0 17. Note: table reflects data available as of 6 December 2010.5 33. and has hinted at the possibility of a managed float.0 30.6 28. but his health issues heighten risks of a disorderly transition.3 42.1 -14.3 8. the next Rada elections are not happening until 2012. Note: table reflects data available as of 6 December 2010. with some upside risks from further upward shifts in commodity prices or subsidy reductions. but the path may be thorny 2009 Real GDP % y-o-y Consumption.5 6. % y-o-y Imports.2011 Global Economic Outlook Rest of EEMEA ⏐ Economic Outlook Tatiana Orlova ⏐ Ann Wyman Ukraine: Slow stabilisation The new standby agreement with the IMF paves the way for reform. gross USD bn External debt % GDP Policy rate %* USDEGP* 4.0 17. The Mubarak succession debate should take centre stage in 2011.5 9.9 -39. driven by domestic demand. **Period average.0 15.0 7.8 2.8 20 26.3 -1.0 8. Source: Nomura Global Economics.5 -5. .0 -25.25 142 2012 4.5 2011 5.2 4.00 146.2 30 6.1 -2. We see a small chance of inflation returning to single digits but policy hikes are unlikely.3 11. • Kazakhstan: Driven by industrial recovery The change in the FX regime expected in March should lead to moderate KZT appreciation 2009 Real GDP % y-o-y Consumption % y-o-y Gross investment % y-o-y Exports % y-o-y Imports % y-o-y CPI % y-o-y ** Government budget % GDP Current account % GDP FX reserves.7 0.2 7.70 2012 5.90 2011 4.6 7.5 -7. and Mubarak may run again.3 16.2 -52.5 12.1 41.25 5. • Nomura Global Economics 77 6 December 2010 .00 6. • *End of period. with the pace of increases dependent on inflation. The parliamentary elections to be held in H2 2011 carry little risk for stability.5 3.1 10.50 • The pace of recovery will likely remain gradual. **Fiscal year ending April.3 7. % y-o-y Gross investment Exports.0 10. Inflation is likely to remain sticky given domestic demand and global oil price increases.1 9.0 1. as the ruling party should retain its dominance in parliament.5 9. The current account should remain in deficit but renewed FDI inflows and IMF support should help keep the hryvnia stable.8 3. Luckily for it.5 0. % y-o-y CPI % y-o-y ** Consolidated budget % GDP Current account % GDP FX reserves. **Period average.40 • The economy fared well through the crisis. though reform progress has slowed.1 -8.9 -3.2 34. supported by wider Middle East linkages. We expect it to intervene in the FX market to prevent USD/KZT from strengthening beyond 141142 by year-end.7 2010 6.0 27.80 2011 5.75 7.25 5.00 148.99 2010 4.0 -0. this should translate into a further build-up in the National Fund and FX reserves.2 -4. IMF funds and external borrowing will likely remain the main tools for financing the budget deficit which the government has pledged to cut to 3.8 13.5 35.0 -0.2 7.6 -1.2 7.5 -1. Source: Nomura Global Economics. Bold is actual data Note: table reflects data available as of 6 December 2010. • Egypt: Anticipating political transition Growth prospects remain strong while concerns about potential political changes simmer 2009 Real GDP % y-o-y CPI % y-o-y * Budget balance % GDP** Current account % GDP FX reserves.2 9.7 -6. • *End of period.1 7. Presidential elections are due in September.3 -2.5 -3.1 8. • *End of period. Source: Nomura Global Economics. We expect robust growth supported by high FDI inflows and continued improvements in the business climate.5 31 7.

Nonetheless.75 2012 4.0 8. which take up a large share of the consumer basket. Bold is actual data Note: table reflects data available as of 6 December 2010.0 34.6 10. and allow further amassing of international reserves.0 6. combined with ongoing fiscal stimulus.5 2.5 5.0 6.2 0.7 5.5 -0.00 3.5 7.5 12.67 2012 14.9 2.67 2010 2.3 5.67 2011 3.0 4. **Period average.0 22.0 25.75 • Saudi Arabia continues to recover. driven by government-led infrastructure spending.8 19.2 2.4 3.0 18. private sector credit growth has yet to pick up noticeably. USDbn Current account % GDP Short-term interest rates % USDAED* 9.4 4.2 9. Although the UAE has opted out of the GCC monetary union.8 12.3 2.0 36.00 3.2 8.67 • Qatar’s outlook remains driven by hydrocarbons.70 3. are supporting an accelerating recovery 2009 Real GDP % y-o-y Hydrocarbon % y-o-y Nonhydrocarbon % y-o-y CPI % y-o-y * Budget balance % GDP Current account % GDP Short-term interest rates % USDSAR* 0. particularly for Abu Dhabi.7 3.4 4.75 2010 4. Nomura Global Economics.0 3.0 2.0 3.0 -4.00 3.2011 Global Economic Outlook Rest of EEMEA ⏐ Economic Outlook Ann Wyman Saudi Arabia: Stronger through oil Increasing oil prices. monetary policy will thus stay anchored to the US interest rate cycle.4 3. inflation pressures are likely to remain at bay. but concerns about other entities remain.50 3.0 2.0 2.5 10.0 23. though it should moderate into 2012. Source: Ministry of Statistics.6 12. Source: Central Bank of UAE. • Nomura Global Economics 78 6 December 2010 .7 3.6 -1.0 0.67 2011 19.5 25.0 2. as should its share in output.9 6.0 0. The cut in the deposit rate to 1. Non-hydrocarbon growth should continue to increase over the next five years.0 10. monetary policy should remain tightly linked to that in the US. SAMA. having prudently managed the effects of the global recession.6 13. especially in the banking sector.67 • Growth should remain constrained by the ongoing process of deleveraging. The completion of the Dubai World restructuring has removed some uncertainty.00 3.2 5.0 1.67 2010 16.70 3.2 -8.5 15. • United Arab Emirates: A long road to real estate recovery Ongoing deleveraging and real estate oversupply constrain growth.6 1.2 0.5 3. • *End of period. Bold is actual data Note: table reflects data available as of 6 December 2010. UAE % y-o-y Hydrocarbon % y-o-y Non H/C Abu Dhabi % y-o-y Non H/C Dubai % y-o-y CPI % y-o-y ** Budget balance % GDP Current account % GDP Short-term interest rates % USDAED* -1. **Period average.0 -8. Nevertheless. The authorities’ strong policy response to the crisis.0 2.6 3. Despite strong growth in output.75 2011 4.0 2.67 2012 3. Its preemptive financial sector response and countercyclical fiscal policy paid off.00 3.4 2. % y-o-y Hydrocarbon % y-o-y CPI % y-o-y ** Budget balance % GDP Current account. Qatar Central Bank. Source: Ministry of Statistics. **Period average. growth is surging. the USD peg is likely to remain firmly in place.5% has reduced the appeal of capital inflows and is hoped to discourage banks from keeping high levels of reserves with the central bank.00 3. Consequently.50 3. inflation remains subdued given the fall in real estate prices. • Qatar: Powering ahead Economic growth should continue to surge as more gas production comes on line 2009 Real GDP. Bold is actual data Note: table reflects data available as of 6 December 2010. The USD peg remains firmly in place given the economy’s dollar links and the government’s longstanding commitment.3 2.6 4. Given the subdued economic outlook.8 1.5 10.1 3. the higher oil price environment will continue to support external accounts.0 2. • *End of period.0 1.50 3.5 11.9 1. but growth remains constrained by a modest recovery in bank lending.0 5. has helped ensure a healthy backdrop to the recovery. Nomura Global Economics.50 3. but oil prices provide support 2009 Real GDP. underpinning the overall credit picture.3 2. Nomura Global Economics.9 3. as well the continued drag from the real estate overhang.0 12.0 5.8 -0.5 10. • *End of period. With two new LNG production facilities coming online.

Brazil food vs non-food price inflation 12 10 8 6 4 2 0 6 % y-o-y Food IPCA ex-Food Index 4 2 0 -2 -4 -6 -8 -10 Industrial production Retail sales Jan-09 May-09 Sep-09 Jan-10 May-10 Sep-10 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Source: Nomura Global Economics. Bloomberg. Added to this. wage and credit policies.53% y-o-y was very close to the Central Bank of Brazil’s (BCB) 4. Brazil Fiscal policies have been loose in 2010 Brazil is facing a commodity-induced inflation surge just as a new government is taking power. leading to higher inflation. spending has kept on climbing strongly during 2010 when we expect the economy to grow by 7.5% inflation target. but could be best addressed by controlling the rise in wages. might undertake a short tightening cycle of around 100bp. Due to high start-of-the-year inflation and indexation of utility prices. since the 2008 crisis the government has been running very expansive fiscal. A common inflation problem will be the major policy challenge for 2011.5% of GDP. we think inflation will still close the year at an above-target 4. non-food price inflation of 4. 79 6 December 2010 Nomura Global Economics .4% y-o-y.indicates deviations from trend. Fears of further currency appreciation will likely result in a slow policy response.18% y-o-y. only to then lower interest rates later in the year. Inflation is the biggest challenge for 2011 The recovery from the late-2008 financial crisis continued strongly this year across most of Latin America. economic performance has been mixed. The continuing rise in service price inflation. Source: Nomura Global Economics. Brazil cyclical industrial production and retail sales Non-food inflation remains stable despite the stimulus We believe the new administration will start fiscal tightening Figure 1. with de-trended retail sales (a proxy for demand) rising from mid-2010. perhaps the biggest conundrum in 2010 has been the relative stability of non-food price inflation (Figure 1). Figure 2. we do recognize a risk: the new BCB team. That said. Thus. and the expansion of credit availability to the “new middle class”. Although it may be justified as part of the vogue for counter-cyclical fiscal policies. Note: Data seasonally adjusted indices. 0 indicates the HP-filtered trend.0% in 2011. Bloomberg. Faced with a highly stimulative policy. generating doubts over the continuity of economic policy. to reaffirm its credibility and manage rising inflation expectations.1% real increase in the minimum wage in 2010 (to which many salaries and pensions are indexed) and increased lending by official institutions equivalent to around 2. which should take the nominal deficit in 2010 to around 3% of GDP. This may be explained by the fact that 2010 has been an election year. We expect the government to tighten spending enough and moderate wage and credit growth to slow economic growth to 4. driven by still-expansive fiscal and monetary policies. there has been a 5. the continuing rally in commodity prices. We see the BCB having room to cut rates in the second half as activity slows and commodity price inflation wanes (see Box: What drives inflation in Latin America). even though food price inflation in October rose 7. now at 7. But the region faces “too much of a good thing”: higher growth and higher commodity prices combined with concerns that tightening monetary policy will amplify currency appreciation are risking the region’s inflation outlook. even as growth begins to be affected by more idiosyncratic factors. is worrisome in the context of tightening labor markets. +/.2011 Global Economic Outlook Latin America ⏐ Outlook 2011 Tony Volpon ⏐ Benito Berber⏐ Boris Segura Too much of a good thing We expect the region to begin 2011 with a surge in commodity-driven inflation. Specifically.85%.45% y-o-y. while de-trended industrial production keeps falling (Figure 2). Haver Analytics. Haver Analytics. Furthermore.

39% 1. though a stronger real (BRL) can partially offset the effect. As a large and relatively closed economy.1907 Brazil Mexico Chile Colombia 10 8 6 4 2 0 -2 -4 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Note: All coefficients significant at 5% level except BRL and MXN which are at 10% level. The former. resulting in a positive output gap and higher inflation.0256 0. Should global food prices continue to rise. Factors at both home and abroad are likely to push prices higher across the region. inflation in Chile is likely to surge. Having identified the big picture. Soaring global food prices do feed into local prices.9805 0. Domestically.2413 Mexico 0. a major upside risk to our mild CPI forecast. coupled with government-set administrative prices that do not always follow economic cycles. ceteris paribus. domestic demand is expected to have more impact on headline CPI. as high copper prices can lead to increased mining investment and private consumption (an income effect).5% central bank target.85%. especially in non-tradable goods (6% y-o-y in October vs. As we expect the output gap to close by H2 2011 and the currency to resume appreciation.0834 0. Modelling domestic drivers of headline CPI Figure 2. Volpon │ G.0076 0. Results for individual countries are equally informative: Brazil: The output gap has a regression coefficient of 0.0184 0.4180 0.5834 0. 80 6 December 2010 . a puzzling observation as Chile is the most open economy. Lei │ S. promptly-closing (or already closed) output gaps and tighter labor markets are pressuring non-tradable goods inflation. Headline inflation in LatAm % y-o-y 12 Brazil Output gap Policy rate Exchange rate AR(1) Adjusted R-squared Durbin-Watson statistic S. suggesting that output gap variations do not necessarily translate into CPI changes. As we expect the new government to tighten spending.6048 0.5207 0. via favorable terms of trade. oftentimes volatile. Figure 1.9710 95. with a slight moderation by Q4. Nomura Global Economics. the item that carries the highest weight in LatAm consumer price indexes (CPIs). boosts domestic demand and causes price pressure. makes us believe that headline inflation will remain stable throughout next year.E. slightly below the 4% upper bound of the target. coupled with our view of a moderate peso (MXN) appreciation. while the latter has a more direct and lasting impact on food prices.26% 1. We forecast high headline inflation in much of 2011. (2) coefficients for the policy rate have a positive sign.96% for tradable goods). risks of higher inflation abound in 2011.3122 0.66% 1. A steady FX path (at least before the financial crises) coupled with stable. inflation expectations might cushion the impact of the output gap into inflation. implying that a 1% positive output gap (actual output above potential) will translate into a 0. we found two interesting facts in all countries: (1) inflation inertia is very high. Source: Nomura Global Economics. as externally-determined food prices.8574 0. inflation pressure from output gap closure should be quite limited. but as tensions with Venezuela have led to plummeting agricultural exports and an oversupply of foodstuff at home.1063 0. Nomura Global Economics Source: Haver Analytics. Nevertheless.92% 1. make accurately forecasting inflation a daunting task. Colombia: The output gap has a low pass-through effect to CPI. closing the year at 4. ample liquidity has driven up prices in both hard and soft commodities. while the exchange rate has the highest pass-through coefficient. We estimate that Brazil’s output gap already closed in Q4 2009 and will remain slightly above potential in 2011. looking at both domestic and international factors. Mexico: The regression coefficient for the output gap at 0. Colombia can suffer badly from external food price shocks.2448 Chile Colombia 0. it is more difficult to foretell the exact causes of inflation. Chile’s output gap may be sensitive to external factors through copper exports. inflation should be well-contained. Ozcan As Latin America expects a new year with higher prices.08 is the lowest. it is inflation.9057 0. we attempt to pin down the main drivers of inflation.42% increase in headline inflation.8782 98. of regression 0.0156 0. albeit high. In sum. implying that monetary tightening cycles largely trail inflation movements.42.5312 0.6812 0.2011 Global Economic Outlook What drives inflation in Latin America? T.9231 93. Chile: The output gap has the largest pass-through effect among the four countries. Globally. we attempt to better understand the key contributors of LatAm inflation. sample period from Jan-2005 to Oct-2010. Mexico is also least affected by international food prices. Given that in 2011 we project the output gap not to close until June. In fact. In Figure 1. food price surges should be largely mitigated. -0. If there is one overarching theme for Latin America in 2011.9438 96.6369 0. above the 4.

3 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Source: Nomura Global Economics. Enrique Peña Nieto (PRI party). coupled with rising commodity prices and increasing government-set prices. the second to increase flexibility in the labor market and the third to unify the municipal police forces under one control per state. Nomura Global Economics 81 6 December 2010 . Mexico output gap 125 Index (2003) 120 6 Inflation target (upper bound) 115 5 110 Potential GDP Actual GDP 4 105 Output Gap 100 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Source: Nomura Bloomberg.00%. above the 3% target but within the 2-4% band. owing to higher commodity and food prices raising inflation in tradable goods and services. Bloomberg. a gradual recovery of credit card lending and low inflation. While labor employment has returned to pre-crisis levels. The central bank will likely keep hiking until 4% We expect the Central Bank of Chile (BCCh) to continue the current pace of rate hikes until its policy rate reaches 4. Mexico headline and core inflation 7 % y-o-y Headline Core Figure 3. The gubernatorial election in the State of Mexico in July 2011 will be closely watched by the market. In addition to the above factors. We project the economy to expand by 4. with worries over the appreciation of CLP leading to a slowdown in an already gradual process of monetary policy normalization. low albeit rising domestic demand pressures and expected MXN appreciation.0-4.5% in 2010.0% inflation target). Global Economics. Inflation is set to remain just within the 2.5% from an already strong 5. Figure 4. The current governor. is one of the most popular political figures in the country and is ahead in the polls for the 2012 presidential election. most of the increase in the total has been in the unskilled sub-component.0% y-o-y in 2011. Second. While a few months ago we projected the output gap to close by Q4 2011. particularly at the states’ level. with tradable still falling by 0. could pressure inflation in 2011. Although the PRI will most likely retain control of the State of Mexico. even though non-tradable goods and service inflation is rising by 6. We believe that Mexico will benefit the most from a US recovery. overall inflation is still at a low 1. Three proposals will be discussed and potentially approved by Congress in 2011: the first to strengthen the anti-trust agency (COFECO in Spanish).9% y-o-y. anything other than a decisive victory might signal that the party is not as strongly positioned to win the 2012 elections as reflected by the polls that give Peña Nieto more than a 20 point lead. There will be major national legislations and state elections Chile Chilean growth has been strong and balanced Chile has had some of the most balanced growth in the region. First. Domestic consumption is looking better due to an expected increase in government spending. as the country’s terms of trade have improved strongly as copper prices have risen (Figure 5).2011 Global Economic Outlook Mexico Growth is picking up due to domestic consumption We are positive about Mexico’s economic outlook for two reasons. we believe domestic aggregate demand will finally recover.0%. We expect growth in 2011 to rise to 6. We project inflation at 3. With CLP rising.5%.0%. Haver Analytics. above the potential growth rate of 3.96% y-o-y. We maintain our view that Banxico will leave the policy rate unchanged at 4. the combination of US monetary and fiscal policies (highly likely an extension of the Bush tax cuts) will improve the likelihood of stabilization in US consumption. consistent with a zero federal funds rate in the US. even though strong demand is likely to lead to an overshoot in inflation to around 3. we now believe it will close by around June 2011 (Figure 3).98% y-o-y (against a 3. led by strong investment demand (due in part to post-earthquake rebuilding) and imports.0% band The faster-than-expected closure of the output gap. Haver Analytics. still easy monetary and fiscal policies have been contributing to growth.5% throughout 2011.

upholding fiscal prudence. Argentine presidential candidate support ratings Figure 2. it is important to bear in mind that Election Day is still five months away and scenarios can change quickly. Incumbent president Alan Garcia (APRA – American Popular Revolutionary Alliance) is barred from seeking reelection by the constitution. Alfonsin brings the added bonus of a possible alliance with the Socialist Party (PS) and other members of the so-called Pan-Radicalismo. and five popular politicians are widely expected to run: 1) Luis Castañeda (SN – National Solidarity). in our view. According to the new Law of Political Parties. causing CDS spreads to widen by 100bp to 250bp. Peru presidential candidate support ratings % support 24 % support Cristina Fernandez Ricardo Alfonsín Julio Cobos Mauricio Macri Pino Solanas No response Total Scenario 1 (*) 46 19 15 10 10 100 Scenario 2 (**) 48 19 13 11 9 100 22 20 18 16 14 12 10 8 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Castañeda K. Castañeda and Toledo appear to have the best chances of emerging from the first round and face off in the second round (Figure 2). particularly the dissident Peronism. making his run all the more difficult. His wife. is now likely to run for re-election and. Nomura Global Economics.2011 Global Economic Outlook Key elections in Latin America Argentina Boris Segura │ Benito Berber │ George Lei In 2011. a second round runoff election will be contested between the top two contenders in roughly 2 months. All frontrunners. a former military officer narrowly defeated by Alan Garcia in the 2006 runoff Presidential election. K. and Congressman Ricardo Alfonsin. boosting infrastructure. Source: Poliarquia. The recent death of former President Nestor Kirchner. as per recent polls. except for Humala. Based on opinion polls. expanding free trade and attracting FDI. Peru Peru’s general election will be held on 10 April 2011 to elect the country’s new President and Congress. right-wing Mayor of the City of Buenos Aires. open and simultaneous primaries are to take place on 14 August 2011. Ironically. Mr. might as well make a run for the Presidency. The possibility of Humala in the second round is quite low. Nomura Global Economics . 5) Mercedes Araoz (APRA). financial markets will keep a close eye on the presidential elections in Argentina and Peru. If no presidential candidate obtains 50% of the votes plus one. both serving five-year terms (2011-2016). A possible Humala victory or election-related social unrest will present major risks for Peru’s asset prices. changed the political landscape of Argentina. Nomura Global Economics. who parted ways with the Kirchners during the conflict with the farmers in 2008. The recent departure of Senator Carlos Reutemann from the race is very telling. 3) Ollanta Humala (PNP – Peruvian Nationalist Party). Mauricio Macri. Mr. 2011. Argentina will be holding general elections on 24 October 2011. 2) Keiko Fujimori (Fuerza 2011). who all of a sudden was left without a reason to exist. current President Cristina Fernandez. former Economy Minister. Fujimori. However. Fujimori Toledo Humala Source: Ipsos Apoyo. Having said that. former President Kirchner’s death left the opposition dazed and confused. leader of the Kirchnerista faction of the Peronist Party (PJ) and purported presidential candidate. Figure 1. is the ruling party candidate who just announced her bid on 2 November. former mayor of Lima (2002-10). have expressed strong commitments to maintain the current market-friendly economic model of promoting growth through controlling inflation. daughter of former president Alberto Fujimori (1990-2000). 4) Alejandro Toledo (PP – Possible Peru). The centre-left opposition Radical Party (UCR – Radical Civic Union) has two candidates: Vice-President (and Head of the Senate) Julio Cobos. his political party PRO (Republican Proposal) lacks electoral machinery and does not enjoy much popularity outside Buenos Aires. and represents a heavy blow to the aspirations of the dissident Peronists. The winner will be inaugurated on July 28. 82 6 December 2010 Note: (*) Alfonsín running. Humala’s pro-Chavez stance and nationalization rhetoric scared investors during the 2006 runoff presidential race. son of former President Raul Alfonsin. a Stanford-trained economist who served as Peru’s president (2001-2006). The official nominations process will start in late December 2010 and end in early January 2011. (**) Cobos running. is the early frontrunner (Figure 1).

Loose fiscal and monetary policies are likely to continue next year. Nomura Global Economics Source: Nomura Global Economics. Capital may flee on election uncertainties However. marginally narrower than in 2010.2% in 2010. The economy is already overheating. However. We also expect growth in private consumption and investment to slow during the second half of the year. a low level of debt and plenty of intrapublic sector borrowing. but we think the authorities are unwilling to contain the expansion in aggregate demand before the elections. Robust FDI should finance the current account deficit Strong domestic demand will likely widen the current account deficit from 2. because of the light amortization schedule. the authorities project a deficit of 3. We expect economic activity to slow in 2011 We expect the pace of Argentina’s economic activity to decelerate in 2011 to 5% y-o-y from 9% in 2010.4% of GDP in 2011 from -2. Chile investments and imports growth Figure 6. 83 6 December 2010 .5% of GDP in 2010 to 3.2011 Global Economic Outlook Colombia GDP growth is set to remain strong for a second year in a row We expect Colombian growth to remain strong in 2011 because of robust domestic demand. The commodity sector.0% target. the authorities are likely to allow for a “controlled” pace of depreciation. partly because of the normalization of the agricultural harvest and owing to lower demand for industrial goods by Brazil. Figure 5. Congress will likely pass a fiscal rule. which is set to double its production by 2015. The fiscal accounts are likely to deteriorate meaningfully next year. For the fiscal accounts. Colombia current account deficit vs net FDI 40 30 20 10 0 -10 -20 -30 % y-o-y 3500 3000 2500 2000 US$ mn Net FDI (lhs) CA deficit (rhs) US$ mn 0 -500 -1000 -1500 1500 Imports Investments 1000 500 0 Mar-06 Mar-07 Mar-08 Mar-09 Mar-10 Mar-05 Apr-06 May-07 Jun-08 Jul-09 -2000 -2500 -3000 Mar-05 Source: Nomura Global Economics. Bloomberg. coal and coffee. in the second half of the year.0% in 2011. which we think will encourage the three major rating agencies to grant Colombia investment grade. However. Haver Analytics. we do not expect inflationary pressures to accumulate as we forecast the currency to appreciate again. At that point. via transfers of “paper profits” and advances from the central bank to the National Treasury. using international reserves in the process. Bloomberg. is likely to keep putting upward pressure on inflation. Our forecast for the “adjusted” overall fiscal balance (excluding transfers of profits from central bank and investment proceeds from Anses) is for it to deteriorate to -3. we think the Republic’s probability of default remains well-contained. the Achilles’ heel of the economy. led by an expanding oil industry. which in 2010 expanded by more than 10% y-o-y. the widening deficit is unlikely to pressure the currency because of robust FDI inflows that are set to continue in 2011 (Figure 6). We expect inflation to be around the central bank’s 3. which would allow the central bank to delay its first hike until H2 2011. We expect GDP growth of 5. Haver Analytics. should benefit from high commodity prices particularly for oil. with general elections approaching. Continued financing of public spending. locals are likely to get anxious and capital flight may pick up.4% of GDP for 2011. However.0% y-o-y in 2011 owing to very strong retail sales. Argentina Argentina is likely to experience a volatile 2011. with general elections in October (see Box: Key Elections in Latin America). which would allow the central bank (BanRep) to keep its policy rate unchanged for most of the year. An improved outlook for the US economy should also support above-potential growth. We think net FDI inflows of more than US$9bn will finance the current account deficit.

6 6.1 1.39 13 4Q11 5.8 4.93 15 2Q11 2. much above the 4.70 1.62 1.50 4.0 36 10.4 2.00 10.00 10.2 6.50% target but declining towards the end of 2011.70 1.2 -0.3 6.70 7.49 -5 -3 -2.0 42.0 -1.2 8.2 9.75 10. Contributions to GDP do not include taxes. While a strong fiscal adjustment would be optimal.2011 Global Economic Outlook Brazil ⏐ Economic Outlook Tony Volpon Inflation risks challenge outlook Overly expansive fiscal and wage policy combined with surging commodity prices have put the inflation outlook at risk.72 1.3 0.4 6.85 5.5 39.0 6.7 3. policy uncertainty is high as we head into 2011.85 5. the political constraints to its execution and the need to re-establish the monetary credibility of the BCB may lead the government to opt to tighten policy rates early in the year.5 2.9 3.4 10.4 13. Slower growth and eventually lower real rates will slow down the appreciation of BRL.1 9.3 5.00 10.6 5. for the economy to slow and inflation to close the year at 4. Only tighter fiscal and wage policy will avoid higher policy rates.2 4.68 1. reverting the expansive policies adopted after the 2008 crisis.1 18.0 2.8 4.5 11.5% target. credit and wage policy.8 18. Trade data are a 12-month sum.00 10. At the close of 2010 we see inflation race ahead once again for basically the same reasons.9 7. As inflation recedes in the middle of the year and the inflation outlook improves.7 4.3 5.1 3.8 4.4 11.1 9.7 13. While the risks of a hike are high.85%.60 1.54 10 -3.9 4.40% in 2010).2 5. Interest rate and currency forecasts are end of period.6 0. Source: Nomura Global Economics.0 5.75 10.4 4.2 7.5 9.3 5.01 6. Inflation: At the beginning of 2010 headline inflation increased due to higher commodity (especially food) prices.0 -2.0 3.64 7. above the 4. With strong headline inflation and doubts over the execution of tighter fiscal and wage policy.60 Notes: Annual forecasts for GDP and its components are year-over-year average growth rates.40 14 -2.6 15.0 2012 4.5 3.3 1.64 8. the market expects an early-year rate hike. which should leave inflation for 2010 at around 5.6 4.7 37.6 5.8 4.75 10.60 1.2 -3.7 -1.1 6. Continued strong export prices will assure a positive trade balance in 2011 even as the current account deficit stays in the 3% region. we believe the BCB will keep rates on hold to give the new government time to tighten fiscal policy and better evaluate the international outlook.7 1.5 7.5 12.28 5.0 4.4 6.8 5.9 -3.8 4.54 10 1Q12 5. wage and credit policy continued to be expansive even as the economy tallied growth of over 7% in 2010.3 5.5 4. and as tighter fiscal policy is executed.21 12 3Q11 4.6 12.12 -3 2010 7. Nomura Global Economics 84 6 December 2010 .00 10.9 4.2 4.85 10.1 -3.1 4.5 -3.6 6.0 39.18 5.65 1.4 8. especially due to seasonal adjustment to contracts indexed to the wholesale IGPM index (which should rise by around 10.6 32.85 10.00 10.0 3.2 7. An aggravating factor has been how the decision to slow the nominal appreciation of BRL has allowed the recent surge in commodity prices to pass-through.0 4.4 0.2 -2.5 5.6 6. fiscal.8 5.8 -7.0 2011 4.9 5.0 5. though this would likely be reverted later in the year.5 4.7 4.5 6.1 5.75 Selic % 1.8 5.4 10. will force the government into deciding between a mix of higher inflation and tighter monetary policy.0 -2.6 4.7 10. Table reflects data available as of 6 December 2010. Risks: The risks in 2011 are for higher inflation and higher policy rates in Brazil. We expect growth to slow down to just below potential in 2011 to around 4% as policy adjusts downward. Numbers in bold are actual values.40 14 1Q11 3.62 1. In 2011 inflation will begin high again. others forecast.33 1 2Q12 5. Activity: After a successful recovery due to pro-cyclical fiscal policies and continued Chinese demand for its exports.75 10.4 5. Policy: With a newly elected government and a new head of the Central Bank of Brazil (BCB).85%. An insufficiently strong enough adjustment to fiscal.75 BRL/USD 1.77 17 4Q10 5. the BCB will be able to cut rates towards the end of 2011 in our view. Nonetheless we expect inflation pressures to ease by Q2 2011. Details of the forecast % y-o-y change unless noted Real GDP Personal consumption Fixed investment Government expenditure Exports Imports Contributions to GDP (pp): Industry Agriculture Services IPCA (consumer prices) IGPM (w holesale prices) Trade balance (US$ billion) Current account (% GDP) Fiscal balance (% GDP) Net public debt (% GDP) 3Q10 6.0 7.9 4.1 4. only to see collapse close to zero in the middle of the year.0 5.6 4.

2011 Global Economic Outlook

Mexico ⏐ Economic Outlook

Benito Berber

A stronger recovery on the way
Mexico is rebounding stronger than expected, which should close the output gap by mid 2011. We expect the first rise in the policy rate to come in Q1 2012. Activity: With the prospect of the US recovery improving, we forecast the Mexican economy to rebound by 5.3% y-o-y in 2010 and by 4.0% in 2011 after collapsing 6.5% in 2009. Indeed, we remain optimistic on Mexican GDP growth because of the recovery of domestic demand. The composition of growth should continue to gradually shift from the external sector to the domestic one. In 2010, the Mexican GDP rebounded because of its strong exports to the US. Fortunately, domestic demand in Mexico has started to pick up. In the previous two crises, growth of consumption, which accounts for two-thirds of demand, has rebounded to around 5.0% y-o-y six quarters after the year-over-year consumption growth bottomed. The economy bottomed this time in Q2 2009. Inflation: We expect inflation to be slightly below 4.0% in 2010 and 2011 due to the output gap taking a while to close, with a more stable FX rate having a marginal impact in keeping a cap on inflation. We estimate that administrative prices, which have been increasing at a rate of 5.0% yo-y in 2010, will adjust to around 3.0% y-o-y in 2011, which would push headline inflation below 4.0% y-o-y. Policy: Banxico will keep the policy rate unchanged at 4.5% during 2011 in our view. We expect the tightening cycle to start in Q1 2012 because of the negative output gap (actual GDP being below potential GDP) projected for at least half of 2011, stable medium-term inflation expectations and a gradual appreciative trend of the MXN. The Finance Ministry will target a fiscal deficit of 2.5% of GDP in 2011, slightly higher than in 2010. Congress will likely approve three major proposals in 2011: a) A proposal to strengthen the independent anti-trust entity. b) A proposal to consolidate various municipal police forces into one unified police force per state. c) A third proposal to increase the flexibility of the labor market. Risks: The main risk to Mexico is a double dip recession in the US economy. In terms of inflation, we see the following risks to our call: (1) rising commodity prices; (2) increases in administrative prices; (3) an acceleration of domestic demand; and (4) a sizable depreciation of the exchange rate.

Details of the forecast
% y-o-y change unless noted Real GDP Personal consumption Fixed investment Government expenditure Exports Imports Contributions to GDP (pp): Industry Agriculture Services CPI Trade balance (US$ billion) Current account (% GDP) Fiscal balance (% GDP) Gross public debt (% GDP) 3Q10 5.3 2.5 0.9 5.3 31.6 22.4 2.3 0.3 2.8 3.70 -3 4Q10 3.9 6.3 2.1 6.2 25.0 23.1 1.3 0.3 2.3 3.95 -3 1Q11 5.0 6.5 4.4 5.8 22.9 20.1 1.5 0.1 3.3 3.82 -4 2Q11 4.1 5.4 6.2 3.5 19.5 18.8 1.4 0.1 2.7 3.75 -4 3Q11 3.3 3.8 6.8 3.8 17.5 17.5 1.3 0.1 2.1 3.79 -5 4Q11 3.6 3.6 7.0 3.6 17.0 17.0 1.2 0.1 2.3 3.89 -5 1Q12 3.3 3.4 5.1 3.4 15.6 15.5 1.0 0.1 2.4 3.95 -4 2Q12 3.2 3.3 5.0 3.4 15.0 16.0 1.0 0.1 2.4 3.90 -4 2010 5.3 4.2 1.1 4.5 28.4 24.2 2.0 0.3 3.2 3.95 -4 -1.0 -2.6 38.0 2011 4.0 4.8 6.1 4.2 19.0 18.3 1.3 0.1 2.6 3.89 -14 -1.3 -2.5 36.0 2012 3.4 3.5 5.1 3.4 15.6 15.6 1.0 0.1 2.4 3.97 -12 -1.5 -2.0 34.0

Overnight Rate % 4.50 4.50 4.50 4.50 4.50 6.50 7.00 4.50 4.50 7.50 4.50 MXN/USD 12.15 11.90 11.80 11.75 11.70 11.50 11.50 12.15 11.70 11.50 12.59 Notes: Annual forecasts for GDP and its components are year-over-year average growth rates. Trade data are a 12-month sum. Interest rate and currency forecasts are end of period. Contributions to GDP do not include taxes. Numbers in bold are actual values, others forecast. Table reflects data available as of 6 December 2010. Source: Nomura Global Economics.
Nomura Global Economics 85 6 December 2010

2011 Global Economic Outlook

Rest of Latin America ⏐ Economic Outlook

Boris Segura │Tony Volpon │ Benito Berber

Argentina: More moderate growth, but still high inflation
High inflation is likely to remain the main macro challenge to authorities.
Real GDP % y-o-y Consumption % y-o-y Gross Investment % y-o-y Exports % y-o-y Imports % y-o-y CPI % y-o-y * CPI % y-o-y ** Primary budget balance % G Current account % GDP Policy Rate % USDARS 2009 0.9 0.5 -10.2 -6.4 -19.0 7.7 14.8 1.5 3.7 9.52 3.81 2010 9.0 8.6 17.2 12.1 35.3 10.7 26.4 1.8 1.8 9.23 3.98 2011 5.0 6.2 9.3 7.9 22.1 10.9 24.4 -0.5 1.3 12.0 4.40 2012 4.7 6.5 11.1 9.0 22.6 10.8 25.4 1.0 1.0 11.0 4.50

Argentina’s growth is likely to decelerate from its rapid rate of growth 2010. The output gap has already closed and, as such, we are unlikely to see any inflation relief. Macro policy remains expansive and is likely to remain so until at least the general elections in October 2011. Inflation is the main policy challenge for the authorities. They are likely to pursue a price-wage arrangement with the labor and business sectors. For this to be sustainable, the authorities would need to pursue consistent macroeconomic policies and promote a friendlier business environment. That is no small feat given recent experience and upcoming general elections.

* official stat, ** private estimate, Bold is actual data

Note: table reflects data available as of 6 December 2010. Source: Nomura Global Economics.

Chile: Growth and inflation are set to accelerate
Continued strong external demand and durable goods consumption pushes growth up, but inflation is a risk.
Real GDP % y-o-y Consumption % y-o-y Gross Investment % y-o-y Exports % y-o-y Imports % y-o-y CPI % y-o-y * CPI % y-o-y ** Budget balance % GDP Current account % GDP Policy Rate % * USDCLP * 2009 2.1 5.7 -11.9 -3.7 -4.0 -1.5 1.5 -3.4 2.7 0.50 507.00 2010 5.5 8.0 20.0 6.0 14.0 3.0 2.5 -2.0 0.7 3.25 480.00 2011 6.5 9.0 22.0 8.0 17.0 3.5 2.7 -1.0 1.5 4.00 440.00 2012 5.0 6.0 18.0 6.5 12.0 3.0 3.0 1.0 1.0 5.00 420.00

Chile’s economy has had a broad-based rebound from the February earthquake, which has proven to be positive for growth, especially for durable goods consumption. Export demand has increased throughout 2010 as the prices of Chile’s commodity exports rose. This has allowed strong growth in exports which, alongside the appreciation of CLP, has damped inflationary pressures even as the economy grew strongly. The Central Bank of Chile (BCCh) has slowed the pace of monetary normalization partly because of fears about currency appreciation. We expect the policy rate (TPM) to continue to rise to 4% p.a. next year, and strong growth to lead to higher headline inflation.

* End of period, ** Period average, Bold is actual data

Note: table reflects data available as of 6 December 2010. Source: Nomura Global Economics.

Colombia: Strong recovery
Economic recovery will likely continue in 2011 with robust FDI inflows supporting the currency.
2009 2010 2011 2012 Real GDP % y-o-y 4.8 5.0 4.5 2.5 Consumption % y-o-y 6.0 5.0 4.5 2.0 Gross Investment % y-o-y 10.0 8.0 9.0 3.0 Exports % y-o-y 10.0 6.0 7.0 -18.0 Imports % y-o-y 30.0 8.0 9.0 -11.4 CPI % y-o-y * 2.7 3.5 3.7 2.0 CPI % y-o-y ** 2.5 3.5 3.7 4.2 Budget balance % GDP -3.6 -3.4 -3.0 -2.7 Current account % GDP -2.5 -3.0 -3.5 -2.2 Policy Rate % * 3.00 4.00 7.00 3.50 USDCOP * 2044.00 1850.00 1760.00 1750.00
* End of period, ** Period average, Bold is actual data

We have increased our GDP forecast for 2011 by 5.0% on the back of strong domestic demand. We maintain our view that the central bank will start the tightening cycle in Q4 2011 by increasing the policy rate by 100bp to 4.0% by year-end. We think Congress will probably pass a fiscal rule to address some of the weakness in the fiscal accounts. We expect the three major rating agencies to upgrade the credit to investment during 2011. Strong FDI inflows and monetization of government debt should keep COP strong. We forecast the COP to appreciate to 1,760 by year-end 2011.

Note: table reflects data available as of 6 December 2010. Source: Nomura Global Economics.

Nomura Global Economics

86

6 December 2010

2011 Global Economic Outlook

Foreign Exchange | Outlook 2011

Simon Flint ⏐ Jens Nordvig

A global balancing act
Stronger EM currencies are crucial to global rebalancing, but cannot be taken for granted.
We see the US dollar consolidating against major currencies

The US dollar is set to consolidate in 2011 versus other major currencies (Figure 1). This view is based on the notion that a number of negatives, which drove US dollar weakening dynamics in 2009 and 2010 are fading. First, the effect from the latest round of quantitative easing (QE2) has already been incorporated in market pricing. Second, with growth set to increase and inflation expectations currently close to the Fed’s preferred level, we find it unlikely that a “QE3” will be needed. Third, the US dollar has weakened broadly and is looking cheap from a valuation perspective against many currencies, especially in the G10 space (Figure 2). While some negative pressure will likely abate, there is no structural growth recovery in the US to underpin currency strength. Indeed, the housing market remains very weak, and with households still deleveraging and fiscal policy set to impact growth negatively, the US economy is set to recover slowly. Hence, we believe that dollar consolidation is more likely than a real recovery in the aggregate. We are likely to see USD gains in selected crosses, while USD weakness can extend versus EM. The euro has weakened in 2010 as a function of fiscal tensions in the periphery. We do not see a clear resolution of the euro area fiscal crisis. The ongoing uncertainty will be a major factor weighing on the euro and a drag on the currency, which is likely to be reflected in a persistent risk premium (Figure 3). However, our baseline view is that Spain will gradually regain bond market access in H1 2011 by delivering on its current fiscal targets. Moreover, we believe that the political commitment towards monetary union will hold, and we regard the tail risk of an ultimate break-up of the euro zone as being small. Thus, we expect downside to the euro to be relatively limited from currently levels where a significant risk premium has already been embedded. This implies that we expect euro to trade in a relatively tight range against the US dollar next year as a result. We expect the Japanese yen to trade in the low 80s against the US dollar in the early part of 2011. This view is based primarily on the still relatively weak economic outlook for the US and large excess capacity in the US economy, which should keep US interest rates anchored at low levels (also due to QE2). Looking further into 2011, we expect the yen to edge higher against the US dollar towards 85, as US 2-year rates edge higher. With respect to sterling, we expect a gradual recovery versus G3 currencies after three year’s of underperformance. Fiscal consolidation is set to reduce the risk premium on the pound, while we think growth will hold up sufficiently well to avoid further QE. This should see the British pound recover from a weak starting point versus the dollar, the euro and the Japanese yen.

A risk premium is set to weigh on the euro

The Japanese yen is sensitive to the outlook for US rates

We see sterling recovering gradually

Figure 1. Nomura’s major FX forecasts out to end-2012
Q4 10 Spot (DXY) (USD/JPY) (EUR/JPY) (EUR) (CHF) (EUR/CHF) (GBP) (EUR/GBP) (AUD) (CAD) (NZD) (EUR/NOK) (EUR/SEK) (CNY) 80.1 83.7 111 1.32 0.99 1.31 1.56 0.85 0.98 1.00 0.76 8.01 9.13 6.65 82.5 111 1.35 1.04 1.40 1.63 0.83 0.98 0.97 0.78 7.90 9.00 6.60 old new 80.7 82.5 107 1.30 1.03 1.34 1.57 0.83 0.94 0.99 0.75 7.90 9.00 6.60 80.0 108 1.35 1.04 1.40 1.67 0.81 1.00 0.99 0.80 7.80 8.90 6.50 Q1 11 old new 79.1 80.0 106 1.32 1.05 1.38 1.63 0.81 0.96 0.97 0.77 7.80 8.90 6.50 82.5 114 1.38 1.03 1.42 1.73 0.80 1.00 0.99 0.81 7.70 9.00 6.40 Q2 11 old new 78.4 82.5 111 1.34 1.06 1.42 1.68 0.80 0.98 0.97 0.80 7.60 8.80 6.40 85.0 117 1.38 1.04 1.43 1.75 0.79 1.00 0.99 0.82 7.70 9.00 6.30 Q3 11 old new 78.3 85.0 115 1.35 1.06 1.43 1.71 0.79 1.00 0.99 0.82 7.60 8.90 6.30 85.0 115 1.35 1.07 1.44 1.73 0.78 1.00 1.00 0.82 7.70 9.00 6.22 End 2011 old new 78.3 85.0 115 1.35 1.07 1.44 1.73 0.78 1.02 0.99 0.84 7.70 9.00 6.22 85.0 115 1.35 1.07 1.44 1.73 0.78 1.00 1.00 0.82 7.70 9.00 6.14 Q1 12 old new 79.0 86.3 115 1.34 1.07 1.44 1.73 0.78 1.02 1.00 0.84 7.70 9.00 6.14 85.0 115 1.35 1.07 1.44 1.73 0.78 1.00 1.00 0.82 7.70 9.00 6.06 Q2 12 old new 79.7 87.5 116 1.33 1.08 1.43 1.72 0.77 1.02 1.00 0.84 7.70 9.00 6.06 85.0 115 1.35 1.07 1.44 1.73 0.78 1.00 1.00 0.82 7.70 9.00 5.98 Q3 12 old new 80.4 88.8 116 1.31 1.09 1.43 1.72 0.77 1.02 1.00 0.84 7.70 9.00 5.98 85.0 115 1.35 1.07 1.44 1.73 0.78 1.00 1.00 0.82 7.70 9.00 5.90 End 2012 old new 81.1 90.0 117 1.30 1.09 1.42 1.71 0.76 1.02 1.00 0.84 7.70 9.00 5.90

Note: “Old” is as published in the FX weekly on 15 November. Source: Nomura Global FX Research. Nomura Global Economics 87 6 December 2010

This assessment is based on a consistent historical pattern of returns during similar points in the cycle. Colombia and Mexico). while we expect Russia's undervaluation in a bullish commodity market to catch up with it. albeit not at quite the pace that occurred in 2010. by slowing the pace of expected monetary tightening (all countries). “post-modern” policy response (see EEMEA Outlook 2011 in this issue). Second. Euro risk premium 14 12 10 8 6 4 2 % GBP NZD KRW TWD NOK BRL INR AUD CHF EUR CAD MXN SEK JPY 0 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10 Note: Inflation adjusted. Note: the measure of the euro risk premium is based on the first principal component of 10 European sovereign spreads corrected for the general credit environment. Source: Nomura Global FX Research. despite risks of slower growth in the developed world. supported. for example. Real FX rates vs. driven by low interest rates in the US and many other developed nations. in our opinion. we expect continued appreciation pressures on the back of inflows by global investors. which we believe will more aggressively accumulate reserves in 2011 and relax outflow exchange controls. In general. 20yr avg (against US dollar) 60 50 40 30 20 10 0 -10 -20 -30 -40 -50 USD undervalued % USD overvalued Figure 3. further quantitative easing by the Fed has led to a further influx of capital. Essentially.22 by end-2011. We expect a broad lack of aggressive currency policy from EEMEA policymakers. The one partial exception to this is South Africa. In Emerging Asia. some major themes are likely to dominate. Turkey’s continued limbo dance of widening the offshore/onshore rate should add complications there. Middle East and Africa) is a distancing of the region from the first round of the notion of currency wars. there are a number of risks to our constructive core scenario. we must watch longer-term yields closely. grey lines represent 20-year range in valuation. and certainly no capital controls. capital inflows into Emerging Asia should remain strong. where these issues are most pressing. We expect a far more subtle. 88 6 December 2010 Nomura Global Economics .22 to the US dollar by end-2011 EEMEA is likely to avoid “currency wars” LatAm currencies remain attractive Figure 2. red dots are current valuation vs 20-year average. how each country in the region responds to the inflation threat will largely determine the currency and rates outlook for 2011. Latin American currencies remain attractive. One theme in EEMEA (Emerging Europe. Fears of a hard-landing in China have fallen markedly and we expect increased demand for CNY from the fast-paced FX liberalization and global political pressure on China to remain. while developed market policy rates looks set to remain low. With currencies appreciating since the start of 2009. intervening to buy US dollars (Brazil. CNY should continue to appreciate next year. by continued strong terms of trade. However. although. as is a too-slow move towards greater currency flexibility in China. the authorities are likely to respond to these strong inflows by stepping up capital controls. But this time authorities in the region are fighting back. In Emerging Asia capital inflows may prompt more controls We see the Renminbi at 6. towards 6. or by imposing capital controls (Brazil). Against that backdrop. at the same time as Asia growth should outperform.2011 Global Economic Outlook We see a gently positive outlook for risky currencies We believe the outlook for Emerging Market and commodity currencies to be gently positive for 2011. Latin American exchange rates are under pressure from a variety of sources. Policy credibility and the progress of fiscal policy will also be important for Poland and Hungary's currency moves in particular. The situation in the Eurozone is one of the most important. First. although we expect such capital controls to have only a limited impact in stemming Asian FX appreciation. We expect appreciation of the Renminbi (CNY) against the US dollar to continue over the medium term. Tighter fiscal and monetary policy should also aid this move. Source: Nomura Global FX Research.

a scenario that is at odds with the recovery over the past year and with recent quarterly earnings. trend and consensus *Calculated by taking the normalised earnings yield less the (equity) weighted global sovereign real yield (nominal 10 year yield less contemporaneous inflation) ** US BAA-AAA Source: Moody's. MSCI. Global EPS: actual. VIX (rhs) 10 0 % 10 9 8 7 6 5 4 3 2 1 0 Percentage points 8 Global Equity Risk Premium (lhs) 7 6 5 4 3 2 1 0 Credit spread (lhs) 2012 17% 15% 13% 11% 9% 16% 15% 113 69 S&P Operating Earnings FTSE All World Regional Indices Source: Nomura Strategy research. yet both volatility and credit spreads are at “normal levels”. we expect asset allocators in developed economies to respond by allocating more assets to equities in 2011. FTSE 100 Topix Nomura Global Economics 89 6 December 2010 . Source: CBOE. with investors heavily exposed to fixed-income assets and relatively underexposed to equities and cash. The recovery described by Figure 3 has been much closer to a “V” than most had been expecting as they looked ahead to 2011. Valuations look too pessimistic on earnings growth Figure 1. Figure 4. The risk premium looks too high The 6% risk premium now embedded in global equities seems inappropriately high to us compared with current volatility and credit spreads. Asset allocations reflect continuing risk aversion. This suggests that stocks are priced for risks that other assets are not. We forecast earnings growth of 16% in 2011.2011 Global Economic Outlook Equity Market ⏐ Outlook 2011 Ian Scott Reducing the risk premium We expect the recovery in global equities to continue in 2011. IBES. Figure 3. Nomura Strategy research. Nomura Strategy research. the risk premium embedded in equity valuation stands out as one of the highest of the past 20 years. MSCI. Global equity risk premium* and implied volatility Figure 2. Multiples have contracted in 2010 as the 8% total return to date has lagged the recovery in EPS. We expect earnings to continue growing in 2011. Lower bond yields mean that there has been a big expansion in equity risk premiums and a reduction in implied growth rates. Global EPS growth forecasts Index Jan 1988 = 100 500 450 400 350 300 250 200 150 12m Forw ard Consensus Earnings Trend US1 Europe x UK2 UK3 Asia Ex Japan2 Japan4 Emerging Markets2 Global2 EPS forecasts S&P Operating EPS Topix Yen 1 2 100 Trailing 4 Quarter Earnings 50 0 1970 1975 1980 1985 1990 1995 2000 2005 2010 Source: MSCI. Nomura Strategy research. and a total return of 20% (Figure 4). As Figure 1 and Figure 2 indicate. With valuations attractive and earnings set to continue growing. Global equity risk premium* and credit spreads Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 *Calculated by taking the normalised earnings yield less the (equity) weighted global sovereign real yield (nominal 10 year yield less contemporaneous headline inflation). Current equity valuations imply medium-term growth rates close to zero. Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 2010 39% 28% 76% 36% 160% 29% 35% 2011 15% 15% 10% 17% 27% 16% 16% 84 50 96 64 3 4 % 10 9 8 7 6 5 4 3 2 1 0 Implied Volatility 70 60 Global Equity Risk Premium (lhs) 50 40 30 20 Implied Volatility.

we are reducing exposure to emerging markets as policy tightening and an alreadyheavy inflow of capital limit the scope for further asset price gains (Figure 5).0 -0. With capex low and free cash plentiful.6 0.6 0.4 Japan 0. should provide a strong incentive for companies to reinvest in their businesses. we overweight the Tech sector and Media sector as we expect these sectors to benefit from increased corporate spending. Developed and Emerging Equity markets’ sensitivity to bond markets We are increasing exposure to Japan and the US We are neutral on Europe We like sectors that are robust to inflation and rising yields Organically growing sectors should do well We avoid cyclicals and defensives Figure 5. In terms of sectors.2 0. while equity valuations in Japan look especially appealing. The large amounts of free cash flow being generated and high levels of profitability.8 0.2 0. Earnings revisions in recent months have moved to favour developed markets over emerging markets.4 Teleco B anks 1 .0 EM stock-bond correlation Developed markets stock-bond correlation . Figure 8. Source: Worldscope. Global EPS growth forecasts 0.6 -0.4 -0.3 -0.2011 Global Economic Outlook We are reducing exposure to EM Regionally.6 Utilities -0. We underweight the traditional cyclical sectors that we find expensive and defensive sectors such as consumer staples and utilities.2 -0.2 0. while capital raising is past its peak and should be less of a concern. We think that sectors that can grow organically should also do well.4 B e ne f it f ro m de f la t io n Co n Cyc 0. Financials should outperform. Recommended regional allocation* Benchmark North America Europe Ex-UK UK Japan Asia Ex-Japan Emerging Mkts 44 18 9 8 8 13 Previous Recommended Recommendation Weighting Weighting 36 21 9 8 9 17 46 18 9 14 5 8 Overweight Neutral Neutral Overweight Underweight Underweight Nov-98 Nov-99 Nov-00 Nov-01 Nov-02 Nov-03 Nov-04 Nov-05 Nov-06 Nov-07 Nov-08 Nov-09 *Benchmark: FTSE All-World (US$). Japanese and world ex-Japan non-financial companies’ free cash flow yields Source: Nomura Strategy research. coupled with the low return on cash. Figure 6. it is an additional source of risk for the market and we are neutral on Europe. We still expect positive returns in emerging markets.2 -0. but underweight the region in a global context (Figure 6). If stock prices and bond yields rise. we overweight those areas of the market that are robust to rising inflationary pressures and higher bond yields (Figure 8). We are increasing exposure to Japanese and US equities because we think both regions will likely continue to benefit from loose monetary policy and the aforementioned asset shift.4 0.0 0. Banks have not responded to the improvements in credit quality. we like “B-to-B” exposure.8 -1. given our bullish view on the market.2 -0.3 World ex Japan Correlation of relative sector performance and US real rates Jan-88 Jan-89 Jan-90 Jan-91 Jan-92 Jan-93 Jan-94 Jan-95 Jan-96 Jan-97 Jan-98 Jan-99 Jan-00 Jan-01 Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 % 12 10 8 6 4 2 0 -2 -4 -6 -8 Healthcare 0. while risk premia for emerging markets are slightly below that for developed markets.8 Cap Go o ds Tech B asic Industries Correlation of relative sector performance w ith changes in US inflation expectations Source: Nomura Strategy research.0 M edia -0.1 Energy -0. Nomura Strategy research.0 0. and the high level of dividend cover should mean that dividends should increase (Figure 7). Earnings momentum has moved to favour the US relative to Europe and policy should also help the US market relative to Europe over the next year. Japanese companies are currently generating a significant amount of free cash flow.0 0. Source: Nomura Strategy research. units: % weighting.4 0. Although we think the European market has overreacted to the likely impact of the sovereign debt crisis. Nomura Global Economics 90 6 December 2010 Nov-10 Correlation 1.8 -0. Figure 7.1 B e ne f it f ro m re f la t io n Insurance Co n Staple -0.

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