FEBRUARY 18, 2014

CREDIT POLICY

GLOBAL RISK PERSPECTIVES

Global Macro Outlook 2014-15: Growing Pains
Executive Summary
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Table of Contents:
EXECUTIVE SUMMARY FORECASTS FOR 2014-15: GROWING PAINS FINANCIAL VOLATILITY IN SOME EMERGING ECONOMIES SOMEWHAT STRONGER OUTLOOK FOR ADVANCED ECONOMIES DEFLATION AND DEBT DYNAMICS RENEWED FINANCIAL TURMOIL IN SOME EMERGING MARKETS DOWNSIDE RISKS REMAIN RELATIVELY SUBDUED MOODY’S RELATED RESEARCH

Analyst Contacts:
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After the global financial crisis and subsequent recessions in advanced economies, the pace of recovery in global activity was weak, compared with recoveries from past downturns. In part, this reflected the fact that financial crises often leave deep and lasting scars on national income. Emerging market economies picked up the baton of growth following the initial stabilization of banking sectors during 2009, but more recently this impetus waned in the face of nascent headwinds to growth such as the prospective removal of monetary stimulus measures. However, advanced economies now appear to have reached a genuine turning point, with several set for robust growth over the coming years. Over the medium term, that should support a gradual strengthening in emerging markets; but in the shorter term, the ongoing adjustment in capital flows as investors rebalance portfolios continues to pose challenges for several emerging economies. As such, stronger growth in advanced economies is likely to be associated with further painful adjustments in some emerging markets. Downside risks to the outlook for global growth remain, but are relatively small compared with some recent adverse scenarios. In the G-20 advanced economies, data revisions have indicated a somewhat stronger growth trajectory in the US and the UK, while the euro area still looks set for a more gradual economic recovery. With Japan exiting deflation, and other advanced economies such as Australia and Canada continuing to expand, the overall outlook remains one of a gradual acceleration in economic activity over the coming two years. Overall, we expect real GDP growth in the advanced G-20 economies to be around 2.3% this year, and around 2.5% in 2015. This is a little stronger than in our November 2013 forecasts. After the deterioration in near-term growth prospects associated with private capital outflows during 2013, emerging market economies appear to have diverged somewhat more recently. Some larger economies, such as China and India, have reported reasonably robust growth. But other economies, such as Turkey and Argentina, have seen renewed financial turmoil. Overall, the broad outlook for emerging economies is little changed from our November 2013 forecasts, notwithstanding further weakness in some emerging markets. We expect real GDP growth in the emerging G-20 economies to be around 5% this year, before rising towards 5.5% during 2015.

Colin Ellis +44.20.7772.1609 Associate Managing Director colin.ellis@moodys.com Ruosha Li Analyst ruosha.li@moodys.com +44.20.7772.8638

Marie Diron +44.20.7772.1059 Senior Vice President marie.diron@moodys.com NEW YORK +1.212.553.1653

Elena Duggar +1.212.553.1911 Group Credit Officer - Sovereign Risk elena.duggar@moodys.com Richard Cantor +1.212.553.3628 Chief Risk Officer richard.cantor@moodys.com Bart Oosterveld +1.212.553.7914 Managing Director - Sovereign Risk bart.oosterveld@moodys.com

Particular concerns relate to the timing and impact of the gradual and necessary normalization of US monetary policy. by recapitalizing banks. some of the large global risks – such as the euro area debt crisis. The outlook for the US and UK in particular is brighter than previously thought. provides an update on our central forecasts for 2014-15. Overall. weighing on near-term growth prospects. and discusses the key risks around our forecasts. and US fiscal deadlock – have significantly receded. by itself.CREDIT POLICY Compared with the past five years. investors are still reallocating capital in the face of the prospective (yet eventual) normalization of US monetary policy. after several years of slow and bumpy progress. At the same time. Real GDP growth in the G-20 economies (weighted by nominal GDP at market exchange rates) is expected to be around 3¼% in 2014. Concerns also remain about China’s ability to induce a managed slowdown in its property and credit markets. At the same time. 2 FEBRUARY 18. but growth then faltered in the face of relatively weak external demand. our current growth forecasts are a little higher than those presented in the previous Global Outlook published in November 2013. But in the short term. some emerging markets have continued to see declines in exchange rates and rises in market yields. followed by around 3. with recent revisions to past data painting a stronger picture than was originally reported. Moody’s Global Macro Outlook underpins our universe of ratings. an immediate renewed flare-up in the euro area crisis seems unlikely. Moody’s believes that the overall magnitude of risks around its central economic scenario remains relatively low. but the region faces deflationary risks as banks in many countries remain unable to fund a stronger pace of economic recovery. Geopolitical risks also remain elevated in several regions. and potential spillover effects on other countries such as emerging market economies with large current account deficits. or the potential for disruption arising from strong credit growth and property price rises in China. This report is an update to our November 2013 Global Macro report. could derail the global economy over the 1 See ‘Global Macro Outlook 2013-15: Navigating towards calmer waters’ (159743). Over the medium term. with several central banks hiking policy rates in an effort to contain inflationary pressures. was limited in many instances. while market conditions have also stabilized in the euro area over the past 18 months. providing a consistent benchmark for analysts and investors. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . Many of the risks around the macroeconomic outlook now relate to country-specific factors such as the impact of the increase in consumption taxes in Japan. Policymakers’ initial focus was to step in to support the banking sector and put a floor under economic activity. the debt crisis remains far from resolved. 1 It reviews key recent developments. and the potential impact of the April 2014 hike in Japan’s consumption tax rate. 12 November 2013. At this juncture. It seems unlikely that the crystallization of any single country-specific risk. But the capacity for fiscal support. Given the somewhat stronger outlook for advanced economies. compared with the substantial risks seen in recent years. As such. Even the prospective normalization of US monetary policy is now having more of a differentiated impact on emerging markets. and several advanced economies subsequently instigated austerity measures that weighed on economic growth. Moody’s judges that the uncertainties around the growth outlook remain relatively subdued. emerging market economies initially rebounded well from the global slowdown. it now appears as if advanced economies have reached a genuine turning point. stronger external demand from advanced economies will also bolster emerging market growth. However. running fiscal deficits and resorting to less conventional monetary stimulus measures. In particular. Forecasts for 2014-15: Growing pains Global synthesis The financial crisis and subsequent recessions in advanced economies cast a long shadow over the global economy.5% in 2015. in particular. This suggests that stronger growth in advanced economies will probably also engender further monetary tightening in some emerging markets.

Blue shading denotes considerable forecast uncertainty relative to historical GDP volatility.5/3.6 1.0/2.0 0.4 4.0/6.9 3.5/3.5 6.5/6.5/5. GDP growth figures are reported on a market price basis.0 3.2 -2.5 3. [2] The percentage point difference between the highest and lowest forecasts of sources such as the International Monetary Fund (IMF).3 0.0 2.4 0.5/6.4 3.5 2.0/2.9 0.5 3. J.9 0.4 0.6 1. Germany.0/3.5 Unemp't central range -5.4 1.9 1.0 ---- 2012 1.3 1.5/7.5/3.0/4.9 0.1 2.4 0.5/2.9 2. the IMF approved a decision calling on Argentina to implement specific measures to address the quality of reported GDP and Consumer Price Index data.1 1.4 0. [3] The standard deviation of real GDP growth over the 15 years to 2012.0/3. the IMF’s Executive Board found that progress had not been sufficient and issued a declaration of censure against Argentina under its Articles of Agreement. orange denotes deterioration.0 2.5/7.0/2.5 0.0 5.0 7.5 2.5 1.0/7.2 0.5 ------6.0 0.9 1.0 4.4 2.6 1. G-20 Advanced includes Australia. France.0/1. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS .4 0.6 0.0 2.6 0.0 2. Canada.4 5.5 --10.0/4.9 1.0/6.3 0. Italy.3 -1.7 -0.P.0/3.0/6.9 2.0 2. weighted by nominal USD GDP shares.0/4.0 3.0/13.5 1.9 3.1 1.2 1.0 1.1 1.5/3. and the US.0 2.0 --12.5 ---- Forecast uncertainty measures 2013 growth range [2] 2. on 1 February 2013.1 2013 [E] 3. it would probably take a combination of different shocks to blow the recovery off course.5 --10.9 0.0 -6.0 2.4 2.5/3. the UK.0/4.5 0. [1] G-20 All includes the 19 individual countries that comprise the G-20.6 1.0 3.5/1.5 1.5 5.9 3. South Korea.0/8.0 1. presenting ranges from the forecasts that we survey and comparing them to the historical standard deviation of real GDP growth.0/2.5/1. » 3 FEBRUARY 18. including an initial set of actions by end-March 2014.5 3.8 4.6 0.0 Notes: Green shading denotes improvement from the November 2013 update.0/8.0/1.0/3.5 5.5 5.0 4.5/4.0 1.CREDIT POLICY coming two years.0 2. and data for 2013 are Moody’s estimates where official statistics have not yet been published.3 2.6 0.0/6.6 0.6 3.4 2.0 0.2 2.5/5. World Bank.9 1.5/3. The blue shading in Exhibit 1 denotes countries with greater forecast uncertainty relative to historical GDP volatility.5/7.5 2.0/4. [4] In February 2012.0 --12.5/4. Organization for Economic Co-operation and Development (OECD).5/11.0/6.0/3.4 ---2014 growth range [2] 5.2 6.9 1.0/2.0 2.3 2.5/3.5 0.0 2.5 1. and Moody’s Analytics.5 1.0 3.0/3.6 1.5 0.5/11.8 2.7 2.1 2.4 0.0 -6. Japan.9 2.5 2.9 1.5 3.8 ---GDP volatility [3] 6.0/13.0 1.0/4.0 2.4 0.0 2.7 -0.9 3. European Commission.5 2.0 ---- 2015F Growth central range 2.5 2.7 7. Morgan.7 7.6 2.0/3.0 1.5 1.6 0.0 Unemp't central range -5.0 5. the Executive Board adopted a decision calling on Argentina to implement specified actions to improve official data.8 5.3 2.5 5.5/6.0 3. We indicate the level of uncertainty for our central forecasts.1 2.5 0. EXHIBIT 1 Moody’s Central Forecast Scenarios for 2014-15 Past growth Countries [1] Argenti na [4] Aus tra l i a Bra zi l Ca na da Chi na Euro a rea Fra nce Germa ny Indi a Indones i a Ita l y Ja pa n Mexi co Rus s i a Sa udi Ara bi a South Afri ca South Korea Turkey UK US G-20 All G-20 Advanced G-20 Emerging 2014F Growth central range 2.0/2.0 5.0 1.0 2.0/3.5 0. We present our central scenario in Exhibit 1 and highlight the following factors: » We express our forecasts for annual GDP growth and unemployment as a range of one percentage point (ppt) to avoid spurious precision and to focus on significant changes that could potentially influence rating decisions.0 3.6 4.3 2.0/6.0 2.7 0.8 0.5/4.5/3.5 2. On 9 December 2013.5 2.5/3.4 0.5 0. Barclays.5/4.7 0. Instead.5 3.8 5.5 ------6.0 0.8 5.6 2.0/3.9 1.0/3.0 7.5 0.5 3.0/7.4 5.

5 3. recent data revisions have indicated a somewhat stronger pace of recovery in the US and the UK in particular. monetary policy makers in emerging markets have raised interest rates to counter the inflationary risks associated with falls in exchange rates.5 2. these yields should rise further as economic recoveries strengthen and central banks start to normalize monetary conditions. economic growth eased at the end of last year. Somewhat stronger outlook for advanced economies The outlook for advanced economies as a whole is similar to our previous assessment. individual countries such as Argentina and Turkey have still experienced significant currency declines. but long-term government bond yields in advanced economies took this in their stride. Overall. with a gradual strengthening in growth likely over the coming years. However. we expect the G-20 economies to grow by around 2. financial markets in some emerging economies have seen considerable volatility recently. Over the longer term. such that US GDP expanded by 4 FEBRUARY 18. This is a little stronger than in our November 2013 forecasts. with prices of many global benchmarks exhibiting little significant trend in recent months. While some countries have seen less pronounced fluctuations in exchange rates than those seen last year (Exhibit 3).0 Per cent EXHIBIT 3 Bilateral exchange rates versus the US dollar Jan 2013-Feb 2014. with a much more muted reaction than was seen in the wake of initial discussions around tapering last May (Exhibit 2). 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS .5 1.3% in 2014. Africa Canada Switzerland China Mexico Euro area UK India UK France 115 110 105 100 95 90 85 80 Germany 2. 1 November 2013 = 100 Australia Japan Brazil S. EXHIBIT 2 Ten-year government bond yields Jan 2013-Feb 2014 US 3. The relative stability of advanced economy yields has been broadly mirrored in commodities. Source: Haver Analytics. In many instances.2% in the fourth quarter according to the preliminary estimate. the pace of growth earlier in the year was also revised up significantly. there is considerable uncertainty around the precise timing of these necessary increases in yields. but over the medium term Moody’s still expects prices to decline gently.0 1.0 Jan-13 Apr-13 Jul-13 Oct-13 Jan-14 Jan-13 Mar-13 May-13 Jul-13 Sep-13 Nov-13 Jan-14 Source: Haver Analytics. In contrast. In the United States.5% in 2015. Oil prices have picked up slightly since November 2013. followed by 2. The US Federal Reserve started tapering its asset purchases in January 2014. with GDP increasing at an annualized rate of 3.CREDIT POLICY Financial volatility in some emerging economies Financial markets have been decidedly mixed in recent months. which should provide some further impetus to the global recovery. However. However.

consistent with stronger economic growth. EXHIBIT 4 US housing market indicators Jan 2003-Dec 2013 FHFA house price index (LHS) 140 130 120 110 100 90 80 2003 2005 2007 2009 2011 2013 1000 500 0 Index. However. several peripheral member states are still struggling to reduce high government borrowing and unemployment. Non-farm payrolls increased at an average pace of 154K a month over the three months to January. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . while the headline unemployment rate fell to 6. somewhat stronger than previously expected. there has also been further positive news from the labor market. This has raised concerns about the ability of the region’s 5 FEBRUARY 18. as a prolonged period of non-employment leads to workers’ skills eroding over time. Both of these factors will impede potential supply over the medium term. Long-term unemployment also remains high. Euro area GDP expanded by 0. The housing market has played an important role in the broader US recovery. Although non-residential investment decelerated during the year. while the decline in joblessness partly reflects further hiring by firms. The sequestration cuts and other fiscal measures are likely to have shaved around 1. while residential investment rose 12%.6% during 2013 as a whole.3% on the quarter during Q4 2013. any normalization of monetary policy in the euro area still looks quite distant. but the unemployment rate remains above 25% and both it and Italy still face slow and bumpy paths towards sustainable fiscal positions and lower rates of joblessness. with building starts and prices both accelerating during 2013 (Exhibit 4). However.CREDIT POLICY 1. after near-stagnation across the single currency area during the third quarter of last year. limiting this erosion and helping to contain any nascent inflationary pressures. Policymakers agreed the outline of a two-year federal budget in December 2013. Source: Haver Analytics. In contrast. it still increased by 2.6%.5 percentage points (ppts) off calendar-year growth during 2013. and that activity should accelerate over the forecast horizon as fiscal drag subsides. as the recovery gathers momentum more workers may rejoin the labor market. Spain managed to register weak positive GDP growth during the second half of 2013. the French and German economies both decelerated following robust growth in the second quarter of 2013 (Exhibit 6). Although considerable progress has been made to reduce fiscal deficits in many countries. the broad picture for the US economy is one of a gradual normalization of fiscal and monetary policy over several years. the lowest since October 2008.9% during 2013 as a whole. against a backdrop of robust growth. Jan 2003 = 100 Housing starts (RHS) Thousands 2500 EXHIBIT 5 US labor market metrics Jan 1996-Jan 2014 Unemployment rate (LHS) 11 2000 1500 Participation rate (RHS) % % 68 67 66 65 64 63 62 10 9 8 7 6 5 4 3 Source: Haver Analytics. This suggests that the private sector saw a robust underlying recovery last year. With the Federal Reserve now also tapering its purchases of financial securities. In addition. The recent performance of the US economy is more remarkable given the considerable fiscal squeeze that hit economic growth last year. and recently suspended the debt limit until March 2015. it is also due to workers becoming discouraged and leaving the labor force (Exhibit 5). At the same time.

With inflation now closer to zero than the European Central Bank (ECB) target of below (but close to) 2%. and several long-term refinancing operations still outstanding.25%. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . Left unchecked.6 0. it is possible that the recent weakness of wages and prices has affected near-term inflation dynamics in the euro area. Faced with unsustainable current account deficits.3 -0. there is a risk that nascent deflationary tendencies in some peripheral countries could become entrenched across the euro area as a whole. However. Deflationary concerns have also resurfaced in recent months.8%. With the main refinancing rate already at 0. as individual countries become unable to control real debt dynamics.CREDIT POLICY larger countries to support growth throughout the single currency area as a whole.7 0.4 Q2 Q3 Q4 EXHIBIT 7 Euro area CPI inflation rates Jan 2006-Dec 2013 Ireland Greece Portugal 8 6 4 % 2 0 -2 -4 2006 2007 2008 2009 2010 2011 2012 2013 Spain France Italy Germany Source: Eurostat. as softer growth prospects in core countries will resonate throughout the rest of Europe. EXHIBIT 6 GDP growth in euro area countries Q2 2013-Q4 2013 Percentage changes on previous quarter 0. including facilitating small and mediumsized enterprises’ access to capital markets. Ideally. which in turn has increased the real burden of debt for households and businesses.8 0.3 0. this process of so-called internal devaluation should now be coming to an end.4 0. Source: Haver Analytics.2 -0. The ECB’s balance sheet has been shrinking as a result of some banks’ reduced reliance on central bank funding. deflation could significantly increase financial fragmentation in the single currency region and bring the risk of breakup back to the fore.5 0.1 -0. with many countries likely to run balanced current accounts during 2014. 6 FEBRUARY 18. Countries such as Ireland and Greece have already experienced some degree of deflation (Exhibit 7). In light of this. Headline CPI inflation fell to just 0. as discussed in Box 1. the ECB may decide to take further steps to support the economy and prevent the euro area from slipping into outright deflation.2 0. and the recent rise in short-term market interest rates relative to policy rates was indicative of a modest tightening in monetary conditions. many peripheral euro area countries have cut nominal prices and wages in order to regain export competitiveness within the confines of the single currency. members of the ECB Governing Council have recently discussed potential further measures to support activity and offset deflationary risks.1 0 -0.7% in January 2014. and core inflation – which excludes volatile items such as energy and food – was just 0.

purchasing Japanese Government Bonds (JGBs) in an effort to raise inflation expectations. such responses have been seen both in the US and the euro area. since 2008. Deflation increases the real value of debt. where Governor Kuroda has been pursuing a more aggressive monetary policy stance since he took office in March 2013. 7 FEBRUARY 18. the health of many euro area banks remains highly uncertain. 2 This is in contrast to the likes of the US Federal Reserve. a general fall in the price level will redistribute wealth from debtors to creditors. deflation can swiftly result in a negative feedback loop between households. such as rising unemployment and credit defaults. would hit corporate and household balance sheets. Current concerns about deflation seem more pressing in the euro area than in the US. The increase in real debt burdens. the prospect of falls in the general price level can lead to consumers and businesses delaying purchases in expectation of cheaper prices. and in other advanced economies. coupled with the probable deterioration in activity. In turn. businesses and banks. Progress has been encouraging. deflationary risks may force a central bank to use less conventional forms of monetary stimulus if the short-term policy rate approaches zero. this will likely lead to a further fall in aggregate demand. deflation can also lead to other consequences. the deflationary impetus in the euro area is more prevalent given the internal devaluation processes seen in many peripheral member states. The risk of deflation was exacerbated by the significant falls in domestic demand as recessions took hold. a key concern for policymakers in advanced economies was to avoid the onset of deflation – outright and sustained declines in the general price level. leading to an increase in non-performing loans and a deterioration in banks’ balance sheets. A more troubling aspect of deflation is the role it can play in exacerbating debt burdens and financial stress. which in turn would further impede economic growth. while US bank balance sheets have largely recovered from the financial crisis. potentially raising the likelihood of a country leaving the single currency. As such. outright deflation would significantly increase pressure from financial markets on governments that are still wrestling with unsustainable fiscal positions. given the lower marginal propensity to consume among creditors than debtors. making it difficult to reflate the economy. 17 February 2014.6% in 2 See ‘German Court Casts Doubt on ECB Bond-Buying Program. with CPI inflation rising to 1. For instance. which left excess spare capacity in many economies. In turn. thereby putting more strain on debtors as it makes it more expensive to service and repay past borrowings. Apart from the normal effects arising from weak aggregate demand. as is usually the case. the Bank of England. Such an increase in the real burden of debt would also likely engender increased financial stress among households and businesses. a Credit Negative for Euro Area Sovereigns’ (165076). these concerns are unlikely to be addressed before the conclusion of the ECB’s comprehensive assessment of the banking system. further weighing on domestic demand. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . For loans and bonds that are denominated in nominal terms.CREDIT POLICY Box 1: Deflation and debt dynamics At the start of the financial crisis. The question of the legal standing of the program was recently referred to the European Court of Justice by the German constitutional court. While inflation rates are currently close to zero in both economies. One option that the ECB has resisted thus far is the purchase of government bonds through its Outright Monetary Transactions (OMT) program. Furthermore. and in particular the Bank of Japan (BoJ). The BoJ has continued in its pledge to expand the monetary base by between ¥60 and ¥70 trillion a year. In addition. Japan’s experience with persistent mild deflation since the late 1990s is often cited in this context.

Alongside the recent sharp decline in unemployment. 8 FEBRUARY 18. UK GDP expanded by 0. However. whereby the stronger pace of growth during 2013 lifts the calendar-year growth rate in 2014.3% in Q4 2013. this effect should prove temporary. inflation should jump higher in April 2014 when the planned increase in the sales tax is implemented. with business investment still almost 25% below its pre-recession peak. UK GDP is likely to expand at a robust pace over the coming two years. EXHIBIT 8 Japanese CPI inflation measures Jan 1995-Dec 2013 % 3 2 1 Headline CPI inflation Core inflation (a) EXHIBIT 9 UK public sector net borrowing (a) Financial Year 2009/10-Financial Year 2018/19 180 160 140 120 100 £bn 80 60 40 20 0 -20 0 -1 -2 -3 1995 1998 2001 2004 2007 2010 2013 (a) Excluding food and energy. Concerns also remain about the unbalanced nature of the UK’s recovery. Australia and South Korea all set to report positive growth throughout 2013. fiscal drag will intensify again during the coming financial year. Due in part to timing effects.9% during 2013 as a whole. echoing a similar tax hike in 1997 (Exhibit 8). The broader risk is that growth stutters once the tax rate is raised. these smaller and relatively open advanced economies should benefit from the stronger tailwinds that ensue. weighing on economic activity.7% during Q4 2013. this is consistent with most of the recent weakness in productivity being permanent. Source: Haver Analytics and Moody’s Investors Service. a weaker pace of growth than seen during the rest of the year. (a) Excluding Royal Mail and Asset Purchase Facility transfers. rather than cyclical. Together with the recent revisions. Other advanced economies have seen steady expansion in recent quarters. with consumers having brought forward spending prior to its implementation. Japan’s GDP expanded by 0. albeit still weaker than its long-run average growth rate. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . In the short term. the government’s efforts to enact structural reforms have borne little fruit thus far. this implies that the economy expanded by 1. In the United Kingdom. as the weaker exchange rate has fed through to consumer prices. raising concerns about Japan’s ability to sustain GDP growth above 1% a year over the medium term. According to the preliminary estimate.CREDIT POLICY December 2013 and core inflation also turning positive. as the increase in the sales tax represents a relative price shift rather than persistent underlying inflationary pressure. following the sharp slowdown in deficit reduction over the past two years (Exhibit 9). with Canada. That represents the UK’s fastest pace of growth since 2007. However. recent data revisions have also painted a more robust picture of recovery than was previously the case. Source: OBR. With many other countries likely to see some acceleration in activity over the coming two years. Meanwhile.

even with this extra funding requirement China’s general government financing needs remain relatively moderate. before rising to 5. While this is somewhat slower than in 2010 and 2011. with wholesale and retail sales accelerating during 2013. 9 FEBRUARY 18. the Chinese authorities are likely to continue to support activity. Over the longer term. suggesting that the central government may need to provide additional fiscal support to local governments. The People’s Bank of China acted to ease credit concerns in December by increasing its funding provision to the banking system. it was unclear how much local governments had been relying on debt to support regional development and investment. 3 January 2014. See ‘New Report Shows Sizeable Debt Accumulation by China’s Local Governments. have seen renewed turmoil in financial markets as investors continue to reassess their portfolios in the wake of tapering by the Federal Reserve. our overall outlook for emerging markets is little changed from November 2013. and we expect real GDP growth in the emerging G-20 economies to be around 5% this year. This uncertainty has been tempered following an updated assessment of local government debt and contingent liabilities by the National Audit Office (NAO) in December 2013. and the authorities are likely to respond in a similar fashion if credit risks crystallize. the impact on other countries has been less pronounced. such as Turkey and Argentina. However. consistent with greater differentiation by market participants. prospects for emerging market economies have diverged somewhat more recently. reversing the trend of the past decade (Exhibit 10). Some countries. One recent uncertainty surrounding the Chinese economy has been the extent of local government borrowing. 3 As such. Total local government debt and liabilities were much higher than in 2011. the official estimate of GDP indicated that the economy grew by 7. While central government borrowing remains relatively low. However. 4 3 4 See ‘Credit Implication of Emerging Market Volatility Depends on the Credibility of Policy Choices’ (163779). which in turn is likely to reflect different underlying economic conditions and policy choices. near-term indicators of growth such as investment spending suggest that economic momentum is likely to be sustained in 2014. 3 February 2013. For now.7% during 2013 as a whole.CREDIT POLICY Renewed financial turmoil in some emerging markets After the widespread deterioration in near-term growth prospects associated with private capital outflows during the summer of 2013. it still represents robust growth. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . In China. unchanged from growth in 2012.5% during 2015. China’s sustainable growth rate is likely to decline as the marginal return on capital declines and the population ages. particularly set against the continuing rapid rise in nominal GDP. This could support a rebalancing of the economy away from investment and saving towards consumption. In the short term. however. a Credit Negative’ (162145).

CREDIT POLICY EXHIBIT 10 Composition of Chinese GDP 1994-2012 Investment 65 60 Percentages of nominal GDP EXHIBIT 11 Effective interest rate relative to nominal GDP (a) 2004-2013 Consumption Brazil 15 10 Percentage points India S. it has also significantly weakened prospects for Turkish economic growth over the near term. progress on necessary structural reforms remains slow. which will impede any acceleration in economic activity. Indian policymakers have somewhat more leeway than their peers to support the economy in the face of further movements in the exchange rate and long-term yields. the Indian economy accelerated during the third quarter. with ten-year government bond yields exceeding 10% in January – a rise of almost 400 basis points (bps) in less than a year. Turkey has seen a sharp tightening in financial conditions over the past eight months. While this should help limit currency volatility and the risk of a balance-of-payments crisis. India’s relatively long maturity profile means that the effective interest rate on government debt has not risen with long-term yields. recent increases in policy interest rates – including the further 25 basis point (bp) tightening in January – and the substantial rise in long-term yields over the past nine months will weigh on domestic growth prospects. financing conditions for government debt remain more favorable than in many other emerging markets. thus supporting the government’s ability to fund itself. Africa Turkey 55 50 45 40 35 30 5 0 -5 -10 -15 -20 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: Haver Analytics. 6 5 6 See ‘India’s Government Debt Structure Mitigates Credit Impact of Macro-Economic Imbalances’ (160589). At the same time. Source: IMF and Moody’s Investors Service. the effective interest rate remains low. But Downside Risks Persist’ (163639). despite the slowdown in growth. After a period of relatively weak growth during 2013 H1. relative to nominal GDP growth (Exhibit 11). As such. 30 January 2014 10 FEBRUARY 18. bolstering expectations that the recent downturn will prove short-lived. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . In response. more pronounced than in other major emerging markets (Exhibit 12) – and a sharp depreciation in the lira. (a) Effective rate paid on government debt minus nominal GDP growth. 5 Furthermore. However. In particular. However. See ‘Turkey: Central Bank’s Monetary Tightening Will Alleviate Foreign-Exchange Pressures. and the rise in long-term yields. 8 January 2014. the Central Bank of Turkey significantly raised policy rates in late January to contain inflationary pressures.

Source: Haver Analytics and CPB Netherlands Bureau for Economic Policy Analysis. Haphazard policymaking is likely to perpetuate uncertainty and exacerbate anxiety. During 2013. the country has run modest current account deficits as capital investment from abroad has sought to develop and market the country’s sizeable natural resources.CREDIT POLICY EXHIBIT 12 Emerging market long-term bond yields April 2013-February 2014 11 10 9 8 7 6 5 India Ten-year government bond yields. Indonesia is the third largest developing economy in Asia. Indonesia looks set for a somewhat swifter bounceback in growth than some other Asian economies. by boosting exports. its subsequent stabilization should support growth in the coming years. Until investor confidence improves. constraining the ratio of investment to GDP and thereby weighing on potential supply. The peso depreciated by a third against the US dollar during 2013. The central bank’s recent efforts to contain inflationary pressure. Elsewhere. economic activity was weaker than first expected. Indeed. near-term growth prospects in Russia remain weak. concerns remain about the long-term sustainable growth rate of the Brazilian economy. Argentina is currently experiencing a pronounced repricing of its economy. While risks remain. As such. with policymakers still striving to boost competition and provide support to smaller businesses in an effort to diversify activity. and subsequently plunged by 17% in one week last month as the government eased currency controls and the central bank limited its market interventions in order to preserve exchange reserves. will also weigh on domestic demand. despite the continued pressure from the IMF. While final construction work ahead of the FIFA 2014 World Cup and the tournament itself may provide some modest spur to activity this year. accounting for just under 40% of regional GDP. Source: Haver Analytics. which have seen it raise the Selic target rate by over 300bps in the past year. economic prospects are likely to remain negative. As the largest economy in Latin America. While this meant that policymakers were forced to spend foreign-exchange reserves to limit the decline in the rupiah in the wake of market concerns about US tapering. The Winter 11 FEBRUARY 18. Near-term prospects for the Brazilian economy remain subdued. there are increasing signs that growth may struggle to return to its pre-crisis pace. Brazil is a critical engine of regional growth. % (a) Turkey South Africa EXHIBIT 13 Indonesian exports and world trade Q1 2003-Q3 2013. representing a market of 250 million people. reflecting businesses’ reluctance to invest and persistently high inflation eroding households’ spending power. while the poor state of official statistics in Argentina. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . During the past two years. with recent falls in productivity growth probably reflecting poor infrastructure and skills. given the strong linkage between exports and world trade (Exhibit 13) and the more robust outlook for global growth. The private sector’s limited appetite for risk is also likely to persist. is likely to have amplified investor caution. Q1 2003 = 100 Indonesian exports (LHS) 230 210 190 170 150 130 110 90 70 2008 2004 2006 2009 2003 2005 2007 2010 2011 2013 2012 World trade (RHS) 170 160 150 140 130 120 110 100 90 80 (a) Domestic currency terms. Brazil looks likely to see relatively lackluster economic growth over the coming two years.

there are remaining risks to growth and macroeconomic stability arising from the euro area debt crisis. Sub-Saharan Africa still looks set for a robust pace of expansion. the Fed will need to strike a careful balance between nurturing recovery and gradually unwinding its monetary stimulus. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . the likely use of measures to stabilize financial conditions will weigh on GDP growth. where the central bank has also raised interest rates in an effort to limit the inflationary consequences associated with the decline in the rand. there are numerous risks around that central view. At the same time. Recent events in Turkey and Argentina. often reflecting a high dependence on capital inflows to fund existing current account deficits. the forward-looking nature of financial markets makes it likely that increases in US Treasury (UST) yields may materialize more quickly. 8 As capital inflows diminish. 30 September 2013. have re-illustrated the potential for disorderly financial corrections. Those countries that are most exposed to rises in rates are also vulnerable to capital flight. Fed tapering could also hit emerging market economies more severely than currently envisaged. remain to be proven. A key risk for the US economy relates to the US Federal Reserve’s efforts to normalize monetary policy. However. although any softness in commodity prices will weigh on exporters such as Peru. with the Fed’s balance sheet likely to expand for much of 2014. which could impact on activity. as a result. This process will be slow and gradual. and as such are also likely to see some pickup in growth over the next two years. While other countries may face less stark adjustments. and spreads over US yields have widened in many emerging markets. potential growth could turn out to be weaker than previously thought. and the target Fed Funds rate only likely to increase by late 2015 at the earliest. with the likes of Poland and the Czech Republic having come through the recent downturn in relatively good shape. and by extension the wider European Banking Union project. This would represent an upside risk to growth and inflation over the short to medium term. Long-term bond yields in many countries have risen over the past year. it could unwittingly engender new bubbles in asset prices. Smaller Latin American nations. should benefit from stronger US growth. in particular. However. notwithstanding the recent slowdown in South Africa. 12 FEBRUARY 18. 7 8 See ‘Sochi 2014 Winter Olympics: Uncertainty over Long-term Legacy Overshadows Benefits’ (163533). in particular. Downside Risks Remain Relatively Subdued The forecasts presented above represent Moody’s central outlook for the global economy. but a downside risk to activity over the longer term when these bubbles eventually burst. 5 February 2014. Over the longer term. if the Fed proves too cautious in tightening policy. meanwhile. Given the importance of long-term rates for the nascent US housing recovery. compared with the substantial risks seen in recent years. 7 Economic prospects in Central and Eastern Europe are broadly unchanged from November.CREDIT POLICY Olympics in Sochi are unlikely to provide any significant macroeconomic boost. Overall. But there are several scenarios that would result in weaker activity and creditworthiness. further currency declines and associated rises in both long-term yields and policy rates are likely in several economies. But in the short term. unemployment and credit quality. tracking UST yields higher. See ‘Credit Consequences of US Monetary Tightening’ (158462). While financial conditions in the euro area have stabilized over the past 18 months. Moody’s judges that the uncertainties around the economic outlook remain subdued. Developing Asian economies remain tied to developments among their larger peers. there is also a risk that it becomes apparent that these economies are more dependent on foreign funding to drive growth than expected. The implications of the ongoing comprehensive assessment of European banks for the credibility of the ECB. falls in exchange rates should help curb current account deficits and rebalance economic activity.

there is a risk that deflation takes hold in the euro area. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . the upcoming April 2014 increase in the Japanese consumption tax rate could hit economic activity. as the recent lowering in tensions has not yet led to a normalization in relations on the peninsula. North Korea also poses a singular geopolitical risk. and a still-robust growth trajectory. Thus far. could also have implications for the exchange rate. the Chinese authorities have been able to respond to these risks as they threaten to crystallize. Ireland and Portugal. it would significantly damage borrowers’ ability to repay their debts. any substantial liquidation of assets. particularly in the face of Israeli unease. However. it could also threaten the popular consensus for the various reforms that policymakers hope to implement. with potentially dramatic consequences for regional trade. and only negligible inflation in Spain. In Asia. In addition. the key risks relate to the two largest economies. the country looks well placed to cope with these risks. With official estimates suggesting that almost a third of aggregate financing is now provided by the shadow banking sector. potentially leading to further financial distress in the region. governments may need to provide further financial support to their banking sectors. the ECB’s ability to mitigate these deflationary risks could prove limited. If deflation became entrenched. While the impact would likely be short-lived. While relations between Iran and the six countries leading the negotiations about its nuclear ambitions and associated sanctions have recently improved. In the absence of full-blown quantitative easing. Without improvements in the ability of banks to fuel the economic recovery with credit. 13 FEBRUARY 18. concerns remain about the pace of property price increases and credit provision. ongoing discussions to limit Iran’s nuclear capabilities could suffer a setback. a potential dislocation in financial and credit markets could have serious consequences.CREDIT POLICY Furthermore. the situation remains combustible. if the war in Syria or domestic turbulence in Egypt were to spillover to neighboring countries and threaten oil supply from the region. is its ability to mobilize resources when it needs to. With many of these structural changes still yet to materialize. at present it is difficult to see this risk materializing over the next 12 months. China’s key advantage. in the absence of an agreement on how to provide communal support to institutions with legacy assets. perhaps in response to unexpected bank losses or local government funding problems. the euro area remains vulnerable to a renewed flare-up in the sovereign debt crisis. In China. At the same time. thereby complicating policymakers’ options. With the world’s largest stock of currency reserves. political stagnation in the face of households choosing to tighten their purse strings could soon be reflected in weaker longer-term economic prospects. the continuing dispute between China and Japan over the Senkaku-Diaoyu islands could escalate. as it would probably take some combination of shocks to result in conditions deteriorating substantially. Meanwhile. Ongoing conflict in the Middle East could also have a global impact. it would only take a modest downside shock to prices to push the aggregate euro area inflation rate below zero. Similarly. With prices already falling in Greece. relative to some other economies. However.

December 2013 (161418) QE Tapering & Turkey: Impact on Various Sectors of Turkish Economy Will Likely be Limited and Short-Lived Given Existing Buffers. May 2013 (153268) Global Macro Outlook 2013-14: Downside Risks Have Diminished. a Credit Negative for Euro Area Sovereigns (165076) Sochi 2014 Winter Olympics: Uncertainty over Long-term Legacy Overshadows Benefits (163533) Credit Implication of Emerging Market Volatility Depends on the Credibility of Policy Choices (163779) Turkey: Central Bank’s Monetary Tightening Will Alleviate Foreign-Exchange Pressures. Government of. December 2013 (161004) Islamic Finance: Global Sukuk Market: Positive Long-Term Growth Trends Set to Continue. November 2012 (146944) German Court Casts Doubt on ECB Bond-Buying Program. But Downside Risks Persist (163639) Argentina Devaluation Is Credit Negative for Banks. Insurers and Securitizations and No Sovereign Panacea. August 2013 (156821) Update to Global Macro Outlook 2013-14: Loss of Momentum. February 2013 (149555) Update to the Global Macro Risk Outlook 2012-14: Slow Adjustment to Weigh on Growth. December 2013 (161827) Sovereign Monitor: Focus on Bilateral and Multilateral Support and Sovereign Creditworthiness. January 2014 (162135) New Report Shows Sizeable Debt Accumulation by China’s Local Governments. a Credit Negative. January 2014 (163059) Egypt’s Constitutional Referendum Is a Credit Positive Step Towards Political Stabilization. January 2014 (160589) Credit Analysis: Brazil. Government of. November 2013 (159743) Update to Global Macro Outlook 2013-14: Rising yields dampen recovery.CREDIT POLICY Moody’s Related Research Recent Global Macro Risk Scenarios: » » » » » Global Macro Outlook 2013-15: Navigating towards calmer waters. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . January 2014 (163343) Below-Trend Growth in Brazil Presents Limited Credit Risks to Rest of Latin America. Corporates. November 2013 (160671) Selected Sovereign Research: » » » » » » » » » » » » » » » 14 FEBRUARY 18. January 2014 (162905) India’s Government Debt Structure Mitigates Credit Impact of Macro-Economic Imbalances. November 2013 (159706) 2014 Outlook – Global Sovereigns. January 2014 (162145) Credit Analysis: France.

Infrastructure at Top of Agenda. January 2014 (162823) Declines in Reinsurance Prices Are Credit Negative. 15 FEBRUARY 18. All research may not be available to all clients. January 2014 (162299) Basel Committee’s Final Standard on Equity Investments in Funds Is Credit Positive for Banks. December 2013 (161540) Early Introduction of European Union Bail-In Regime Is Credit Negative for Banks’ Unsecured Bondholders. November 2013 (160089) European Banks: ECB’s Comprehensive Assessment Is Credit Positive. Note that these references are current as of the date of publication of this report and that more recent reports may be available. December 2013 (161948) Credit Implications of the German Coalition Agreement: Energy. November 2013 (159844) To access any of these reports. click on the entry above.CREDIT POLICY Selected Financial Institution and Corporate Sector Research: » » » » » » » » Europe’s Open Access Rule Will Not Affect Exchange Credit Quality. January 2014 (163355) Systemically Important Designation for Asset Managers and Funds Is Credit Positive. 2014 GLOBAL RISK PERSPECTIVES: GLOBAL MACRO OUTLOOK 2014-15: GROWING PAINS . But Crucial Questions Left Unanswered. December 2013 (161802) European Business Services: Recovery Is Fragile. But Prospects Are Improving.

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