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

Economics Research and Analytics January 2009

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

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


Origin of Crisis

The Genesis: Sub Prime Story
Sub Prime Model
Home Buyer

• • • • Defaults •

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

Loan remains in the banks books

Loan Mortgages are traded

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

Mortgage Market Mortgages not in banks books


Loss Due to Defaults

Genesis: From Financial Sector to Real Sector
Defaults Sub-Prime Mortgages Lack of Capital for Companies $ Tightening Credit Markets Financial Institutions Losses Suspension of Interbank Lending Lack of Trust in Financial Institutions



Banks Slow Lending Down

Lack of Lending for Small Business

Slower Growth

Consumers Reduce Spending


Lack of Retail Credit

Economy Slows Down/Contracts


Internationalization of the Crisis

European Banks European Banks Lose Money on Sub Prime Withdraw Investments in Eastern Europe Mortgages Unwinding of Yen Carry Trade and FII Withdrawals Lower Exports From Asia Due to Lower American Oil Prices Drop on and European Demand Slower growth in Europe and USA

Withdrawal of FII Inflows: Currency Depreciation


How Fear Drove the Recession – Fear is Now Bottoming Out

“The only thing we have to fear is fear itself.”
-- Franklin Roosevelt


Bottoming Out Now

Employment Creation Hits Bottom; Due for an Upswing
Beginning of great moderation; macroeconomic policies smooth business cycles Current employment levels the lowest of the Great Moderation Era, suggesting bottom-out

• •

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

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

Has Industrial Production Bottomed-Out?

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

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

Industrial output showing a rebound from recent lows, suggesting the recovery of underlying fundamentals.

Consumers Are Continuing to Buy

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

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

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

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

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

The crisis is reaching a bottom


Global Economy to Rebound by June 2009

Mega Drivers for Rebound
• • •

• • • • •

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

Global Response: Massive Government Stimulus

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

UK: Germany: Belgium & Switzerland: ECB France

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

Russia Support for ruble; $20 billion stimulus package

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

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

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

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

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

European Union

Japan and South Korea

Emerging Markets

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


Easing of Inflationary and Liquidity Pressures
1 .0 2 1 .0 0 % Y.on Y 8 .0 6 .0 4 .0 2 .0 0 .0 -2 .0 20 02 20 03 20 04 20 05 20 06 20 07 Ja a pn Lt A e a ain m ric 20 08 20 F 09

Inflationary Pressures: Easing Worldwide

Increase in Real Income

UA S E roA a u re A v n e e o o ie da c d c n m s

Ensuring Liquidity

Y on Y

Policy Rate Reduction Leading to Addition in Liquidity


Decline in Commodity and Oil Prices
300 250 Index 2005=100 200 150 100 50 0 1980M 1 1982M 1 1984M 1 1986M 1 1988M 1 1990M 1 1992M 1 1994M 1 1996M 1 1998M 1 2000M 1 2002M 1 2004M 1 2006M 1 2008M 2 In d u s tr ial In pu ts Pr ice Ind e x A g r icu ltu r al Raw M ate r ials In d e x M e tals Pr ice In d e x Fu e l/En e r gy In d e x

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

300 250 200 150 100 50 0
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 Ja nJa nJa nJa nJa nJa nJa nJa nJa nJa nJa nJa nJa nJa nJa nJa nJa n08


Com m odity Fue l (e ne rgy) Inde x, 2005 = 100, include s Cr ude oil (pe trole um ), Natur al Gas , and Coal Price Indice s


Emerging Markets - China
20 18 16 14 12 10 8 15.4 6 4 2 0

Industrial Output China (2008)









Month (Year 2008)

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

Growth Rate (%)

M ar ch

Se pt em be r

Ju ne

Ap ril

M ay

Ju ly

Au gu st

Fe br ua ry

Source: National Institute of Statistics

O ct ob er

• • • •

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

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

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

Emerging Markets - India
Industrial Output India (2008)
S p me e te b r Months (Year 2008) Ags u ut Ju ly Ju e n My a A ril p M rc a h Fe ru ry b a 0 0 .0 1 0 .0 2 0 .0 3 0 .0 4 0 .0 5 0 .0 6 0 .0 7 0 .0 8 0 .0 9 0 .0 5 7 .4 9 2 .5 1 .0 0 0 4 7 .3 6 2 .2 5 3 .5 1 2 .4 7 7 .3 4 0 .8

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

G w R te %(Y Y ro th a o)

Source: CSO

• • • •

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

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

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

World Economy - Composition and Growth
60.00 50.00 40.00 $ Trillion 30.00 20.00 10.00 0.00 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Developing Econom ies Advanced Econom ies

2008 2009

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


Road to Recovery

US/European Stimulus Package

Increasing Government Consumption

Output Stabilizes-Aided by Capital Goods and Infrastructure

Increasing Demand for Capital Goods Increasing Consumption

Credit Market Stabilize

Resumption of Corporate Lending

Stemming Job Losses



Boom in Asia

Chinese Stimulus

Consumer Spending Gets Back on Track Restarting of Retail Credit

Recovery/End of Trough Asian Stimulus

Increasing capacity utilization and expansion


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