Statement 2: Economic Outlook
The outlook for the international economy
The world economic outlook has deteriorated significantly since the February 2009 Updated Economic and Fiscal Outlook (UEFO), with the first annual contraction in six decades expected for world GDP in 2009 (Chart 1).
Chart 1: World GDP growth
Source: International Monetary Fund (IMF) and Treasury.
No economy has emerged unscathed from the global financial crisis. Following the rapid intensification of global financial market stress in September 2008, strong financial and real economy linkages led to an unprecedented synchronised fall in world trade and production in the December quarter of last year (Box 1). With an estimated annualised contraction of 6¼ per cent, that quarter witnessed the sharpest fall in global output on record, and GDP outcomes were worse than already pessimistic expectations in every major economy.
Nearly every advanced economy is either in recession or recorded a decline in GDP late last year. Recent indicators, including first estimates from the United States and the United Kingdom, point to another set of sharp contractions or very weak rates of growth around the world in the March quarter 2009.
Against this backdrop, and in light of low levels of confidence, growth forecasts for 2009 have been marked down for most economies. The world economy is now expected to contract by 1½ per cent in 2009, a substantial 2 percentage point downward revision from the forecast in UEFO (Table 2).
Box 1: The sharpest synchronised global downturn
Global economic activity plunged dramatically in the final months of 2008 following the collapse of Lehman Brothers in September.
While the prospect of a rapid intensification of financial market stress had earlier been identified as a clear downside risk to the global outlook, the speed and extent of the deterioration in global financial and economic conditions exceeded any event in living memory.
With rapid declines in credit flows, equity values and consumer confidence, strong financial and real economy linkages saw the tremors which rocked financial markets transform into an unprecedented synchronised global contraction of production, trade, and capital flows. The result was an annualised global GDP contraction of around 6¼ per cent in the December quarter 2008 (Chart A).
Chart A: December quarter 2008 GDP growth
Source: National statistical publications and IMF.
While every country was inevitably affected, the impacts were especially stark amongst advanced economies. In the US and euro area, GDP declined in the December quarter at an annualised rate of over 6 per cent. Advanced economies in our region were hit even harder. Japan and Korea contracted at annualised rates of 12.1 and 18.8 per cent, with massive falls also recorded in Singapore and Taiwan.
Against this backdrop, and with signs of another set of sharp GDP contractions around the world in the March quarter, forecasts for global growth have been revised down significantly and frequently. The April World Economic Outlook presented the IMF's fifth set of forecast revisions in the past seven months, with a cumulative 4.3 percentage points shaved off the forecast for global growth in 2009 (Chart B).
Chart B: Evolution of 2009 global growth forecast
Note: IMF forecasts from April 2008, October 2008, January 2009, and April 2009.
Source: IMF and Treasury.
IMF forecasts for production and trade are similarly dire. Global industrial production is expected to shrink by over 6 per cent in 2009, exceeding the contraction in industrial production during any post‑war global downturn. Global merchandise trade is expected to fall by 11 per cent (Chart C).
While the rate of global economic decline witnessed since last September is unlikely to continue, the flow‑on effects of the rapid fall in activity will linger. Around the world, households and businesses face an extended period of constrained credit, rising unemployment and heightened uncertainty, as policy makers seek to restore and reform financial markets and shield their economies from what would otherwise be the full brunt of even larger falls in aggregate demand.
Chart C: Trade and industrial production growth
Note: World trade forecasts and data since 1981 are from IMF, earlier data from the World Trade Organisation (WTO).
Source: IMF, WTO and OECD.
The global recession of 2009 looms as not only the most synchronised, but also the most severe in living memory.
Deep contractions are expected in virtually every advanced economy in 2009, with advanced economies collectively expected to contract by 3¾ per cent (Chart 2). While still expanding, China is forecast to grow at a below‑trend pace. In other emerging economies, growth will be impeded by a combination of weaker external demand, capital outflows, and the associated negative spill‑over effects on domestic demand.
Eight of Australia's top 10 trading partner economies are expected to contract in 2009, with major trading partners collectively expected to contract by 2 per cent — far weaker than their performance during the Asian Financial Crisis.
With post‑war record falls expected in industrial production, trade and capital flows around the world, the global recession is expected to be the most severe since the Great Depression. The pace of the recovery is dependent on the success of global measures to stabilise the global financial system, restore credit flows, and boost growth and support jobs (Box 2).
While there have been signs of improvement in financial market conditions in recent months, the global financial system remains under significant strain. After nearly halving, global equity prices have risen since early March. While still elevated relative to pre‑crisis levels, indicators of stress in global credit markets have eased since late last year, providing some encouragement that the financial crisis may be moderating in its severity. Nevertheless, bank balance sheets remain under pressure, and much depends on the success of policy responses aimed at removing toxic assets from the balance sheets of US and European banks.
Table 2: International GDP growth forecasts(a)
- World, euro area and advanced economies growth rates are calculated using GDP weights based on purchasing power parity (PPP), while growth rates for major trading partners, NIEs and ASEAN‑5 are calculated using export trade weights.
- Production‑based measures of GDP.
- The Newly Industrialised Economies (NIEs) are Hong Kong, South Korea, Singapore and Taiwan.
- The Association of Southeast Asian Nations group of five (ASEAN‑5) comprises Indonesia, Malaysia, the Philippines, Thailand and Vietnam.
- Composed of the 33 industrialised economies classified as advanced by the IMF.
Source: National statistical publications, IMF and Treasury.
Chart 2: GDP growth in advanced and major trading partner economies
Source: IMF and Treasury.
Box 2: Global policy responses
Confronted with the worst economic conditions in living memory, global policy makers have responded by providing significant insurance against an even deeper and more prolonged recession and a delayed recovery.
Following the collapse of Lehman Brothers, authorities provided liquidity to financial markets on an unprecedented scale. Governments worldwide extended retail deposit guarantees and announced guarantees of banks' wholesale funding. In some countries, weak or insolvent financial institutions were recapitalised with public funds.
Policy responses have also focused on breaking the vicious cycle between financial market stresses and real economic activity.
Central banks have cut interest rates to record lows, and used a range of unconventional policy tools to support demand and ease credit market conditions, although the effectiveness of monetary policy has been hampered in some economies by problems in financial markets. The severity of the global recession has seen governments around the world implement substantial fiscal stimulus to boost growth and support jobs.
According to the IMF, the G‑20 economies, as of late March 2009, had already announced fiscal stimulus worth 2 per cent of GDP in 2009 and 1½ per cent of GDP in 2010. This stimulus, as well as the operation of the automatic stabilisers, is expected to raise G‑20 GDP by up to 3¼ percentage points in 2009.
Falling revenues, together with fiscal expansions, have resulted in worsening fiscal positions in major advanced economies (Chart A).
Chart A: Budget balance
forecasts for 2009
Source: IMF.
At the London Summit on 2 April 2009, G‑20 Leaders committed to address decisively the problem of toxic assets, restore the stability of the financial system, and put in place credible exit strategies to ensure long‑term fiscal sustainability and price stability.
Problems in accessing capital could further weaken economic activity in emerging economies. A key global response has been the G‑20 Leaders' agreement to US$1.1 trillion of additional resources for the world economy through the international financial institutions and trade finance. These additional resources, together with enhanced and newly created facilities provided by the international financial institutions, are reducing the risk of damaging contagion.
Key to the recovery will be the restoration of confidence. Predicated on some degree of normality returning to the financial system by late 2009, the monetary and fiscal stimulus in the pipeline is expected to support a gradual recovery in the global economy in 2010. Notwithstanding this, output in the United States, the euro area and Japan — the three largest advanced economies — is still expected to be below pre‑crisis levels by mid‑2011 (Chart 3).
Chart 3: Level of GDP in major advanced economies
Note: US series includes the actual outturn for the March quarter 2009.
Source: National statistical publications and Treasury.
The economic outlook for the United States has deteriorated considerably since the beginning of the year, reflecting weaker economic conditions and ongoing stress in the financial system. The US economy is expected to contract by 3 per cent in 2009, before a modest recovery takes shape in 2010.
The labour market continues to worsen at a rapid pace, with around 6 million Americans joining the jobless queue since the beginning of the US recession. With rising unemployment, extremely tight credit conditions and plunging wealth, the outlook for consumption is bleak. The fiscal stimulus is expected to assist consumption in the second half of 2009. However, consumption growth is expected to be subdued in 2010 and 2011 relative to the pre‑recession pace as household savings are rebuilt from historic lows.
Given the depth of the GDP contraction and the tightness of credit, business investment, which had held up relatively well over most of 2008, has weakened sharply in recent quarters. The slump in the housing market continues, with the large oversupply of homes adding further downward pressure to house prices, which have already fallen by around 30 per cent from 2006 peaks, although there are signs that the rate of decline is slowing. A recovery in the housing sector is not expected until 2010.
While the US outlook is grim, the fiscal stimulus package provides some upside risk. Should financial market policies succeed in restoring trust and confidence, then the impact of the stimulus will be bolstered in 2010.
The euro area is expected to experience a severe recession in 2009. Investment is expected to detract most from growth, reflecting deteriorating credit conditions and falling global demand. Private consumption is expected to remain weak because of low confidence as well as falling employment and lower levels of wealth. Exports are expected to slump in line with sharply weaker global demand. A modest recovery is forecast for 2010.
China has been a key driver of global economic growth in recent years but its economy has now slowed dramatically (Chart 4), with 2009 GDP growth expected to be half its 2007 rate. The Chinese economy is expected to grow by 6¼ per cent in 2009, with a sharp slowing expected in its exports as a result of the severe slowdown in global demand.
Chart 4: GDP growth in China
Source: CEIC Data.
The RMB 4 trillion (around 15 per cent of 2007 GDP) fiscal package is already boosting public infrastructure investment and credit growth. The package includes both previously announced and new spending (around 6 per cent of GDP, according to the IMF). In line with this, industrial production has picked up. However, private investment will continue to be adversely affected by the widespread fall in export demand and a weak property market.
Though exports have slowed considerably, internal sources of growth should provide support to economic activity. With continued resilience in private consumption, and fiscal stimulus supporting growth from the second half of this year, China is likely to be the first major economy to recover from the global recession. Indeed, the recent GDP outcome for the March quarter suggests that the slowdown may already be bottoming out.
While a return to double‑digit growth in 2010 and 2011 is unlikely given the expected tepid pace of the global recovery, growth of 8 per cent in 2010 and 8½ per cent in 2011 should see China contribute around 1 percentage point to annual world growth in both years, and help support the expected recovery in the Australian economy.
The economic outlook for Japan is bleak, with the economy set to experience a deep and protracted recession. In the December quarter 2008, Japan registered its largest quarterly GDP contraction since 1974. Industrial production is likely to continue to be undermined by falling corporate profits and business sentiment.
Exports, which in recent years have been an engine of growth, are expected to be a significant drag on the economy due to a strong yen and weak external demand. High unemployment and slower income growth have taken a toll on consumption, hampering the effectiveness of fiscal stimulus measures in restoring growth. Nevertheless, the recent announcement of a large economic stimulus package provides an upside risk to the forecasts.
The Newly Industrialised Economies (NIEs) are in the midst of a deep recession. Heavy dependence on exports and close financial integration with the rest of the world have made the NIEs extremely vulnerable. Exports have contracted at an extraordinary pace (Box 3), and industrial production has plummeted as firms run down inventories in response to the rapid fall in external and domestic demand. These economies are expected to contract by 4¾ per cent in 2009, a worse outcome than that recorded during the Asian Financial Crisis. The NIEs are expected to grow by 2¾ per cent next year.
Economic activity in the ASEAN—5 region has weakened significantly in recent months, led by a collapse in exports. Elevated borrowing costs and disrupted access to funds also remain concerns. The Thai economy continues to be weighed down by political turmoil, with reduced tourism and foreign investment likely to hinder the recovery. While growth in Indonesia and Vietnam has slowed significantly, their growth in 2009 and 2010 is expected to be relatively stronger than the other economies.
The Indian economy's recent strength is subsiding, with significantly weaker growth forecast over the next two years. Industrial production is declining at a rapid pace as the demand for manufacturing exports is drying up. The vibrant services sector, a major driver of economic growth in recent years, is unlikely to shield the economy from the corrosive impact of escalating job losses, shrinking foreign investment and deteriorating confidence.
Box 3: Asia's trade
Global trade is expected to shrink by 11 per cent in 2009, the first fall since 1982. If realised, this will be the sharpest fall in world trade in the post‑war period, with Asia expected to account for most of the decline.
Exports from Asia have fallen sharply since September 2008 (Chart A). According to the IMF, merchandise exports in the region fell by 70 per cent in annualised terms between September 2008 and February 2009 — 1½ times worse than the 2001 global downturn and three times as bad as the Asian Financial Crisis.
Chart A: Export growth
- Calculated using export trade weights.
Note: Data are 3-month moving average.
Source: CEIC Data.
Three factors explain why the region's trade declines in recent months were worse than in past downturns. First, the speed and force of the recession drove world demand down to unprecedented lows.
Second, the drop in global demand disrupted Asia's integrated web of trade linkages, production networks and supply chains. Third, as credit conditions deteriorated, access to trade finance became more difficult.
The current fall in trade appears more synchronised across Asia than in past recessions. This partly reflects growing trade interdependence in Asia. China's role as a hub for processing is critical, with the NIEs and ASEAN‑5 economies reliant on sending their intermediate inputs to China for final assembly. Between September 2008 and February 2009, the IMF estimates that exports from the region to China fell at an annualised rate of 80 per cent.
As most manufactured exports from Asia ultimately end up in the US or Europe, exports are very susceptible to abrupt changes in discretionary spending in advanced economies. Recent falls in demand from advanced economies were quickly transmitted to final goods producers in China, and then to parts and components suppliers in the NIEs and ASEAN‑5 economies.
Asia's heavy reliance on external demand will have a significant impact on Australian exports, over 60 per cent of which are to Asia. This, coupled with the sharp fall in commodity prices, will have adverse effects on Australia's national income.
When the global economy recovers, the growth trajectory of Asia's trade could be lower for many years. Global demand will be weaker and there is a risk that trade protectionism may rise. The extent to which domestic demand can be built up, thus boosting the share of final demand met in the region, will also influence Asia's trade prospects.
The most significant downside risk to the world economic outlook is around the possibility of an intensification of the adverse feedback loop between the financial system and the real economy in advanced economies. The mutually reinforcing nature of faltering economic activity and tightening financial market conditions is already apparent, with the ferocity of the global recession adding to, and being augmented by, the ongoing distress in the financial system. This feedback loop could become even more debilitating, and hamper production, trade and employment in hitherto unaffected regions and industries. If the current influenza outbreak were to worsen, this could negatively affect already fragile confidence in international financial markets.
Capital scarcity in emerging economies represents another key risk to the world outlook. Net capital flows to emerging markets have fallen to a fraction of their pre‑crisis levels, and for these economies, problems in rolling over loans could further weaken economic activity and dent fragile confidence. A prolonged slump in global demand remains the key downside risk to the outlook for Australia's major trading partners in Asia.
On the other hand, should the substantial policy measures already in the pipeline restore stability in financial markets earlier than anticipated and boost consumer and business confidence, then the substantial global macroeconomic stimulus could present upside risks to the growth forecasts.
Even when growth returns, the recession will leave a legacy of significant policy challenges across the world. The extraordinary measures being taken to combat the current crisis will have to be unwound carefully.
As households and firms continue to repair their balance sheets, domestic demand in many advanced economies, including the US, will grow at a slower pace than in the recent past. This in turn could lead to excess capacity in export‑oriented manufacturing in emerging economies, restraining investment and creating a strong premium on policy settings that support private consumption.
The global output gap will continue to widen into 2010, and deflationary forces will continue to mount. However, the substantial monetary and fiscal policy responses will act to limit the risk of substantial deflation becoming entrenched. Unemployment, already rising sharply, will remain high beyond 2010. With double‑digit unemployment rates and markedly weaker fiscal positions in many economies, there is a risk that protectionist tendencies will surface.
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