As reported at Budget, the world economy recorded its fastest growth rate in over 30 years in 2006. World growth remained strong in the first half of 2007, although recent disruptions in global financial markets have resulted in a more uncertain outlook. While continued robust growth in emerging market countries, particularly China and India, is expected to underpin global growth in the coming period, downside risks have increased and require careful monitoring.
Growth in China and India accelerated over the first half of 2007, continuing to exceed expectations. Growth has also been exceptionally strong across other emerging market economies in Latin America, Eastern Europe, the Commonwealth of Independent States and sub‑Saharan Africa, with high commodity prices supporting economic activity in a number of these regions. Demand from these regions has fuelled export growth in major developed economies, in particular the euro area and Japan. Growth in the United States has remained constrained by weakness in its housing market and a recent tightening in corporate credit conditions. A return to trend growth for the US in 2008, as expected at Budget, now appears unlikely.
The world economic growth forecasts for 2007 remain unchanged at 5 per cent and have been revised down slightly to 4¾ per cent in 2008 (Table 4). The downward revision in 2008 reflects a weaker outlook for the United States.
In contrast, major trading partner growth has been revised up by ½ of a percentage point to 5 per cent in 2007 and by ¼ of a percentage point to 4¾ per cent in 2008. This upward revision is largely due to higher‑than‑expected growth in China and India, and the other East Asian economies in the first half of 2007, and an expectation of continued strong growth for China and India in 2008. The upward revisions more than offset a downward revision to the outlook for the US economy over both years. In the absence of the forecast deeper slowdown in the United States, economic growth in emerging economies would likely have been stronger than currently forecast.
Table 4: International GDP growth forecasts(a)(b)
- Percentage change from preceding year.
- Growth rates for the World and euro area are calculated using GDP weights based on purchasing power parity, while growth rates for major trading partners and other East Asia are calculated using export trade weights.
- Other East Asia comprises the newly industrialised economies (NIEs), which constitutes Hong Kong, Korea, Singapore and Taiwan, and the Association of Southeast Asian Nations group of four (ASEAN4) which constitutes Indonesia, Malaysia, the Philippines and Thailand.
Source: National statistical publications, IMF and Treasury.
Recent financial market developments present a significant downside risk to the favourable world outlook. Continued deterioration in the US sub‑prime mortgage market, and concerns over exposures to financial securities backed by sub‑prime mortgages, have triggered a repricing of risk, a flight to liquid financial assets and a tightening in corporate credit conditions across global markets. The flight to liquid assets has generated a large rise in the spread between policy rates and inter‑bank lending rates.
Major central banks have responded by injecting large amounts of liquidity into banking systems. Further, at its September meeting, the US Federal Reserve lowered the target for its main policy rate, the federal funds rate, by 50 basis points to 4.75 per cent. The Fed noted that its action was 'intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets'. Other major central banks have adopted a 'wait‑and‑see' approach with regard to their policy rates. Prior to the recent financial market turbulence, the European Central Bank, the Bank of England and the Bank of Japan had all been expected to raise rates further this year.
Developments in the US sub‑prime mortgage market have the potential to cause further disruption in global financial markets. With a large number of outstanding sub‑prime mortgages originated over 2005 and 2006, in the latter stages of the US housing boom, arrears and defaults could increase throughout the remainder of 2007 and into 2008.
While there are some pressures to headline inflation around the world from sharp increases in food and fuel prices, core inflation generally remains contained. Crude oil prices (West Texas Intermediate) have trended upwards since May this year, underpinned by increasing demand from US refiners. Global oil markets remain tight, which could lead to further rises in oil prices and consequently add to global inflationary pressures.
The recent financial market turbulence increases the possibility of a recession in the United States in 2008. Notwithstanding this possibility, most forecasters continue to expect modest growth. We now expect the US economy to grow by 2 per cent in 2007, ¼ of a percentage point lower than at Budget, and 2¼ per cent in 2008, ¾ of a percentage point lower than at Budget. These forecasts factor in some impact from the repricing of risk on housing and consumption.
The US labour market has shown signs of gradual softening over the past year. Nevertheless, continued employment growth, together with solid growth in personal incomes, has supported ongoing consumption growth. In addition, business investment appears to be firming, with high corporate profits and capacity utilisation rates likely to support further investment. US exports have been growing at a strong rate over the past year and robust world growth is likely to support a further expansion into 2008.
The economic outlook for Japan is unchanged since Budget, with growth of 2 per cent expected in both 2007 and 2008. The 2007 outlook reflects solid, but slowing, business investment growth and firm export growth. In 2008, a modest improvement in consumption and continued support from exports is expected to offset a moderation in the pace of business investment. A key challenge remains to generate and sustain rising consumer prices, something that has been absent from Japan for a decade.
Economic growth in China has exceeded expectations since Budget, driven largely by a pick‑up in investment and net exports. Growth for 2006 was also revised up from 10.7 per cent to 11.1 per cent. The Chinese economy is now forecast to grow by 11¼ per cent in 2007 and 10½ per cent in 2008, upward revisions of ¾ and ¼ of a percentage point since Budget.
Strong GDP growth, along with a recent surge in consumer prices, has seen increasing concern about the sustainability of China's growth. However, economic fundamentals in China remain relatively favourable, with growth more broadly based than in earlier periods. Investment growth appears more sustainable, company profits are strong and domestic consumption is increasingly contributing to growth. In addition, core inflation remains subdued, with little evidence of wider price pressures.
Economic conditions in India have also been stronger than expected, with growth revised up to 9.6 per cent in 2006. The stronger growth has continued into 2007, driven by strong domestic demand, particularly from the service and industry sectors. The Indian economy is now forecast to grow by 9¼ per cent in 2007 and 8½ per cent in 2008, a little higher than expected at Budget. The expected mild slowing in 2008 reflects a moderation in domestic demand, partly due to a recent tightening of monetary conditions by the Reserve Bank of India.
Expectations for growth in the rest of East Asia have been revised up slightly since Budget, with the 2007 and 2008 forecasts both higher by ¼ of a percentage point to 5¼ per cent. Since Budget, growth has converged across the region due to stronger‑than‑expected consumption and investment in the NIEs. Growth in the rest of East Asia is now forecast to be supported by solid domestic demand in 2007 and a slight pick‑up in exports in 2008.
Expectations for euro area growth in 2007 have improved modestly since Budget, with the 2007 forecast revised up by ¼ of a percentage point to 2¾ per cent. Although GDP growth fell below trend in the June quarter, it is expected to rebound over the remainder of 2007. In 2008, growth is expected to moderate to 2¼ per cent, reflecting the impact on domestic demand of previous monetary tightening and slightly slower export growth, reflecting the high euro exchange rate.