Special Report Rising East, emerging West

by **hlk** Thu 05 Dec 2013, 13:00

Business & Markets 2013
Written by Standard Chartered Global Research
Thursday, 05 December 2013 11:52
A + A - Reset
WE EXPECT a better 2014, with world economic growth picking up and
inflation staying benign. We expect global growth to increase to 3.5% in 2014
from 2.7% in 2013, helped by improvements in the US and Europe.
A pick-up in growth in the West is good news for the rest of the world, and we
expect emerging economies’ growth to outpace G7 growth by 3.8 percentage
points (ppt). The outperformance of emerging economies is unlikely to subside.
Asia will be strong, but we do not expect it to boom.
We forecast that China’s growth will remain stable at 7.4% in 2014, and that
growth will pick up in most Asian countries. Reform and rebalancing will be in
focus. Elections in India and Indonesia will probably delay structural reforms,
but China’s economic rebalancing — with consumption gaining importance
relative to investment — is moving along.
The Third Plenum set an ambitious agenda for economic and social reform.
Given the objective of giving a greater role to market mechanisms, volatility is to
be expected. Policy will play a key role, as it has since the start of the Great
Recession.
A better growth outlook will make it easier for the US Fed to start normalising
monetary conditions. Tapering of quantitative easing (QE) will probably happen
by June 2014. In the run-up to June, markets will likely become increasingly
volatile; countries with current account deficits will be the most vulnerable.
We see 2014 as a year of broader economic recovery, but with more market
volatility as global monetary conditions are tightened.
Although we expect more aggressive quantitative easing in Japan, this will not
be enough to compensate for the effects of US QE tapering. The re-pricing of risk and the repositioning of markets will likely peak in the
second quarter. While we expect 2014 growth to be better than in 2013, it will be a year of two halves, with a stronger second half (2H)
compared to 1H.
The possibility of policy mistakes — especially in the West, where recoveries are still fragile — is the main risk to our positive outlook.
A more benign economic environment
Recoveries in the US and Europe will be a key driver of higher global growth. Asia and the emerging world have been strong for some
time, despite a weak global economic environment.
In the US, we expect a gradual acceleration in economic activity in 2014, with growth rising to 2.4% from 1.7% in 2013. We expect most of
this growth to come in the second half of the year.
Medium-term prospects for the US economy are positive. Unnecessarily tight fiscal policy, a result of the challenging relationship between
the Democrat administration and the Republican-dominated House, has been the main factor holding back the US economy. Considering that the US recession started in December 2007, stronger growth is long overdue. We expect a less destructive fiscal policy
environment in 2014, with fiscal headwinds subsiding.
Private sector deleveraging should also gradually dissipate throughout the year. In Europe, aggressive fiscal tightening in the south has
been front-loaded, pushing the euro area into recession.
Fiscal conditions should begin to ease, and economies in the south have reduced their deficits and rebalanced.
We therefore expect southern European economies to slowly recover, albeit from a very low base and with unemployment remaining
dangerously high. One of Europe’s main problems was that aggressive fiscal tightening and current account rebalancing in the south were
not offset by fiscal stimulus and a reduction of the current account surplus in Germany. The result was a deep recession, with the
eurozone current account swinging from a small deficit to a significant surplus that reduced private demand not just in the euro area but
also in the world economy.
We expect a moderate improvement on this front. Immigration, rising real wages, a stronger job market and solid public finances in
Germany should support better spending in 2014 and 2015.
We forecast that the eurozone current account surplus will fall to 2% of gross domestic product in 2014 from 2.1% in 2013. Although the
improvement is marginal, the surplus is at least not getting larger.
There are still risks to the euro- zone. Greece, which has a weak coalition government, needs new external funding, and a change in
government is always a possibility. Portugal may also be an important stress point. We expect the euro area economy to recover, with
growth rising to 1.3% in 2014 from -0.4% in 2013. Although this is a positive change, the recovery is fragile and is unlikely to be enough to
significantly reduce unemployment.
Asia to benefit from better global environment
Asian economies have grown strongly in the past few years, despite a weak global environment. Asia will continue to grow strongly in
2014, and the improved global environment is good news for the entire region.
China’s performance will have significant implications, not only for Asia but for the global economy. We expect 7.4% GDP growth in 2014,
following 7.6% in 2013, with the authorities probably targeting a growth rate between 7-7.5%.
In contrast to our outlook for the US and global economies, we expect China’s growth to be stronger in 1H than in 2H, benefiting from
positive momentum from 2013 before slowing moderately in 2H on tighter credit conditions.
In Southeast Asia, Asean economies will find strong support from important structural factors. Their competitiveness against China will
support their manufacturing sectors and attract continued foreign direct investment flows.
Urbanisation, which is usually related to strong growth, still has a long way to go and is likely to benefit from a further pick-up in industrial
activity and improvements in infrastructure.
India’s outlook is more uncertain, and will depend to a large extent on the outcome of the general elections in May 2014. The better global
growth environment and a possible recovery in the investment cycle after the elections should support a gradual recovery. Nevertheless,
growth is likely to remain below India’s potential rate of 6%.
A worker operates a machine to cut a pipeline at a factory in
Qingdao in Shandong province. China’s factory growth held at an
18-month high in November on firm domestic and foreign demand,
defying expectations the economy faces a modest slowdown as
2013 draws to a close.
Solid growth for Africa and most of MENA
The growth outlook for Africa is generally solid, with the exception of South Africa. Sub-Saharan Africa in general should benefit from the
recovery in external environment.
Resource exploration is an important factor, and commodity output gains should compensate for weaker prices in terms of the impact on
growth. South Africa’s growth could receive a boost from the recovery in key trading partners, although domestic economic momentum
remains weak.
Rates of unsecured lending growth have peaked and consumption is sluggish. Oil and gas discoveries in East Africa will be a key driver of
economic momentum. New infrastructure development will also drive growth, and we expect East Africa to outperform.
In the Middle East we expect strong growth in the resource rich Gulf Cooperation Council (GCC) countries.
Although the risk premium in oil prices has declined following a perceived improvement in geopolitical risks in the region, oil prices are
likely to remain above fiscal breakeven levels.
Saudi Arabia’s infrastructure investment is set to continue at a fast pace. Abu Dhabi is also likely to continue to invest in key infrastructure
projects. In Qatar we expect a pick-up in activity, although infrastructure investment related to its hosting of the 2022 FIFA World Cup is
more likely to accelerate after 2015.
Job creation is a challenge throughout the Middle East and North Africa (MENA) region. Oil importers face slower economic activity, rising
fiscal pressures and rising youth unemployment. In the oil-rich GCC, job creation per se is not the problem as economies are booming, but
the challenge is to encourage greater participation of the local labour force in the private sector. The region depends strongly on the
government sector for employment, and this looks unlikely to change in 2014.
Benign inflation
Inflation is likely to remain benign. This is particularly the case in the US
and Europe, where there is considerable slack in the labour markets.
Elsewhere, relatively stable commodity prices and tighter global monetary
conditions should help, although there will be pockets of inflationary
pressure in individual economies in Latin America, Africa, the Gulf and
parts of Asia. These are the exceptions to the overall inflation picture,
and even in these economies, inflation rates are unlikely to reach
worrisome levels.
The important role of policy
Policy works. It can help economies recover faster from a downturn. In
some cases, the wrong policy response can delay a recovery
significantly.
Japan is a success story of how fiscal and monetary policy can work together to encourage a cyclical rebound. Abenomics has worked
well so far, but a sustainable recovery will depend on structural reforms, which are more difficult to implement.
The key event of 2014 will be the US Fed’s expected tapering of QE. Given that the Fed will have a new chairman, and our view that the
US economy will gain momentum in 2H of 2014 rather than 1H, we do not expect the Fed to rush into tapering.
In our view, it will need to see strong evidence that the economy is about to accelerate before it tapers. We expect tapering to take place
by June 2014, a bit later than what the market is currently anticipating.
QE was never the answer to all the challenges the US economy was facing. With policy rates hovering close to 0%, QE was unlikely to
raise growth and encourage job creation. And it did not. It did, however, play an important role.
QE helped the Fed manage future interest rate expectations. A central bank that is implementing QE is highly unlikely to hike interest rates
soon. As a result, long-term market interest rates remained low and this helped some parts of the economy, particularly the housing
market.
With QE being tapered and eventually ending, the Fed will rely mostly on forward guidance to influence market rates, which is unlikely to
be as effective as QE.
We therefore expect market interest rates to move higher in 2014. We forecast that 10-year Treasury yields will be on a sustainable
(although gradual) upward trend above 3%, even though we expect the Fed to start hiking policy rates only in 2016.
The change in US monetary policy will tighten global monetary conditions. This will increase market volatility, especially in countries with
current account deficits.
In some emerging markets, domestic monetary policy will also be tightened. In Asia, we expect broad monetary tightening amid a new
focus on reducing leverage and maintaining capital inflows. We also expect a focus on policy reform in Asia, particularly in China, where
the Third Plenum set the agenda for long-term reforms.
Some of these reforms could start to be implemented in 2014. We expect a stronger push for land and state-owned enterprise (SOE)
reform, a further opening of the capital account, and less intervention in the currency markets.
We believe China’s new leadership is committed to these reforms. They are necessary to the sustainability of China’s growth, but
short-term volatility cannot be ruled out.
Final thoughts
We expect a better 2014 compared with 2013. The economic recovery has so far been limited to emerging economies, and we expect
growth to be broader in 2014. This is also good news for emerging markets, and we expect them to sustain their outperformance relative
to G7 economies. The road will not, however, be free of risks and challenges. The Fed’s expected tapering of QE is likely to cause market
volatility, which may leave economies with large current account deficits vulnerable. — by Standard Chartered Global Research