Prospects for 2013 and Beyond: Recovery and Recession in a Divergent Outlook

Citi GPS Opinion Article

27 November 2012 – We expect that 2013 will be another year of modest global growth, a little below its long-run average, with sizeable divergences between regions and individual countries. Our base case is for global growth of 2.6% in 2013 and 3.1% in 2014 (at current exchange rates), after growth of just 2.5% in 2012. Our forecasts are a little below the consensus and IMF forecasts (the IMF expects global growth of 2.9% in 2013 and 3.5% in 2014 at current exchange rates). But, we do expect modest near-term growth to give way to faster expansion subsequently, with real global GDP growth of 3½%-4% year-on-year in 2015-17 (although our forecasts for later years also are a bit below the IMF’s). Against this backdrop, major central banks probably will continue to keep policy loose in the near-term, and generally loosen further in 2013, with tightening not likely until 2015 in the US and rather later in Europe and Japan.

Over the last five years, global growth has been heavily China-dependent, and China’s growth has been heavily investment-dependent. In all, China’s GDP accounted for 45% of global growth in 2008-12 and an even bigger share including the spillovers from China’s expansion to other countries. China’s economy is now transitioning to a slower growth path of about 7% per year, with a marked pick up in consumer spending. China will likely remain a global powerhouse , with real GDP doubling every ten years or so and directly accounting for about a third of global growth in 2013-17. Nevertheless, this impetus will be supplemented by a gradual but powerful renewed acceleration in US growth. In addition, we expect consumption and investment will grow rapidly across many emerging markets in coming years, especially in Asia and the Middle East, reflecting policy loosening plus background drivers of rapid growth of middle-income consumers, urbanization, plus major infrastructure projects by cash-rich governments and state-linked bodies.

Same crisis, different recovery paths

Although the global financial crisis of 2007-09 hit both the US and Europe, we expect very different recovery paths, reflecting differing policy choices in managing the deleveraging process, plus underlying differences in terms of the economy’s potential growth and the availability of energy. In 2012, US real GDP growth outperformed the euro area by about 2¾%, the widest gap since 1993. We expect similar sustained US outperformance in coming years. With improving private sector balance sheets and falling energy costs, we believe that — provided near-term fiscal tightening is gradual — US growth will gradually transition to 3%+ from late-2013 and into subsequent years. US real GDP per head probably will regain its 2007 level in 2013 or 2014, and rise about 9-10% above the 2007 level by 2017 — clearly outperforming Japan’s “lost decade” (real GDP per head rose by 5% from 1992 to 2002).

By contrast, we expect continued recession in 2013 and 2014 in the euro area and prolonged weakness thereafter — with ongoing financial strains and, over the next few years, Grexit plus a series of sovereign debt restructurings. In the euro area and the UK, real GDP per head will probably remain 3-4% below the level achieved in 2007 through at least 2017, with a greater shortfall in many periphery countries — markedly underperforming versus Japan’s “lost decade”. The European economies still have underlying potential to grow: but, we expect that private sector deleveraging, a weak banking system, early fiscal austerity and financial strains resulting from flawed EMU structures will continue to cap demand for an extended period.

The main uncertainties in the global outlook concern the interplay between high private sector debt levels and the high fiscal deficit levels across many advanced economies. Our base case assumes the US will manage a “goldilocks” policy transition, with gradual fiscal tightening kicking in as private deleveraging eases. If fiscal consolidation is excessively deferred, then bond yields could back up sharply, especially as private savings fall. Conversely, as Europe’s experience has shown, aggressive early fiscal tightening could tip the US economy back into stagnation, or worse. In Europe, we assume that in the near-term, as recently, creditor nations will continue to do just enough — through official support — to prevent the EMU from disintegrating, but not enough to return the periphery countries to sustainable fiscal paths. Eventually, we expect Grexit and a series of sovereign debt restructurings, alongside moves towards tighter integration among EMU countries.

Current account surpluses/ deficits likely to change globally

The aggregate current account surplus of emerging market countries is likely to vanish in coming years as the growth of domestic demand and imports continues to outpace that of advanced economies. However, sizeable imbalances probably will remain and some new ones will develop. We still expect that China will continue to run current account surpluses in coming years, while in aggregate other emerging market countries will run modest deficits. At the same time, the US will probably remain in a current account deficit, while in the euro area, like Japan, sluggish domestic demand will probably produce persistent current account surpluses and capital outflows. By and large, we do not expect current account imbalances to be a major destabilising factor in the global outlook, but there may be strains in some individual EM countries.

For more information, please refer to the report Global Economic Outlook and Strategy : Prospects for Economies and Financial markets in 2013 and Beyond, dated 26 November 2012 on Citi Velocity