Thursday, 29 January 2009

It is still downhill from here

IMF's most recent revision of the global growth estimate came as a surprise to many. However, it was largely in line with our position in December – namely that the market consensus regarding economic growth in 2009 was way too optimistic. IMF has now confirmed this view with a strong downwards revision of the global growth from the previously expected 2.2% to 0.5%. We believe that this view will have to be revised downwards once again.

There were, however, several interesting points. One is that the UK economy is now considered basketcase #1 in the industrialised world. Household debts to mortgage institutions (-banks) and credit card companies are worse than is the case in the US. The housing market is probably even more inflated than elsewhere, and adding insult to injury, both current account and public sector were heavily in deficit as the crisis struck. Forecasting a contraction of 2.8% in 2009 still appears a bit on the positive side, but rightfully places UK among the hardest hit economies.

The forecast for USA of a modest 1.6% negative growth in 2009 followed by positive growth of the same magnitude in 2010, however, indicates some kind of heavy meddling from political circles. A number of respected US economists have estimated that the accumulated contraction in output would end up anywhere between 5 and 10% over a three year period. We know that 3rd quarter 2008 was bad for the US economy and that 4th quarter was even worse. But probably they did not add up to anything that would bring the combined fall in output anywhere near 5% in 2008 and 2009. US consumers have already redressed their savings rate considerably, as fears for the future have driven many away from spending on holidays, new cars and so on. But it is not enough to save the economy from a severe downturn. The overhang of bad debt is worse than in the UK, so even a hike in households' savings rates, a period of sub-par growth is highly likely.

Germany also finds a place among the laggards, with an expected contraction in output of no less than 2.5% per cent in 2009 and almost zero in 2010. Main driver for this collapse is of course the exports, which are being hit hard by the rapidly shrinking international trade flows.

China and other east Asian nations have been held out by many as the best hope for a growth pole, able to pull the global economy. This idea is also being reviewed now, and the result is not nice. China and India will both see significant slowing in 2009. Even if the growth numbers for these countries are dodgy, the hope that the domestic demand in those two countries would "replace" falling consumption in the developed economies is now off the table.

While all of this is interesting, there are a couple of things that deserve mention. The noble art of making growth forecasts always implies making a number of heroic assumptions regarding the behaviour of governments and other background variables. In this case, these variables deserve some extra assumptions. IMF is in commendably clear about some background variables. It assumes that political efforts to solve the banking crisis will eventually bear fruit. And that the various stimulus packages in fact arrive on time and have the desired effects on domestic demand.

It is probably exactly on this point where the IMF report has its weakest point. For political reasons, IMF cannot at this point in time begin to publicly vent doubts that the various programmes or policy packages will not work. With the most recent near-panic in the UK banking sector and the slow deterioration of credits worldwide, it appears we are entering a phase where it will be clear that the good money so far thrown after the bad money will not have the desired effect. The stimulus packages so far are far from being enough to lift the economies out of the slump, but IMF cannot make a blanket criticism of the programs.

In this way, the IMF forecast is an important statement to politicians that things are continuing to go downhill, but as regards the actual forecasts it is very likely to be more politically correct than anything else.

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