
Table 1: International GDP growth forecasts(a)
World outlook
As the global financial crisis intensified in September 2008, strong global and financial integration combined to produce a very sharp decline in world trade and production, with global GDP collapsing in the December quarter 2008. The decline in global GDP in that quarter exceeded already pessimistic expectations, and was the largest recorded decline in the post war era. Recent indicators point to another large decline in global GDP in the March quarter, although at this stage, the decline is unlikely to exceed the magnitude of the December quarter.
Against this backdrop, and in light of continued financial market distress, low levels of confidence, and the apparent limited effects thus far of recent policy responses to restore the health of the financial system, growth forecasts for 2009 have been marked down for every country (Table 1).
Global GDP is now forecast to contract for the first time in sixty years, by 1¼ per cent in 2009. Compared to UEFO, the current forecast for 2009 is a substantial downward revision of 1¾ percentage points (Chart 1).
No economy has emerged unscathed from the effects of the global financial crisis. Within our major trading partners economies, advanced economies are expected to bear the brunt, with deep contractions forecast this year, particularly in Japan. China is forecast to grow at a below-trend pace, but will be the main source of growth in 2009. In other emerging economies, growth will be impeded by a combination of weaker external demand and lower commodity prices as well as the associated negative spillover effects on domestic demand.
Chart 1: World GDP growth
Source: IMF and Treasury.
The massive macroeconomic stimulus, on both the monetary and fiscal fronts, as well as measures to shore up bank balance sheets and restore credit flows should help the global economy eke out a gradual recovery in 2010.
However, any self-sustaining recovery is conditional on the success of comprehensive policy steps in stabilising financial conditions, a gradual improvement in credit conditions, a restoration of global trade flows, as well as a bottoming in the US housing market and a marked lift in confidence. The deleveraging process will continue, acting as a substantial headwind to the economic outlook.
Notwithstanding the significant global policy response, the global financial crisis shows little sign of abating in the near term. Global stock markets have fallen around 50 per cent since their peak, while indicators of stress in money and credit markets - both inter-bank and corporate bond spreads - remain elevated.
Ongoing pressure on bank balance sheets suggests that conditions are unlikely to normalise anytime soon. Much depends on the success of policy responses aimed at removing toxic assets from the balance sheets of US and European banks.
According to the IMF, losses for financial firms worldwide will ultimately reach US$2.2 trillion, and the IMF estimates that US and European financial institutions are likely to experience a net capital shortfall of at least US$500 billion. While part of this projected capital shortfall may be met from internal sources and from private capital markets, it is likely that further significant injections of public capital will be required.
Risks
The most significant downside risk to the outlook revolves around an intensification of the negative feedback loop between the real economy and the financial system. This would lead to an even deeper and more prolonged recession, and work to delay the projected recovery.
However, should the policy measures prove effective at restoring stability in financial markets and boost consumer and business confidence, the substantial macroeconomic stimuli cascading through the global economy will present upside risks to these below trend growth forecasts.
The global output gap will continue to widen into 2010, and by implication, deflationary forces will continue to mount. With annual inflation likely to enter negative territory in a number of major economies, fears of deflation will intensify, although the massive expansion of the monetary base by central banks will act to limit the risk of substantial deflation becoming entrenched.
When growth returns, the current downturn will leave a legacy of high unemployment and marked deteriorations in fiscal positions in many advanced economies. Thus, policymakers will continue to face significant challenges over the medium term.
Country summaries
The United States economic outlook has deteriorated considerably since UEFO, reflecting weaker economic conditions, a lack of traction for the Financial Stability Plan, a weakening outlook for business investment, and the final fiscal stimulus package being smaller and less front-loaded than originally anticipated. Given this bleak outlook, GDP is forecast to fall by 3 per cent in 2009. Growth is forecast to reach ¼ per cent in 2010 and 1¾ per cent in 2011.
GDP fell by 1.6 per cent in the December quarter 2008, with consumption the largest detractor from growth in the quarter. With rising unemployment, and plunging values of all three major asset classes on household balance sheets - real estate, equities, and non-equity financial assets - the outlook for consumption remains weak.
The labour market continues to deteriorate at an alarming pace, with payrolls falling sharply and the unemployment rate rising rapidly. The number of jobs lost so far in this recession already exceeds the total in each of the previous two recessions.
Meanwhile, credit conditions are extremely tight, adding to the bleak consumption outlook for the first half of 2009. Some recovery in consumption is expected in the second half of 2009, due to the tax credits from the fiscal stimulus, and the flow on effects of the creation of a projected 3.5 million jobs.
Business investment weakened significantly in the December quarter, reflecting the strong decline in the equipment and software component. The structures component also declined in the December quarter for the first time since 2005, and is expected to weaken further in coming quarters. Business investment is not expected to recover until mid-2010 due to an intensification of the adverse macro-financial feedback loop.
The slump in the housing market continues, with the large oversupply of homes adding further downward pressure to house prices. House prices have fallen by 27 per cent since their peak in mid-2006 according the Case-Shiller house price index and futures markets anticipate a further 8 per cent fall by May 2010. Given the fall in prices and massive oversupply, building permits have plummeted suggesting residential investment will detract from growth for some time yet. A recovery is not expected until the second half of 2010.
While the US outlook is bleak, there is some upside concerning the fiscal stimulus package. Our current estimates of the fiscal stimulus's impact on consumption may be conservative, especially in 2010. Should financial market policies restore trust and confidence, then the impact of the stimulus will be bolstered.
The Japanese economy remains in deep recession, with few signs that the pace of contraction has abated over recent months. Japanese exports and industrial production have suffered an astonishing collapse on the back of depressed global demand and the strong yen, highlighting the country's reliance on export-led growth. J
apanese equity markets are now at over 25 year lows and credit conditions have tightened, while business and consumer confidence remain mired at near all-time lows. Consumption continues to provide limited support to growth amid a worsening employment and income situation.
Compared to UEFO, Japan is expected to suffer a deeper and more protracted recession, with GDP forecast to contract by 5½ per cent in 2009 - substantially worse than the previous forecast of a 2½ per cent contraction. A modest return to growth of ¼ per cent in 2010 and ¾ per cent in 2011 is forecast.
Since UEFO, the outlook for China has softened only very slightly, with continued sharp falls in export demand being only partially offset by the impact of fiscal stimulus and strong lending growth. The Chinese economy is forecast to grow by 6¼ per cent in 2009, before recovering to 8 per cent in 2010.
China's export growth has contracted sharply in recent months due to extremely weak global demand - especially from Asia - falling by over 40 per cent in value terms since December 2008. Slower global demand will put further downward pressure on China's exports, while investment growth will continue to be affected by a subdued property market and the flow-on effects of lower export demand. Investment is expected to pick up from mid-2009 as a result of the Government's fiscal measures aimed at boosting infrastructure investment. Growth is expected to be around 8½ per cent in 2011, due to stronger major trading partner growth and the continued effects of the stimulus package.
Sustained weakness in global demand remains a key downside risk to China's forecasts. This, coupled with weak industrial production outcomes, means that more stimulus measures may be needed if the Chinese Government wants to meet its target of 8 per cent growth in 2009. However, there have been signs that the stimulus package is already flowing through to the Chinese economy. Loan growth surged over December and January, while investment in transport-related infrastructure, a large part of the stimulus, has risen sharply.
The resilience of the Indian economy is fading rapidly. Growth of only 3¼ per cent is now forecast for 2009 before a slight recovery to 4¼ per cent in 2010. Industrial production is in sharp decline as demand for India's manufacturing exports has dried up. India's vast services sector, having provided strong support to growth in recent years, will now struggle to stave off the compounding negative impacts of mass job losses, diminishing foreign investment, tight credit conditions and waning business confidence.
The capacity of the Indian Government to respond to falling growth is also very limited. Debt levels are high, promoting warnings of a looming downgrade of India's credit rating to below investment grade. Monetary policy also can provide only limited relief owing to low levels of household indebtedness and the limited capacity of India's domestic financial institutions to substitute for competitive foreign sources of credit.
The economic outlook for the Newly Industrialised Economies (NIEs) has continued to worsen amid the ongoing fall out from the global recession. The NIEs' heavy dependence on exports and their close financial integration with the rest of the world has made them extremely vulnerable.
The value of exports for the NIEs fell by 34 per cent through the year to January 2009, a trend that is likely to continue through most of the year, although the magnitude of the decline should begin to ease as the year progresses. Industrial production has also plummeted as firms ran down inventories in response to the rapid decline in external and domestic demand.
GDP for the region is now forecast to decline by 4½ per cent in 2009, with Taiwan and Singapore expected to suffer steeper contractions than during the Asian Financial Crisis. With the global economy expected to stage a modest recovery, growth in the NIEs is forecast to grow by 2¾ per cent in 2010.
Economic activity in the ASEAN-5 region has weakened significantly in recent months, led by a collapse in exports against a backdrop of constrained global financial markets. GDP is forecast to decline by ¾ per cent in 2009 before strengthening to 3¼ per cent in 2010 and 4¾ per cent in 2011.
Exports are expected to contract further in line with weaker major trading partner growth, investment is expected to remain weak as borrowing costs and access to funds remain challenging, while consumption is also expected to moderate sharply. Growth is forecast to strengthen towards the end of 2009 and into 2010 as external conditions begin to improve and fiscal stimulus measures begin flowing through the economies.
The outlook for the euro area has deteriorated significantly since UEFO. Following a record contraction of 1.5 per cent in the December quarter 2008, GDP is forecast to contract by 3¼ per cent in 2009 and make only a mild recovery, with growth of ¼ per cent in 2010.
The recession in 2009 is expected to be led by investment as a result of deteriorating credit conditions and lower internal demand, and declining export growth in line with sharply weaker global demand. Private consumption is expected to remain weak reflecting low confidence levels, falling employment and negative wealth effects. Predicated on a recovery in the external environment and reflecting the impact of policy actions, a below trend recovery is forecast.
Growth prospects for the United Kingdom have deteriorated markedly, driven by the stress in financial markets. GDP is forecast to contract by 3½ per cent in 2009 - the largest contraction since World War II. A mild recovery is expected in the second half of 2009, conditioned primarily on improvements in the cost and availability of credit.
The recession in 2009 will be broad based, led by a contraction in dwellings and business investment, followed by private consumption. Despite the large depreciation of the sterling, net exports are not expected to provide a significant contribution to growth. GDP is forecast to grow by ½ per cent in 2010.
Forecasts for the New Zealand economy are also gloomy, with the economy facing a protracted adjustment to household balance sheets and the current account. The economy has been in recession since the beginning of 2008, and GDP is forecast to contract by a further 2¼ per cent in 2009.