GDP UPDATE
August 2012
McIlvaine Company
TABLE OF CONTENTS
Massive U.S. government spending cuts and tax hikes due next year will cause even worse economic damage than previously thought if Washington fails to come up with a solution, the Congressional Budget Office warned on Wednesday.
Without action by Congress to avoid a "fiscal cliff," Americans should expect a "significant recession" and the loss of some 2 million jobs, CBO director Doug Elmendorf said in his gloomiest assessment yet.
He said the economy is already being "held back" by the mere anticipation of the fiscal cliff and the uncertainty surrounding it, causing businesses to put off investment and hiring decisions.
"The sooner that uncertainty is eliminated, the better," Elmendorf told a news conference. "The stakes are very high in the fiscal policy decisions we're going to have to make very shortly."
The report from the nonpartisan agency should intensify pressure on Congress and the White House to resolve deep differences over cutting spending or extending tax cuts enacted during the George W. Bush administration.
But chances for a deal before the Nov. 6 election are slim. They could improve during the post-election lame-duck session of Congress, but that's unpredictable as well.
Reactions to the report did not signal any signs of movement by Democrats or Republicans from entrenched partisan positions that form the basis of their campaigns.
"This is a challenging time for America and one thing I will do is I will finally cut federal spending, encourage growth and as a result of those two things get America to a balanced budget," Republican presidential hopeful Mitt Romney said on the campaign trail in Little Rock, Arkansas.
The CBO report, added Amanda Henneberg, a Romney campaign spokeswoman, is "another indictment of President Obama's economic policies that have resulted in overspending, increasing debt and a growing financial burden on the next generation."
White House Press Secretary Jay Carney batted the blame back to Republicans in Congress.
"They're willing to hold the middle class hostage unless we also give massive new tax cuts to millionaires and billionaires -- tax cuts we can't afford that would do nothing to strengthen the economy," Carney said in a statement.
The "fiscal cliff" refers to the impact of around $500 billion in expiring tax cuts and automatic spending reductions set for 2013 as a result of successive failures by Congress to agree on some orderly alternative method of reducing budget deficits.
Failure to avoid it would spark U.S. fiscal tightening on a scale not seen since the 1969 tax increases to pay for the Vietnam War—slamming the economy into recession as it did back then.
The CBO estimated that U.S. gross domestic product under this scenario would shrink 0.5% in 2013, with a crushing first-half contraction of 2.9% followed by a weak second-half rebound of 1.9% growth.
In a May estimate of fiscal cliff effects, the CBO had forecast full-year 2013 GDP growth of 0.5%, with a 1.3% first-half contraction and second-half growth of 2.3%.
The main reasons for the gloomier outlook now are a weaker global economy, the growing uncertainty mentioned by Elmendorf about what Congress will do, and a determination that the cliff is somewhat steeper than previously thought.
The May estimate did not include the effect of expiring payroll tax cuts and the end of extended unemployment benefits. Factoring in the end of those streams of cash to Americans would increase the shock to aggregate demand.
Were Congress to extend all current tax policies and simply halt the automatic spending cuts, as many Republicans have proposed, the CBO said the economy would continue to grow, albeit weakly.
GDP growth under this more optimistic scenario would be modest in 2013 at 1.7%, with an 8.0% unemployment rate compared with 9.1% should the U.S. go over the fiscal cliff.
But it would cause the deficit to remain above $1 trillion for a fifth consecutive year, versus a sharp fall to $641 billion under the fiscal cliff scenario. Elmendorf said keeping deficits this high would greatly increase the chances of a U.S. debt crisis that spikes interest rates higher, dramatically raising all borrowing costs.
The current fiscal year, which ends on Sept. 30, is on track to produce a $1.128 trillion deficit, CBO said -- a slight reduction from its most recent estimate of $1.171 trillion
Part of this reduction was due to lower spending on the federal health programs Medicare and Medicaid.
Helen Fessenden, an analyst with Eurasia Group, which tracks political risks for investors, noted that the CBO report showed some slightly better-than-expected revenue estimates, which could buy the U.S. Treasury a bit more time before the $16.4 trillion U.S. debt ceiling needs to be raised.
Currently, the Treasury expects to reach that limit around the end of the year, but can take extraordinary measures to stretch its borrowing capacity into early 2013.
The next major development on the fiscal cliff is a report due from the White House on Sept. 6 that details programs where the Obama administration plans to concentrate the automatic spending cuts should they occur. Half of the $109 billion in cuts for 2013 will be borne by the military and half by domestic programs.
Chile's seasonally adjusted economic growth picked up in the second quarter from the first quarter to 1.7% buoyed by domestic demand, according to the central bank, but the bank is still seen keeping interest rates steady in the short term.
The economy of the world No.1 copper producer expanded 5.5% in the second quarter, as expected, from a year earlier, propelled by domestic demand, which rose 7.1%, the bank added.
Chile's small, export-dependent economy is bracing for fallout from the euro zone's sluggish economic growth and a cooling in top trade partner China, but many in the financial markets have don't see the central bank cutting interest rates soon due to solid local growth and easing inflation.
"This was within expectations and we don't see major (monetary policy) changes for now," said Matias Madrid, chief economist with Banco Penta in Santiago.
"The central bank remains in wait-and-see mode and we're projecting a hold for what's left of the year."
The Andean country's central bank held its key interest rate steady at 5.0% for a seventh straight month last week.
"All the economic sectors grew, though services, retail and construction can be highlighted," the bank said in its report. In terms of trade, exports showed a small increase, in contrast with dynamic imports."
In addition to producing around a third of the world's copper, Chile exports wine, wood, fruits and salmon. The South American country is particularly at risk from softening global demand for its key exports. The economy in the first half of the year expanded 5.4% compared with the first half of 2011, the bank added.
Chile's posted a $2.442 billion current account deficit in the second quarter. The yawning current account deficit, which was $129 million in the first quarter of the year, is due to brisk domestic demand for imports and falling prices for top export copper, analysts say.
The bank revised first quarter seasonally adjusted economic growth to 1.3% from a previous estimate of 1.4% compared with the last quarter of 2011. It also downwardly revised first quarter year-on-year GDP growth to 5.3% from a previous estimate of 5.6%.
Chile revised down its forecast for economic growth this year to 4.7% from 5.0%, its budget director said.
The Chilean interest rate futures market is pricing in that the central bank will keep its benchmark interest rate steady through November.
China's potential economic growth rate for the next 10 years will likely be around 8%, Li Daokui, a former adviser to the country's central bank, said recently.
That would be below the average GDP growth rate of around 10% that the country has achieved for over 30 years since it began its reform process.
Mr. Li, speaking at a forum, added that China is likely to enter a long period of "relatively high" inflation. The process of urbanization whereby rural populations move to cities is driving up wage rates as well as prices for agricultural goods, he said.
India's slowdown has been faster than expected, with first quarter GDP growing just 5.3%. Analysts have lowered their FY2012 growth projections and ratings agencies have threatened to downgrade the country to junk territory.
Citi analyst Rohini Malkani thinks India's GDP growth is likely to "skid to a ten year low" for five key reasons:
1. "Drought fears are coming true": Malkani has lowered her FY13 growth forecast to 5.4% and FY14 forecast to 6.2%. And if drought conditions worsen growth could drop to 4.9% this year.
2. Politics and policies are deterring investments: Malkani thinks in the last 1.5 years markets have become "increasingly disillusioned with the pace of reform, with a number of investment projects stalled and corruption allegations tainting the incumbent government." And the emergence of regional parties and Congress' dismal performance in state polls means they're starting to play it safe with their politics and economic policies.
3. Power outages are impacting growth: The recent power outage that left 50 percent of the country in darkness, and "anecdotal evidence of worsening power shortages" are all impacting growth. What's more, notified power cuts are at record highs and do not cover a massive chunk of the country that isn't connected to the power grid.
4. Consumer confidence is low and could impact consumption: Unlike the slowdown in investment which is well recorded, declining consumer confidence shows that consumption which has been stable could slow too.
5. The weakness in the rupee isn't helping exports, and exports are impacted by global demand: The share of exports in GDP has increased and while the weakness in the rupee would be expected to boost exports, the composition of India's exports is dominated by high-value goods, so the weaker rupee is unlikely to have a major impact. Rather exports will be affected by global demand. Export growth is expected to be soft in coming months.
But it isn't all bad, India still has a domestic demand driven economy, its demographics are strong and it still has a high savings rate. The unwillingness of the political class to implement much-needed reforms has however left investors expecting 5 - 6 percent growth in the next two years.
Indonesia has a huge population of nearly 240 million, with a median age of 28. The country has the largest economy in Southeast Asia and has enjoyed strong economic growth for almost a decade. For the last five years, gross domestic product (GDP) growth has averaged about 6%, based mainly on consumption and infrastructure investment.
Infrastructure investment is an important driver of the Indonesian economy. The government has been trying to jump start the sector this year, but legal issues have stood in the way.
However, a major hurdle was recently removed when Indonesia President Susilo Bambang Yudhoyono signed an implementation directive for a wide-ranging land reform bill. This action should overcome obstacles that have blocked the government’s efforts to acquire land, finally paving the way for major infrastructure development plans that have been stalled.
The implementation directive clearly outlines steps for land acquisition and introduces special tax incentives to encourage landowners to voluntarily participate in the land clearance process.
Indonesia’s infrastructure is one of the worst in Southeast Asia. Investment in infrastructure not only helps the economy over the long haul, but also generates substantial construction work for thousands of local workers.
Bank Indonesia, the country’s central bank, recently announced a widening of the current account deficit in the second quarter to US$6.9 billion, or 3.1% of GDP. Regardless, this worrisome development did not precipitate any tightening in monetary policy. Bank Indonesia acknowledged that its loose policy has helped widen the deficit, but the weak global economy is compelling the nation’s policymakers to err on the side of stimulus, especially as oil prices subside.
For now, the central bank will support the country’s currency and local financial markets by deploying some of its US$107 billion in reserves. The reasoning is that financing the deficit will become easier, as the economy grows.
Meanwhile, the latest government budget recently passed by Indonesia’s Parliament pumps an extra US$2.7 billion in spending for roads, bridges and other fixed capital investments in six provinces in eastern Indonesia, from now into 2013. The Jakarta administration also is in the process of awarding contracts for the construction of the first Mass Rapid Transit line that will be 111 kilometers long and cost US$1.5 billion.
The combination of large public sector funds allocated to infrastructure, combined with government initiatives to stimulate private sector spending, should provide a massive boost that results in a multiyear boom for the domestic construction industry.
Indonesia’s spending on infrastructure still remains below that of its neighbors, providing plenty of room for future spending. Despite the sharp projected increase in infrastructure capital expenditures, the government’s spending is only expected to rise to US$18 billion per year, representing a mere 2% of Indonesia’s GDP. Malaysia, with an economy one-third the size of Indonesia’s, plans to spend almost an equal amount of money on infrastructure development during the same period.
Under Indonesia’s economic plan for 2011-2014, infrastructure has been targeted as requiring up to US$191 billion, for the economy to grow at its full potential. Local as well as foreign investors are eager to get in on this activity; annual returns from investing in such projects as toll roads and power utilities are expected to reach 20%.
The Indonesian stock market has been a relative underperformer this year among its Asian peers. This isn’t surprising, because the market has been a huge outperformer in 8 of the past 10 years and cheaper markets have been trying to catch up.
That said, the view here is that the country’s infrastructure spending will serve as the new growth catalyst for both its economy and stock market.
Asian markets were mostly lower after news of slower-than-expected growth in Japan's economy and as evidence mounts of a worsening slowdown in China.
Preliminary data showed that Japan's economy grew an annualized 1.4% in the April to June quarter, far short of the 2.7% average forecast of economists surveyed by Dow Jones Newswires, as the global slowdown and the European debt crisis hurt exports.
The Japan data is the latest sign of struggling economies in Asia, coming hard upon China's report last week of disappointing industrial and trade data. Although the recent data has raised hopes that China will take policy measures to boost growth, that seemed to encourage only the Australian market. The rest of the region mostly took a break following recent gains.
United Overseas Bank (Malaysia) Bhd has raised its forecast for Malaysia's full year gross domestic product (GDP) for 2012 to 5.0%, up from 4.3%.
UOB Group's head of research and investor relations Jimmy Koh said Malaysia's economy "is on track to deliver full-year growth at the top of the official forecast range of 4.0% to 5.0%".
He added the government's investment plans for nation building activities under the Economic Transformation Program (ETP) would continue to support domestic demand.
Commenting on the first half of 2012, he said strong domestic activity and sustained fixed investment in the first half compensated for slower export growth affected as a result of weaker demand from the Eurozone and the U.S.
As for the ringgit, he said there was some volatility in its trading against the US Dollar in the second quarter, due to problems in the Eurozone.
"While the markets have settled somewhat recently, the ringgit could face renewed downward pressure over ongoing Eurozone concerns," he said.
Koh said a thriving domestic economy and a steady interest rate outlook in Malaysia would be positive for the ringgit even though the global risk environment hinged on Eurozone developments.
"We expect the ringgit to edge lower against the U.S. dollar and reach RM3.15 by the end of the year," he said.
Thailand's economy grew a stronger-than-expected 3.3% in the second quarter from the previous three months as it continued to recover from last year's devastating floods, helping it withstand the global slowdown for now.
Given the recovery, economists said there was no pressing need for the central bank to cut interest rates. Most expect it to leave policy on hold all year after cuts in November and January to help industry deal with the disaster.
The second-quarter figure reported by the National Economic and Social Development Board (NESDB) was higher than the 1.7% expected in a Reuters poll, and came after a revised record 10.8% expansion in the first quarter, when economic activity started to rebound from the floods.
"Second-quarter GDP increased because factories were able to increase their manufacturing capacity, although that is not back to full potential yet," Arkhom Termpittayapaisith, secretary-general of the NESDB, told a news conference.
A high number of tourists also helped in the second quarter, the NESDB said.
"Domestic demand remained strong and is providing enough cushion against global economic risks, at least for the near future," said Usara Wilaipich, an economist at Standard Chartered in Bangkok.
Elsewhere in Southeast Asia, growth in Indonesia and Malaysia was also surprisingly buoyant in the second quarter, with strong domestic demand and government spending offsetting weaker exports, though Singapore's trade-reliant economy shrank.
Despite external uncertainty, the NESDB said it expected the Thai economy to grow 5.5-6.0% this year, little changed from the 5.5-6.5% predicted in May, betting on domestic demand and further recovery in the manufacturing sector.
"The agency has trimmed the higher end of the forecast because exports to Europe have been affected," Arkhom said.
Exports fell in June and were forecast by a Reuters poll to drop again in July.
The NESDB cut its export growth forecast for 2012 to 7.3% from 15.1%. Arkhom said that was also due to lower rice exports as a result of a government intervention scheme that has made prices uncompetitive.
Even so, reflecting the unusual post-flood situation and the steady recovery in industry, exports in the second quarter were much improved from the first. They were only 0.4% lower than a year before after a drop of 4% in January-March.
The government has introduced measures to help firms cope with the floods, and demand has benefited from policies promised during last year's election, such as big wage increases and the rice intervention scheme, which will boost income and spending.
German gross domestic product (GDP) rose 0.3% in the second quarter of 2012, following a 0.5% increase in the previous quarter, according to data from the Federal Statistics Office. This result was in line with analysts’ expectations.
Compared with the previous year, German GDP increased 0.5% in the second quarter, after growing 1.7% in the first quarter.
The nation's economic expansion in the quarter was driven by exports and household spending, the data shows, which offset the drop in capital demand and construction spending. Exports rose 2.5% from the first quarter and private consumption increased 0.4%.
The Federal Statistics Office also said German the budget balance posted a surplus of 8.3 billion euros ($10.4 billion), worth 0.6% of GDP, in the first half of the year. This was the first time since the first half of 2008 that the nation's public finances have been in the black.
Meanwhile, the Markit preliminary composite purchasing managers' index (PMI) for Germany indicated that private sector output fell at faster rate during August, as a renewed contraction in services offset slower drop in manufacturing activity. The 47.0 reading, down from 47.5 in July, signaled the steepest rate of private sector output contraction since June 2009.
Earlier this week he Bundesbank warned that growth may slow further in the second half due to prevailing uncertainty.
Mainland Norway grew at a slower pace in the second quarter, in line with economists' expectations, data released by Statistics Norway revealed.
Gross domestic product increased 1% quarter-on-quarter, following a revised 1.2% growth in the first quarter. Economists were looking for a 1% expansion.
Strong growth in the supply of electricity contributed in isolation to an increase of 0.3 percentage points in the growth of the mainland economy, the agency said.
Overall GDP grew 1.2% sequentially in the second quarter, after increasing 1.5% in the previous three months. Economists had forecast 1.3% growth.
Russian GDP growth in percentage terms surpassed Brazil in the first half of the year. And while this is no surprise, and the market still prefers Brazil’s diverse economy over Russia’s any day of the week, Brazil is now dead last in terms of economic growth in the big four emerging markets.
Russian statistical agency, Rosstat, said the economy grew 4.4% in the first half, on par to what the government is hoping for by year’s end. Meanwhile Brazil’s economy grew by around 1% in the first half of the year. India is also sluggish, growing under 6% and China’s GDP is consistently being revised downward from 8% for the year to around 7.5% to 7.9% by most economists’estimates. In April, the Russian Economic Development Ministry cut its forecast for Russia’s economic growth in 2012 from 3.7% to 3.4%, suggesting expectations for a worsening second half.
Economic Development Minister Andrei Belousov has previously said Russia’s economic growth in January-June 2012 was facilitated by a fast rise in investment and rapid output expansion in manufacturing. But July’s latest investment data shows investors have soured early.
The release of July economic indicators showed investment slowed to 3.8% year over year from 4.7% in June, and was below the 5.5% year over year consensus forecast. Retail sales also disappointed at 5.1% versus consensus of 6.2%. It was 6.9% in June. Real wage growth moderated to 10.2% year over year (consensus was 11.2%), while the initial June data was revised down to 10.2% from 12.9%.
On the positive side, unemployment remained at a record low 5.4%. Earlier reported industrial production also showed signs of an improvement to 3.4% year over year in July from 1.9% in June.
“Despite weaker-than-expected consumer and investment data, however, we believe it is too early to revise our 2012 GDP growth forecast lower,” said Vladimir Pantyushin, an economist at Barclays Capital in Moscow. BarCap has a GDP forecast of 4.3%
Pantyushin said that Russia’s real wage growth of above 10%, despite a surge of inflation in June-July, provides a solid basis for retail sales growth in the coming months.
As measured by the equity markets, Russia is the second best performing BRIC, but is still underperforming the MSCI Emerging Markets Index.
Spain's government said it anticipates that the country will remain in recession next year amid stepped-up austerity measures, as one of the largest Spanish regions said it will tap a newly-created emergency fund due to problems refinancing its debt.
Speaking in a press conference, Budget Minister Cristobal Montoro said the gross domestic product of the euro zone's fourth-largest economy is now likely to contract by around 0.5% in 2013, compared to a previous forecast of 0.2% growth, presented earlier this year.
At the same time, Mr. Montoro said, Spain's government spending ceiling (not including interest debt payments) will be set at €73.3 billion next year, 6.6% below the ceiling for this year. That will include a 12% cut in available funding for central government ministries. That comes just three months after similarly strict austerity cuts were announced for this year.
This announcement also follows a set of salary cuts for civil servants and other saving measures approved by parliament, which have triggered significant protests across Spain, plus a one-day strike called by civil servants' unions in September.
"The situation we face is tough, difficult," Mr. Montoro said. "These steps are not negative, they simply seek to lower the deficit, because there's no alternative to lowering the deficit."
Spain's borrowing costs surged on the news of Valencia's appeal for help and the forecasts downgrade, with the spread between the yield on Spain's 10-year benchmark bond and the German equivalent--seen as a safe haven for euro investors--rising to more than six percentage points, the highest level since the euro was launched a decade ago.
The worry is that Spain's steady stream of austerity cuts, as the country seeks to lower its budget deficit to 8.9% of GDP last year to 2.8% of GDP by 2014, is hurting a weakened economy further. These cuts are making it impossible for government spending to offset lost private sector demand, as households and corporations deleverage from a decade of borrowing--the policy essentially followed by many countries that control their own monetary policy, such as the U.S. and the U.K.
The austerity is having a particularly serious effect on regional governments, which control more than a third of all government spending, including healthcare and education, but have few taxation powers. Valencia, a lightly- industrialized region that has been heavily hit by a five-year property slump across the country, said that a lack of access to markets spooked by Spain's worsening prospects has left it facing a liquidity crisis.
The fund that Valencia intends to tap was launched last week by Spain's central government and is handled by Mr. Montoro's Budget ministry, the country's paymaster. It will have up to EUR18 billion available for regions that have trouble with debt maturities, and is accessible as long as the regions agree to additional austerity cuts and commitments.
Spain also downgraded its forecast for 2014 growth, to 1.2% from a previous 1.4%. However, it upgraded this year's forecast, to a 1.5% contraction compared with a previous estimate of a 1.7% fall. For 2015, the government also increased its estimate slightly, and is now forecasting 1.9% growth compared with a previous forecast of 1.8% growth.
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