Disappointing economic data suggest that the global recovery has entered a "soft patch." Temporary factors, such as the supply chain disruption following the March 11 earthquake in Japan, are in part responsible for the lackluster world economic growth in the second quarter of this year. And other, longer-lasting trends have also surfaced, such as flagging consumer demand in developed markets and a slowdown in emerging markets following tighter monetary policies.
Still, Standard & Poor's doesn't expect a double dip in developed markets. We believe emerging markets will continue to be a major driver of global growth. Our now more balanced outlook for emerging markets carries a couple of important implications, however, for private sector companies in developed economies. First, higher inflation in emerging markets means that input costs are rising as well. In the past decade, emerging markets exported "disinflation" to developed markets as their export prices kept contracting. This is no longer the case. Second, tighter monetary policies are reining in growth in emerging markets. This means that the booming demand for foreign products is gradually easing.
Purchasing Managers Indices Show A Slide In Developed Markets
The most recent release, in May, of the Purchasing Managers Indices (PMIs, which measure private sector output growth in the manufacturing and the services sectors), reinforce the view that the recovery in developed markets has slowed markedly in the second quarter from a strong performance in the first three months of the year. Japan is the only major economy showing some improvement. But this is on the back of a sharp contraction in March after the devastating earthquake that hit the country. The U.S., the eurozone, and the U.K. show a continued slide. The U.S. manufacturing and services sectors posted the weakest growth since August 2009. Manufacturing in the U.K. recorded its lowest growth rate so far this year, as did the eurozone as a whole. Within the the euro area, PMI readings reveal meaningful slowdowns in Germany and France, after a robust first quarter.
Two factors--some temporary, some persistent--explain the slowdown in the second quarter: the disruption in the global supply chain following the Japan earthquake and the squeeze on consumer spending.
The Japan earthquake caused pronounced disruption in the global supply chain, especially in the automotive, aerospace, and IT sectors. Markit Economic Research, which produces the PMIs, suggests that global delivery delays hit a near-record high in April. These disruptions should become less of an issue in the coming months. Japanese industrial production picked up 1% in April after a dramatic 15% contraction in March. And even more encouraging, Japanese exports rose 2.5% month-on-month in May after a 13.3% plunge during the previous three months.
Surging energy and food prices have hit consumers in the U.K. and the eurozone. Rising global commodity prices, including oil and gas, have pushed up headline inflation across Europe, reducing consumers' purchasing power. Commodity prices now seem to have eased somewhat, but we anticipate that consumption will remain weak in the coming 12 months. This is because in most countries, consumers initially drew on their savings to offset weaker real income gains. Consequently, consumption held firm to a degree in 2010 and in the first quarter of 2011, despite higher unemployment and feeble growth in real wages. But savings rates have now fallen to historical lows (see chart 2). As governments further tighten fiscal policies, implying higher income taxes and cuts in public employment, we see no let up in pressure on consumers' incomes.
Under our baseline forecast, which already factored in sluggish consumer spending, we continue to expect positive world GDP growth, albeit subpar by historical standards, for the rest of this year and in 2012. Critical to this anticipation is continued growth in emerging markets, which have been fueling the global recovery since 2009. The most recent data releases suggest, however, that those markets may be slowing as well.
The Strength Of The Global Recovery Relies Largely On Steady Expansion In Emerging Markets
Based on preliminary data, world trade volume plummeted 2.5% in April from the previous month, according to the Netherlands Bureau of Economic Research World Trade Monitor. Emerging economies in Africa, the Middle East, and Asia witnessed the biggest declines, registering an average 4.7% drop. This is a stark contrast to the lift in world trade following the spectacular bounce back in emerging markets--with Latin America, the Middle East, and Asia leading the way--after the 20% contraction in real terms between September 2008 (when Lehman Brothers collapsed) and May 2009.
By the end of the first quarter of this year, imports from emerging markets had hit fresh historical highs, well above precrisis levels. Strong demand from these markets was a major impetus behind the recovery in core European countries, especially Germany. German exports have closely tracked emerging market imports. In turn, the upswing in the German economy has benefitted its main suppliers, such as France and the Benelux (the economic union between Belgium, the Netherlands, and Luxembourg) economies.
On the downside, however, there's an increasing link between buoyant growth in emerging markets and higher domestic inflation in these same markets. The stronger demand from emerging markets has lifted commodity prices, while robust domestic demand in emerging economies has boosted the bottlenecks in their the manufacturing sector. Central banks were initially slow to react to the renewed inflation pressures their economies were experiencing. This is because their "natural" response--raising interest rates--would have triggered appreciation in their currencies' foreign exchange rates, and subsequently deterioration in their exports' competitiveness. But since the middle of 2010, monetary tightening has gained momentum in most emerging economies. For instance, compared with their mid-2009 levels, policy interest rates are now 350 basis points (bps) higher in Brazil, 475 bps in Chile, 275 bps in India, and 175 bps in Thailand.
China, in particular, provides a good illustration of the repercussions of rising inflation. The country's seven-day government bond repurchase rate, a very meaningful gauge of short-term funding costs, hit 8.9% in the middle of June, a three-year high. The All-China Federation of Industry and Commerce subsequently warned that Chinese small and midsize enterprises were facing a worse cash squeeze than the one in the 2008 global financial crisis. The Chinese central bank's decision to increase required reserves for commercial banks for the sixth time this year was the root of the repurchase rate spike. The central bank acted after China's inflation hit 5.5% in the 12 months to May, coming close to a three-year peak.
Tighter monetary policies go a long way in explaining the recent slowdown in emerging market growth. Should we consequently be seriously concerned about a double dip in developed economies in the final months of 2011, just as the No. 1 global growth engine starts spluttering? We do not think so. We suggest that the slowdown in emerging markets should be put in perspective. Real GDP growth in 2010 swelled to 10.3% in China, 8.5% in India, and 7.5% in Brazil, to mention a few key countries. These rates appear unsustainable in the long run and have become associated with signs of overheating (higher inflation). More stringent monetary policies therefore seem to be a necessary evil to prevent inflation from galloping out of control.
At the same time, the growth prospects for infrastructure investment in the main emerging markets remain rosy, as local business surveys continue to testify. Capital spending was up 26% in the first five months of this year in China, against 24.4% in 2010. Furthermore, consumer demand is gaining momentum in countries such as China and India, on the back of stronger real income gains. This gradual rebalancing of domestic demand between investment and consumption will help fuel more sustainable economic growth in the long term.
The Global Recovery Slowly Stretches On
We continue to see emerging markets as a major impetus behind world growth. But these economies' contribution is likely to decrease proportionately as their stricter monetary policies begin to curb growth. In our view, developed markets will adapt to lower growth and less demand in emerging markets while keeping the recovery on track.
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