Growth projected to recover, but some short-term pain in store
The International Monetary Fund, which can be viewed as the world’s central bank, issued its spring economic projections yesterday, outlining its most pessimistic growth projections for the near term, since it was set up. The IMF believes that world output will shrink by 1.3% in 2009, but would then resume growth in 2010.
The world economy will contract largely because the developed countries are in a recession, while many of the large emerging economies will continue to grow, but more slowly. For instance, the US economy is expected to contract by 2.8% this year, the countries that share the Euro, to shrink by 4.2%, output in Japan is forecast to fall 6.2% and that in the UK by 4.1%. On the other hand, Chinese growth will remain quite high at 6.5%, but well below the 10%+ growth rates seen on average over the past decade. India, another one of the four large emerging market economies that account for an increasing share of world output, is projected to expand by 4.5%, although that represents a notable slowdown from the 7.3% growth rate of 2008 and 9.3% of 2007. Other large developing economies will fare less well, with Brazil GDP seen shrinking by 1.3%, Russia’s by 6% and Mexico’s by 3.7%.
The IMF forecasts are more or less on par with those in the private sector, with some variation, country by country. Ball park, the forecasts are mostly in line, but not everywhere.
The IMF thinks that after this year’s 4.1% decline, the UK economy will contract by a further 0.4% in 2010. These forecasts are more pessimistic than those of the private sector, or of the UK Government. The market consensus for UK growth is for a contraction of 3.5% this year and a return to growth of 0.3% in 2010, before the recovery picks up speed. The Chancellor of the Exchequer said yesterday in the annual Budget statement that he also expects the economy to contract by 3.5% this year, but to expand by 1.25% in 2010.
The Chancellor is naturally biased to forecast better growth than the private sector. As Chancellor, Gordon Brown had a better record of forecasting the UK economy than the market, but only over short periods of time. In a broad sense, his prediction of fiscal prudence and no more booms or busts proved wrong and while he may explain the current downturn in the economy as a global phenomenon, the UK was at the epicentre of the financial crisis, which was a function of inadequate economic policies at home.
On this occasion, the Chancellor is erring on the optimistic side in order to provide a less threatening public sector finance picture than what was outlined in the Budget, although it is possible that the Government’s forecasts are met, if employment doesn’t fall as much as the market expects. Recent employment figures have been less bad than earlier. Economic growth next year will be a function of the extraordinary monetary and fiscal stimulus and the recovery abroad, which will help the foreign trade sector, as will the weak level of sterling.
A notable feature of this year’s Budget is that the UK economy has been put on course to accumulate significant debt over the next several years. The Government will borrow the equivalent of 12.4% of GDP in the current fiscal year, then 11.9% in 2010, 9.1% of GDP in 2011, 7.2% in 2012 and 5.5% in 2013. As a result, the net Government debt will rise to close to 80% of GDP by FY 2013-14 from 36.5% in FY 2007-08. Gross debt will be higher.
This means that after the economic recovery has taken shape over the next 2-3 years, as projected by the IMF, the Government will have to reverse course on fiscal policy, as well as on monetary policy and may need to run a counter-cyclical fiscal policy for some years. Higher debt means higher interest rates and also a more than doubling of Government expenditure on servicing the debt at a time when interest rates are likely to be much higher.
In a sense, the Government doesn’t have much choice with its fiscal policy at the moment, unless it wants the economy to find its own equilibrium, which will entail numerous bank failures and a deep and prolonged recession. Notwithstanding, as a result of the policy relaxation now, the economy will probably grow by less than its average in the past decade for a number of years after the initial recovery has taken shape, as officials spread the payback of former excesses over time.
Despite the fact that the UK fiscal position will deteriorate over the next few years, the projections incorporated in the Budget are not out of line with what had already been expected by the market. The fiscal stance in other jurisdictions, the US most notably, will also deteriorate significantly and the amount of public debt in the UK will still be much lower than that in many other developed economies. As such, the implications for sterling from the deteriorating national balance sheet shouldn’t be significant beyond the very near term. The downbeat IMF growth forecasts also apply to most nations under considerations and with the projections again not out of line with the market, the currency implications shouldn’t be pronounced beyond the near-term volatility related to announcement effects.
Therefore, despite the near-term negative sentiment implications of the UK budget revelations, value still remains in GBP going forward. The emphasis that we have always placed on the importance of sentiment and the economic environment in entering structural trades will continue. This may mean periods of remaining in GBP until value and environment align, but does not in any way dampen our enthusiastic expectations for the opportunities in GBP going forward to prevail. The post-Budget decline in sterling also encourages us to think that we have been correct to maintain a relatively cautious approach in our risk taking so far this year.