Swedbank's Global Economic Outlook, August 2011

Global Economic Outlook
by Cecilia Hermansson 17 August 2011

Global growth is slowing – without reforms
the world economy is at risk
 Since our spring forecast, economic growth, primarily in the US but more recently in the
euro zone as well, has slowed. Turbulence in the financial markets has increased and
confidence is falling. We have revised our global GDP growth forecast downward to
3.8% this year (4.1%) and expect it to remain just under 4% in 2012 and 2013.
 Our main scenario, which we give a probability of 60%, does not include a new global
recession, but does anticipate a slower recovery in developed countries due to budget
austerity. Economically and politically, we seem to be “muddling through”. Emerging
countries are driving the global economy.
 The risk picture is weighted heavily to the downside. We give a less favourable
scenario – where global GDP growth falls below 2% – a 30% probability. The debt
crisis is worsening in the euro zone and causing a major stock market sell-off, currency
worries and shrinking economies. Even emerging countries don't seem to be immune.
On the other hand, we can’t totally exclude the possibility of stronger growth, upwards
of last year's 5%. The probability is low, however, at 10%, and requires newfound faith
in the political systems in the US, Japan and the euro zone.
 This report identifies the needed reforms in the US, the euro zone, China, emerging
countries and across national borders. The time for denial is over. We need economic
policies that will best help us to overcome the debt crisis that Western countries are
now going through and the overheating that worries emerging countries. The EMU is
already a transfer union, and a fiscal policy coordinated with the Eurobond market
would be a more effective solution. Extensive reforms are needed to strengthen growth
prospects over time. Until then decision-makers will have to apply both the gas and the
brakes.
Cecilia Hermansson

Contents: Page
1. Our main scenario: Modest growth in spite of everything 2
2. An increasingly complex risk picture 6
3. Economic policy: Few tools 9
4. Our assumptions about the commodity and financial markets 15
5. A lot depends on emerging economies 23
- USA 24
- China 28
- Japan 30
- India 32
- Brazil 34
- Euro zone 36
- UK 40
6. Conclusions for our home markets 42

Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740
E-post: ek.sekr@swedbank.se Internet: www.swedbank.com Responsible publishers: Cecilia Hermansson, +46-8-5859 7720.
Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897

1. Our main scenario: Modest growth in
spite of everything
Since our spring forecast, the global economy has continued to Economic pessimism
muddle through while financial unrest has grown, which is clearly and the debt crisis
reflected in the recent stock market sell-off around the world. Two have caused a major
key factors are creating nervousness in the financial markets: the stock sell-off
debt crisis in the US and Europe, and the risk of a new global
recession.

The debt crisis is largely a question of a loss of faith in politicians The US debt crisis is
to manage crises. In the US, it took a long time to negotiate a the fault of politicians
higher debt ceiling, at the same time that the medium-term debt
reduction was insufficient and poorly structured without any tax
increases. A debt downgrade by Standard and Poor’s followed
soon afterward.

In the euro zone, the debt crisis has spread from Greece, Ireland The euro crisis is
and Portugal to larger countries such as Spain and Italy. worsening as larger
Inadequate institutional frameworks and increased nationalism countries see interest
are undermining the euro cooperation and threatening the rates rise
currency's future. Interest rate differentials between fiscally
“sound” and “unsound” euro countries have been driven higher.
Poor growth prospects due to the competitive weakness of many
crisis countries also make it harder to manage the budget
consolidation process.

Although the most recent rescue package caused Greek, Irish
and Portuguese interest rates to fall, Spanish and Italian rates
have instead risen. The only way to stop this was for the
European Central Bank to buy bonds from these large countries,
which is hardly a long-term solution.

Interest rate differential between German and other EU 10-year government bonds

17,5

15,0

12,5
Percentage points

10,0
G reece

7,5

5,0 Ireland
S pain
P ortugal
2,5 Italy

0,0
UK F rance B elgium
S weden
-2,5
07 08 09 10 11
S o urce : R e u te rs E co W in

2 Swedbank’s Global Economic Outlook • 17 August 2011

The risk of a double dip recession has grown. In GDP terms, this Growing fears of a
means global growth of less than 2%. The nervousness stems double dip
partly from the purchasing managers indexes around the world,
which are now dangerously close to a reading of 50, signalling
that there is essentially no growth in industry, and partly from the
risk that the stock sell-off will have a negative wealth effect and
reduce confidence, in turn leading to lower global trade,
consumption and investment.

Purchasing managers index in various countries/regions 2006-2011

65

60

55

50

45

40 USA
UK
J a p an
35 E u rola n d
C h ina
In d ia
30 G lo ba l

25
07 08 09 10 11
S o u rc e : R e u te rs E c o W in

Despite the worries in the financial markets, we haven’t changed In spite of everything,
our view that the global economy will “muddle through”, although we are sticking by our
we see growth prospects worsening compared with our spring main scenario, i.e.,
forecast. We are also adding something new by extending our that the economy will
forecast to 2013. “muddle through”, but
with weaker growth
Our growth revisions primarily concern the US and Japan,
compared with last
although the euro zone is also expected to grow more slowly. For
spring
the US, the key has been a significantly weaker than expected
recovery this year, which can't be blamed on temporary factors
alone, but stems more so from major structural problems in the
labour and housing markets as well as an antagonistic political
climate.

For Japan, the focus has naturally been on the earthquake For 2011, we have
disaster in March, which has reduced activity this year, but is revised the US and
very likely to raise it starting late this year and for several Japan downward...
quarters to come as the reconstruction progresses. We have
also had to revise our GDP growth estimates upward in several
… but we have also
countries. Germany has strong momentum and is benefitting
revised the euro zone,
from demand from emerging countries, along with its relative
through Germany and
fiscal strength, a fairly weak euro and low interest rates. Growth
France, upward…
slowed more than expected during the second quarter, however,
including in France.

Swedbank’s Global Economic Outlook • 17 August 2011 3

China has surprised with stronger growth than we had projected. … while China has
Even though we see a slowdown in activity going forward, we also surprised on the
have revised our GDP growth forecast upward on the basis of the upside to date
strong results. Many emerging countries are raising interest rates
to reduce the risk of overheating, and this is gradually affecting
demand. When developed countries grow more slowly, it also
reduces the risk of a hard landing. In the event of a major
slowdown, economic tools are available, since interest rates can
be cut and the government budget can be allowed to expand.

Global GDP forecast

Autumn Forecast Spring Forecast
GDP growth (%) 2010 2011 2012 2013 2010 2011 2012
US 3,0 2,1 2,3 2,7 2,9 3,0 3,0

Euro zone: 1,8 1,7 1,3 1,3 1,7 1,5 1,5
of which: Germany 3,6 2,9 1,8 1,6 3,6 2,4 1,9
France 1,4 1,5 1,5 1,4 1,6 1,5 1,6
Italy 1,3 0,8 0,7 1,0 1,3 0,9 1,0
Spain -0,1 0,6 0,8 1,2 -0,1 0,3 1,0
UK 1,3 1,3 1,6 1,8 1,4 1,5 1,8

Japan 4,0 -0,2 2,8 1,4 4,0 0,6 3,0
China 10,3 9,0 8,4 8,0 10,3 8,8 8,4
India 10,4 7,8 7,5 7,5 9,1 8,0 7,5

Brazil 7,5 3,8 4,1 4,5 7,5 4,3 4,0
Russia 4,0 4,5 4,4 4,2 4,0 4,6 4,5

Global GDP in PPP 5,0 3,8 3,9 3,8 4,9 4,1 4,2
Global GDP in US dollars 4,1 2,9 3,1 3,1 4,0 3,2 3,4

Sources: National statistics and Swedbank’s forecasts. Note: These countries
represent about 70% of the global economy. To arrive at total GDP growth,
approx. 0.3 percentage points should be added. The World Bank’s weights from
2009 have been used, which raises total figures by 0.1-0.2 percentage points
compared with our spring forecast, when 2009 weights were used.

Developed countries aren't in the same position as emerging Few economic tools
economies, since they have already used up their “ammunition” are left in the West if
in connection with the financial crisis and the global recession in economic conditions
2008-2009. We still feel, however, that a new slowdown in the worsen…
global economy like the one we saw after the Lehman Brothers
bankruptcy can be avoided. The global economy is better
prepared today. The financial system, though far from fully
repaired, is not as unbalanced. This time we don’t have as much
debt-financed activity, but there is overcapacity still hanging
around since the last recession. If the stock sell-off ends without
too much damage to the financial sector and the real economy,
the recovery can continue, though at a weaker pace.

Nonetheless, growth prospects can be considered fairly decent … but a new Lehman
despite the concerns that currently exist and which the financial Brothers-like crash can
markets won't be rid of anytime soon. Following are a number of be avoided
additional reasons why we believe that the global economy will
avoid a new recession:
 There is a greater awareness after the Lehman Brothers bankruptcy of
the costs to the global economy of not addressing financial turbulence
in time


 The financial system, though not yet healthy, is less imbalanced today

 Emerging countries would be affected by a slowdown, but still could
resort to economic stimulus and gradually increase intraregional trade

 Emerging countries are “catching up,” which means high growth

 Slower global growth is contributing to lower demand for raw materials,
which is slowing the rise in commodity prices, and in turn inflation

 High productivity and lower cost pressures through wages and raw
materials are raising corporate profits  paving the way for investment
and new hirings

 Extremely low interest rates for several years will keep investment
costs down

 Major need for new investment in infrastructure, energy and climate

However, the recovery will still remain slow in the developed
economies going forward, and here is why:
 Continued debt restructuring in the private sector and low loan demand

 Fading impact of economic stimulus

 Negative impact on growth of budget consolidation

 Higher benchmark interest rates, though further in the future

 Little faith in the ability of politicians to resolve crises

 High volatility in the financial markets is a cause of concern

 Emerging countries will downshift when faced with overheating

 Weak labour markets are hurting consumption

 Stiffer regulation of the financial sector could make capital more
expensive

 Remaining capacity surplus on a global level

A lot depends on emerging countries to keep the wheels of the The global economy is
global economy turning. Yet it is essential for them that dependent on
developed countries avoid a new recession and at least maintain emerging countries,
some growth in order to preserve demand for imports from and vice versa
emerging countries.

We are aware that the risks of an economic decline (or perhaps Huge swings make
an improvement) are great. In some sense, the situation is worse accurate forecasts
today than after Lehman Brothers if the global economy were to difficult – risks have to
truly slide into a new recession, since few economic tools are be carefully analysed
available to more developed countries – or they are no longer as
effective. In the next section, we discuss alternative scenarios
and what could trigger them. It’s also worth noting that it is very
difficult to build an accurate scenario for the years ahead at a
time of financial turbulence and when forecasting parameters
change on a daily basis.

In summary, the recovery will continue in our main scenario, but
it will be slower than in our spring forecast, and GDP growth will
average less than 4% in 2011-2013. Emerging countries
represent two thirds of growth during the period, at the same time
that developed countries are struggling with the debt crisis, a
crisis of political faith and structural problems after the financial
crisis, all factors that are restricting growth.


2. An increasingly complex risk picture
When the global economy is in a period of dramatic change, it is
difficult to make reliable forecasts. The assumptions about
various markets, political decisions and the reactions to them can
quickly prove inaccurate.

In the following chapter we discuss a number of factors that can We also offer one
produce better or worse scenarios than our main scenario. better and one worse
What’s difficult is that the risk picture becomes more complex scenario – but the risk
when risks affect each other. This makes it important not only to picture is complex and
analyse risks individually, but also the dynamic between them. skewed
The risk picture is skewed, and the forecast risks on the
downside are greater in number, more serious and larger than
the risks on the upside.

We discuss two scenarios other than our main scenario, one with
slower growth which we give a 30% probability, and a better
scenario with a 10% probability. Our main scenario is also
relatively uncertain, with a probability of 60%.

Main scenario/low growth scenario with global GDP growth
of 3.5-4%

In our main scenario, we have projected global GDP growth in We give our main
PPP terms of 3.5-4% in 2011-2013. In this scenario, the debt scenario with 3-4%
crisis doesn’t worsen appreciably in the developed countries, but growth a 60%
budget austerity does further impact growth prospects. The probability, a better
political process, like the global economy, “muddles through”, as scenario 10% and a
politicians react to the financial turbulence rather than being worse scenario 30%
proactive. The market jitters will ease, but a significant rebound is
not in sight. Emerging countries will manage to maintain growth
reasonably well with stimulus measures and without major
inflation problems.

A recession scenario with global GDP growth in PPP terms
below 2% next year

 A global economic slowdown is already evident, and
after a delay the stock market sell-off could lead to even
lower demand through negative wealth effects and a
further loss of confidence among households and
businesses. An accelerated slowdown cannot be
checked with interest-rate cuts or more expansive
fiscal policies in developed countries. On the contrary,
we head toward a period of government debt restructuring
which constrains growth.

 A new recession in the US becomes more likely after
the political crisis has worsened, US debt has been
downgraded and households lose confidence, which
translates into lower consumption. The labour and
housing markets are already developing weakly, and if
growth slows further we could see a negative spiral of
lower confidence and growth as well as a weaker financial
sector. The risk of deflation in the US economy will rise if


growth slows significantly. The Federal Reserve can give
asset prices a boost through quantitative easing, but
can do little to strengthen the labour market or growth.
Fiscal policy is too tight at present and too loose in the
medium term, but American politicians lack the will and
courage to do the opposite, which makes it difficult to lift
the US out of a new recession.

 A new recession in the US would worsen growth
prospects in the rest of the world, including the BRIC
countries. Another quantitative easing would again
increase overheating problems in emerging countries
due to increased capital inflows to them and to commodity
markets. This would also make it more difficult for
emerging countries to rely on an economic stimulus,
which could spark higher inflation. As a result, they may
not be able to “rescue” the world this time. Increased
capital inflows could also lead to a currency war and
protectionism. Chaotic currency corrections have
been avoided so far, but could be the outcome if the
dollar and/or euro weaken substantially.

 An expanded debt crisis in the euro zone that spreads
to Spain, Italy and even France would be the most
important catalyst for a global recession by spreading to
the banking system and real economy. This could be
the result if political consensus and courage cannot be
found to address a larger crisis. For example, the EFSF
won’t be big enough if, in addition to Greece, Ireland
and Portugal, Spain and Italy also have problems. This
would require more than 1 500 billion euros, compared
with the 440 billion euros the fund now has at its disposal.
The next version of the fund, ESM, won't be enough
either, at 700 billion euros. If the big euro countries have
problems, responsibility will rest squarely with AAA-
rated Germany, France and the Netherlands. The
sovereign debt crisis would worsen at the same time that
more banks go bankrupt or are rescued by already highly
indebted governments. The euro’s collapse would no
longer be unlikely if the political will can’t be mustered,
which could be the case if responsibility rests squarely on
Germany and the Germans tire of financing the rest of the
euro zone’s overconsumption.

 A huge stock sell-off and anxiety in the financial
markets that spreads to the real economy and
banking system would be the outcome of a major debt
crisis in the euro zone and a new recession in the US.

 Social unrest increases in the wake of high
unemployment and a sharp decline in future confidence,
particularly among young people. Violent protests,
revolts and uprisings, especially in developed countries,
pave the way for greater populism and nationalism.


This leads to even greater political impotence, which in
turn accelerates the collapse of the euro.

 An expanded crisis in connection with the democracy
movement in the Arab world spreads to Saudi Arabia,
causing oil prices to rise and threatening supplies.

 Another reason why commodity prices could stay high
in a negative growth environment is if emerging countries
develop fairly strongly with high demand for raw
materials, while developed countries continue to slide
backward with an increased risk of a stagflation
scenario.

 Even if the effects on the global economy shouldn’t be
overestimated, natural disasters, climate change,
power shortages and other infrastructure problems,
war and terror, and, not least, the “unknown factor”
could also hurt future confidence and set back the
economy, serving as a catalyst for a major slowdown in
an already negative growth climate.

A high-growth scenario with global GDP growth upwards
of 5% or more next year

 Worries about a new recession turn out to be
overblown, as evidenced by China's strong export data
for June. Nervousness in the stock market eases and
does not have a major impact on the economy. The
recovery continues to gain momentum once sentiment
changes from pessimism to optimism.

 The financial system has repaired the large part of its
balance sheets and is ready to begin lending again, at
the same time that consumer debt restructurings wind
down, which leads to increased credit demand.

 Lower commodity prices and cost pressures create
higher profits. With higher productivity and better
confidence, the willingness to invest and recruit rebounds.

 Decision-makers find the strength and courage to
address the current crisis. Instead of reacting, they take
the initiative with respect to the euro cooperation, the US
medium-term budget consolidation and Japan’s
longstanding debt crisis and political crisis. Confidence
grows when measures have a tangible effect. Politicians
collaborate nationally across parties and also succeed in
achieving greater international coordination. Although the
measures could weaken growth through austerity, there
are greater positive effects from increased confidence,
which creates a willingness to invest and consume.


3. Economic policy: Few tools
The same crisis – but it has expanded to the public sector

When the financial crisis erupted in 2008, few people predicted The 2008 financial
that the debt problems in the private sector would spread to the crisis is still alive and
public sector and that it would take years to overcome. An has mutated
economic recovery may have begun in 2009, but with the
stimulus programs it was hard to tell how self-sustaining it was
and whether it was mostly just a bounceback after the severe
recession.

Countries with balance sheet problems such as the US, the UK,
Spain and Ireland have had a hard time recovering. The balance
sheet recession they face requires major structural changes to
the economy. The focus in their case is on debt restructuring and
less willingness to borrow and consume. Countries without
imbalances, such as Germany, Sweden and Finland, have
recovered reasonably well, in no small part due to strong growth
in Asia, Latin America, the Middle East and Africa.

The problem is that it is the larger industrialised countries Nearly all industrialised
(Germany accepted) that are now reporting huge budget deficits countries have debt
and swelling government debt. Countries that originally had problems
problems with private debt are being joined by others with large
public debt such as Greece, Italy, Belgium and France.

There are fears that the public debt crisis will work its way back
to the private sector through the banking system and that the
next crisis will include not only credit problems but also currency
problems due to a collapse of the euro zone. There is also a risk
that the private and public debt restructuring will adversely affect
growth, without which any debt restructuring will be even more
difficult.

Economic tools – then and now

The realisation that politicians and central bankers do not have The lack of
the same ammunition to stop a new recession that they did in ammunition is a
2008/2009 is now baked into expectations. Back then benchmark cause of concern
rates were cut to nearly zero, quantitative easing reduced long-
term interest rates and drove up stock prices, liquidity was
supplied, and banks were rescued, at the same time that fiscal
policy supported the economy through higher spending and/or
lower taxes.

Stimulus packages were coordinated around the world, including
with emerging countries, which gained a stronger voice through
the G20. It was fairly easy to be a politician, and the financial
markets appreciated the resolute efforts to support the financial
sector, asset markets and the economy. Economic policy has
now become more of a national concern, and in the absence of
any tools it has become much more difficult to be a policymaker.

An important distinction from an economic standpoint is that
interest rates are already low and that it is generally felt that


another quantitative easing would have little effect. While an
easing could lead to higher stock prices, they won't last if the
global economy still shows signs of weakness. At the same time
a quantitative easing produces higher capital flows to asset and
commodity markets, with an increased risk of overheating.
Furthermore, demand for government bonds is relatively high in
countries with a balance sheet recession, since many investors
have to seek out safe havens. This is also evident by the decline
in long-term interest rates despite the stock market turbulence.

Another important distinction – including from a political A fiscal stimulus may
standpoint – is that there is little or no support for a new fiscal be economically
stimulus. That includes countries where the financial market motivated…
could finance one without exorbitant risk premiums, such as the
US, Japan and the UK. For countries with balance sheet
recessions, monetary policy isn't the important thing, since
businesses and households have less interest in borrowing.
Instead, there is more focus on fiscal policy, especially in
combination with structural reforms, to raise growth potential.

The crisis in the euro zone leaves few alternatives other than … but there isn’t a
austerity, even at a point when the recovery is unravelling. For political consensus
crisis countries, risk premiums are soaring and they are finding
hard to finance their deficits. In the US, the Tea Party movement
has made another stimulus, e.g., to help the labour market
recover more quickly, politically inexpedient. Instead, the
emphasis has shifted to reducing the size of the government
regardless of the potential impact.

Political leadership and economic advice

We have acknowledged that the job of politicians has been made
more difficult by a lack of tools. In addition, the scope of the crisis
has become more complex. When a crisis becomes less acute,
the focus shifts to moral hazards. The economy cannot be
stimulated without considering the driving forces, i.e., whether the
system is encouraging market participants to create or avoid a
similar crisis in the future. Crisis management now seems to
mean biding time. In the euro zone, politicians won't react until
the financial markets act, and usually ineffectually, which has led
to a steady succession of new summit meetings.

A lot of attention is being paid to how voters will react to political The crisis
decisions. This is especially true in Germany, where the management
reluctance to pay for the debt problems of its undisciplined capabilities of
neighbours has grown. Nationalism has been allowed to fester, politicians leave much
and real problems are being obscured. Instead we hear a lot of to be desired …
sloganeering: “The euro is stable and secure” or “The euro won't
collapse”. What aren’t being discussed enough are a vision and
the benefits of an integrated Europe.

If crisis management has been a stumbling block for politicians, … but contradictory
economists seem to disagree on the right advice, which certainty advice from
doesn’t make it easier for politicians. Some suggest that another economists hasn’t
quantitative easing is needed, while others want it to end. Some helped


want to see a fiscal stimulus, while others want to see rapid, far-
reaching austerity programmes.

Another difference compared with 2008/2009 is the labour
market. Unemployment has soared in many crisis countries, or
taken longer to decline. Strikes, demonstrations and violent
unrest are a sign of resignation, anger and fear. Many young
people are at risk of becoming a “forgotten generation” with a
lower standard of living for the rest of their lives. Income gaps
and social tension are growing.

Political developments have become a source of growing Forecasters are
concern when assessing the economy. In addition to economics becoming increasingly
and psychology, political science has to be included for a holistic interested in political
perspective. A lack of faith in the political process is affecting the risks
willingness to invest and consume and hurting stock prices.

One area that has to be better explored is the euro zone’s
development from a democratic standpoint. Can political leaders
agree on changes at summits without having to rely on
commissions to voice objections and make improvements? How
do you create confidence in such a process, which is now
inexorably leading to greater supranationalism as a result of the
debt crisis?

In the US and Japan, the bigger question is how political
campaigns are financed and what it means to political decisions?
In the US, it is never easy to raise taxes on the rich, who not
insignificantly are the ones who pay for election campaigns. The
divide between politicians and voters is growing, which is making
it more difficult to reach effective economic policy decisions.

What’s a sensible policy from an economic perspective?

From an economic perspective, we suggest several measures
below to reduce the risk of a new recession and slow the crisis in
a few years’ time. We focus on developments in the US, the euro
zone, China and other emerging countries. We also offer
suggestions for better international accords.

USA
 President Obama has to explain the seriousness of the recession (a
balance sheet recession) that the US is in, why the usual tools aren't
working and why fiscal policy is more important than monetary policy at this
juncture.

 Another fiscal stimulus targeting growth and jobs is needed in the short
term, but with tighter budget consolidation in the medium term (the opposite
of what is now being done). Greater clarity with regard to medium-term
fiscal policy would strengthen confidence.

 Taxes and spending eventually have to be balanced by expanding the tax
base, eliminating deductions and increasing taxes on the wealthy. A
reassessment of the social security system and defence spending is
needed.

 A new round of quantitative easing is reasonable only if there is another
recession and deflation signals increase. The introduction of an inflation


target to increase the independence of the central bank could improve
confidence.

 Structural reforms are needed to improve the housing and labour markets,
with a focus on encouraging hiring and employability, especially among the
long-term unemployed.

 Reshaping the political system is also important to the economy. This
includes reforming campaign financing laws, changing the size of voting
districts and increasing the effectiveness of Congress.

The euro zone
 The currency union is irrevocable, which has to be realised. If a country is
forced to leave (e.g., Greece), expectations are that its currency (drachma)
will weaken, leading to capital flight and the spread of the banking crisis to
other countries. This wouldn't apply to Germany, where expectations are
the opposite, i.e., that the currency (D-mark) would strengthen and lead to
capital flows from other countries. Of course in Germany’s case it would
also mean lower exports due to a stronger currency and the crisis in the
rest of the union. Rescuing one or more countries is less costly than
breaking up the entire union.

 The time for denial should be over within the euro zone, including
Germany. The euro zone’s debt crisis is not only a liquidity crisis but also a
solvency crisis. Aid packages have to contain better terms and write-offs.
For Greece, for example, the percentage agreed to on July 21 is too small,
since its debt ratio will reach 150% of GDP and it will lose a decade in
terms of GDP growth.

 The state of denial includes the euro zone’s banks. Excessive write-offs
threaten their balance sheets and they therefore have to recapitalise in
expectation of the next round of write-offs. The expansion of the European
Financial Stability Facility (EFSF) is a step in the right direction, since it can
now (if parliament ratifies the proposal) be used to support banks in crisis,
not only countries in crisis.

 It is also time for the crisis countries to stop denying reality. They are
waking up too late after risk premiums have risen and their deficits can no
longer be financed. The crisis countries have to surprise the financial
markets with more extensive reforms and a greater focus on growth and
competitiveness – Italy’s nominal growth must exceed the interest rates on
its debt. Austerity programmes have to be reasonable based on
effectiveness and income distribution, with a sensible balance between
spending cuts and higher taxes. The emphasis must be on eliminating
bureaucracies, inefficiencies, tax evasion and the informal sector.
Privatisations are often necessary, not least to raise productivity.

 The European Central Bank (ECB) has adopted a questionable attitude
toward its responsibility as a lender of last resort. Although the ECB wasn't
supposed to assume the responsibility of politicians to rescue governments
in need, it has purchased nearly 100 billion euros in government bonds
from Greece, Ireland, Portugal and most recently Spain and Italy. This is in
addition to just over 400 billion euros in outstanding loans to banks in June,
two thirds of which were to banks in Greece, Ireland, Portugal and Spain.
The ECB is protective of its independence and now may have to ask
governments in the euro zone for a recapitalisation. The question is how
long the ECB can keep buying Italian and Spanish government obligations
and where to draw the line, as well as what would happen if it withdraws its
support?

 The idea that the EFSF, with an estimated size of 440 billion euros (its
lending capacity is now 225 billion euros), would be big enough even if Italy
faced major problems is questionable. Instead, the fund would have to
triple in size to 1 500 billion euros or more to handle a more serious crisis.
The question then is whether France and Germany could maintain their
high credit ratings, which they need to get the best interest terms. When


the European Stability Mechanism (ESM) takes effect in July 2013,
conditions will be more stable with a lending capacity of 500 billion euros
and a total facility of 700 billion euros. Of this amount, 80 billion euros will
be paid through tax revenues and the rest of the capital can be called in or
guaranteed.

 The ECB’s bond purchases and risk of recapitalisation, as well as the
EFSF and ESM stability facilities, clearly show that the euro zone has
already developed into a transfer union in spite of denials by politicians.
The question is what’s the best way to facilitate transfers, so that they are
effective economically and acceptable politically. The currency union has to
be complemented by greater fiscal coordination, a common bank regulator
and a central bank that takes responsibility as a lender of last resort. That
would help to instil the confidence in the common currency that politicians
are hoping for.

 A Eurobond market doesn't solve the immediate problem of the need for
debt write-offs and support mechanisms. However, it would certainly go
hand in hand with greater fiscal coordination and automatic sanctions if
budget rules aren't followed. A proposal by the think tank Bruegel (“The
Blue Bond Proposal” by Jacques Depla and Jakob von Weizsäcker) would
pool Eurobonds up to 60% of GDP (about 5 600 billion euros) and assign
this tranche – the blue bond – a lower interest rate than the current
average. Thanks to the increased liquidity, even countries such as
Germany might find the proposal appealing, and the euro’s position as a
reserve currency would be strengthened. Member states themselves would
have to manage debts in excess of 60% of their GDP. Lower liquidity and
higher interest rates would be an incentive to reduce debt to 60%. This
proposal addresses moral hazards and maintains budget discipline despite
the joint Eurobond. In addition, an institution is needed to oversee the
allocation of blue bonds, so that mismanaged countries are no longer
allowed to participate. By extension, the federal budget has to expand as
well and extend its focus beyond common agricultural and structural policy.

 The currency union is an economic project that complements the EU’s
integration and strengthens the region’s position in the global economy. At
the same time it is just as much a political project, which requires a political
commitment to support the cooperation. The problem today is that national
concerns have taken precedence at the same time that democracy has
been overshadowed. It wouldn't be unreasonable to transition from poorly
prepared and less-than-transparent summits to commissions that are given
more time, produce reports and allow for objections and discussions.
Complementing the currency union with a fiscal union, a common bank
regulator and a central bank that takes full responsibility will take time, but
the important thing is that the process begins with a vision and openness.

China
 A continued – and possibly faster – depreciation of the renminbi is needed
to choke off inflation and strengthen domestic demand, which would also
reduce global imbalances.

 It is important that Chinese financial sector and financial markets develop
and that renminbi becomes convertible, but a deft touch is required, as well
as a change in China’s growth model. Greater openness is needed for
foreign players in China’s financial sector, in addition to greater
opportunities for the Chinese to do business abroad. The process is under
way, and it is important that it continues.

 Improvements to the social security system would reduce the need to save.
Domestic demand could then increase and income gaps would eventually
shrink.

 Increased transparency about debt is important on the part of the national
government, public authorities and regions. Officially, government debt as a
share of GDP is less than 20%, but all indications are that total debt is
higher, 50-70%. To understand how much room there is for a stimulus,


debt and inflation data have to be more transparent. Better GDP data is
also needed.

Emerging economies
 Supply and demand have to be better balanced to avoid overheating, e.g.,
in India.

 Fiscal policy has to be tightened where signs of overheating are strong and
growth is high, e.g., Brazil.

 The peg to the dollar has to be removed to avoid external and internal
imbalances, e.g., the Middle East.

 Subsidies have to be reduced to improve economic drivers and reduce
budget deficits. This includes increased use of environmentally friendly
energy, e.g., the Middle East, India.

 Efforts to reduce corruption must be intensified in a number of countries,
including India, Brazil and China.

Across national borders
 The separation of responsibility between the Basel Committee and the
Financial Stability Board (FSB) is unclear, as is the line between the
banking system and the shadow banking system.

 Decisions to regulate capital flows and currencies are made at the national
level despite international effects.

 The G20 has lost steam. Greater efforts are needed to determine whether
the Basel III capital requirements are sufficient (which seems doubtful),
how banking activities should be managed across national borders
(including large institutions and what happens when they fail), and the role
of the International Monetary Fund (IMF) in managing global imbalances,
volatile capital flows, exchange rate problems and uncertainties about the
build-up of foreign exchange reserves.

 The desire of China and other countries to use Special Drawing Rights
(SDR) as a new currency isn't realistic; it would make more sense to
prepare for a transition from the dollar as a reserve currency to a
triumvirate of the dollar, euro and renminbi – a reality in about a decade
given that China’s financial sector will continue to develop and that there is
still confidence in the dollar and euro as global currencies.


4. Our assumptions about the commodity
and financial markets
In the following, we describe the assumptions that support our
forecast with respect to the commodity, equity, fixed income and
currency markets. The basis for our assumptions consists of
growth and inflation estimates, psychological effects, political
commitments and crisis management expectations. Uncertainty
is great, and developments that significantly deviate from our
assumptions could materially change the economic outlook.

Commodity markets
The rise in commodity prices in 2010 and early this year has Slower global growth
levelled off. A weaker global economy is lowering demand for means lower
commodities. Supply problems in commodity markets have also commodity prices
eased. Droughts and fires had earlier caused food production to
drop, but supplies are now holding up better. The Arab Spring
has entered a second phase, and is worrying the oil market less.
The quantitative easing in the US has run its course, which has
meant less investor interest in the commodity markets. We also
believe that we have seen the worst of the dollar’s decline in
trade-weighted terms, leaving producers no reason to still
demand compensation for currency fluctuations.

Commodity prices (total), food prices and commodity prices excluding oil (index)

175
T o ta l c o m m o d ity p ric e , e x c l o il

150

125
T o ta l c o m m o d ity p ric e
Index

100

75

50
F o o d p ric e s

25
00 01 02 03 04 05 06 07 08 09 10 11

In our spring forecast we predicted that oil, which was trading
around USD 115 at the time, would fall when uncertainty about
the Middle East and the global economy eased. It took a while to
prove true, and now the reason has more to do with weak global
economic growth. We saw last spring that the risks were on the
upside due to problems in the Middle East and Japan.

We therefore have to revise upward our previous estimate of Oil price estimates
USD 105 this year and USD 98 in 2012, since oil prices have have been revised
held up longer than we expected. Instead we anticipate a price of upward since the
USD 110 this year. As global growth slows, oil will gradually spring forecast
return to a level of just over USD 97 next year and USD 94 in


2013. This is still relatively high and is based on continued strong
demand in emerging countries, which are gradually increasing
their consumption of raw materials.

Commodity prices and projections 2009-2013
(Brent crude oil in US dollars per barrel, food and metals in index 2010 = 100)

140

130

120

110

100

90 Food
Metals
80
Oil
70

60

50

40
2009
2009
2009
2009
2010
2010
2010
2010
2011
2011
2011
2011
2012
2012
2012
2012
2013
2013
2013
2013
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

We expect price declines for industrial metals (by 3-6%) and food
(by 4-7%) in 2012 and 2013, after they rose by 32% and 20%,
respectively, in 2011. Supplies should remain steady while Precious metals rise –
demand declines, producing a downward trend. The opposite is while industrial metals
true of precious metals (primarily gold and silver), which will fall
continue to rise in price in the immediate future due to jittery
financial markets and the US credit downgrade.

The risk of lower commodity prices is related to a more The risks are still on
pessimistic growth scenario and unease in the financial markets. the upside, and
There are also risks on the upside, which could be realised if we emerging countries are
were to see faster global growth, another quantitative easing in playing a more
the US and a further decline in the dollar. New supply problems important role
in connection with disruptive weather and unrest in the Middle
East, for example, could contribute to higher prices. It should also
be noted that emerging countries are increasingly important to
prices in more developed countries. Since activity will increase
faster in Asia, Latin America and the Middle East than in more
developed countries, commodity prices could still rise more than
desired given weak growth prospects in the West.

Inflation and interest rates
Lower commodity prices are expected to contribute to a much
more favourable inflation outlook than in 2010 and 2011.
Basically all we need are more stable food and energy prices for
inflation to begin to fall on an annual basis. We think inflation will
soon peak for now and turn lower in both developed and
emerging countries.

The main factors affecting inflation in more developed countries A weak job market and
are the budget consolidation and the weak labour market, which budget consolidation
are slowing demand, including wage and price pressures. Europe are restraining price
and the US face similar situations, with a lower inflation outlook. and wage pressures
We expect Japanese inflation to be temporary against the


backdrop of higher commodity prices, but once they fall we again
see a period of deflation in Japan.

Inflation (CPI) in a number of countries 2004-2011

1 7 ,5
In d ia
1 5 ,0

1 2 ,5
C h in a
1 0 ,0
Percent

7 ,5
B ra z il
5 ,0
UK
2 ,5 US
G e rm a n y
0 ,0
Japan
-2 ,5
08 09 10 11

Emerging countries are finding it harder to rein in inflation. Overheating risks are
Tighter economic policies are helping to prevent an overheating, easing in emerging
and capital inflows should also shrink due to the economic countries, but can’t be
weakness and the end to quantitative easing. The key for many totally overlooked
emerging countries is to expand their capacity, so that supply
better meets demand.

Inflation outlook measured by the annual increase in CPI (%)

CPI 2010 2011 2012 2013
US 1,6 3,2 1,7 2,0

Eurozone 1,6 2,8 2,0 2,0
UK 3,3 4,1 2,5 2,0

Japan -0,7 0,2 0,7 0,5
China 3,3 5,5 4,2 3,0
India 9,2 8,5 6,5 5,2

Brazil 5,9 6,4 5,0 4,2
Russia 6,9 9,5 8,0 6,5
Global CPI 2,8 4,2 3,0 2,6

Sources: National statistics and Swedbank’s forecasts.

We expect inflation to gradually fall from its current levels and In our main scenario, a
that emerging countries as a group will avoid an economic hard hard landing is averted
landing. Weaker growth in industrial countries will also impact
demand in emerging countries. India has already seen an
improvement compared with when monsoon rains caused food
prices to rise sharply. Brazil has to limit credit growth, and with
lower global growth and commodity prices its economy should
slow, reducing price pressures. Chinese inflation will soon peak,


but a further economic tightening may be needed to sustainably
reduce inflation.

A more favourable inflation outlook will relieve central banks of The threat of
the worry of stagflation in the West. On April 13 the European stagflation will now
Central Bank (ECB) raised its benchmark rate by 25 bp to 1.25% become less evident
after inflation rose to high levels, and followed it on July 13 with a
new hike to 1.5% before pausing at its latest meeting in August.

US, British and Japanese central banks, on the other hand, have The ECB is pausing
kept their key rates unchanged. In the British case in particular, and others are
this has been criticised, since inflation peaked at 4.5% in April delaying rate hikes
and May before falling to 4.2% in June. The private consumption
deflator has also risen in the US, to nearly 2%, but with prospects
of lower growth and easing inflation, central banks can now wait
even longer before tightening monetary policy. The Bank of
England is waiting until the first half of 2013 to raise rates, and
any increases after that are likely to start slowly.

Benchmark rates 2000-2010

8
N orway A ustralia
7

Euroarea
6 UK

5
Percent

4

3

2
S weden
1 US
Japan
0
00 01 02 03 04 05 06 07 08 09 10 11
Sou rce: R euters E co W in

In our spring forecast, we didn't think the Federal Reserve would We do not expect a US
have to raise rates until the second half of 2012, but due to rate increase before
weaker growth prospects and modest inflation it has decided to mid 2013
wait even longer. Chairman Ben Bernanke has now announced
that the Fed won’t raise rates until at least mid-2013. This is the
“easiest” way for the central bank to create more expansive
monetary policy.

The continued shakiness of the US recovery and weakness of Little marginal benefit
the labour market – combined with greater difficulty financing the from an additional
budget deficit after the credit downgrade – is raising demands for quantitative easing
a new quantitative easing of some sort (QE3). We don't rule one
out, but expect that the Fed will want to see signs of deflation
before taking such a step. It should also be noted that QE2 didn’t
have much effect on long-term interest rates initially. In fact, they
rose after the programme was announced. The subsequent


decline was more likely the result of increased pessimism about
growth.

In addition, long-term interest rates are already so low that the
effects on the labour market of trying to push them lower still will
probably be minimal. The costs to expand the central bank’s
balance sheet, which would make exit strategies more
challenging, aren't negligible either. The easing – if there is one –
should perhaps be seen in light of concerns about financing the
huge budget deficit of about 10% of GDP, the risk of a larger
decline in the dollar, and most importantly the risk of deflation.

Given the worries about the euro zone’s growth and the
sovereign debt crisis in the periphery countries – coupled with a
lower benchmark rate in the US and slower inflation – the ECB
may pause until the second half of 2012 before raising rates. Not
until then do we anticipate a rate hike of 0.25 bp, to 1.75%, to be
followed by another hike in the first half of 2013. The core
countries of Germany and France may be the ones that have to
resort to further austerity to keep inflation around the ECB’s
target of just under 2%.

Benchmark interest rates 2011-2013

16 aug 11 31 dec 11 30 jun 12 31 dec 12 30 jun 13 31 dec 13
Federal Reserve 0,25 0,25 0,25 0,25 0,25 0,75
ECB 1,50 1,50 1,50 1,75 2,00 2,00
Bank of England 0,50 0,50 0,50 0,50 1,00 1,50
Bank of Japan 0,10 0,10 0,10 0,10 0,10 0,10

We don’t expect the BOJ to raise its benchmark rate during the Japan is still struggling
forecast period. The risk of a new period of deflation is high, with deflation and a
especially since budget cutbacks to stabilise debt and afford the strong yen
reconstruction will impact economic demand. The BOJ would like
to weaken the value of the yen and keep interest rates low for the
same reason.

Since our spring forecast, long-term market rates (10-year
government bonds) have retreated. British long-term rates have
dropped below the low levels seen in 2010, and rates in
Germany and the US are well on their way. A more downbeat
economic outlook, lower commodity prices and lower inflation are
keeping the trend pointed downward. Just as importantly, the
stock market sell-off is causing many investors to flee to safety,
which is also keeping US and European long-term interest rates
low.

Despite the credit downgrade, funding costs are now declining, a Growth pessimism and
trend we also saw when Japan’s credit was downgraded in 2002. the stock sell-off are
Investors still turn to the US when stocks are volatile. Over the reducing bond yields
forecast period, 10-year government bonds will rise by about 100
bp in Europe, 75 bp in the US and 50 bp in Japan.


Long-term interest rates (10-year government bonds)

6 ,0

5 ,5

5 ,0

4 ,5 UK

4 ,0
G e rm a ny
Procent

3 ,5

3 ,0

2 ,5 USA
2 ,0

1 ,5 Jap an
1 ,0

0 ,5
07 08 09 10 11
S o u rce : R e u te rs E co W in

Demand for safe havens – government bonds from financially Interest rates are also
sound countries – will increase in the years ahead as Basel III affected by tighter
creates pressure to better capitalise banks. While this will regulations
contribute to lower bond yields, the costs to maintain more capital
in the banking system are likely to mean permanently higher
margins, which in turn will lead to higher market rates. The
impact of Basel III is difficult to determine, however, especially
since a more stable financial sector could also help to reduce risk
premiums and thereby lower interest rates. This shows just how
much uncertainty there still is regarding the effects of Basel III.

Exchange rates
Since our spring forecast, the dollar has continued to weaken in The dollar has
nominal terms, and a number of emerging countries have seen weakened since our
their currencies appreciate. Brazilian Finance Minister Guido spring forecast, putting
Mantega, for one, is concerned. Developed countries such as pressure on emerging
Switzerland and Japan have also tried to keep their currencies countries
from appreciating by loosening monetary policy and intervening
in currency markets. Such interventions aren't usually very
effective or long lasting. In real terms, the Japanese yen isn't
especially overvalued either from a long-term perspective,
although the recent change has been a complicating factor for a
number of companies.


Nominal exchange rates in relation to the US dollar, index 2008-08-15 = 100

160
Brazilean Real

150 Swedish Krona

Korean W on
140

130

Euro
120

110

100
Yuan

90 Swiss Franc

80

70
Yen
60
jan m aj sep jan m aj sep jan m aj sep jan m aj sep jan m aj
07 08 09 10 11
Source: R euters EcoW in

We anticipate that the debt crises in the euro zone and the US Debt problems in the
will keep the dollar-euro exchange rate fairly stable initially, after US and euro zone –
which the dollar could appreciate against the euro on the basis of euro/dollar exchange
slightly stronger growth and possibly how the debt crisis is rate fairly stable at this
managed. point

US dollar, trade-weighted in nominal terms

125
120
115
110
105
A v e ra g e 1 9 9 0 -2 0 1 1
100
Index

95
90
85
80
75
70
90 92 94 96 98 00 02 04 06 08 10
S o u r c e : R e u te r s E c o W in

A further credit downgrade could reduce interest in the dollar, If the euro zone
especially as emerging countries gradually diversify their tackles its debt
currency portfolios and turn to other investments. problems but the US
doesn’t, the dollar could
Exchange rates 2011-2013 fall
16 aug 11 31 dec 11 30 jun 12 31 dec 12 30 jun 13 31 dec 13
EUR/USD 1,44 1,42 1,38 1,35 1,35 1,30
RMB/USD 6,38 6,16 6,00 5,79 5,64 5,44
USD/JPY 77 80 83 85 87 90
EUR/GBP 0,88 0,88 0,85 0,83 0,8 0,77


China continues to allow the renminbi to appreciate against the
dollar by about 6% per year in nominal terms. Since China’s
inflation is higher than the majority of its trading partners, the
appreciation is even higher in real terms. Efforts to
internationalise the renminbi continue. Without a well-functioning
financial market and a convertible currency, China is still
dependent on the dollar, euro, yen and other international
currencies.

The Japanese yen is weakening in the wake of a shrinking trade When the crisis
surplus and a slightly larger interest rate differential vis-à-vis subsides, the yen
Europe and the US. Our assumption that the US won’t replace should weaken
QE2 with QE3 should also contribute to a weaker yen.

Stock prices
Even before the recent slide, stock markets in developed
countries had performed modestly at best. While markets in
emerging countries nearly returned to their 2007 peak, stocks in
the US, euro zone and Japan have a long way to go. Recent
market jitters are the product of lower global growth expectations,
the debt crisis in developed countries, the US credit downgrade
and a severe crisis of confidence in the ability of decision-makers
to manage crises. Political risks are especially difficult to
evaluate, which is creating uncertainty and nervousness.

Corporate profits could be affected by poorer growth prospects,
though on the other hand cost pressures are easing due to lower Political risks are
commodity and input goods prices. Negative news will garner a influencing market
bigger reaction than positive news. Considering the challenges in psychology right now
handling the debt crisis and euro cooperation, this will continue to
frustrate the market for some time to come. It is impossible,
however, to determine by how much and for how long the
markets will be hurt.

Equity prices in emerging countries ( MSCI EM), USA (S&P 500), the euro zone
(FTSE EZ 300) and Japan (Nikkei 225) 2007-2011, index January 2007 = 100

150

140 MSCI EM
130

120

110

100
Index

U SA S& P 500
90

80
FTSE EZ 300
70

60

50
N ik k e i 2 2 5
40
07 08 09 10 11


5. A lot depends on emerging economies
The global economy has downshifted to a lower gear. The The global economy
recovery continues, but not as quickly as in 2010, a rebound year has now shifted into a
after the financial crisis and global recession. The risk picture has lower gear
also become more negative. This year growth is being slowed by
higher commodity prices, the Japanese disaster and the
continuing balance sheet correction. Tighter economic policy will
then be an increasing drag on growth.

Annual GDP growth (%) in several major countries/regions

6,00

5,00

4,00

3,00 BRIC‐countries
OECD‐countries
2,00

1,00

0,00
2010 2011 2012 2013

We expect the slowdown in emerging countries to be modest and Emerging countries
that this group will remain the biggest contributor to growth (65- account for over two
70%). Their growth has trended below the historical average, and thirds of global growth
without fiscal and monetary ammunition, reforms will be needed
to speed their structural transformation and improve the medium-
term outlook. Emerging economies have to implement reforms
that immediately reduce the problem of overheating and create
more sustainable domestic demand. That would also help to
reduce global imbalances.

US current account balance and China’s currency reserves

4 ,5 100

4 ,0 0

3 ,5 -1 0 0

3 ,0 -2 0 0
USD (thousand billions)

2 ,5 -3 0 0
USD (billions)

2 ,0 -4 0 0

1 ,5 -5 0 0
U S c u r re n t a c c o u n t
1 ,0 (rh s ) -6 0 0

0 ,5 -7 0 0

0 ,0 -8 0 0
C h in a 's c u r r e n c y
-0 ,5 r e s e r v e s ( lh s ) -9 0 0
90 92 94 96 98 00 02 04 06 08 10


The US – structural problems are impacting
the economic outlook
 Major downward revision of GDP growth against the
backdrop of weaker economic data and growing pessimism
– growth is too weak to significantly impact unemployment

 The debt ceiling agreement is welcome, but the political
process was a failure

 Debt restructuring is starting slowly, but the long-term cuts
seem inadequate to stabilise the debt burden

The optimism surrounding the US economy late last year was A deeper recession in
illusory. Rising unemployment, higher inflation, falling housing 2008-2009 and a
prices and political discord on fiscal policy have left Americans slower recovery in
anxious. During the first half of 2011 GDP growth has been 2010-11
weaker than expected – 1.8% at an annual rate and 0.8% at an
annualized rate – which is also less than considered normal in a
recovery, when there is usually available capacity. We also now
know that the recession was deeper than indicated by previous
data, with GDP falling by 5.1% in 2008-2009 rather than 4%.

US GDP and inflation (annual change %), and unemployment (% of labour force)

12,5 10,0
10,0 9,5
Unemployment --->
7,5 9,0
CPI
5,0 GDP - annualized quarterly growth 8,5
2,5 8,0
Percent

Percent

0,0 7,5
-2,5 Private consumption 7,0
-5,0 deflation 6,5
-7,5 6,0
-10,0 5,5
-12,5 5,0
Q1 Q3 Q1 Q3 Q1 Q3 Q1
08 09 10 11
Source: Reuters EcoWin

Temporary factors partly explain the slower development, Both structural and
including the earthquake in Japan, unusual weather and temporary factors
shrinking confidence in the ability of US politicians to solve the explain the economic
budget and debt ceiling problems. The more important thing, doldrums
however, is that the structural problems in the US economy
haven’t been resolved and that the labour, housing and credit
markets aren’t working normally in the wake of the financial
crisis. Balance sheets still need correcting. Without another fiscal
stimulus, the US economy will continue to trend below its
historical growth.


In addition to the economic crisis, a political crisis is under way. A The US faces both an
growing number of experts are characterising the political system economic and a
as dysfunctional. There is little willingness to compromise, and political crisis
the goal for politicians to get re-elected often overshadows the
goal to help the country grow. After the financial and real estate
crises, the US has to find a new identity in economic, political,
cultural and geopolitical terms. American households can no
longer be the growth engine for the global economy. Defence
spending will shrink and will affect the ability of the US to respond
in global hot spots. At home, a structural transformation is
needed, at the same time that the government’s role is shrinking
since tax hikes won't be tolerated by Congress. Income gaps are
growing, and it is becoming harder to help those who have
dropped out of the system. The negative confidence spiral has to
be broken.

Household and corporate expectations for the next half year (Conference Board)

120

110
H o u s e h o ld c o n f id e n c e
100

90

80

70

60

50

40 B u s in e s s c o n f id e n c e

30
97 98 99 00 01 02 03 04 05 06 07 08 09 10

We expect GDP growth to top out at 2.1% this year. Activity will
increase during the second half year as gas prices fall slightly
and the Japan Effect tapers off at the same time that political
concerns ease, giving future confidence a needed boost. This
represents a significant downward revision from our spring
forecast of 3% and reflects the downturn in future confidence in
recent months in pace with weaker GDP and job numbers.

We still expect the growth engine in the form of consumer
spending to falter, at the same time that other components in the
supply balance aren’t able to raise growth above its average. In
2012, an election year, GDP growth will reach 2.3%, before
climbing to 2.7% in 2013, when confidence could grow with new
leadership. Monetary and fiscal policy will be tighter, however,
which will keep growth below 3%.


The US Congress has had major problems agreeing on how to “You can always count
consolidate the budget in the years ahead. The increase in the on Americans to do the
debt ceiling was contingent on spending cuts, and at the last right thing – after
minute Republicans and Democrats agreed to raise the ceiling by they’ve tried everything
USD 2.1- 2.4 trillion by the end of 2012, which means that it won’t else”
be an issue in next year’s election campaign.
- Winston Churchill
The debt ceiling will initially be raised by USD 400 billion, then by
another USD 500 billion unless blocked a Congressional
resolution. The remaining USD 1.2-1.5 trillion will be part of a
packaged agreement agreed to by a committee of
representatives from both parties and containing spending cuts,
tax reforms and other debt reductions. In the first years there will
be little in the way of cutbacks, and consolidation has instead
been pushed off to the future. While this may seem reasonable
given the weak recovery, it creates uncertainty, since another
Congress will have to implement today’s decision.

Total government debt now exceeds 100% of GDP, while the Gross public debt is
federal debt as a share of GDP is just over 70%. Had nothing now greater than GDP
been done, it would have risen to 90% of GDP by 2030 and then
about 200% in 2060, after the healthcare reform, which reduces
the debt burden by about 100% of GDP between 2011 and 2060.

Federal budget revenues, expenditures and balance

350 50

F in a n c in g n e e d - - >
300 25

250 0
USD (billions)

USD (billions)

200 -2 5

150 -5 0
< --- B u d g e t
e x p e n d itu r e s
100 -7 5

50 < --- B u d g e t re v e n u e s -1 0 0

0 -1 2 5
70 75 80 85 90 95 00 05 10

The medium-term plan that would have been needed to stabilise Twice as large a
the debt burden in the second half of this decade is thought to be budget consolidation
at least USD 4 trillion, or about 20% of GDP. Revised growth could be needed
prospects also will mean greater difficulty stabilising the debt as a
share of GDP. The plan now calling for cuts of just USD 2.1-2.4
trillion doesn’t go far enough. The US therefore risks another
credit downgrade. A lower rating could raise funding costs, add to
financial turbulence and weaken the dollar considerably.

The job market will be the focus of the campaign leading up to
the presidential election in November 2012. No president has
been re-elected in the last 50 years with unemployment higher
than 7.2%. In July it was 9.1%, which is still higher than at the


beginning of 2011 even after declining slightly from June. It was
also just a modest decline compared with the October 2009 peak
of 10.1%. Compared with before the crisis, unemployment has
more than doubled to 14 million. When you include those who
are working part-time not by choice and those who are no longer
actively looking for work, 29 million Americans are now counted
as unemployed, about half of whom can also be considered long-
term unemployed.

The housing market has yet to bounce back. Housing The housing market
construction appears to have hit bottom, but will remain there for has hit bottom and will
some time. The same applies to new home prices and sales, stay there for a while
which have been fairly stagnant and where the latter are back at
their 1998 level. Low interest rates should have helped the
housing market more, but households are continuing to fix their
balance sheets at the same time that the credit market is having
problems with new lending. Another critical factor is the vast
inventory of unsold housing, which will keep prices low for some
time to come.

Housing market

8 27 5

7 25 0

6 22 5
Number of (millions)

S ale s of n e w ho m e s
5 20 0
Index

4 17 5

C as e/S h ille r
3 S ale s of e x isting h om e s h o use p ric es for 15 0
1 0 cities --->
2 12 5

1 10 0
R e side ntial co ns tru ctio n

0 75
90 92 94 96 98 00 02 04 06 08 10
S o u rc e : R e u te rs E co W in

Inflation measured by CPI has risen due to higher energy and
food prices, although core inflation (excluding energy and food)
has also begun nearing uncomfortable levels, at just under 2%.
On the other hand, we expect that when food and gas prices
decline, inflation will ease, giving the Federal Reserve a respite
before launching a period of rate hikes. We don’t anticipate the
first hike until the second half of 2013, in line with the Fed’s
announcement.

This summer QE2 ended. Since deflation concerns have eased, Demands for QE3
we don’t anticipate another quantitative easing. Although a are gaining steam
gloomier growth outlook and higher unemployment are now
raising demands for a new easing to keep interest rates low and
strengthen asset prices, the Fed isn’t likely to consider one until
there are signs of deflation. Besides, another quantitative easing
may not have much impact on growth and jobs, and the side


effects on global inflation, commodity prices and capital flows to
emerging countries can’t be overlooked.

China – growing faster than planned
 GDP growth has surprised on the upside, but is expected to
slow in quarters to come

 Inflation will peak this year and drop to 3-4% in 2012-2013

 The goal to “rebalance” the economy will take time and
require more reforms

Expectations that China’s GDP growth will more visibly slow did
not come to fruition earlier this year when GDP rose in the first
two quarters by 9.7% and 9.5% at an annual rate. Despite lower
credit growth and higher inflation, the economy continued to grow
at a rapid pace.

The wheels of the Chinese economy have since begun to slow The wheels of the
slightly. This was caused by the rise in interest rates in order to Chinese economy are
check inflation and is also evident in the purchasing managers now rolling more
index, which indicates slower economic activity. Slower import slowly
growth is also a sign of weaker domestic activity. A slight
slowdown is already evident on an adjusted quarterly basis, but
as usual there is reason to be cautious in interpreting these
sometimes dubious data.

However, we are revising GDP growth upward by 25 bp to 9.0%
this year on the basis of stronger results. GDP growth will then
fall to 8.4% in 2012 and 8.0% in 2013. This means that the goal
in China’s latest five-year plan of average GDP growth of 7% per
year in 2011-2016 in all likelihood will not be reached.

Growth in GDP, industrial production and auto sales

2 0 ,0 90
< - - In d u s tr ia l p r o d u c tio n C a r s a le s - - >
80
1 7 ,5
70
1 5 ,0
60
< - - G D P - g r o w th
1 2 ,5 50
Percent

Percent

1 0 ,0 40

30
7 ,5
20
5 ,0
10
2 ,5 0

0 ,0 -1 0
04 05 06 07 08 09 10


Swedbank's Global Economic Outlook, August 2011

Swedbank's Global Economic Outlook, August 2011

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