December 2019
Special Report • Global Outlook
2020 Vision
Forecasts
For the Year
Ahead
Contents
2020 GLOBAL OUTLOOK • BLOOMBERG ECONOMICS
Introduction
2
Europe and the
Middle East
Germany faces too many
pitfalls to rebound soon
21
Global Outlook
France is buoyant, but trade
threats could change that
22
Is a global slowdown inevitable?
A lot is up in the air
Italy will limp from one
crisis to another
Three scenarios for trade—
and a truce is only one
Spain’s economy is cooling fast
4
6
U.S. consumers continue
to carry the day
8
Calculating the odds
of a U.S. recession
10
China tries to stave
off a further slowdown
12
Is Japan headed for
a recession?
14
The ECB can’t protect the
euro region from trade wars
16
Draghi’s legacy,
Lagarde’s challenge
17
A snap election and Brexit:
Reading the U.K. tea leaves
18
23
24
Sweden’s long season of gloom
25
Testing Putin’s long game
26
Turkey has climbed out of
recession, but risks remain
27
Geopolitics, oil prices—not
much looks rosy in Saudi Arabia
28
What’s behind falling oil prices
29
Asia
At last, a recovery in India
31
Monetary easing will bear
fruit for the Asean-5
34
Australia will chug ahead
35
Finding opportunity
on the frontier
36
The Americas
Canada can count on Ottawa
for an assist
38
After pension reform, Brazil
is hungry for growth
39
Uncertainty in Mexico imperils
growth
40
Argentina’s new leader has no
time to waste to spur a pickup
41
Sluggish economies—again—
in Chile, Colombia, and Peru
42
Scoring how emerging-markets
economies will do
44
No, Mr. Trump, the dollar isn’t
at a record high. Here’s why
48
The trade war will tamp South
Korea’s prospects
32
Hong Kong’s long recession
33
Bloomberg Economics’
Country Forecasts
48
Introduction
The global economy started 2019
with hopes for a trade truce, only for
those to be dashed as waves of tariff
increases hit exports and dented
confidence. In 2020 the pattern could
be repeated. A U.S.-China deal, if it
sticks, would put monetary policy
back on hold and a floor under sliding
growth. If it doesn’t—a distinct
possibility given the gap between the
two sides and the pressures of the U.S.
presidential election—expect growth
to grind lower and central banks to
wrack their brains for how to add
stimulus when interest rates are
already so low.
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Global
Outlook
Global Outlook
Can the World Dodge a Major
Slowdown? A Lot Needs to Go Right
By TOM ORLIK
HERE’S WHAT HAS TO GO RIGHT for the world economy to steer clear
of a deeper slowdown in the next 12 months. Trade tensions have
to ease. Jobs growth and consumption in the U.S. need to remain
robust. And central bank stimulus has to gain at least some traction. It would also help if Britain escaped its Brexit impasse, Hong
Kong found a way to end violent confrontations, and Argentina’s
new government wins the confidence of skeptical markets.
Some of those will go right. Not all of them will. The U.S. and
China face a further slide in growth. Germany is flirting with recession. An orderly Brexit would allow the U.K. to dodge a downturn.
With an election looming, that’s far from guaranteed.
Global growth is increasingly lackluster. Bloomberg
­Economics’ global gross domestic product tracker shows the pace
of expansion has slowed to 2.4% in the third quarter, from 4.7%
at the start of 2018. In the U.S., the Institute for Supply Management (ISM) factory gauge has fallen to its weakest level since 2009.
China’s GDP is expanding at the slowest pace since the early 1990s.
Germany’s economy contracted in the second quarter, and early
indicators suggest weakness persists. Japan has just hiked its
sales tax; the last time it did so, growth went into reverse.
True, some of the latest developments look positive. The
U.S. and China are working on a “phase one” trade deal. The
­chances of a no-deal Brexit have been reduced. Given the experience of the past two years, though, investors are rightly wary of
false dawns. As the International Monetary Fund’s new managing
director, Kristalina Georgieva, has said, amid a synchronized slowdown of major economies, the global outlook is “precarious.”
The room for policy to fight a slowdown is limited. The
­European Central Bank is experimenting with deeper negative rates
and a fresh round of quantitative easing. But even many inside the
ECB are questioning the effectiveness of these steps—and their
potential costs. For the Bank of Japan, options are even more limited.
China’s high debt limits its ability to splurge on more c
­ redit-fueled
investments. In the U.S., elevated uncertainty about trade policy
will dent the effectiveness of Federal Reserve rate cuts.
The trade war is the biggest drag. Sweeping U.S.-China tariffs
have taken global trade from growth of 4.1% in the first half of 2018
4
to contraction so far in the second half of 2019. That’s pushed
manufacturing into recession, triggered a slowdown in investment,
and hit factory employment. In a worst-case scenario of rising
tariffs, pervasive uncertainty, and a 10% drop in global equity
markets, Bloomberg Economics estimates the price tag for the
trade war could add up to $2.7 trillion by the end of 2021.
To put a floor under global growth, the first requirement is
for trade tensions to ease. A phase one deal between China and
the U.S. is under negotiation. China has offered commitments on
commodity imports in return for the suspension of planned tariff
increases. The Asia-Pacific Economic Cooperation summit that
was to be held in Chile—mooted as the venue for a deal—was
canceled amid mass protests. With fading growth sharpening
incentives on both sides, a mini deal remains possible.
It isn’t guaranteed. Past U.S.-China talks have ended with an
assurance that talks are back on track, only for a breakdown to
follow immediately after. This time around, with potential flashpoints
related to Hong Kong, Huawei Technologies Co., and human rights,
the stakes are higher and the chances of success lower. To have a
meaningful impact on 2020 growth, any mini deal would have to
include canceling December’s tariff increase and provide assurance
that the truce would hold.
Another necessary ingredient for continued global growth
is that U.S. consumers remain resilient. There are risks. The pace
of job creation has slowed, and consumer sentiment took a tumble
over the summer. But unemployment is at its lowest level in
50 years and wage growth is steady above 3%. In a ­consumer-driven
economy, even with stalling investment and stumbling exports,
that’s enough to keep growth not too far from potential. We believe
a combination of job creation above 100,000 a month and, if
needed, further Fed cuts should mean the world’s biggest economy
dodges recession.
A number of other things could surprise us on the upside
and add support to global growth:
• China might outperform. We think limits to stimulus will see
GDP growth slow to 5.8% in the fourth quarter, down from 6.4% a
year earlier. At the same time, we also see a lot of ­infrastructure
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Global Outlook
spending in the pipeline. It’s possible state investment will rise
enough to deliver an upside surprise.
• A decisive outcome for the U.K. election—slated for Dec. 12—
would remove an overhang of Brexit uncertainty. Relative to the
current morass, a win for either the Conservatives, with a mandate
to deliver on the withdrawal agreement, or the opposition, with the
prospect of a second referendum, would mean a boost to confidence.
• With the ECB ratcheting up the pressure on governments
to do their part, we could see a significant loosening of fiscal policy
in key euro zone economies, including Germany, in the 2020
budgets countries adopt in the fourth quarter of 2019.
• In Argentina, it’s possible that incoming President Alberto
Fernández could follow the example of Mexico’s Andrés Manuel
López Obrador by pivoting from a populist campaign to relatively
orthodox policies.
Where does that leave the outlook for global growth? Our base
case is a slowdown for most (including the U.S., China, and Japan)
and recession for a few (Germany and, if no-deal Brexit returns, the
U.K.). Risks to that forecast are tilted to the downside. If a fading
manufacturing sector in the U.S. and the euro zone proves a leading
indicator of weakness in the larger services sector, the downturn will
be more widespread.
Slower and Slower …
Nations shaded by region:
Europe
Asia and Pacific
Americas
Africa
Percentage-point difference between Q3 ’19
real GDP growth and year-ago period*
Bubble size represents nominal GDP
South Africa
$10t
1
$1t
Brazil
South Korea
China
U.K.
Indonesia
Canada
$11.5t
-2.0
-1.5
0
France
Japan
U.S.
Russia
Australia
Italy
-1
$18.7t
Germany
-1.0
- 0.5
0
0.5
-2
Percentage-point difference between Q3 ’19 GDP growth and 10-year average*
*Figures for Australia, Brazil, Germany, India, Indonesia, Japan, Russia, South Africa, and the U.K. are for Q2 ’19.
Source: Bloomberg Economics
5
Global Outlook
Truce, War, or Peace:
Three Scenarios for 2020 Trade
By TOM ORLIK and DAN HANSON
in 2019 has been the story of
trade conflict. An escalating U.S.-China trade war, acrimony
­between Japan and South Korea, the risk of a hard Brexit, and U.S.
threats against Mexico, Canada, and Europe have conspired to
drag growth to its lowest level since the financial crisis.
What will 2020 look like? Focusing on the U.S.-China trade
conflict, we forecast there will be no escalation, but no respite
either. That said, the conflict has taken surprising turns in the past,
and could do so again. We map out three scenarios: truce without
respite (our base case); war (damaging, but not impossible); and
peace (unlikely, given the scale of the problems).
THE STORY OF THE GLOBAL ECONOMY
1) Truce Without Respite
The U.S.-China trade war has been damaging to both sides. China’s
gross domestic product growth has slowed to the lowest level
since the early 1990s. In the U.S., job creation and business surveys
have slumped. Even as economic conditions deteriorate, agreement on the major ­issues—market access, intellectual-property
protection, and i­ ndustrial subsidies—remains elusive.
The obvious solution, and the one toward which both sides
are groping, is a mini deal: The U.S. suspends tariff increases;
China restores agricultural imports to their pre-trade-war levels.
The cancellation of the Asia-Pacific Economic Cooperation s­ ummit
in Chile—mooted as the venue for signing a deal—complicates
the picture. An agreement before the end of the year remains a
strong possibility.
The impact on growth depends a little on the suspension of
tariffs and a lot on the tone of negotiations that follow:
6
• The U.S. delayed its October tariff increase. If it takes the
planned Dec. 15 move off the table, and China reciprocates, the
two countries would dodge a blow to annual GDP of 0.1% and 0.2%,
respectively.
• The larger impact would come if tariffs were suspended
and policy uncertainty reduced. Our analysis suggests the
­whiplash-inducing reversals in trade talks add up to a drag of 0.6%
of GDP for the U.S. and a 1% drag for China.
How Bad Could Trade Wars Get?
Percentage-point impact on global GDP
Current tariffs*
Uncertainty shock (U.S., China, Europe)
30% punitive tariff on all U.S.-China trade
10% fall in equity prices
0
- 0.5
-1.0
Q2 ’18
Q4 ’22
-1.5
*Assumes average U.S. tariffs of 17% and average Chinese tariffs of 20%
Source: Bloomberg Economics
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
The December tariff increase would leave essentially all
sales from China to the U.S.—including smartphones, tablets, and
laptops—facing a punitive levy. That’s a cost both sides will be
eager to avoid, making a mini deal more likely. A shift to a more
transparent and predictable negotiation process to resolve
­outstanding issues is less certain. Indeed, given President Trump’s
known proclivities, and the additional pressure on him because
of the 2020 election and impeachment inquiry, it seems unlikely.
Our base case: Markets will get a truce, but not a respite.
Tariffs will stay on hold. Uncertainty will remain.
2) War
A mini deal is likely. But it’s far from certain. Past talks, including
top-level meetings between Trump and Chinese President Xi
Jinping in Buenos Aires at the end of 2018 and in Osaka in the
summer of 2019, have ended with assurances of progress, only
for a breakdown to immediately follow. This time around, rancorous disputes over free speech, human rights, and national s­ ecurity
add to the difficulty.
The U.S. presidential election is another complication. Since
Bill Clinton ran for president in 1992, candidates have competed to
be tough on China. Trump might be an exception. He’s been so tough
on China that he could cut a deal and still claim to have extracted
more concessions than any previous president. Still, at a minimum,
the drumbeat of the campaign will be a complicating factor.
In a risk scenario, where punitive tariffs escalate to 30% on
all U.S.-China trade, uncertainty remains elevated, and global ­equity
markets sell off, the blow to growth would be significant. Our
analysis puts the cost at 1.1% of GDP in the U.S. and 1.6% in China,
in addition to the cost of existing tariffs.
3) Peace
What if there’s a sudden outbreak of peace? If negotiations were
narrowly confined to the protection of intellectual property,
­ensuring market access, and ending forced technology transfer,
that would be possible. The reality is they aren’t. With many on
both sides seeing the conflict through the broader lens of East vs.
West, ­authoritarianism vs. democracy, socialism vs. capitalism,
the ­chances of a comprehensive deal look vanishingly small.
Still, if there’s one thing that’s become clear in the past year,
it’s that trade talks can take unexpected turns. If tariffs are rolled
back to 25% on $50 billion in trade in both directions and uncertainty ebbs back to pre-trade-war levels, the U.S. and China could
benefit from a GDP boost of 0.8% and 1.4%, respectively.
A Note on Average Tariffs
In 2017 average U.S. tariffs on Chinese goods were about 3% and
average Chinese tariffs on U.S. goods were a little less than 7%.
Over the course of the trade war, the U.S. has imposed tariffs of
25% on $250 billion in Chinese goods and 15% on about $110 billion. China has imposed additional duties at various rates on
$110 billion. Bloomberg Economics calculates that average U.S.
tariffs on Chinese goods are now about 17%. Average Chinese
tariffs on U.S. goods are about 20%. In our risk scenario of 30%
punitive tariffs, average U.S. tariffs would increase to 33% and
Chinese tariffs to 37%.
7
Global Outlook
Consumers Will Continue to Shore Up
The Record U.S. Expansion
By CARL RICCADONNA and YELENA SHULYATYEVA
activity in the second half of 2019
provides a reasonable template for what to expect in the coming
year, as several drivers of growth fade and consumers are left
dominating the outlook to an even greater degree than usual.
In 2020, Bloomberg Economics estimates real gross
­domestic product growth will decelerate to the slowest pace since
2016, but it will be strong enough for the U.S. economy to avoid
slipping into a downturn.
Nonetheless, slower growth will cast a chill over a slew of
economic indicators, such as industrial surveys and job creation,
which could in turn impact voter sentiment before the 2020 presidential election. In our baseline scenario, the Federal Reserve will
put i­nterest-rate cuts on hold in the coming year, yet will stand
ready to provide accommodation, if needed, against downside
economic risks.
GDP growth is poised to decelerate to 2% in 2020, compared
with an estimated 2.2% in 2019. Growth prospects will largely
depend on consumers, as business investment and exports languish because of trade tensions, economic uncertainty, and slowing
global growth. Growth won’t slow enough for the unemployment
rate to begin drifting higher.
Bloomberg Economics expects the Fed to remain on hold in
2020, having provided an adequate amount of insurance cuts in 2019
to offset challenges related to trade tensions; however, the central
bank could ease further to ameliorate inversion of the yield curve.
DECELERATING U.S. ECONOMIC
Trade War Headwinds Are Stiffening
Despite exports accounting for a relatively small share of GDP compared with other developed economies, the U.S. isn’t immune to
trade-related headwinds. The economy, at least superficially,
­appeared to take tariffs in stride in 2018. Neither GDP growth nor
consumer inflation showed much deviation from the trends that had
prevailed over the previous five years. However, trade tensions did
extract a toll, eroding much of the boost from the Trump tax reforms.
In 2018, a year when growth was initially poised to be the strongest
in a decade, economic uncertainty instead rattled consumers and
dampened businesses’ plans for capital investment and hiring.
These same obstacles continue to intensify: Earlier in 2019,
the 10% tariffs on $200 billion of Chinese imports increased to
25%, and new tariffs of 15% on roughly $111 billion of additional
imports were implemented in September. The economic cost of
8
these ­m easures is approaching $50 billion, up from about
$33 billion in 2018. A slower-growth economy is less equipped to
absorb this shock.
Further rounds of tariff increases are conditional on constructive trade talks in the fourth quarter of 2019. The hike in tariffs
from 25% to 30%, scheduled for October, was suspended. However,
an additional $156 billion of imports—mainly consumer goods—will
be subject to 15% tariffs in mid-December unless a deal between
China and the U.S. is reached. These tariffs carry a price tag of
roughly $13 billion and $23 billion, respectively, bringing the total
for 2019 tariffs to roughly $83 billion—2.5 times the cost in 2018.
A slower pace of growth, larger tariff price tag, and less room
for the impact to be buffered by compressed producer margins
will make the cost of trade tensions more evident in coming
­economic data compared with last year’s.
In addition to the direct cost from tariffs, households and
businesses are increasingly acknowledging that there won’t be a
swift resolution to trade talks. The resulting psychological malaise
is leading to a sharp curtailment of capital investment; the risk is
that defensive posturing among hiring managers will weaken labor
conditions, too.
Consumer attitudes have demonstrated impressive resilience over the first three quarters of 2019, but have started to
A Tax Cut Tailwind Is Consumed by the Trade War
U.S. Q4 real GDP, year-over-year change,
seasonally adjusted
Trump tax cuts
and trade war
3%
2
BE forecast
1
2010
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
2020
0
Sources: Bureau of Economic Analysis, Bloomberg Economics
Global Outlook
show some more recent signs of erosion. A weakening consumer
outlook would materially diminish growth prospects.
A Growth Recession Isn’t in the Cards
Trade tensions and slowing global growth dominate Bloomberg
Economics’ medium-term outlook. We expect business fixed
­investment to essentially grind to a halt amid economic u
­ ncertainty,
exports to wither in response to a combination of debilitating d
­ ollar
strength and sluggish external demand, and housing to show only
a feeble response to declining interest rates. Government s­ pending
will provide a moderate positive contribution.
The pace of growth will therefore be inordinately tied to household demand. Consumers have shown some signs of restraint of late:
After posting the second-strongest performance of the cycle in the
second quarter, personal spending showed clear signs of downshifting
in the third quarter—more consistent with the underlying income trend.
The savings rate has edged toward the high end of its range
over the past five years, while at the same time households’ expectations for the future have deteriorated relative to their assessment
of current conditions. These are telltale signals that consumers
are becoming more cautious. Even so, with unemployment at the
lowest level in 50 years, minimal slack in the labor market should
support the wage and salary income trend and, in turn, provide a
backstop to consumers.
In Consumers We Trust
U.S. indicators, year-over-year change in 12-month moving average
Personal income (wages and salaries)
Personal spending
8%
4
0
1/2014
9/2019
-4
Source: Bureau of Economic Analysis
As the chart below illustrates, consumer spending typically
tracks relatively closely with the wage and salary trend, particularly
in the middle-to-late stages of economic cycles. Wage and salary
growth has averaged just below 5% over the past year, so accounting for roughly 2% inflation, a baseline forecast of 3% consumer
spending is reasonable.
Bloomberg Economics projects a somewhat weaker profile
to take into account reduced hiring momentum and a more conservative outlook among consumers. Our baseline forecast is for
inflation-adjusted consumer spending of 2.3% in the coming year,
resulting in overall GDP growth of 2%.
With the pace of growth decelerating from 2.6% in the first
half of 2019, much of the economic data will be sluggish. This is
already becoming evident in industrial surveys, such as the Institute for Supply Management’s slumping manufacturing index.
However, the slowdown won’t be so pronounced as to result in
rising unemployment—a condition economists refer to as a “growth
recession.” Bloomberg Economics estimates that consumer spending would need to slow below 2% for overall growth to decelerate
below the threshold (roughly 1.4%) where the unemployment rate
would drift higher.
The Fed Will Stay Put, But Is Ready to Act
We anticipate the Fed will remain on hold next year after having
provided an estimated 100 basis points of cuts in 2019. If the
federal funds rate remains above 10-year Treasury yields at the
2019 yearend, then further reductions will follow in 2020—though
officials will be increasingly reluctant to act as the election nears.
At present, our base case is that the midcycle easing will
prove adequate to stabilize growth, though our central scenario
is exceptionally vulnerable to changes in the trade outlook. A rapid
reduction of trade tensions would mitigate the need for further
accommodation, but continued escalation would push
­policymakers closer to the zero bound.
To be sure, the U.S. economy is poised for a tough slog over
the next few quarters, but conditions remain fertile for a robust
rebound when and if trade headwinds subside: Interest rates are
significantly accommodative; labor scarcity is keeping a floor under
wage pressures; and corporate balance sheets and profit growth
are primed to support faster hiring and investment when animal
spirits return.
9
Global Outlook
As Risks Rise, the Odds
Of a U.S. Recession Are 25%
By ELIZA WINGER, YELENA SHULYATYEVA, and ANDREW HUSBY
U.S. recession probability indicator
shows the chance of a downturn within the next 12 months is
about 25%. That’s a warning sign but not yet a panic signal. The
reading is higher than it was a year ago but significantly lower than
before the last recession.
• The yield curve is the workhorse of recession probability
models and has a strong track record of predicting past downturns. This time, quantitative easing and depressed term premiums mean that—on its own—the yield curve may not be sending
a reliable signal.
• Reflecting that, our model incorporates a range of financial
market indicators, activity data, and measures of background
imbalances. The flat yield curve is flashing a warning. Other indicators, such as accelerating real wage growth, suggest recession
odds are limited.
• The model outcome—a 25% chance of recession in the
next year—aligns with our view that robust consumption will
­continue to support growth close to potential. Amid trade tensions,
BLOOMBERG ECONOMICS’ NEW
Flashing Yellow, But Not Yet Red
Probability of a U.S. recession within 0 to 12 months
Recession
100%
50
1/1992
9/2019
0
Source: Bloomberg Economics
10
smart policy execution by the U.S. Federal Reserve should enable
the record-long expansion to extend further.
Forecasting a recession is challenging, especially over a
long time horizon. Signals become clearer three to six months
before a downturn and more obvious the closer it gets. Modeling
works best when analysts see the whites of a recession’s eyes,
but the most valuable forecast is the one that predicts risks well
ahead of time.
Given the limitations, our model used a range of financial
market, real economy, and economic imbalance indicators to gauge
the immediate, 3-, 6-, and 12-month risk of recession.
To provide a reading on whether the economy is on the
­immediate cusp of a recession, we looked at the level of jobless
claims, stock prices relative to trend, and the Institute for Supply
Management orders index reweighted to reflect the share of manufacturing and services in the economy. Taken together, these
variables provide reliable signals on turning points. The concurrent
recession probability is close to zero—the U.S. is not on the brink
of a downturn.
At the three-month horizon, our model focuses on financial
market variables. In addition to stock movements, we looked at
the slope of the 10-year/3-month yield curve and changes in highyield spreads. The yield curve is signaling a heightened probability of recession. Credit spreads suggest investors don’t see funding pressures or an imminent downturn in activity. Based on those
indicators, the three-month recession probability is about 5%.
Looking six months ahead, the Conference Board’s Leading
Economic Index is a valuable predictor. The index combines
10 ­financial market and activity indicators that tend to move before
changes in the overall economy. Our probability indicator, based
on the index, implies a less than 10% chance of a recession starting in six months.
Extending the forecast horizon, we relied less on financial
market variables, which are standard in the academic literature,
and looked at a broader set of data. Looking 12 months ahead, we
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Global Outlook
applied a probit model individually to data within three tranches:
financial indicators, gauges of economic activity and consumer
sentiment, and measures of i­ mbalances in the corporate sector:
• Within the financial indicators group, we looked at the
10-year/3-month Treasury spread, as well as corporate credit
spreads. In addition, we looked at the difference between nominal
gross domestic product and the federal funds rate—an indicator
of policy tightness that tracks closely with past downturns.
• For activity, we focused on consumer sentiment and labor
market indicators.
• To assess underlying imbalances, we monitored movements
in corporate profit margins, financing gaps, and interest payments
relative to corporate profits.
Taking all those indicators together, the probability of the
U.S. economy heading into recession 12 months out is about 15%.
The headline odds of a recession within 12 months are based
on the product of “no recession” probabilities at the zero, 3-month,
Recession Probabilities at Different Time Horizons
Probability of a U.S. recession
Over 0 to 12 months
0-month horizon
3-month
6-month
12-month
Recession
100%
50
1/1992
9/2019
0
Source: Bloomberg Economics
6-month, and 12-month horizons. At around 25%, the chance of
recession generated by our model is consistent with our view that
the current economic expansion will continue. Our base case is
that robust consumption will maintain growth close to potential,
despite elevated risks from a global slowdown and trade uncertainties.
A 25% probability is markedly up from the level a year earlier, when our model pointed to about a 15% chance of recession.
It’s also down from the level over the summer, and below a reading of 50% a year before the Great Recession. The drop from summer highs is a reminder that financial market indicators are noisy
and volatile, sometimes contributing to false positive signals. The
low level compared with the period before the Great Recession
is a reminder that, despite high temperatures in the markets and
heightened risks in the world economy, in many respects e
­ conomic
fundamentals in the U.S. remain sound.
A Note on Forecasting
Assessing the state of the U.S. economy a year in advance is challenging, particularly when dealing with a binary outcome variable.
One consequence of that: In our model, the probability of recession at a 12-month horizon never gets close to 100%, even as the
cumulative probability of recession from zero to 12 months q
­ uickly
nears 100% as recession approaches. This is a feature of any
model that seeks to identify recession at a 12-month horizon,
including the New York Fed’s yield curve model.
At shorter horizons, noisy financial markets and volatile
leading indicators can result in false positives. In some cases, the
model sends an accurate signal of risks, but real-time policy
­responses from the Fed ease fears, boost activity, and head off
the chances of a downturn.
Bloomberg Economics recognizes the limitations of the
recession probability model, but still views it as a valuable tool
providing a high-frequency, consistent gauge on the evolution of
recession risk.
11
Global Outlook
China’s Growth Could
Fall Below 6%
By CHANG SHU, DAVID QU, and QIAN WAN
CHINA’S GROWTH IN 2020 could fall below 6%. ­Challenges from the
trade war, global slowdown, and weak business sentiment mean
the economy will continue to lose momentum at least into the
first half of 2020. We don’t expect a crash landing, but we do see
an extended slowdown.
Intensified policy support is a necessity and a near certainty,
but officials are likely to use their policy ammunition carefully to make
sure each measure counts.
• We expect growth to slow to 5.8% in the fourth quarter of
this year from the period a year earlier, following a below-­consensus
expansion of 6% in the third quarter. For 2019 as a whole, growth
should ease to 6.1%, close to the lower end of the 6% to 6.5%
official target range.
• For 2020, we forecast growth will slow further, to 5.7%.
• Policy is likely to be loosened on all fronts—fiscal, ­monetary,
and combining structural elements. This should help put a floor
under growth.
• At this stage of intensive easing, the People’s Bank of C
­ hina
will probably continue to combine reductions in the reserve
­requirement ratio (RRR) and in interest rates.
The Central Bank Deploys Its Tools
China monetary policy instruments
Reserve requirement ratio for major banks (left axis)
Intensive
tightening
25%
Interest rate* (right axis)
Intensive
easing
15
5
8%
6
1/2000
9/2019
4
*Before August 2019, the one-year benchmark rate. After, the one-year loan prime rate.
Sources: PBOC, Bloomberg Economics
12
• We project the one-year loan prime rate (LPR)—the new
de facto interest-rate benchmark—will continue to fall in small yet
frequent steps in 2020. The de jure benchmark lending rate could
be adjusted from time to time to reflect the cumulative changes
in the LPR.
Multiple Obstacles in 2020
GDP growth avoided falling below 6% in the third quarter, but it
slowed more than the consensus forecast. On balance, the trends
in industrial production, fixed-asset investment, and exports point
to slowing momentum. It will be challenging for the economy to
find a firm footing in the near term. Details of a “phase one” trade
deal with the U.S. are still unclear, and U.S. tariffs of 15% to 25%
on $360 billion of imports from China remain in place—a significant
external headwind.
What’s more, a negative feedback mechanism has kicked
in: The trade-war-induced slowdown in China is exacerbating a
downturn in global growth, which in turn hurts demand for Chinese
exports. Squeezed corporate profits and weak business sentiment
suggest it will take a long time for the private sector to stabilize.
Headline consumer price inflation has picked up on surging
pork prices. But the underlying trend in prices is weak, as ­reflected
in lackluster core inflation and falling producer prices.
Government Spending Has Constraints
The objective now appears to be to prevent a sharp slowdown,
not rev up growth. The government has been cautious in d
­ ispensing
general stimulus compared with previous easing cycles. This­
­reflects a few considerations. First, uncertainties associated with
the trade war mean that a cautious use of policy ammunition is
prudent. Second, there’s a realization of challenges in making the
impact of stimulus measures felt. The central bank, for example,
is grappling with the difficulties of lowering funding costs for corporations, especially small private companies. The focus is on
making each measure count.
Fiscal policy will probably continue to focus on infrastructure
spending and implementing tax cuts. The 2019 quota for special
bond issuance—a source of funding for infrastructure investment
by local governments—has been used up. The aim was to ­accelerate
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Global Outlook
placement of the proceeds for big projects by October. There are
plans to front-load special bond issuance for next year.
The government recently announced proposals to raise
local governments’ share in fiscal revenue. This will increase their
fiscal capacity and incentives to follow such central government
stimulus measures as tax cuts.
One problem with relying on infrastructure investment to
prop up growth is that it’s not as easy to ramp up spending now
as in previous cycles. This isn’t only because of a much bigger
base. China’s public investment per capita is almost as high as
that of some advanced economies, suggesting limited room for
rapid expansion. Investment per capita by the private sector—
critical to sustainable longer-term growth—is lagging ­significantly.
Combining Monetary Policy Tools
The PBOC has historically tended to combine the use of RRR and
interest-rate tools in intensive periods of easing or tightening. This
was the case during the tightening phases of 2006-07 and 2010-11,
and the easing phase of 2015-16.
The latest easing also combines these tools. The central
bank announced a 50-basis-point, broad-based RRR cut and a
100-bp, targeted RRR cut for eligible regional banks in September.
China’s Economic Forecasts
China indicators
Actual
Forecast
Q1 ’19 Q2 ’19 Q3 ’19 Q4 ’19
GDP growth forecast (Oct.)
Tariffs on all Chinese goods,
rates at 15%-30% by yearend
2018
2019
2020
6.4
6.2
6.0
5.8
6.6
6.1
5.7
Consumer price index
Year-to-date
1.8
2.2
2.5
2.6
2.1
2.6
2.8
Loan prime rate
One-year
4.31
4.31
4.20
4.10
4.31
4.10
3.70
Source: Bloomberg Economics
It also overhauled its interest-rate framework in August, introducing a loan prime rate formulated under a new, more market-based
mechanism. This rate has been guided down in August-October,
taking it 15 bps below the benchmark lending rate. Also n
­ oteworthy,
it’s moving in much smaller increments than the typical 25-bp
shifts in benchmark rates.
This pattern of paced easing through a combination of the
RRR and interest-rate reductions is set to continue. We expect
200 bps of reductions to the RRR and a series of incremental cuts
to the LPR, totaling 50 bps from the fourth quarter of 2019 to the
end of 2020.
The cuts in the LPR, which sets prices for new loans, have
been much smaller than typical 25-bp changes when the benchmark lending rate was used. The benchmark rate retains a key role
in that it governs the funding cost of existing loans. We expect it
to be adjusted in two steps by the end of 2020 to reflect cumulative changes in the LPR.
The Yuan Breaching 7 and the “Impossible Trinity”
The yuan’s depreciation in early August beyond 7 per dollar—a
long-defended level—was significant. The move, which came after
the U.S. threatened to hike tariffs further, was in line with our
expectation that the PBOC would focus on controlling volatility
rather than on a specific level. The central bank succeeded in
quickly anchoring expectations after 7 was breached, stemming
disorderly currency adjustment.
The yuan’s decline shifted the PBOC’s position within the
“Impossible Trinity,” a doctrine stipulating that a country can’t
maintain an independent monetary policy, an open capital account,
and a fixed exchange rate at the same time. The currency flexibility creates room to maneuver on the other two policy fronts, particularly on monetary policy, in addition to helping absorb some
of the trade-war shock.
The signals from Bloomberg Economics’ daily and monthly
stress gauges suggest the yuan should find some support in the
near term. A faster pace of monetary easing by the U.S. Federal
Reserve relative to the PBOC is one such source of support. This
reprieve, though, is fragile given the downside risks from China’s
slowing growth and the trade war.
13
Global Outlook
In Japan, Recession Threats Emerge
By YUKI MASUJIMA
JAPAN’S ECONOMY IS LOSING MOMENTUM as 2020 approaches. W
­ eaker
external demand is taking the wind out of the manufacturing ­sector,
and a higher sales tax threatens to dent consumption. Our recession risk model has flashed a tentative warning.
For now, we think a recession will be avoided. Public
­expenditure is increasing, investment by nonmanufacturers is
holding up, and spending on services is steady. Sales at supermarkets and convenience stores rebounded from a sharp dip
after the sales tax went up on Oct. 1, according to daily data. ­Taken
together, the economy is showing resilience.
That said, the downward pressures are strong. The U.S.-­
China trade war and slowing global growth are damping exports.
The higher sales tax will squeeze consumers and could push the
economy over the edge. Our view is that the Bank of Japan will
take a long view—while we acknowledge rising chances of a preemptive boost to stimulus, our baseline scenario is for a steady
policy course through next year.
• The latest reading on our recession probability model was
above a key threshold associated with the past six recessions.
• The economy will take a hit in the fourth quarter from the tax
hike, but we expect a quick rebound that would dodge a r­ ecession.
• We see gross domestic product growth at 0.8% in 2019
and a slowdown to 0.2% in 2020.
• Falling bond yields underline increasing market expectations
that the BOJ could try to squeeze more stimulus out of its monetary
framework this year. Our view is that any benefits of extra stimulus
would be countered by heavier strain on the­financial system.
• Our baseline scenario assumes mild yen appreciation to
105 per dollar at the end of 2020. Unexpected yen strength beyond
100 would damp inflation and hurt competitiveness, likely
­prompting BOJ easing.
Leading and coincident indicators compiled by the Cabinet
Office give a fairly reliable read on the economic cycle.
• The leading indicator, which includes 11 data series, has
tumbled since late 2017, reaching the lowest level since 2009 in
August—mainly on weaker signals on consumer confidence, the
producer inventory/shipments ratio, small and midsize e
­ nterprises’
sales outlook, and the Nikkei 225.
• The coincident indicator, which comprises nine different
data series including industrial production, retail sales, and
The Likelihood of a Recession Is Growing
Japan recession probability index
Actual
Six-month moving average
Recession
Great East
Japan
Earthquake
Sales
tax hike
1.0
0.5
1/1985
8/2019
0
Sources: Bloomberg Economics, Cabinet Office
14
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Global Outlook
­overtime working hours, has shown some resilience.
Bloomberg Economics’ recession probability model uses
the relationship between Japan’s leading and coincident indicators
and past downturns to assess the likelihood of a recession s­ tarting
over the next month.
• The latest reading came in at 0.76 in August—marking a
second straight month above the key threshold of 0.65 that was
associated with the past six recessions.
• That isn’t yet a definitive recession signal. A couple of
months above 0.65 is cause for concern, but we’d want to see it
there for three to six months to increase our conviction. The sixmonth moving average is 0.40, as of August.
• What’s more, readings above the 0.65 threshold aren’t
always followed by recession. The gauge exceeded 0.65 in 2011,
when Japan was clobbered by a massive earthquake, and in 2014,
when the sales tax was last raised. Each time, the economy
­suffered sharp setbacks but managed to avoid outright recessions,
as defined by the government.
• The recession indicator uses a probit model, regressing
the leading and the coincident indexes on the date of past downturns to determine recession risk. The sample period is from
­January 1985 to August 2019.
Much of our confidence in a benign scenario for the e
­ conomy
rests on our view that sources of resilience will prevail.
• Public spending has been stronger than expected this year
and should do more to prop up growth.
• Prime Minister Shinzo Abe’s administration has taken pains
to smooth the transition to a higher sales tax level—applying
­exemptions on food and increasing spending on infrastructure,
child education, and subsidies for low-income elderly.
• The service sector is also providing a largely under­
appreciated source of support for growth. This is helping to offset
weakness in manufacturing as exporters gear down in response
to weaker supply chain demand.
If the economy rides out the sales tax increase as we expect,
pressure on the BOJ to boost stimulus should abate somewhat—
allowing it to stay on hold through yearend 2020. Even so, it will
be tough going.
• With growth likely to slow next year to below potential (which
Growth Will Lose Steam in 2020
Japan real GDP
Percentage-point contribution of selected components
Private final consumption
Private non-residential investment
Private residential investment
Public demand
Net exports
BE forecast
2%
1
0
2014
2020
-1
Sources: Cabinet Office, Bloomberg Economics
the BOJ estimates at 0.7%), inflationary pressures will weaken.
• We see core inflation at 0.6% in 2019 and 0.4% in 2020,
excluding the effects of the sales tax hike. With the higher tax,
we see core inflation at 0.8% and 1.1%, respectively. The BOJ’s
­target is 2%.
Our BOJ policy conditions index, which takes in the VIX
­volatility gauge and Japan’s core inflation, indicates that the hurdle
for additional stimulus is high, especially considering the financial
costs for consumers and banks that’s associated with lower rates.
The message from the index could change, though, if the yen jumps.
A surge beyond 100 per dollar would likely flip the signal to easing.
The Abe administration has earmarked much of additional
revenue expected from the higher sales tax for funding free
­education and providing subsidies for the low-income elderly—
leaving little extra to rein in the budget deficit. Even so, Abe isn’t
likely to hesitate to add fiscal stimulus if the economy slumps into
a technical recession. The cost would be a further delay in shifting
the primary balance into surplus from deficit by fiscal 2025—yet
­another setback for fiscal consolidation for a country whose debt
will amount to about 240% of GDP in 2019.
15
Global Outlook
The ECB Can’t Save the
Euro Area From Trade Wars
By DAVID POWELL and MAEVA COUSIN
THE EURO AREA’S FRAGILE recovery is being blown off course by
headwinds from abroad. Bloomberg Economics expects the bloc
to avoid recession, but the risks of a contraction are elevated—a
trade spat with the U.S. would cause some significant damage.
The European Central Bank has probably done all it’s willing to do
for now, and fiscal policy is unlikely to be loosened anytime soon.
Euro area gross domestic product growth is likely to be lackluster for several quarters. We look for the economy to expand only
0.2% in the fourth quarter and again in the first quarter of 2020. That
tepid pace will do nothing to lift underlying inflation—we forecast the
core measure may stand at 1.2% in 2020. With asset purchases tied
to actual inflation, we expect the ECB will still be buying bonds in 2021.
The economic outlook has deteriorated. The Purchasing
­Managers Index for manufacturing has declined to levels not seen
since the monetary union’s existential crisis in 2012. Germany has
been the primary driver of the weakness. The country makes up 29%
of the monetary union’s GDP, but it’s been responsible for about
60% of the decline of the PMI from its peak in December 2017.
Germany Drives Decline in Euro Area Manufacturing PMI
Decline in euro area manufacturing PMI since December 2017
Percentage-point contribution:
Germany
France
Italy
Rest of the euro area
0%
-8
12/2017
9/2019
-16
Sources: Bloomberg Economics, Markit
Germany’s economy has slowed primarily because global
i­nvestment growth has ebbed, and that’s unlikely to turn around
anytime soon. Until global trade policy becomes more predictable,
business sentiment will remain weak and investment will be held back.
The downturn in Germany won’t necessarily be disastrous
for the euro area as a whole. History shows that generally when
the German economy shrinks, growth in the euro region slows,
but not enough to tip it into recession. Growth in other member
16
states has historically helped defend the bloc against contractions
in its largest economy.
The services sector, which makes up about 75% of GDP, has
buoyed the German economy as manufacturing has weakened. ­But
there’s some evidence the shock to confidence from actual and
potential disruptions to trade is spreading: The services PMI has
tumbled recently. The deterioration since its peak has been broadbased across the four largest economies of the monetary union.
Our GDP forecasts for the final quarter of 2019 and the first
quarter of 2020 are below our estimate of trend growth of 0.3%
to 0.4% a quarter. That means the pace of expansion will be insufficient to ensure unemployment keeps falling, wage growth continues to accelerate, and inflation keeps climbing.
Economic conditions could deteriorate further. Time is running
out for progress on a European Union-U.S. trade deal. If talks collapse,
there’s a high chance euro region autos will be hit with hefty tariffs.
The deterioration in the euro area is occurring before the
ECB managed to undo the damage to inflation from the economy’s
last heart attack, in 2012. As a result, the core inflation reading
has failed to come close to the target of less than, but close to,
2% for more than a decade and now stands at about half that goal.
A new round of monetary stimulus should provide the e
­ conomy
with some support, although it’s unlikely to lead to rapid improvement.
Our estimates indicate about two years of asset purchases will be
required before the ECB can declare victory. Given the discord among
Governing Council members caused by the decision to relaunch
quantitative easing, the bar to a
­ dditional stimulus looks high.
The Last Game in Town
The limited room for easing monetary policy and its potentially
muted impact will keep calls alive for fiscal stimulus. Former ECB
President Mario Draghi has loudly and clearly called on those
governments with fiscal space to loosen their purse strings.
He has a point. The ECB has expanded its balance sheet to
a size that would have been previously unimaginable, and fiscal
policy has done little to support the recovery. Government
­spending is increasing a bit this year, but the impact on the region’s
economy will probably be little more than a rounding error.
We don’t expect that to change much. Germany has the most
fiscal flexibility, but a deep recession at home would probably have
to occur before Berlin pulls the trigger on stimulus. The bloc’s largest
economy is ignoring the cue from the Netherlands. And neither France,
Italy, nor Spain have much breathing room if they want to avoid falling
foul of budget rules imposed by the European Commission in Brussels.
As new ECB President Christine Lagarde settles in, her calls
for belt-loosening are also likely to go unheeded.
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Global Outlook
Lagarde Will Need All Her
Magic Touch to Reunite the ECB
By FERDINANDO GIUGLIANO
THE TRANSITION AT THE TOP of the European Central Bank is among
the most important changes affecting the euro zone in 2020. The
ECB is the most powerful institution in the currency area. In the
wake of the sovereign debt crisis at the start of this decade,
­investors regard it as the main guardian defending the integrity of
a still-fragile monetary union.
The replacement of Mario Draghi with Christine Lagarde in
November 2019 has been couched in terms of continuity. Lagarde
has publicly supported her predecessor’s commitment to do
“whatever it takes” to protect the euro. Draghi has vowed that
the ­changes he helped introduce in the central bank’s armory—
including asset purchases and negative interest rates—will outlive
his presidency.
And yet the two bring to the job very different qualities. For
all his remarkable political nous, Draghi was the ultimate ­technocrat.
He believed in the power of his intuitions even at the cost of sacrificing consensus. Lagarde is more political: As the managing
director of the International Monetary Fund, she helped rebuild
the brand of an oft-loathed institution. The question is whether
her magic touch will suffice to hold the ECB together at a time of
resurfacing divisions.
There’s little doubt that Draghi leaves the ECB and the euro
area in much stronger shape than he found it at the end of 2011.
The monetary union was engulfed in a sovereign debt crisis, and
the central bank had just gambled with its reputation by raising
interest rates twice in spite of a visible slowdown. Eight years
later, the ECB is still far from its objective of keeping inflation
below, but close to, 2%. Yet most economists agree that, in the
absence of the measures Draghi helped introduce, the central
bank would be even further from hitting its inflation target. Some
go as far as thinking that without him, the monetary union wouldn’t
have survived in its current form.
Draghi carries remarkable intellectual heft, courtesy of his
long career as an academic, treasury official, and central banker.
He commands the respect of outside observers and fellow ­monetary
policymakers, which has helped him push his preferred policies
through the central bank and convince investors they would be
­effective. He had little time for disagreement: In September, he
chose to hammer through a package of rate cuts and asset ­purchases
in spite of widespread opposition, including from the governors of
the central banks of Germany, France, and the Netherlands.
­ abine Lautenschläger, a member of the ECB’s executive board from
S
­Germany, resigned soon after the decision, which she had ­staunchly
opposed. For good or ill, Draghi hasn’t been a man of compromise.
Lagarde will be a different kind of president. A lawyer by
training, and a former defense and finance minister in France, her
emphasis will be much more in building bridges—across nations
and with the public. In a confirmation hearing at the European
Parliament, she vowed to make the central bank clearer to ordinary
people. “I want the people of the euro area to understand why
decisions are being made,” she told lawmakers. The contrast with
Draghi is striking: “It’s important that the language being used
maintains the subtle distinction between the central banking
system and politics,” he said in a hearing only a few weeks later.
“It’s easy, in order to use the language of the people, to enter
terrain that is not that of central banking but becomes politics.”
Lagarde’s skills could come of great use at a time when
critics fear monetary policy is stretched and can do little to foster
the r­ ecovery. The euro zone needs more help from fiscal policy,
especially in countries such as Germany that have space to
­increase spending and cut taxes without risking a market crisis.
It also needs to take steps toward creating a common budget,
which can help countries when they face an isolated shock. While
Draghi has ­repeatedly advocated these changes, they’ve never
occurred during his p
­ residency. At the IMF, Lagarde was used to
reconciling the differences of her various shareholders. If anyone
can have a shot at addressing the long-standing deficiencies of
the monetary union, it’s her.
There’s a risk, however: Instead of advancing the effectiveness of the currency union, she could lose the hard-fought gains
the ECB has made under Draghi. The deep division she encounters
as she walks into the central bank could be an ominous prelude
to what will come next. The heads of the national central banks,
which have been sidelined during Draghi’s term, may seek a more
collegial decision-making process, which could bog down the ECB.
Lagarde will also have to rely a lot more on the central bank’s staff,
as she did during her time at the IMF. The question is w
­ hether in
the event of a new crisis, she will be able to act with the c
­ reativity
and credibility of her predecessor.
The ECB is a very different place from when Draghi joined
in 2011. It would be foolish to imagine it will be the same when
Lagarde leaves in 2027.
17
Global Outlook
The U.K. Economy’s Fate
Hangs on the Snap Election
By DAN HANSON
THE RESULT OF THE U.K. general election, due on Dec. 12, will have
the biggest bearing on Britain’s economic outlook for 2020. We
expect the vote to return a mandate for Prime Minister Boris
Johnson to deliver his Brexit deal. But we recognize the outcome
is highly uncertain and could result in a Labour-led government or
a hung Parliament. Our central forecast for 2020 sees a rebound
in growth, below-target inflation, and higher interest rates.
The U.K. economy has taken a battering in 2019. The main
culprit: unrelenting uncertainty created by Brexit. A slowing global
economy has also taken its toll. Quarterly growth has been ­volatile—
gross domestic product surged in the first quarter as companies
stockpiled, and then dropped back in the second quarter. On an
underlying basis, it’s probably rising at a quarterly pace of 0.2%,
about half the average since the 2016 referendum. Still, the
economy looks like it will easily avoid a technical recession.
Forecasting the economy beyond the third quarter requires
looking at how the Brexit saga will unfold. Since our last forecasts
were published, there’ve been three key developments.
First, Johnson secured a revised Brexit deal that appears to have
the broad support of the Conservative Party. Second, the U.K. asked
for a Brexit extension to Jan. 31, which the European Union granted.
Third, Parliament voted in favor of holding an early general election.
For the purposes of our latest central forecast, we’ve
assumed that:
Conservatives Lead in the Polls
Average support among last five polls
Conservatives
Labour
Liberal Democrats
Brexit Party
40%
20
1/1/19
10/25/19
0
Sources: Britain Elects, Bloomberg Economics
18
• Reflecting its lead in the polls, the Conservative Party wins
a small majority in the election on Dec. 12.
• The U.K. leaves the EU based on the terms agreed to by
Johnson. We’d previously assumed he would end up taking the
country out of the EU without a deal at the start of 2020. We now
think that’s unlikely.
• The government indicates it’s willing to extend the t­ ransition
period to complete negotiations for a free-trade agreement with
the EU. Failing to do so would see Britain trading on terms set by
the World Trade Organization at the start of 2021, while uncertainty
persists during 2020.
Our Base Case: Johnson Wins, Plus a Brexit Deal
Under a new Johnson-led government, GDP growth will probably
pick up from the subdued underlying pace seen in 2019. Capital
spending is likely to return to growth, though the bounce will be
limited by uncertainty about the nature of the future relationship
with the EU. The weaker global economic backdrop should also
mean net trade drags.
Consumer spending, the heartbeat of the economy since
the 2016 referendum, is likely to get a lift from the boost to real
incomes from the rise in sterling. We expect this windfall to be
spent rather than saved, as it has been in the past.
Looser fiscal policy will probably also support private
­domestic demand. Chancellor of the Exchequer Sajid Javid has
hinted that he might accelerate investment spending, and the
pledges Johnson made on tax cuts during his leadership campaign
may also be honored. We’ve assumed a fiscal loosening of about
1% of GDP next year.
The Bank of England Is in No Rush
Under this scenario, which is our base case, the next move in
interest rates would be higher. That said, we doubt the Bank of
England’s Monetary Policy Committee would be in any rush to
tighten, particularly if the world economy still looks fragile. The
near-term outlook for inflation might also buy the committee
time—we expect price gains to remain below 2% through 2020.
The MPC has recently raised concerns that uncertainty
about the U.K.’s future relationship with the EU could become
entrenched and prevent growth from accelerating in 2020. Our
view is that domestic demand will gather enough momentum to
erode the small margin of spare capacity that exists in the economy.
Given that the MPC will want to see evidence of a rebound under
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Global Outlook
way, we don’t expect a move until the end of next year.
Looking beyond the election and Brexit, the other big
­unanswered question for U.K. monetary policy is who will be the
next governor of the Bank of England? Mark Carney’s term is due
to finish at the end of January, though with an election ahead, it’s
possible it will be extended again. It’s far from clear who will replace
him, but if the appointment comes from inside the BOE, we
wouldn’t expect a material shake-up in policy.
Johnson’s Deal Is Worse Than May’s
Beyond 2020, Johnson’s deal implies a harder Brexit than the one
with the EU agreed to by his predecessor Theresa May. That
­featured a shared customs territory between the U.K. and EU with
close regulatory alignment. Moving away from that model is likely
How Four Different Brexit Outcomes Could Affect Growth
Level of GDP (index, Q1 ’19 = 100)
Remain after second referendum
Customs Union after second referendum
Johnson’s deal after extension
No-deal at the end of 2020
108
104
Q1 ’19
Q4 ’23
100
Sources: Office for National Statistics, Bloomberg Economics
to introduce more customs costs and nontariff barriers for
­companies.
Overall, our modeling suggests Johnson’s agreement is consistent with U.K. trend growth of a little less than 1.5%. That compares with about 1.6% if the U.K. were in a customs union with the
EU and 1.7% under May’s deal. At the extreme ends of the spectrum, a no-deal Brexit would see trend growth of 1.2%, while in
the case of Remain, we would expect gains of 1.9%.
Those differences may sound small, but they add up over
time. The economy will probably be about 5% smaller under Johnson’s agreement after 10 years, compared with a world where the
U.K. chooses to remain part of the EU.
Recognizing Uncertainty
Elections in the U.K. have become increasingly hard to predict,
and it’s quite possible that the vote goes another way. We sketch
a few possibilities below.
• A Labour-led coalition and second referendum. If the opposition Labour Party won the most seats, it could manage to form
a coalition government with the Scottish National Party and
­possibly the Liberal Democrats, who would probably vote on policy
on a case-by-case basis.
Such an outcome would take the prospect of a no-deal Brexit
off the table entirely and put a referendum in play. We would expect
many of the Labour Party’s more radical policies to get parked
under a coalition. But there still may be some uncertainty in financial markets about the domestic policy agenda.
On balance, we would expect sterling to rise on the prospect
of a more market-friendly Brexit outcome. The lift to real incomes
is likely to dominate any tax increase on high earners because they
have a relatively low propensity to consume. This should boost
consumption.
The possibility of a Remain vote or softer Brexit would
prompt a pickup in business investment. A recovery in capital
spending would probably come alongside higher public investment.
Longer term, private investment would be lower: Labour Party
leader Jeremy Corbyn wants to raise the corporation tax rate to
26%, dealing a blow to profits.
Overall, under this scenario we would expect growth to be a
little faster and inflation lower in 2020 relative to a C
­ onservative-led
government. Interest rates would increase, too.
• A hung Parliament, and the torment continues. In this s­ cenario,
the election returns a hung Parliament with no combination of parties
able to form a stable working majority. If that happens, the U.K. is
likely to remain in limbo—unable to move forward with Brexit and
relying on the goodwill of the EU to grant repeated extensions.
Underlying growth would probably remain anemic, at a quarterly pace of 0.2%-0.3%, as the economy suffers under the weight
of entrenched uncertainty. The BOE’s Monetary Policy Committee
warned about such a scenario in the minutes of its September
meeting. We would expect the committee to respond by cutting
rates, probably as early as the second quarter of 2020.
19
Europe
and the
Middle East
Europe
Trouble Ahead for Germany
As It Skirts Recession
By JAMIE RUSH
reflecting a turn in the global
investment cycle, uncertainty over global trade, and turmoil in the
auto industry. Leading indicators suggest 2020 will begin on a
weak footing, and the risk is that a brief dip becomes a deeper
downturn. One trigger: a potential breakdown in U.S.-European
Union trade negotiations, leading to fresh tariffs.
Once a source of strength, industry has become a
­vulnerability in Germany. It accounts for a bigger share of the
economy than in most countries and has shrunk by almost 7%
since ­reaching a peak in 2017. Much of the decline is in intermediate and capital goods—those product categories typically
­exported to trading partners around the world. We can trace the
sources of the production weakness to the decline in exports,
which is of a similar composition.
GROWTH HAS SLUMPED IN GERMANY,
China Isn’t the Only Problem
Year-over-year change in German exports, 3-month moving average
Total
Euro area (percentage-point contribution)
Non-euro area
9%
6
3
0
1/2014
9/2019
-3
Source: German Federal Statistical Office
Year-over-year export growth has plunged by about 8 percentage points since the end of 2017. It’s easy to blame China’s
slowing economy for Germany’s weakness, but that’s only part
of the story. As the chart above shows, euro area trading partners
are as much to blame as those outside the c
­ urrency bloc. And
within that, a little more than 1 percentage point of the decline is
directly accounted for by weaker trade with China. The slowdown
in trade is global.
One of the main r­ easons for the trade slowdown: ebbing
global investment. In the second quarter of 2019, business investment by Group of Seven countries was growing 1.5% year on year,
down from 4.4% in the fourth quarter of 2017. Will that turn around
anytime soon? Almost certainly not. Until global trade policy is
more predictable, business sentiment will remain weak and
­investment spending will be held back.
On top of all this, structural issues, such as the shift away
from diesel cars after the Volkswagen emissions scandal, affect
Germany more than its peers in the euro area. The introduction
of new emissions tests caused huge disruption to auto production
in Germany. There may be a little more to come as new standards
are implemented in ­stages; the second phase of Real Driving Emissions rules will go into effect at the start of 2020.
Put weakness in trade, investment, and autos together, and
it’s no surprise growth is extremely weak in Germany and set to stay
that way. The indicators that we think give the best read on underlying momentum show the malaise is spreading to the services sector,
and the slowdown will continue not only in the fourth quarter but also
into early 2020. Whether a technical recession is recorded in the near
term is of little significance—they’re fairly common in Germany. The
question is whether the recession deepens and lengthens.
The big risk is tariffs. Time is running out for progress on a
U.S.-EU trade deal. If talks fail, there’s a chance EU autos will be hit
with hefty tariffs. About 1% of German economic activity is embedded in autos and parts destined for the U.S., and the indirect impact
of tariffs on growth through a loss of confidence would be significant.
The U.S. has pulled back from the brink with China, possibly
suggesting that slower growth has made the administration less
likely to open up a new front in the trade war. Still, President Trump
has said the EU is worse than China when it comes to trade. A
long-­running dispute between Boeing Co. and Airbus SE is also in
the mix, meaning goodwill is in short supply.
Our forecast is for gross domestic product growth of 0.5%
in 2019 and just 0.4% in 2020. Against that backdrop, it’s h
­ ardly
­surprising that former European Central Bank President Mario
Draghi called on countries with fiscal space to spend more, and
­Germany is likely to see its budget surplus shrink in the next year
or so. Still, Berlin has so far r­ esisted calls for more action, even as
its northern neighbors have loosened their purse strings.
We don’t expect Berlin’s attitude to fiscal policy to change
in the near term. It would take more than a shallow downturn to
shift the political calculus in favor of a major stimulus package.
The risk is that Germany’s economy just bumps along the bottom
for an ­extended period and the government fails to act, leaving
Chancellor Angela Merkel’s successor to deal with the electoral
consequences. Solid growth has helped keep populism at bay in
the euro area’s biggest economy, but that could change.
21
Europe
France’s Steady Pace
Is at Risk From Trade Threats
By MAEVA COUSIN
has weathered the global slowdown
and violent civil unrest. Activity should remain resilient in 2020—we
forecast growth of 1.4% year-on-year, up from 1.3% in 2019—but
challenges are building. Escalation of trade tensions with the U.S. and
a disorderly Brexit represent large downside risks. Even so, we doubt
these shocks will be big enough to tip the economy into recession.
As Germany has succumbed to the impact of the global
trade slowdown, France has held up pretty well. That’s because
the economy is much more sheltered than its euro area peers
from the effects of the cyclical swings in external demand. Exports
make up less than a third of gross domestic product, and a lot of
these are essential goods, such as food and pharmaceuticals.
IN 2019 THE FRENCH ECONOMY
Confident—and Cautious—Consumers
This resilience is visible in the data—the recent drop in global trade
has prompted slower export growth, but it’s still positive. ­Looking
ahead, with France’s main export markets struggling, external
demand will likely weigh on growth in the next few quarters.
Domestic spending should hold up and help offset the weakness in trade. Government handouts at the end of 2018 in the wake
of the yellow vest protests have provided a welcome boost to houseLimited Exposure to Cyclical Swings in Trade
Exports as a share of 2018 GDP
Food, beverages, and pharmaceuticals
hold disposable income. And the government has confirmed in its
2020 budget its intention to keep support for households in place.
So far, consumers have remained cautious, and the fiscal giveaways have been banked rather than spent. This has boosted the
household savings rate to 14.9%—well above the average of the last
four years—providing a buffer for households to maintain consumption in the face of adverse shocks to income. Consumer confidence
is strong, and we expect French households to lower their savings
rate to maintain spending, even if trade uncertainty stays elevated.
Still, external threats loom large. Trade tensions with the U.S.
are mounting, as the recent spat over Airbus subsidies illustrates.
France is the main contributor to European Union exports of transport
equipment to the U.S., and Washington’s retaliatory tariffs on EU
aircraft makers will hurt. Pressure on the bloc in trade negotiations
to open up its agricultural markets to grown-in-­America products
could deliver a bigger blow. With 2.1% of French activity embedded
in EU exports to the U.K., a disorderly Brexit would also cause harm.
The key risk is that one or more of these shocks affect b
­ usiness
and consumer sentiment, with weakness spreading from external
to domestic demand. Indeed, Bloomberg Economics’ recession
probability models show the dangers are getting bigger for France.
Our central forecast is for the economy to remain resilient, supported
by consumer spending and the government’s readiness to provide
some support if needed. But fiscal space is limited, and risks are
clearly tilted to the downside.
Other
Export Performance to Start Weighing on Growth
Luxembourg
Malta
Ireland
97
Slovakia
88
Belgium
85
Slovenia
84
Netherlands
82
Lithuania
75
Estonia
64
Cyprus
59
Latvia
55
Austria
47
Germany
44
Portugal
39
Finland
36
Greece
34
Spain
32
Italy
31
France
225%
145
French GDP growth, quarter-over-quarter
122
Percentage-point contribution:
Household consumption
Government consumption
Gross fixed capital formation
Exports
Imports
Inventories
1.0%
0.5
0
Q2 ’18
Sources: Eurostat, Bloomberg Economics
22
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Q3 ’19
- 0.5
Sources: Eurostat, Bloomberg Economics
Europe
Italy: A New Start, the Same Woes—
Slow Growth and High Debt
By DAVID POWELL
are making up after a long budget bust-up.
That’s done a lot to ease tensions in financial markets. If the
­rapprochement lasts, the Italian economy should grow. The risk
is that Italy’s ruling coalition collapses and a resurgent Matteo
Salvini, head of the League, returns to power. If that happens,
rocketing yields and evaporating confidence would once again
derail the country’s recovery from the euro crisis.
We forecast Italian gross domestic product will expand by
only 0.1% in the fourth quarter of 2019. The rate of expansion
should accelerate to a still-meager 0.2% in 2020. Sluggish growth
will leave Italy with an output gap of about 1.5% of potential GDP
at the end of 2019. Weak underlying inflation is a reflection of this
sizable spare capacity.
BRUSSELS AND ROME
A Fragile Peace
Two disparate political parties—the Democratic Party and Five
Star Movement—have put aside their differences and formed a
government with Giuseppe Conte returning as prime minister. But
those differences are significant, and the only glue holding the
coalition together is a mutual dislike of the League and Salvini.
That isn’t a solid foundation.
The alliance will be especially tried when it has to make the
numbers for next year’s budget add up. Italy still needs to find about
€24 billion in savings to repeal the hike in value-added tax that’s
­already been legislated. That’s about 1.4% of GDP. The ­debate ahead
of the budget being finalized will be contentious, and neither coalition
partner will want to be seen as the instigator of more austerity.
Salvini is no longer occupying the corridors of power but
remains popular with the electorate. Recent opinion polls still give
his party about a 10-percentage-point lead over its closest rivals.
The League would be well-positioned to fight a general election if
the government were to collapse in acrimony.
Draghi’s Parting Gift
Expectations for additional monetary easing from the European
Central Bank have helped grease the wheels of the economy. The
10-year government bond yield for Italy has declined by more than
150 basis points since former ECB President Mario Draghi began
to hint at his press conference in June that a major monetary
stimulus package would soon be announced.
The recent soft data point to some improvement. The quarterly average of the composite purchasing managers’ index survey
has recovered from the trough of 49.5 posted at the end of 2018.
The European Commission’s Economic Sentiment Indicator for
Italy may have bottomed out as well. However, the hard data provide less reason for cheer—industrial output continues to decline.
On balance, we expect the economy to eke out a small
amount of growth in the fourth quarter, expanding by only 0.1%.
That’s an improvement on the contractions last year, but still very
weak. Domestic political discord may have ­faded, but ­uncertainty
is here to stay—President Trump has repeatedly threatened to
slap tariffs on the EU before the end of the year. That’s one reason
we look for the expansion to be lackluster in 2020 as well.
Heavy Baggage
Italy’s problems started long before populist governments came
to power in Rome and Washington. The country never fully recovered from the disastrous euro crisis. Its output gap widened to
5.1% in the second quarter of 2014 and has narrowed only to 1.6%.
That’s larger than any other of the monetary union’s four largest
economies. We think the output gap is significantly wider than the
European Commission does.
Italy Is Still Plagued by Spare Capacity
Euro area output gap as a percentage of potential GDP
Percentage-point contribution:
Germany
France
Italy
Spain
Rest of euro area
1%
0
-1
Q1 ’11
Q2 ’19
-2
Source: Bloomberg Economics
With its weak recovery, Italy is a significant drag on inflation
for the euro area as a whole. We forecast core prices to rise by
only 0.7% in the country in 2019. That’s well below the 1.2% we
look for in Germany and 1.1% in Spain, though above the 0.6% we
expect in France. Persistent slack will cause inflation to accelerate
only slowly in years to come.
Weak productivity growth and an aging population mean we
don’t expect the economy to materially outgrow its debt in years
to come. As a result, Italy is likely to hobble from one crisis to the
next for the foreseeable future.
23
Europe
Spain’s Economy Has Less Momentum
Going Into the Next Hill
By MAEVA COUSIN
SPAIN’S ECONOMY IS COOLING rapidly. Job creation has slowed, tourist
numbers are stalling, and the global economy is faltering. In addition,
political uncertainty is on the rise again. With weaker growth prospects, there’s a risk this could have a bigger impact on consumers’
and businesses’ willingness to spend than in recent years. We f­ orecast
growth will slow to 1.5% in 2020, but see little risk of recession.
Spain’s economy has cooled faster than previously thought.
Revised data show it’s expanded at an average quarterly rate of
0.5% since 2018. That’s down from 0.8% in 2017 and lower than
the 0.6% previously reported. The downgrade reflects less
­domestic demand—both household consumption and gross fixed
capital formation. The historical data series for unemployment
has also been revised higher by the statistics office.
This underscores evidence of an economy well into a new phase
of slower expansion. This was always to be expected after the stellar
rate of growth from 2014-17 fueled by a r­ eturning workforce left idle
by the euro crisis. But this newfound slowdown means the economy
faces the next set of challenges with less momentum than we previously anticipated. And these challenges are getting bigger as ­external
headwinds intensify.
Spain has a relatively closed economy, with exports making
up only about a third of gross domestic product, compared with
an average of 50% for its euro area peers. This should make its
economy relatively sheltered from cyclical swings in external
­d emand, but it also relies heavily on one particularly cyclical
­industry—tourism. In 2017 the tourist industry represented almost
12% of all economic activity, evenly distributed between spending
by Spaniards on staycations and foreign visitors.
Tourism, particularly from overseas, made a strong positive
contribution to GDP growth from 2014-17, as visitors headed for the
beach again after several lean years during the euro crisis. The terror
attacks in Tunisia in 2015 also diverted holidaymakers from North
African destinations. But tourist numbers stopped rising in 2018 and
2019, and other sectors have failed to offset this impact on growth.
Spain’s tourist industry is likely to face further pressure.
With growth slowing in the U.K. and Germany, the outlook for the
sector looks less rosy. The sharp depreciation of sterling also isn’t
helping. Higher labor costs following an i­ ncreased national minimum
wage could make the sector less competitive at a time when some
North African destinations are regaining holidaymakers’ trust.
Beyond tourism, other external threats loom for Spain’s
­exporters. Fortunately, the country is less exposed than many of its
euro area peers to the risk of a disorderly Brexit and U.S. tariffs on
Europe. But some sectors, notably the textile and car industries, and
24
to some extent agriculture and food manufacturing, could have a lot
to lose, especially from Brexit.
Spain is likely to face several significant external challenges
going into next year, with the labor market already showing signs
of running out of steam. Deteriorating ­consumer sentiment, given
the very low household savings rate, could q
­ uickly lead consumers
to scale back their spending.
Slower Job Creation to Weigh on Sentiment
Spain indicators
Consumer confidence balance in percentage points (left axis)
Employment, quarter-over-quarter change (right axis)
0
2%
-15
0
-30
-2
- 45
Q1 ’93
Q2 ’19
-4
Sources: European Commission, Eurostat, Bloomberg Economics
Meanwhile, political risk is building at home. Spain’s fourth
election in as many years on Nov. 10 left parliament even more
fractured, which is likely to result in the same political stalemate.
A Supreme Court decision in October to imprison a group of Catalan separatist leaders prompted a wave of protests in the region
and could turn the Catalonia issue into a national crisis again.
Catalonia is the largest economic region in Spain, accounting
for about a fifth of the total value of the country’s output and capital
formation. Concerns about its future could prompt businesses to
postpone local investment, denting Spain’s overall performance when
companies are already growing cautious about investment decisions.
The economy has shown itself equal to the task of shrugging
off political instability in recent years. But that was when growth
was strong, making it easier to dismiss political skirmishes as a
sideshow to the recovery. With job creation slowing, external threats
building, and the chance of another Catalonia crisis flaring up again,
things might be different this time around.
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Europe
Freezing Sweden’s Rates At Zero
By JOHANNA JEANSSON
GROWTH IN SWEDEN ALMOST ground to a halt in the first half of 2019,
and the weakness is here to stay. Global headwinds are blowing
strong, and the cooler housing market will continue to act as a
drag on the economy. As a result, the Riksbank rate is frozen at
zero for a couple of years.
In early 2019, it almost looked like Sweden’s highly export-­
oriented economy could ride out the global trade war and ­Brexit
uncertainty. In the third quarter, however, incoming data worsened quickly. Indicators such as the purchasing managers’ index
pointed to shrinking production, and unemployment seems to
be edging up.
Exports of goods and services make up almost half the
­Nordic region’s biggest economy, and this makes Sweden highly
sensitive to a slowdown in the rest of the world. Our own forecasts
show gross domestic product growth among Sweden’s top five
trading partners as likely to fall to 1.4% in 2020, from 2.7% in 2017.
This largely reflects the slowdown in Germany, where our forecast
is below consensus.
Darker Outlook for Exports
Sweden indicators
Exports, year-over-year change (left axis)
Trade-weighted change in trade partner GDP (right axis)
BE forecast (right axis)
15%
3%
10
2
5
1
0
Q1 ’10
Q4 ’20
0
Sources: Statistics Sweden, Bloomberg Economics
The Housing Market Cools
Domestic factors are also set to contribute, as an earlier boost to
growth from housing has turned into a drag. This comes amid an
­increase in supply coupled with macro-prudential measures imposed
by Sweden’s financial supervisory authority. Housing investment
eased in 2018, after rising more than 70% from 2012-17, and has kept
declining this year. The weakness is likely to persist for some time
before stabilizing in line with early indicators such as housing starts.
The slowdown means unemployment is likely to climb further, keeping a lid on wages at a crucial time. With more than half
of Sweden’s workers striking deals, 2020 will be a bumper year
for pay negotiations. Modest wage hikes could help ­cushion the
impact on employment from faster deterioration in the economy.
The flip side for the Riksbank is that continuously weak wage
growth will make it even more difficult for the bank to achieve its
2% inflation target.
Inflation Is Slowing
Inflation has already slowed in 2019 after hitting a 20-year high of
2.5% in September 2018. As in Sweden’s main export markets
such as Germany, the cheaper cost of energy is the main reason.
Excluding energy, price pressures are also weaker than a
year earlier. The krona’s decline has failed to lift import prices
enough to reach the inflation target, and service price inflation
remains modest. Add the lackluster outlook for global growth, and
it’s clear inflation pressures will remain muted. We see headline
and core inflation at a mere 1.5% in 2020.
Swedish households also expect the economy to slow.
­Consumer confidence has fallen since the end of 2017 to below
its long-term average. The effect on households from the slackening labor market will be only partly offset by a somewhat more
­expansionary fiscal policy in 2020. We don’t ­expect the latest
budget moves to be enough for consumption to lift growth
­substantially in the near term.
Trade Wars and Brexit
For 2020 as a whole, we forecast economic growth of below 1%,
down from 1.2% in 2019. As 2021 approaches, growth should pick
up in tandem with a cyclical upturn in the euro zone.
To be sure, a U.S.-China mini deal, Brexit deal, and weaker
­krona may help Sweden steer clear of the worst shocks from ­global
trade tensions and pull the economy back on track more quickly.
Since the end of 2016, following the Riksbank’s decision to
cut the benchmark rate to -0.5% in February that year, the trade-­
weighted krona has weakened more than 10%. But there’s mixed
evidence on the benefit of such a depreciation, given that global
value chains mean most exporters also face rising import costs
when the krona slumps.
Riksbank Governor Stefan Ingves, who steered the economy
through the 2008 financial crisis, presided over an increase in the
central bank’s main repo rate to -0.25% in December 2018. The bank
had aimed to hike rates further toward the end of 2019 and in 2020.
But with sputtering growth in Sweden’s main export markets,
uncertainty about global investment demand, and more cautious
household spending, we don’t expect this to happen. The central
bank recently repeated its stated aim of raising rates to zero. But
after that, like the Riksbank, we expect them to stay on hold until
the skies clear.
25
Europe
Slow Growth, Unrest in Russia
Could Test Putin’s Long Game
By SCOTT JOHNSON
some momentum going into
2020, but growth will remain frustratingly slow. For now, President
Vladimir Putin has only mild stimulus on order. He’s focused on
bolstering the country’s long-run security, rather than delivering a
fleeting boost. That could change if external demand softens further
or slow growth stokes domestic unrest.
For Russia, now is an especially inopportune time for global
growth to slow. The economy is still shaking off the effects of January’s
increase in value-added tax, which pushed up prices and squeezed
consumers. The government only r­ ecently launched an ambitious
multiyear drive to boost investment and exports.
The latest data show lingering weakness in domestic s­ pending,
reflecting stagnating incomes. External demand is also flagging, a
worrying sign. But these obstacles don’t appear strong enough to
prevent a recovery from the sharp slowdown earlier in the year. Mild
stimulus from looser fiscal and monetary policy should give some
extra lift. We see the expansion gradually gathering pace each quarter, with annual growth reaching 2% in 2020, up from 1.1% in 2019.
RUSSIA’S ECONOMY SHOULD GATHER
Exports Are Shrinking
Further ahead, though, peak speed won’t get much faster. That’s
a problem for Putin. He’s pledged to push growth sustainably above
3%, and getting back to 2% will only soften the disappointment. The
government’s development agenda looks promising, but it’s heavy
on infrastructure investments and ­productivity-boosting measures,
which will take years to bear fruit.
Mild stimulus isn’t enough to bridge the gap, but so far the
Kremlin shows little inclination to do more. Indeed, it probably can’t
without reneging on commitments to maintain price stability, wean
the economy off oil and gas, and build up financial buffers. These are
top priorities for Putin in his drive to secure Russia against crisis at
home and political pressure abroad.
The Finance Ministry has penciled in $17 billion in extra
­spending for 2020-21. Yet relative to earlier plans, that may add
only 0.1 percentage point to 0.3 percentage point to GDP growth
in 2020, and not much in future years. It’s also being paid for with
a windfall in nonenergy tax revenue. A fiscal rule will still channel
$45 billion in oil and gas proceeds into reserves in 2019 and almost
$40 billion a year going forward.
Putin could hit his growth targets by tapping the government’s
energy savings to bankroll further stimulus. But that would only
provide a temporary boost, and at the cost of long-run stability,
deepening the economy’s dependence on hydrocarbons.
The Bank of Russia is acting more decisively. The central
bank has cut interest rates by 125 bps since June, but it’s only
26
using the policy space provided by a sharper-than-expected slowdown in inflation. While the Kremlin will welcome the extra kick
for growth, it can’t rely on the central bank for stimulus.
We see the easing cycle stopping with the key rate at 6%, still
within the 6%-7% range considered neutral. Policymakers will be
reluctant to go much further, especially with price pressure likely to
reemerge as the government loosens its belt.
Putin hasn’t stayed entirely true to his fiscal framework. He’s
left the option of investing a portion of the country’s ­energy savings
into high-quality projects at home—a potential source of off-budget
stimulus. But we expect the Finance Ministry to avoid weakening its
fiscal rule significantly, which means the sums will be small.
What might force a change of plans? Keep an eye on the streets.
The next major election isn’t until 2021, but the public could lose
patience with slow-and-steady investments—health care and
­education are particular pinch points. Protests this year ahead of
municipal elections caught the Kremlin off guard. Plodding growth
could itself become a security risk.
More immediately, a darkening global outlook might also require
the Kremlin to rethink its strategy. Exports account for more than a
quarter of Russia’s GDP, and they’ve been contracting. The stimulus
penciled in so far may not be enough to offset a steeper slide.
In our view, Putin would accept a shortfall against his growth
targets if he can at least show signs of improvement. That would
be better than returning the economy to a more volatile long-run
course. But he’s unlikely to tolerate a deep downturn when there’s
cash to spare and room to cut rates.
Russia’s Unspent Windfall
Russian oil and gas revenue diverted to reserves
BE forecast
$60b
As a
share of
GDP
1.8%
30
0.9%
2017
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
2022
0
Sources: Russian Ministry of Finance, Bloomberg Economics
Europe
Turkey’s Finally Out of Recession,
But Not Yet in the Clear
By ZIAD DAOUD
for Turkey’s economy—it’s out of
recession, inflation is falling, and the current-account deficit has
narrowed dramatically. But unpredictable policy, geopolitics, and
global sentiment could quickly undo that progress.
Greater currency stability, monetary easing, and credit
growth should drive economic expansion of 2.5% in 2020, up from
zero this year.
But Turkey still faces domestic, regional, and global risks. The
strength of its fiscal position could be a useful buffer in a downturn.
Turkey has staged a recovery from the currency crisis of
2018. After a short recession in the second half of that year, it’s
growing again. Growth was initially aided by fiscal stimulus and
credit expansion, but the partial withdrawal of these measures
hasn’t sent the economy back into recession.
The current account has seen a remarkable adjustment,
going from a significant deficit of almost 6% of gross domestic
product in 2017 to a surplus. This was due partly to slow ­economic
growth, which depressed imports, but also reflected the impact
of lira depreciation.
An improved current-account balance has reduced external
vulnerability and helped stabilize the currency. This in turn has
driven a deceleration in inflation and allowed the central bank to
cut interest rates aggressively. The benchmark rate has been
slashed by 1,000 basis points so far this year.
The government is targeting 5% growth next year and is
expected to throw the stimulus kitchen sink at the economy. We
think its efforts will probably lift growth to 2.5%. Improved growth
and a relatively benign global environment should stabilize the lira,
allowing inflation and interest rates to fall further.
Still, Turkey’s recent history suggests there will be risks and
surprises around our baseline scenario. Three of these risks are
particularly prominent:
1) Policy error: Dissatisfied with what might be perceived
as slow growth, authorities in Turkey have repeatedly tried to
generate unsustainable booms. To this end, from 2012 to 2018
they kept interest rates too low for too long, engineered a sizable
credit boom, and capped deposit rates at banks. This has invariably
backfired, leaving the currency to pay the price.
2) Geopolitics: Tensions between Turkey and the U.S. took
their toll on the lira in the summer of 2018 and the spring of 2019.
Turkey’s military incursion in Syria threatened to bring this risk
back to the fore, though this threat has now been largely allayed.
The risk for Turkey is if the U.S. imposes sanctions on the country’s financial institutions. Turkish banks need $60 billion of foreign
currency financing in the next 12 months, according to Bloomberg
Intelligence. Sanctions would make securing this funding hard.
THE WORST IS PROBABLY OVER
Another risk is the possibility of penalties from the E
­ uropean
Union—Turkey’s larger trading partner. The EU has already
­restricted military exports to Turkey. Volkswagen AG has decided
to delay building a car plant in the country. President Recep T
­ ayyip
Erdogan has threatened to send millions of Syrian refugees into
Europe if the EU doesn’t stop criticizing his military operation.
3) Global sentiment: Turkey was a victim of the negative
sentiment against emerging markets in 2018. But it has benefited
from monetary easing among the world’s major central banks this
year. This explains why investors hardly punished the lira after Erdogan
unexpectedly sacked the central bank governor in July or when the
central bank unveiled deeper-than-expected rate cuts in July,
September, and October.
But sentiment can turn quickly. After all, easier global monetary policy is a response to a slowing world economy. If the slowdown turns from mild to severe, the relentless search for yield
could turn into a flight to safety out of Turkey.
Fiscal War Chest
What tools do policymakers have to tackle a new downturn? The
bedrock of Turkey’s economy is the government’s balance sheet.
Public debt was relatively low at 29% of GDP in 2018, giving the
authorities room to act in the event of a downturn.
The government has announced a growth target of 5% in
2020. If it seeks to engineer a credit boom to achieve this, then
the economy and the currency may face another bout of instability. And that fiscal space may well be needed.
Inflation Slowed, Current-Account Deficit Closed
Turkey indicators
Current-account balance (left axis)
Consumer price index, year-over-year change (right axis)
$3b
28%
0
21
-3
14
-6
7
-9
1/2017
8/2019
0
Sources: Central Bank of Turkey, TurkStat
27
Middle East
Black Swans, Oil Bears—Saudi Arabia
Faces a Menagerie of Risks
By ZIAD DAOUD
SAUDI ARABIA IS LIKELY TO SHOW little or no growth this year. Could
it tip into recession in 2020? We identify four potential triggers:
a deeper cut to output from the group of OPEC+ oil producers,
involuntary crude outages, fiscal retrenchment, and a geopolitical upset.
We estimate the risk of recession at a relatively moderate
40%. Saudi Arabia has less ammunition to tackle a downturn
today than five years ago, when oil prices were running above
$100 a barrel.
Our base case is that growth will reach 1% in 2020, up from
almost zero this year. Oil output should stabilize following a contraction in 2019. Non-oil growth will ease slightly as monetary and
fiscal stimulus diminish.
More Debt, Lower Reserves
Saudi Arabia public debt as a share of GDP
20%
$656b
Forex reserve assets
10
$496b
2012
2018
0
Sources: IMF, Saudi Arabian Monetary Authority
With such slow growth, we highlight four forces that could
tip the economy into recession. Not all downturns are equal—some
are technical; others are malicious.
First, the most benign is a voluntary oil production cut as
part of a wider OPEC+ agreement. This will make overall growth
28
negative, but it doesn’t reflect weaker economic activity. A similar
technical recession occurred in 2017. We attach a subjective probability of 20% to this possibility.
Second, an involuntary decline in oil output could occur
­because of delays in the repairs to reinstate production at the
kingdom’s main crude-processing plant after the Sept. 14 attacks.
The official guidance is that full capacity will be restored before
the end of the year, and the latest news is that Saudi Arabia is ahead
of schedule. Still, risks have increased, and we think there’s a small
probability, about 5%, of the outage affecting next year’s output.
Third is fiscal consolidation—probably stemming from a fall
in oil prices as global demand weakens or supply surges from either
Iran or the U.S. This would lead to a recession only if the government
sharply cut expenditures, reduced subsidies, or raised the consumption tax. We estimate there’s a small chance, maybe about
5%, of this occurring.
Fourth are black swans in geopolitics. Recent history offers
some examples: an escalation of tensions with Iran or the war in
Yemen; another government-labeled “anti-corruption” campaign
that damages domestic sentiment; or attacks on economically
important facilities in the kingdom. We attach a 10% probability
to this happening.
Limited Recession-Fighting Tools
What’s certain is that if a recession occurs, the authorities have
less policy space today to address it than five years ago. Public
debt reached 19% of gross domestic product in 2018, compared
with almost zero just four years earlier. Foreign exchange reserves
have declined by a third since their peak in 2014.
The kingdom also lacks monetary tools to engineer a
­recovery. Monetary policy is neutral; the Saudi Arabian Monetary
Authority simply follows the U.S. Federal Reserve in its interest-rate
decisions. And the optimism generated by Saudi Arabia’s transformation agenda has waned since the kingdom unveiled its
­Vision 2030 plan almost four years ago.
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Middle East
The Oil Price Decline: 70% Trade War,
30% Supply Glut
By ZIAD DAOUD
BRENT CRUDE HAS FALLEN 21% since April. We estimate that weak
demand linked to the impact of the trade war accounts for 70%
of the decline. Abundant supply is responsible for the rest. This
trend is likely to continue next year, posing a dilemma for the group
of conventional oil producers known as OPEC+.
Oil is down about $14 since peaking in April. Our model,
which decomposes price movements into demand and supply
drivers, shows that $10 of the decline reflects weaker demand,
while $4 is due to excess supply. Oil markets are likely to remain
oversupplied next year, forcing OPEC+ countries to choose
­between lower prices or a shrinking market share.
Drivers of Oil Prices
Change in oil price per barrel since April 24, 2019
Change due to supply
Change due to demand
$0
Start of
U.S. tariffs
on Chinese
imports
Chinese tariffs
on U.S. goods
4/24/19
-10
More tariffs on
Chinese imports
Yuan sliding past 7
Aramco
attacked
10/14/19
growth will reach 2.2 million barrels per day (b/d), absorbing all
demand growth (1.2 million b/d), and then more. Excess supply
will be 1 million b/d if OPEC sustains current production levels.
The bearish outlook is shared by financial markets. The
­average Brent crude oil price in 2020 forecast by markets is $57 per
barrel, down from an expected $63 this year.
A Dilemma for OPEC+
The environment poses a question for conventional oil producers
in OPEC+: Should they deepen cuts in output beyond March to
help balance the market? The short-term financial needs of the
members may prompt them to do just that.
But this strategy hasn’t quite worked since it was introduced
in late 2016. The short-term price boost gave high-cost shale
producers a lifeline to pump more, subsequently suppressing oil
prices. OPEC producers sell oil at a similar price today as they did
in early 2017, but now they have a lower market share. Looser
compliance with production quotas among members may also
undermine any deepening of cuts.
ethodology: Attributing Shocks
M
To Demand, Supply Factors
To attribute crude price movement to demand and supply components, we assume: strong demand lifts oil and equity prices; supply
disruption raises oil prices but lowers nonenergy equities; and in any
30-minute period, oil is affected by demand or supply, but not both.
-20
Source: Bloomberg Economics
Impact of Different Shocks on Asset Prices
Effect of a shock
The outlook for the global economy, and hence oil demand,
has been steadily deteriorating, taking a toll on oil prices. The
­International Monetary Fund’s downgrade of its global growth
forecast is the latest example. Our model shows that the escalation of the U.S.-China trade war, particularly in May and August,
was especially negative.
The supply picture hasn’t been positive, either. OPEC+ might
have thought its agreement in December to extend production
cuts would have been enough to boost prices. But other parts of
the world, such as the U.S., have pumped more oil than expected,
pushing crude prices lower.
A Daunting Surplus
Ample oil supply and weak demand are likely to continue next year.
The International Energy Agency forecasts that non-OPEC supply
Leads to higher values
Leads to lower values
Oil
Equities
Higher demand
+
+
Lower supply
+
Source: Bloomberg Economics
In terms of procedure, we split the trading day into ­30-minute
intervals. In each interval, if oil prices and nonenergy equities move
in the same direction, we attribute the change in oil price to
­demand. If they move in opposite directions, we attribute the
change to supply. We treat the close-to-open period as one long
interval and attribute the shocks as above.
29
Asia
Asia
Central Bank Easing and Tax Cuts
Will Spur a Recovery in India in 2020
By ABHISHEK GUPTA
INDIA’S RECOVERY, WHICH HAS BEEN a long time coming, finally seems
to be around the corner. By next year, rural incomes should rise, the
central bank’s rate cuts are expected to lead to lower lending rates,
and post-tax corporate profits are likely to be higher. Combined,
these should revive consumer and investor sentiment.
The turnaround is likely to show up beginning in the
­October-December quarter, though largely because of a low base
in the year-earlier period. A genuine recovery should start in 2020.
• We expect gross domestic product growth to rise sharply
in fiscal 2021 ending in March, to 7.1%, from an estimated 5.7% in
fiscal 2020. On a quarterly basis, we expect growth to remain flat
at 5% in the second quarter of fiscal 2020 ending in September,
recover to 6% in the third quarter, and rise to 6.8% in the fourth
quarter ending in March 2021.
• Good rainfall and government income support is expected
to boost farmers’ income and drive rural consumption. The Reserve
Bank of India’s liquidity support and rate cuts have started to bring
down borrowing rates for home loans and personal consumer loans.
These should support overall consumption.
• Deep cuts in corporate tax rates are also likely to add impetus
to the recovery, reviving animal spirits among businesses and shareholders and, over the medium term, attracting more investment.
• Several other factors also bode well for the outlook. The
government’s decision to infuse capital into public-sector banks and
the central bank’s measures to revive non-deposit-taking financial
companies should help strengthen the financial system. The RBI’s
transfer of surplus capital reserves to the government also creates
more leeway to increase fiscal spending.
The government lowered the corporate tax rate in SeptemLower Corporate Taxes and RBI Cuts
Will Aid a Sustained Recovery
India GDP, year-over-year change
Quarterly
Annually
Bloomberg
Economics
forecast
10%
7
Q1 ’13
Q1 ’21
4
Sources: Bloomberg Economics, Ministry of Statistics and Programme Implementation
ber for existing companies to 22%, from 30%, and for new manufacturing companies to 15% from 25%. This is likely to boost private
investment and has the potential to attract greater foreign investment over the next few years—just as the U.S.-China trade war is
prompting global manufacturers to rethink their supply chains.
Weak Inflation to Allow More Room for RBI Easing
Subdued consumer price inflation gives the RBI room for further
easing. Inflation jumped to 3.99% in September, from 3.28% in August,
but still undershot the RBI’s 4% target for a 14th straight month.
• We expect average inflation to rise to 4.3% in the fiscal
third quarter of 2020, from 3.5% in the second quarter. Beyond
that, inflation should drop to an average 3.8% in the fiscal fourth
quarter of 2020 and 3.5% in the first quarter of 2021.
• Monsoon rains from June through September were 10%
higher than their average historical levels. This bodes well for a
bumper harvest this year and is expected to cool inflation in food
prices in the year ahead.
• Core inflation (excluding gold prices) has continued to ease
since June 2018, reflecting weak consumer demand and a lack of
retail pricing power. The downward trajectory in core inflation has
helped counter some of the acceleration in food inflation since
November 2018.
• We expect core inflation to soften further because, among
other factors, companies are expected to pass on the benefit of
recent tax cuts to consumers. Also, we expect a lower tax on consumer goods and services; a greater supply of affordable housing;
lower input costs for businesses because of declining gasoline prices;
and favorable base effects during the October to December period.
Closing the Output Gap With RBI Rate Cuts
Under Governor Shaktikanta Das, the central bank has been
­responding to a widening output gap and subdued inflation with
accommodative policies since the start of this year.
• The bank has clarified multiple times that its topmost priority is to close the negative output gap. Das also highlighted recently
that the monetary policy committee will continue its accommodative
stance as long as necessary to revive growth.
• The RBI delivered a 25-basis-point rate cut in October, for
a cumulative easing of 135 bps since February. We expect the bank
to reduce the policy rate further, to a terminal 4.5%, by March
2020, from 5.15% now.
• The RBI has sustained surplus liquidity conditions since June,
which has eased liquidity pressures within the financial system. This
has also helped lead to lower lending rates. We believe its recent
push for banks to use the policy rate as a benchmark for lending
rates will improve the transmission of monetary easing.
31
Asia
The Trade War Will Continue
To Weigh on South Korea
By JUSTIN JIMENEZ
TRADE TENSIONS WILL CONTINUE to shape South Korea’s outlook in
2020, with the export-oriented economy expected to face stiff
challenges. To support growth, the government has pledged an
expansionary fiscal stance in 2020, proposing another record budget. The Bank of Korea, which cut its policy rate by 50 basis points
this year, has kept the door open for easing. Despite the step up in
stimulus, policymakers will need to remain on the defensive given
heightened risks.
• Our baseline forecast is for the economy to grow 2.3% in
2020, as stimulus supports the economy and private investment
starts to stabilize. That’s up from our expectation of a 1.9% rise in
2019. Barring an unexpected shock, the risk of recession remains
relatively low.
• The government’s expansionary fiscal position should relieve
some of the burden on the Bank of Korea to support growth. With
the benchmark interest rate back at its record low of 1.25%, and
policymakers concerned about financial imbalances, the hurdle for
any further easing will be high.
Fiscal policy has played a key role in buttressing the South
Korean economy so far in 2019. In particular, government spending
has bolstered the labor market, with jobs gains centered around the
public and social-service sectors. That’s helped offset a pullback in
private investment, which has slumped since the second quarter of
2018 but should show signs of stabilizing in the year ahead—more
because of technical reasons than renewed animal spirits. The manufacturing sector has faced sustained job losses since April 2018.
Expansionary Fiscal Policy to Support Growth
South Korea budget, in won
Main
Extra
10.6% change in main budget, year-over-year
500t
9.3%
250
2009
2020*
0
*Government proposal
Sources: South Korea Finance Ministry, Bloomberg Economics, news reports
32
That trend of greater spending is expected to continue into
2020 with the government’s proposed budget of 513.5 trillion won
($440 billion). If approved, that would be 9.3% higher than the
2019 main budget, broadly in line with this year’s 9.5% rise and
one of the largest increases since the global financial crisis. Even
so, the downward pressures on growth from continued trade
uncertainty mean more stimulus may be needed. It’s worth noting
that South Korea has a tendency to propose supplementary
budgets when the economy loses steam, which it may do again
next year.
Indeed, the threats to the country’s economy remain. Global
growth will likely be tepid in 2020, especially among South Korea’s
major trading partners. Even with a tentative trade truce between
China and the U.S., growth in China—the destination for about a
quarter of South Korea’s overseas sales—is expected to slow. If
hostilities with the U.S. resume, the Chinese economy would
­probably slide further.
The trade war’s hit to the global tech sector also means
weaker demand for South Korean components of Chinese electronics. Bloomberg Intelligence sees the pullback in tech sales
extending into 2020. Semiconductors account for about 20% of
the country’s total exports and have been contracting since
December 2018.
Those problems are compounded by the uncertainty
­surrounding Seoul’s trade dispute with Tokyo. South Korea’s hightech manufacturers are highly reliant on Japan for specialized
materials. Japan’s tighter regulations and its removal in August of
South Korea from its list of most-trusted trading partners threaten
to disrupt tech supply chains and muddle investment plans. That
could hinder a potential rebound in Korea’s memory chip industry.
Those risks suggest the central bank will need to remain on
the defensive following its 50 bps of rate cuts this year. We think
the severity of trade tensions will play a defining role in whether it
proceeds with more easing in 2020. Governor Lee Ju-yeol said the
bank has room for further action, but it must exercise caution in
cutting the policy rate below its effective lower bound—though he
didn’t specify what that level might be. Record-low inflation and
easing by the U.S. Federal Reserve give the BOK room to maneuver
if it needs to lower its benchmark rate further.
Even so, policymakers remain conscious of the impact of
lower rates on financial imbalances. Possibly reflecting those
concerns, two board members dissented in favor of a hold on rates
at the October meeting. Another factor to consider in the year
ahead: The terms of four of the BOK’s seven board members are
up in April, and the new composition may affect the bank’s
policy preferences.
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Asia
When Will the Hong Kong
Recession End?
By QIAN WAN
HONG KONG’S ECONOMY HAS BEEN crippled by months of civil unrest,
the U.S.-China trade war, and the global slowdown. The city is in
recession, with a second straight quarter of contraction in the
third quarter, and a further slump expected in the fourth. The
outlook for 2020 isn’t much brighter, though growth could pick
up marginally off a low base this year.
Bloomberg Economics forecasts gross domestic product
will expand 0.5% in 2020, after a contraction of 1.3% a year earlier,
which reversed a rise of 3% in 2018. Much hinges on how the protests play out and whether the U.S. and China manage to dial down
the trade war. Either way, the impact of political unrest—initially
sparked by ­concerns about Beijing’s encroachment on the city’s
autonomy—will endure.
Measures to support the economy—including long-term plans
sketched out by Chief Executive Carrie Lam in an annual policy
Fourth-Quarter Outlook Is Dimmed by Escalating Unrest
Hong Kong indicators, year-over-year change
Actual
Forecast
Q1 ’19 Q2 ’19 Q3 ’19 Q4 ’19
BE baseline GDP scenario
Unrest calms in November
2018
2019
2020
0.6
0.5
-2.9
-3.5
3.0
-1.3
0.5
Additional GDP scenario
Unrest continues and
intensifies into 2020
0.6
0.5
-2.9
-4.0
3.0
-1.5
-0.5
Consumer price index
2.2
3.0
3.3
3.5
3.0
3.0
3.0
Source: Bloomberg Economics
address and two rounds of fiscal stimulus announced by Financial
Secretary Paul Chan—are insufficient to restore confidence. The
short-term stimulus may relieve some pain for certain sectors, but
it’s unlikely to significantly lift growth.
The economy contracted 2.9% in the third quarter from the
period a year earlier, reflecting the compounding impact of
the trade war on exports and social unrest on retail and tourism,
as well as the drag created by a broader China slowdown.
The fourth quarter will likely be no better. Shops have been
shutting down on weekends or closing earlier than usual. Service
for the Mass Transit Railway has been disrupted. Both point to
broader damage to the economy. Retail sales and visitor arrivals
will probably register a double-digit decline.
China Slowdown Will Be a Drag to Recovery in 2020
Even under our baseline scenario—with social unrest easing this
year and the U.S. refraining from further tariff hikes on ­China—we
are more pessimistic on the city’s 2020 growth outlook than the
International Monetary Fund and the market consensus.
The external environment will continue to work against the
small, open economy. The city is a major channel for trade between
the U.S. and China. Bloomberg Economics expects China’s economy
to slow further to 5.7% in 2020—below the IMF’s 5.8% projection—
and projects the U.S. to slow to 2%. If the U.S. keeps 15%-25% tariffs
on $360 billion of Chinese exports in place, weak external demand
will remain a heavy drag on growth.
Even if unrest subsides by yearend, the impact on the
economy will linger. Concerns about further disruptions have put
a damper on business investment. What’s more, anti-China
­sentiment in the city deters tourists to Hong Kong from the mainland. The current protests have lasted longer, and have been more
violent, than the 2014 Occupy Central Movement. It’s worth noting
that after 2014 it took three years for mainland tourist numbers
to fully recover.
The Risks: Prolonged Trade War and Social Unrest
A further escalation in the trade war is a downside risk for Hong
Kong’s growth outlook. If the U.S. continues to hike tariffs on
­China’s exports, the city’s trade and logistics industry—which
accounts for about 20% of GDP and employment—would suffer
a heavy blow.
Longer term, potential damage to the city’s reputation as an
open, stable financial hub is the bigger risk. This would deter
­investment in the city and could spur an exit of foreign companies,
undercutting the foundation of the banking and commercial hub.
Undoing that sort of damage would not be easy.
33
Asia
Trade Deal or Not, Asean
Economies Should Pick Up
By TAMARA HENDERSON
A SHARP SLOWDOWN IN Southeast Asia’s largest economies in 2019
should set the stage for a pickup in 2020. That’s when this year’s
monetary easing should bear more visible fruit. Also, barring a
further escalation in the U.S.-China trade war, export growth
should look strong coming off of last year’s anemic levels. A full
rebound, though, might have to wait until 2021. Even with a trade
deal, investment may remain subdued until uncertainty about
the U.S. presidential election clears in November.
• Growth in the first half of 2019 for the five largest economies
of the Association of Southeast Asian Nations—Indonesia, Malaysia,
the Philippines, Singapore, and Thailand—was the weakest half-year
performance since the global financial crisis. The outlook into
yearend and the first quarter of 2020 appears even worse, given
further increases in U.S. tariffs.
• Recession risk is significant for Singapore and Thailand, the
region’s more open economies. But the slump should be short-lived,
especially if authorities ramp up stimulus.
• We expect Asean-5 growth to slow to 3.3% on average this
year, from 4.7% in 2018. A trade truce in 2020 could boost the expansion to 3.9% next year.
In the first half of 2019, growth from a year earlier in Southeast
Asia’s five largest economies was just 3.7% on average, down from
5.1% in the period a year earlier. The deceleration began after the U.S.
slapped a 10% duty on $200 billion of its imports from China.
Those tariffs were subsequently hiked to 25% in May, and duties
were placed on additional consumer-oriented products in September. This will weigh more heavily on the Asean-5 economies’ export
growth, but only until midyear 2020 if no more duties are added.
Ongoing U.S. tariff uncertainty could conceivably continue to
subdue investment throughout 2020. Asean-5 investment in the
second quarter fell 0.2% from the quarter a year earlier. An escalation in the trade war would likely further damp capital expenditure
and hiring, weakening growth next year.
The ability of companies to avoid punitive U.S. duties by diverting production from China to Asean nations appears limited. The
Trump administration’s offensive on trade is global, and Asean
countries are already in its crosshairs.
34
Growth May Partially Rebound
GDP growth
2018
2019 forecast
2020 forecast
6%
4
2
Asean 5
Singapore
Thailand
Malaysia
Indonesia
Philippines
0
Sources: National statistical agencies, Bloomberg Economics
Asean Nations Could Attract More U.S. Tariffs
Malaysia, Singapore, and Vietnam were added to the U.S. Treasury’s
watchlist for currency manipulation in May. In July, the U.S. slapped
tariffs of more than 400% on steel imports from Vietnam. It will suspend some Thai trade preferences in the second quarter next year.
The Trump administration has also hinted at tariffs on countries with undervalued currencies. Bloomberg Economics’ fair value
estimates suggest the Malaysian ringgit and Indonesian rupiah are
undervalued by 15% and 6%, respectively. Tariff risk is more significant for Malaysia and Vietnam because they have sizable trade
surpluses with the U.S.
The ability to underpin domestic demand with joint fiscal and
monetary stimulus appears constrained where it’s needed most—in
the Asean-5’s more open economies. Singapore and Thailand, for
example, have fiscal firepower, but trade-war effects are large and
the scope for monetary support is limited. Net exports account for
25% of Singapore’s economy and 9% of Thailand’s. Investment in
both countries is about one-quarter of GDP.
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
Australia
In Australia, Expansion Is
More Likely Than Recession
By TAMARA HENDERSON
AUSTRALIA’S GROWTH IS POISED to gain traction in the second half
of this year, setting the stage for a pickup in 2020. Risks of a
­recession appear low, with growth to be supported by rate cuts,
tax relief, and a recovery in the housing market. Even so, the central bank’s forecast of a 2.75% expansion in 2020 might be hard
to achieve without further easing or a rollback in U.S.-China trade
war tariffs, which would strengthen global demand.
Growth was just 1.4% in the second quarter from the same
period a year earlier, the weakest since the global financial crisis.
But a turnaround appears ahead. Election uncertainty has passed,
house prices are recovering, and government tax relief will augment
disposable income. The Reserve Bank of Australia has renewed
its easing cycle, cutting interest rates by 75 basis points from June
Household Spending Remains Key
Current Account Defies Trade War, Swings to Surplus
Australia’s current-account balance, seasonally adjusted, in Australian dollars
Total
Goods and services
25b
0
Q1’ 80
Q2 ’19
-25
Australia indicators, year-over-year change
Real GDP
Household spending
Sources: Australian Bureau of Statistics
6%
3
Q4 ’98
Q2 ’19
0
Sources: Australian Bureau of Statistics
to October, and has left the door open for more stimulus.
The RBA’s aim in easing is to accelerate progress on inflation
with a further tightening of the labor market. But it takes time for
rate cuts to filter through to hiring decisions. What’s more, there’s
been an increase in the labor supply, with older workers and w
­ omen
entering the workforce. This pushed the jobless rate up to 5.3%
in August.
In the meantime, RBA rate cuts should help reinforce a
­nascent recovery in the housing market. Demand will also be
­supported by looser mortgage lending rules. Prolonged unrest in
Hong Kong may divert capital flows to Australia’s housing market.
After almost two years of monthly declines, the median
house price in Australian cities started rising in July. If sustained,
this turn in the housing market should start to boost consumption
by mid-2020. Household spending growth tends to track house
prices, with about a 12-month lag.
The escalation in trade tensions between the U.S. and ­China
has slowed A
­ ustralia’s export growth, as has a drought, which has
reduced farm output. Even so, net exports have soared, pushing
the current account into a rare surplus in the second quarter.
Several factors have cushioned the impact of the trade war
so far, including relatively resilient prices for Australia’s key
­commodity exports and a softening in the Australian dollar against
trading partners. Beijing’s retaliation against U.S. tariffs also
­benefited Australia’s agricultural, tourism, and education sectors.
At the same time, import growth slumped.
A recovery in household demand among Australians in 2020
would likely boost imports, creating a headwind to the country’s
growth. But this might be offset to some degree by the stabilization of foreign demand, barring further escalation in U.S. tariffs.
Easing by major central banks should also start to shore up ­global
demand in 2020.
35
Asia
In Search of Growth:
A Frontier Economy Scorecard
By YUKI MASUJIMA
to the global slowdown or
the impact of the U.S-China trade war. But relatively fast,
­domestic-demand driven growth should provide a buffer—for
some more than others.
Bloomberg Economics’ Frontier Economy Scoreboard
­suggests Rwanda, Kenya, and Vietnam are better positioned to
ride out the bumps. The adoption of information technologies is
helping to support growth in Rwanda and Kenya. A shift in supply
chains out of China is giving a boost to Vietnam, which is also
cashing in on a regional free-trade pact.
The emphasis in the scoreboard is on assessing growth
prospects and exposure to the trade war and China’s downturn
—key considerations in the current environment. In a different
environment, if capital outflows were a key consideration, more
emphasis would be placed on capacity to service debts.
Business conditions have been improving rapidly in the top
three countries in the scorecard —Rwanda, Kenya, and Vietnam.
Each also has an advantage that could help it cope with the ­global
slowdown and U.S. protectionism: Rwanda has a relatively low
level of dependence on China; Kenya has a high level of fintech
development; and Vietnam boasts high mobile phone penetration,
FRONTIER ECONOMIES AREN’T IMMUNE
providing fertile ground for catch-up in the digital economy.
Underdeveloped infrastructure in frontier countries makes life
harder for businesses and deters foreign companies, hindering
­sustainable growth. The upside: They can start from scratch without
the cumbersome legacy of outmoded infrastructure. This is particularly true in the digital economy. Proliferation of mobile phones and
­greater fintech access are making it easier for people in rural areas
to shop and bank online, opening new avenues for growth.
Heavy dependence on China is a challenge for some frontier
economies. Those with closer trade and investment ties to China
benefited when it was booming. These days, they’re feeling the
drag from its slowdown. China’s penetration in trade is more
­pronounced in Asia’s frontier. The Belt and Road Initiative has also
led to increased Chinese lending to infrastructure projects in ­Africa
and Central Asia, creating greater reliance on China.
The scoreboard tracks growth, growth drivers (business
climate and opportunities in the digital economy), and risks for 14
frontier economies: seven in Africa (Ethiopia, Guinea, Ivory Coast,
Kenya, Rwanda, Senegal, and Tanzania) and seven in Asia (Bangladesh, Cambodia, Laos, Myanmar, Tajikistan, Uzbekistan, and
­Vietnam). Each total score is an average of the 10 gauges.
Grading the Frontier
Frontier
economy
More positive
More negative
Growth
Growth Drivers
GDP
Rwanda
Vietnam
Kenya
Ivory Coast
Bangladesh
Senegal
Uzbekistan
Myanmar
Tajikistan
Tanzania
Cambodia
Guinea
Ethiopia
Laos
Demography
Change in
2018 (%)
Outlook*
8.6
7.1
6.0
7.4
7.7
6.2
5.0
6.7
7.0
6.6
7.3
5.8
7.7
6.5
1.1
-0.2
0.4
-0.5
-0.4
0.6
-2.1
0.5
-2.3
-2.6
-0.3
-2.7
-1.2
0.0
Ease of doing business
Working-age
Current
Rank change,
pop. ratio index ranking past 3 years
57.1
69.5
57.2
54.8
67.0
54.3
67.3
67.8
61.1
52.2
64.2
54.8
56.5
63.4
29
69
61
122
176
141
76
171
126
144
138
152
159
154
-30
-22
-52
-17
-2
-5
-6
1
-4
0
10
-9
0
18
Risks
Digital economy
Dependence External debt
China
Mobile
phones†
Fintech
access (%)††
FDI share of
’17 GDP (%)
Share of
’18 GDP (%)
Share of
’18 trade (%)
79
147
96
135
97
104
76
114
112
77
119
96
37
52
4.6
20.5
26.1
7.1
3.5
10.4
7.1
3.6
12.8
11.6
3.8
4.5
0.6
7.1
3.1
5.8
0.8
2.3
0.7
2.4
1.5
5.8
2.9
2.0
12.7
4.9
5.0
8.7
35.1
43.1
29.6
31.2
16.4
37.0
42.9
23.5
78.2
31.5
48.5
12.7
33.1
78.6
7.7
27.1
20.1
9.1
19.1
14.7
22.9
34.7
27.9
19.5
16.0
33.7
20.8
27.0
Composite
ranking
1
2
3
4
5
6
7
8
9
10
11
12
12
14
*Average annual percentage-point differential between the growth outlook for 2019-21 minus actual growth for 2016-18, based on IMF’s World Economic Outlook, April 2019; †Subscriptions per
100 persons, figures for Tajikistan, Ethiopia, and Uzbekistan as of 2017; ††Share of people age 15 and older who used the internet to pay bills or to buy something in the past year.
Sources: Bloomberg Economics, IMF, World Bank
36
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
The
Americas
The Americas
Canada Can Count on a Strong Labor
Market and a Leg Up From Ottawa
By ANDREW HUSBY
lackluster in 2020, weighed down
by debt-laden consumers, global trade risks, and business uncertainty. The country’s open economy isn’t immune to the impact
of slower growth in the U.S. or the broader global manufacturing
malaise. A strong labor market and incremental policy stimulus
should prevent a slowdown from turning into something worse.
Solid job gains, coupled with on-target inflation, stayed the
Bank of Canada’s hand in 2019. Without clearer signs of significant
and sustainable progress in U.S.-China trade talks, we project a rate
cut by early 2020 as global growth sags. Low government debt
levels and a mild budget deficit mean Prime Minister Justin Trudeau’s
new minority government will have room to implement programs
to stimulate the economy.
In 2020 economic growth will hold near the low end of its
potential range (1.5%-2.1%, according to BOC estimates). Support
from the consumer sector is weaker than strong job market numbers
suggest. In 2019 higher household debt levels, well above those
seen in the U.S. before the 2008 financial crisis, plus earlier central
bank rate hikes in 2017 and 2018, led to the weakest pace of household spending growth since 2009. Given our view of limited BOC
easing, any resulting reduction in ­consumer debt-servicing costs
will be modest.
The unemployment rate will hold steady as strong job gains
decelerate. In that context, stability or even a slight rise in the
jobless rate wouldn’t be a negative sign. Quicker wage inflation
entices a greater share of the population to enter the labor force,
putting some upward pressure on the unemployment rate, which
is good for an e
­ xpansion’s durability.
After having a negative impact on growth in 2018 and 2019,
housing will make a modest contribution in 2020. The central
bank’s reprieve on rate increases injected new life in the economy
in late 2019, while a federal initiative that aids first-time ­buyers
with down payments should bolster demand as housing supplies
remain tight, supporting prices.
Canadian manufacturing and exports should be stronger.
The economy is less competitive than Canada’s educated, diverse,
well-­integrated workforce suggests. Headwinds include labor
shortages and bottlenecks in the energy sector, stricter regulations
and higher labor costs, and limited exposure to f­ aster-growing
CANADA’S EXPANSION WILL BE
38
markets. The trade-weighted Canadian dollar has been steady
since 2015, stabilizing after a 26% decline from ­early 2011 through
December 2015.
More Exposed to Sluggish Trading Partners
Bubble size denotes country’s share of Canada’s exports
2020 GDP
growth forecast
India, 0.8%
6%
China
6.3%
70.4%
Mexico, 2.5%
U.K., 3.0%
Germany, 1.0%
-8
3
South Korea, 1.3%
U.S.
Japan, 2.6%
0
6
0
Percentage-point change in share of Canadian exports from 2007 to 2018
Sources: Bloomberg, IMF
Limited exposure to faster-growing economies is also an
obstacle. Exports to China are just over 6% of Canada’s total
­exports, and exports to India make up less than 1%. While exposure
to the U.S. (70.4%) has diminished over the last decade, the bulk
of Canada’s trading partners are experiencing slow growth.
Business uncertainty remains not only because of the
U.S.-China trade conflict but also because of a divisive U.S. political environment that leaves ratification of the United States-­
Mexico-Canada Agreement in limbo. A U.S. infrastructure plan will
have to wait until after the 2020 election, restraining any boost to
complementary Canadian exports.
Core inflation measures remain contained despite wage
acceleration in the last half of 2019. Growth risks that tilt toward
a wider output gap should continue to keep inflation in check and
give the BOC space to act in support of the expansion.
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
The Americas
A Quest for Growth Will
Set the Tone for Brazil
By ADRIANA DUPITA
IF 2019 WAS THE YEAR OF PENSION reform in Brazil, 2020 will be the
year to focus on growth. Three issues will shape the c
­ oming year:
First, when and how growth will respond to record-low ­interest
rates; second, how the government will respond if low rates fail
to ignite activity; and third, how the reform agenda will evolve
before municipal elections in October.
We expect moderate growth of about 2% in 2020 will prevent
the government from returning to fiscally irresponsible populist
measures. But we’re growing skeptical that Congress will enact
any significant reforms.
Annual growth of 1% over the last three years didn’t bring
Brazil’s output back to its pre-recession level. This has left the
country with ample economic slack, which has kept inflation and
inflation ­expectations below target—set at 4% for 2020. Interest
rates have been at historical lows since early 2017, yet growth has
failed to respond. The culprit: low confidence. Neither consumer
nor ­business confidence has returned to levels consistent with a
­stronger pace of growth.
We expect the central bank to deepen its monetary ­stimulus,
cutting the policy rate to 4.5% by the end of 2019 from 6.5% midyear. Risks seem inclined to the downside. Should growth continue to disappoint, and if inflation expectations remain well anchored,
we believe the central bank may bring rates closer to 4%, which
would imply real interest rates of lower than 1% for the first time
in several decades. The narrowing interest-rate ­differential should
keep the currency under pressure. We see the real trading above
4.00 per U.S. dollar for most of 2020.
The painfully slow recovery has revived debate on whether
President Jair Bolsonaro’s economic team should rely on fiscal
stimulus in addition to rate cuts. We think this would be untimely.
The government is still running a primary deficit greater than 1%
of gross domestic product, fueling a continued rise in the public
debt, which is now about 80% of GDP. Should growth remain
lackluster, though, there may be greater political pressure for
fiscal stimulus, as well as increased resistance to additional reforms
necessary to nurse the public sector back to solvency.
Those reforms would include measures to control payroll and
other mandatory expenditures. According to the Doing ­Business
survey, the Brazilian tax system is the most time-­consuming in the
world, and companies in Brazil spend 10 times longer than their
emerging-markets peers just filing their taxes. A tax overhaul that
reduces complexity would also be welcome for its effects on productivity, even if it doesn’t bring additional revenue. A
­ dvancing these
initiatives will be challenging. B
­ olsonaro lacks a majority in Congress,
and legislative activity is expected to stall before midyear as politicians focus on the October m
­ unicipal elections.
Sagging Consumer Confidence Saps Growth
Pension Reform Only Prevents the Deficit From Rising
Brazil GDP growth, year-over-year
Forecast pension expenditures as a share of GDP
Without reform
With reform
100.4
10%
Brazil consumer
confidence index
10%
5
88.5
9
0
Q3 ’05
Q2 ’19
-5
Sources: IBGE, FGV
2020
2029
8
Sources: Ministry of Economy, Bloomberg Economics
39
The Americas
Government Plans, Trade Uncertainty
Will Weigh on Mexico
By FELIPE HERNANDEZ
to weigh on Mexican
i­nvestment and growth in 2020. This implies downside risks and
higher exposure to a possible external downturn or o
­ ther shocks.
We expect output growth to accelerate modestly, to 1.5%, next
year, below the potential rate, which the central bank estimates is
close to 2.0%-2.5%. With fuel shortages and workers’ strikes of the
past year no longer a problem, the economy can pick up the pace.
Exports should extend their upward trend and continue to
outperform, as shipments benefit from outstanding trade preferences and U.S. demand. Tariffs on U.S. imports from China would
allow Mexico to continue gaining market share.
Private consumption should rebound modestly in 2020. A
large minimum wage increase this year and next would provide
support, as would lower interest rates and abating inflation. With
the country’s protracted slowdown and growing labor costs, fewer
jobs are being added and unemployment is rising, putting up obstacles to growth. Falling consumer confidence would also be a drag.
LINGERING UNCERTAINTY WILL CONTINUE
Subdued Investment Growth, With No Relief in Sight
Mexico gross fixed capital formation index, seasonally adjusted
Total
Private
Public
120
100
80
Q1 ’12
Q2 ’19
60
Source: INEGI
Investment should continue to underperform next year
because of uncertainty on U.S. trade relations and concerns over
immigration and border security as the U.S. election nears. The
ratification and implementation of the United States-Mexico-­
Canada Agreement to replace Nafta could be further delayed if
Democrats in the U.S. House of Representatives are reluctant to
hand President Trump a victory before the 2020 presidential election. In the short term, Nafta should remain in place, but it could
come under fire amid the political debate.
Mexican President Andrés Manuel López Obrador’s economic
40
plans continue to undermine business confidence. His decision to
abandon energy reform, cancel construction of the Mexico City
airport, and renegotiate pipeline contracts left a bad taste with
investors. Officials and private investors have kept a dialogue going,
but results have been limited by their mutual distrust.
The government has reiterated its commitment to responsible
fiscal policy. Its spending remains limited by fiscal constraints, but
better budget execution, common after a first year in office, would
provide some relief. Optimistic revenue assumptions in the budget
imply that additional spending cuts may be necessary to meet the
goal of a primary fiscal surplus of 0.7% of gross domestic product in
2020. Lower spending would weigh on plans to boost growth by
increasing public investment. A wider deficit would raise broader
concerns and jeopardize the country’s­­i­nvestment-grade rating.
AMLO is likely to maintain strong support for Petróleos Mexicanos (Pemex), adding pressure on fiscal accounts. Amid a potential revenue shortfall and little room to accommodate a wider
deficit, this could accelerate the debate on tax reform.
We forecast average inflation will fall close to the midpoint
of the 3.0% +/- 1 percentage-point target in 2020. With greater
slack in the economy and less pressure from accumulated
exchange rate depreciation and supply shocks, core inflation is
likely to ease. F
­ ollowing a sharp decline in fuel prices this year,
more stable prices should contribute to higher noncore inflation.
We expect the central bank to cut interest rates slowly, to
6.0%, by the end of 2020. Decelerating inflation and increasing
slack would allow policymakers to ease monetary conditions, and
low external interest rates should provide them with additional
flexibility. An implied real interest rate of almost 3.0% compares
with the central bank’s estimate of a neutral real rate near 2.6%.
External risks to the outlook include weaker-than-expected
U.S. growth and potential trade disruptions from tariffs or NaftaUSMCA complications. A sustained drop in the global appetite for
risk would also be a concern.
Domestic risks include the government deserting its commitment to fiscal prudence and losing its investment-grade rating;
ongoing declines in oil production and deteriorating conditions at
Pemex; and resilient inflation and inflation expectations, which
could limit room for the central bank to ease monetary conditions.
The real exchange rate has partially recovered from the sharp
sell-off in 2015 and 2016, but it remains weak relative to exchange
rate data since 2001. A weaker currency has contributed to higher
exports, lower imports, and a sharp adjustment in the trade balance
and current account. The implied risk premium has fallen, but
lingering uncertainty suggests volatility could remain high, and
renewed pressure on the currency can’t be ruled out.
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
The Americas
Challenges Mount for
Argentina’s Fernández
By ADRIANA DUPITA
of challenges in 2020, and they will
shape the fate of the economy for years to come. Chief among
them are a deep recession, high inflation, huge debt maturities
early on, and a shaky relationship with the International Monetary
Fund. It will be impossible to solve all the problems at once, and
it’s yet unclear what President-elect Alberto Fernández will
­prioritize. There’s no room for policy experimentation or mistakes—and no time to waste.
The good news is that there seems to be limited pent-up
depreciation pressure for the peso, which is critical for Argentina’s
heavily dollarized economy. Alternative measures show that recent
capital controls haven’t yet substantially misaligned the currency.
This suggests that, should the government opt to remove those
controls, the currency may depreciate only moderately, implying
a similar impact on dollarized domestic prices and debt.
What happens to the peso over the medium term, though, will
depend largely on how the country handles its fiscal challenges and
conducts monetary policy. Floating the currency seems to be the
most sustainable course of action. But if Argentina wants to evade a
currency meltdown, it will also need fiscal and monetary conservatism.
Fiscal discipline is essential to keep the country from printing money
to finance the government, which would weaken the currency and
fuel inflation. Some degree of monetary austerity is crucial to slow
inflation, which has hovered around 50% since late 2018.
In the best of times, such measures would be painful. In the
middle of a long, deep recession, it would take great resolve for a
government—even one empowered by a recent election win—to
bear the political costs. In 2020 the new administration will have
to choose between adopting such measures or resorting to quick
fixes and shortcuts to avoid painful policies.
An early test will be how the government chooses to address
the mounting debt maturity at the beginning of the year. It seems
likely Argentina will at least seek to renegotiate when the payments
are due, and possibly to reduce the value of the debt. Its best bet
for success is to repeat Uruguay’s strategy in 2003, when that country
negotiated a five-year postponement of debt payments with the
majority of its bondholders, and to do so with the IMF’s blessing.
But IMF help is usually conditional, with a floating currency,
fiscal discipline, and monetary austerity as the traditional prescriptions. While the fund may be willing to accept a slow transition with
transitory unconventional measures, such as partial capital controls
and a temporarily managed currency, the conventional toolkit is
likely to be part of the endgame if the IMF is to remain involved.
We assume that Argentina will opt for an orderly exit from
the crisis. This will probably involve a haircut to privately held and
IMF debt, coupled with a credible effort to effect a gradual fiscal
ARGENTINA WILL FACE PLENTY
rebalancing. That could allow for a program to alleviate poverty, but
would hardly be consistent with any attempt to fuel consumption
via subsidies or higher public-sector salaries or pension benefits.
We expect to see a clear monetary rule in 2020, even if it’s
not as strict as the central bank’s abandoned target of monetary-base stability over the past year. That would allow A
­ rgentina
to float its currency without the economy melting down. If all this
is done in a credible manner, we see stable gross domestic product
in 2020, with inflation falling moderately to below 40%. This would
require a balanced budget and ­double-digit interest rates in real
terms into 2021.
There are abundant risks to this view. The government may
opt for a more confrontational approach, with a forceful debt
restructuring, discretionary rate cuts, fiscal stimulus, and interventionist measures such as stricter capital controls and price
freezes. The result would probably be continued recession, an
inflation spiral, and a resurgence in the black market for dollars.
It may opt for monetary and fiscal orthodoxy, but offset
with an interventionist, protectionist approach elsewhere—i.e.,
price-­setting or domestic input minimums for production. This
could keep inflation and the currency under control, but might
fail to revive growth.
Finally, Argentina could begin a pro-market agenda—but
then succumb to political pressure and reverse course if some of
those in Fernández’s political group and the population consider
the results insufficient.
Argentina Is Midway Through Rebalancing
Color indicates presidential administration
Néstor Kirchner (May 2003 - Dec. 2007)
Cristina Kirchner (Dec. 2007 - Dec. 2015)
Mauricio Macri (Dec. 2015 - present)
Argentina current-account
balance as a share of GDP
8%
2003
2019
’09
forecast
’12
’16
’17
’15
’14
’13
’11
’07
’08
’06
’05
’04
0
’10
’18
- 8%
0
6%
-6
Argentina fiscal balance as a share of GDP
Source: IMF data and forecast as of October 2019
41
The Americas
Another Year of Subpar Growth
For the Andean Countries
By FELIPE HERNANDEZ
DECELERATING GLOBAL GROWTH and lower commodity prices will be
hurdles in 2020 for the small, open, and commodity export-­oriented
economies of Chile, Colombia, and Peru. Floating exchange rates,
credible inflation targets, and responsible fiscal goals should help
those economies adjust to the challenging external outlook.
Policymakers will be happy to let their exchange rate float
to absorb the impact from any potential shocks. The currencies
have recently depreciated in real terms, but they’re still stronger
than at the end of 2015. They’re not far from levels consistent with
fundamentals, a sign there aren’t large imbalances.
A protracted period of subpar growth has undermined government revenues, weighed on fiscal and debt figures, and left
little room for additional fiscal stimulus. Lower commodity prices
would also weigh on revenues. Sovereign debt ratings are already
under review.
Interest rates across the region are low and consistent with
Economic Activity Maintains a Moderate Uptrend
Measure of economic activity, seasonally adjusted (index, 2013 = 100)
Peru
Colombia
Chile
120
110
100
1/2013
7/2019
90
Sources: Central Bank of Chile, DANE, INEI
Copper output should recover from transitory disruptions
caused by floods this year and get a boost from increasing production at the Chuquicamata mine. The outlook points to higher
exports and greater mining activity.
Consensus forecasts and forward contracts signal average
copper prices will be lower next year, which would imply weaker
terms of trade. Oil prices are also expected to decline, partially
offsetting the drag.
Expansionary monetary conditions should continue to
support domestic demand. Credit growth, in line with low interest
rates, is likely to keep rising.
Investment will continue to benefit from the construction
of large mining projects, and government stimulus plans would
provide additional support.
The main risks to the outlook are weaker-than-expected
global growth and lower copper prices. Lingering social discontent
is also a concern.
We expect headline and core inflation to slowly increase
next year but remain below the midpoint of the 3.0 +/- ­1 percentage-­
point target. Higher prices of tradable goods, in line with accumulated depreciation of the peso, would help explain the result.
Subdued prices for services, in line with lingering economic slack,
would limit the advance.
We expect the central bank to hold interest rates steady in
the first half of 2020. Officials would begin slowly reducing policy
accommodation in the second half as inflation approaches 3%.
Inflation Remains Within Target Range
Consumer price index, year-over-year, non-seasonally adjusted
Peru
Colombia
Chile
8%
expansionary monetary conditions. Credible central banks, low
inflation, and lingering economic slack imply there’s room for
further cuts. Low external interest rates also provide flexibility.
Political gridlock has hindered debate on reforms needed
to increase productivity and attract investment. This undermines
the region’s ability to withstand negative shocks.
Chile
We expect economic growth to rise to 3.2% in 2020 from 2.2%
this year, below potential growth of 3.4%. The forecast implies a
more stable, but still negative, output gap.
42
4
0
1/2009
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
9/2019
-4
Sources: INE, DANE, INEI
The Americas
Colombia
We expect growth to fall to 2.8% in 2020 from 3.1% this year, below
potential growth of 3.6%. That implies a negative and ­widening
output gap.
Oil output, which peaked earlier this year, should start slowly
falling in 2020 as oil fields age and reserves stagnate. The outlook
points to weaker exports and declining mining activity, which helps
explain the lower growth projection. Consensus forecasts and
forward contracts anticipate lower oil prices, an additional drag.
Lower oil revenues would also have a negative impact on
­external and fiscal accounts. The accounts imply widening twin
deficits and risks that could contribute to additional depreciation
of the peso.
We expect average inflation of 3.5% in 2020, close to the
level in 2019. Core inflation should increase to 3.4% from 2.7%,
driven by accumulated peso depreciation, exchange-rate
­pass-through, and higher prices of tradable goods. Increasing
economic slack should limit pressure on prices and partially offset
the advance. Lower noncore prices, due to abating food inflation,
would also contribute. Our forecast compares with a 3.0% +/1 percentage-point target.
We expect Colombia’s central bank to maintain interest
rates, which are already low and consistent with modest expansionary monetary conditions. A widening negative output gap
would argue for more accommodation, but higher core inflation
and wider twin deficits should be a constraint.
Lower-than-expected oil output and prices are important
risks to the outlook for Colombia in 2020.
Peru
We expect growth to rise to 3.4% in 2020 from 2.5% this year,
below potential of 3.6%.
Exports are likely to rebound in line with recovering mining
activity after transitory shocks from floods in 2019. Additional
copper and gold output from mines that are starting production
this year and next should contribute to growth.
Consensus forecasts and forward contracts point to lower
average copper prices next year, which would imply weaker terms
of trade. Gold prices are expected to increase and partially offset
the drag.
Political noise in Peru is poised to remain loud and weigh on
Floating Currencies Absorb Shocks
Real effective exchange rate of national currency (index, 2005 = 100)
Peru
Colombia
Chile
140
120
Low Interest Rates Provide Stimulus
100
Ex-ante real monetary policy interest rate
Peru
Colombia
1/1999
Chile
9/2019
80
Source: Bank for International Settlements
3%
0
1/2009
9/2019
-3
Sources: Regional central banks
domestic demand. Legislative elections in January could weaken
the opposition in Congress. The government is unlikely to win
control and would still need support from other parties to pass
any ­legislation.
Lingering economic slack signals subdued price pressures,
with inflation remaining close to the midpoint of the 2.0% +/1 percentage-point target. Lower oil prices would provide some
deflationary pressure. Consistent with expansionary monetary
conditions, the central bank will keep interest rates low to
support growth.
43
The Americas
Rebound or Recoil? An
Emerging-Markets Scorecard
By SCOTT JOHNSON and TOM ORLIK
FOR MANY EMERGING MARKETS, 2020 is looking slightly better than
2019. In a Goldilocks scenario, Fed rate cuts will stabilize U.S.
growth—gifting emerging markets with steady capital flows and
strong external demand. That isn’t guaranteed. If an escalating
trade war turns a global slowdown into a global downturn, a
­combination of weaker exports and capital outflows could push
vulnerable emerging markets back to the brink.
In that risk-off scenario, our scorecard suggests Argentina
and Turkey are most vulnerable to disruption, with South Africa
and Colombia not far behind.
To assess risk, we rank countries across seven metrics:
growth, the current account, external debt, exchange rate
­sensitivity, reserve coverage, inflation, and governance.
• Growth: We compare expectations for 2020 gross domestic product growth with the 15-year average. Argentina—facing
stagnation even on an optimistic read—stands out. Even in economies likely to see acceleration—Turkey, Russia, and Brazil—the
pace is set to fall short of the long-run trend.
• Current-account balance: If the global outlook deteriorates,
a dash for safety could punish economies that rely on external
funding. Colombia, South Africa, and Chile have the largest
­current-account deficits as a percentage of GDP. Details matter.
44
In Colombia’s case, that gap is offset by stable inflows of foreign
direct investment.
• Maturing debt: High levels of external debt maturing in the
next year could compound stress. Argentina tops the list, but it
has the backing of the International Monetary Fund, at least for
now. Malaysia and Taiwan look vulnerable by this measure.
• Currency risk: Drawing on work by Japan economist Yuki
Masujima, we create a risk ranking for currencies, regressing ­daily
changes on the CBOE Volatility Index (VIX), controlling for yield
differentials. South Africa, Colombia, and Turkey show up as the
most vulnerable in global risk-off moments. South Korea also looks
noticeably exposed.
• Reserve coverage: Ample foreign exchange reserves are a
force for stability. Argentina and Turkey have reserve coverage
below the 100%-150% threshold the IMF considers adequate.
• Inflation: High inflation erodes the value of investments.
Argentina and Turkey appear most vulnerable on this metric.
• Governance: Questions about governance can erode
­investor confidence. That was clear in Turkey in 2018, when threats
to central bank independence contributed to a slide in the ­currency.
Based on metrics from the World Bank, Egypt and Brazil have the
biggest challenges in this area.
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
The Americas
An Emerging-Markets Scorecard
Indicator
score
Saudi Arabia
Philippines
Thailand
Taiwan
Malaysia
Egypt
South Korea
Russia
Brazil
India
Poland
Peru
China
Mexico
Indonesia
Chile
Colombia
South Africa
Turkey
Argentina
More positive
More negative
Projected GDP
growth in 2020 vs.
15-year avg. (ppt)
Current-account
balance as a share
of GDP (%)
Short-term
external debt as a
share of GDP (%)
Rank of exchange
rate sensitivity to
market volatility
Reserve coverage
as a share of
adequacy (%)
CPI inflation, ppt
deviation from
target in Q3 ’19
Government
effectiveness
score in 2018
Vulnerability
ranking (1 = most
vulnerable)
-2.8
0.7
-1.9
-1.7
-0.9
1.3
-1.4
-1.0
-0.3
-0.6
-1.0
-2.0
-3.5
-0.9
-0.6
-0.7
-1.3
-1.5
-3.1
-3.3
4.4
-2.0
6.0
11.4
3.1
-3.1
3.2
5.7
-1.2
-2.0
-0.9
-1.9
1.0
-1.2
-2.9
-3.5
-4.2
-3.1
-0.6
-1.2
5.4
5.9
19.3
30.4
40.8
5.4
11.8
6.1
7.7
10.0
19.1
6.3
9.9
7.8
5.8
16.5
10.6
17.9
19.2
43.5
19
11
14
12
18
19
6
9
8
10
15
16
17
13
5
4
2
1
3
7
397.0
183.0
201.8
194.0
115.7
85.3
113.2
323.9
159.9
138.7
120.4
239.9
85.0
116.1
77.6
89.5
133.0
65.5
75.0
85.9
-4.1
-1.3
-1.9
-0.6
-0.7
-4.5
-1.9
0.3
-1.3
-0.5
0.3
0.0
-0.1
0.3
-0.1
-0.5
0.8
-0.4
8.6
37.4
0.32
0.05
0.35
1.36
1.08
-0.58
1.18
-0.06
-0.45
0.28
0.66
-0.25
0.48
-0.15
0.18
1.08
-0.09
0.34
0.01
0.03
15.9
13.1
13.0
13.0
12.7
12.6
12.1
12.0
11.6
11.3
11.0
10.3
10.1
9.7
9.4
9.3
6.1
6.1
5.0
5.0
The vulnerability ranking is an equally weighted composite of country scores for the seven indicators. GDP growth forecasts are produced by Bloomberg Economics or, where unavailable, the IMF.
Current-account balance, short-term external debt, and foreign-exchange reserve coverage are IMF projections for 2019. Reserve coverage is relative to the IMF’s Assessing Reserve Adequacy
metric, which includes short-term external debt (excluding nonresident holdings of local treasuries), other external liabilities, broad money, and exports. Values for Taiwan’s short-term debt and
ARA have been estimated using national statistics, with data on longer-term bond amortization drawn from Bloomberg’s Fixed Income Search function {SRCH <Go>}. Exchange rate sensitivity is
relative to the VIX and estimated with separate regressions of one-day changes over 260 trading days, controlling for moves in yield differentials. CPI inflation reflects national quarterly figures
compared with the midpoint of central bank targets, where available. For countries without targets, inflation is primarily shown relative to the 15-year average annual value. Argentina’s figure reflects
its latest target, abandoned in 2018. Egypt’s target is assumed to evolve in a linear fashion from its Q4 ’18 level (13%) to its goal for Q4 ’20 (9%); we use 11.5% for Q3 ’19. Government effectiveness
is a World Bank rating.
Sources: Bloomberg Economics, IMF, World Bank, national statistics agencies
45
The Americas
Is the Dollar at a Record High?
Real Measures Say No
By DAVID POWELL
U.S. PRESIDENT DONALD TRUMP’S tweeted complaints have focused
attention on the problem of dollar strength. He has a point. The
currency is overvalued. In historical and international comparison,
however, it isn’t overvalued by enough to trigger a sharp correction.
Our preferred valuation model, which uses the ­International
Monetary Fund’s methodology, indicates the real effective
­exchange rate (REER) of the dollar is overvalued by about 7.5%.
Other models used by the IMF point to the U.S. currency
being 13% to 17% above its fair value—figures that don’t stand out
as extreme given the experiences of other countries. The
­current-account deficit indicates only a modest overvaluation.
One simple metric—a purchasing power parity model—gives
more reason for pause.
Keeping Track of Your Dollars
Trump cares about the strength of the currency for reasons that
differ from those of investors. He worries about its effect on the
real economy and his prospects for reelection. Through that lens,
depreciation is attractive and every little bit helps. Asset managers focus on whether concerns of overvaluation are sufficient to
trigger a sharp reversal and the consequences for their portfolios.
We’re looking at it from the latter perspective.
On Aug. 30, as the euro dropped to more than a two-year
low against the U.S. dollar, Trump tweeted:
“The Euro is dropping against the Dollar ‘like crazy,’ giving
them a big export and manufacturing advantage … and the Fed
does NOTHING! Our Dollar is now the strongest in history. Sounds
good, doesn’t it? Except to those (manufacturers) that make
product for sale outside the U.S.”
The only measure of the dollar that’s at a record high is the
broad trade-weighted nominal dollar. The Federal Reserve breaks
its measure into two constituent parts: currencies from developed
46
markets and those from emerging markets. They show this broad
measure has been driven higher over the last 40 years by the
latter. All that’s demonstrating is that emerging-market currencies
have lost value relative to the dollar through the tumultuous
­decades of devaluation and depreciation induced by high rates of
inflation—no big surprise.
The broad real dollar is the measure that matters for the real
economy and for evaluating the misalignment of the c
­ urrency. It’s
adjusted for inflation, and therefore takes into account what the
currency can actually buy. That time series paints a different picture.
The index was about 10% higher during the dot-com boom and
25% stronger in the runup to the Plaza accord in 1985, when France,
Germany, Japan, the U.K., and the U.S. agreed to manipulate
­exchange rates by depreciating the dollar relative to the Japanese
and German currencies. However, the dollar’s fair value can change
over time, so that doesn’t tell us how overvalued it is.
There are a slew of valuation models to determine the
strength of a currency. The deviations they show can be used in
two ways. The first is to compare the misvaluation with those of
other ­currencies. That provides a sense of the level of mispricing
that the current environment may be able to support. The second
is to look at the deviation relative to the currency’s past. That gives
an idea of what kind of misalignment a particular country can bear.
The Bloomberg Economics Model
Bloomberg Economics has replicated the IMF’s REER index m
­ odel
from the fund’s External Balance Assessment, and it’s our preferred tool for assessing currency strength. Looking at that, the
dollar’s appreciation doesn’t appear extreme relative to other
currencies. Those of several other developed countries are in the
same ballpark. In addition, the Thai baht, Indian rupee, Hungarian
forint, and Czech koruna are almost 20% above our fair-value
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
The Americas
Emerging Markets: More Overvalued Than the Dollar
Percentage difference between actual real effective exchange rate and fair-value estimate
-25%
0
25%
Thailand
India
Hungary
Czech Republic
Peru
Philippines
Belgium
Denmark
U.S.
Switzerland
Netherlands
estimates, or more than twice as overvalued as the dollar.
The greenback’s strength doesn’t look extreme from an
historical point of view, either. The U.S. currency was about 17%
overvalued in the early 2000s. And its misvaluation was almost
5 percentage points greater in 2012 than now, though in the
­opposite direction.
The IMF uses the same model to provide different fair-value
­estimates based on where fundamentals should be in the medium
term. Its latest figures showed an overvaluation of 8%, and the U.S.
REER has increased by about 5.2% since they were c
­ alculated,
pointing to total overvaluation of 13.2% at present. That’s not particularly extreme compared with numbers for Japan (-15%), Malaysia (-26%), Mexico (-18.9%), Turkey (-23.1%), and Sweden (-23.2%).
Canada
China
Brazil
Spain
Portugal
Finland
Italy
Austria
New Zealand
Greece
Indonesia
Euro area
South Korea
Australia
Germany
Chile
Poland
Russia
Sweden
Norway
France
Japan
Ireland
U.K.
Malaysia
South Africa
Colombia
Mexico
Turkey
Source: Bloomberg Economics
Alternative Models
The IMF has other valuation metrics as well. It introduced a REER
level model (as opposed to the REER index model we replicated)
in 2015 to explain differences in the level of relative prices across
countries. Once again, it shows that the dollar, with a current
overvaluation of 17.1%, isn’t in a league of its own compared with
figures for Belgium (20.6%), Malaysia (-37.5%), Turkey (-21.1%),
or Switzerland (19.8%).
The IMF also has a method that focuses on current accounts.
Similarly, it indicates the dollar is a bit strong, but there’s no reason
to press the panic button.
The purchasing power parity model on the Bloomberg terminal shows the dollar is particularly overvalued against a few
currencies. Historically, PPP misvaluations of more than 20% have
been unsustainable. However, they only take into account the
prices of goods and services across countries; in reality, currency
movements are influenced by many other variables. A more comprehensive survey suggests it’s too early to fret.
47
Forecasts
Bloomberg Economics’ Forecasts
GDP (% YoY)1
Headline CPI (% YoY)2
Central bank rate (%)2
2019
2020
2021
2019
2020
2021
2019
2020
2021
2.2
1.5
2.0
1.5
1.9
1.5
2.3
2.0
2.3
2.1
2.3
2.1
1.50
1.50
1.50
1.50
1.50
2.00
1.2
1.3
0.5
0.2
1.1
2.0
2.4
1.3
1.0
1.4
0.4
0.7
2.0
1.5
0.9
1.4
1.3
1.7
1.2
0.9
2.2
1.4
1.5
1.7
1.2
1.3
1.3
0.8
4.5
0.8
1.7
1.8
1.1
1.4
1.3
0.9
3.3
1.3
1.5
1.8
1.4
1.9
1.4
1.3
4.0
1.9
1.5
2.0
0.003
—
—
—
6.25
—
0.00
0.75
0.003
—
—
—
6.00
—
0.00
1.00
0.003
—
—
—
6.00
—
0.00
1.25
1.7
6.1
6.88
5.0
0.9
4.2
5.9
1.9
-0.1
1.8
2.5
5.7
5.7
5.2
0.2
4.5
6.4
2.3
0.5
2.9
2.7
5.5
7.1
5.5
0.6
5.0
6.5
2.5
2.0
4.0
1.8
2.6
3.48
3.5
0.87
1.5
2.5
0.4
0.5
0.5
2.2
2.8
3.7
3.5
0.6
1.8
3.0
1.3
0.5
0.5
2.4
2.6
3.5
3.5
0.7
2.0
3.1
1.4
1.0
1.0
0.75
4.10
6.255,8
5.00
-0.10
3.00
4.00
1.25
—
1.25
0.25
3.70
4.505
4.75
-0.10
2.75
3.75
1.25
—
1.25
0.25
3.45
4.505
4.75
0.00
2.75
3.75
1.25
—
1.25
-2.6
0.8
2.0
3.0
0.2
2.3
0.0
2.1
3.2
2.8
1.5
3.4
2.1
2.5
3.0
2.7
2.0
3.3
52.1
3.4
2.2
3.6
3.7
2.2
38.5
4.0
2.9
3.5
3.1
2.1
29.3
3.8
2.9
3.4
3.3
2.3
60.00
4.50
1.50
4.25
7.25
2.50
45.00
4.50
2.50
4.25
6.00
2.25
35.00
7.00
2.50
4.25
5.00
2.25
0.1
0.5
1.0
2.5
1.5
3.0
-0.3
12.0
2.0
10.0
2.0
9.0
2.005
14.006
2.005
12.006
2.005
11.006
North America
U.S.
Canada
Europe
Euro area
France
Germany
Italy
Russia
Spain
Sweden
U.K.
Asia
Australia
China
India4
Indonesia
Japan
Malaysia
Philippines
South Korea
Singapore
Thailand
Latin America
Argentina
Brazil
Chile
Colombia
Mexico
Peru
Middle East & Africa
Saudi Arabia
Turkey
As of Nov. 8, 2019
Footnotes
1. Full-year growth
2.End-of-year forecast, except for Europe, China,
South Korea, and Philippines CPI, which are year average
3. Main refinancing operations rate
4. Fiscal-year forecast (e.g., 2020 refers to April ’19-March ’20)
5. Repo rate
6. One-week repo rate
7. Includes 0.9% sales tax hike effects
8. Fiscal 2019 values are actuals, not forecasts
48
SPECIAL REPO RT • B LO O M B ERG ECO N O M ICS
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