A year ago, it all seemed so much simpler. Following a bumper year in 2006, most economists were looking for a continuation of the good times into last year. Some talked about worries over the health of the US economy, but the expectation was that any downturn would be short-lived. Sub-prime may have been on many economists' radars, but the phrase would have meant little to the public.
At the start of this year, things look gloomier. Most economists expect the US to grow by less than 2.5 percent, with a sharp slowdown in the eurozone to about 2 percent, and the UK, worse affected than many, down to about 1.9 percent.
However, thanks to continued robust growth in the likes of India and China, globally growth should stay above four percent. If this proves to be the low point in the current economic cycle, that would not be a bad performance overall.
The Organisation for Economic Co-operation and Development is trying to remain optimistic. Jørgen Elmeskov, its acting head of the economics department, said in its most recent report: “Several shocks have hit OECD economies recently: financial turmoil, cooling housing markets, and higher prices of energy and other commodities.
“Fortunately, they have occurred at a time when growth was being supported by high employment, which boosts income and consumption; by high profits and strong balance sheets which underpin investment and resilience in the face of financial losses and tighter credit; and by still-buoyant world trade, driven by robust growth in emerging economies.”
Merrill Lynch echoed the sentiment that the world economy ought to be robust enough to cope with the fallout from the credit crisis. Its global economics team wrote: “We remain optimistic that the global economy remains resilient in the face of a US slowdown, and forecast a moderation of global growth ex-US to 5.6 percent this year from 6.0 percent, even as the US slows… to 1.4 percent.”
Goldman Sachs is among those taking a more sanguine line. Jim O'Neill, its head of global economic research, said: “Our gross domestic product forecasts show a period of weaker-than-consensus growth this year, before a gradual return to trend next year.
“Our forecasts for both the US and the Bric economies of Brazil, Russia, India and China for 2008 are now below consensus. Given that close to 70 percent of all the growth so far this decade has originated in either the US or the Brics, this suggests it will be very difficult for the world to avoid a further slowing unless others surge.”
Merrill is even gloomier than Goldman on the prospects for the US this year. Its economics team wrote: “The US consumer is on the precipice of experiencing its first recessionary phase since 1991, the last time we had the combination of high, punishing energy prices; weakening employment conditions; real estate deflation and tightening credit conditions.”
It sees a sharp decline in the early part of the year. The economists wrote: “A more solid tone to the global economy and a weak dollar will help bolster exports but it is doubtful this will be enough to prevent overall GDP growth from declining in real per capita terms in the first half of 2008.” The bank expects it may take until late this year for a sharp recovery to take hold.
In Europe, inflation is a growing worry, at least in the short term. Deutsche Bank wrote: “Inflation has deteriorated and the European Central Bank hawks are growing more vocal. The question is, will growth slow enough to prevent inflation risks from materialising? We think yes, on balance.” For the rest of the world, the outlook is also uncertain.
Merrill Lynch wrote: “In Japan, a profits squeeze at smaller firms has derailed the labour market, with a bottom likely only from the middle of this year as wages resume their rise and the Bank of Japan adopts a more reflationary policy bias. In the rest of Asia, liquidity is abundant, but economic resource constraints are drawing near.
“We see upside risks to inflation, domestic asset prices, or both. Latin America looks forward to another year of solid growth.”
Some of the biggest questions remain with the UK, with the impact of the credit crunch on the housing market, and hence on consumer spending. With inflation still at the upper end of the Bank of England's comfort zone, it may be more reluctant than others to cut interest rates in the event of a slump. If so, it will be the country as a whole, not just the capital's financial community, that is likely to be in for a rocky year.
Ten geopolitical risks to watch out for this year
1) The Middle East
Iran: The perceived risk of military intervention against Iran's nuclear programme is likely to remain the biggest single political influence on the price of oil. However, we continue to judge the probability of such an attack as low.
This is because: although there are conflicting assessments of Iran's progress on uranium enrichment, most experts – including the US intelligence agencies – agree the Iranians are several years away from building weapons; diplomacy continues and there are signs that non-UN financial sanctions are starting to bite; political turmoil within Tehran is encouraging hopes that President Mahmoud Ahmadinejad's supporters may suffer a setback in the March 2008 majlis (parliamentary) elections; and the risk military action poses to the global economy all stand to weigh heavily, especially in a US election year.
Israel/Palestine/Syria/Lebanon: Despite some positive signs from the November 2007 Middle East peace conference in Annapolis, expectations of progress on resolving the region's conflicts are low.
Pakistan has topped international news since former Prime Minister Benazir Bhutto's assassination on December 27 (at least until Kenya hit the headlines thanks to post-election rioting) and is probably set to remain there for some time. Pakistan has been in continuous political turmoil for most of the past year with no visible impact on market sentiment towards India.
Nevertheless, the risk which Pakistan poses in terms of exporting terrorism – to India and globally – remains a real one and another terrorist strike against the Mumbai infrastructure could have an impact on market sentiment towards India. One way or another, we expect political turmoil to continue in Pakistan for a protracted period – and for the long-term trend to remain downhill.
3) US elections
Opinion polls continue to suggest that former First Lady Hillary Clinton will win the Democratic Party primary and ultimately become the next US President, and that former New York Mayor Rudolph Giuliani will win the Republican primary. But there is plenty of scope for an upset in either party's primary. The Democrats are expected to retain their majority in the House of Representatives and to increase their seats in the Senate from the current 51, which includes two independents.
4) Trade friction
Failure to reach agreement in the Doha multilateral trade round has highlighted concerns over swelling protectionist sentiment – especially in the run-up to the US elections – with the focus likely to remain on China's alleged “unfair” trade practices and problems over product safety. Absent accelerated renminbi appreciation, such sentiment could rapidly spread, notably to the EU, where the Commission is seeking additional powers to impose “countervailing duties”.
5) Sovereign wealth funds
National security concerns, legitimate or otherwise, around the rising power of SWFs, their desire for greater diversification of their holdings and the emergence of new funds in China and Russia stand to fuel protectionist sentiment in Europe and the US.
The opposition ‘pan-blue' alliance led by the Chinese Nationalist Party (KMT) looks likely to win the January 12 parliamentary election, with its candidate Ma Ying-jeou favoured to win the March 2008 presidential election, having been cleared late last month of corruption allegations that could have prevented him from running. KMT wins should bring some easing of economic constraints with China in the months ahead but are unlikely to lead to a major political shift.
Despite a reconstitution of the electoral process that was widely thought not to favour supporters of the former prime minister Thaksin Shinawatra – now largely reconstituted from the banned TRT into the PPP – the PPP leader, Samak Sundaravej, announced at the end of last week that, following the December 23 general election, he expects to be able to form a (narrow) majority coalition with the support of three small parties.
Samak may be able to persuade Chart Thai and Peua Pandin, which have 65 seats between them, to join, too. PPP emerged from the election as expected as the largest single party with 233 seats out of 480. PPP's lead over the Democrats (165 seats) is such that, in our view, the Election Commission – currently investigating 139 petitions over alleged electoral misdemeanours – looks unlikely to disqualify sufficient PPP members to alter the outcome.
The election outcome has underlined that Thailand remains a country deeply divided between its pro-Thaksin rural population and the urban middle class and elite. Political uncertainty looks set to continue.
The pro-Kremlin United Russia party emerged from the December 2, 2007 parliamentary elections with the majority required to push through constitutional amendments. This could help President Vladimir Putin's intention to retain a grip on power after he steps down following this year's March 2 presidential election.
The GNP's Lee Myung-bak won last month's presidential election (with 48.7 percent of the vote – higher than expected albeit on a low turnout), but is subject to a renewed corruption investigation. However, our judgment is that Lee will take office on February 25. Parliamentary elections are due on April 9.
Pro-business Lee is expected to put significant emphasis on economic growth but looks likely to do little to slow the growth of economic nationalism in Korea. He is also expected to foster closer ties with the US as the six-party talks on dismantling North Korea's nuclear programme enter a critical phase early this year.
10) South Africa
Jacob Zuma has been elected leader of the ANC despite the efforts of President Thabo Mbeki. But the National Prosecuting Agency has charged Zuma with corruption and scheduled a trial for August – a move his supporters claim is politically motivated to block him from election as President of South Africa in January next year. We therefore judge that any hope of reconciliation between Mbeki and Zuma is slim and that political uncertainty will continue.