A “Foreclosure For Sale” on a house in the Boston, Massachusetts. Photo/REUTERS
In the United States, most experts are betting that the economy will grow stronger this year, but they warn that high unemployment, a depressed housing industry and other problems could dampen growth.
Meanwhile, the fate of the euro is still in question, and the spectre of inflation looms large in China, Latin America and India despite their resilience to the recent global downturn.
In the Middle East, observers expect renewed growth, but they note that resource constraints will become an increasing problem for the region.
Knowledge@Wharton spoke with Wharton faculty and other experts to get their views on what’s ahead for the world economy in 2011.
Unemployment risks
In the US, “the threat of a double dip [recession] has passed,” says Wharton finance professor Richard Marston. The congressional compromise to extend the Bush-era tax cuts for two years should help the country’s recovery, he predicts. “With the added stimulus of the tax bill, we will have continued growth in 2011.”
Still, “there are some very severe downside risks,” says Wharton finance professor Franklin Allen.
One main concern is housing: Allen, Marston and other experts agree that the uncertain housing market will continue to be a drag on the economy.
“In the housing market, the data is going in different directions,” Wharton real estate professor Susan M. Wachter notes.
Some reports show sales picking up, while others show prices continuing to stagnate.
“The bottom line is that we’re bouncing along the bottom.... We’re likely to be in a holding pattern.”
Fortunately, Wachter says, the weak housing market probably will not do too much additional damage to the economy, as most of the harm has already been done.
New-home construction is not likely to go lower, for example.
According to Wachter, the housing market has enjoyed some stability because many lenders have been reluctant to foreclose and sell homes at fire-sale prices.
A lender is typically willing to sell when a foreclosed property can fetch as much as the appraisers say it is worth, she says, but appraisers rely on backward-looking data that is quickly out of date in a volatile market, making it hard for the lender to know what a property is really worth.
Another problem, Wachter notes, is the recent rise in mortgage rates, which increases payments, makes homes less affordable and undermines sales.
In addition, high unemployment reduces the number of potential buyers, she adds.
“The unemployment situation is still not good, and that’s going to take a long time to change,” Allen agrees. “There’s been some upturn in consumer spending, but until things start looking better on the housing and unemployment fronts, I think [consumer spending] won’t drive things forward.”
While many US retailers reported a good holiday season, it is not certain that consumers, who are the most important force in the economy, will continue to reverse the tight-fisted habits developed in the past few years, Allen says.
Whether they have really loosened their purse strings or did so only for the holidays is unclear.
US economic growth also could be hampered by ripple effects from the continuing debt problems in a number of European countries, Allen notes. In addition, economies are starting to overheat in some developing countries, especially China, he says.
China has started to raise interest rates to curb inflation, but that could draw more foreign money into China, possibly depriving other countries of capital they need to speed growth while worsening China’s inflation problems.
Takes over
In Europe this year, whoever takes over from Jean-Claude Trichet as head of the European Central Bank (ECB) in October will inherit a different set of issues than the French banker did when he began his term back in 2003, according to Allen.
Back then, the euro zone’s single currency was still in its infancy, and most Europeans were happy to give fiscal and monetary union the benefit of the doubt.
But the European Union’s big macroeconomic imbalances and debt crises that began with Greece’s near-default last year and spilled over to Ireland, Spain, Portugal— and potentially could affect Italy and Belgium — have left plenty of skepticism over the lack of policy flexibility granted to members of the 17-nation euro zone (with Estonia the latest to join as of January 1).
The Frankfurt-based institution is expected to announce Trichet’s successor this spring, and the appointment “will really matter a lot,” says Allen.
A frontrunner is Axel Weber, head of Germany’s central bank who is seen as a close ally of German Chancellor and major euro proponent Angela Merkel.
Another strong candidate is Mario Draghi, governor of the Bank of Italia, “who is extremely talented,” notes Allen, “but I can’t see the Germans allowing a southern European to head the bank.”
All that will unfold as euro zone countries tumble through recovery at different speeds, depending on the range of austerity measures undertaken.
But collectively, according to a recent report from Guillaume Menuet and Silvia Ardagna, analysts at Bank of America Merrill Lynch, “while the pace of recovery [in Europe] post the 2008 recession looks to be quite reasonable, overall levels of GDP have a long way to go before recouping output lost in the downturn.”
They add that the euro zone’s “pre-crisis level of GDP is unlikely to be matched before the third quarter of 2012,” and they forecast that GDP growth in the bloc will reach 1.7 per cent this year, compared with 1.8 per cent in 2010 and -four per cent in 2009. (Globally, they forecast GDP growth in 2011 to be four per cent.)
While by the spring the worst of the sovereign debt crisis is expected to be over, the analysts note that “since the existence alone of the [EU and IMF’s financial] safety net has not proved a sufficient deterrent to arrest the contagion that threatens to engulf one country after the other, Europe must be ready to consider new solutions, including preventive action.”
But thus far, for experts such as Allen, there are few signs that this is happening.
“The level of the debate is going back to very basic stuff— for example, they’re talking about collective action clauses” to be included in sovereign debt contracts in order to protect investors. “It’s good to have them, but that’s not the main issue. It’s financial stability.”
At the country level, “the politicians — and the civil servants — seem to have no idea about the dimension of the problem. What they have to do is basically revamp banking regulation to deal with ... sovereign debt,” Allen states.
Beyond the traditional inflation-fighting concerns, the ECB’s new head will need to guide the euro zone through a resolution of the region’s sovereign debt woes.
The 750 billion euro ($1 trillion) crisis-rescue fund the ECB and the International Monetary Fund put in place last May expires in 2013.
According to Bloomberg, Weber expects the ECB to start withdrawing early this year some of its emergency measures, such as buying up the government bonds of the troubled countries to restore liquidity.
What then? Will it agree to monetise the debt or allow countries like Portugal to default?
Best solution
While the chances of the euro zone dissolving “in one go” are around 10 per cent, predicts Allen, another option would be to have two euro zones overseen by separate central banks— with France, Spain, Italy and the smaller countries staying with the current system, while the likes of Germany, the Netherlands and a few others join a new bloc.
“In my view, that’s probably the best solution to the problem,” he says.
“Rather than trying to force these very different countries with very different histories in terms of fiscal responsibility into one area, it would be much better to have two.”
China watchers are beginning 2011 much as they did 2010 — concerned about inflation.
Though still low by international standards, consumer price inflation early last year was hovering at less than two per cent.
But since the massive monetary expansion of late 2008, liquidity continued to flood in, putting upward pressure on prices.
Housing and food prices surged during the year, and a growing wave of discontent among workers seeking long overdue pay raises swept across the country.
By November, consumer prices were up 5.1 per cent year on year.
In a December report, London-based Economist Intelligence Unit (EIU) predicted that average year-on-year consumer price inflation will be 3.9 per cent in 2011, helped largely by intense price competition among goods manufacturers.
But this could change if, for example, wages increase and push up the cost of manufacturing, causing price hikes.
Agriculture, which accounts for a sizable portion of the country’s consumer price index, is arguably a greater concern.
Local newspapers are reporting that blue-collar workers in cities like Shanghai are unable to stretch their meager paychecks to cover the rising costs of staples, such as milk and vegetables.
“Having stimulated the economy tremendously, the government now has to deal with the consequences of it,” says Wharton management professor Marshall W. Meyer.
He and others note that the country’s enviable growth — the EIU estimates that real gross domestic product growth in 2010 will average 10.2 per cent —has been fueled by a massive expansion of money supply.
The inflationary consequences have been largely hidden in the form of rising asset prices, he says.
Reuters reported in mid-December that China has set a four per cent target for consumer inflation next year, up from this year’s three per cent objective, “an indication that the government will desist from aggressive tightening even as price pressures mount.”
Even among more bullish observers, inflation is seen as problematic when set in a broader social context, notes Horst Loechel, economics professor of China Europe International Business School in Shanghai.
“I’m quite optimistic about the Chinese economy. We’ll see an average inflation rate of around four per cent. This should be fine for an economy that is growing at around 10 per cent,” he says. “The main point for China in 2011 is how can they transfer the success of the country to the income of the people and really improve consumption levels.”
Loechel notes that consumption levels as a percentage of GDP in China are dramatically low.
“We’re talking about 35 per cent to 37 per cent,” he says. “In a normal economy, it’s 60 per cent to 70 per cent, and even in India, you have more than 50 per cent.” Rising prices won’t ameliorate that. “If we look at this overall picture, inflation has a role. It means decreasing purchasing power.”
The EIU says from 2011 through 2015, real GDP growth will slow to an average of 8.3 per cent a year.
The need to mop up excess liquidity in the economy comes at a time when trading partners, particularly the US, insist that the currency is being kept artificially low in order to protect China’s exporting manufacturers, says Allen.
“The argument they’re using — that they can’t let the exchange rate rise because of exports — is becoming quite short sighted,” particularly amid inflationary pressures.
Muscling ahead
In India, December 2010 saw corruption charges rise to a crescendo and a whole session of Parliament was lost as opposition parties, demanding deeper investigation into the scams, refused to let it function.
None of the political parties wants a fresh election, so this government will continue.
But its trajectory has obviously been affected. “The political climate is uppermost in the investor’s mind,” says Vallabh Bhansali, chairman of Enam Securities, a capital market services firm. “If there are policy logjams, they could create confusion.”
But the economy is expected to muscle ahead regardless.
Estimates of GDP growth vary from 9.7 per cent (the IMF prediction for 2011) to 7.7 per cent (the Credit Suisse prediction for fiscal 2011-12).
Credit Suisse is a rare pessimist; almost everybody else has upped their forecasts. The government projection is 8.75 per cent, with a possible 0.35 per cent addition.
One big worry is inflation. Dharmakirti Joshi, chief economist at credit rating agency Crisil, says inflation will be the biggest challenge in 2011. His other concern is the impact of rising capital inflows on the rupee.
Naresh Takkar, managing director and CEO of credit rating agency ICRA, also lists inflation as a top concern, especially in commodity prices.
He sees improving international economic sentiment as a “double-edged sword” for India.
“Sectors that are dependent on international demand will benefit, but commodity prices will see a further upturn,” he says.
Interest rates
If inflation climbs, the Reserve Bank will have to hike interest rates.
This could result in “some moderation” in the growth rates of investment and private consumption, according to Joshi. Bhansali also sees “a bit of a cyclical downturn in growth, but it may be only a few quarters or a few months.”
It’s on the reforms front— inextricably linked to politics — where there is the greatest amount of uncertainty.
Much could happen. Joshi pins big hopes on the proposed new goods and services tax, which he describes as a “game changer.”
A slow approach would be just right for new banking licenses, suggests Rajesh Chakrabarti, finance professor at the Indian School of Business.
“The dominant view is that caution and safety are key, and no rush towards greater liberalisation is warranted.”
He also expects the recent corruption scandals to create a bigger role for the government, “as the false assurance of the cleanliness of the private sector is now gone.”
“There are far too many policy reforms that are pending, but unfortunately, the parliamentary system has been bogged down by controversies, scams and corruption. No substantive reforms could move forward during 2010,” said Bhandare. “Our political parties must realise the adverse consequences of their actions.”
Middle East
As Dubai slowly emerges from its debt woes, sentiment among Arab business leaders and government officials is one of cautious optimism.
After largely managing to avoid the effects of the global economic downturn, the Middle East anticipates renewed growth this year.
Leading the region’s economic pace will be Qatar and Saudi Arabia.
Steady energy demand —oil and natural gas prices are expected to rise in 2011 -- and economic opportunities within their borders have been an appealing mix for investors.
The two countries received $44 billion in foreign direct investment in 2009, half the region’s entire investment flow, according to the World Investment Report 2010.
Though garnering world attention with its successful bid to host the 2020 World Cup, Qatar already has a record of high profile investment plays, such as the $2.3 billion acquisition of luxury retailer Harrods.
Qatar now has roughly $75 billion in external investments, according to research site RGE Monitor.
Coupled with its efforts to diversify its economy beyond liquefied natural gas and crude oil exports, Qatar’s GDP is expected to grow more than 20 per cent in 2011, according to the IMF.
Saudi Arabia, meanwhile, has concentrated on internal investment, spending an estimated $70 billion on infrastructure in 2010 alone.
Seeking to diversify its economy, the Kingdom has embarked on an ambitious plan to build four economic cities at an initial cost of $60 billion.
It has also made progress liberalizing its economy— real estate investors eagerly await passage of a planned mortgage law early in 2011, which analysts expect will set off a residential building boom in the country.
Such activity is a needed shot in the arm for the Islamic loan industry, which reached a five-year low in 2010.
Qatar’s World Cup preparations— expected to cost $65 billion -- will bring new Islamic finance deals.
Additionally, the successful restructuring of Dubai World’s debt restored some confidence in the market, observers note.
Providing a further boost will be the advent of more Western-based Islamic finance issuances, as markets from France to Australia revamp regulations to accommodate the industry.
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