Global economic prospects for 2009

Author: Media Eghbal

Date published: 21 Jan 2009

The outlook for the global economy turned bleaker during the closing months of 2008. The collapse of housing markets, which began with the US sub-prime mortgage sector in 2007 and spread to many countries, was much swifter and deeper than expected. It quickly spread to equity markets, placing many major financial institutions in peril. A majority of industrialised countries are in recession or soon will be, as will some developing economies. This article looks at several factors that will shape the global economy in 2009 and beyond and considers some of the consequences for each region.

The world economy will see appreciably slower growth in 2009 with output in industrialised countries contracting for the first time in the post-war period.

Global prospects deteriorated dramatically during the fourth quarter 2008. A credit crunch has left consumers and businesses without the finance to support demand and investment. The confidence of both groups has plummeted and unemployment has soared as world demand weakens. According to the IMF, the world economy grew by 3.7% in 2008 but growth will drop to around 2% in 2009. In industrialised countries, output is expected to contract by -0.3% during 2009 while in emerging countries, average growth will fall to 5.1%.

Most analysts do not expect a recovery in commodity prices for at least several years.

Driven by a combination of rising demand and loose fiscal policies, commodity prices soared over 2003-mid 2008. This trend was reversed as the financial crisis spread, depressing output, investment and global demand. Analysts are divided about the outlook for commodity markets. Some regard price falls as a correction in a longer “super-cycle” driven by strong demand in emerging countries and supply constraints. However, most are convinced that the boom has come to an end. They argue that lower rates of population growth, relatively modest gains in income and declining use intensities for metals and energy will moderate prices in commodity markets.

The threat of inflation will significantly diminish in the medium term but there could be a downside.

Weaker demand has brought a sharp fall in world prices for oil and other commodities. Inflation in industrialised countries should be around 1.5% or less in 2009. The developing world will also see price gains moderate, although more gradually than in richer countries. Risks are still manifest in some developing countries owing to persistent wage demands and inflationary expectations.

Some industrialised countries may also face deflation (a broadly based fall in prices and demand associated with a reduction in credit). If prices were to trend downwards persistently, real interest rates could rise despite efforts of central bankers to ease monetary policy. The profitability of producers with significant fixed costs would be undermined as well.

The degree of economic uncertainty over 2009 is greater than at any time in recent history.

The fall in spending that affects so many economies stems directly from heightened uncertainty. Households will defer purchases and firms are postponing investments. If government programmes succeed in reducing uncertainty, consumer spending and investment should recover rapidly. However, further deterioration in the global financial situation will have the opposite result.

The efforts of central banks and governments to reassure markets are complicated by the fact that their implementation of financial support is proving to be more complex than originally envisaged. Policy changes and ambiguities have added to overall uncertainty. A large number of industrialised and emerging economies will try to agree on a broad roadmap for action in the first quarter 2009.

The pace of recovery for most of the world's larger economies will be languid.

Bankruptcies, corporate defaults and volatility in equity markets will continue throughout 2009. Business investment in most major countries is also expected to fall. In many countries, the strain in credit markets should begin to abate by mid-2009 and the downturn in housing markets could bottom out before end-2009. The recovery will nonetheless be slow because consumption will be held back by large loses in household wealth.

The USA will not begin to pull out of recession before the second half of 2009 - at the earliest. By that time, the recession would be longer than either of the two previous ones, which both lasted about eight months (July 1990-March 1991 and March 2001-November 2001). The depth and severity of the recession will vary in other countries, with some not seeing a recovery before 2010.

North America:

Economists expect real GDP of the USA to decline by -0.7% in 2009. Many thought that Canada's economy could avoid a recession but most Canadian analysts believe that their economy will shrink by around -0.4% during 2009.

The fiscal stimulus in the USA in 2009 will be especially important for the recovery. Relative to other industrialised countries, the USA must rely more heavily on fiscal policies to pull it out of recession as most social policies are less generous than those in Europe and Asia.

The US currency strengthened during the last quarter of 2008 when investors rushed to the safety of the world's international reserve currency. International capital inflows into the USA were at a record high in the fourth quarter 2008. Investors are expected to renew their flight to safety in 2009, although many are likely to move out of dollar-denominated assets. If that happens, the downward trend in the value of the dollar will resume during 2009. There is a danger that the US dollar could fall precipitously, forcing the economy into a harder landing and pulling the global economy further into recession.

Latin America:

The region's equity markets lost half their value (in dollar terms) in the fourth quarter 2008. The cost of corporate and government borrowing is also on the rise. As a result, investment is slowing. These factors, combined with a drop in exports and remittance inflows, will lead to a drop in Latin American's growth in 2009. The IMF expects regional GDP to rise by about 2.5% in 2009 (from 4.5% in 2008). The World Bank forecasts growth of 2.1% in 2009.

The fact that world prices for commodities are expected to remain depressed for several years will make it more difficult for the region's larger economies to recover. These countries are major exporters of oil, minerals and agricultural products. According to calculations by oil analysts, the Venezuelan government loses US$5 billion in revenues for every US$10 fall in the price of oil. Brazil, the region's largest economy, will see its growth rate fall to less than 3% as credit markets tighten and exports slump.

Western Europe:

The IMF expects growth in the eurozone to fall by -0.5% in 2009 while the World Bank predicts a decline of -0.6%. Germany and Spain will be two of the hardest-hit economies. Germany is the world's largest exporter and is vulnerable to the downturn in foreign markets - German economists fear that the recession could last until 2010. Spain's plunging housing market and soaring unemployment will mean a long and harsh recession. In the UK, private consumption growth is expected to fall to less than 1% in 2009 and the economy may not begin a recovery until 2010.

In December 2008, the EU unanimously agreed on a stimulus plan. They had to waive existing requirements for fiscal discipline in its stability and growth pact until the emergency is passed. The plan, which will total around 1.5% of the organisation's GDP, is valued at €200 billion. Member states are expected to contribute €170 billion while the EU provides €30 billion.

The EU will continue to struggle to reform its institutions and streamline the work of the enlarged EU. The latest attempt was the Treaty of Lisbon, which was rejected by Irish voters in 2008. After lengthy negotiations, Ireland will vote again in 2009. If this fails, it is likely that countries keen on a greater degree of European integration will form an informal club and a “two-tier” organisation will evolve.

Eastern Europe

Analysts predict a sharp slowdown in 2009 for Eastern and Central Europe. The IMF expects a fall in growth to 2.5% in 2009 while the World Bank forecasts 2.7%. The banking industry in several countries (notably Russia, the Ukraine, Hungary and the Baltic States) will be under pressure. Some are also struggling with massive current account deficits, which will become more difficult to finance.

Russia's policy makers will face a harsher economic environment in 2009. The fall in oil prices and the shrinking trade surplus could force officials to dip into the oil stabilisation fund to keep state-owned corporations afloat. Russia's growth rate could be halved in 2009, falling to 3-3.5%. The economy's performance will be much more dependent on foreign investment but its foray into Georgia and the government's increasingly belligerent tone scares many western capitalists.

Asia Pacific and Australasia:

Few of Asia's developing economies will sink into recession in 2009. Domestic demand – supported by fiscal stimuli – should ensure continued growth, albeit at a slower pace. The IMF has trimmed its growth forecast for developing Asia to about 5.0% in 2009. Most governments have low public debt and ample foreign exchange reserves so are in a good position to help counter a flagging economy. Possible exceptions are India, Pakistan and Taiwan where efforts to mount financial stimuli will be more problematic. Among the region's industrialised economies, Japan and New Zealand entered recession in 2008. Australia, however, should be able to avoid the same fate.

In China, the IMF forecasts growth of 8.5% in 2009 while the World Bank predicts 7.5%, significantly lower than historical rates. Nonetheless, with exports dropping sharply and unemployment rising, the risks for Beijing are on the downside. Much will depend on the effectiveness of policy responses.

More than other regions, Asian economies depend on inflows of foreign investment and participation. Any further deterioration in investor sentiment will hit inflows of foreign investment hard and lead to substantial capital outflows. Many Asian governments are likely to accelerate efforts to integrate into the regional economy. These moves will include policies to strengthen domestic demand, accelerate intra-regional trade and investment, and strengthen financial markets.

Africa and Middle East:

The Middle East and North Africa will suffer less than other regions. The World Bank predicts growth in the sub-region will be 3.9% in 2009 from 5.8% in 2008. Gulf States have accumulated huge budget surpluses, which will allow them to absorb substantial losses, although many development projects will be postponed or scaled back.

The IMF expects growth in Sub-Saharan Africa to fall to 5.1% in 2009 but the World Bank is more pessimistic, calling for growth of 4.6%. South Africa is the Sub-Saharan country most directly exposed to the global financial crisis. Large outflows of portfolio investment will have negative repercussions on macroeconomic stability and the already-large current account deficit. Other countries are only marginally integrated into global financial markets but weaker export demand and lower commodity prices will be the primary drags on growth.

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