david nowakowski, senior director of research · •global sentiment encourages reforms •em...

Roubini Global Economics

David Nowakowski, Senior Director of Research

© Roubini Global Economics Copyright 2014 Reproduction or redistribution prohibited without prior written consent.

roubini.com | [email protected] Tel: 212.645.0010 | [email protected] / [email protected] Tel: +44 (0) 20 7092 8850

• Global Overview—Themes, Risks, Forecasts

• Here We Go Again? Property Bubbles & Banking Risks

• Macro-Prudential Brakes and Opportunities:

Infrastructure and Reform Needs

• Appendix: The World in 2014-2018

Contents

2 roubini.com | [email protected] Tel: 212.645.0010 | [email protected] / [email protected] Tel: +44 (0) 20 7092 8850

Global Themes

• Growth prospects weak but improving

• EM structural weaknesses being exposed

• Chinese rebalancing

• Gradual Fed normalization; experiments with “macro-pru”

• More central bank action ahead in Europe, Japan


Some Old Tail Risks remain but have changed

Tail Risks lower, but have not disappeared:

• Eurozone break-up (Grexit; Italy/Spain lose market access)

• U.S. fiscal crisis (high deficit, government shutdown, debt

ceiling fight, unfunded liabilities at state & federal level)

• Public debt crisis in Japan

• Low-flation and deflation

• Geopolitics: Iran–Israel War, Middle East turmoil


• Fed QE and ZIRP exit – risk of going too fast

• New asset bubbles/financial instability – risk of going too slow

• China hard landing

• EM crises and fragility

• Secular stagnation/Japanification

• Geopolitics: Russian Revanchism, Chinese expansionism,

North Korea, EU Secession (Scotland, Catalonia, UK)

5

Rising Tail Risks


6

Selected Growth Forecasts: A Lower “New Normal”


U.S.: Structural Challenges and Opportunities


Challenges

• Baby boomers retiring; workforce will

grow by 0.5% rather than 1%

• Risk of permanent labor-market damage

• Low capex in spite of high profits

• Regulation that makes credit, financial

services more expensive

• Income and wealth inequality

• Political gridlock

Opportunities

• New technologies

• Shale gas/oil

• Fiscal space for greater infrastructure and

education programs

• Sound immigration policies

• Deep financial sector

Bottom line: Potential/trend growth in U.S.

will be 2.5-2.8%

Close to the End of U.S. Household Deleveraging

Potential Growth Still Strong

Chinese Shadow Banking: Risky, Not Fatal


• Total debt reached 240% of GDP in

2013

• Asset quality has deteriorated; there

will be more defaults in 2014

• But state-owned banks are still

primary suppliers of credit, and

liabilities in shadow system have

longer maturities than in DMs

• This should help policy makers to

contain contagion effects

• Nevertheless, slow-moving financial

crisis will weigh heavily on growth for

next few years

• 20% chance of acute crisis (most likely

trigger is falling property prices)

Unsustainable Debt Dynamics (CNY, trillions)

Trust Assets By Borrower Type (CNY, trillions)

Source: Bloomberg, Haver, MoF, ADB, BIS, China Trustee Assoc., RGE

150

160

170

180

190

200

210

220

230

240

250

0

50

100

150

2003 2005 2007 2009 2011 2013

Loans Shadow Finance

Gov. Bonds PBoC Bonds

Pol. Bank Bonds Corp. Bonds

Total % of GDP (right axis)

0

2

4

6

8

10

12

2010 2011 2012 2013

Infrastructure Industry Financial Institutions Real Estate

Stocks IPOs Bonds Others

Overvalued Housing Markets Vulnerable


• Home prices: extremely elevated in Norway, France, Canada, the UK, Sweden and Australia

• Debt service: at historical lows and rising incomes mean a catalyst for correction will await rate

hikes or recession – end of QE is not likely to be the spark, if forward guidance succeeds

• Emerging markets: only Hong Kong stands out, but Turkey’s and China’s markets are ripe for a

downturn and Brazil shows cause for concern

Percentage deviations compared to long-term averages; positive = overvalued; negative = undervalued

Financial Wealth Has Rebounded


• Central Banks have reflated

assets with low rates and QE

• Corporates have maintained

discipline and benefitted from

productivity, unemployment

record profits

• SWFs and public pensions

have long-term challenges in

an era of lower expected

returns

• Huge wealth, inequality,

deficits, and high gov’t debt

could be a toxic mix

Household Financial Net Worth, % of GDP

Household Borrowing (Debt/GDP)

Source: National Central banks, Haver, RGE

40

50

60

70

80

90

100

110

120

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Eurozone Japan UK U.S.

100%

150%

200%

250%

300%

350%

99 00 01 02 03 04 05 06 07 08 09 10 11 12 13

Eurozone Japan UK U.S.

Scenarios: Near-Term Downside Risks Avoided 2014-15 Scenarios

• Liquidity buys time for eurozone fiscal/political integration; modest growth & inflation

• U.S. GDP back to potential

• Chinese rebalancing is delayed

• Global sentiment encourages reforms

• EM capital outflows and credit hang-over: slower growth and disruptive overshoots

• Disorderly events/politics in eurozone

• Chinese rebalancing turns into a hard landing

• External shocks or policy mistakes restart U.S. private deleveraging

• DM growth and unemployment high, wages and inflation low

• Eurozone muddles through: debt sustainability a concern

• Chinese slow grind, growth shifts to 7%

• Modest fiscal consolidation

70% 65% gradual

rebalancing; low and

volatile growth environment

25% 20% steady

recovery toward

normalization

2014-15 2016-18 Probability

5% 15% severe

recession in at least one

major region


2016-18 Scenarios

• Eurozone reform growth, rebalancing

• U.S. innovation extends dominance; bubbles and New Normal fate avoided

• Chinese rebalancing is delayed

• EM adjusts to post-QE; credit moderates; reforms/investment boost potential GDP

• EMs enter inflation-depreciation-default loop

• Eurozone politics fragments, with disorderly defaults in Spain or Italy; exit risk returns

• China: economic and political upheavals

• U.S. debt fragility, unfunded liabilities, and financial bubbles/busts have global spillovers

• New Normal for DMs: low growth, deflation, periodic debt restructurings and bail-ins

• China grows at 4-6%, financial crisis avoided as banks recapitalized

• EM growth slows due to credit tightening and opportunity cost of missed reforms

Under All Scenarios, Role Of Governments Rising

Leviathan Redux? • State Capitalism • Sovereign Wealth Funds • Conclusion: despite high deficits, governments will not be idle investors

Return of the Nanny State (for financials, anyway) • Dodd-Frank, Volcker Rule • Basel III, Solvency II, Counter-cyclical add-ons and “macro-pru” • Quantitative Easing, Credit Easing • Stress Tests, Resolution Regimes • Fed, BoE, ECB become supervisors, regulators, lenders of first/last resort • Conclusion: Banks are more constrained in an era of higher regulation

Reform School • Demographic certainty means status quo is dangerous for governments • “Reform” is a catch-all – important to know what it means. • 90% of it is legal or legislative, not economics per se. • OECD categorization of “areas for reform”

Avoiding Stagnation Huge reform needs in EM & DM

• Labor participation disabilities, disincentives, retirement reform, gender equality

• Unempoyment “active labor market policies”; reduce labor costs, wage & union reform, hiring/firing policies

• Productivity Increase quantity and quality of infrastructure Increase provision and effectiveness of education Expand and support innovation

• Competition Product market regulations Reduce public ownership Strengthen competition framework

Reduce barriers to trade and FDI

Shift tax burden from labor & income consumption, property, or activities with negative externalities (pollution, finance)

Cut subsidies to housing, energy, agriculture, etc.

Promote financial & capital market (BRIC especially)

Improve efficiency of government, healthcare

Enforce rule of law See OECD, “Economic Policy Reforms 2014”

http://www.keepeek.com/Digital-Asset-Management/oecd/economics/economic-policy-reforms-2014_growth-2014-en#page58

Governments Face Short & Long-term Budget Pressures


Infrastructure Needs Huge; Unlikely To Be Met


• U.S. needs $500bn annually just to maintain existing infrastructure

(American Society of Civil Engineers)

• EU funding needs for transport, energy, communication $325bn annually

(European Commission)

• Global estimate for capital 2013-2030 is $70 trillion; $4 trillion annually

(World Bank)

• Deficits and Demographics Will Strain Government Finances

World Population: 6.1 billion (2000) 8.8 billion (2050)

Developed Countries: 1.2 billion now, 1.2 billion in 2050, 1.1 billion in

2100; Southern & Eastern Europe could lose 1/3rd of population

Avg Age in Europe will increase from 3748; % of 65+ will double

http://www.un.org/esa/population/publications/longrange2/WorldPop2300final.pdf

Where will credit come from? Capital Markets! • International Debt outstanding, has stagnated

• Domestic debt mostly sovereigns & financials; “only” $8 trillion in corporate debt

$0

$10,000

$20,000

$30,000

$40,000

$50,000

$60,000

$70,000

$80,000

19

93

19

94

19

95

19

96

19

97

19

98

19

99

20

00

20

01

20

02

20

03

20

04

20

05

20

06

20

07

20

08

20

09

20

10

20

11

20

12

20

13

USD

bill

ion

Domestic Debt - Corporates Domestic Debt - All International Debt - All

Source: Haver, BIS

17

Summary:


The good news: No secular stagnation!

Jury is still out on Europe, but full ”Japanification” unlikely

“Slow, old, but still rich” is the overall verdict, but not necessarily fated

UK, Germany, Ireland taking risks to over-achieve

U.S. will continue to support global economy via productivity growth

Chinese rebalancing to be gradual The challenges: Plenty of rebalancing ahead, and staying on course will be tough

Chinese slowdown and rebalancing toward consumption will have fallout…

…together with end of a commodity supercycle

…political instability in some EMs

…policy tightening in DMs and EMs

…credit booms in China and many EMs, and new housing bubbles

Permanent loss of output and reduced potential growth in EM and DM (especially Europe) if structural reforms occur too slowly

19

Growth Trends: Most Countries Set For Secular Slowdown


Eurozone public debt sustainable, but not in all countries


• Eurozone government debt/GDP will

likely peak around 96% in 2014

• Fiscal deficits will continue to fall, but at

a slowing pace: from 4% of GDP in 2012

to 1.5% in 2018

• Continued fiscal consolidation and return

to weak growth will enable this fall

• Some countries face unsustainable debt

dynamics (Italy, Spain, Portugal), while

others should return to sustainability

through improved nominal GDP growth

(Ireland)

• We expect some forms of ALME (Active

Liability Management Exercises) to deal

with debt/GDP ratios rising beyond 130%

Sustainable Public Debt at Eurozone Level (% of GDP)

Unsustainable Public Debt for Some Eurozone Economies (% of GDP)

Source: Bloomberg, Haver, RGE

0

40

80

120

160

200

2006 2008 2010 2012

Greece

Italy

Portugal

Ireland

Spain

-4.5

-4.0

-3.5

-3.0

-2.5

-2.0

-1.5

-1.0

-0.5

0.082

84

86

88

90

92

94

96

98

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022Fiscal deficit (RHS) Debt/GDP (LHS)

Low inflation will persist


• In 2013, sharp increase in % of items in

eurozone inflation index with low or

negative annual inflation

• Energy was biggest driver, but

disinflation spread to other goods

• As of February 2014, all countries in the

eurozone had inflation below 2%, the

ECB’s target

• Ample slack in the goods and labor

markets and weak demand prospects

imply continued low inflation

• We believe inflation far below the 2%

target will eventually force the ECB to

ease further (refi rate cut, negative

deposit rate cut, quantitative easing)

Disinflation and Deflation Are Spreading Across Goods/Countries

All Eurozone Countries Now Have Sub-2% Inflation

Source: Bloomberg, Haver, RGE

0%

10%

20%

30%

40%

50%

60%

70%

Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14Total Weight of Items with HICP <= 1 % Total Weight of Items with HICP <= 0 %

0

2

4

6

8

10

12

14

-6%

-1%

4%

9%

14%

Jan-2006 Jan-2007 Jan-2008 Jan-2009 Jan-2010 Jan-2011 Jan-2012 Jan-2013 Jan-2014

Countries with HICP <= 0 % (RHS) Euro Area y/y % change

Min y/y % change Max y/y % change

Debt Trajectory and Active Liability Management Exercises

Guarantees: • Issuance guaranteed by a more creditworthy entity • Insurance

Collateral: • Secured bonds, senior to other bonds (U.S. “tobacco

bonds,” EU lottery revenues) • Sequestration of revenue streams

Liability Management: • Maturity extensions via debt swaps, including

deferral, capitalization or PIK of interest due

Loans (following an ECCL program): • IMF or ESM would lend long term at low rates

(compared to bond yields) • ESM and ECB could also conduct secondary-market

purchases

OSI (in cases where multilateral, bilateral loans comprise large part of overall debt burden): • Lending gets extended and reduced in real terms

through a combination of measures

PSI (external debt and/or local law debt) • Default or debt swaps (voluntary or forced)

0

20

40

60

80

100

120

140

160

180

200

2006 2008 2010 2012 2014 2016 2018 2020 2022

Greece

Italy

Portugal

Spain

Ireland

Projections

Debt-GDP Ratios (%) ALMEs

ALME Examples Portugal: • Sovereign Debt Swap – 3 Dec 13 Italy: • Debt Exchanges – 18 Nov 13 • Debt Buyback – 10 Dec 13 Cyprus: • Bonds maturing in 2013-2016 exchanged for same

coupon/par amount but longer maturities

Eurozone: RGE Forecasts (2016-2018 averages)


Output gap of around 2.5% of GDP, potential for catch-up growth

• Lack of demand will make it hard to close that gap

Potential growth low in the eurozone

• Low public investment—lack of fiscal space

• Demographic change kicking in—except in France

• Structural reforms slow—progress in Spain and Portugal, little in Italy, France, Greece

Cyclical unemployment will become permanent, and turn into structural unemployment

• Hurting growth potential, reinforcing the negative impact of demographic change

Bottom Line: No Japanification

• Inflation low, but will remain positive

• Potential growth low, but Germany (30% of eurozone economy) to grow robustly

• Major risk: World demand—the critical growth driver for most eurozone countries

GDP Inflation CA Gov. Debt 3m Eonia 10y Rate

Baseline 1.5% 1.6% 2.4% 94% 0.7% 2.2%

Upside 2.5% 2.5% 2.0% 80% 1.5% 3.5%

Downside 0.5% 0.0% 3.0% 110% 0.1% 1.0%

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david nowakowski, senior director of research · •global sentiment encourages reforms •em...

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