News Room - Business/Economics

Posted on 25 Aug 2008

Contraction in GDP likely Global economic slowdown to continue

This year’s budget is certainly set amidst a challenging world economic scenario, in which the gross domestic product (GDP) of developed countries is expected to contract between -0.2% to -0.8% annually.

Amid the pessimistic forecasts, the global economic slowdown is expected to continue with high inflation reinforced by rising energy and commodity prices. This is particularly in emerging and developing economies, where food and fuel make up a larger share of consumption baskets .

Leading sources of foreign direct investment (FDI) will continue to be the developed countries, led by the United States, Germany, Britain and France.

The European economy has begun to feel the tensions emanating from the US credit crisis and higher oil prices, eroding consumer confidence and business sentiment.

The European Central Bank raised its policy rate by 25 basis points in early July, and the strengthening euro together with tight monetary policy could restrain growth in 2009.

The US Federal Reserve slashed interest rates aggressively to prevent the housing slump and credit crunch from dragging the US economy into a severe recession.

The Fed and the International Monetary Fund (IMF) have recognised that the US would see a mild recession this year, and a protracted downturn has not been ruled out. The IMF has drastically revised downwards its projection for the US economy in 2008 to 0.5% in April from a 1.5% forecast in January (2007:2.2%)

The huge US current account deficit implies that over the medium term, further exchange rate adjustments to reduce the global imbalances are inevitable.

The Japanese economy has also retreated owing to weaker consumer spending and easing export growth.

However, the strong trade and financial linkages with the US would mean that the spillover would not be negligible.

Japan’s real GDP is forecast to register a slower growth of 1.4% in 2008 (2007:2.1%) as the trade exposure to the US takes its toll.

The growth had been the lowest among G7 countries which include Canada, Italy, Germany, France, US and Britain,

China, while a magnet for investment and retail sales, remains one of the largest sources of FDIs with its GDP growth surging to 11.4% in 2007.

Despite a bleak global outlook and higher interest rates, China’s economy is still predicted to grow by about 10% in 2008 and 2009.

China has allowed greater flexibility on the yuan and it has the option of relaxing monetary policy to counter the weaker external demand.

In terms of real GDP, growth in advanced countries is expected to pull back led by the slowing growth in the US.

Growth in the euro area also shows a slowdown in activity, with Britain is possibly in recession.

Building on the slower growth momentum since the second half of last year and amidst continuing productivity declines, the US GDP is expected to contract to 0.517% in 2008 on an annual percentage change. It is expected to decelerate to 0.561 % in 2009 due to weak consumer spending and a swelling trade deficit.

Nevertheless, the IMF remains optimistic and maintains its projection of a GDP growth of 0.6% for 2009.

Economic activity in the more than US$9.0 trillion euro area has fallen for the first time since the pan-European recession of 1992-1993.

Supported by an accommodative monetary policy, improved external environment, as well as pick-up investments, the 15-nation euro area is, however, forecast to post a better-than-expected growth. Financial risks would remain high as rising losses due to a global slowdown could add to strains on capital and exacerbate the squeeze on credit crunch and availability.

In a nutshell, inflationary pressures worldwide have intensified with purchasing power in commodity-importing economies, such as Japan, eroded as many were unable to pass on the higher costs.

Meanwhile, some low and middle-income countries are facing difficulties in ensuring adequate food supplies for their citizens and are in danger of losing macro-economic stability achieved in recent years.
 
The only consolation is that commodity prices are projected to stabilise and inflation for 2008 is expected to be lower next year.

Moreover, commodity prices are usually cyclical.

Other temporary factors include unfavourable weather conditions like the heat wave, which is likely to have mixed effects moving forward.

Finally, in many emerging countries, monetary policy tools such as interest rates targeting needs to be tightened, combined with greater fiscal and expenditure restraint and in some cases, greater exchange rate management to reverse the recent build-up in inflation.