Important disclosures appear at the back of this document

Global Economics Weekly

Issue No: 10/17
May 5, 2010

Goldman Sachs Global Economics,
Commodities and Strategy Research
at https://360.gs.com
Improving Prospects for Global Investment
Investment spending in advanced economies
has collapsed in this recessionreal private-
sector investment in the G4 (US, Euro-zone,
Japan and UK) has fallen by 25% from its
peak, accounting for more than 75% of the
peak-to-trough decline in real GDP. If the
global recovery is to be strong and sustained,
private-sector investment will also have to
play an important role in the upturn.
The existence of spare capacity is unlikely, in
itself, to hold back a recovery in investment
spending: the sharpest accelerations in G4
investment in the past 30 years took place in
1983, 1992 and 2002corresponding to the
largest observed output gaps in each of the last
three global recessions. While firms with spare
capacity may not wish to expand their capital
stocks, many will still need to accelerate gross
investment spending just to stabilise those
stocks at a lower level. Such has been the
collapse in business investment spending in
this downturn that gross investment is no
higher than depreciation, implying no growth
in the G4 real capital stock.
That investment spending has fallen to the
replacement rate provides one reason to expect
it to rise in the future. This has also coincided
with an improvement in the underlying drivers
of investment spending: the global return on
capital has fallen by less than in past
recessions and is now rising, borrowing costs
are low, financial conditions easy and a rise in
the G4 q-ratio (the market value of installed
capital) suggests that the market will reward
companies that invest in new capital.
The biggest challenge for global investment
spending is not the demand to invest but
whether firms have the ability to fund that
demand. However, there are also encouraging
signs on this front: corporate free cash flow
has risen sharply and lending conditions have
begun to ease across the G4.
Jim ONeill
jim.oneill@gs.com
+44 (0)20 7774 2699

Dominic Wilson
dominic.wilson@gs.com
+1 212 902 5924

Kevin Daly
kevin.daly@gs.com
+44 (0)20 7774 5908

Anna Stupnytska
anna.stupnytska@gs.com
+44 (0)20 7774 5061

Swarnali Ahmed
swarnali.ahmed@gs.com
+44 (0)20 7051 4009

Alex Kelston
alex.kelston@gs.com
+1 212 855 0684
9.0
10.0
11.0
12.0
13.0
14.0
9.0
10.0
11.0
12.0
13.0
14.0
85 87 89 91 93 95 97 99 01 03 05 07 09
% of
GDP
% of
GDP
Gross Business Investment No Greater
Than Depreciation...
Bus Fixed Invest Total Bus Invest
Depreciation Dep+Trend Growth
Source: National sources & GS Global ECS Research
G4 (US, EMU, Japan & UK)
0.6
0.8
1.0
1.2
1.4
1.6
1.8
11.0
11.5
12.0
12.5
13.0
13.5
14.0
14.5
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Index % of
GDP
...While The Incentive to Invest
Has Increased
Bus Investment (% GDP)
Adjusted Q (RHS)
Source: National sources & GS Global ECS Research
G4 (US, EMU, Japan & UK)
May 5, 2010 Issue No: 10/17 2
Global Economics Weekly Goldman Sachs Global Economics, Commodities and Strategy Research
Improving Prospects for Global Investment
Recession Led by a Collapse in Investment
The recession in advanced economies has been led by a
collapse in private-sector investment. Total private
investment (business fixed investment, housing and
changes in inventories) has fallen 25.0% from its peak in
the G4 economies (the US, Euro-zone, Japan and the
UK).
1
Housing has obviously played a key role in this
decline but total business investment has fallen by a
similar amount (24.9%). By comparison, the peak-to-
trough decline in private consumption measured in real
US$ has been only 1.9% (Chart 1).
Of course, private consumption accounts for a much
larger share of GDP, so smaller changes matter more:
over the past 30 years, real private consumption has
averaged 62% of G4 GDP, whereas real private
investment has accounted for 17% and business
investment just 12%. But, even adjusting for their relative
sizes, investment spending has still accounted for a
greater share of business cycle volatility than
consumption spending.
Chart 2 weights annual changes in private consumption,
private investment and business investment by their
contribution to overall G4 GDP growth (and plots them
on comparable scales). Investment spending has typically
been a more important source of G4 business cycle
fluctuations than private consumption, both in the
downturn and the subsequent recovery.
Reflecting the severity of this recession and the direct
effect that the financial crisis had on the ability of firms
to fund investment, real total private-sector investment as
a share of GDP, has fallen from 19.1% to 14.6% (Chart
3). Of the 4.7% decline in real G4 GDP registered
between 2008Q1 and 2009Q2, weaker investment
spending accounted for more than 75% of the total.
This week, we consider the outlook for global investment
spending. We focus on the prospects for global business
investmentaccounting for 70% of total private
investment in the past 30 yearsto the exclusion of
housing investment. We do so because business
investment typically exhibits a much stronger global (i.e.,
common) elementthe average correlation between
business investment growth in the G4 and in the US,
Euro-zone, Japan and UK is 0.8, but this falls to 0.6 for
housing investment. There are country-specific factors
affecting business investment, of course, but they are less
important than those that affect housing investment
today.
Spare Capacity No Bar to Investment
Investment is the means by which firms and households
adjust their capital stocks to the desired levels. Because
the stock of capital adjusts relatively slowly (via
-25
-20
-15
-10
-5
0
5
10
15
20
80 81 83 85 86 88 90 91 93 95 96 98 00 01 03 05 06 08 10 11
% yoy
Chart 1: Private Investment in Advanced
Economies Has Collapsed
Private Consumption
Total Private Investment
Total Business Investment
Source: National Accounts, GS calculations
G4 (US, EMU, Japan & UK)
-4.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
-3.0
-2.0
-1.0
0.0
1.0
2.0
3.0
80 82 84 85 87 89 91 93 95 97 99 01 03 05 06 08 10
% yoy
Chart 2: Contibution to Annual G4
GDP Growth
Private Consumption (LHS)
Total Private Investment (RHS)
Total Business Investment (RHS)
Source: National Accounts, GS calculations
G4 (US, EMU, Japan & UK)
1. Together, these four economies now account for around 60% of global GDP, measured in current US$ at market exchange rates. We use these
economies as a proxy for all advanced economies. However, the growth and investment performance of the BRICs and other EM economies has
been markedly stronger.
10
11
12
13
14
15
14
15
16
17
18
19
20
80 81 83 85 87 88 90 92 94 95 97 99 01 02 04 06 08 09
% of
GDP
% of
GDP
Chart 3: Total Private Investment in the G4
Falls to an All-Time Low
Total Private Investment (LHS)
Total Bus. Investment (RHS)
Source: National Accounts, GS calculations
G4 (US, EMU, Japan & UK) Real Priv & Bus Inv as % of GDP)
May 5, 2010 Issue No: 10/17 3
Global Economics Weekly Goldman Sachs Global Economics, Commodities and Strategy Research
depreciation/scrappage in downward adjustments or the
gradual accumulation of capital in upward adjustments),
investment spending must work very hard to bring about
the desired adjustment. It is this relation between the
stock of capital and the flow of net investment that gives
rise to the high observed volatility in gross investment
spendingsmall changes in the desired capital stock or
small adjustments in expectations can require sharp
swings in investment.
While the advanced economies are now showing signs of
recovery, the recession has created a substantial amount
of spare capacity, which will take some time to unwind.
The OECD estimates that the overall OECD output gap
stood at 4.4% of GDP in 2010Q1. Given such a large
amount of spare capacity, a widely held concern is that
this will hold back any recovery in investment spending.
Historically, however, the existence of large amounts of
spare capacity has not been a bar to an acceleration in
investment spending. Indeed, the sharpest accelerations
in G4 investment spending in the past 30 years took place
in 1983, 1992 and 2002corresponding to the three
largest observed output gaps in the last three global
recessions.
The relationship between stocks and flows helps to
explain the volatility of investment spendingand also
explains why investment often accelerates in the depth of
a recession: while firms with spare capacity may not wish
to expand their capital stocks, many will still need to
accelerate gross investment spending to stabilise those
stocks at a lower level.
The simple illustration of capital stocks and
corresponding investment flows set out in Chart 4 sheds
some light on these dynamics. In this simple model we
assume there is zero growth to start off with, and thus
investment only takes place to replace depreciating
capital (I
1
=K
1
). Now suppose there is a negative shock
(the financial crisis) that results in firms wanting to
reduce the aggregate capital stock from K
1
to K
2
. To
bring about this adjustment as quickly as possible, firms
cut investment spending to zero. However, even with
zero investment, the adjustment process still takes some
time, as redundant capital slowly depreciates. Once the
capital stock has reached the new lower leveli.e., at the
end of the recession when spare capacity is high
investment spending re-accelerates back to K
2
. If it
didnt, the capital stock would continue to fall, dropping
below the new desired level (and ultimately reaching
zero). While this is a highly stylised representation, it
helps to explain why investment spending typically re-
accelerates at the end of a recessionoften ahead of
other areas of demanddespite the existence of a large
negative output gap at that stage.
2

Investment Struggles to Keep Pace with
Depreciation
In practice, aggregate gross business investment spending
in the G4 has remained above the level required to keep
pace with depreciation prior to this recession. Even in
bad times, it is likely that there was still some expectation
of demand growth in the future and, because different
types of capital are not interchangeable, structural
changes in the economy ensured that some sectors were
expanding their capital stocks even while others were
attempting to reduce theirs.
Such has been the collapse in gross business investment
in this cycle, however, that business fixed investment in
the G4 is now no higher than depreciationimplying no
growth in the G4 real fixed capital stocksfor the first
time in more than 30 years. If one also includes inventory
changes in a measure of total business investment,
business investment has fallen below the replacement rate
(Chart 5). This reflects the weakness of investment but
also a gradual rise in the depreciation rate.
There are cross-country differences in this pattern: most
Source: GS Global ECS Research
Chart 4: Investment Typically Rises at the End of
Recession to Stabilise the Capital Stock
t
1
t
2
t
2
t
1
K
1
K
2
I
1
= K
1
I
2
= K
2
t
t
9.0
10.0
11.0
12.0
13.0
14.0
9.0
10.0
11.0
12.0
13.0
14.0
85 87 89 91 93 95 97 99 01 03 05 07 09
% of
GDP
% of
GDP
Chart 5: Gross Business Investment No
Greater Than Depreciation
Bus Fixed Invest Total Bus Invest
Depreciation Dep+Trend Growth
Source: National Sources & GS Global Research
G4 (US, EMU, Japan & UK)
2. Another way of thinking about this is that, if spare capacity limits the speed at which companies want to expand their capital stocks, it should also
limit the degree to which the I/Y ratio ultimately rises. But the growth contribution from investment is given by the change in the I/Y ratio rather
than its level and the existence of spare capacity has notand should notprevent I/Y from reversing direction.
May 5, 2010 Issue No: 10/17 4
Global Economics Weekly Goldman Sachs Global Economics, Commodities and Strategy Research
notably, US business investment exceeds its replacement
rate, while UK business investment lies below the
replacement rate. However, as economic prospects begin
to recover, business investment in all four economies has
some way to catch up if the capital stock is to rise in line
with the long-term trend growth.
The Global Return on Capital Remains High
The relation between capital stocks and investment flows
and the role played by depreciation is important in
understanding the dynamics of gross investment
spending. It implies that there is a strong mean-reverting
element to the investment/GDP ratio over the cycle.
While the fact that net business investment/GDP has
never been this low before in the G4 provides one reason
for optimism, this development has also coincided with
an improvement in the underlying forces that drive
investment demand.
In the accompanying box we set out two complementary
theories of investment behaviour: one in which firms
respond to fundamental factors affecting investment
demand (such as the expected return on capital (ROC),
the cost of borrowing and the relative price of investment
goods) and another in which firms respond to market
signals regarding the effect that additional investment
will have on the value of their companies. Both appear to
be signalling an acceleration in investment demand.

Taking each of the main inputs in the fundamentals
approach in turn:
The return on physical capital is highly cyclical,
reflecting the cyclicality of corporate profits, so it is no
surprise that the global ROC fell sharply in 2008 and
2009 (Chart 6).
3
However, this decline was registered
from record high levels and, although this recession
was deeper in magnitude than the past three global
recessions, the global ROC has remained above its
long-term average. The data only exist on an annual
basis but, with profits now showing signs of recovery,
it appears likely that the global ROC will rise in 2010
relative to 2009. Expectations of future corporate
earningsas reflected in IBES estimatesare also
rising sharply.
There has been less action this year in the other key
inputs in the fundamentals approachthe cost of
borrowing and the relative price of investment goods
but they remain supportive of investment:
The cost of borrowing remains very low and financial
conditions more broadly are very easy. The real
(index-linked) yield of 10-year government bonds in
the G4 stood at 1.5% in Q1 (Chart 7).
The cost of business investment relative to output
prices remains historically low, although the trend
decline in this series has levelled off in recent years
(Chart 8).
3. The return on capital measure is for the private non-financial corporate sector. For more on the construction of this measure, see The Savings
Glut, the Return on Capital and the Rise in Risk Aversion, Goldman Sachs Global Economics Paper No. 185, May 27, 2009.
In this box we very briefly set out two (complementary)
models of investment spending.
The fundamentals theory explains investment
spending as a response to fundamental factors
affecting investment demand. The most important of
these are the expected return on capital (net of
depreciation and taxes), the cost of borrowing, and the
relative price of investment goods.
Roughly speaking (and ignoring expectational terms),
the fundamentals model posits that the real investment
ratio (I/Y) is given by:


Where is the spread between the return on
capital and the cost of borrowing and
reflects the relative price of output to investment goods.
In the q-theory of investment, firms respond to market
signals regarding the effect that additional investment
will have on the value of their companies. The q-ratio
was first discussed by the economist James Tobin and is
defined as the ratio of the market value of installed
capital, as reflected in equity prices, to the replacement
cost of that capital.
Under certain conditions, the q-ratio should capture all
relevant investment incentives for firms (i.e., nothing
else should matter). The most important of these
conditions are that (i) stock market valuations are fully
rational (in the sense that they reflect all fundamental
information); and, (ii) credit markets work perfectly
borrowers are not constrained from obtaining the loans
they desire at the prevailing market interest rate.
If both of these conditions are met, then the two models
should be identical and the fundamentals theory
becomes redundant. However, if these assumptions do
not hold, then both models can provide independently
useful information about future investment spending.
P
yt
P
it

The Underlying Drivers of Investment Demand
R0C
t
r
t

I
t

t
= o
1
+ o
2
(R0C
t
r
t
) + o
2
P
yt
P
it
+ e
t
May 5, 2010 Issue No: 10/17 5
Global Economics Weekly Goldman Sachs Global Economics, Commodities and Strategy Research
The Recovery in Equity Prices Increases the
Incentive to Invest
An alternative approach to modelling investment
spending is to suppose that stock markets fully discount
each and every fundamental factor, leaving firms to
respond only to the price signals that the market provides
them with. These market signals can be summarised by
the q-ratio (the ratio of the stock market value of capital
relative to the replacement cost of that capital). If the q-
ratio is relatively high, then firms are incentivised to
invest in new capital.
The model has performed reasonably well in the past,
leading changes in the G4 business investment/GDP ratio
by 6-12 months (Chart 9).
4
The sharp rise in equity prices
in the in the past 12 months has driven the q-ratio higher,
indicating that the stock market will reward companies
that invest in new capital. Given the typical lags that have
existed in the past, this would likely feed through into a
pick-up in investment spending quite soon.
Funding Conditions Begin to Ease
As we discussed in the introduction, one reason why the
financial crisis had such a negative impact on investment
spending is that, in addition to reducing firms desired
capital stocks, it also directly affected the ability of firms
to fund investment. With the financial system slowly
recovering, one can argue that the biggest challenge for
future investment spending is not investment demand but
whether firms have the ability to fund that demand.
However, there are encouraging signs on this front also:
Corporate free cash flow has risen sharply. Chart
10 displays the savings balance for the Private Non-
Financial Corporate (PNFC) sector in the US, Euro-
zone and UK (Japan produces annual data only).
Reflecting the weakness of investment and the start of
an improvement in profits, the PNFCs external
funding requirement has fallen to zero.

0.6
0.8
1.0
1.2
1.4
1.6
1.8
11.0
11.5
12.0
12.5
13.0
13.5
14.0
14.5
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10
Index % of
GDP
Chart 9: The Incentive to Invest Has
Increased
Bus Investment (% GDP)
Adjusted Q
Source: National sources & GS Global ECS Research
G4 (US, EMU, Japan & UK)
0.8
1.0
1.2
1.4
1.6
1.8
2.0
2.2
2.4
80 81 83 84 86 88 89 91 92 94 95 97 99 00 02 03 05 06 08 10
Index
2000 = 1
Chart 8: The Price of Investment Goods
Remains Cheap Relative to Output Prices
Source: OECD Source: OECD
OECDBusiness Investment Deflator/GDP Deflator
7
8
9
10
11
12
13
14
80 85 90 95 00 05 10
%
Chart 6: The Global Return on Capital Remained
Above its Long-Term Average in 2009
YIELD
ROC
Source: Goldman Sachs estimates based on nat accts
Avg =
10.7
Global ROC, Capital-Stock Weighted
2010
F'cast
0
1
2
3
4
5
6
7
72 75 78 81 84 87 90 93 96 99 02 05 08 11
% Chart 7: Global Real Bond Yields
Remain Very Low
Source: Goldman Sachs estimates
G4 (US, EMU. Japan & UK) Index-
Linked Bond Yields
4. Our measure of the G4 q-ratio is an index measured relative to its historical average, so a reading of 1 does not imply that the stock market
attaches an equivalent value to equity and physical capital. One would expect the q-ratio to forecast developments in nominal rather than real
investment/GDP but, in order to make the chart comparable, we have made the relative price adjustment to the q-ratio rather than to real
investment/GDP.
May 5, 2010 Issue No: 10/17 6
Global Economics Weekly Goldman Sachs Global Economics, Commodities and Strategy Research
Lending conditions have begun to ease across the
G4. The improvement in the aggregate funding
requirement obviously disguises sharp differences
across companies (those with surplus cash are not
necessarily the same firms that want to invest) and this
aggregate improvement could still be disguising
widespread strains. More encouraging, therefore, is the
sharp improvement in credit conditions to corporates
that has been seen across the G4. Chart 11 provides a
weighted average of credit conditions surveys for the
US, Euro-zone, Japan and UK. From a position of
extreme tightness in 2009H1, there has been a clear
easing in conditions in the past six months.
We have some way to go before lending conditions can
be considered in any way normal. But the well-known
problems with the credit channel help to explain how the
global economy fell into recession, not how it develops
from here. The evidence of sequential improvement is
therefore an encouraging sign for future growth.
Stronger Investment: Capital Goods Producers the
Biggest Short-Term Beneficiary
What would a sharper-than-expected recovery in global
investment imply for financial markets?
The most obvious beneficiary would be the producers
of capital goods themselves. Our Capital Goods teams
in the US and Europe are constructive on the sector
reflecting, in part, the optimistic signals from the
return on physical capital (see Upgrade cycle not yet
complete, supportive valuations, GS European
Capital Goods, January 11, 2010).
Economies whose production mix is skewed towards
capital goods are also likely to benefit. Examples
include Japan, Germany and Sweden.
More broadly, many of the factors underlying the
recovery we expect in investment spendingsuch as a
rising global return on capital and low borrowing costs
are also positive for equity returns in general. We remain
strategically constructive on risky assets.
Finally, however, the underlying driver of global interest
rates is the balance between ex-ante savings and
investment decisions. A recovery in global investment
spending is likely to be negative for fixed income in the
long run. Although, in the year ahead, we expect modest
positive returns.
Kevin Daly
85
90
95
100
105
110
115
120
125
03 04 05 06 07 08 09 10
Index Chart 11: Lending Supply to Corporates is
Easing
Sources: US Fed, ECB, BOJ, Bank of England, GS calculations
Weighted average of US Fed, ECB, BOJ, and Bank of England
credit conditions surveys to corporates. Mean=100, St.Dev=10
Easier
conditions
-3.5
-3.0
-2.5
-2.0
-1.5
-1.0
-0.5
0.0
0.5
00 01 02 03 04 05 06 07 08 09 10
% of
GDP
Chart 10: The PNFC Sector, In Aggregate,
Does Not Need External Financing
Source: National accounts, GS Gloabl ECS Research
PNFC Financial Balance (US, EMU & UK)
Greater Need
For External
Financing
May 5, 2010 Issue No: 10/17 7
Global Economics Weekly Goldman Sachs Global Economics, Commodities and Strategy Research
Equity Risk and Credit Premiums
Our ECP fell modestly in March as the fall in corporate
bond yields was offset by the decrease in the US ERP.
The US ERP has increased by 36bp since its recent low in
early April, mainly due to the fall in real bond yields.
1.5
1.9
2.3
2.7
3.1
3.5
3.9
4.3
Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10
% US ERP
US ERP, calculated daily
US ERP 200 Day Moving Average
Source: GS Global ECS Research
-3
-2
-1
0
1
2
3
4
5
81 83 85 87 89 91 93 95 97 99 01 03 05 07 09
%
Our ECP Fell by 6bps in March
1985-1998
average
2 standard deviations
band
Credit
relatively
expensive
Source: GS Global ECS Research
I, Kevin Daly, hereby certify that all of the views expressed in this report accurately reflect personal views, which have not been influenced by
considerations of the firms business or client relationships.

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Current Estimates for the Equity Risk Premium*
Real GDP
Growth
Real Earnings
Growth +
Dividend
Yield =
Expected Real
Return -
Real Bond
Yield =
Implied
ERP
Expected
Inflation
Expected
Nominal Return
US 3.0 3.0 1.9 4.9 1.3 3.5 2.0 6.9
Japan 1.5 1.5 1.6 3.1 0.8 2.3 0.5 3.6
UK 2.8 2.8 3.5 6.3 -1.1 7.4 2.0 8.3
Europe ex UK 2.3 2.3 3.1 5.4 -1.1 6.4 2.0 7.4
World 2.5 2.5 2.4 4.9 0.3 4.6 1.8 6.7
Source: Datastream; real GDP growth and expected inflation are GS Economics Research f orecasts.
*Calculated as of 04 May 2010
Issue No: 10/17 8 May 5, 2010
The World in a Nutshell
OUTLOOK KEY ISSUES
UNITED STATES
We forecast real GDP growth for 2010Q2 at 3%qoq.
In the second half of 2010, we believe growth will slow
to 1.5%qoq as the supports from fiscal stimulus and
inventory rebuilding fade. Starting in 2011, however,
we expect a reacceleration in growth to the 2.5%-
3.5%qoq range. We continue to believe that inflation
will trend lower in 2010-11 and that the FOMC will
keep the funds rate on hold at its current near-zero
level through end-2011.
The US is still benefiting from substantial policy
support. Fed policy remains easy and the multiplier
effects from earlier fiscal policies are still rippling
through the economy. After 2010Q2, the onus for
growth will fall much more heavily on final private
demand. Housing remains mired in excess supply,
bank lending is still depressed, and employers are
reluctant to hire. Still, there may be upside risk to our
outlook if strength in final sales continues from Q1.
JAPAN
Our real growth forecast is +2.4%yoy for 2010 and
+1.8%yoy for 2011 on stronger exports and capex
spending. We continue to forecast deflation, with
consumer prices falling 1.4% in 2010 and 0.4% in 2011
due to the wide output gap and other factors. This
makes our nominal GDP growth forecast 0.7%yoy in
2010 and 1.8%yoy in 2011. We believe exports will
strengthen 18.4%yoy in 2010. We think it is premature
to begin discussing the BoJs exit strategy given
continued deflation and political pressures.
Our 2010 outlook is for a stronger-than-expected
recovery chiefly due to exports and consumption, as
well as our projections that the global recovery will
continue. We believe capex has bottomed out thanks
to support from strong exports, which in turn were
driven by strong capex spending in Asia. We also
expect spending on consumer durables to continue to
grow, fuelled by government stimulus measures.
Additionally, we see childcare subsidies providing
additional support for consumption.
EUROPE
Europe should continue to benefit from the stronger
global growth environment. We expect EU-27 real
growth to be 1.8%yoy in 2010 and 2.5%yoy in 2011
(from 1.3% and 2.3% before). For the Euro-zone, we
forecast growth at 1.7% in 2010 and 2.2% in 2011
(from 1.25% and 1.9% before), clearly above
consensus and above the forecasts from official
institutions. However, the cyclical position of each
country is different.
Given the significant trade linkages among
European countries, stronger global growth and the
increase in trade activity, particularly with Asia, have
added a self-reinforcing element to the upswing.
The weaker than expected Euro, reduced
inventories, and better labour markets should also
help growth. At the same time, we remain aware of
the many structural challenges in the region,
including the ongoing fiscal concern.
NON-JAPAN ASIA
For 2010 and 2011, we forecast 9.1% and 8.5%
growth for Asia ex Japan. We expect the recovery to
continue in 2010, with most countries at or close to
trend growth. Domestic demand will be the growth
driver in China, India and Indonesia, as it was through
2009; Taiwan and Korea are likely to benefit from this
dynamic via greater linkages with China in particular.
Tightening across the region is becoming more
visible, but China needs to rein in lending quickly to
reduce the risk of a policy mistake. In India, we
believe higher inflation is here to stay as the output
gap has closed, commodity prices continue to rise
and inflation expectations are building. Our forecast is
now for 7.5% WPI inflation in 2011.
LATIN AMERICA
Our LatAm growth forecast (5.6% for 2010 and 4.1%
in 2011) is optimistic due to an encouraging global
outlook, continuance of easy policy in the advanced
economies, our expectation that global liquidity will
lead to capital inflows to LatAm, and high commodity
price forecasts.
For Brazil, we have upgraded our real GDP growth
forecast for 2010 to 7.5% from 6.4%, on the back of a
9.6% expansion in domestic demand. We have also
raised our 2010 IPCA inflation forecast to 6.2% from
5.8%. In Argentina, we upgraded our forecast for real
GDP growth in 2010 to 5.3% from 4.0%.
CENTRAL & EASTERN
EUROPE, MIDDLE EAST
AND AFRICA
The CEEMEA was the hardest-hit region in the world
during the crisis. For 2010-11, we believe recovering
external demand, rising commodity prices and low US
rates will provide a favourable backdrop. We expect
all the countries we cover, with the exception of
Hungary, to enjoy positive growth in 2010, but
domestic demand in countries that experienced
banking crises will likely rebound only gradually.
Turkey continues to have the easiest financial
conditions within CEEMEA by a wide margin.
Financial conditions remain loose in Poland and have
recently eased quite a bit in Hungary and the Czech
Republic, which should speed recovery in both.
Financial conditions remain tight in Russia, although
we expect Russia to start posting strong sequential
growth later this year.
THE GLOBAL ECONOMY
CENTRAL BANK POLICIES
CURRENT SITUATION EXPECTATION
UNITED STATES: FOMC
The Fed cut the funds rate to a range
of 0%-0.25% on December 16, 2008.
We expect the Fed to keep the funds rate
near 0% through the end of 2011.
JAPAN: BoJ Monetary
Policy Board
The BoJ cut the overnight call rate by
20bp to 0.1% on December 19, 2008.
We expect the BoJ to keep the policy rate
at 0.1% through 2011.
EUROLAND: ECB
Governing Council
The ECB cut rates by 25bp to 1.0% on
May 7, 2009.
We expect the ECB to keep the policy rate
on hold until a 25bp hike in 2011Q1.
UK: BoE Monetary
Policy Committee
The BoE cut rates by 50bp to 0.5% on
March 5, 2009.
We expect the BoE to begin hiking in
2010Q3 and continue to 1.5% by end-2010.
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