Global

Economic
Outlook
3rd Quarter 2016
Global Economic Outlook

CONTENTS
Introduction|2 China: The deceleration
By Ira Kalish continues|26
Our team of global economists offer their views By Ira Kalish
on the United Kingdom, Eurozone, United States,
Data related to industrial production, manufactur-
China, Japan, Brazil, Mexico, South Africa, India,
ing, electricity output, and retail sales all indicate
and the economic implications of oil price fluctua-
that the Chinese economy continues to decelerate.
tions.
Growing debt is also a cause for concern. There
are warnings that unless China takes up serious
reforms, the expansion of debt could lead to a finan-
United Kingdom: After Brexit, cial crisis, low economic growth, or both.
what lies ahead?|6
By Ian Stewart
After Brexit, the final shape of Britains economic
Japan: Will households oblige
and political relationship with the European Union by spending more?|30
and the rest of the world may take years to fully By Akrur Barua
emerge. Right now, the most useful response would
Private consumption holds the key to growth at a
be for the UK government to signal the direction of
time of slowing exportsso how can Japans poli-
its negotiations with the European Union.
cymakers create incentives for consumers to spend?
The Bank of Japan actually may already be doing
that, by both lowering borrowing costs and reduc-
Eurozone: Life after ing the governments debt burden.
Brexit|12
By Alexander Brsch
While the Eurozones economic recovery has con-
Brazil: A glimmer of
tinued and even gained momentum, the outlook is hope|38
shaped by Brexit. Key among the questions now are By Akrur Barua
how to structure the future relationship with the
Brazils new government, though temporary, has its
United Kingdom as well as how to manage political
task cut out. GDP contracted for the fifth straight
risks.
quarter, fiscal deficit is in double digits, and infla-
tion is way above target. However, the president
has started on the right note by putting in place a
United States: Businesses credible economic team.
take a (hopefully) temporary
breather|18
By Patricia Buckley
What effect will the first-quarter contraction in
business investment and slower employment
growth have on the outlook for US economy? Going
by recent trends, annual GDP growth may not slow
down overall. However, unless business investment
picks up, longer-term growth might be at risk.

II
 3rd Quarter 2016
CONTENTS

Mexico: Embracing the The oil mighty: The

advantage of its northern
neighbor|46
By Daniel Bachman
Previously, Mexico attempted to keep its distance
from the United States. Since the resolution of the
1980s debt crisis, however, Mexico has instead
embraced the advantages of its large neighbor.
There are signs that this strategy may be starting to
pay off.
economic impact of oil price
fluctuations|70
By Rumki Majumdar
Wide fluctuations in oil prices have played an
important role in driving recessions and even
regimes collapsingwhich is why oil price move-
ments are closely watched by economists, investors,
and policymakers. The two recent cycles of historic
highs and lows suggest that the world economy is in
unchartered territory.

South Africa: In search of an

economic foothold|52 Economic indices|78
By Lester Gunnion
South Africas economic challenges have intensified. Additional resources|81
The economy contracted in the first quarter of 2016;
and weak growth, political unrest, and deteriorating
fundamentals have resulted in the currency slipping About the authors|82
and inflation climbing. Policymakers will likely face
difficulty in navigating internal and external chal-
lenges. Contact information|83

India: Slow and steady may

not be enough to win the
race|62
By Rumki Majumdar
Two years into the new Indian government, how
has the economy fared? It has been a mixed bag so
far: Much-needed reforms have been initiated, but
their progress has been slow. Uncertainty in the tax
environment, poor implementation of structural
reforms, and the lack of an assertive stance to im-
prove trade are among the problem areas.

Illustrations by Stephanie Dalton Cowan

III
Global Economic Outlook
Introduction
By Ira Kalish
I
N the summer of 2016, suddenly, there are new
uncertainties concerning the global economy,
not the least of which is the British referendum
in which a majority voted to exit the European
Union. This raises questions about the short- and
long-term outlooks for Britain, the future of the
Eurozone, and the future of globalization and eco-
nomic integration. Other current issues of concern
include surprisingly weak job numbers in the Unit-
ed States in May, continued deflationary pressures
in the Eurozone economy, and rising corporate debt
in China. These issues are affecting the decisions of
policymakers and, as a consequence, the outlook for
the global economy. Other issues that had been top
of mind only a few months ago seem to have disap-
peared from the headlines: oil prices, the Chinese
currency, emerging-market debt, and the recession
in Russia.
In this issue of the Global Economic Outlook, we
begin with Ian Stewarts assessment of the poten-
tial impact of the British referendum. Ian explains
the various possible scenarios that might take
place, noting that the uncertainty itself is likely to
have a negative impact on the economy. He says
that although Brexit will likely cause a slowdown in
growth, he believes that the United Kingdom will be
able to avoid a recession. Moreover, he points out
that, aside from the impact of Brexit, the UK econo-
my continues to retain many positive attributes that
should serve it well. Finally, Ian looks at the poten-
tial impact of Brexit on the rest of Europe.
2
Next, Alexander Brsch looks at the Eurozone. He
notes that economic growth has accelerated recent-
ly, with real GDP up 0.6 percent in the first quarter.
Yet he worries that a British exit from the European
Union could have a negative impact on the Euro-
zone countries, especially those with sizable trading
relations with the United Kingdom such as Ireland,
the Netherlands, and Belgium. Alexander also dis-
cusses the impact of Brexit on business sentiment,
noting that a recent survey found that German busi-
ness managers are worried that Brexit could lead to
other country exits and a weakening of the Euro-
pean Union.
In our article on the US economy, Patricia Buck-
ley says that, although she continues to believe the
United States will have moderate growth in 2016,
downside risk has definitely increased. While she
is not spooked by the slow growth in the first quar-
ter, Patricia is especially concerned that business
investment has now declined for two consecutive
quarters, the first time this has happened since
2009. She also notes that the drop in investment
was accompanied by a slowdown in job growth.
While she expects the economy to have rebounded
in the second quarter and that the job slowdown
might be temporary, she says that a further drop in
investment could put longer-term growth at risk.
In my article on Chinas economy, I discuss the lat-
est data indicating that the economy continues to
decelerate, led by weaker exports and weaker in-
 3rd Quarter 2016
INTRODUCTION

Global
Economic
Outlook
vestment. I also examine the growing debate about
the consequences of Chinas big increase in private
sector debt, especially corporate debt. I note the cri- published quarterly by
tique of Chinas policy response posed by the Inter- Deloitte Research
national Monetary Fund and others, as well as the
Chinese governments reaction to its critics. I con- Editor-in-chief
clude that the debt situation poses a risk to future Dr. Ira Kalish
economic growth, especially if China doesnt allow
weak businesses to fail or restructure. Managing editor
In his article on the Japanese economy, Akrur Ba- Aditi Rao
rua offers an interesting view on the relationship
between monetary policy and the large amount of Contributors
debt issued by the central government. The central
Akrur Barua
banks program of bond purchases means that the
Dr. Alexander Brsch
volume of debt held by the public will rapidly de- Dr. Patricia Buckley
cline. The result could be that, with a reduced debt Dr. Daniel Bachman
burden, the government can contemplate fewer tax Lester Gunnion
increases and more spending. That, in turn, might Dr. Rumki Majumdar
help to boost inflation at a time of continued defla- Ian Stewart
tionary pressures.
Editorial address
Akrur Barua also wrote this quarters article on Bra-
zil. Akrur says that, while the economy remained in 350 South Grand Street
Los Angeles, CA 90013
recession in the first quarter, there are signs that
Tel: +1 213 688 4765
the worst is over. Notably, exports have begun to
ikalish@deloitte.com
respond to a weak currency. Moreover, Akrur dis-
cusses the current and potential impact of the new
regime, which is considered to be focused on re-
forms. Markets have responded well, with increased
equity prices, an appreciated currency, and lower
bond yields. The new government has appointed

3
Global Economic Outlook

a credible economics team and intends to consoli-
date fiscal policy, reform pensions and the tax code,
privatize state-run companies, and boost private
sector participation in infrastructure investment.
In our next article, Danny Bachman offers his
thoughts on the Mexican economy. He notes
that, despite implementing many favorable poli-
cies, growth remains low compared with other big
emerging markets. On the other hand, Danny notes
that a sensible monetary policy has lowered infla-
tion. Plus, a flexible exchange rate has enabled the
country to weather various storms. Danny is opti-
mistic that the governments reform agenda will ul-
timately pay off in terms of stronger growth.
South Africa faces considerable headwinds, accord-
ing to our next article by Lester Gunnion. Real GDP
fell in the first quarter. Moreover, as Lester points
out, South Africa faces subdued commodity prices,
weak external demand, a strong dollar, and sluggish
global trade. Furthermore, weak growth, political
unrest, and deteriorating fundamentals have seen
the rand slip and inflation climb. The countrys
government also just barely avoided a ratings down-
grade. Lester concludes that the short-term outlook
is rather dim.
In her article on India, Rumki Majumdar notes that
Indias economic performance has been reasonably
good, assisted by low commodity prices and better
governance. Yet, she says, economic reforms, which
are needed to boost the future rate of growth, have
been slow in such areas as regulation, financial
market rules, relations between the center and the
states, and trade relationships.
In our last article, Rumki Majumdar looks at the
global oil market. Specifically, she reviews the his-
tory of the last 50 years of oil price movements and
provides thoughts on the factors that tend to drive
prices. She then examines the current situation and
concludes that, on balance, it is likely that oil prices
will remain relatively low in a fairly narrow corridor.
Finally, Rumki examines the likely winners and los-
ers stemming from the likely path of oil prices.
Dr. Ira Kalish
Chief global economist of
Deloitte Touche Tohmatsu Limited

4
 3rd Quarter 2016

5
Global Economic Outlook

UNITED KINGDOM

After Brexit, what lies ahead?

By Ian Stewart

B
Y the late afternoon of June 23, the day of
the United Kingdoms EU referendum, the
betting markets had priced an 84 percent
probability of a Remain vote; in the preceding
week, equities and the sterling had rallied strongly
on expectations that Remain would win. The unex-
pected vote to leave the European Union triggered
a bout of financial market, political, and economic
uncertainty. The immediate effects were seen in risk
assets, including, most graphically, the biggest-ever
one-day decline, of 8.0 percent, in the value of the
British pound against the US dollar on June 24.
The final shape of Britains economic and political
relationship with the European Union and the rest
of the world may take years to fully emerge. How-
ever, uncertainty is likely to moderate as the shape
of the governments ambitions for the European
Union take form. The next main landmark is the
election of a new leader of the Conservative Party,
and the new prime minister, on September 9. In a
surprise move, the front-runner and leading Brexit
campaigner, Boris Johnson, dropped out of the
leadership race on June 30; the new prime minister
is Teresa May, the former home secretary and a low-
key supporter of Remain during the campaign.
There are numerous possible permutations of out-
comes for the United Kingdom. It is possible that
the United Kingdom will not leave the European
Union at all. The referendum vote was only advisory,
70 percent of MPs favor Remain, and some Leave
voters seem to be suffering from buyers remorse.
Against this backdrop, the United Kingdom could

It is possible that the United Kingdom will not leave the

European Union at all. The referendum vote was only ad-
visory, 70 percent of MPs favor Remain, and some Leave
voters seem to be suffering from buyers remorse.

6
 3rd Quarter
United 2016
Kingdom

7
Global Economic Outlook

conceivably hold a second referendum or a general with the European Union, as countries such as
election that might result in the United Kingdom Australia do. Under such a scenario, exports from
deciding to remain in the European Union. the United Kingdom to the European Unionand
vice versamight be subject to customs controls
But at the time of writing, in the aftermath of the
and tariffs. Crucially, the access of the United King-
vote, the most likely outcome seems to be that the
doms highly successful financial service sector to
new prime minister will invoke Article 50 of the Lis-
the lucrative Single Market could be severely con-
bon Treaty, which starts the process of withdrawal,
strained. While such a regime would create a new
and that the United Kingdom will leave the union.
barrier to trade, especially in services, and would
A central issue in negotiations will be the United have pronounced sectoral effects, many successful
Kingdoms ability to retain access to the European exporters to the European Union, including China,
Single Market while do cope with it.
limiting the right of EU
As a shock, Brexit has
citizens to work in the
United Kingdom. UK As a shock, Brexit some elements in com-
mon with the 2008 fi-
business wants to access
the Single Market and
has some elements nancial crisis. But while
that was an economic
overwhelmingly favors in common with the shock that threatened
free movement of peo-
ple, yet David Cameron 2008 financial crisis. the solvency of the bank-
ing system and triggered
told European leaders
that it was concerns
But while that was an a credit crunch, Brexit
is a political shock. Its
about immigration and economic shock that impact on the economy
free movement of peo-
ple that caused UK vot- threatened the sol- is more indirect, at least
in the short term, and
ers to vote Leave.1
vency of the banking manifests via financial
The United Kingdom markets and the knock-
may try to square the system and triggered on effects on business
circle by negotiating for
somewhat reduced ac-
a credit crunch, Brexit and consumer confi-
dence.
cess to the Single Market is a political shock. A declining financial-
and tighter constraints
market risk appetite
on EU migration. So
tends to weaken the cor-
far, the European Union
porate sectors risk ap-
sounds unyielding on its insistence on free move-
petite. Companies react by battening down hatches,
ment of people, one of the four key principles of the
paring investment, and sharpening their focus on
union. Indeed, Angela Merkel warned the United
cost control. Foreign investors could also take fright
Kingdom that it would not be able to cherry-pick
and hold back on investing in the United Kingdom.
the parts of the European Union it likes, such as
Since the United Kingdom needs overseas capital
the Single Market, without accepting its core prin-
to cover its yawning current account deficit, such a
ciples.2
buyers strike would further weaken the pound.
If the European Union maintains this line and the
To generate a full-blown recession, consumers, who
United Kingdom insists on taking control of EU mi-
account for two-thirds of GDP, would need to stop
gration, the United Kingdom might find itself in a
consuming, as they did in 200910. The transmis-
more distant economic relationship with the Euro-
sion mechanism would come through rising uncer-
pean Union, perhaps operating under the rules of
tainty and a squeeze on spending power from high
the World Trade Organization without trade deals

8
 3rd Quarter
United 2016
Kingdom

inflation and weak earnings. But for now, this does be politically unviable in the face of opposition from
not seem to be the most likely outcome. many MPs. In todays exceptional circumstances,
the government could put deficit reduction on the
There are two lessons from economic history about
back burner and use public spending and tax cuts
the effect of external shocks. One is that the impact
to bolster growth. Such an approach has particular
reduces over time; economies are resilient, and
appeal to those who believe that monetary policy is
activity, in time, bounces back. The second is that
a spent force. Thus it seems that the United King-
shocks that threaten growth prompt a countervail-
dom faces slower growth with Brexit, but it should
ing policy response. Authorities dont sit on their
be able to skate around recession.
hands and do nothing.

Today, the most useful response would be for the

government to signal the direction for the United
But what about the effects
Kingdom in its negotiations with the European on the European Union?
Union. In markets and business, as in life, intent
Last Thursdays vote is as much a shock for the Eu-
matters. The usual policy levers could also be pulled.
ropean Union as the United Kingdom. The sharp
The Bank of England may well undertake more
decline in Continental European equity markets
quantitative easing, stepping up the volume and the
on hearing the news testifies to concerns about the
range of assets purchased to boost liquidity and as-
knock-on effects. A British exit would represent the
set prices as well as drive down long-term interest
greatest political setback to the European Union in
rates. Agreed, inflation may head higher as a weak-
its 65-year history. This comes at a time when the
er pound pushes up import prices. But as a one-off
European Union is coping with a migration crisis
phenomenon in an economy facing great uncertain-
and is trying to strengthen the euro area against fu-
ty, such temporary inflation would not justify inter-
ture shocks. After a period of rapid economic and
est rate rises. Fiscal policy may need to play a role,
political integration in the 90s and 00s, Europe
too. The chancellor previously suggested that Brexit
is seeing slower, more divergent growth and a loss
would lead to an austerity budget in order to balance
of political momentum. Figure 1 shows some of the
the books. That would dent growth and might well
possible Brexit effects on the union.

Figure 1. The future of the European Union

Challenges Response

1. Brexit, further secessions

Step up integration?

2. Slow growth
Multispeed Europe?
3. Migration, borders

Muddle through?
4. Fixing the euro

Source: Deloitte UK Economics and Markets team.

Graphic: Deloitte University Press | DUPress.com

9
Global Economic Outlook
In terms of the fundamentals, based on international
measures of competitiveness, the United Kingdom
looks in decent shape.
More extreme, anti-establishment political parties
such as the Freedom Party in Austria, the Five Star
Movement in Italy, the Front National in France,
and the Freedom Party in the Netherlands are gain-
ing ground. The immediate concern is the risk of a
domino effect as Eurosceptic parties elsewhere in
the European Union demand their own referenda.
Recent research conducted by Deloitte and the Ger-
man employers organization BDI found that 66
percent of German businesses believe a British exit
would lead to further such votes in the European
Union.3
A complicating factor for any UK negotiations with
the European Union is a series of national elections,
most crucially in the Netherlands (March 2017),
France (AprilMay 2017), and Germany (August
October 2017; dates to be confirmed later). It is pos-
sible that Europes de facto leaders, Angela Merkel
and Francois Hollande, will leave office in 2017.
The United Kingdoms departure from the European
Union also raises questions about the future direc-
tion of the trade bloc. Without the United Kingdom,
the European Union loses a significant supporter of
free-trade and free-market policies. Analysis by the
think tank Open Europe suggests that the United
Kingdoms exit will tilt the balance of power in the
European Union under qualified majority voting
significantly toward a more protectionist, less free-
market, approach.4
Faced with the risk of further secessions across Eu-
rope and seeking to avoid political drift, EU lead-
ers may seek to double down on ever-closer union.
10
Press reports have suggested that European leaders
have already been drawing up plans for a future
union without the United Kingdom, developing a
so-called Plan B focused on closer security and
defense cooperation.5
Yet the integration that the European Union sees as
necessary to strengthen the European project could
run into resistance from national electorates. The
Pew Research Center recently reported a decline
in support for the European Union across 10 major
member states. The research also found that those
European voters who favored the transfer of power
from nations to the European Union were outnum-
bered two to one by those who wanted to see pow-
ers returned from the European Union to national
governments.6
At times of great uncertainty, marginal new infor-
mation, both important and trivial, is subject to
great scrutiny. Dramatic but unrepresentative or er-
ratic events are sometimes given more significance
than they deserve. Fundamentals can get drowned
in a torrent of speculation and news flow. In terms
of the fundamentals, based on international mea-
sures of competitiveness, the United Kingdom looks
in decent shape. The World Bank, the World Eco-
nomic Forum, and the Heritage Foundation rank
the United Kingdom in the top tier of their league
tables of competitiveness, up there with countries
such as the Netherlands, Denmark, and Australia
(figure 2). This ranking speaks of a flexibility and
resilience that will be vital to the United Kingdom
as it navigates what lies ahead.
 3rd Quarter
United 2016
Kingdom

Figure 2. United Kingdom ranks as competitive

Global competitiveness rankings

Heritage Foundation World Bank World Economic Forum

#1 Hong Kong Singapore Switzerland

#2 Singapore New Zealand Singapore

#3 New Zealand Denmark United States

#4 Switzerland South Korea Germany

#5 Australia Hong Kong Netherlands

United Kingdom 10 6 10

Sweden 26 8 9

Poland 39 25 41

Spain 43 33 33

France 75 27 22

Italy 86 45 43

Greece 138 60 81

Note: Higher rankings indicate better, usually simpler, regulations for businesses; greater ease of doing business; stronger protections of
property rights; and lower corruption.
Source: Business Index and Heritage Foundation Index of Economic Freedom; Deloitte UK Economics & Markets team.

Endnotes
1. Gabriela Baczynska and Elizabeth Piper, At last EU summit, Cameron voices regret for Brexit, Reuters, June 29, 2016, http://in.reuters.com/
article/britain-eu-summit-idINKCN0ZE23E.

2. Ian Wishart, John Follain, and Jonathan Stearns, Merkel tells Cameron before EU summit: Dont delude yourself, Bloomberg, June 28, 2016,
http://www.bloomberg.com/news/articles/2016-06-28/merkel-tells-cameron-before-eu-summit-don-t-delude-yourself.

3. Deloitte Germany, EU referendum: Brexit und die Folgen fr deutsche Unternehmen, June 2016, http://www2.deloitte.com/content/dam/De-
loitte/de/Documents/financial-services/Deloitte-Deutschland-BDI-Brexit-2016.pdf.

4. Open Europe, http://openeurope.org.uk/.

5. Alex Barker, Stefan Wagstyl, and Anne-Sylvaine Chassany, Paris and Berlin ready Plan B for life after Brexit, Financial Times, May 26, 2016,
https://next.ft.com/content/09668b3e-2357-11e6-9d4d-c11776a5124d.

6. Bruce Stokes, Euroskepticism beyond Brexit: Significant opposition in key European countries to an ever closer EU, Pew Research Center,
June 7, 2016, http://www.pewglobal.org/2016/06/07/euroskepticism-beyond-brexit/.

11
Global Economic Outlook
EUROZONE
Life after Brexit
By Alexander Brsch
W
HILE the economic recovery in the Eu-
rozone has continued and even gained
some momentum, the Eurozones out-
look is shaped by the decision of the United King-
dom to leave the European Union. The first exit of
an EU member (besides Greenland, then part of
Denmark in the mid-1980s) poses a variety of ques-
tions for the European Union, in the political as well
as economic spheres. Key among them are how to
structure the future relationship with the United
Kingdom as well as how to manage political risks in
the European Union.
Some good news
on the recovery
The Eurozones economic recovery gained some mo-
mentum in the first quarter. This was not necessar-
ily expected: After the financial market turbulences
in the beginning of the year and the various external
risk factors, a weakening dynamic was more likely.
Nevertheless, the growth rate of 0.6 percent in the
first quarter was the strongest since Q1 2015.
External uncertainties did not scare the Eurozones
consumers, who have continued to drive the recov-
ery. Wages are growing, unemployment is slowly
12
shrinking, and low energy prices do their part to en-
courage private consumption. At the same time, the
net effect of external trade is negative, as imports
have grown stronger than exports, even in the case
of Germany, the Eurozones main exporter. The key
reasons behind this are the waning tailwinds of a
weak euro and weaker demand from emerging mar-
kets.
The arguably most important component for a self-
sustaining recovery, corporate investments, has
been the weak spot of the Eurozones recovery since
it started in 2013. Overall, the level of capital invest-
ments in the Eurozone is still hardly higher than it
was in 2010. But finally investments in the Euro-
zone show some signs of life: Overall investments
have grown robustly, at 0.8 percent, for the second
quarter in a row.
Whether these encouraging developments indicate
higher growth dynamics is not clear. In any case,
they have been overshadowed by the June-end de-
cision of the UK electorate to leave the European
Union. While the possibility of Brexit was widely
seen as one of the key tail risks for Europe and the
world economy and was widely discussed, the likeli-
hood of its occurrence was seriously underestimat-
ed, not least in the financial markets.
 3rd Quarter 2016
Eurozone

How does Brexit affect

European business? Interestingly, the stock mar-
At first glance, the main economic and political ef- kets in Germany and France
fects of leaving the European Union should fall on
the United Kingdom, the second-biggest EU econo- dropped more than the UK
my. However, this is only partly true. Interestingly,
the stock markets in Germany and France dropped
market did on the day after
more than the UK market did on the day after the
referendum. To some degree, this is because Brexit
the referendum. To some de-
comes at a very unfavorable time for the European
Union.
gree, this is because Brexit
The European Union has a host of challenges to
comes at a very unfavorable
solve, ranging from migration policy to the stabili-
zation of the Eurozone and pressure from the rise
time for the European Union.
of anti-EU and populist parties. In addition, Brexit
has happened just when the recovery gained some
momentum.

13
Global Economic Outlook

The political challenges for the European Union play out

in two dimensions: the European Unions position in up-
coming UK exit negotiations, and the regions future.

While the immediate effects of Brexit play out in the

financial markets, the effects on the real economy
in the Eurozone will depend on Brexits impact on
consumer and corporate confidence. Forecasts proj-
ect the likely GDP losses in 2017 for the Eurozone
to be 0.3 percentnot enormous, but sizable given
the growth trend of around 1.5 percent. Given that
there are no historical precedents, the effects will
ultimately hinge upon the degree of political and
financial market uncertainty surrounding Brexit in
the coming months.
What kind of divorce?
The political challenges for the European Union
play out in two dimensions: the European Unions
position in upcoming UK exit negotiations, and the
regions future. According to the EU treaties, the
EU-UK negotiations are supposed to be concluded
within two years, starting from the date the United
Kingdom formally gives notice of its wish to leave
the European Union. This period can be extended if
both parties agree.

Figure 1. EU member exports to United Kingdom (2014)

UK exports to EU
(percentage of UK GDP)

Ireland 11.2 12.5

Malta 8.4

Cyprus 7.6

Belgium 7.5

Netherlands 6.7

Luxembourg 5

Spain 3.1

EU27 3.1

Germany 3

Poland 2.9

France 2.2

Italy 1.7

Source: International Monetary Fund, 2016.

Graphic: Deloitte University Press | DUPress.com

14
 3rd Quarter 2016
Eurozone

Given that the negotiations need to disentangle legal agreement to deter secessionist movements in other
relations that have developed over 40 years and set EU countries or set other priorities than Brexit.
up a new trade regime, it is doubtful that two years
On the other hand, from the European Unions per-
of negotiations will be enough. The EU-Canada ne-
spective, a smooth divorce with a liberal trade re-
gotiations over a free trade agreement just entered
gime inevitably requires the free movement of peo-
their seventh year. Some EU countries are likely to
ple. The models under discussion with no or limited
be more affected by a disruption of trade relations.
disruption of trade relations (the United Kingdom
On average, the export volume of EU countries to
as member of the
the United Kingdom
European economic
is around 3 percent
area, or a Swiss-style
of their GDP, but
negotiated access to
this number is 611
percent for countries
From an economic stand- the Single Market)
include open borders
such as the Nether-
lands, Belgium, and
point, both sides are for employees. This

Ireland (figure 1). interested in a mutu- might be hard to ac-

cept for a new British
ally beneficial outcome government that is
Best and committed to real-
and minimal trade re- izing the anti-immi-
worst cases
strictions. However, the gration demands of
the Brexit movement.
In a best-case sce-
nario, the divorce Brexit decision itself is In this sense, a best-
develops smoothly.
Both sides realize evidence that economic case scenario with
minimal trade re-
that erecting trade
barriers will lead
considerations do not strictions faces con-
siderable hurdles on
to a lose-lose situa- necessarily prevail. both sides and is far
tion. From an eco-
from automatic. A
nomic standpoint,
worst-case scenar-
both sides are inter-
io, with disruption
ested in a mutually
of trade relations and major economic damages
beneficial outcome and minimal trade restrictions.
in terms of lower trade volume and foregone eco-
However, the Brexit decision itself is evidence that
nomic growth, is equally possible. The expectations
economic considerations do not necessarily prevail.
of which scenario will prevail is very likely to move
The European Union might be tempted to block
financial markets and investment decisions during
the coming years of negotiations.

15
Global Economic Outlook

A best-case scenario
with minimal trade re-
strictions faces consid-
erable hurdles on both
sides and is far from
automatic. A worst-case
scenario, with disruption
of trade relations and
major economic dam-
ages in terms of lower
trade volume and fore-
gone economic growth,
is equally possible.

16
 3rd Quarter 2016
Eurozone

Figure 2. German managers expectations regarding the consequences of Brexit on the European Union

Which consequences would a Brexit have, in your opinion, for the future of the EU?

High risk of further exits from the EU 66%

Stronger political fragmentation of the EU 42%

Weakening of market-oriented economic policies 40%

Regression of the EU to a pure free-trading zone 39%

Higher willingness of the remaining EU members 12%

to cooperate in order to solve joint problems
Stronger integration of the remaining EU members 9%

I do not expect any signicant consequences 5%

I cannot estimate it 3%

0% 10% 20% 30% 40% 50% 60% 70%

Source: Deloitte Germany, EU referendum: Brexit und die Folgen fr deutsche Unternehmen, June 2016, http://www2.deloitte.com/-
content/dam/Deloitte/de/Documents/nancial-services/Deloitte-Deutschland-BDI-Brexit-2016.pdf.
Graphic: Deloitte University Press | DUPress.com

What kind of future In this sense, Brexit creates a variety of political

risks for the European Union, and an intense dis-
European Union? cussion about its goals and future governance struc-
ture will likely emerge. Quite a few scenarios are
The second (political) factor involves the future of
plausible. They range from deeper integration and
the European Union itself. Given the emergence of
the emergence of a more state-like European Union
populist parties in many European countries, Brexit
to the return to a free-trade area with more politi-
has already led to calls for similar referenda else-
cal powers at the member-state level. As always in
where, as well as to fears that Brexit could be the
uncertain times, more extreme scenarios are also
beginning of a wider disintegration of the European
imaginable.
Union.
From an economic perspective, the crucial factor is
Enterprises also recognize this risk. In a joint survey
how open and market oriented the future European
conducted by Deloitte Germany and the Confedera-
Union will be. Consequently, political decisions are
tion of German Industry shortly before the Brexit
likely to shape the Eurozones economic outlook to
decision, two-thirds of the 215 polled German man-
an unusually high degree.
agers saw the risk of further exits in the aftermath of
Brexit, and many fear political fragmentation of the
European Union. Only a few see Brexit as a catalyst
for deeper integration (figure 2).

17
Global Economic Outlook

UNITED STATES

Businesses take a (hopefully)

temporary breather
By Patricia Buckley

B
USINESS investment contracted in the first
quarter, and employment growth slowed over
the first half. Although it is too soon to walk
away from our previous outlook that 2016 will be
a year of moderate growth, downside risk has defi-
nitely increased.1 This is particularly true in light
of the recent Brexit vote, which may well translate
into slower world growth. The fact that first-quarter
GDP growth was only 1.1 percent (annualized) is not
in itself a big concern. The United States has had
a string of weak first quarters followed by stronger
growth later in the year. For example, first-quarter
2014 GDP growth was -0.9 percent and first-quarter
2015, 0.6 percent, and each of those years achieved
overall growth of 2.4 percent.2 However, the fact
that a contraction in business investment played
such a large role in the low topline number, and that
this was the second contraction in a row, is worri-
some, particularly when considered in combination
with slowing employment growth.3
Figure 1 shows the contributions of the various cat-
egories of GDP to overall growth for the most recent
five quarters.
The contribution from personal consump-
tion was almost the same in the first quarter of
2015 as in the first quarter of 2016, at 1.2 and
1.0 percentage points, respectively. In the later
quarters of 2015, the contribution from personal
consumption was higher on strong employment
growth and some increase in real wages.
The drag from business investment was 0.6 per-
centage points in the first quarter of 2016, fol-
lowing the 0.3-percentage-point subtraction
in the fourth quarter of 2015. This is the first
time that business investment has fallen for two
consecutive quarters since 2009, the year the
recession ended.

The United States has had a string of weak first

quarters followed by stronger growth later
in the year.

18

Residential investment was the one bright spot
in the first quarter of 2016, as its contribution
rose to 0.5 percentage points from the 0.3-per-
centage-point contribution in each of the prior
four quarters.
Private inventory investment declined in the first
quarter, as it did in the preceding three quarters.
The contribution from exports was near zero,
weighted down by a relatively high dollar and
slower global growth.
The slight positive contribution from imports
in the most recent two quarters indicates falling
imports, as the slowdown in business invest-
ment and change in consumers purchasing pat-
19
3rd Quarter
United 2016
States
terns outweighed the high dollar impact (which
makes imports cheaper).
Government spending made a positive contri-
bution to first-quarter GDP, which was more
than accounted for by state and local spending.
Spending at the federal level contracted.
The decline in business investment is even more
notable because it is driven by negative contribu-
tions from two of its components: structures and
equipment. The third component, intellectual prop-
erty (IP), made a positive contribution in the first
quarter of 2016 after making no contribution in the
fourth quarter of 2015. As shown in figure 2, it is not
unusual for any individual component to decline in
a particular quarter, but the last time that two of
Global Economic Outlook

Figure 1. Disaggregation of GDP growth

Percentage point contribution to GDP

2.5

2.0

1.5

1.0

0.5

0.0

-0.5

-1.0

-1.5
Personal Business Residential Change in private Exports Imports Government
consumption investment investment inventories spending

Q1 2015: 0.6% Q4 2015: 1.4%

Q2 2015: 3.9% Q1 2016: 1.1%
Q3 2015: 2.0%

Source: Bureau of Economic Analysis.

Graphic: Deloitte University Press | DUPress.com

Figure 2. Contribution of business investment to GDP growth by type

Percentage point contribution

1.5

1.0

0.5

0.0

-0.5

-1.0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

2013 2014 2015 2016

Structures Equipment Intellectual property Business

products investment
Source: Bureau of Economic Analysis.
Graphic: Deloitte University Press | DUPress.com

20
 3rd Quarter
United 2016
States

the components contracted in the same quarter be-

fore the two most recent quarters was in the second
quarter of 2013.
Although industry details
Looking now at the individual components of busi- are not available for soft-
ness investment, it is clear that the investment de-
cline in structures is concentrated in the mining ware, the major funders of
sector (figure 3). Real dollar investment in mining,
which includes mining exploration, shafts, and wells,
R&D investment are manu-
has fallen 70 percent from its peak investment of
$137.3 billion in the fourth quarter of 2014 to only
facturers, who currently ac-
$41 billion in the first quarter of 2016. Investment in count for 83 percent of all
manufacturing structures registered strong growth
between mid-2014 and mid-2015 before leveling off business R&D spending.
at the same investment dollar amount as power and
communication structures. Investment in commer-
cial and health care structures has continued to rise.

Figure 3. Investment in structures by type

Billions of chained (2009) dollars

160

140

120

100

80

60

40

20

0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

2013 2014 2015 2016

Commercial and health care Manufacturing

Power and communication Mining exploration, shafts, and wells

Source: Bureau of Economic Analysis.

Graphic: Deloitte University Press | DUPress.com

21
Global Economic Outlook

Figure 4. Business equipment investment by type

Billions of chained (2009) dollars, seasonally adjusted at annual rates

350

300

250

200

150
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

2013 2014 2015 2016

Information processing equipment Industrial equipment

Transportation equipment Other equipment

Source: Bureau of Economic Analysis.

Graphic: Deloitte University Press | DUPress.com

Figure 5. Private xed investment in IP products by major type

Billions of chained (2009) dollars, seasonally adjusted at annual rates
350

340

330

320

310

300

290

280

270

260

250
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1

2013 2014 2015 2016

Software Research and development

Source: Bureau of Economic Analysis.

Graphic: Deloitte University Press | DUPress.com

22
 3rd Quarter
United 2016
States

Unlike the decline in structures, the slowdown in

equipment investment is more widespread, but
even in this category, the sharp slowdown in mining
has been a contributor, although it is not possible
to gauge its exact contribution. As shown in figure
4, most of the decline in equipment investment has
been in transportation equipment and the other
category. Although the data are not broken down by
users of transportation equipment, it is reasonable
to assume that some of the decline, particularly in
heavy trucks, is tied to the oil and gas industry. Also,
mining and oilfield machinery make up around 13 Manufacturing em-
percent of the other category. However, the weak-
ness in equipment investment that has been evident ployment has actually
across all categories must be more widespread than
can be accounted for in a sector that currently con-
contracted so far in
tributes only 1.4 percent of value to the economy. 2016, while the rate of
The two primary categories of IP investment are
shown in figure 5. The other, much smaller cat-
employment growth
egory of investment in entertainment, literary, and slowed substantially
artistic originals, with current real annual invest-
ment of around $80 billion, is not shown. With in professional and
both investment in software (own account, custom,
and prepackaged) and research and development
business services,
(R&D), the decline in mining activity has probably construction, and lei-
played a minor role in the change in trend. In both
of these IP categories, investment sentiment seems sure and hospitality.
to have shifted in the second quarter of 2015a year
after the price of oil began its steep slide. Software
investment picked up in the first quarter, even as
investment in R&D has remained flat. Although in-
dustry details are not available for software, the ma-
jor funders of R&D investment are manufacturers,
who currently account for 83 percent of all business
R&D spending. The largest sectors include phar-
maceutical and medicine manufacturers, electronic
and electronic component manufacturers (includ-
ing semiconductors), and motor vehicle and parts
manufacturers.

Concurrent with the decline in business investment,

there has been a slowdown in employment growth.
During the first five months of 2016, total non-
farm employment increased by only 150,000 jobs
per month on average. The comparable number

23
Global Economic Outlook

for 2015 was 229,000 jobs per month. Should this
slowdown persist, the United States would see job
growth of only 1.8 million this yeara substantially
lower increase than the 2.7 million jobs created in
2015. Although unemployment is at a very low 4.7
percent, labor force participation (people working
or looking for work as a percentage of the popula-
tion) and wage growth are also low, making it un-
likely that the job growth rate is slowing because of
lack of potential employees.4
Since peaking in September 2014, mining employ-
ment has fallen by almost 25 percent, and figure 6
shows that the pace of decline has not begun to de-
crease. However, this is not the only sector where
employment conditions have deteriorated. Manu-
facturing employment has actually contracted so
far in 2016, while the rate of employment growth
slowed substantially in professional and business
services, construction, and leisure and hospitality.
Most of the currently available economic data are
pointing to a substantially stronger second-quarter
GDP growth rate, so the low employment increases
seen so far in 2016 might just be a temporary pause.
However, unless business investment, particularly
in equipment and IP, picks up, longer-term growth
might be at risk. These are the investments that cre-
ate and incorporate innovation into production pro-
cesses, which in turn drive productivity increases,
and productivity growth has been sadly disappoint-
ing so far in this recovery.

Figure 6. Average monthly employment growth by sector

Thousands

60
50
40
30
20
10
0
-10
-20
g

erv nd
l

ies

are

ita nd

nt
tai
nin

rin
tio

lity

me
ice
ss la

ho ure a
vit
Re

hc
uc

ctu
Mi

es na
cti

rn
alt
str

sp
ufa

sin sio
la

ve
is
He
n

Le

Go
cia
Co

bu ofes
Ma

an

Pr
Fin

2015 2016
Source: Bureau of Labor Statistics.
Graphic: Deloitte University Press | DUPress.com

24
 3rd Quarter
United 2016
States

Endnotes
1. Patricia Buckley, United States: Moderate growth to continue, but when will wages begin rising? Global Economic Outlook, Q2 2016, Deloitte
University Press, April 29, 2016, http://dupress.com/articles/global-economic-outlook-q2-2016-united-states/.

2. There is a strong likelihood that there are technical issues with the seasonal adjustment to the data underlying the first-quarter GDP
estimates. For example, researchers at the Federal Reserve Bank of San Francisco applied a second round of seasonal adjustment to the
published real GDP data and found that first-quarter GDP has been underestimated since the late 1990s, and that the underestimation
has risen in recent years to about 1.5 percentage points. For details, see Glenn D. Rudebusch, Daniel Wilson, and Tim Mahedy, The
puzzle of weak first-quarter GDP growth, Federal Reserve Bank of San Francisco, May 18, 2015, http://www.frbsf.org/economic-research/
publications/economic-letter/2015/may/weak-first-quarter-gdp-residual-seasonality-adjustment/.

3. Unless otherwise noted, the data in this chapter are from the Bureau of Economic Analysiss National Income and Product Accounts.

4. Bureau of Labor Statistics.

25
Global Economic Outlook

CHINA

The deceleration continues

By Ira Kalish

T
HE latest data indicate that the Chinese econ- other low-wage emerging markets. Meanwhile, the
omy continues to decelerate.1 Data on Chinese Chinese central bank continues to sell foreign cur-
trade indicate continued weakness in exports rency reserves in order to stabilize the currency and
but a slower pace of decline for imports. First, dol- prevent a sharper depreciation.
lar-denominated ex-
Imports, which have
ports fell 4.1 percent in
been consistently fall-
May versus a year ear-
lier, sharper than the
Part of the problem ing for some time, fell
only 0.4 percent in May
1.8 percent drop in the for China, however, versus a year earlier.
previous month. This
reflected weak demand is that, although its This was a far smaller
decline than the 10.9
in both Europe and the
United States. In local
currency has fallen percent drop in April.
There were some special
currency terms, exports in value, it has fallen circumstances, how-
were actually up slightly.
The difference between far less than that of ever. First, the rise in
commodity prices has
dollar- and renminbi-
denominated exports
other emerging coun- boosted the import bill.
Second, imports from
reflects the deprecia- tries. Thus Chinas Hong Kong increased
tion of the renminbi
over the past year. Part exports have lost 242.6 percent from a
year earlier, possibly
of the problem for Chi-
na, however, is that, al- competitiveness ver- meaning that investors
engaged in fake invoic-
though its currency has
fallen in value, it has
sus other countries. ing in order to move
funds out of the country.
fallen far less than that
Specifically, importers
of other emerging coun-
can invoice amounts far
tries. Thus Chinas exports have lost competitive-
larger than the actual cost of the imported goods.
ness versus other countries. Indeed some manufac-
This makes it appear that imports were much
turing capacity has departed from China, heading to

26
 3rd Quarter 2016
China

27
Global Economic Outlook
greater than was actually the case. Yet it enables the
importer to send money out of the country without
appearing to violate the governments controls on
capital movements. Thus underlying imports were
likely quite weak, probably reflecting weak domes-
tic demand. Moreover, many Chinese exports rely
on imported inputs. Weakening exports have the ef-
fect of weakening imports as well.
Fixed asset investment in China was up 9.6 percent
in the first five months of 2016 compared with a
year earlier. This was the slowest rate of investment
growth in 16 years. Interestingly, private sector in-
vestment was up only 3.9 percent, while investment
by state-owned enterprises (SOEs) was up 23.3 per-
cent. The latter figure might be of concern, given
that there is considerable excess capacity in the
state-run sector, producer prices for SOEs are de-
clining, and SOEs are disproportionately laden with
debt. The significant slowdown in private sector in-
vestment might also be alarming, and could bode
poorly for growth. Finally, investment in real estate
was up 6.6 percent from a year earlier, a consider-
able slowdown from before. Excessive investment in
property has been one of the hallmarks of Chinas
economy lately. Thus slower growth of property in-
vestment is surely welcome. The challenge for China
will be to shift away from investment-led growth
and toward consumer-led growth. In addition, it
would be helpful if investment by the private sector
increases as a share of the total. This is clearly not
happening now.
Chinese industrial production increased 6.0 per-
cent in May versus a year earlier. This was in line
with growth over the past year. Manufacturing out-
put was up 7.2 percent, while that of electricity, gas,
and water was up only 2.4 percent. Mining output
declined 2.3 percent. The weak growth of electric-
ity output will be seen by some as a proxy for the
state of the overall economy. In addition, output
of cement and steel rose modestly, and that of coal
dropped sharply. Meanwhile, Chinese retail sales
were up 10.0 percent in May versus a year earlier.
This was the slowest rate of expansion in quite some
time. All of these data suggest an economy that con-
tinues to decelerate.
28
Consumer price inflation in China decelerated in
May. Prices were up 2.0 percent from a year ear-
lier, less than the 2.3 percent inflation recorded in
April. The central banks target rate of inflation is
3.0 percent. The weakening of inflation, despite a
modest depreciation of the currency in the past year,
suggests weakness of domestic demand. As such, it
may presage further efforts by the government to
stimulate the economy, either through monetary or
fiscal policy. Meanwhile, the producer price index
fell 2.8 percent in May versus a year earlier. This is
less than the 3.4 percent decline in April. Producer
prices have been consistently falling for a long time,
driven by excess capacity. The fact that producer
price deflation has abated may have to do with the
recent rise in commodity prices. Still, as producer
prices continue to fall, it will exacerbate the diffi-
culties some companies may face in servicing their
large debts.
In May, foreign direct investment (FDI) into China
was down 1.0 percent from a year earlier. For the
first five months of 2016, FDI was up 3.8 percent
from the same period a year earlier. In that five-
month period, investment in manufacturing was
down 3.2 percent, while investment in service in-
dustries was up 7.0 percent. Investment in services
accounted for 70 percent of the total.
Debating debt
The International Monetary Fund (IMF) has entered
into the debate about Chinas growing debt. The
deputy managing director of the IMF, David Lipton,
said that corporate debt remains a seriousand
growingproblem that must be addressed imme-
diately and with a commitment to serious reforms.
He pointed out that corporate debt is now about 145
percent of GDP, which is very high by any mea-
sure. He warned that, if unchecked, the expansion
of debt could lead to a financial crisis, low economic
growth, or both. He also said that the measures
taken so far by Chinese authorities are inadequate.
These include securitization of debt as well as debt-
for-equity swaps. The problem with such measures
is that they dont address the underlying problem
 3rd Quarter 2016
China

China appears to face the risk of something akin to

what happened in Japan in the 1990s, when banks
rolled over bad loans to poorly performing compa-
nies. The result was a plethora of poorly performing
companies being propped up by troubled banks.

of poor performance of the debtor companies, espe-
cially SOEs. Lipton noted that, while SOEs account
for about 22 percent of economic output, they ac-
count for about 55 percent of corporate debt in Chi-
na. Many of them are essentially on life support.2
Critics of Chinas policies say that such enterprises
must be reformed or shut down. Debt-for-equity
swaps simply allow banks to own shares in these
companies. Such measures do little to improve the
performance of these companies. Banks are left
with little incentive to force these companies to
fail. Critics also say that it would make more sense
for the Chinese authorities to simply allow banks
to let companies default, and then establish a ve-
hicle to clean up bank balance sheets. Such a policy
would lead to the bankruptcy and possible closure
of some unprofitable and highly inefficient compa-
nies. While this might be painful in the short run,
it would boost long-term productivity and enable
the economy to restructure away from loss-making
businesses.
Interestingly, the deputy governor of Chinas cen-
tral bank, Zhang Tao, says, Any industry that lacks
the mechanism to elevate winners and eliminate
losers cant develop in a healthy and sustainable
way. This suggests a willingness to let failing com-
panies failalthough this has not yet happened.
He also addressed the issue of banks that hold bad
debts, saying We will permit financial institutions
to go bankrupt in an orderly way, restructure those
that need restructuring, shut those that need to be
shut, and strengthen market discipline.3 Mean-
while, debt continues to expand. Lipton noted that
in a setting of slower economic growth, the combi-
nation of declining earnings and rising indebted-
ness is undermining the ability of companies to pay
suppliers or service their debts. Banks are holding
more and more nonperforming loans, and the past
years credit boom is just extending the problem.4
Some observers have raised the specter of a crisis
for China in which a large financial institution fails
due to excessive bad assets. Yet this seems unlikely.
Rather, China appears to face the risk of something
akin to what happened in Japan in the 1990s, when
banks rolled over bad loans to poorly performing
companies. The result was a plethora of poorly per-
forming companies being propped up by troubled
banks. This led to limited credit creation, no eco-
nomic growth, excess capacity, and deflation.

Endnotes
1. National Bureau of Statistics of China, Homepage, http://www.stats.gov.cn/english/, accessed June 29, 2016.

2. Shawn Donnan and Tom Mitchell, IMF sounds warning on Chinas corporate debt, Financial Times, http://www.ft.com/cms/s/0/3f8dcf22-
304c-11e6-bda0-04585c31b153.html#axzz4ChmrxqxF.

3. Ibid.

4. Ibid.

29
Global Economic Outlook

JAPAN

Will households oblige

by spending more?
By Akrur Barua

O Economic growth
VER the past decade, there is an increas-
ing sense among Japans policymakers that
growth must be stimulated and deflation picked up in Q1
countered. Arguably, the most spectacular of these
The economy grew at a seasonally adjusted annual
measures has been aggressive monetary easing, es-
rate (SAAR) of 1.9 percent in Q1, reversing from a
pecially the use of negative interest rates this year.1
1.8 percent decline in Q4 2015 (figure 1). This was
The verdict on some of these policies is mixed from
the second estimate for Q1, up from the 1.7 percent
a broad macroeconomic perspective. However, vari-
rise quoted in the first estimate. Private consump-
ous components of the economy might throw pleas-
tion (2.6 percent) was a
ant surprises. Private
key growth driver in Q1,
consumption, which
with households spend-
holds the key to growth
at a time of slowing ex- Its likely that the im- ing more, especially
on durable goods and
ports, is one such exam-
ple. While consumers pact of aggressive services. Investments
continued to disappoint,
obliged by increasing
spending in Q1, they
monetary easing on with both private resi-

face strong headwinds the Japanese yen dential and nonresiden-

tial investments declin-
in the medium to long
term from an aging and has run its course. ing during the quarter.
A deeper look at busi-
declining workforce. So
ness investment reveals
how can Japans poli-
that spending on build-
cymakers create incen-
ings and structures as
tives for consumers to spend? The Bank of Japan
well on machinery and equipment has been weak
(BOJ) actually may already be doing that, not just
for the past year. This is not an encouraging sign
by lowering borrowing costs but also by reducing
for an economy eager to ramp up productivity in
the governments debt burden.
the face of disadvantageous demographics. Exports

30
 3rd QuarterJapan
2016

Figure 1. GDP growth picked up in Q1, led by private consumption

Percentage, SAAR
30

25

20

15

10

-5

-10

-15

-20
Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 Q1-16

GDP Private consumption

Government consumption Gross xed capital formation
Exports

Source: Haver Analytics, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

31
Global Economic Outlook

Figure 2. In the last few years, employee compensation has slowed

Percentage, year over year

10

-2

-4

-6

Q1-81 Q1-86 Q1-91 Q1-96 Q1-01 Q1-06 Q1-11 Q1-16

Nominal Real
Source: Haver Analytics, Deloitte Services LP economic analysis.
Graphic: Deloitte University Press | DUPress.com

provided much-needed succor to the economy in Q1,
expanding 2.4 percent. However, the pace is lower
than what Japans policymakers would want. Its
likely that the impact of aggressive monetary easing
on the Japanese yen has run its course.
A key concern for
private consumption
is demographics
Analysis of national accounts data reveals that
while compensation of employeesboth nominal
and realhas gone up in the past year (figure 2),
the share of household spending in GDP has con-
tinued to decline (figure 3). This seems surprising,
given a strong labor marketunemployment is at a
two-decade lowand real income gains due to low
inflation. Japans low inflation, however, is due to
deflationary pressures. So instead of spending more,
consumers have held back, waiting for prices to
stabilize. Moreover, as economic growth fluctuates,
households appear pessimistic, with consumer con-
fidence still in negative territory.2
Private consumption faces a deeper problem: de-
teriorating demographics. In the last 10 years, Ja-
pans population has fallen 0.6 percent, and its la-
bor force, 0.7 percent (down 2.7 percent since 1996).
This means that the number of earning individuals
has declined. The burden of supporting welfare now
rests on a shrinking workforce. Japan is also aging
fast, which is evident in the composition of its labor

32

Figure 3. Household consumption's share in the economy has gone down since Q1 2014
61
59
57
55
53
51
Q1-81 Q1-86 Q1-91 Q1-96
Share in GDP (nominal, left axis, percentage)
Growth (real, right axis, percentage)
Source: Haver Analytics, Deloitte Services LP economic analysis.
force (figure 4). So a rising share of the labor force
has to focus more on savings for retirement than on
current spending. (See the sidebar Interview with
Nobuhiro Hemmi for more insights on this.)
Will the BOJs asset purchase
program aid consumers?
The BOJ, through its quantitative easing (QE) pro-
gram, has eased the governments debt burden
about 240 percent of GDPby reducing the share of
publicly held debt.3 For example, between January
2013 and May 2016, the BOJs holdings of govern-
ment debt shot up 212.3 percent, while government
debt increased just 12.1 percent. Consequently, the
BOJs share in total government debt has increased
33
3rd QuarterJapan
2016
10
8
6
4
0
-2
-4
-6
Q1-01 Q1-06 Q1-11 Q1-16
Graphic: Deloitte University Press | DUPress.com
at the expense of others (figure 5). How does this
help as total debt has not gone down? The BOJ
now can easily convert this debt to perpetual-zero
coupon bonds or, in the worst case, wipe it off its
own balance sheet. Will this not increase risks and
push yields up? Not really, because the level of pub-
licly held debt has gone down due to the BOJs ris-
ing share and hence has become more manageable.
Moreover, the BOJs ultra-loose monetary policy
and global financial volatility have driven borrow-
ing costs to extremely low levels (figure 6).4 Inter-
estingly, the government has more leeway now to
introduce fiscal stimulus without spooking markets
about rising debt.
The BOJs QE program aids consumers by mak-
ing publicly held debt more manageable, allowing
Global Economic Outlook

Figure 4. The labor force and, within it, the share of relatively young people are declining
Millions, seasonally adjusted Percentage

70 63

68 61

59
66

57
64
55
62
53

60
51

58 49

56 47
Jan-81 Jan-86 Jan-91 Jan-96 Jan-01 Jan-06 Jan-11 Jan-16

Size of the labor force (left axis)

Share of the age group 1544 years in the labor force (right axis)

Source: Haver Analytics, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

Figure 5. BOJ is transferring a large share of government debt to its balance sheet

1,100 35

1,050 30

1,000
25
950
20
900
15
850
10
800

750 5

700 0
Q1-06 Q1-08 Q1-10 Q1-12 Q1-14 Q1-16

Central government debt (JPY trillion, left axis)

Share of BOJs holdings in central government debt (percentage, right axis)

Source: Haver Analytics, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

34

Figure 6. 10-year government bond yields are now negative
Percentage
2.0
1.5
1.0
0.5
0.0
-0.5
Jan-06 Jan-08 Jan-10
Overnight call rate (uncollateralized)
Source: Haver Analytics, Deloitte Services LP economic analysis.
the government more time to service that debt, in
turn allowing consumers some breathing space. For
example, it is possible that the second part of the
two-part sales tax (first introduced in 2014) may be
pushed beyond the revised date of 2017. Also, with
a declining and aging population, the government
may be hoping to partially shelter its working popu-
lationthose who pay taxes and contribute to social
welfarefrom the burden of rising debt. In addi-
tion, the BOJs move could help in the fight against
deflation. This argument probably runs counter to
35
3rd QuarterJapan
2016
Jan-12 Jan-14 Jan-16
10-year government bond yield
Graphic: Deloitte University Press | DUPress.com
examples in Venezuela, Argentina, and Zimbabwe,
where monetizing the governments debt has led to
hyperinflation. Japan, however, need not to worry
about that. Increasing consumption through reduc-
ing the debt burden might just help ease excess ca-
pacity in the country, thereby reducing deflationary
pressures, which, in turn, might benefit Japanese
companies who are likely to face increasing head-
winds from slowing global growth. The BOJ and the
government must be hoping the plan works, bring-
ing much-needed respite for the economy.
Global Economic Outlook

INTERVIEW WITH NOBUHIRO HEMMI

To understand more about recent policies and challenges ahead, I spoke with
Nobuhiro Hemmi, partner and head of Global Business Intelligence at Deloitte
Tohmatsu Consulting, Japan, and a member of the Deloitte Global Economist Council.

Akrur Barua (AB): The BOJ decided to keep rates on hold. Is it because BOJ thinks that
monetary policy is not effective anymore? Or is it because the external environment is
challenging, and the BOJ wants to wait and watch?

Nobuhiro Hemmi (NH): Both, I think. Officially, they seem to have announced a wait and
watch policy as is evident from the BOJ governors interview.5 However, they introduced
negative interest rates, which is not traditional monetary policy. This sort of contradiction
reflects the new challenges that the BOJ faces.

AB: We have seen fiscal stimulus and strong monetary easing. The initial results were good, but
they appear to be faltering now. When is the third arrow of Abenomics coming? What are the
challenges? Which reforms do you think they should target?

NH: The market appears to have overestimated the impact of the third arrow, which has been
the fundamental issue for Japan in the last two decades. So far, discussions around the third
arrow have focused on growth strategies and easing regulations. However, the key issue is how
to tackle the decrease in working population.

AB: The yens rise is opposite to what Japanese policymakers would want. How are exporters
coping? Where do they see additional demand coming from? And which economies do they
think will be the big markets over the next 510 years?

NH: Overall, from a macroeconomic point of view, the yens rise seems opposite to what
policymakers would want. However, the impact (and implication) depends on industries and
companies within these industries. Some companies have already shifted their operations
outside of Japan, and others have hedged currency risk in the short term. Asia will still be
a strong market for Japanese companies in the next 510 years. But there will be market
segmentation, with a shift to a city-based approach from a country-based one.

AB: To stimulate domestic demand, Japanese corporates should invest more. Why have
investments not picked up?

NH: If domestic demand is not positive in the near future, it will make sense for Japanese
companies to be more conservative.

AB: With an aging society, what changes do you see in the next 510 years that will prop up
domestic demand? More immigration or higher wages? Or longer working tenures?

NH: More than immigration, womens participation in the labor market is an important issue for
Japan. If policymakers cannot successfully implement a womenomics policy, they will introduce
a further extension of the retirement age. Wages and tenures are not the key issues right now.

36
 3rd QuarterJapan
2016

Endnotes
1. Akrur Barua and Rumki Majumdar, Impact of negative interest rates: Living in the unknown, Global Economic Outlook, Q2 2016, Deloitte
University Press, April 29, 2016, http://dupress.com/articles/impact-of-negative-interest-rates-controlling-inflation/.

2. Haver Analytics, June 2016.

3. Enda Curran and James Mayger, Japans debt burden is quietly falling the most in the world, Bloomberg, June 1, 2016, http://www.bloom-
berg.com/news/articles/2016-06-01/japan-s-debt-burden-is-quietly-falling-by-the-most-in-the-world; Kevin Buckland and Shigeki Nozawa,
BOJ owning more debt than Japan banks is slow death for the markets, Bloomberg, December 17, 2015, http://www.bloomberg.com/news/
articles/2015-12-17/boj-owning-more-debt-than-japan-banks-is-slow-death-for-market.

4. Haver Analytics, June 2016.

5. Leika Kihara and Stanley White, BOJ holds off on easing despite weak inflation, sparks yen spike, Reuters, June 16, 2016, http://www.
reuters.com/article/us-japan-economy-boj-idUSKCN0Z12SN; BOJ to wait a few months to see effect of stimulus: Kuroda, Reuters, May 11,
2016, http://www.reuters.com/article/us-boj-policy-kuroda-idUSKCN0Y21YA.

37
Global Economic Outlook

BRAZIL

A glimmer of hope
By Akrur Barua

B The economy contracted

RAZIL will soon host the Summer Olympics.
When Brazil won the race to host two ma-
jor eventsthe 2014 Soccer World Cup and yet again in Q1
the 2016 Olympicsit was a proud moment for a
There was not much respite for the economy in Q1
country that was emerging as a strong contender on
as real GDP contracted 0.3 percent quarter over
the global stage. However, much water has flowed
quarter. This was, however, an improvement from
down the Amazon since then. The economy is in bad
the 1.3 percent decline in Q4 2015. Domestic de-
shape. Political acrimony is high. Indeed, doubts
mand faltered yet again, with gross fixed capital for-
have also emerged about Olympic host city Rio de
mation (-2.7 percent) and private consumption (-1.7
Janeiros ability to
percent) contracting
complete facilities
in Q1. Even though
on time.1
government con-
Things seem to be
improving though.
The new government sumption expanded
1.1 percent, any sup-
The new government appears determined to port to the economy
appears determined
to restore fiscal restore fiscal health and from the fiscal side
will be temporary,
health and reform
the economy. Mar-
reform the economy. given the dire need
to get government fi-
kets have responded nances back on track.
positively. There is
good news for the The big standout for
Olympics, too. The World Health Organization has the quarter was exports, which expanded 6.5 per-
given its consent to the games despite the Zika virus cent (figure 1). Exports are benefitting from a rise in
threat.2 And the federal government has stepped competitiveness due to a weak realboth nominal
in with financial support for Rio de Janeiro.3 As in and trade weighted.4 With imports declining in Q1,
the Olympics, however, victoryin this case for the net exports contributed positively to GDP growth,
economyhinges on continuing the momentum of thereby providing much-needed relief to the econ-
economic reforms, if not increasing it. omy.

38
 3rd QuarterBrazil
2016

Figure 1. Exports were a rare bright spot for the economy in Q1

Percentage, quarter over quarter

12

-3

-6

-12

Q1-14 Q2-14 Q3-14 Q4-14 Q1-15 Q2-15 Q3-15 Q4-15 Q1-16

GDP Private consumption

Government consumption Gross xed capital formation
Exports
Source: Haver Analytics, Deloitte Services LP economic analysis.
Graphic: Deloitte University Press | DUPress.com

39
Global Economic Outlook

The new government The governments first step has been to improve
transparency in fiscal management. In May, law-
means businesses makers approved a primary deficit of 170.5 billion
Brazilian reals (2.8 percent of GDP) instead of a sur-
The new government has its work cut out. GDP con-
plus as projected in the initial budget. Without this
tracted for the fifth straight quarter and for the sev-
approval, the government would have ground to a
enth time in eight quarters. The fiscal deficit is in
halt. Clarity on budget figures is also likely to boost
double digits. Inflation is way above Banco Central
credibility among rating agencies and investors.
do Brasils (BCBs) 2.56.5 percent target. Worse,
confidence in politicians is at an all-time low.5 In its efforts to cap spending, the government in-
tends to amend the constitution to index budget
Thankfully, President Michel Temer appears to have
spending to inflation for the next 20 years.6 If rev-
started on the right note by putting in place a cred-
enues go up due to any economic recovery, the ex-
ible economic team. The finance minister, Henrique
cess amount will be used solely to narrow the deficit.
Meirelles, headed BCB during 200311 and was at
Interestingly, curbs on spending will extend to two
the forefront of the fight against inflation in the last
key sectorseducation and healththat have often
decade. Ilan Goldfajn, the new BCB governor, has
remained outside the ambit of budget cuts. The gov-
reiterated his commitment to tackle inflation. Most
ernment has also asked the public sector develop-
importantly, both of them agree on the need to im-
ment bank BNDES to repay its treasury debt.7
prove the governments finances.

Figure 2. The real is recovering this year

5.0

4.5

4.0

3.5

3.0

2.5
Jan 15 May 15 Sep 15 Jan 16 May 16

USD/BRL EUR/BRL

Source: Haver Analytics, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

40
 3rd QuarterBrazil
2016

Figure 3. 10-year government bond yields have retreated from their highs
Percentage Basis points

18 600

17

16 500

15

14 400

13

12 300

11

10 200
Jan 15 May 15 Sep 15 Jan 16 May 16

10-year government bond yields (left axis)

Brazil 10-year USD credit default swaps (right axis)

Source: Haver Analytics, Bloomberg, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

The new administration has also talked about pen-

sion reforms, a key component of government
spending. According to the Wall Street Journal,
about 41 percent of Brazils federal budget spending
is directed toward pensions; the comparative figure
for the United States is 24 percent.8 Temers team
has started consultations with labor unions in a bid
to prepare a proposal for pension reforms soon.9
The government is also mulling other reforms such
as scrapping the sovereign wealth fund, greater par-
ticipation of private companies in the oil and gas
sector, increased privatization, more infrastructure
concessions to the private sector, and tax reforms.10
If carried out, these measures will likely help Brazil
gain competitiveness in the medium to long term.
The markets are loving
itfor the moment
Markets seem to approve of the changes. Equities,
for example, have bounced back this year, although
much of the change was priced in earlier. The
Ibovespa stock index is up 17.3 percent this year,
while the financial indexa key forward indicator
of macroeconomic movementsis up 24.4 per-
cent. Given Brazils relatively open capital markets,
rebounding equities will help stem capital flows.
Confidence will be further strengthened if the gov-
ernment passes key reforms. The real has already
benefitted (figure 2) and is one of the strongest
emerging-market currencies this year. This, in turn,

41
Global Economic Outlook

Figure 4. Governments borrowing requirements and interest payments have fallen

Percentage (share of GDP)
12

10

0
Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16

Interest payments Nominal decit

Source: Haver Analytics, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

has helped curb imported inflation; import prices of

Falling bond yields and both consumer goods have been contracting (year
over year) since last year.11

a return of confidence Arguably, the best news is the decline in long-term

interest rates. Yields for 10-year government bonds
have mitigated the have fallen about 3.7 percentage points so far in

threat of fiscal domi- 2016 (figure 3). This will bring down the cost of
servicing government debt. If this trend of falling

nance to a large extent. yields persists, the BCB will find it easier to cut rates
when inflationary pressures retreat.

42
 3rd QuarterBrazil
2016

Figure 5. It will be some time before BCB eases monetary policy

Percentage

15

12

0
Jan 14 Apr 14 Jul 14 Oct 14 Jan 15 Apr 15 Jul 15 Oct 15 Jan 16 Apr 16

SELIC (policy rate) Ination

Source: Haver Analytics, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

The threat of fiscal Despite these improvements, restoring confidence

in monetary policy will not be easyat least, not un-
dominance abates further til inflation falls back to the target range of 2.56.5
percent (figure 5). Without that, BCB will not be
Falling bond yields and a return of confidence have
able to cut the policy rate, which, at 14.25 percent,
mitigated the threat of fiscal dominance to a large
is the highest among prominent emerging econo-
extent. The governments borrowing requirement
mies. In June, BCB kept its policy rate unchanged
is now at about 10.1 percent of GDP, while inter-
yet again, waiting for more improvements on the
est payments amount to 7.8 percent, lower than at
fiscal front. In a sign that market participants are
the beginning of the year (figure 4).12 Inflation has
still unsure about price pressures, inflation expecta-
eased partially to 9.3 percent in May from 10.7 per-
tions for the next 12 months have gone down by just
cent in January. It is likely that the lagged impact
one percentage point this year.13
of monetary policy and the base effect have come
into play.

43
Global Economic Outlook

The way forward

wont be easy
The key hurdle for Brazils economy is political un-
certainty. Trouble has already started for the new
governmentalthough it is a temporary one, at least
until former president Dilma Rousseffs impeach-
ment process is completed. Three ministers have re-
signed so far.14 Also, while the proposed reforms are
encouraging, the passage of these reforms faces dif-
ferent hurdles. Pension reforms, for example, will
face opposition from labor unions, especially those
aligned with the previous government. Unions re-
sent the proposal to raise the retirement age and
want to make any changes to pensions applicable to
just new job market entrants.15 Other reforms, such
as the one on inflation-indexed budget spending,
will have to be passed in the legislature with a two-
thirds majority. For now though, the government
appears to have the numbers.16

External problems also abound. Brexit will weigh

on global markets, and emerging economies such
as Brazil will be no exception to this volatility. That
could, in turn, put pressure on Brazils currency
and push bond yields up. A global shock could also
dent exports, a key source of sustenance for Brazils
economy of late. And while markets have given the
benefit of doubt to the new administration, they can
be unforgiving if the administration fails to deliver
on reforms. Latin American economies, including
Brazil, have learnt this the hard way. The govern-
ment will do well to keep that in mind.

44
 3rd QuarterBrazil
2016

Endnotes
1. Andrew Downie, Venues ready, but many challenges remain for Rio Games, Reuters, April 27, 2016, http://www.reuters.com/article/
us-olympics-rio-100days-idUSKCN0XN2CP.

2. BBC, Zika crisis: WHO rejects move Rio Olympics call, May 28, 2016, http://www.bbc.com/news/world-latin-america-36401150.

3. Marcela Ayres and Lisandra Paraguassu, Brazil agrees to $15 billion in state debt relief through 2018, Reuters, June 20, 2016, http://www.
reuters.com/article/us-brazil-politics-idUSKCN0Z7053.

4. Akrur Barua, Brazil: Yearning for the good times, Global Economic Outlook, Q2 2016, Deloitte University Press, April 29, 2016, http://dupress.
com/articles/global-economic-outlook-q2-2016-brazil/.

5. Joe Leahy and Samantha Pearson, Brazil: Tales of everyday agony, Financial Times, May 15, 2016, http://www.ft.com/cms/s/0/1c067b52-
1829-11e6-bb7d-ee563a5a1cc1.html#axzz4CIp0blBO.

6. Alonso Soto, Brazil mulls time limit on spending ceiling: Sources, Reuters, June 14, 2016, http://www.reuters.com/article/
us-brazil-economy-spending-idUSKCN0Z02Q9.

7. Brazil court to assess legality of BNDESs Treasury loan repayment, Reuters, June 1, 2016, http://www.reuters.com/article/
brazil-budget-accounts-idUSL1N18T26M.

8. Paulo Trevisani, Brazils acting president Michel Temer vows to tackle insolvent pension system, Wall Street Journal, May 24, 2016, http://
www.wsj.com/articles/brazils-acting-president-michel-temer-vows-to-tackle-insolvent-pension-system-1464132981.

9. Lisandra Paraguassu and Alonso Soto, Brazils Temer wants proposal for pension reform within 30 days, Reuters, May 16, 2016, http://
www.reuters.com/article/us-brazil-politics-idUSKCN0Y72CG.

10. Anthony Boadle and Lisandra Paraguassu, Brazil recovery on track despite political turmoil: Top Temer aide, Reuters, June 2, 2016, http://
www.reuters.com/article/us-brazil-politics-padilha-idUSKCN0YO23F.

11. Haver Analytics, June 2016.

12. Ibid.

13. Ibid.

14. BBC, Brazil tourism minister resigns over graft scandal, June 16, 2016, http://www.bbc.com/news/world-latin-america-36556214.

15. Trevisani, Brazils acting president Michel Temer vows to tackle insolvent pension system; Paraguassu and Soto, Brazils Temer wants
proposal for pension reform within 30 days.

16. Anna Edgerton and Mario Sergio Lima, Temer proposes spending cap in effort to fix Brazils budget, Bloomberg, June 15, 2016, http://www.
bloomberg.com/news/articles/2016-06-15/temer-proposes-spending-cap-in-attempt-to-fix-brazil-budget.

45
Global Economic Outlook

MEXICO

Embracing the advantage

of its northern neighbor
By Danny Bachman

T
HAT the Mexican economy is very closely tied neighbor. There are some signs that this strategy
to its northern neighbor is not news. Lately, may be starting to pay off.
this not-news has been both good and bad:
bad because disappointing growth in the United
States has translated into disappointing growth in Follow the leader
Mexico; good because Mexico still has an advantage
The close connection between the two most popu-
over other emerging economies. Similar economies
lous North American economies can be seen starkly
that are more closely tied to Europe have had to
in figure 1. Although the common business cycle
cope with European stagnation, and many other
originates in the United States, Mexican GDP is
r e so u r c e - d e pe n d en t
more volatile than US
economiesincluding
GDP. It fell more dur-
other countries in Latin
ing the two US reces-
Americahave felt the
recent Chinese slow-
Since the 1990s, sions since 1995 and

down. In contrast, the
United States has re-
mained a relatively sta-
ble source of economic
growth for Mexico.
Mexico has traded grew faster during the
post 200809 recovery.
that cycle for coor- This reflects Mexicos
integration with the
dination with the US manufacturing sec-

US business cycle.
Before the 1990s, Mex-
ico attempted to keep
its distance from its
neighbor. That was per-
haps understandable given the past history of the
two countries. But the attempt to go it alone in
economic growth yielded little beyond some finan-
cial crises and an infamous political business cycle.
Since the resolution of the 1980s debt crisis, Mexi-
co has instead embraced the advantages of its large
tor, which itself is more
cyclical than the rest of
the US economy.
The common cycle is
new. Before the 1990s, the government ramped up
spending in the year before each election, and the
new president (Mexican presidents serve only one
term of six years) then would spend two or three
years tamping down spending and trying to get the
budget under control. This resulted in a six-year

46
 3rd Quarter 2016
Mexico

boom-bust cycle patterned after the presidential

term, which was completely unconnected to busi-
ness cycles in the United States.1 Since the 1990s,
Vietnam and Indianeither
Mexico has traded that cycle for coordination with
the US business cycle.
of which has the geographical
This makes it seem like Mexicos relationship with advantage of Mexicohave
the United States is a choice. In reality, it is a fact of
geography that postWorld War II Mexican policy-
seen growth take off (not to
makers attempted to ignore for several decades. But
Mexicans have finally realized that their fatelike
even mention China). What is
that of the other North American Free Trade Agree- the secret sauce that allowed
ment (NAFTA) partner, Canadais closely connect-
ed to that of the United States. those countrieswith surely
just as many fundamental is-
Taking medicine
This eventually resulted in Mexicos adopting a take
sues as Mexicoto reach
your medicine approach to economic policymaking. such high rates of
Even before the 1994 peso crash (and the US-orga-
nized rescue), Mexico had taken a number of steps growth?
to move away from its earlier attempt to decouple

47
Global Economic Outlook

Figure 1. Mexican and US GDP growth

Year-over-year percentage change

10.0

7.5

5.0

2.5

-2.5

-5.0

-7.5

-10.0
98 00 02 04 06 08 10 12 14

Mexico United States

Source: IMF/Haver Analytics.
Graphic: Deloitte University Press | DUPress.com

Mexicos flexible exchange rate helped to miti-

gate the impact of the US financial crisis and re-
cession. As economists predicted, some of the
impact of lower demand in the United States
was absorbed by improved Mexican competi-
tiveness as the exchange rate depreciated.

48
 3rd Quarter 2016
Mexico

Figure 2. Growth in selected emerging markets

20-year average per capita GDP growth rate

10

0
Brazil South Africa Mexico Argentina Indonesia India Vietnam China

Source: IMF/Haver Analytics.

Graphic: Deloitte University Press | DUPress.com

from the global economy (and the United States). allowed those countrieswith surely just as many
After the passage of NAFTA, Mexican authorities fundamental issues as Mexicoto reach such high
generally attempted to follow the Washington Con- rates of growth? The answer is not clear.
sensus, although domestic political opposition has
Despite such concerns, Mexican policymakers
slowed reform. This approach stressed liberalizing
continue to believe that market-friendly structural
financial and product markets, making labor mar-
changes are the key to long-term prosperity. In 2012,
kets more flexible, and adopting floating exchange
Mexicos political leaders doubled down. The main
rates. As part of the approach, Mexican authorities
political parties agreed on an ambitious framework
considered the countrys proximity to the United
for modernizing the Mexican economy (the Pacto
States as an opportunity rather than a curse. They
de Mxico), and Congress has indeed passed a num-
began pushing back against the entrenched inter-
ber of broad reforms in areas such as education and
ests that preferred an isolated, less dynamic coun-
telecom.3
try that protected some of its citizensunionized
workers and politically connected businesses, for Mexican authorities have also adopted responsible
exampleagainst outside competition.2 monetary and exchange rate policy. Before the re-
forming spirit took hold in response to the 1980s
Figure 2 shows the disappointing results of Mexicos
debt crisis, Mexico attempted to maintain a fixed
reform attempts so far. Mexico is not alone, as Latin
exchange rate. That was to the advantage of Mexi-
American economies in general have done poorly
can consumers (especially those wealthy enough to
compared with East Asia. Mexicans might wonder
afford imported goods), but high inflation in Mexico
why they havent seen better results. Vietnam and
created a series of currency crises. The 1994 crisis
Indianeither of which has the geographical advan-
was the last straw. Mexico let the peso float in early
tage of Mexicohave seen growth take off (not to
1995. Not long before, the government had given
even mention China). What is the secret sauce that

49
Global Economic Outlook

Figure 3. Ination and the exchange rate

Year-over-year percentage Pesos/dollar

200 20

160 16

120 12

80 8

40 4

0 0
1975 1980 1985 1990 1995 2000 2005 2010 2015

CPI (left axis) Exchange rate (right axis)

Source: IMF/Haver Analytics.
Graphic: Deloitte University Press | DUPress.com

the Bank of Mexico autonomy and a single mandate
of keeping inflation in check.
The results of the new monetary policy speak for
themselves (figure 3). The exchange rate became
more volatile, and the trend has been toward de-
preciation, as the average dollar/peso rate has more
than doubled. But the inflation rate has become
less volatileand much lower. Even better, Mex-
icos flexible exchange rate helped to mitigate the
impact of the US financial crisis and recession. As
economists predicted, some of the impact of lower
demand in the United States was absorbed by im-
proved Mexican competitiveness as the exchange
rate depreciated.
So it would be wrong to say that the Mexican au-
thorities willingness to stick to the path of reform
has been fruitless. The turn to an independent mon-
etary policy has been a huge success in eliminating
the previous pattern of exchange rate crises and
in keeping inflation under control. With luck, the
harder-to-implement structural reforms will suc-
ceed as well.
Moderate growth continues
Mexicos GDP growth accelerated a bit in the first
quarter, to 0.8 percent for the quarter. That kept
up Mexicos record of consistent economic growth
(between 2 and 3 percent) since the second quarter
of 2014. Its an enviable record given the volatility
of global financial markets and the changing risks
in the global economy over that period. Mexican
growth continued at moderate rates even as US

50
 3rd Quarter 2016
Mexico

The one-two punch of lower oil prices in 201415

plus the recent slowdown in US manufacturing has
been a formidable drag on the Mexican economy.

growth slowed in Q4 and Q1although some may
say that this supports the hypothesis that US GDP
figures suffer from seasonality problems.4 At the
same time, Mexicos inflation remains restrained
(also between 2 and 3 percent per year).
Mexicans would, of course, prefer to see higher
growth. The one-two punch of lower oil prices in
201415 plus the recent slowdown in US manufac-
turing has been a formidable drag on the Mexican
economy. Domestic demand has remained strong
enough to keep GDP growing, although the Q1 fig-
ures show slower growth in domestic demand as
well. Absent a pickup in US growth (and, even bet-
ter, global growth), Mexicos economy will eventu-
ally slow even more.
Mexicos long-term problems remain. Productivity
growth is slow: The Bank of Mexico estimates that
output per worker in manufacturing was virtually
unchanged over the past three years. And Mexicos
headlines are still all too often dominated by vio-
lence, whether related to teachers unions (as hap-
pened in June in Oaxaca5) or drug cartels. But the
Mexican economy remains vibrant, and Mexican
authorities remain committed to market-based re-
forms.

Endnotes
1. See, for example, Maria de Los Angeles Gonzalez, Do changes in democracy affect the political budget cycle? Evidence from Mexico, Review
of Development Economics 6, no. 2 (2002): pp 20424.

2. For a more complete history of Mexicos postWorld War II economy and reforms, see Timothy J. Kehoe and Felipe Meza, Catch-up
growth followed by stagnation: Mexico, 19502010, Federal Reserve Bank of Minneapolis Research Department working paper 693,
November 2012.

3. See Organization for Economic Development, Economic surveys: Mexico, January 2015, for a description of some of the specific reforms from
the pact and an analysis of their impact on the Mexican economy.

4. Patricia Buckley, United States: Another negative startor was it? Global Economic Outlook, Q3 2015, Deloitte University Press, July 23,
2015, http://dupress.com/articles/global-economic-outlook-q3-2015-united-states/.

5. Associated Press, Clashes between police, teachers leave 6 dead in Mexico, New York Times, June 20, 2016, http://www.nytimes.com/
aponline/2016/06/19/world/americas/ap-lt-mexico-teacher-protests.html?_r=0.

51
Global Economic Outlook
SOUTH AFRICA
In search of an
economic foothold
By Lester Gunnion
S
OUTH Africas economic challenges have in-
tensified. The economy contracted in the first
quarter of 2016, as mining production and ex-
ports came under pressure from subdued commod-
ity prices, weak external demand, a strong US dol-
lar, and sluggish global trade. Furthermore, weak
growth, political unrest, and deteriorating funda-
mentals have resulted in the South African rand
slipping and inflation climbing. In June, South Af-
rica narrowly escaped a rating downgrade to below
investment status.1 Even though the economy has
some time to mend before it comes under the scru-
tiny of ratings agencies again, the route to growth is
unclear, especially as monetary and fiscal policy is
tightened. Furthermore, the United Kingdoms de-
cision to exit the European Union is likely to add to
global uncertainty, which in turn will add to South
Africas burden. Policymakers are likely to face sev-
eral difficulties in navigating internal and external
challenges. The short-term outlook is therefore like-
ly to be rather dim.
A grim picture for growth,
mining, and exports
Economic growth slipped into negative territory in
Q1 2016. Real GDP, measured from a production
standpoint, contracted at a seasonally adjusted an-
nualized rate of 1.2 percent in Q1, down from growth
of 0.4 percent in the previous quarter.2
52
Mining was the major drag on overall growth. The
sector shrank 18.1 percent, resulting in a 1.5-per-
centage-point subtraction from growth in real GDP
(figure 1). In Q1, the mining sector was hit by lower
production of iron ore and platinum group metals.
The drop in production is linked to a downward
trend in global commodity prices, stemming from
weak global demand, growing uncertainty, and an
appreciation of the US dollar. Production has also
been hit by rising costs of inputs and labor. The Q1
decline in mining production also caused a contrac-
tion in both the electricity and transport sectors due
to weak demand.
Analyzed from an expenditure-on-GDP standpoint,
the South African economy shrank at a seasonally
adjusted annualized rate of 0.7 percent in Q1. This
is the first time that South Africa has included an ex-
penditure-on-GDP statistic in its quarterly release.
The expenditure lens, which puts overall demand
in focus, paints an equally grim picture. Household
spending, net investment, and trade registered de-
clines, while government consumption grew, albeit
at a slower pace than the previous quarter. Trade
was hit the hardest, with both exports and imports
declining at an annualized rate of 7.1 percent. The
decline in exports shaved off 2.2 percentage points
from overall growth in expenditure on GDP in Q1. A
decline in exports, particularly exports from South
Africas mining sector, links back to the overarching
trends of weak external demand, global uncertainty,
 3rdSouth
QuarterAfrica
2016

Figure 1. Mining production volume

25%
20%
15%
10%
5%
0%
-5%
-10%
-15%
-20%
Jan-11
Mar-11
May-11
Jul-11
Sep-11
Nov-11
Jan-12
Mar-12
May-12
Jul-12
Sep-12
Nov-12
Jan-13
Mar-13
May-13
Jul-13
Sep-13
Nov-13
Jan-14
Mar-14
May-14
Jul-14
Sep-14
Nov-14
Jan-15
Mar-15
May-15
Jul-15
Sep-15
Nov-15
Jan-16
Mar-16
Apr-16

Physical volume of mining production index, 2010=100, year-over-year percentage change

Source: Statistics South Africa, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

53
Global Economic Outlook

a strong dollar, and sluggish global trade, catalyzed

by a slowdown in China. The decline in GDP from
both a production as well as an expenditure per-
spective indicates that South Africa faces both inter-
A decline in exports, par- nal supply-side challenges as well as weak internal

ticularly exports from South and external demand.

Africas mining sector, links Different factors likely to

back to the overarching keep exports under pressure
trends of weak external de- South Africas exports, which constitute nearly a
third (30 percent) of all expenditure on GDP, are
mand, global uncertainty, likely to remain under duress given the current
global economic backdrop. In particular, economic
a strong dollar, and slug- developments in South Africas major export desti-
nations are likely to work against exporters. China,
gish global trade, catalyzed which is South Africas single-largest export desti-
nation (accounting for roughly 10 percent of all ex-
by a slowdown in China. ports in 2015), is slowing as it attempts to transition
away from fixed investment as the primary driver
of economic growth. As a result, Chinese demand
for commodities has declined. This is pertinent for

Figure 2. Chinas imports of South Africas major commodities (USD million)

1,200 300

1,000 250

800 200

600 150

400 100

200 50

0 0
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Chinas imports of mineral products from South Africa, non-seasonally adjusted (left axis)
Chinas imports of basic metals from South Africa, non-seasonally adjusted (right axis)

Source: China Customs/Haver Analytics, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

54
 3rdSouth
QuarterAfrica
2016

South Africa because 84 percent of all South Afri-
cas exports to China are either mineral products or
base metals. In fact, South Africa is, on the whole,
a commodity-exporting nation: Mineral products,
precious stones and metals, and base metals consti-
tuted more than half (54 percent) of the countrys
total exports in 2015.3
Figure 2 shows that Chinas imports of minerals
and metals from South Africa have declined in dol-
lar terms, while figure 3 shows a decline in the price
of industrial inputs and metals. Commodities are
priced in US dollars, so a strong dollar means that
commodities cost fewer dollars than before. This re-
sults in commodity exporters such as South Africa
earning fewer dollars for their exports. Another fac-
tor influencing South Africas exports to China is the
devaluation of the renminbi. Chinas currency is at
a five-year low against the dollar, with further de-
valuation a possibility. A weak yuan makes Chinese
imports of commodities, priced in dollars, compar-
atively more expensive, increasing downward pres-
sure on demand.
Apart from China, South Africas large single-coun-
try export destinations include the United States (9
percent of exports) and Japan (6 percent of exports).
However, despite the strong dollar and appreciat-
ing Japanese yen, the value of imports (in dollars
and yen respectively) from South Africa to both of
these destinations has declined (figure 4). Addi-
tionally, the Eurozone, an important export market
for South Africa (the European Union as a whole
accounted for 24 percent of South Africas exports
in 2015), has also displayed tepid demand.4 As a
result, the Eurozones imports from South Africa
have remained flat, as seen in figure 5. Moreover,
Brexit is likely to have repercussions on South Af-
ricas trade with both the United Kingdom and the
European Union, particularly due to the uncertainty
surrounding the renegotiation of trade deals in the
short term.
Besides a drop in the value of South Africas exports,
export volumes have also flattened over the last four
quarters, as shown in figure 6. The recent dip in vol-
ume stems from weak global trade (figures 7 and 8).

Figure 3. Indices of primary commodity prices

2005=100, in terms of USD

200

180

160

140

120

100

80

60

40

20

0
Jan-14 Apr-14 Jul-14 Oct -14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16

Industrial inputs Metals

Source: International Monetary Fund, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

55
Global Economic Outlook

Figure 4. US and Japanese imports from South Africa

USD million JPY billion

1,200 120

1,000 100

800 80

600 60

400 40

200 20

0 0
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

US imports from South Africa, non-seasonally adjusted (left axis)

Japans imports from South Africa, non-seasonally adjusted (right axis)

Source: Census Bureau/Ministry of Finance Japan/Japan Tari

Association/Haver Analytics, Deloitte Services LP economic analysis.
Graphic: Deloitte University Press | DUPress.com

Figure 5. Eurozone imports from South Africa

EUR million, non-seasonally adjusted

1,600

1,200

800

400

0
Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 Jan-16

Source: Statistical Oce of the European Communities/Haver Analytics,

Deloitte Services LP economic analysis.
Graphic: Deloitte University Press | DUPress.com

56
 3rdSouth
QuarterAfrica
2016

Figure 6. South Africas volume of exports including gold, (seasonally adjusted, 2010=100)

120

115

110

105

100

95

90

85

80
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1

Source: South African Reserve Bank/Haver Analytics, Deloitte Services LP economic analysis.
Graphic: Deloitte University Press | DUPress.com

Figure 7. World trade, total imports (USD billion)

1,800

1,600

1,400

1,200

1,000

800

600

400

200

0
Jan-80 Jan-84 Jan-88 Jan-92 Jan-96 Jan-00 Jan-04 Jan-08 Jan-12 Jan-16

Source: International Monetary Fund/Haver Analytics, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

57
Global Economic Outlook

Not only has the value of global trade dipped, the
volume of trade has also been suppressed.
The interplay of all these factors is likely to keep ex-
ports under pressure. This is likely to contribute to
South Africas current account deficit.
External and internal
challenges likely to make
policy formulation difficult
South Africas current account deficit has been in
negative territory since Q2 2003. The trade deficit
contributes a fifth (an average of 22 percent over
the last three quarters) to the total current account
deficit. However, net foreign investment income
payments account for 60 percent of the countrys
current account deficit.5 Furthermore, since Q4
2014, net foreign nondirect investment income pay-
ments have become more prominent (figure 9). As
a result, net foreign investment income payments
are no longer dominated by net payments to direct
investors. The risk associated with the rising share
of payments to nondirect investors is that short-
term foreign portfolio investments, or hot money,
could flow out of the South African economy quickly
if better risk returns are available elsewhere or if
South Africas economy deteriorates further.
Brexit poses a threat in the short term because Brit-
ish banks claims on South African entities stand
at 178 percent of South Africas foreign currency
reserves.6 In the medium term, the US Federal Re-
serves (Feds) normalization of monetary policy
also poses a threat. For the time being, the Feds
gradual, cautious approach is likely to be advanta-
geous to South Africa as well as to other emerging
markets.
A further complication is that South Africa also
runs a budget deficit. In fact, the budget has been in
deficit every year since 2008.7 Alongside weak eco-
nomic growth and political unrest, a budget deficit

Figure 8. Global trade in terms of volume

World trade in volumes, seasonally adjusted, quarterly percentage change
6

-2

-4

-6

-8

-10

-12
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1 Q1

Source: World Trade Organization, Deloitte Services LP economic analysis.

Graphic: Deloitte University Press | DUPress.com

58
 3rdSouth
QuarterAfrica
2016

The conundrum that the

central bank faces is that
the price rise and subse-
quent tightening of mon-
etary policy come at a time
when the economy is at risk
of entering a technical re-
cession. However, arresting
inflation and supporting the
rand also remain key con-
cerns for the central bank.

Figure 9. South Africa net income payments, current account balance

ZAR million

100,000
90,000
80,000
70,000
60,000
50,000
40,000
30,000
20,000
10,000
0
2012 2013 2014 2015 2016
Q1 Q1 Q1 Q1 Q1

Foreign direct investment net income payments

Foreign nondirect investment net income payments

Source: South African Reserve Bank/Haver Analytics, Deloitte Services LP economic analysis.
Graphic: Deloitte University Press | DUPress.com

59
Global Economic Outlook

and a trade deficit have resulted in downward pres- tant is achieving economic growth. However, in an
sure on the rand, which is further complicated by environment marked by weak internal and external
Brexit. As a result, despite recovering some ground demand, declining confidence among consumers
between mid-January and the beginning of May, and businesses alike, and tight monetary and fiscal
the rand has depreciated roughly 33 percent against policy, growth will be hard to come by. In such a
the dollar since the beginning of 2015 (as of June 24, situation, South Africas persistent weaknesses are
2016). A weak rand, coupled with the fact that the underscored. Unemployment, for instance, climbed
country is in the grip of severe drought, has resulted to an astounding 26.7 percent in Q1, up from 24.5
in consumer prices rising above the central banks percent in the previous quarter. Low labor force
upper limit of 6 percent. The consumer price index participation (58.7 percent in Q1 2016, of which 73
rose 6.5 percent in May percent are employed)
from a year ago. Food means that just above
prices, in particular, 40 percent of South Af-
are a cause for concern, Continued economic ricas total population is
rising 12.3 percent in employed.9
May.8 In response, the weakness could also
Productivity also has
South African Reserve
Bank (SARB) has been
put South Africa un- been a problem: Real

tightening monetary der the lens of ratings output per employee

has declined year over
policy: The policy in-
terest rate has edged agencies later in the year for the last five
quarters. As productiv-
up from 5.0 percent at
the start of 2014 to 7.0
year. A downgrade ity declines, labor costs

to below investment
continue to rise. Unit la-
percent as of May 2016.
bor cost in the nonagri-
The conundrum that
the central bank faces status would make cultural sector climbed
an average of 5 percent
is that the price rise and
subsequent tighten- an already uphill jour- year over year over four
quarters in 2015.10 An
ing of monetary policy
come at a time when
ney a lot steeper. economic environment
of rising prices and low
the economy is at risk
growth could mean that
of entering a technical
business owners will
recession. However, arresting inflation and sup-
not be able to meet the demands of trade unions,
porting the rand also remain key concerns for the
therefore leaving room for labor strikes that disrupt
central bank. Furthermore, real interest rates need
production and hamper economic growth.
to be kept attractive, especially because South Af-
ricas current account deficit is funded (and in part A positive sliver in South Africas otherwise gloomy
fueled) by foreign investment. economic situation is the relative absence of roll-
ing power cuts in 2016 compared with 2015, mainly
Fiscal policy is also likely to remain tight. The bud-
due to the renewal of aging coal-powered plants. In
get for the fiscal year 201617, released in February,
similar fashion, South Africa will probably have to
outlined measures to curb spending and increase
make the best use of all the resources at hand. In
taxation in order to rein in the budget deficit. This
such a scenario, policy formulation is likely to re-
is crucial if South Africa is to avoid a rating down-
main extremely challenging.
grade to below investment status. Equally impor-

60
 3rdSouth
QuarterAfrica
2016

GDP growth likely to remain

weak in the short term
South Africas economy runs the risk of entering a
technical recession, its first since 2009. The myriad
internal challenges and external headwinds facing
the economy are likely to keep growth subdued.
The International Monetary Fund and the SARB
both forecast a growth rate of just 0.6 percent in
2016.11 However, global developments stemming
from Brexit are likely to lower forecasts. Continued
economic weakness could also put South Africa un-
der the lens of ratings agencies later in the year. A
downgrade to below investment status would make
an already uphill journey a lot steeper. South Africa
desperately needs to find an economic foothold if it
is to escape such a plight.

Endnotes
1. South Africa escapes S&P downgrade to junk, Financial Times, June 3, 2016, http://www.ft.com/fastft/2016/06/03/south-africa-escapes-
sp-downgrade-to-junk/.

2. Statistics South Africa, Gross domestic product: First quarter 2016, June 8, 2016, http://www.statssa.gov.za/publications/P0441/P04411st-
Quarter2016.pdf. All statistics in this section are from this source unless otherwise stated.

3. Department of Trade and Industry, South African Revenue Service/Haver Analytics, South Africa international trade and BOP: Trade in
goods by country and commodity, millions of rand, monthly, NSA, accessed June 24, 2016; Deloitte Services LP economic analysis.

4. Ibid.

5. South African Reserve Bank/Haver Analytics, South Africa: Balance of payments, including trade with BLNS countries in Q1 2010, balance
on current account, SAAR, millions of rand, quarterly, accessed June 24, 2016; Deloitte Services LP economic analysis.

6. Natasha Doff, Rand snared and ruble spared Brexit risk in U.K. finance web, Washington Post with Bloomberg, June 16, 2016, http://
washpost.bloomberg.com/Story?docId=1376-O8JV136KLVRN01-5AGFIM27KH58GA9K6GPL3K03QE.

7. National Treasury/Haver Analytics, South Africa: Main budget framework budget balance, millions of rand, annual, fiscal year April 1 to
March 31, accessed June 24, 2016; Deloitte Services LP economic analysis.

8. Statistics South Africa/Haver Analytics, South Africa: Consumer price indexes, all areas (national), SA, December 2012=100, monthly, year-
over-year percent change, accessed June 24, 2016; Deloitte Services LP economic analysis.

9. Statistics South Africa/Haver Analytics, South Africa: Employment and unemployment, quarterly, NSA, accessed June 24, 2016; Deloitte
Services LP economic analysis.

10. South African Reserve Bank/Haver Analytics, South Africa: Productivity and costs, nominal unit labor cost, SA, quarterly, year-over-year
percent change, accessed June 24, 2016; Deloitte Services LP economic analysis.

11. International Monetary Fund, South Africa and the IMF, https://www.imf.org/external/country/ZAF/, updated June 13, 2016; South African
Reserve Bank, Selected forecast results: MPC meeting May 2016, May 19, 2016, http://www.resbank.co.za/Lists/News%20and%20Publica-
tions/Attachments/7300/Forecast%20May%202016.pdf.

61
Global Economic Outlook
INDIA
Slow and steady may not be
enough to win the race
By Dr. Rumki Majumdar
I
T has been two years since the Narendra Modi
government came to power with a historic win
in the national elections. It was expected that the
new government would embark upon much-needed
economic reforms and radically restructure the In-
dian economy. The actual performance record of
the government, however, has been a mixed bag.
Several macroeconomic fundamentals have im-
proved in the past two years. Even if one sets aside
the discrepancies in growth data, there is hardly any
doubt that India is among the better-performing na-
tions in terms of growth and stability. Inflation has
come down, thanks to falling oil prices. Although
food inflation has remained vulnerable and the re-
cent firming of oil prices has pushed up consumer
prices, the overall inflation expectation remains an-
chored. The current account deficit has narrowed,
and the government has pursued its commitment to
adhere to fiscal consolidation.
While it can be argued that global conditions, by
way of low oil prices, have helped improve the key
economic fundamentals, the government deserves
some credit for its efforts in ushering in transpar-
ency in system and procedures; emphasizing good
governance; undertaking initiatives to improve the
investment climate; and taking a few bold initiatives,
such as showing restraint in raising minimum sup-
port prices, which play a key role in food inflation.
62
According to the 2016 Deloitte India CFO survey,
business leaders continue to remain optimistic
about the Indian economy: Not only did 90 percent
of the CFOs express optimism about the mid-term
economic outlook, 94 percent expressed long-term
economic confidence. Close to 60 percent expressed
satisfaction with the timeline and effectiveness of
government initiatives.1
However, there are a few areas where the glass re-
mains half empty. These include uncertainty in the
tax environment, poor implementation of structural
reforms and regulatory impediments, slow reforms
in the banking sector, the failure to transform his-
torically weak relations between the center and the
states, and the lack of an assertive stance to improve
Indias trade, especially exports.
Economic performance
GDP growth in Q4 of FY 201516 accelerated to 7.9
percent year over year.2 The full-year growth in FY
201516 (the year ending March 2016) accelerated
to 7.6 percent from 7.2 percent in FY 201415. Al-
though methodological concerns continue to cast
doubts on the buoyant growth data, there is no
doubt that the economy is growing at a steady pace
despite global uncertainty.

Expenditure data show that the improvement in
GDP growth in Q1 was largely driven by higher pri-
vate consumption, indicating that domestic demand
is holding up well. Lower inflation has also helped
improve households purchasing power (table 1).
However, investment declined for the first time
since Q1 of FY 201314. Growth momentum had
started to slow in Q3 of FY 201516, and growth
contracted by 2.4 percent in the following quarter,
primarily due to a reduction in fixed investments
(-1.9 percent). This probably reflects the slowdown
in capital expenditure by the center and the state
governments as they try to adhere to the targeted
fiscal consolidation. That said, growth in invento-
ries slowed in Q4 of FY 201516, which bodes well
63
3rd QuarterIndia
2016
for investment in the coming quarters. Government
spending on infrastructure (roads and railways)
and a revival of private investment in response to
rising domestic demand will likely be the key deter-
minants of investment growth. While exports con-
tinued to contract for the fifth consecutive quarter,
the drag on GDP from net exports was relatively
small due to falling imports as oil prices remained
low. Slowing global growth and poor demand in
an uncertain global economic environment have
adversely impacted Indian exports. Consequently,
the manufacturing sector, which accounts for 60
percent of the export basket, has failed to take off
despite the governments efforts to push the sector
through various initiatives.3
Global Economic Outlook

The current account deficit fell 1.1 percent of GDP

this fiscal year to the lowest level in nine years, pri-
Government spending marily because of falling oil prices.4 There has been

on infrastructure (roads
a significant improvement in foreign direct invest-
ment (FDI) inflows, which grew 31 percent in FY

and railways) and a revival 201516. However, the overall capital account more
than halved from $90 billion to $41 billion due to
of private investment in negative net portfolio investments, which reversed
from an inflow of $41 billion in FY 201415 to an
response to rising do- outflow of $4 billion in FY 201516 (figures 1 and 2).

mestic demand will likely The government is expected to meet the fiscal defi-

be the key determinants cit target of 3.9 percent of GDP in FY 201516, and
has pledged to reduce it further to 3.5 percent in the
of investment growth. next year.5 By adhering strictly to the fiscal road-
map, the government has sent out a clear message
that the goals are to accelerate growth and ensure
macroeconomic stability.

Table 1. GDP and the expenditure side

FY 201516

Q1 Q2 Q3 Q4

GDP 7.5 7.6 7.2 7.9

Consumption 5.7 5.7 7.4 7.6

Private 6.9 6.3 8.2 8.3

Government -0.2 3.3 3.0 2.9

Investments 6.6 9.6 2.0 -2.4

Fixed 7.1 9.7 1.2 -1.9

Inventories 3.6 5.4 7.7 5.6

Valuables 0.6 12.4 13.5 -17.2

Exports -5.7 -4.3 -8.9 -1.9

Imports -2.4 -0.6 -6.4 -1.6

Source: Central Statistical Organization, May 2016.

64
 3rd QuarterIndia
2016

Figure 1. Capital account balance: FDI grew while foreign portfolio investment (FPI) turned negative
USD million
100,000

80,000

60,000

40,000

20,000

-20,000

2012 2013 2014 2015

FDI inow in India Net FPI investment Business

investment
Source: Ministry of Finance, Government of India, May 2016.
Graphic: Deloitte University Press | DUPress.com

Figure 2. Fiscal and current account balance

Percentage of GDP
7

0
200809 200910 201011 201112 201213 201314 201415 201516

Current account balance Central government gross scal decit

Source: Reserve Bank of India, Ministry of Finance, Government of India, May 2016.
Graphic: Deloitte University Press | DUPress.com

65
Global Economic Outlook

Glass half full: Major is also exploring how to ensure subsidies go to only
those who need them, and thereby checking waste
initiatives and reforms and leakages. Total subsidies are now less than 2
percent of GDP.8
The government has undertaken several initiatives
and reforms in order to propel India to a higher The government has also started initiating labor
growth path. Various programs and schemes such market reforms in a prudent manner. Instead of in-
as Make in India, troducing the reforms at
Digital India, Smart the center, the govern-
Cities, Startup In- ment has encouraged
dia, and Skill India,
among others, were Instead of introduc- states to implement
these reforms. The pos-
launched with the in-
tention of improving
ing the reforms at the sible logic may be that
once states start imple-
the manufacturing abil- center, the govern- menting reforms and
ity of the country, pro-
moting innovation and ment has encouraged see the benefits, there
will be little resistance
entrepreneurship, cre-
ating job opportunities,
states to implement to accepting reforms at
the center. Some states
and improving infra- these reforms. The such as Rajasthan, Mad-
structure and skills. hya Pradesh, and Ma-

The government also

possible logic may harashtra have already

undertook several diffi- be that once states started amending labor

laws.
cult structural reforms,
such as the passage of start implementing According to the 2016
the bankruptcy code
and bills to foster fair
reforms and see the Deloitte India CFO sur-
vey, business leaders are
play and transpar- benefits, there will highly optimistic about
ency in the allocation
of natural resources.6 be little resistance the economic outlook
(figure 3). The survey
Rationalizing existing
laws, encouraging FDI,
to accepting re- suggest that many CFOs
support these initia-
increasing governance forms at the center. tives and reforms, and
efficiency, and, most are upbeat about the
importantly, the gov- expected outcomes, al-
ernments willingness though they agree that
to seek feedback from industries on challenges in the effectiveness of these can fully be assessed only
doing business have improved the overall business after a while.9
environment. According to the World Banks Doing
Business report, India moved up four spots and now
ranks at 130 out of 189 countries in ease of doing Glass half empty
business.7 Although moderate, the improvement in
However, the survey has pointed to several chal-
the investment climate is reflected in the rise in FDI
lenges that are impacting CFOs risk-taking ability
in the past year (figure 1).
and investment growth. Regulatory impediments,
The Indian government has taken advantage of the concerns over uncertainty in the tax environment,
oil price windfall to reduce subsidies by deregulat- and delays in clearing goods and services tax (GST)
ing fuel prices and increasing excise taxes, which bills and land acquisition bills are eroding business
have improved the fiscal balance. The government confidence. Structural reform progress in three

66
 3rd QuarterIndia
2016

Figure 3. Deloitte CFO Survey: Economic outlook

70% 68%

60%

50% 47% 47% 47%

40% 38%

30%
22%
20%
13%
10% 8%
5%
2% 2% 1%
0%
Next 1 year 23 years 45 years

Very optimistic Neutral Optimistic Not optimistic

Source: Deloitte, Still reluctant to spend: 2016 Q1 Global CFO Signals, 2016,
http://www2.deloitte.com/us/en/pages/advisory/articles/global-cfo-signals.html.
Graphic: Deloitte University Press | DUPress.com

areasGST, banking, and tradehas been signifi-

cantly delayed.

Goods and services tax: Different Indian states

have different and complicated regulations, licens- While the lack of coop-
ing schemes, and tax systems, which has impacted
investment decisions and the business environment eration between the two
across India. The GST bill is expected to streamline
the process of taxation and make it more effective.
houses of parliament has
The bill, which was supposed to be functional this been an important rea-
fiscal year, still needs to be passed in the upper
house, where the government lacks majority. The son for the delay, the lack
government is expecting to bring the GST bill for
consideration during the monsoon session in July
of assertion and inter-
August 2016. If passed, it will likely boost business nal political conflicts are
sentiments.

The banking sector: Reforms in the banking sec-

also impeding the abil-
tor have remained unimpressive. The sector contin- ity of the government to
ues to be dominated by public sector banks (PSBs),
which account for over 70 percent of the total bank- take up bold reforms.
ing system assets. This is not consistent with the
modern banking system and the growth model for
India.

67
Global Economic Outlook

Figure 4. Banking business and poor credit growth

Year-over-year percentage
25

20

15

10

5
200809 201011 201213 201415

Outstanding credit growth Aggregate deposit growth

Source: Reserve Bank of India, May 2016.

Graphic: Deloitte University Press | DUPress.com

Gradual reforms in the banking sector is one of the
primary reasons for the decline of banking and poor
credit growth in recent years (figure 4). Despite rel-
atively high real interest rates, growth in aggregate
deposits for all scheduled commercial banks fell to
a historic low of 9.9 percent in FY 201516. Growth
was 19.5 percent in FY 200910 and has steadi-
ly declined since then. On the other hand, bank
credit growth, which was as high as 25 percent in
FY 200910, declined to 9 percent in the past fiscal
year. While loan growth in all sectors has declined
after the 2008 global financial crisis, the industry
and services sectors have suffered the most due to
rising corporate leverage and the concentration of
risks in a few stressed sectors, such as iron, steel,
power, and communication.10 This is reflected in the
increase in nonperforming assets in banks balance
sheets.
When the Modi government came to power two
years ago, banking conditions were still good, and a
move to privatize the PSBs might have gone a long
way in overhauling the entire banking system. That
window of opportunity is probably gone now, given
the high proportion of nonperforming assets, banks
low profitability, and poor operating environment.
The valuation of these banks is currently low, and
there are not many investors interested in these
PSBs.
Trade: India has been signing trade agreements at
a blistering pace in recent years. However, the pur-
pose of these agreements is not being met. Rising
trade agreements have resulted in a stronger pres-
ence of enterprises from partner countries in the
Indian market. Consequently, India has witnessed
a sharp rise in imports following these agreements.
On the other hand, exports have failed to gain mo-
mentum. Poor export competitiveness, a weak man-
ufacturing sector, infrastructure bottlenecks, spe-
cial economic zones not reaching their full potential,
and Indias poor link to global value chains are hurt-
ing Indias export ability. Moreover, poor domestic
infrastructure and lack of awareness among indus-

68
 3rd QuarterIndia
2016

tries and exporters, especially those in the medium
and small-scale enterprises, have limited the ben-
efits of trade agreements. In addition, Indias delay
in taking firm action in participating in new forms
of trading arrangements and deciding on the pace
and extent of such participation is hurting trade
prospects.
In the right direction,
but lacking pace
The Modi government has undertaken a few land-
mark reforms since it came to power two years
ago. However, the pace of reforms remains slow.
Systemic infrastructure bottlenecks, lack of trans-
parency, and uncertainty in corporate governance
rules continue to impact the environment for doing
business and business sentiments. While the lack of
cooperation between the two houses of parliament
has been an important reason for the delay, the lack
of assertion and internal political conflicts are also
impeding the ability of the government to take up
bold reforms. The modernization of India that Modi
promised during the 2014 election is mired in chal-
lenges. If the government wants to fulfill its election
promises, it has to be more assertive in speeding
up reforms. The government has three more years,
and only time will tell if it can make a meaningful
change in its stance to drive the economy on the
path that Modi had promised.

Endnotes
1. Deloitte, Still reluctant to spend: 2016 Q1 Global CFO Signals, 2016, http://www2.deloitte.com/us/en/pages/advisory/articles/global-cfo-
signals.html.

2. Growth is measured in year-over-year terms, unless specified otherwise.

3. Prachi Priya and Anuj Agarwal, Exports need a Make-in-India push, Financial Express, March 16, 2015, http://www.financialexpress.com/
article/fe-columnist/exports-need-a-make-in-india-push/53963/.

4. Reserve Bank of India, May 2016.

5. Ministry of Finance, Government of India, Key features of Budget 20162017, 2016, http://indiabudget.nic.in/ub2016-17/bh/bh1.pdf.

6. Mines and Minerals (Development and Regulation) Amendment Bill, 2015; Coal Mines (Special Provisions) Bill, 2015.

7. World Bank Group, Doing business 2016: Measuring regulatory quality and efficiency: Economy profileIndia, http://www.doingbusiness.org/
reports/global-reports/~/media/giawb/doing%20business/documents/profiles/country/IND.pdf.

8. Ministry of Finance, Government of India, Chapter 2: Public finance, Economic Survey 201617, 2016, http://indiabudget.nic.in/es2015-16/
echapvol2-02.pdf.

9. Deloitte, Still reluctant to spend.

10. Reserve Bank of India, May 2016.

69
Global Economic Outlook
SPECIAL TOPIC
The oil mighty: The economic
impact of oil price fluctuations
By Dr. Rumki Majumdar
I
N 1973, Egypt and Syria waged a surprise war on
Israel, which soon divided many countries into
supporters of either side. Subsequently, several
oil-exporting Arab nations curtailed oil production
(known as the oil embargo), quadrupling oil pric-
es within a quarter. This oil crisis was one of the big-
gest factors that pushed some oil-consuming, indus-
trialized nations such as the United States and the
United Kingdom into an economic recession that
lasted over a year.1 History repeated itself when dis-
ruptions in Irans oil production during the Iranian
revolution, followed by the Iraq-Iran war, caused oil
prices to skyrocket in 197980. This time, in addi-
tion to a supply shock, increased inventory demand
in anticipation of supply shortages and rising global
demand contributed to the oil price rise. The price
shocks had a substantial impact on US GDP, and
the US economy went into a recession.2
The timeline of the Soviet Union collapse can be
traced to Saudi Arabia deciding to stop protecting
oil prices and increasing production fourfold in
1985. The sudden fall in oil prices was one of the
key factors that weakened economic fundamentals
of the Soviet Union. The region lost approximately
$20 billion per year due to lower revenues from oil
exports, which resulted in huge government bor-
rowing in the following years. By 1989, the Soviet
economy had stalled.3
70
Wide fluctuations in oil prices have played an im-
portant role in driving economies into recession and
even regimes collapsingwhich is why movements
in oil prices are closely watched by economists, in-
vestors, and policymakers globally. Since 2008, oil
prices have seen two cycles of highs and lows, with
no indication of a steady path in the near future. The
historic high values of oil prices during 201013 and
the following prolonged downturn during 201416
(the longest since the 1980s) suggest that the world
economy is in unchartered territory (figure 1).
In recent months, oil prices have shown signs of a
recovery, after touching a low of $26 per barrel in
January 2016.4 While many forecasters are optimis-
tic about the recent price rise and are predicting that
the oil glut may be over, some are concerned that
there is a lot of uncertainty surrounding the current
rebound. The direct influence of the Organization of
Petroleum Exporting Countries (OPEC) on oil pric-
es has changed due to rising competition from US
shale oil producers. Instead of defending price lev-
els, OPEC has changed its strategy to defend market
share rather than price, by producing more at low
prices. This supply strategy has been a critical fac-
tor in the current oil price trajectory. On the other
hand, uncertainty in global demand poses downside
risks to oil prices. The question everyone is asking is,
 3rdSpecial
Quarter topic
2016

Figure 1. Real oil price movements since 1970 mapped to global events
Monthly imported real crude oil price (USD per barrel)
140 Unrest in
Middle East
countries
Iranian revolution 2008
120 and Iraq-Iran war nancial
crisis

100
Arab Oil Saudi Arabia The fall of
embargo increases Soviet Union
production Dot-com bubble,
80 9/11 attack

60 Asian
economic
crisis
40

US shale
20 revolution

0
1974 1979 1984 1989 1994 1999 2004 2009 2014

Note: Monthly average imported crude oil price, nominal deated by the US consumer price index. The grey bars refer to the
economic recessions in the United States.
Source: Energy Information Administration, June 2016.
Graphic: Deloitte University Press | DUPress.com

71
Global Economic Outlook

By how much and how soon will oil prices go up?
While oil prices are expected to rebound to $58 per
barrel in the next couple of years, they are unlikely
to reach the previous high of $100 per barrel any-
time soon.5
Explaining the past decades
demand-supply conundrum
Historically, volatility in oil prices is often explained
by shocks to demand and supply of oil arising from
any combination of business cycles, geopolitical
factors, the discovery of new fields, or technologi-
cal changes. The past one-and-a-half decades have
witnessed an interplay of all these factors, resulting
in extreme oil price fluctuations (figure 2).
Oil prices surged during 200308 due to an unex-
pected global economic boom, especially in emerg-
ing Asian economies such as China and India, while
oil producers failed to keep up with the rising de-
mand. Post May 2007, rising inventories in antici-
pation of increasing demand added to the existing
demand pressures. Within a year, oil prices nearly
doubled, reaching $113 dollars in May 2008.
After a brief fall in oil prices during the 2008 finan-
cial crisis, prices quickly picked up by mid-2009 on
the back of strong growth in some of the emerging
nations. The political uprising and civil wars in a
few Middle Eastern countries resulted in intermit-
tent oil supply disruptions. Oil prices reached $100
per barrel in 2010 and remained steady at $90120
per barrel during 201114.
All this changed, however, when oil prices dropped
over 70 percent between June 2014 and January
2016, as supply outstripped demand. New oil fields
and advancing technologies in the United States
enabled US oil producers to increase production
(figure 3). Post 2014, Libya and Iraqs faster-than-
expected resumption of oil production; US energy
companies resilience in continuing supply despite

Figure 2. Oil demand-supply balance (million barrels per day)

3
102

Strong
Demand outgrowing demand amid
supply rising supply 2
97 Global economic
slowdown and
geopolitical
uncertainty 1

92

87
-1
Oil glut

82 -2
2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

Oil supply (left axis) Oil demand (left axis)

Implied stock change (right axis)

Note: The oil in the gure comprises crude oil, condensates, NGLs, and oil from nonconventional and other sources of supply.
Source: Energy Information Administration, June 2016.
Graphic: Deloitte University Press | DUPress.com

72
 3rdSpecial
QuarterTopic
2016

falling prices; and increased production by Canada, had borrowed heavily. Rising yields on the bonds
Russia, and, lately, Iran after sanctions were lifted (most of them non-investment grade) issued by
led to a sustained increase in oil supply. these companies led to impending defaults. Conse-
quently, crude oil production in the United States
However, the biggest contributor has been Saudi
has started declining. While Iran, Saudi Arabia, and
Arabias (the biggest oil producer within OPEC) un-
Russia have continued to boost oil production, un-
willingness to not counter the increasing supply but
planned supply disruptions due to production out-
instead maintain the production at historically high
ages in a few countries, such as Nigeria, Canada,
levels despite the perceived glut. Its intention might
and Venezuela, have impacted the overall oil sup-
have been to preserve market share at the expense
ply, and thereby prices. At the time of this writing,
of Iran and the United States, even if that meant
benchmark oil prices are close to $50 per barrel.
lower prices.
Much has been made of the alleged role of specula-
Meanwhile, global growth slowed because of the
tive trading in oil futures markets and hedging in
economic slowdown in China; modest growth in
determining oil prices, especially when oil prices
most of the advanced economies, including the
touched record-high levels in 2008 or when they
United States; and increasing uncertainty in the Eu-
were in free fall post 2014. However, there is no sig-
rozoneleading to a steady fall in oil consumption
nificant evidence justifying this argument.7
growth by these big oil importers. Slowing demand
growth amid rising supply resulted in a sharp in-
crease in inventories during 201415. By the end of Where are oil prices headed?
January 2016, oil prices slid to $26 per barrelthe
lowest level since 2003.6 As we move past mid-2016, there is substantial un-
certainty around how demand and supply dynamics
The magnitude and the duration of the fall in oil will evolve in the future. The proven ability of US
prices gradually started impacting revenues and in- oil producers to generate growth even at low break-
vestments made by the US energy companies that even prices, the unwillingness of OPEC members to

Figure 3. US crude oil production (thousand barrels per day)

10,000

9,000

8,000

7,000

6,000

5,000

4,000
Mar-2006 Mar-2008 Mar-2010 Mar-2012 Mar-2014 Mar-2016

Source: Energy Information Administration, June 2016.

Graphic: Deloitte University Press | DUPress.com

73
Global Economic Outlook
cut production, and the rising tension among OPEC
members due to geopolitical reasons could lead to
two possibilities in the short run.
If OPEC makes any attempt to curtail production
either because of limited spare capacity (except in
Saudi Arabia), low investment ability, high pro-
duction cost, or a combination of any of theseoil
prices will likely move up too quickly. Given that
there remains plenty of known shale available, pro-
duction in the United States is more likely to revive
as price signals become more appropriate.8 If that
happens, OPEC may run the risk of losing market
share to the US oil-producing companies.
On the other hand, in a bid to retain their market
share, OPEC members, in particular Saudi Arabia,
may prefer to keep prices low to prevent US shale
companies from resuming production. That would
imply that OPEC may choose to continue produc-
tion rapidly in the future to maintain downward
pressure on oil prices. If past behavior is any indica-
tion of future conduct, this will be the most prob-
able event in the near term.
In either of these possibilities, oil prices are expect-
ed to remain low relative to past levels and bounce
74
around in a relatively narrow corridor in the near
term. Moreover, several indicationssuch as OPEC
continuing oil production and large volumes of
existing, shut-in production in Nigeria, Venezuela,
and Libya waiting to enter the marketpoint to
more downside risks for oil prices. Oil prices are
likely to increase to $58 per barrel in the next cou-
ple of years, but not return to $100 per barrel.9
However, the steep decline in oil prices in 2015 and
the new reality of low prices for a prolonged period
have led to many high-cost projects being deferred,
which may create a shortfall in future production.
According to Deloitte MarketPoint, production
will likely see a production fall of 2 million barrels
per day from 2018 to 2020.10 Consequently, prices
might increase further in the medium term.
However, the pace of the oil price rise will likely
depend on the revival of global demand. Given the
modest outlook for the US economy, rising post-
Brexit uncertainty in the Eurozone and the rest
of the world, and considerable downside risks to
Chinas economy, the demand for oil may grow only
moderately between 2018 and 2020.11 Thus, the
tight demand-supply balance will likely push prices
up further, but the rise may not be significant.

Much has been made of the alleged role of speculative
trading in oil futures markets and hedging in determining
oil prices, especially when oil prices touched record-high
levels in 2008 or when they were in free fall post 2014.
The winners and the losers
Lower oil prices will result in a redistribution of
resources. Gains will likely be spread across many
economies, while losses may be concentrated
among a few.
Oil importers: The beneficiaries of persistently
low oil prices are likely to be the oil-importing na-
tions, because of improved household consumption
spending, business investment as production costs
fall and profits increase, and external accounts. Low
oil prices also provide these nations an opportunity
to cut down energy subsidies, which improves fiscal
balance overall but reduces the benefits accrued to
households and businesses.
Within oil importers, nations that are experiencing
high inflation (primarily emerging nations) are like-
ly to benefit from falling import prices, which put
downward pressure on both core and headline infla-
tion. On the other hand, persistently falling oil pric-
es do not bode well for nations that are battling de-
flationary pressures (primarily advanced nations).
Major advanced nations, such as Japan, the United
States, and those in Europe, have implemented
unconventional monetary policies, and falling oil
prices may complicate the conduct of such policies.
These economies are constrained by interest rates
that are either near zero or negative, so they cannot
offset the deflationary impact of falling oil prices by
reducing interest rates further, as they could have
done in normal times. In order to anchor deflation,
these economies may have to rely on forward guid-
ance by monetary authorities for the medium term,
extending the duration of the unconventional mon-
75
3rdSpecial
QuarterTopic
2016
etary policies, or both. However, prolonged imple-
mentation of unconventional policies may lead to
greater economic and financial uncertainty in the
long run.12
Oil exporters: Oil-exporting nations will likely be
adversely impacted as real income goes down and
profit margins for oil producers get stressed. Energy
companies weak financial positions may deterio-
rate the balance sheets of the financial institutions
that lend to these companies and thus may threaten
the financial stability of these economies. At the
same time, the governments will likely take in less
revenue, and their budgets and external balances
are expected to come under pressure.
That said, the impact of falling prices on oil export-
ers will differ depending on the contribution of oil
exports to each countrys GDP and revenue. Growth
in economies such as Venezuela and Angola is high-
ly dependent on oil exports (relative to Russia and
Saudi Arabia), and any vulnerability in oil prices
is likely to have a severe impact on their economic
activity. Similarly, in many countries, oil revenues
account for more than 50 percent of total govern-
ment revenuesfor a few countries such as Iraq and
Qatar, the share is as high as 90 percent.13
The International Monetary Fund (IMF) estimates
the break-even prices at which Middle Eastern
and Central Asian countries can balance their fis-
cal and external accounts (figure 4). Prices below
these break-even levels may result in severe fiscal
and external account deficits, which may affect the
valuation of the local currency, inflation, and exist-
ing debt.
Global Economic Outlook

Alternate policies and
diversification might
counter price instability
Price instability intensifies economic uncertainty,
and this impact is generally more pronounced in
nations highly dependent on oil exports. The tight
demand-supply balance for oil (discussed in the
previous section) along with external shocks, such
as political and policy shifts in the United States
and Europe, may result in sustained pressure on oil
price stability.
Given the uncertainty, oil exporters such as Brazil
and Russia might benefit from undertaking struc-
tural reforms as well as adjusting fiscal and mon-
etary policies, with the speed of adjustment deter-
mined by the extent of vulnerabilities. Reforms in
the financial sector and strengthening the private
non-commodity sector could help boost non-oil
growth.
In the long term, diversifying the economy away
from oil can help cushion the impact of low oil prices
and ensure economic stability in the face of extreme
oil price fluctuations. Saudi Arabia has already an-
nounced a Vision 2030 reform program that aims
to lessen the countrys dependence on the public
sector to foster private sector entrepreneurship.
The government is also taking steps toward improv-
ing the educational system to enhance skills that

Figure 4. Oil prices required to balance twin accounts (USD per barrel, 2016)

Yemen

Libya

Bahrain

Algeria

Oman

United Arab
Emirates

Saudi Arabia

Iran

Iraq

Qatar

Kuwait

0 50 100 150 200 250 300 350 400

External breakeven Fiscal breakeven

Note: These are the IMFs estimated projections as of January 2015. Yemen has been a net oil importer in 2015 and 2016.
Source: IMF database, 2015.
Graphic: Deloitte University Press | DUPress.com

76
 3rdSpecial
QuarterTopic
2016

could promote diversification.14 These measures, if
successful, may help Saudi Arabia reduce its depen-
dence on oil. This, in turn, may enable the country
to regain its influence over the global oil market, be-
cause then hard decisions to continue pumping oil
at low prices may not come at the cost of economic
deceleration. Similarly, Nigeria has also announced
a zero oil plan to help the country increase non-oil
exports over the next decade.15 However, the pace
and scale of these diversification efforts and their
success will depend on a number of factors, includ-
ing empowerment of the private sector and workers.
Only time will tell whether these measures bear the
fruit the respective governments expect.

Acknowledgements
The author would like to thank Andrew Slaughter, managing director, Center for Energy Solutions, De-
loitte Services LP; and Anshu Mittal, executive manager, Research & Eminence, Deloitte Services India Pvt.
Ltd. for their contributions.

Endnotes
1. The beginning and ending points of recessions are set by the National Bureau of Economic Research, a private, nonprofit, nonpartisan
organization. See http://www.nber.org/cycles/sept2010.html.

2. Christiane Baumeister and Lutz Kilian, Forty years of oil price fluctuations: Why the price of oil may still surprise us, Journal of Economic
Perspectives 30, no. 1 (2016), https://www.aeaweb.org/articles?id=10.1257/jep.30.1.139

3. Yegor Gaidar, The Soviet collapse: Grain and oil, American Enterprise Institute for Public Policy Research, April 2007, http://www.aei.org/
wp-content/uploads/2011/10/20070419_Gaidar.pdf.

4. Europe Brent spot price FOB, Energy Information Administration, January 20, 2016.

5. George Given and Jeff Suchadoll, The balancing act: A look at oil market fundamentals over the next five years, Deloitte MarketPoint, 2016,
http://www2.deloitte.com/us/en/pages/energy-and-resources/articles/future-of-oil-markets-next-five-years-marketpoint.html.

6. Europe Brent spot price FOB, Energy Information Administration, January 20, 2016.

7. Lutz Kilian, Recent oil price fluctuations linked to world economy, University of Michigan working paper, http://www.lsa.umich.edu/UMICH/
econ/Home/Research/Economics%20Research%20in%20the%20Department/Kilian%20Oil%20Price%20Fluctuations.pdf, accessed June 30,
2016; Baumeister and Kilian, Forty years of oil price fluctuations; Rabah Arezki and Olivier Blanchard, Seven questions about the recent oil
price slump, iMFdirect, December 2014, https://blog-imfdirect.imf.org/2014/12/22/seven-questions-about-the-recent-oil-price-slump/#_ftn3.

8. Given and Suchadoll, The balancing act.

9. Ibid.

10. Ibid.

11. Daniel Bachman, United States Economic Forecast, Q2 2016, Deloitte University Press, June 15, 2016, http://dupress.com/articles/
us-economic-forecast-2016-q2/.

12. Aasim M. Husain et al., Global implications of lower prices, IMF, July 2015, https://www.imf.org/external/pubs/ft/sdn/2015/sdn1515.pdf.

13. Arezki and Blanchard, Seven questions about the recent oil price slump.

14. Margherita Stancati and Ahmed Al Omran, Saudi Arabia approves economic reform program, Wall Street Journal, April 25, 2016, http://
www.wsj.com/articles/saudi-arabia-approves-economic-reform-program-1461588979

15. Olusegun Awolowo, Zero oil plan and an export revolution, Guardian, March 20, 2016, http://guardian.ng/opinion/
zero-oil-plan-and-an-export-revolution/.

77
Global Economic Outlook

Economic indices
GDP growth rates (percentage, year over year) GDP growth rates (percentage, year over year)
7 15
6

5 10

4
5
3

2
0
1

0
-5
-1

-2 -10
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
10 10 10 10 11 11 11 11 12 12 12 12 13 13 13 13 14 14 14 14 15 15 15 15 16 10 10 10 10 11 11 11 11 12 12 12 12 13 13 13 13 14 14 14 14 15 15 15 15 16

US UK Eurozone Japan Canada Brazil China India South Africa Russia

Source: Bloomberg, Haver Analytics. Source: Bloomberg, Haver Analytics.

Graphic: Deloitte University Press | DUPress.com Graphic: Deloitte University Press | DUPress.com

Inflation rates (percentage, year over year) Inflation rates (percentage, year over year)
4 20

15

2
10

5
0

-2 -5
May 12 Jan 13 Sep 13 May 14 Jan 15 Sep 15 May 16 May 12 Jan 13 Sep 13 May 14 Jan 15 Sep 15 May 16

US UK Eurozone Japan Canada Brazil China India South Africa Russia

Source: Bloomberg, Haver Analytics. Source: Bloomberg, Haver Analytics.

Graphic: Deloitte University Press | DUPress.com Graphic: Deloitte University Press | DUPress.com

Major currencies versus the US dollar

1.8 125

120
1.7
115
1.6
110
1.5
105

1.4 100

95
1.3
90
1.2
85
1.1
80

1 75
May 12 Nov 12 May 13 Nov 13 May 14 Nov 14 May 15 Nov 15 May 16

GBP-USD EUR-USD USD-JPY (right axis)

Source: Bloomberg, Haver Analytics.

Graphic: Deloitte University Press | DUPress.com

78
 3rd Quarter 2016

Yield curves (as of June 27, 2016)*

US Treasury Eurozone
Japan Canada
Bonds & UK Gilts Govt.
Sovereign Sovereign
Notes Benchmark

3 Months 0.25 0.45 -0.54 -0.27 0.50

1 Year 0.47 0.30 -0.53 -0.31 0.52
5 Years 1.07 0.57 -0.53 -0.27 0.64
10 Years 1.56 1.09 -0.05 -0.17 1.16

Brazil Govt. China India Govt. South Africa

Russia*
Benchmark Sovereign Bonds Sovereign

3 Months 14.16 2.30 6.71 8.00 10.53

1 Year 13.33 2.42 6.98 - 9.88
5 Years 12.45 2.87 7.41 8.89 8.79
10 Years 12.42 2.91 7.46 9.09 8.60

Composite median GDP forecasts (as of June 27, 2016)*

South
US UK Eurozone Japan Canada Brazil China India Russia
Africa

2016 1.9 1.8 1.6 0.6 1.4 -3.5 6.5 7.5 0.5 -0.9
2017 2.3 2.1 1.6 0.8 2 0.9 6.2 7.6 1.3 1.2
2018 2.1 2.2 1.6 0.6 2.2 1.8 6.2 7.8 1.9 1.5

Composite median currency forecasts (as of June 27, 2016)*

Q3 16 Q4 16 Q1 17 Q2 17 2016 2017 2018

GBP-USD 1.47 1.48 1.48 1.49 1.48 1.52 1.55

Euro-USD 1.11 1.1 1.1 1.11 1.1 1.11 1.15
USD-Yen 110 112 111.5 112 112 114.5 113
USD-Canadian Dollar 1.3 1.31 1.31 1.3 1.31 1.25 1.3
USD-Brazilian Real 3.7 3.75 3.8 3.96 3.75 3.95 4.1
USD-Chinese Yuan 6.6 6.7 6.73 6.75 6.7 6.8 6.9
USD-Indian Rupee 67.83 68.5 68.57 68.5 68.5 68.82 67.59
USD-SA Rand 15.7 16 16.07 16.2 16 15.42 14.68
USD-Russian Ruble 66.67 68 66.42 66.75 68 65.75 63

*Source: Bloomberg MICEX rates Source: OECD

79
Global Economic Outlook

OECD composite leading indicators (Amplitude adjusted)

United United Euro South Russian

Japan Canada Brazil China India
States Kingdom area Africa Federation

Jan 13 100.0 99.9 98.7 99.7 99.6 100.5 100.7 99.4 100.7 99.5
Feb 13 100.1 99.9 98.8 99.9 99.5 100.3 100.8 99.3 100.7 99.5
Mar 13 100.2 100.0 98.9 100.1 99.5 100.1 100.8 99.2 100.7 99.4
Apr 13 100.3 100.0 99.0 100.4 99.5 99.9 100.9 99.1 100.7 99.4
May 13 100.4 100.1 99.2 100.6 99.6 99.7 100.9 99.0 100.6 99.4
Jun 13 100.5 100.3 99.3 100.8 99.6 99.5 101.0 98.9 100.6 99.5
Jul 13 100.5 100.5 99.5 100.9 99.7 99.2 101.0 98.8 100.6 99.6
Aug 13 100.5 100.8 99.7 101.1 99.8 99.1 101.0 98.7 100.6 99.8
Sep 13 100.5 101.0 99.9 101.2 100.0 98.9 101.0 98.6 100.6 100.0
Oct 13 100.5 101.2 100.1 101.4 100.0 98.8 101.0 98.6 100.5 100.2
Nov 13 100.6 101.3 100.3 101.4 100.1 98.7 100.9 98.5 100.5 100.4
Dec 13 100.6 101.4 100.4 101.5 100.1 98.6 100.9 98.5 100.4 100.6
Jan 14 100.6 101.4 100.4 101.4 100.1 98.4 100.8 98.5 100.3 100.8
Feb 14 100.6 101.4 100.5 101.2 100.2 98.4 100.7 98.5 100.2 101.0
Mar 14 100.7 101.5 100.5 101.0 100.2 98.4 100.6 98.6 100.1 101.2
Apr 14 100.7 101.5 100.4 100.8 100.3 98.5 100.5 98.6 100.0 101.5
May 14 100.8 101.5 100.4 100.6 100.3 98.6 100.4 98.7 100.0 101.7
Jun 14 100.8 101.5 100.3 100.3 100.4 98.7 100.3 98.8 100.1 101.9
Jul 14 100.8 101.4 100.2 100.2 100.4 98.8 100.2 98.9 100.2 101.9
Aug 14 100.8 101.3 100.1 100.1 100.5 98.8 100.0 98.9 100.3 101.9
Sep 14 100.8 101.2 100.1 100.0 100.4 98.8 99.9 99.0 100.3 101.6
Oct 14 100.8 101.1 100.1 100.0 100.4 98.7 99.7 99.1 100.4 101.3
Nov 14 100.7 101.0 100.1 100.0 100.3 98.5 99.6 99.1 100.4 101.0
Dec 14 100.7 100.9 100.2 100.1 100.3 98.3 99.4 99.2 100.3 100.6
Jan 15 100.6 100.9 100.3 100.1 100.2 98.1 99.2 99.3 100.2 100.3
Feb 15 100.5 100.8 100.4 100.2 100.1 97.9 99.0 99.3 100.2 100.2
Mar 15 100.4 100.7 100.5 100.2 100.0 97.8 98.9 99.4 100.1 100.2
Apr 15 100.3 100.6 100.5 100.2 99.9 97.8 98.8 99.5 100.1 100.3
May 15 100.2 100.5 100.5 100.2 99.9 97.8 98.7 99.6 100.1 100.3
Jun 15 100.0 100.3 100.5 100.2 99.9 97.8 98.5 99.6 100.0 100.2
Jul 15 99.9 100.1 100.5 100.2 99.8 97.8 98.3 99.7 99.9 100.0
Aug 15 99.7 99.9 100.5 100.1 99.7 97.8 98.1 99.8 99.7 99.8
Sep 15 99.5 99.7 100.6 100.0 99.6 97.9 97.9 99.9 99.6 99.5
Oct 15 99.3 99.5 100.6 99.9 99.5 97.9 97.8 99.9 99.6 99.1
Nov 15 99.2 99.3 100.6 99.8 99.3 97.8 97.8 100.0 99.5 98.7
Dec 15 99.0 99.2 100.6 99.6 99.2 97.8 97.7 100.0 99.5 98.4
Jan 16 98.9 99.1 100.5 99.5 99.1 97.7 97.6 100.1 99.5 98.0
Feb 16 98.9 99.2 100.5 99.6 99.3 98.0 98.4 100.2 99.5 98.3
Mar 16 98.9 99.2 100.4 99.6 99.4 98.3 98.4 100.3 99.5 98.6
Apr 16 98.9 99.1 100.4 99.6 99.5 98.8 98.4 100.4 99.4 99.2

Note: A rising composite leading indicator (CLI) reading points to an economic expansion if the index is above 100 and a recovery if it is below
100. A CLI that is declining points to an economic downturn if it is above 100 and a slowdown if it is below 100.
Source: OECD.

80
 3rd Quarter 2016

Additional resources

Deloitte Research thought leadership

Asia Pacific Economic Outlook, Q3 2016: Australia, Indonesia, Singapore, and South Korea

United States Economic Forecast, Q2 2016

Issue by the Numbers, June 2016: In whose interest? Examining the impact of an
interest rate hike

Please visit www.deloitte.com/research for the latest Deloitte Research thought leadership or contact
Deloitte Services LP at: research@deloitte.com.

For more information about Deloitte Research, please contact

John Shumadine, Director, Deloitte Research, part of Deloitte Services LP,
at +1.703.251.1800 or via e-mail at jshumadine@deloitte.com.

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Global Economic Outlook

About the authors

Dr. Ira Kalish is chief global Dr. Alexander Brsch

economist of Deloitte Touche is director of research,
Tohmatsu Limited. Deloitte Germany, Deloitte &
Touche GmbH.

Dr. Patricia Buckley is Ian Stewart is chief economist,

director of Economic Policy and Deloitte UK.
Analysis at Deloitte Research,
Deloitte Services LP.

Dr. Rumki Majumdar is a Akrur Barua is an economist

macroeconomist and a and a manager at Deloitte
manager at Deloitte Research, Research, Deloitte Services LP.
Deloitte Services LP.

Lester Gunnion is an Dr. Daniel Bachman is

economist and a senior a senior manager for US
analyst at Deloitte Research, macroeconomics at Deloitte
Deloitte Services LP. Services LP.

82

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