Capital flows to the emerging markets are diminishing
The latest figures available reveal a somewhat slower rate of activity in the emerging economies than expected, especially in China. The latest figures available reveal a somewhat slower rate of activity in the emerging economies than expected, especially in China. In addition to the relatively restrained tone of the economic cycle is the change in the Fed's rhetoric which, on seeing continued improvement in the US labour market, has set a time limit for its latest round of quantitative easing (QE3). Both factors lie behind the sale of emerging assets which, should they persist, might complicate the reacceleration of the most vulnerable economies.
UNITED STATES
Within this context of emerging economy containment, US GDP in the first quarter was revised downwards (from 1.8% to 1.6% year-on-year). An unexpected revision that, nevertheless, does not alter our scenario of a moderate recovery and has led us to minimally revise our growth forecast for 2013 (from 2.0% to 1.9%) due to base effects. Most of this downward correction in the first quarter figure can be explained by the revision of private consumption, specifically services, although they are still the main driving force. For its part productive investment, also revised downwards, should be boosted sooner or later by improved financial conditions and corporate earnings that continue to be high.
The timeline established by the Fed for the progressive normalization of its monetary policy supports this view of a sustained recovery with fewer risks of relapse. On 19 June, the Federal Reserve Chairman presented a possible timeline to withdraw the QE3 which would begin towards the end of 2013 and finish mid-2014 provided the labour market continues to evolve positively. Specifically, the Fed conditions the end of its programme on an improved unemployment rate of 7% and any subsequent hikes in interest rates on an unemployment rate of 6.5% (in May this stood at 7.6%) (see the Focus «The Fed: from words to action?» and «The Federal Reserve's controversial "exit strategy"»). All this within a context of low inflation, leaving room for expansionary policies if necessary.
Most activity indicators for the US economy confirm that its recovery is progressing. The Conference Board consumer confidence index rose by 7 points in May, more than expected, reaching its highest level since January 2008 (76.2). A large part of consumption's vitality is due to the continued recovery in real estate, albeit still with risks. House prices continued to rise and have now accumulated 15 consecutive months of increases. Moreover, while housing starts grew, the sale of second-hand housing increased by a healthy 12.9% year-on-year. However, the restrictive shift attributed (probably prematurely) to the Fed has led to a significant increase in the average mortgage interest rate which could jeopardize this recovery in real estate.
JAPAN
While some are setting a date for their expansionary measures to end, others are just beginning. This is the case
of Japan and its Abenomics (the programme promoted by Prime Minister Shinzo Abe, hence the name, based on monetary, fiscal and structural policies), whose aim is to free the Japanese economy from the deflationary trap and firmly boost growth. For the moment, the monetary expansion that started in February 2013 has spurred on Japanese exports (in value although not in volume) as the yen has depreciated. Specifically, in May exports grew by 7.9% year-on-year compared with a drop of 2.9% in 2012.
Given this expansionary situation, Japan revised upwards its growth figure for the first quarter of 2013 (from 0.9% quarter-on-quarter to 1.0%). This revision raises our own growth forecast for the whole of 2013 to 1.8% (previously 1.6%) due to base effects. However, whether this growth continues in 2014 will depend on the structural reforms of Abenomics and on whether the VAT hike is implemented in 2014 which was approved a year ago and which might halt or slow down the current expansionary tone. Similarly, the upward revision of the scenario of macroeconomic projections given by the central bank could result in a smaller expansion of its balance sheet than initially expected. Should this happen, it would also lessen the expansionary impetus of the first few months of 2013.
For the time being, the third pillar of Abenomics is not compelling. The Prime Minister called for the need to «reactivate» the Japanese economy by encouraging private and foreign investment, protecting innovation and entrepreneurship and improving regulations. However, some of the actions proposed by Shinzo Abe on 6 June (the establishment of special economic zones, tax discounts for FDI or fewer restrictions on drug sales) are raising doubts as to the true extent of the structural reforms. More substantial measures are expected to be announced after July's elections (for the upper house).
Most analysts agree that far-reaching labour reforms need to be carried out which among other things, should dilute the current duality (workers who have acquired extensive rights co-exist with others that have much less protection). Similarly, women need to be encouraged to enter the labour market, with a significant margin for improvement in Japanese society (below 50%, compared with 57% in the USA or 53.4% in Spain). A third line of action should focus on reducing the excessive corporate savings. To this end, a business framework with greater shareholder power in order to avoid cash hoarding and/or a fiscal framework that penalizes such hoarding are two possible remedies. Continuing in the fiscal sphere, measures are also required that ensure public debt is sustainable in the long term (larger than 200% of GDP), as well as offsetting the ageing of the population.
EMERGING ECONOMIES
On the other side of the Pacific, Mexico is actually making headway in its structural reforms (see the Focus «Mexico: from reform to reform»). Although these reforms could establish greater growth potential in the medium term, the macroeconomic stability promoted over the last few years will be of vital importance in the short term, especially if the recent retreat of financial flows from emerging markets continues.
On the other hand Brazil, Turkey and India, with significant external and fiscal imbalances and without a rigorous reform plan underway, could compromise their economic growth rate. In Turkey, the internal conflicts faced by the government and society, together with the impact of the Fed, have highlighted its weakest points: excessive dependence on capital inflows (required to finance a current account deficit of around 6%) and ever-present inflationary tensions. Also affected by popular dissent, Brazil has little room to manoeuvre in fiscal or monetary terms to sort out both its social tensions and the complex macroeconomic situation it is facing, with inflation running high and growth just starting to recover. With regard to India, among the large emerging countries this is the economy with the largest current account and fiscal imbalances and the one encountering the most difficulty in achieving the political consensus required to promote structural reforms.
Signs of moderation and liquidity tensions raise doubts regarding China's upswing. Weak-looking activity indicators and an institutional desire to change the country's model (towards more balanced growth) have led us to revise downwards our growth forecasts for 2013 (from 7.9% to 7.6%) and 2014 (from 8.4% to 7.8%). Since the Chinese government lowered its 2013 growth target in March to 7.5%, the latest decisions from the executive corroborate its desire for a change in model; its aim is to rely more on domestic consumption and less on exports. Although this would result in more balanced and sustainable growth in the medium term, the transition will be lower growth in the short term and pose downward risks. In this respect, recent actions by the Chinese authorities must be interpreted through this prism of balanced growth. For example, the initial reticence of the People's Bank of China (PBOC) to provide liquidity to offset the sharp rise in interbank rates could be interpreted as a warning to financial institutions to moderate the increase in credit, especially outside the official, regulated system (shadow banking, see the Focus «China: interbank tensions»). Although this goal is welcome, in the short term it intensified liquidity tensions. Nonetheless, when these tensions increased too much, the PBOC did not hesitate to announce its prompt intervention.
