The document summarizes the state of the global economy, with a focus on challenges in the eurozone. It discusses: 1) How the eurozone debt crisis is spreading from southern Europe to core countries, threatening the stability of the currency union. 2) How the inability to resolve fiscal problems in the US and eurozone crisis could lead to a global economic slowdown or recession. 3) The rising risk of recession in the eurozone as fiscal austerity, credit constraints, and declining business/consumer confidence hurt growth prospects.

1. The Global Economy
Monthly letter from Swedbank’s Economic Research Department
by Cecilia Hermansson No. 8 • 30 November 2011
The debt crisis in the euro zone – from periphery to core
• The inability to resolve the euro zone’s debt problems could create a recession in
the region and complicate the global recovery. The crisis is spreading from
southern Europe to the euro zone’s core countries. The situation is growing more
serious, and even though there is a commitment to save the currency union, there
is a lack of agreement which tools to use.
• Until the third quarter the global economy was strengthening at a reasonable pace.
Leading indicators, purchasing managers indexes and confidence data are now
signalling that growth will slow, especially in the euro zone and the UK. An inability
to resolve the budget problems in the US and the crisis in the euro zone could
drag the US economy into a new recession. If tax cuts are extended, this risk is
reduced. Emerging economies are expected to slow, but not at all to the same
extent as the euro zone, where fiscal austerity, credit austerity and lower future
confidence among businesses and households are hurting the growth outlook.
The risk of recession has risen economically and politically fragile US as well as in
In recent months the debt crises in the euro zone export-dependent emerging economies.
and the US have escalated. For Europeans, the
In the following sections we review prospects for
situation is acute, while Americans are more
the euro zone, the US, Japan, China and India. We
focused on their continued confidence problems
argue that the situation is a fiscal and real economic
and growing challenges in the medium term.
challenge, and analyse how our forecasts have held
up. It should be noted that development through the
Pessimism whether euro politicians can resolve the
third quarter was relatively good, but that the
euro crisis has grown. Despite repeated pledges to
outlook is now worsening due to fiscal and credit
keep the currency union intact, there is little
austerity and declining confidence. Leading OECD
agreement which tools to use.
indicators suggest a downturn in industrial
production, which hasn’t even returned to the 2006
The inability to resolve the debt crisis is contributing
level and still has far to go to reach the pre-crisis
to growing economic pessimism. This is affecting
peak of early 2008.
the stability of the financial sector and leading to
slower growth through a loss of confidence, higher Industrial production and leading indicators in the OECD
financing costs and increased credit austerity. 15 120
Lower confidence in turn means less investment, Index Level
hiring and trade. The situation is serious, but not 10 Production Change (Y/Y) 110
hopeless. Time is running out, however, and the
5 100
longer politicians wait to make tough decisions –
like whether to utilise the ECB as their most 0 90
Percent
important tool, e.g., by providing lending to the
EFSF or directly buying debt from crisis countries – -5 80
the more the crisis will spread from the periphery to -10 70
the core. Leading Indicators
-15 60
The euro crisis could lead to a recession in the
-20 50
region while also endangering growth in an 80 85 90 95 00 05 10
Source: Reuters EcoWin
Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740
E-mail: ek.sekr@swedbank.se Internet: www.swedbank.com Responsible publisher: Cecilia Hermansson, +46-8-
5859 7720, Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897

2. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 8 • 30 November 2011
The euro zone – the global economy’s liquidity in the ECB. Furthermore, the ECB has to
biggest risk provide increased support to banks that lack
liquidity, and financial stability is threatened at the
Concerns about the euro’s future and the risk of an
same time that credit austerity is growing.
escalating sovereign debt crisis have grown in the
last month. As a result, euro zone growth forecasts The gap between interbank loan rates and short-term
have been downgraded by a number of analysts. government debt (TED spreads) in the US and Europe
We suspect we will also have to lower our growth 5,0
outlook from 0.8% next year, when growth in 4,5
Percentage Points
Germany and France – though still positive – will be USA
considerably weaker than the current 1 – 1.25%. 4,0
3,5
The most important recent events were the
3,0
changes in government in Greece, Italy and Spain,
the first two of which are now led by technocrats 2,5
who will have to launch reforms and build 2,0
confidence in their policies. UK
1,5 Sweden EMU
Despite the new governments, the financial 1,0
market’s confidence has waned and bond yields 0,5
have risen to painful levels of over 7% for Italy and Japan
Spain. Confidence in France, Belgium and other 0,0
07 08 09 10 11
core countries has declined as well. Worries that Source: Reuters EcoWin
the institutions that were designed to rescue these
crisis countries will prove inadequate are an While there is probably still a strong commitment to
indication of the severity of the problems. keep the currency union intact, there is little
agreement on which tools to use. Unless the acute
The European Financial Stability Facility (EFSF) is crisis is resolved, there is a risk it will spread to the
facing greater difficulty in terms of financing. The core countries, as evidenced by the fact that the
fact that Italy and Spain represent over 30% of its Netherlands and Finland have also seen their bond
assets, and France another 20%, shows that the yields rise at the same time that only 60% of
funds available to guarantee the crisis countries Germany’s latest bund issue was covered (perhaps
may not be enough. 1.98% was too low an interest rate considering the
growing risks in the entire euro zone and the
The most pressing need is to expand the ECB’s
intensifying debate on eurobonds, which should
mandate to buy bonds from these countries (not
also raise the risk premium for Germany).
just banks) or lend to the EFSF, which in turn can
provide guarantees. On the other hand, Italy, France and even Spain all
have more stable economies than Greece. Private
At the same time the EU Commission has
savings are higher and growth dynamics are better.
presented three eurobond proposals, which could
In addition, their governments are in better fiscal
be part of a solution to the crisis. Germany has also
shape, despite that deficits have to be reduced and
offered a proposal for a temporary eurobond
reforms have to be implemented more rapidly to
solution where debt exceeding 60% of GDP is
stimulate growth, e.g., improving labour market
pooled and paid off over 25 years with the help of
efficiencies. Spain's high unemployment speaks for
higher taxes.
itself: 45% of young adults are now out of work.
Germany is demanding closer fiscal cooperation as
Although high interest rates are straining
a condition for the changes in the ECB’s mandate
government finances, the debts of these countries
and the eurobonds, which is reasonable. Moreover,
are maturing over time. In Italy's case, over more
it is demanding changes to the EU Treaty, which
than seven years. It will take a while before it faces
could take time to get passed by the 17 member
major problems with high interest rates. On the
states.
other hand, 33 billion euro has to be refinanced in
The risk of a collapse of the currency union has January and 48 billion euro in February. The
grown, but still isn’t imminent. The situation in the situation is not as severe as it has been in the case
financial markets is serious, with rising risk of Greece.
premiums. Interbank rates have also risen, because
of which many banks are placing their surplus
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3. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 8 • 30 November 2011
The euro hasn’t weakened in a way that would much will depend on whether the crisis is resolved
suggest that its time has passed. This is partly and on growth prospects outside the euro zone.
because the situation isn’t much better in the debt-
ridden US. Both currencies have depreciated in The UK continues to slow
nominal and trade-weighted terms in the recent In the third quarter the British economy grew by
year. Another possible reason why the euro is 0.5% compared with the second quarter. Although
maintaining its strength is that banks in the euro this may not seem too bad, the figure hides a
zone are now repatriating their assets from couple of inconvenient truths. For one thing, GDP
subsidiaries in Eastern Europe and Turkey, for grew slower than normal in the second quarter due
example. to the Royal Wedding and the Japanese disaster.
For another, third-quarter growth was aided by an
A weaker euro isn't a bad thing in this situation,
inventory build-up and public spending, while the
since the growth outlook has worsened. It is
private sector foundered.
important, however, to avoid a collapse of the euro
due to a complete loss of confidence, which would Order bookings have fallen, as has business
mean a similar lack of confidence in the ECB and in confidence. Households are feeling the effects of
the ability of the countries to resolve the debt crisis. government austerity as their incomes are
squeezed by high inflation and a weak job market. It
The deterioration in the real economy is manifested
isn’t strange then that their confidence has declined
by declining orders. The purchasing managers
as well. Debts in the household sector have to be
index has now dropped below a reading of 50 in
further reduced, and a savings ratio of 7.2% is
many countries. If it continues to decline, it would
evidence of the need for debt relief and increased
indicate a new recession in the industrial sector.
buffer savings given the increased uncertainty.
There are several reasons to downgrade growth
Our previous forecast of 1.2% GDP growth for 2011
forecasts: 1) credit austerity following in the wake of
seems more or less impossible despite recent
an unstable financial sector; 2) the effects on
progress. Considering that the fourth quarter is
growth of austerity, which could exceed 1-1.25
likely to be worse, it is more reasonable to expect
percentage points depending on the decisions
growth of 0.8-0.9% this year.
ultimately made in France, Italy and Spain, where
the budgets haven’t yet been fully resolved; and 3) In the face of continued austerity and the euro
confidence in the ability of politicians to resolve the crisis, which is affecting both businesses and
crisis has faded, because of which companies and households, we expect a weak fourth quarter and
households are delaying investments and new first half of 2012. At the same time British banks
hirings and in the process further fuelling the have lent generously to public and private
downturn. borrowers in the euro zone, which now means they
have to be more cautious (credit austerity) at home
Annual GDP growth (%) in the euro zone
and that customers will pay higher interest
12,0
expenses.
9,5
The UK’s dependence on exports has increased as
Spain Greece
7,0 Ireland
a result of the crisis at the same time that the
Germany
financial sector, retail sales and the real estate
4,5 market have diminished in importance. The pound’s
Percent
depreciation compared with the period before the
2,0
crisis, i.e., from 2007, has helped to improve export
-0,5 conditions. Then again with the euro zone
Eurozone
France struggling, 2/5 of exports are at risk. In October
Italy
-3,0 business activity declined as measured by the
purchasing managers index, which fell to 47.4 in the
-5,5
manufacturing sector and 51.3 in the service sector.
-8,0
00 01 02 03 04 05 06 07 08 09 10 11 There are risks on both the upside and downside.
Source: Reuters EcoWin Inflation below the current 5% would help
It is not hard to envision another recession in crisis households, and all indications are that it is headed
countries such as Italy and Spain, but it is not as in that direction. The Bank of England will maintain
clear that Germany and even France will reach that its benchmark rate at 0.5% at the same time more
point. They still have some ammunition left, though quantitative easing is stimulating the economy. On
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4. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 8 • 30 November 2011
the other hand, public austerity, credit austerity and affected by at least 1.1 percentage points in 2012.
the euro crisis could have an even greater impact This is in addition to other measures that expire and
on the economy, because of which prospects for will reduce growth by a percentage point or more.
2012 and 2013 look even worse. The risk of
another major recession has risen, but it isn’t yet US Federal revenue and spending as well as Federal debt
our main scenario. One or more quarters of slightly through August 2011
15 350
negative growth is a likely scenario, however.
14 Total federal 325
debt
13 300
Inflation in the UK according to various measures (%)
6 12 275
USD (thousand billions)
Policy interest CPI 11 250
rate
USD (billions)
5 10 Federal 225
expenditures
9 200
CPI - services
4 8 175
Federal
CPI with 7 income 150
Procent
unchanged
3 taxes 6 125
5 100
2 4 75
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Source: Reuters EcoWin
1
CPI, excluding energy, food, alcohol and
The inability to compromise also affects
0
tobacco negotiations on the Bush tax cuts, which expire at
05 06 07 08 09 10 11 the end of 2012. Growth in 2013 and forward will be
Source: Reuters EcoWin
affected if they are not extended. The Republicans
want to extend them for everyone, while the
The US – a costly budget failure Democrats want to limit the cuts to low and medium
On November 22 we published our latest US income earners. If they are not extended at all, the
analysis, where we looked at the Super Committee budget outlook would improve by USD 3 300bn in
fiasco and its impact on growth and the budget. We the next ten years, but at the same time growth
stated at the time that GDP growth would probably would decline by 1.5–2 percentage points.
be slightly higher than our October forecast of 1.6%
for 2011 and 1.9% for 2012, i.e., two or three tenths A new plan to improve the medium-term budget and
of a percentage point higher in both years, since the debt outlook isn’t likely to have an effect until
growth prospects have improved slightly compared 2014 at the earliest. Since next year is an election
with the gloominess of the first half-year. year, negotiations won’t be held until 2013 and
won't have an impact until following years.
At the same time there are a number of risks that
deserve repeating. Although Black Friday marked However, USD 1 200bn in automatic cuts are
the start of the best shopping weekend since 2007 scheduled to take effect on 1 January 2013, in
and exports have improved, the US still faces major addition to USD 917bn agreed to immediately after
challenges, not least a low household savings rate, the Republicans consented to raise the debt ceiling
which is far from sustainable. Add to that the risk of by USD 400 + 500bn in fall 2011. These cuts will be
further deterioration in the euro zone and that the implemented over a ten-year period, but will begin
US, through its banking system and real economy, having an effect in 2013 and will hurt growth.
could very well find itself in a new recession. Four
of five Americans believe that the country still is in Although we feel GDP growth could be slightly
recession compared to when it was officially stated higher than seemed to be the case in October,
it was over, i.e., June 2009. there is plenty of reason to be cautious considering
the budget debacle and euro crisis.
A dysfunctional budget process could also hurt the
economy. The failure of the Super Committee Japan changes strategy to weaken the yen
further reduces public confidence in Washington GDP grew by 1.5% in the third quarter on a
and complicates next year’s budget negotiations. quarterly basis, but compared with the same period
The key is to reach an agreement on temporary tax last year was practically unchanged. This is slightly
cuts and extended unemployment benefits to worse than expected. There are several reasons for
mitigate the current crisis, especially in the labour the disappointment: weaker international demand
market. If they aren't extended, growth will be owing in part to the debt crises in the US and
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5. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 8 • 30 November 2011
Europe, supply problems resulting from the floods stabilised at around 78 yen per dollar during periods
in Thailand and the strong yen. Compared with the when yen demand is unusually high.
historical average for the last three decades, the
yen is now 60% stronger in nominal terms and 11% China is easing its economic policies
in real terms. Less restrictive economic policies are an indication
that the Chinese government is also worried about
Nominal and real exchange rates compared with long-term
the crisis in Europe. Cash requirements for some
average
160
small and medium-sized banks as well as for rural
150
credit unions have been reduced.
140
The fact that interest rates haven't fallen could be
130
because there are still concerns that inflation hasn't
120
declined quickly enough or could begin rising again.
110
Index
100 Should China worry about slower economic
90 growth? Lower growth is what it projected in the
80 latest five-year plan.
70
60
What would really be worrisome is if export orders
50 Nominal Effective Exchange Rate Index
fall in an uncontrolled manner and the real estate
Real Effective Exchange Rate Index market cools too quickly. The purchasing managers
40
80 85 90 95 00 05 10 index has dropped below 50, but it will probably
Source: Reuters EcoWin have to fall much further to suggest a new
recession in the export sector.
Industrial production and exports have been weaker
than expected in recent months. As a result, Change in consumer prices and lending (annual percentage)
sluggish GDP growth following the tsunami and 35,0 9
nuclear power accident will continue. 32,5 8
30,0 7
Our forecast for the current year of -0.2% will 27,5 6
probably end up a couple of tenths lower, closer to - 25,0
<--- Credit expansion
5
0.5%. Nor is it likely that GDP will grow by 2.5%
Percent
Percent
22,5 4
next year if the rest of the West continues to
20,0 3
weaken.
17,5 2
China’s relatively good growth is certainly helping 15,0 1
exports, but trade with China will probably slow as 12,5 0
well. More important is whether domestic 10,0 Consumer prices ---> -1
investments to rebuild the impacted region will 7,5 -2
00 01 02 03 04 05 06 07 08 09 10 11
actually get started.
Source: Reuters EcoWin
The Japanese central bank has tempered growth
Lower sales volume in the property market is
and inflation expectations for the current year and is
desirable, but could mark the start of a more
forecasting that GDP will increase by 0.3% and that
precipitous price decline if the outlook abroad and
consumer prices will stabilise (compared with 0.4%
in the domestic Chinese economy worsens.
GDP growth and 0.7% inflation in previous
Housing prices rose by about 2% at an annual rate
forecasts).
in Beijing in October, compared with 22% in May
The benchmark rate is being held at 0–0.1%. 2010. In 2009 prices fell for several months, and it
What's new, however, is that asset purchases are is reasonable to expect another price decline unless
being expanded by JPY 5 trillion to JPY 20 trillion in economic policies are further loosened when
order to stimulate the economy now that downside growth prospects worsen.
risks have risen. What's also new is that instead of
India – last rate hike
intervening in the currency market through large
purchases, the central bank has chosen to buy In late October the Indian central bank raised its
smaller amounts more frequently, i.e., every day. benchmark rate for the 13th time since the recent
Few experts believe that the value of the currency period of rate hikes began in 2010. Although
can be reduced, however. Possibly it can be inflation is still in the double digits, it is pointing
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6. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 8 • 30 November 2011
lower. Given weaker global growth prospects, this
will probably be the last rate hike for a while.
Growth has slowed in recent quarters, reaching an
annual rate of 7.7% in second quarter, compared
with 9.4% in the first quarter of 2010.
The investment rate has declined. In the first
quarter there was no increase at all, although
growth accelerated slightly in the second quarter. In
light of the rate hikes and declining confidence in
the global and domestic economy, the investment
rate is likely to continue to slow going forward.
Benchmark rate and exchange rates against the euro and
dollar
9,0 80
Policy Interest EUR/INR
8,5 75
rate (right)
8,0 70
Rupie to Euro och US dollar
7,5 65
7,0 60
Percent
6,5 55
6,0 USD/INR (right) 50
5,5 45
5,0 40
4,5 35
05 06 07 08 09 10 11
Source: Reuters EcoWin
China, India and other emerging economies in Asia,
Latin America, the Middle East and Africa continue
to grow at a relatively fast pace, but won’t be able to
avoid the effects of the slowdown in the West
through trade and financial markets. The absence
of major debt problems or similar imbalances
should limit any decline in their growth rates,
however.
China and India now have an opportunity to loosen
the reins on their economic policies given that
inflation is slowing, which should remain the case
since the western world faces an increasingly
dismal economic future.
Cecilia Hermansson
Swedbank
Economic Research Department Swedbank’s monthly The Global Economy newsletter is published as a service to our
SE-105 34 Stockholm, Sweden customers. We believe that we have used reliable sources and methods in the preparation
Phone +46-8-5859 7740 of the analyses reported in this publication. However, we cannot guarantee the accuracy or
ek.sekr@swedbank.se completeness of the report and cannot be held responsible for any error or omission in the
www.swedbank.se underlying material or its use. Readers are encouraged to base any (investment) decisions
Legally responsible publisher on other material as well. Neither Swedbank nor its employees may be held responsible for
Cecilia Hermansson, +46-88-5859 7720. losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’s
Magnus Alvesson, +46-8-5859 3341 monthly The Global Economy newsletter.
Jörgen Kennemar, +46-8-5859 7730
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