STRATEGY
Subprime Cirsis, Energy to Drag Worldwide Growth
January 30, 2008
Christopher Bjorke

From the Jan/Feb 2008 edition of Exchange magazine

Despite the increased uncertainty in equity markets, commodity prices and exchange rates, the outlook for the developing world's strongest performers is still good, according to a recent World Bank report. As expected, China's economy is expected to stay at the head of the pack, with projected growth of 10.8%, down somewhat from its 11.3% growth over the past year, but still stronger than any major economy.

Two thousand eight will likely be no disaster, but no picnic, either.

Economists and professionals have modest expectations for this year's economic conditions. While there are a number of large question marks that could affect 2008-how far the price of oil will rise or how low the U.S. dollar will sink --the general outlook calls for modest growth in the West and healthy growth in the developing world.

"A substantial global slowdown, led by a possible recession in the United States and trouble in the Chinese economy is clearly a risk," wrote Michael Mussa, senior fellow with the Peterson Institute for International Economics in a recent paper. "The more likely outcome for 2008, however, is moderately slower global growth, in the neighborhood of 4%."

The World Bank also forecast restrained growth for the coming year. Its projection of 3.3% is down from 3.6% in 2007 and 3.9% in 2006.

In its Global Economic Prospects 2008 report, the Bank noted that "global markets have entered a phase of heightened uncertainty" following the troubles in mortgage-backed securities in the United States.

A common outlook is an expectation of stability in the face of growing risks, such as financial turbulence in the U.S. and the spiking price of oil and other commodities.

"While global growth prospects continue to look reasonably good and global inflation appears likely to remain generally well contained, risks to global economic performance are greater than in recent years," Mussa wrote.

Trouble made in America

The big question for 2008 is how far the fallout from the housing troubles in the United States will reach? Will it spark a U.S. recession, pulling down other economies with it? Or will it be contained, and allow dampened, though respectable growth in the States?

"The largest downward revisions to growth are in the United States, which is now expected to grow at 1.9% in 2008; in countries where spillovers from the United States are likely to be largest; and in countries where the impact of continuing financial market turmoil is likely to be more acute," according to the IMF report.
BMO Capital Markets Chief Economist Michael Gregory said that due to Canada's trade dependence on its southern neighbor, the subprime crisis puts its own economy under stress.

"The downturn we are seeing in the U.S. housing market, which just seems to deepen day by day, is not only critical for the U.S. economy, but because of that, also critical for the Canadian economy," Gregory said. "Our estimation is that we have yet to hit bottom in the housing sector. Probably we've got several more quarters of continued contraction ahead."

Mussa's paper expects mediocre outcomes for the United States in 2008.

"Looking forward through the end of 2008, the most likely prospect is that the U.S. economy will continue to grow sluggishly at about 2% annual rate," he wrote. "Specifically, after a weak fourth quarter in 2007, I forecast that U.S. real GDP will increase 2.25% on a Q4/Q4 basis during 2008. This implies that year-over-year growth for 2008 should also be about 2%."

Developing prospects

Despite the increased uncertainty in equity markets, commodity prices and exchange rates, the outlook for the developing world's strongest performers is still good, according to the World Bank's report.

"Notwithstanding the increased volatility, the impact on developing countries has been relatively minor to date," according to the report. "Risk premiums have escalated, but remain relatively low in a historic context, and capital inflows remain plentiful, although bank lending has dropped off. Aggregate growth in developing countries continues to be strong, reflecting improved fundamentals in many countries, sizable revenues from commodity exports and continued access to international finance at moderately higher cost."

As expected, China's economy is expected to stay at the head of the pack, with projected growth of 10.8%, down somewhat from its 11.3% growth over the past year, but still stronger than any major economy. The other developing giant, India, is expected to grow at a rate of 8.4%, according to the World Bank.

"Because developing economies have been less affected by the fallout from the subprime crisis than high-income economies, the anticipated slowdown of growth in 2008 should be less pronounced," according to the Bank's report. "Gains among developing countries are projected to slow from 7.4% in 2007 to 7.1% in 2008."

However, according to Mussa, China's continued double-digit growth cannot be maintained long and demands some economic or political adjustment.

"Inflation has been accelerating in China. Rising food prices had a lot to do with this, but the inevitable pressures from continued very rapid growth are also an important part of the story," Mussa wrote. "The fact is that it is very difficult to maintain monetary control when the country is being flooded with gigantic inflows of foreign exchange reserves that are the consequence of resisting currency appreciation."

Continuing investment

Companies are expecting a tougher time in 2008, but plan to continue to hire and invest, according to a quarterly survey by the McKinsey Quarterly.

"A bit more than a third of the respondents to the survey think that economic conditions in their countries will remain the same over the next six months; 37% believe that conditions will deteriorate, compared with only 13% six months ago."

Despite less-than-desirable conditions, companies still expect that they will expand, and will be more likely to invest in research, acquisitions and equipment, according to McKinsey.

Responding to the developing world's relative immunity to the slowdown in North America and Europe, executives are looking forward to more hiring and investment there.

"The proportion of companies planning to raise their recruitment and training investments soars to 54% in the Asia-Pacific and 62% in developing markets," according to McKinsey, which also found the outlook for new hires to be strongest in the Asia-Pacific region.

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