nordic outlook 1305: fight against economic slowdown escalates

7/30/2019 Nordic Outlook 1305: Fight against economic slowdown escalates

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Economic policy shit will boostgrowth in 2014

Increasing defationary pressurein Europe

Nordic OutlookEconomic Research May 2013


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Contents

Nordic Outlook May 2013 | 3

International overview 5

Theme: Fiscal policy 11

The United States 13

Japan 17

Asia 19

The euro zone 22

The United Kingdom 27

Eastern Europe 28

The Baltics 29

Sweden 30

Theme: Swedens changing labour market 34

Theme: Swedish ination targeting policy turns 20 35

Denmark 36

Norway 38

Finland 41

Economic data 43

Boxes

US: Net deleveraging will soon be over 14

US: Ageing population will strain public nances 16

Japan: Abenomics what it will deliver 17

Japan: Risks to nancial market & world economy 18

China: Plenty o long-term risks and challenges to growth 20

Euro zone: One year with Hollande in the lyse Palace 24Euro zone: The crises in the euro zone at a glance 26

Sweden: Rigid bureaucracy hampers housing construction 31

Norway: Dont blame demand or subdued ination 39

Finland: Why is the recovery weaker in Finland than Sweden? 42


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4 | Nordic Outlook May 2013

Economic Research

This report was published on May 21, 2013.

Cut-o date or calculations and orecasts was May 16, 2013.

Robert Bergqvist Hkan FrisnChie Economist Head o Economic Research+ 46 8 506 230 16 + 46 8 763 80 67

Daniel Bergvall Mattias BrurEconomist Economist+46 8 763 85 94 + 46 8 763 85 06

Ann Enshagen Lavebrink Mikael Johansson

Editorial Assistant Economist+ 46 8 763 80 77 + 46 8 763 80 93

Andreas JohnsonEconomist+46 8 763 80 32

Gunilla Nystrm Ingela HemmingGlobal Head o Personal Finance Research Global Head o Small Business Research+ 46 8 763 65 81 + 46 8 763 82 97

Susanne Eliasson Johanna WahlstenPersonal Finance Analyst Small Business Analyst+ 46 8 763 65 88 + 46 8 763 80 72

SEB Economic Research, K-A3, SE-106 40 Stockholm

Contributions to this report have been made by Thomas Kbel, SEB Frankurt/M and Olle Holmgren,Trading Strategy. Stein Bruun and Erica Blomgren, SEB Oslo are responsible or the Norwegian analysis.Thomas Thygesen and Jakob Lage Hansen are responsible or the Danish analysis.


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International overview


Recovery with increasingly clear divergences Broad recovery will lit US economy in 2014

Central banks testing limits

Increased deation risks in euro zone

Fiscal austerity being eased

Small upturn in bond yields

USD appreciating against both EUR and JPY

The world economy is on its way towards recovering. Thegrowth rate will gradually rise in 2013 and 2014, but the recov-ery is divergent and anaemic. The main actors on the plusside are cyclical orces and economic policy. Global inventorylevels are squeezed and corporate balance sheets are strong. Inthe United States, the housing market and capital spend-ing are rebounding while household debt levels are now closeto long-term equilibrium. Emerging economies will also ac-celerate cautiously, although several important countries havesuered reversals. Central banks are setting new monetaryrecords. Their actions are ensuring historically low interest

rates and an unlimited supply o liquidity. Stock markets havereacted positively, and rising household wealth is benetingprivate consumption in many countries. A shit in attitudes to-wards austerity policy is also now under way. In the euro zone,crisis-hit countries are being granted longer respites to achievetheir targets. This means that governments are abstaining romunveiling new belt-tightening measures.

Despite many positive orces, the global recovery is surroundedby continued uncertainty. The downside risks are mainlyconnected to the major problems o the euro zone. Al-though a number o countries have made progress in terms ocompetitiveness and oreign trade imbalances, negative orces

continue to predominate. Many economies are still in recession.Unemployment will continue to rise in the next ew years, lead-ing to persistent political uncertainty. The integration processis proceeding sluggishly and today there is still a risk that jointand national institutions will be incapable o making necessarydecisions to ensure the survival o the euro. High private andpublic sector debt in the largest industrialised countries is alsoan impediment to long-term growth. Chinas rapid growthis also associated with risks, especially in the credit market.Its economic policies are being re-assessed and their contoursremain unclear.

In terms o global economic and nancial policies, Japanis a joker in the pack. The international community and theJapanese themselves have given the green light to Abenom-ics, a very expansionary set o scal and monetary policiesnamed or Prime Minister Shinzo Abe. During our orecast

period, 2013 and 2014, these policies will signiy a positiveinjection in the world economy by means o higher growth anddownward pressure on global interest rates. In the long term,Japan instead constitutes a risk actor. In order or Abenomicsto succeed in a sustainable way, the weakening o the yen mustresult in higher pay increases, thereby ending Japans deationspiral. Restructuring policies that lead to higher labour orceparticipation, especially or women, are another important ele-ment o this strategy.

Overall, we expect GDP growth in the 34 countries o the Or-ganisation or Economic Cooperation and Development(OECD) to end up at 1.3 per cent in 2012 and in 2013 and toaccelerate to 2.3 per cent in 2014. In emerging economies,there will be an acceleration to 5.3 per cent in 2013 and 5.6 percent in 2014. For the overall world economy (in terms o pur-chasing power parities, PPP), growth will rise rom 3.3 percent in 2012 to 3.6 per cent in 2013 and 4.2 per cent in2014. Compared to Nordic Outlookin February, this representsa downward adjustment in 2013 but a more rapid upturn in2014.

Our scenario o low international price pressures remains inplace: i anything, ination has provided downside surpris-es. This gives central banks substantial room or manoeuvre.Looking ahead, low resource utilisation and downward pressureon wages and salaries indicate that the low-ination environ-ment will persist. Ination expectations are stable and com-modity prices have recently shown a alling trend. Especially inEurope, there is a mounting risk o excessively low ination withelements o Japanese economic policy problems.

Central banks stretching their limitsLow interest rates, rising ination expectations and highershare prices indicate that economic policies are inspiring con-dence. But this is a high-stakes game; it is all happening


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in an environment o economic, nancial and political regimechanges in the atermath o globalisation and global recession.Decision makers around the world are seeking new nationaland international consensus views about such matters as thecauses and eects o ination, nancial inrastructures and theinterplay among monetary, scal and regulatory policies.

Unconventional monetary policy is continuing in an ex-pansionary direction. The US Federal Reserve is keeping itskey interest rate at 0-0.25 per cent, while its monthly USD 85billion in purchases o government and mortgage-backedsecurities will be cautiously phased out only in early 2014.The Bank o Japan and Bank o England are not expected totake urther steps beyond the instruments/volumes alreadyannounced. The European Central Bank (ECB), like Swe-dens Riksbank, will lower its key interest rate by another25 basis points, but we do not expect the ECB to introducenegative interest rates due to the risk o undesired eects inthe unctioning o the interbank market and systemic technical

problems. In emerging economies, interest rates will remainrelatively stable at signicantly higher levels.

Central banks are grappling with three main questions that willshape monetary policy in a slightly longer perspective:

New ination pattern? Central banks today are uncertainabout the causes o ination. The size o the output gap isdifcult to determine ater a relatively long period o low capitalspending and high unemployment. Meanwhile the monetarisa-

tion o economies poses new risks. Low ination and inationexpectations make it possible to continue pursuing a low inter-est rate policy with increased ocus on growth and new jobs,but the risk o new nancial bubbles may become a problem.

Distorted pricing? Long-lasting monetary stimulus increasesthe risk o incorrect pricing o credit and market risks. It is clearthat riskier assets have risen in value with the help o liquidityand low interest rates and that nancial market players areunder pressure to ll their balance sheets with more risk.

Macroprudential tools? Instruments that can directly inu-ence credit volume by means o regulations and requirements

that govern the balance sheets o banking systems (size/com-position) will play a bigger role in the uture. But today there isdisagreement at both the national and global level about theeectiveness and reliability o various instruments. The alloca-

tion o responsibility among governments, central banks andregulatory authorities is also unclear in most countries.

The eectiveness and impact o monetary policy depends onscal credibility. A theme article (page 11) in this issue discussesin greater detail the short- and medium-term scal policy shitin a more neutral direction that is now on its way to beingimplemented. It is important or this to be supplemented withrestructuring measures and long-term plans to bring down gov-ernment debt. We can also discern certain signs that monetarypolicy is being increasingly subjected to political control. I thistrend continues, it may drive up uture ination expectationsand interest rates.

Continued US upturn ater temporary slumpThe underlying conditions or a lasting US economic upturn areimproving. The housing market is in the process o recover-ing in earnest, while by late 2013 household debt will declineto what we view as an equilibrium level. Debt will have allen

rom a peak o 130 per cent o annual disposable income toabout 100 per cent. Looking ahead, this will lay the groundworkor stronger private consumption. A renaissance or Americanindustry, especially in the energy sector, is another reason wehave revised our GDP growth orecast upward to 3.2 percent in 2014. This is higher than both trend growth and thecurrent consensus orecast.

During the next ew quarters, however, we oresee acertain slowdown. Several leading indicators have allen

in recent months, and the sharp 2013 US scal tightening isequivalent to about 2 per cent o GDP: a somewhat more se-vere headwind than we had previous expected. GDP growththis year will thus reach only 2.0 per cent.

The US labour market will continue to improve at a airly slowpace. Although the April gure was better than expected,during the next ew quarters the growth slump will aect em-ployment. Companies are also trying to restore productivitygrowth and prot margins, thus hampering job growth. Weexpect employment to increase by an average o 140,000 jobsper month in 2013. The 2014 gure will be 220,000. Labour

market participation will continue to all. By the end o 2013it will be at its lowest level in 30 years. This is one reason whyunemployment will all somewhat this year. It will then continuedownward to 6.6 per cent in December 2014. Unemployment


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will thus remain above the Feds 6.5 per cent benchmarkthroughout our orecast period.

Global GDP growthYear-on-year percentage change

2011 2012 2013 2014

United States 1.8 2.2 2.0 3.2Japan -0.6 2.0 1.7 1.4Germany 3.2 1.0 0.3 1.3China 9.3 7.8 7.9 7.7United Kingdom 1.0 0.3 1.1 1.6Euro zone 1.6 -0.6 -0.7 0.7Nordic countries 2.3 1.0 1.0 2.2Baltic countries 6.4 4.1 3.3 3.9OECD 1.8 1.3 1.3 2.3Emerging markets 6.3 4.9 5.3 5.6World, PPP 3.8 3.3 3.6 4.2World, nominal 3.1 2.6 2.9 3.5Source: OECD, SEB

Slowdown occurring as planned in ChinaAter a recovery in Asian emerging economies, activity againslowed early in 2013. We expect growth to be somewhat belowtrend during the next couple o years, but still signicantlyhigher than in the OECD countries.

GDP growth in China slowed to 7.7 per cent during the rstquarter. This gure led to disappointment in nancial marketsbut is in line with the ofcial growth target o 7.5 per cent in2013, a rate we believe is equivalent to trend growth. The con-tribution rom consumption exceeded that rom capital spend-

ing, another step in the right direction towards a growth modelbased to a greater extent on domestic consumption. Lookingahead, we expect growth to accelerate slightly, averaging 7.9per cent in 2013 and 7.7 per cent in 2014.

Chinas leadership change has now been ormally completed,but it is still too early to determine how willing the newleadership is to implement reorms. In the near uture,economic policy makers will ace a dilemma because creditgrowth remains at a high level despite the economic slowdown.Credit expansion outside traditional bank lending is a particularsource o concern. Since late 2012 the central bank has usedrepo transactions to withdraw liquidity. Our assessment is that

the bank will hold o on raising its key interest rate until late2013, when a 25 basis point hike to 6.25 per cent will occur.

Economic activity in India probably bottomed out in theourth quarter o 2012, when it reached a weak 4.4 per centyear-on-year rate, but there are not yet any clear signs o recov-ery. Purchasing managers indices, or example, are well belowtheir historical average. Overall, though, we still believe GDPwill rise 5.5 per cent in 2013 and 6.0 per cent in 2014.

A sizeable government budget decit rules out scal expan-sion, but the slowdown in ination over the past ew monthsprovides some support. In April, ination (WPI) was 4.9 per

cent, the lowest gure since late 2009. So ar the central bankhas lowered its key interest rate three times, and we expectmore rate cuts during the second hal o 2013.

Euro zone crisis rolls onDevelopments in the euro zone crisis are characterised byboth positive and negative trends. Crisis-hit countries haveprogressed quite ar in improving their external balances, andseveral countries have also substantially adjusted their costsituation. Yet the peripheral euro zone countries Cyprus,

Greece, Ireland, Italy, Portugal and Spain, which together ac-count or 40 per cent o the currency areacontinue to showa dangerous combination o weak growth, high bond yields,continued large budget decits, high government debt andpolitical instability. Because o these serious challenges, theuture o the euro project remains uncertain.

The euro zone economic outlook is weak due to continuedadjustments in balance sheets, especially in southern Europe.Unlike the US, the household sector still aces most o thedeleveraging process aimed at bringing its debts down to morereasonable levels. Financially, borrowing costsand solvencyriskor governments and banks have been lowered sharplywith the help o the ECBs Long-Term Renancing Operation(LTRO) and Outright Monetary Transaction (OMT) programmesand the European Stability Mechanism (ESM), a bail-out und.Politically, some restructuring policies have begun to bearruit, but there are lingering questions about the ability ogovernments and parliaments to stick to the decisions theyhave made, while also making new decisions about growth andrestructuring policies. In addition, steps towards a euro zonepolitical union seem to be shorter and slower. Socially, theeuro zone crisis is reected by continued rising unemploymentin several o the crisis-hit countries.

One undamental problem in southern Europe is that thetransmission mechanism is not working. There are variousreasons why even solvent companies have difculty gettingloans. Banks are squeezed by undercapitalisation, low protlevels and a growing percentage o bad loans. Home prices arecontinuing to all, or example in Spain, and additional down-ward adjustment remains in some countries. Borrowing costsor companies in euro zone crisis countries are also about 2percentage points higher than in other euro zone countries,adversely aecting the competitiveness o these companies.

The task o creating a banking union aimed at decouplingdebt-ridden governments rom weak banks is stumbling a bit.

Looking ahead, we also expect Spain and Slovenia to receivesupport in order to recapitalise the banking sector.

Overall, we predict that the euro zone economies will show zerogrowth in the third quarter ater a downturn in the rst hal o2013. Not until the ourth quarter will GDP increase. Measuredas annual averages, GDP will all by 0.7 per cent in 2013and then increase by 0.7 per cent in 2014. Because theeconomy will again be growing at below trend in 2014, unem-ployment will continue upward. There are major dierencesamong euro zone countries, but even the German export sectoris now being aected by the crisis. GDP growth in Germany willend up at a low 0.3 per cent this year and then increase to 1.3

per cent in 2014. The French economy will largely be stagnantin both years.


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Symmetric risk pictureAs in the February Nordic Outlook, we view the risks to ourmain scenario as symmetric. Despite an upward revision inour growth orecast or the US, upside potential still pre-dominates. Rising wealth due to both higher home and shareprices may contribute to an even clearer consumer-led recovery

in the US.

On the downside, the main risks are that the economic andpolitical crisis in the euro zone will be deeper than we ex-pect in our main scenario. We also see certain downside risksin our orecast or the Chinese economy. This perhaps mainlyconcerns the longer-term eects o demographic changes,but during our orecast period, credit market turbulence mayalso create difculties or economic policy makers in keepinggrowth at the desired level.

Alternative scenariosYear-on-year percentage change 2013 2014

A. Deeper euro zone crisis/Chinese risks (15%)United States 1.5 1.7Euro zone -1.5 -1.0OECD 0.5 0.8Emerging market economies 4.3 4.4B. US-led recovery (15%)United States 3.2 4.5Euro zone 0.5 2.0OECD 2.5 3.5Emerging market economies 6.0 6.7

Overall, we estimate the probability o our main scenario at 70

per cent, while assigning a 15 per cent probability to bothalternative scenarios. This implies a lower probability or thealternative scenarios than previously. The reason is that wehave already raised our basic orecast o US growth. On thedownside, the lower probability is due to the Japanese stimuluspolicy and increased credibility or ECB measures.

Divergent trends in the Nordic countries tooRecenteconomic signals indicate more divergent trends in theNordic region as well. Even though the euro has weakened, theDanish and Finnish economies are characterised by stagna-tion. In both countries, slumping exports are combined with

sagging domestic demand. GDP will grow this year by 0.2 percent in Denmark, while a similar downturn will be recorded inFinland. One bright spot is that a rapidly alling ination ratewill strengthen real household income, which will help push upgrowth in both countries to 1.6 per cent next year.

Nordics and Baltics, GDP growthYear-on-year percentage change

2011 2012 2013 2014Sweden 3.7 0.8 1.3 2.5Norway 1.2 3.1 1.7 2.4Denmark 1.1 -0.5 0.2 1.6

Finland 2.8 -0.2 -0.2 1.6Estonia 8.3 3.2 3.3 3.7Latvia 5.5 5.6 3.5 4.8Lithuania 5.9 3.6 3.2 3.5Source: OECD, SEB

In Sweden, and especially in Norway, the domestic economyis signicantly more resilient. This helps maintain growth to agreater degree than in Western Europe generally, even thoughexports and investments are being hampered by weakinter-national economic conditions and appreciating currencies. In2013, GDP will increase by 1.3 per cent in Sweden and by 1.7 per

cent in Norway. Then growth will accelerate in 2014 to around2.5 per cent in both countries.

Baltic countries again topping EU growthFor the third straight year, in 2013 the Baltics will be the astest-growing economies in the EU, though activity is expected tocool in Latvia and Lithuania. Meanwhile growth in Estonia willremain almost unchanged rom 2012. Next year, Latvia will stayin the lead, with a growth rate at 4.8 per cent, while Estoniasgrowth rate will be 3.7 per cent and Lithuanias 3.5 per cent. In2013-2014 growth will be driven mainly by private consump-tion, but exports will also increase at a decent pace thanks togood competitiveness ater earlier internal devaluations. In

Estonia, however, cost pressures are beginning to crop up inthe wake o high wage and salary increases. Ination will slowin all three countries but remain above 3 per cent in Estonia.We are sticking to our assessment that Latvia will receive thegreen light or euro zone accession in 2014, based on thissprings evaluation by the European Commission and the ECB.We believe Lithuania has a 50 per cent chance o achieving itstarget o euro zone accession in 2015, but it may be difcult tobring down ination ast enough to stay below the maximumqualiying level one year rom now.

Divergent commodity price trendsThe outlook or commodity prices is mixed. In the past year,

commodity prices have been sustained by increased risk appe-tite and investors search or higher returns. In addition, varioussupply disruptions, or example weather-related disruptions inproduction, have pushed up prices.

In February 2013 the upward price trend, which had been underway since the ourth quarter o 2011, came to an end. Yet evenater a correction, commodity prices are generally at historicallyhigh levels. The price correction has been driven by renewed

worries about global growth, especially in ast-growing econo-mies such as China. In the background there are also positivesupply eects ollowing the large investments o recent years in


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production capacity. In addition, there are currently large inven-tories o some commodities, such as copper. The sharp pricedecline or gold during the springa gradual downturn beganas early as the end o 2012is due to diminishing worries thatcentral bank stimulus programmes will generate ination downthe road.

Our main orecast o a gradual recovery in the world economyprovides a platorm or relatively stable commodity priceperormance in 2013 and 2014. Gold and agricultural prod-ucts are exceptions, with downward price pressures.

During the past two years, oil (Brent) has traded at a relativelystable average level o USD 105 per barrel. In 2012, global oildemand rose by 0.9 million barrels per day, while production in-creased by 2.5 million barrels. This led to a build-up o reserves.The Organisation o Petroleum Exporting Countries (OPEC)wants oil prices o close to USD 100/barrel and still has enoughclout to control price levels. Our oil price orecast is USD 110/

barrel or both 2013 and 2014, as yearly average.

Mounting deation risksInation has mainly provided downside surprises early in 2013.Falling commodity prices have been an important actor behindthis. In addition, various tax hikes in the euro zone have disap-peared rom the 12-month statistics. But a broader downturn incore ination is discernible as well. Ination expectations havealso allen in recent months and are now close to their lowestlevels o recent years. In Japan, however, the governments newpolicy has succeeded in its ambition o raising ination expec-tations. Actual prices are still alling.

Although commodity prices are now stabilising, we expectcontinued downward pressure on ination. Pay increases inthe US have admittedly risen somewhat, but in Western Europewe oresee a alling trend. Our orecast implies that the eurozones Harmonised Index o Consumer Prices (HICP) will dropbelow 1 per cent late in 2013. German ination is now also ataround 1 per cent, which is making the rebalancing process inthe euro zone more difcult.

Downward pressure on ination is illustrated by the act that

the Swedish, Norwegian and European central banks wererecently orced to make signicant downward revisions in theirination orecasts. This implies greater room or sustaining

growth and the labour market. But alling ination also impliesrisks and policy dilemmas. The euro zone is now beginningto enter a deationary spiral with Japanese elements,which may delay economic recovery and lead to a new wave oprice declines in the housing market. In Norway and Sweden,the dilemma or central banks will be dierent. They have room

or urther interest rate cuts, but then risk pushing up homeprices and household borrowing urther. In this environment,there is an increasing need or eective macroprudential su-pervision tools ( instruments to regulate credit volume) that canease the burden on central banks.

Long-lasting low interest rate environmentThe global low interest rate environment will continue or thenext two years. During the spring o 2013, G7 interest rateshave again been pushed downward towards historically lowlevels. German 10-year sovereign bond yields have even comeclose to setting a new record low o less than 1.20 per cent. Thismeans that the bond market has deed the new stock marketrecords and worries that extreme global monetary stimulus willlead to higher long-term ination pressure.

As long as the market has condence in economic policiesand in a continued low-ination environment, interest rateswillremain depressed along the entire yield curve . Centralbanks have sufcient tools, including almost unlimited capacityor market intervention aimed at enorcing their promises olow interest rates. Continued conversion risk, albeit lower thanearlier, is helping push down interest rates in core euro zonecountries. The risk o rising interest rates and yields is mainlyassociated with possible negative reactions by credit ratingagencies to more exible attitudes towards austerity policiesand the act that the independence o central banks is beingquestioned to a greater extent.

We expect long-term yields to rise cautiously by a totalo 40 to 60 basis points between now and the end o 2014.German long-term (10-year) sovereign bond yields are thusexpected to be 1.80 per cent at the end o 2014, and their UScounterparts 2.50 per cent. Partly due to higher key interestrates, we oresee somewhat higher long-term yields in Norway

and Sweden. The yield spread against Germany at the end o2014 will be 75 basis points in Norway and 20 points in Sweden.


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The stock market will continue risingThis spring, the stock markets in such developed economies asthe US, Germany and the UK have reached record levels despitevarious economic disappointments in the US as well as Europe.In particular, the German stock market has perormed stronglyin the past six months, largely driven by a brighter outlook in

the banking sector. Commodity-heavy stock markets in coun-tries like Brazil and Russia, however, have moved in the oppo-site direction. The global stock market (MSCI) has gained 11 percent so ar in 2013 and 24 per cent in the past 12 months. Posi-tive driving orces mainly include new monetary easing bycentral banks and the absence o signals about exit poli-cies. In addition, quarterly company reports have mainly deliv-ered upside surprises, ending up above or in line with expecta-tions. They have oten included cautiously optimistic utureguidance.

Our conclusion about the stock market trend in the comingyear is generally the same as during the past six months: cau-tiously positive. Valuations are not too high, we would arguethat the levels are normal considering the current state o thebusiness cycle, our outlook and the alternatives. Although thegrowth picture is somewhat unclear in the short term, we ex-pect the stability o the US recovery to sustain global risk ap-petite. Low ination and stable ination expectations also addpredictability and cause no major changes in the expansionarypolicies o central banks. Milder austerity policies contributeto a avourable stock market climate as well. At the same time,

the attractiveness o alternative asset classes such as corporatebonds and xed income securities with narrow credit spreadsand historically low yields is diminishing. Taken together, thisprovides continued support or stable and rising stock marketsahead.

Central banks determine currency trendsLooking ahead, the various monetary policy strategies chosenby central banks will be the most important driving orce orthe oreign exchange (FX) market. We expect the US dollar tobecome stronger during our orecast period, reaching USD 1.20per euro by the end o 2014. The dollar will be sustained byan improved US economy and by the Fed, which we expectto begin phasing out its monthly purchases o government andmortgage-backed securities starting early in 2014. In addition,the euro will be pushed down by the many-acetted problems

o the euro zone. The US dollar has shown signs o moving in7-8 year long-term trends. The situation today means that in e-ective terms, the dollar is already at weak levels. Trend analysissupports a orecast o a stable to stronger dollar ahead.

Meanwhile we expect the Bank o Japans monetary policy toincrease the pressure on Japanese pension companies to seekreturns and exposure abroad, or example in European and USxed income and stock markets. The ow eect is difcult toassess, but our scenario is that global portolio managers nor-mally currency hedge their xed income portolios. This meansthat the nancial market should assume that BoJ policies willhave their greatest impact on xed income and to a signi-cantly lesser extent in the FX market. Our orecast is that theUSD/JPY rate will be 110 at the end o 2013 and 120 at the endo 2014, primarily based on the appetite or the yen as a nanc-ing currency. But unlike a decade or so ago, competition todayor cheap nancing currencies is considerably tougher, withmany countries aiming at both zero interest rates and weak cur-

rencies.

We expect both the Swedish krona and the Norwegian kroneto appreciate during our orecast period. Key interest rate di-erentials will buoy these two Nordic currencies, though not asmuch as a ew months ago. We expect the EUR/SEK rate tobe 8.35 at the end o 2013 and 8.10 at the end o 2014. Ourcorresponding orecasts or the EUR/NOK rate are 7.45and 7.35. Risks associated with European economic perorm-ance and the expansionary trend in credit and housing markets

will dampen international interest in Nordic market invest-ments, despite continued strong internal and external balances.


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Theme: Fiscal policy


From austerity to more neutral scal policy Looser austerity measures recommended

More neutral eects on growth in 2014

Major long-term challenges

During the 1980s and 1990s especially, scal policy led anobscure existence; a widespread consensus opinion was thatmonetary policy should assume predominant responsibility orstabilisation policy. In recent years, there has been a greatlyintensied ocus on scal policy. One important reason orthis is that euro zone countries must resort to scal measuresas national economic policy. Moreover, monetary policy haslargely run out o ammunition, due to interest rates close tozero and the unclear eectiveness o unconventional policy.

Attitudes towards scal policy have been the subject o con-tinuous lively debate. The risk that synchronised global auster-ity measures would push the world economy into a depressivespiral has been weighed against the need to stop the sovereigndebt explosion and preserve the credibility o sustainablepublic nances. This dilemma is especially severe or euro zone

countries, where the absence o a central bank o their ownthat can print money has created a genuine risk o deaultspreviously not associated with developed countries.

Fiscal policy directionChange in structural balance, per cent o GDP

2011 2012 2013 2014United States 0.8 1.3 2.0 0.6Japan -0.6 -0.7 -0.5 0.0United Kingdom 1.9 1.2 1.4 1.2Euro zone 1.4 1.4 1.1 0.0

O which GIPS* 0.9 2.3 2.0 1.0

Nordic countries 0.3 0.0 0.2 0.2OECD 0.8 1.0 1.1 0.3

Source: IMF, OECD, SEB*Greece, Ireland, Portugal and Spain

We can dierentiate several distinct periods in the world econ-omy during the course o the crisis:

During the 2004-2007 economic boom, scal policywas relatively expansionary. During the most euphoricphase o globalisation, countries thus squandered the op-portunity to improve their preparedness or uture shocks.

During the acute phase o the nancial crisis in 2008

and 2009, scal policy was clearly expansionary inmost countries. Both specially designed stimulus pack-ages and the eects o automatic stabilisers contributed tothis.

In recent years (2011-2013), rather powerul austeritypolicies have predominated. Ater a pause in 2010, coun-tries were orced into major belt-tightening in responseto the euro zone crisis. In southern Europe, the tighteningeect is equivalent to about 2 per cent o GDP in both 2012and 2013. In the US, the eect is peaking at 2 per cent oGDP in 2013.

Looser scal policy in 2014-16. We are now moving into aphase o more neutral scal policy. Growth remains modest

and resource utilisation is low, while actual budget decitshave allen to less alarming levels.

Longer-term austerity. In the long term, high governmentdebt combined with demographic strains will orce manydeveloped countries to cut costs. This scal policy phaseis likely to begin when resource utilisation reaches normallevels in a medium-term perspective (3-5 years).

Many reasons or a change in the debate

climateOur orecast, based on the IMFs table o current scal actionprogrammes, means that the overall tightening eect in theOECD countries will decrease rom 1.1 per cent o GDP in 2013to 0.3 per cent in 2014. New austerity measures are unlikely tobe launched. International organisations such as the OECD, IMFand European Commission are more and more clearly startingto advocate more expansionary policies. Crisis-hit euro zonecountries will be given a longer respite to achieve the targetedbudget decit o 3 per cent o GDP, but countries like the USand the UK will also be advised to take it a bit easier with theirausterity measures. A straightorward stimulus policy is still

unusual. Japan is a major exception at the global level, whileNorway and Sweden are examples o smaller economies thatcan take advantage o their underlying strong nances.


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Theme: Fiscal policy

Public scal balancePer cent o GDP

2012 2013 2014 Debt*United States -8.5 -6.5 -5.4 109.2Japan -10.2 -9.8 -7.0 244.6

United Kingdom -8.3 -7.0 -6.4 97.1Euro zone -3.7 -2.9 -2.6 95.3Sweden -0.7 -1.5 -2.0 40.8OECD -5.9 -4.7 -3.8 109.5EM sphere -2.4 -1.3 -1.3 23.0* Gross debt, 2014

Source: IMF, OECD, SEB

Our approach to scal policy is changing, due to many actors.

Public budget decits are shrinking signicantly inmany countries. In the US, or example, the decit hasshrunk rom over 10 per cent o GDP in 2009 to a orecasto just above 5 per cent in 2014. In the euro zone as awhole, decits will drop below the 3 per cent threshold asearly as this year.

Austerity measures in southern Europe have had a largeradverse impact on the economy than indicated bycurrent rules o thumb. Hopes that this impact wouldbe sotened by such counter-orces as lower lending ratesor reduced household savings, in line with the Ricardianequivalence theorem, have been in vain.

Mounting deation risks are paving the way or moreexpansionary policy. All else being equal, our orecast olower ination rates means that real interest rates will be

higher and monetary policy thus less eective (liquiditytrap). This strengthens the motives or looser scal policy.

A continued rise in unemployment in southern Europeis increasing political risks. Demanding new austeritymeasures as gloomier growth prospects weaken publicnances would increase tensions in the euro zone andincreasingly undermine the legitimacy o the incumbentgovernments. The risks o permanently high unemploy-ment (hysteresis) also grow the longer the jobless rateremains at record levels.

In recent years, various decision makers have cited theconclusions o American economists Carmen Rein-hartand Kenneth Rogo. Their empirical study seemedto show that 90 per cent o GDP was a clear threshold atwhich high government debt began to hamper economicgrowth. This research turned out to include dubious dataselection procedures and technical errors. Although thereare still many reasons to avoid soaring government debt,the recent discreditation o this study has inuenced publicdiscourse.

Multi-dimensional competitivenessOur euro zone section discusses the competitiveness o crisis-plagued countries. Measured in terms o unit labour costs,

southern Europes adjustments have made some progress. Butcompetitiveness can also be viewed in a broader perspective.We are now seeing how the general business climate is increas-ingly being used as a means o competition, or example by

lowering corporate income tax in various countries. SouthernEuropean countries thus ace dual challenges. While they mustimprove the efciency o their tax collection, they must alsobe able to oer competitive conditions in order to prevent thedeparture o companies and skilled labour.

Ambiguous German attitudeGermany occupies a key position in terms o approaches toscal policy and has been criticised or various reasons. Onecriticism is that the Germans themselves have done too littleto help oset austerity measures in southern Europe. Anotheris that Germany has so stubbornly insisted on demanding ullimplementation o austerity policies in southern Europe.

Our orecast indicates that scal policy in Germany will largelybe neutral in 2013 and 2014 and is thus continuing a relativelycautious strategy. As or approaches to the problems o south-ern Europe, we can see ambiguity among leading Germanpoliticians rom Chancellor Angela Merkel on down. In reality,

Germany is beginning to give in and to accept longer respitesin meeting scal targets in southern Europe and France. Aboveall, Germany wishes to avoid open conict with France, sincedisunity between the euro zones two key countries mighthave a broad impact on market condence. At the same time,a tougher line is clearly popular among voters. In the run-upto this autumns parliamentary election, Chancellor Merkel islikely to continue making rather harsh statements about howthe problems o southern Europe are a consequence o earlierneglect and have nothing at all to do with the necessary auster-ity and sacrices now being made.

Unenthusiastic Swedish stimulus measuresSwedish scal policy will have an expansionary direction that isequivalent to 0.7 per cent o GDP in 2013 and 0.9 per cent 2014.Yet there are clear parallels between German and Swedishpublic debate. Although both Swedens low government debtand resource utilisation indicate the need or more aggressivepolicy, the Alliance government and the Social Democraticopposition are competing to prove who is more aithul to theexisting scal policy ramework, whose target is a surplus o 1per cent o GDP over an economic cycle. The main reason orthis is probably historical. Previous non-socialist governmentsin the post-war period have ailed to keep their nances undercontrol. Finance Minister Anders Borg has established himsel

as the main guarantor o sound government nances, therebychanging the political landscape. Social Democratic leadersseem to view this as politically important and are thus preparedto pursue a policy rejected by most economists as well as theirown trade union allies. In this environment, it is likely to takesome time beore changes in the scal policy ramework areimplemented, even though a number o economic reasonsindicate that its surplus target is ripe or re-assessment.


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The United States


Decent growth despite ederal budget-tightening GDP growth will speed up in 2014

Home prices up by 7-10 per cent annually

Unemployment will all below 7 per cent

Fed will start unwinding QE in early 2014

Decent GDP growth in the rst quarter will help bring thisyears annual average growth to around 2 per cent. As in

2010-2012, however, the economy will decelerate during thesecond and third quartersthis time due to scal headwinds.The dose o ederal austerity will increase rom the equivalento 1.3 per cent o GDP in 2012 to 2.0 per cent in 2013. In 2014 aless austere scal policy is one reason why we predict that GDPgrowth will accelerate to 3.2 per cent: above consensus.

Slower GDP growth in the coming quarters will give the FederalReserve grounds or continuing its monthly bond purchases(quantitative easing) at an undiminished pace. Only in early2014 will the Fed start applying the brakes. In the secondquarter o 2014, bond purchases will end once unemploymenthas allen below 7.0 per cent. A key interest rate hike will hap-

pen only in early 2015. Annual averageunemployment willbe 7.6 per cent this year and 6.9 per cent in 2014, assum-ing that labour orce participation levels out next year ater alengthy decline.

Rich households driving consumptionA combination o tax hikes and higher petrol (gasoline) priceshas led to lower household condence indicators, but con-sumption was unexpectedly resilient in the rst quarter o2013. The rate o increase climbed rom 1.8 to 3.2 per cent.Rising wealth levels are probably one reason why householdsare generally comortable with their current meagre level osavings the savings ratio is at a ve-year low. The top 20

per cent o income earners (who account or 40 per cent oconsumption) benet especially rom rising share and homeprices. Higher taxes and petrol prices are a bigger burden onlow and medium income earners, as reected in predictedweak sales at low-price retail chains like Wal-Mart. In the nextew quarters, we expect budget-tightening and temporarilyslower job growth to help decelerate consumption. Measuredas annual averages, private consumption will grow by 2.3per cent this year and 2.8 per cent in 2014.

Faster home price increasesThe housing market continues to gain strength. Both homeprices and sales rose last year and will continue upward dur-ing the next couple o years. Using the Case-Shiller Index, weexpect home prices to rise by 7-10 per cent both this yearand in 2014. We have increased our price orecast comparedto earlier assessments, partly due to tighter supply (measuredas the number o months the inventory o homes or sale wouldlast at the current rate o sales). Record-low mortgage interestrates and aordability indices point in the same direction.


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The United States

Our picture o the housing market is not exclusively positive,however. Optimism in the construction sector has dimmed, ac-cording to the NAHB index. In addition, speculative purchasesin cash are now contributing to higher home sales. This is be-cause many companies, among them major institutional play-ers like Blackstone, have bought bankruptcy assets or renova-

tion and rental. A combination o low long-term interest ratesand a search or returns is driving this trend and partly explainswhy new home sales are lagging behind existing home sales.There is thus a speculative element in the housing marketagain, though it is too early to warn o a new housing bubble.The growing number o rental units also means that rents arerising signicantly more slowly than home prices. Residentialinvestments will grow by 15 per cent both this year andnext, compared to 12 per cent last year.

Capital spending surge in 2014Ater a strong start to 2013, business condence indicatorshave allen. A composite index o the Institute or Supply Man-agement surveys in the manuacturing and service sectorspoints towards GDP growth o around 2 per cent during thecurrent quarter, which is in line with our orecasts. Condencein the small business sector, which ell steeply around the turn

o the year, has meanwhile regained some o this decline.

So ar during the recovery, capital spending activity has beenvery low, leading to a decline in capital stock. I this trendcontinues, it will hurt the supply side o the economy andlead to persistently weak productivity. Developments in thepast year indicate that potential economic growth has alreadyallen; despite modest 2 per cent real GDP growth, the joblessrate has allen more than hal a percentage point in the pastyear. In terms o Okuns Law, potential growth is thus around 1per cent today. The supply side, measured as productivity pluslabour orce growth, points in the same direction.

Yet in our assessment, the growth potential o the economyhas not been permanently damaged. The uncertain scalpolicy playing eld o recent years has hampered capital spend-ing. But as uncertainty eases, a rebound in xed investmentis in the cards, especially in light o technological advances inoil and gas extraction, which will mainly benet the competi-tiveness o US manuacturers. Stronger corporate investments,combined with robust housing investments, will help lit GDPgrowth in 2014. Capital expenditures by businesses willgrow by 7.5 per cent this year and by more than 11 per centin 2014.

Net deleveraging will soon be overFrom the end o 2007 until spring 2009, one ourth (or USD 16trillion) o household wealth disappeared. Empirical studiesindicate that this kind o wealth shock aects consumption or

a three-year period. The impact o the downturn should thushave aded. In addition, 90 per cent o this lost wealth hasbeen recovered since 2009, so wealth will instead contrib-ute positively to consumption during our orecast period.In relation to income, however, there is some way to go untilreaching earlier peaks; net household wealth is now 544 percent o income, compared to 653 per cent at the end o 2007.

Despite the rising wealth o recent years, household debtdeleveraging has continued. One key question or the eco-nomic recovery is how much longer this deleveraging willcontinue. At the end o 2012, household debts were equivalentto 105 per cent o disposable income, or 24 percentage points

below their 2007 peak. A long-term trend line rom 1960 to2000 indicates that the equilibrium level is now somewhatbelow 100 per cent o income. Yet rising home prices reducethe need or deleveraging, while credit market statistics indi-

cate rising consumer loans. These actors conrm our earlierassessment that deleveraging will end in 2013, setting thestage or a stronger consumption-led recovery in 2014.


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The United States

Strong dollar will hamper exportsThere is a clear connection between American exports, on theone hand, and global demand and changes in the value o theUSD, on the other. Imports, however, are relatively insensitive toUSD movements and are mainly aected by domestic demand.In trade-weighted terms, the dollar has risen by 8 per cent

since last autumn. I USD appreciation continues, it will lowerexports by 1.5 percentage points, according to our calculations.Given the size o exports (less than 14 per cent o the econo-my), the eect o the USD appreciation on GDP will be 0.2percentage points. Foreign trade will make a slightly nega-tive contribution to growth in 2013-2014. This downwardrevision in our export orecast since the last Nordic Outlookisoset, however, by such actors as stronger consumer growth.

Unemployment will slowly allEmployment has increased by an average o 196,000 permonth so ar during 2013, compared to 182,000 last year. As inthe past ew years, job growth will slow in the spring and sum-mer: this time because scal policy is creating obstacles. Theimpact o automatic ederal budget cuts (the sequester)is more powerul than we oresaw in the February issue oNordic Outlook. This will lead to the elimination o positions,especially at the ederal level. According to the CongressionalBudget Ofce (CBO), the outcome will be 750,000 ewer jobsby year-end. Companies are also trying to restore productivitygrowth and prot margins, which hampers employment. Takentogether, we are lowering our short-term orecast and predict-

ing that employment will increase by an average o 140,000people per month in 2013. Our 2014 orecast is that jobgrowth will average 220,000 per month.

Our employment orecast or 2013 would normally be compat-ible with unchanged unemployment. However, labour orceparticipation, which is aected by both structural (demograph-ic) and cyclical actors, will continue to all, reaching at its low-est level in 30 years by the end o 2013. This will help pushdown unemployment to an annual average o 7.6 per centthis year. The jobless rate will then continue alling to 6.6 percent in December 2014, with 6.9 per cent as the annual aver-age. Our orecast or 2014 assumes that labour orce participa-

tion will level out.

Continued low ination in 2013-2014Despite monetary policy activism and alling unemployment,the low ination environment will persist. We expect consumerprices to rise by only 1.6 per cent this year and in 2014. Thisassessment assumes that there will still be plenty o idle re-sources in the economy, but various dark clouds have becomevisible in the ination picture. Certain economic sectors areexperiencing a shortage o qualied job candidates, accordingto the Feds Beige Book. Average hourly wages, which had beentrending downward until last autumn, have rebounded in thepast six months.

Greater scal austerity this yearPartly due to the ederal expenditure cuts that went into eectthis spring, the scal headwinds will be stronger than wehad previously anticipated. In 2013 as a whole, budget-tight-ening will be equivalent to 2 per cent o GDP. Unexpectedlystrong resilience in the economy, plus the act that some ex-penditure cuts were already included in orecasts, explain whyour GDP orecast or 2013 remains unchanged. Next year, scalausterity measures will shrink to 0.6 per cent o GDP. Currentscal policies will help reduce the ederal decit rom 8.5 percent o GDP in 2012 to 5.4 per cent in 2014. The national debtwill peak at 109 per cent o GDP next year.

The measures that have been approved will not solve the eder-al governments long-term scal problems, however. Accordingto CBO projections, the budget decit is expected to all to 2.1


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The United States

per cent o GDP by 2015 but to start increasing again in 2016.Sustainable long-term debt management will probably requirea combination o spending cuts and tax hikes or the middleclass as well. Since the 1960s, transers to households haveincreased rom 6 per cent to 18 per cent o their total income.In 1960, social service and entitlement programmes accounted

or one third o ederal spending, compared to two thirds today.

Continued loose monetary policy in 2013Late in 2012 the Federal Reserve added the ofcialunemployment rate to key variables guiding its monetarypolicy. The Feds research shows that the jobless rate is thesingle best labour market indicator. Looking ahead, a givenchange in unemployment has strong explanatory value; sincethe 1980s, when unemployment has allen by hal a percentagepoint during a six-month period, the probability o a urtherdecline during the ollowing six months has been 75 per cent.But jobless gures also have limitations. In recent years, thedecline in unemployment has largely been due to many people

leaving the labour market. The quantity o idle resources in theeconomy is thus probably larger than ofcial unemploymentindicates. This is one reason why the Fed has declared that the6.5 per cent unemployment threshold will not necessary signalthe starting point or interest rate normalisation.

The Feds main interest rate (ed unds) has remained at 0-0.25per cent since December 2008. According to our orecast, itwill not be raised until 2015. In real terms, this key interestrate has been negative since 2009. Even i a new Fed chairmantakes over in 2014, we believe that the direction o the bankspolicies will remain the same. Our main scenario is that Ben

Bernanke will step down when his term o ofce expires inJanuary 2014. President Barack Obama will then have to nomi-nate a successor. One requently heard name is Janet Yellen,Vice Chair o the Feds Board o Governors, who is regarded asdovish on interest rates.

As or quantitative easing, our orecast is that that the Fed willbuy mortgage-backed and Treasury bonds at an undiminishedrate (USD 85 billion per month) until December 2013. Thesepurchases correspond to an estimated interest rate cut o 10basis points per month. In 2014 they will be phased down toUSD 60 billion per month during a three-month period. Whenthe bond purchasing programme ends in March 2014, the Feds

balance sheet will stand at nearly 30 per cent o GDP,compared to 24 per cent today. Unemployment will meanwhilebe 7 per cent, according to our orecasts, which may be com-patible with the substantial improvement in the labour mar-ket that the Fed is aiming at beore ending QE.

Ageing population will strain public nancesIn both the US and other developed countries, an ageing pop-

ulation will strain public nances. In the OECD countries, thepopulation aged 65 or over as a proportion o the working-age population will increase rom 14 per cent today to 34 percent in 2050. The situation is the most serious in Japan, but inGermany the demographic trend also looks gloomy. The situ-ation is brighter in the US. Although many people born in the40s and 50s are retiring, there will be a sizeable inow intothe labour orce, with 88 million Americans aged 10-29.

Although the demographic challenge is gigantic in manyplaces, there are bright spots. During their crisis years anumber o countries, including Portugal, Italy and Greece,have implemented reorms that neutralise the budget impact

o the ageing population. Forecasts so many years in advanceare also marked by great uncertainty; minor changes in un-derlying assumptions may have a very large impact 40 yearsrom now.


16/47

Japan


Weak light at the end o a long untested tunnel Aggressive economic policies will boost

growth and ination in 2013-2014

Pay increases and structural reorms vital inending two decade-long deation problem

Abenomics may succeed and ail

Japan is in a hurry to stop deationary orces, stabilise itssovereign debt and manage the consequences o a rapidlyageing population. The expansionary economic policy (Abe-nomics) initiated by the new prime minister, Shinzo Abe, hasbeen accepted both internationally and by the Japanese. Weexpect it to boost GDP growth to 1.7 per cent in 2013 and 1.4per cent in 2014, almost a percentage point above the annualaverage o the past two decades. But the economic outlookbeyond 2014 is unclear and will depend on rising wages andsalaries, increased labour supply, political perseverance and thecondence o nancial investors.

Financial market reactions to these economic policies havebeen powerul. The Tokyo Stock Exchange (Nikkei index) has

gained 55 per cent in the past six months, equivalent to almostUSD 2 trillion. During the same period, the yen has weakenedby nearly 25 per cent in eective terms, while long-term yieldshave risen by about 15 basis points to 0.85 per cent. In our view,the yen is still about 10 per cent overvalued. Our orecastis thus that the USD/JPY exchange rate will climb to 110 by theend o this year and 120 by the end o 2014.

We expect broad-based growth in 2013-2014, sustained by adepreciating currency, alling real interest rates and risingwealth. Both private and public sector consumption will in-

crease, along with private investments. Both households andbusinesses have reacted positively to Abenomics, as reectedin rising condence in various surveys. One reason why growthwill be stronger in 2013 than in 2014 is that some consumptionwill be accelerated due to coming tax hikes; another reason isthe ading eect o stimulus packages. Exports will benet roma weak yen and robust Asian economic expansion. A ull 25 percent o Japans exports go to China, or example. Given thisgrowth picture, unemployment will remain stable at about,or even below, 4 per cent. New regional conicts that increasetensions in Asia pose a risk to the Japanese economy.

Hopes o rising ination will only be partly ullled . CPIination excluding ood will reach 0.3 per cent in 2013 and2.5per cent 2014. The most important explanation is that theconsumption tax hikes in 2014 and 2105 will boost CPI inationby 2.0 and 0.7 percentage points, respectively. Rising import

Abenomics what it will deliverMr Abe has given his name to an economic policy with threepillars: i. a big scal stimulus package (some 2 per cento GDP) including higher public investments; ii. A nearlyunlimited expansionary monetary policy that will doublethe monetary base by purchasing long-term (up to 40 years)government securities, a new 2 per cent ination target andreduced central bank independence; iii. A growth/structuralpolicy including increased labour supply, improved educationand health care and greater efciency in the agriculture andenergy sectors.

Abenomics is aimed at achieving the ollowing:1. A weaker yen. A weak currency provides manoeuvring

room to carry out necessary, tough, time-consuming reorms.A 10 per cent decline in the yen provides an export stimulusthat boosts GDP growth by 0.2-0.3 percentage points. Mean-while it raises the value o Japanese assets abroad. So ar,

this increase in value has been equivalent to USD 1.5 trillion.

Larger capital buers help saeguard the countrys creditrating.

2. Higher wages and salaries. Political leaders want toreduce deationary orces and increase optimism by boostingwages and salaries. Pay increases will ease the eect o con-sumption tax increases. Japan will thus experience combinedexternal devaluation (weaker yen) and internal revaluation(higher pay), which may explain the lack o global criticism oJapans monetary policy.

3. Low interest rates. I the policy is successul, nominallong-term yields may stabilise above todays 0.7 per cent or

so, while real interest rates turn negative (higher ination).Pensioners and others will thus see their xed-income port-olios lose value, which may be partly oset by higher shareprices.


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Japan

prices and somewhat higher wages and salaries will also con-tribute to the ination upturn. At present it is too early to writeo deationary orces, however. The Japanese economy stillhas plenty o idle resources and companies have been cautiousabout pay so ar. The outcome o loose monetary policy in2001-2007 also shows how stubborn deation is.

Today public debt is 220 per cent o GDP and is expected toreach nearly 250 per cent by the end o 2014, the highestlevel ever recorded in an OECD country. Ater a temporary allto less than 0.5 per cent in late March/early April, 10-year gov-ernment bond yields have increased to 0.9 per cent. Mean-while 10-year break-even ination expectations have risen rom0.5 to more than 1.5 per cent in the past six months. Long-termreal yields are thus now negative. Our orecast is that nomi-

nal long-term yields will remain low in 2013-2014.

Owners o Japans sovereign bonds

Banks 41%Insurance companies 22%Pension unds 13%Foreign market players 7%Households 4%Others 13%Source: Financial Times

To stabilise the debt level, the government needs to bothcut spending and raise taxes. The budget decit this yearis nearly 10 per cent o GDP, or the th straight year. Thedecit is expected to shrink as earlier stimulus packages arephased out. The planned consumption tax hike will occur instages: rom 5 to 8 per cent in 2014 and to 10 per cent in 2015.Further such tax hikes are expected later. But steps must alsobe taken to ease the impact o the ageing population on public

spending. Later this year, the government is expected to unveila medium-term plan or how public nances can be put on amore sustainable, credible path.

The labour orce has shrunk by 0.2 per cent a year in the pastdecade. Under current rules, the pace will accelerate to 0.6-0.8per cent yearly in the coming decade or two. To manage thesituation, the Abe administration is planning measures to raiselabour market participation among young people and women.Expanded child care and changes in tax and benet systemsgiving women incentives to return to the labour market aterhaving children will probably be key elements o this policy.Also needed is deregulation and efciency improvements in

sectors such as health care, education, energy and the environ-ment. Within a ew months, the government will present moredetails o its growth package.

Risks to nancial market & world economyI Abenomics ails, the main threat to global growth will benancial eects, not real economic ones (Japan accounts or8 per cent o the world economy). Japans main impor t coun-tries are China (24 per cent o total imports), the US (9), SaudiArabia (8), Australia (7) and South Korea (5). Rapidly risingJapanese yields, due to declining condence in Japans abilityto service sovereign debt and rising ination risk premiums,will create problems (loss o value) mainly or Japanese banksand pension companies, which hold most government securi-ties. Japan has net claims on the rest o the world equivalentto 55 per cent o GDP or USD 3.25 trillion. This will help easecondence problems.

In our risk scenario, Japanese yields rise 150-200 basispoints (= a weak positive real yield plus an ination andcredit risk premium o 2 per cent). This will give the bankingsystem an unrealised loss o USD 150 billion. According tothe Bank o Japan this is manageable, though small banksmay have problems. The result will probably be a strongeryen, since repatriation o oreign assets will be needed to

cover losses; stock market declines are thus probable.The government budget decit will increase by about1 per cent o GDP; the eect will be gradual since averagesovereign debt maturity is about 6 years. Sovereign debt

will increase about 10 percentage points in two years. Thegovernment is expected to react by raising taxes to narrowthe budget decit which, together with poorer export pros-pects, will send the economy into recession.

The eects on the rest o the world o the above sce-nario are probably manageable. The situation would beworse i the crisis were even deeper, with serious losses o

condence and secondary nancial eects. In such a sce-nario, 1) yields would climb more, by nearly 400 basis points,2) international yields would also react by rising, 3) the USand Europe would remain in a low growth pattern or eventip into recession.

What makes really severe risk scenarios less probableis that the Bank o Japan has instruments to preventsharply rising yields. By liting yield and credit risk into itsbalance sheet, it can ease upward pressure on yields. TheBoJ has unlimited resources or such a policy. But the chal-lenge is to be able to continue operating with undamaged

condence in the economy and government economicpolicy.


18/47

Asia


Weak external demand a actor in below-trend growth Subdued ination pressure and expansion-

ary monetary policy

China: Near-trend growth

India: Production has bottomed out

Ater a recovery in Asian emerging economies during the ourthquarter o 2012, activity again slowed early in 2013. Growthwill remain below trend, but is ar higher than in the OECDcountries. Although purchasing managers indices have climbedin several countries during the past ew months, levels justabove the expansion threshold o 50 indicate that manuactur-ers are still struggling. Yet exports have strengthened some-what in recent months, driven primarily by demand rom otherdeveloping countries. The improvement is modest, however,and export order bookings indicate that the recovery is begin-ning to ade. Total export demand will thus be weak comparedto earlier years and will help hold back growth in the regionboth in 2013 and 2014.

In recent years, the region has developed at dierent rates, withsome countries beneting rom strong domestic demand (In-donesia, Thailand) while export-dependent economies (Malay-sia, Singapore, Taiwan) have been hampered by weak externaldemand. This divergence is now starting to narrow.

Headline ination has allen in most economies during thepast year and is at a historically low level. Core ination is alsosubdued and there are ew signs that price pressures will soonintensiy. A stable outlook or global commodity prices is ben-eting the region, which is a net importer o both metals andenergy. Meanwhile low producer price increases reinorce theimpression o a low-ination environment. The avourableination situation is creating potential or continued expan-

sionary monetary policy. So ar in 2013, key interest rateshave been unchanged in most economies, but India is amongthose that have lowered rates. Late in 2013 and during 2014,we expect rate hikes to begin at a modest pace. One exceptionis India, where some urther easing o monetary policy is ex-pected as once-rapid ination nally begins to slow.

China: Stable growth at a lower levelYear-on-year GDP growth ell to 7.7 per cent in the rst quar-ter, compared to 7.9 per cent in the ourth quarter o 2012.

Purchasing managers indices usually show a clear seasonalimprovement in March, but this years upturn was signicantlyless than usual. In April, which is usually a strong month, theindex ell. Final hard data or February are difcult to interpret,since Chinese New Year celebrations shit between January andFebruary. March export and industrial output gures indicatea weak ending to the rst quarter, while retail sales showedbetter resilience. The beginning o the second quarter has alsobeen modest; a weak base o comparison in 2012 along withcalendar eects imply that gures or retail sales and industrialproduction actually are weaker than they rst appear. Overall,the picture o a modest recovery has emerged more strongly in

recent weeks. We expect Chinas GDP growth to end up at7.9 per cent in 2013 and at 7.7 per cent in 2014.

The weaker rst quarter GDP gure was met with disappoint-ment in nancial markets, but the reaction o Chinese authori-ties seems relatively calm. Their growth target or 2013 is 7.5per cent, which we estimate to be close to the trend rate ogrowth. Nor are there signs that the labour market has weak-

ened. Viewed rom a more long-term perspective, the GDPgure was benecial, since the contribution rom consumptionsurpassed the contribution rom capital spending. This mustcontinue to enable China to transition rom a growth model


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Asia

based on capital spending and exports to one driven by do-mestic consumption. The national leadership change has nowbeen ormally completed, but it is still too early to determinehow eager or reorms the new leaders are. One positive sign,however, is that the central bank governor, Zhou Xiaochuan,who has been a prominent advocate o reorms in the nancial

sector, has been appointed to another term.

It is worrisome that credit growth remains at a very high leveldespite the slowdown in the economy. Both the broadest meas-ure o lending, total social nancing, and traditional banklending accelerated greatly in March and surpassed expecta-tions. Rapid credit growth contributed to a decision in April bythe credit rating agency Fitch to downgrade Chinas creditrating one notch to A+. Chinese authorities are mainly worriedabout the credit growth being generated outside o traditionalbank lending and have thus begun to tighten regulation owealth management products. Because o this tightening,credit growth is expected to level out during 2013.

Ater an expected temporary peak in February as a result othe Chinese New Year, ination ell again. In April ination was2.4 per cent. The temporary increase in February was driven byood price increases. We expect ination to accelerate some-what during the rest o the year, driven to some extent by risingpork prices. Measured as annual averages, ination will end

up at 3.3 per cent in 2013 and at 3.5 per cent in 2014. Gen-erally speaking, price pressure is low, with core ination below 2per cent and producer prices still alling year-on-year.

Home prices have begun to accelerate again; measured in70 major cities, prices rose by more than 4 per cent in April.Although the number o home sales decreased in April salesare on an increasing trend since the beginning o the year.Theauthorities have announced that steps will be taken to slow theupturn, but these are expected to be relatively mild in order notto jeopardise already modest GDP growth.

The key interest rate has been unchanged since it was lowered

in July 2012, and we expect no change during the next sixmonths. Our assessment is that the key interest rate will re-main at 6.0 per cent until the ourth quarter o 2013, whenwe expect a 25 basis point hike. During 2014, we expecttwo more hikes pushing the key interest rate to 6.75 percent. Since the end o 2012, the Peoples Bank o China (PBoC)has ocused its monetary policy on using repo transactions totry to withdraw liquidity rom the nancial system. Also, theocus o monetary policy has swung rom the lending rate tothe deposit rate. The deposit rate is expected to be hiked romthe current 3 per cent to 3.25 per cent by the end o 2013 andto 3.5 per cent by the end o 2014.

During 2013 the appreciation o the yuan against the US dollarhas regained momentum, setting new records. The PBoC hasaccepted more rapid strengthening o the yuan against thedollar, but market pressure indicates that appreciation shouldactually be occurring even aster. The yuan has also clearly

Plenty o long-term risks and challenges togrowthIn the short term, the risk picture in the Chinese economyis dominated by rapid domestic credit growth and weakexternal demand. Beyond our orecast horizon, however,there are a number o challenges that may impact growth.

Geopolitical developments in South-east Asia have at-tracted attention in the past year. Chinas border conictswith its neighbours are undamentally due to difculties inmanaging its growing economic, political and military inu-ence. A recent rise in the number o incidents indicates agreater risk o limited conict between China and Vietnam orthe Philippines, or example. Such a conict would be geo-politically serious but would not necessarily have major eco-nomic eects. Chinas growing strength has also contributedto a partial shit in US security policy ocus rom the MiddleEast to East Asia.

Demographic changes pose another challenge to Chinese

growth. According to the Asian Development Bank, avourabledemographics have contributed some 0.7 per cent per year toChinas GDP growth in the past two decades. China now acesa rapid demographic shit, with a shrinking labour orce along

with an ageing population instead pulling down growth. Itsimpact can be limited, however, by a continued transer o thelabour orce rom the agricultural sector to the manuacturingand service sectors, which will sustain productivity growth.

Meanwhile there is rising discontent among Chinas populationwith inequality, environmental problems and corruption.The demographic trend and social discontent are both inter-twined with Chinas growth model. The current model, basedon government capital spending and exports, has reached theend o the road. A transition to a model based on consumption-driven growth would be a way to manage both demographicchange and popular discontent. Because o the ageing popula-tion, the need or both health care and elder care is increasing.These needs must be met through increased public sectorconsumption, which in turn stimulates private consumptionby reducing the need or household savings. However, localgovernments have no revenue source to pay or social welare.Introduction o a property tax would be the rst step to provide

revenues in order or local governments to increase socialwelare payments. Generally speaking, the new leadership hasnot yet shown how it intends to deal with Chinas long-termgrowth challenges.


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Asia

strengthened in trade-weighted terms during 2013. Our as-sessment is that yuan appreciation will continue but at a slowerrate. We expect the USD/CNY exchange rate to be 6.10 atthe end o 2013 and 6.00 at the end o 2014.

India: Growth has bottomed out

The growth o the Indian economy slowed urther during theourth quarter o 2012, ending up at a historically weak 4.5per cent year-on-year. GDP growth or the ull year 2012 thusreached only 5.1 per cent. Economic activity probably bot-tomed out during the ourth quarter, but there are no guar-antees o a clear recovery. Purchasing managers indices remainar below their historical averages, and in April the compositeindex ell to its lowest level since October 2011. Although indus-trial production has stabilised somewhat, in March it increasedby a modest 2.5 per cent year-on-year. Exports have improvedin recent months, and Indias large trade decit shrank inFebruary and March but increased again in April. The alreadysizeable current account decit grew urther during the ourthquarter o 2012. The real eective exchange rate o the rupeehas weakened again recently, but we now expect a slight ap-preciation against the USD ahead. We expect the rupee totrade at 51.0 per USD by the end o 2013 and at 48.0 by theend o 2014.

Domestic demand is also weak. Car sales, an important indica-tor o consumer demand in the absence o retail sales statistics,ell by more than 10 per cent year-on-year in April. Overall, GDP

will climb by 5.5 per cent in 2013 and by 6.0 per cent in2014. Because o Indias sizeable budget decit, combined withlimited room or key interest rate cuts, there is little opportunityto stimulate the economy in the short term.

Despite government reorm initiatives (such as reducing uelsubsidies and relaxing oreign investment rules), continuedreorm eorts are in jeopardy. The chances that the govern-ment can push through more reorms to strengthen economicgrowth and reduce the budget decit will diminish urther asthe May 2014 parliamentary election approaches. Unless re-orm eorts regain momentum, the explicit target o returningto 7-8 per cent growth will remain distant.

The budget decit has allen somewhat in the past year butremains above 5 per cent o GDP. According to the budgetunveiled in late February, decit reduction eorts will continue,but the government aces a difcult task. Next years electionwill increase pressure on the government to increase expendi-tures, while its own GDP orecasts look too optimistic.

The slowdown in ination during the past ew months willprovide some support to the economy. In April, wholesale priceindex (WPI) ination was 4.9 per cent, the lowest gure sincelate 2009. Ination is expected to end up at 5.9 per cent in2013 and at 6.5 per cent in 2014. The ination slowdown haslargely been driven by a signicant drop in ood price inationand has, in turn, made it possible to loosen monetary policy.The central banks key interest rate cut in late January wasollowed by urther 0.25 percentage point cuts in March andMay to 7.25 per cent. Slowing ination, combined with veryweak growth, will enable the central bank to ease mon-etary policy a bit urther. Our assessment is that the key rate

will be cut by another 0.75 percentage points during thesecond hal and will thus be 6.5 per cent at the end o 2013. Weexpect the key rate to remain at this level during 2014.


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The euro zone


The crisis is not over, despite massive ECB support Leading indicators again point downward

GDP will stabilise in the third quarter

Ination below 1 per cent

ECB will be orced to take urther action

Since last summer, euro zone nancial developments havebeen positive in many respects. The actions o the European

Central Bank (ECB) have clearly reduced risk premiums, orexample as reected in narrower bond yield spreads betweenGermany and southern Europe. Meanwhile adjustments in thecost situation and oreign trade have made some progress.Periods o market instability, such as during the Cyprus crisisor when Portugals constitutional court invalidated portionso that countrys scal consolidation programme, have beenrelatively brie, with little spill-over to other crisis-hit euro zonecountries.

Yet major challenges remain. The process o deepening eurozone integration is slowly moving ahead, amid various disap-pointments. Some steps have been taken towards a banking

union, which might de-couple the nancial problems o indi-vidual governments and the banking sector. Some countries,especially Germany, are hesitant due to ear o being orced topay the costs o crisis-plagued banks in other countries. Theregion as a whole remains in recession as well. One importantcause o this recession is a poorly unctioning credit markettransmission mechanism that is holding back economic activityin southern Europe, especially capital spending. The bankingsystem, mainly in southern Europe, also remains weighed downby a growing share o bad loans.

In this environment, various players ace difcult dilemmas.

The ECB is being orced to expand its role as a crisis managerand test the limits o its manoeuvring room under EU treaties.Individual governments are being pressed hard, as continuedrecession pushes up unemployment in a way that is generatingsocial tensions and political uncertainty. As earlier, the uture othe euro project thus remains uncertain.

Shrinking GDP, then below-trend growthIndicators improved late in 2012, but this spring both pur-chasing managers indices (PMIs) and the European Commis-sions Economic Sentiment Indicator (ESI) have again turneddownward. The levels vary between countries, but even inGermany the manuacturing sector PMI has dropped below the

expansion threshold o 50. Germanys IFO business sentimentindex, however, remains above its historical average. Industrialproduction has shown a slowing trend in the past year, whileexports have remained at an unchanged level in recent months,measured year-on-year.

Euro zone GDP continued to shrink in the rst quarter o 2013,but the quarter-on-quarter downturn decelerated to 0.2 percent, compared to 0.6 per cent in the ourth quarter o 2012.Short-term indicators point to continued very weak economicperormance. We thus expect GDP to all in the second quarteras well and then reach zero growth in the third quarter. Startingin the ourth quarter o 2013, GDP will climb slowly. Measured

as annual averages, GDP will all by 0.7 per cent in 2013,while achieving 0.7 per cent growth in 2014. Our orecastis below consensus or both years. Throughout our orecastperiod, growth will remain well below trend.

GDP, selected countriesYear-on-year percentage change

2011 2012 2013 2014Germany 3.0 0.7 0.3 1.3France 2.0 0.0 -0.2 0.6Italy -0.5 -2.8 -1.7 0.3Spain -0.4 -1.9 -1.9 0.0

Greece -7.1 -6.4 -5.0 -1.0Portugal -1.6 -3.2 -2,2 0.3Ireland 1.4 0.9 0.9 1.5GIPS countries -1.2 -2.3 -2.0 0.1Euro zone 1.6 -0.6 -0.7 0.7Source: Eurostat, SEB

Behind this ragile economic perormance are orces pulling indierent directions. Exports are showing a decent growthrate and will be helped in the coming months by strongerglobal demand, especially rom the US. A weaker euro will alsohelp drive the export upturn. Domestic demand is being ham-pered by various actors. Household optimism is squeezed

by political uncertainty, austerity measures and risingunemployment. So ar, relatively high ination has also playeda part in undermining real income, but ination is now rapidlyon its way down. The dose o scal austerity in the euro zone


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The euro zone

will also decrease in 2014, leading to diminished headwinds ordomestic demand.

Credit market problems are a major impediment to

southern European economic growth. Despite a record-lowECB key interest rate, lending volume to households and non-nancial companies continues to all. For example, the IMF hasestimated that non-nancial companies in southern Europeneed to reduce their loans by 20 per cent; Spain and Portugalare two countries singled out as especially hard pressed. Evensolvent companies nd it hard to get loans in an environmentwhere banks are generally shrinking their balance sheets. Thereis an obvious need or alternative tools besides interestrates to remedy the shortcomings o the transmissionmechanism. A recapitalisation o the banking sector andclearer progress in euro zone cooperation on bank supervisoryand guarantee issues will be important pieces o the puzzle inresolving this problem.

Looking back at GDP growth since the economic crisis brokeout, only Germany now has a higher GDP level than in early2008. France has also recovered, but its GDP remains about 1per cent below its 2008 level. Ireland, whose recovery is citedas a successul example among crisis-hit countries, has a GDPthat is still 5 per cent below 2008. In the hardest-hit countries,the decline rom 2008 levels is continuing. In Greece, GDP was

about 20 per cent lower in 2012 than in 2008.

Germanys export engine is sputteringDespite the relative strength o the German economy, a clearslowdown is now apparent there. The global recovery is notenough to compensate German exporters or weaknesses closeat hand. Ater recovering in 2010, exports have decelerated. Incurrent prices, they are now at a lower level than a year ago.

Industrial production has allen since the summer o 2012 butcompanies are expecting an improvement, according to theIFO business sentiment survey. Construction sector activity hasalso weakened, though partly because o cold winter and springweather. Household condence and retail sales are provid-ing dierent signals at present; retail sales ell in March whileconsumer condence improved. Wage and salary agreementsin the labour market point to pay increases o 2.5-3.0 per cent,which in a low-ination environment will lead to good increasesin real purchasing power. We expect Germanys GDP growth torecover gradually, reaching annual averages o 0.3 per cent in2013 and 1.3 per cent in 2014. This means that in both years,

German growth will be about 1 percentage point above theaverage or the rest o the euro zone.

German scal policy wil l be relatively neutral in 2013 and 2014ater belt-tightening equivalent to 1 per cent o GDP in 2012.This implies that the budget balance will be close to 0 per cento GDP during the period 2012-2014. Germany will thus notyield to international pressure to pursue a more expansionarypolicy as a counterweight to scal cutbacks in southern Europe.

In September 2013, Germany will hold its ederal parliamentaryelection. Chancellor Angela Merkels European policy enjoysbroad support, and the Christian Democrats (CDU/CSU) have a

clear lead in opinion polls, but Merkels Liberal coalition partner(FDP) is teetering close to the 5 per cent threshold and maylose all seats in the Bundestag. The EU-sceptic Alternative orGermany has gained ground but, according to opinion polls,will not make it into the Bundestag. There are thus many indi-cations that the governing coalition will lose its parliamentarymajority. Since the Greens have resisted working with the CDU,there is a high probability that Merkel will be orced into agrand coalition between Christian Democrats and Social Dem-ocrats. I so, it will be or the third time in the post-war period.Regardless o governing constellation, we expect Germanyscurrent policies towards Europe to remain in place.

France in recessionThe French domestic economy showed clear resilience duringthe sharp international economic downturn o 2008-2009, butin 2011 and 2012 its weak growth lost momentum. During theourth quarter o 2012, GDP ell 0.3 per cent compared to thepreceding quarter. Given a GDP decline o 0.2 per cent in therst quarter o this year, France is now in arecession. Thecomposite purchasing managers index also signals a signi-cant risk o continued GDP decline.

The French economy is weakening mainly because privateconsumption, which was previously resilient, is now being

squeezed by rising unemployment and austerity measures. Theweak export trend is not providing support to growth, either.Since the central governments ragile nances rule out scalstimulus, this spring the government has revised its GDP ore-


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The euro zone

casts sharply downward. Our GDP orecast is more pessimisticthan that o the government. In our assessment, France willexperience a alling GDP, -0.2 per cent,in 2013, ollowed by aweak GDP increase o 0.6 per cent in 2014. The deteriorat-ing growth picture has orced the government to postpone itstarget o achieving a budget decit o 3 per cent o GDP by one

year until the end o 2014.

Milder austerity policies in crisis countriesThere are increasingly clear signs o a policy shit rom ront-loaded cost-cutting to allowing more time. Meanwhile therewill be an even greater ocus on structural reorms. Ger-many will have to abandon some o its earlier positions in orderto avoid a continued downward spiral in the euro zone, withrising unemployment and deepening political uncertainty. Onthe other hand, crisis-hit countries will have to accept that theTroika (the IMF, ECB and European Commission) will continueto monitor their nances or a long period.

Portugal has been given more time to meet its targets, andFrance will not achieve its 2013 or 2014 budget targets. Spainalso needs more time to meet the budget targets it has es-tablished. The ailure to achieve these targets is largely a con-sequence o the more negative growth outlook. This, in turn,is because the austerity measures that have been imposed

have had a bigger adverse impact on demand than traditionalrules o thumb would indicate. The overall dose o auster-ity (measured as structural savings) will decrease rom theequivalent o 1.4 per cent o GDP in 2012 to 1.1 per cent in 2013and neut

nordic outlook 1305: fight against economic slowdown escalates

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