Unsustainable economic recovery?


The global recovery is now well under way, with economic conditions improving in most regions. After shrinking by 1% last year, world GDP at purchasing power parity will grow by 3.6% in 2010. However, the recovery is reliant on unsustainable inventory effects and policy stimulus. This raises the risk of a renewed slowdown once the inventory cycle has run its course and stimulus is withdrawn.

The Economist Intelligence Unit’s latest forecast for the world economy is fractionally higher than in last month’s report. Previously we expected growth of 3.5%. The upgrade largely reflects the fact that we have also slightly raised our forecast for China. We now expect Chinese GDP to grow by 9.5% this year.

More broadly, the apocalyptic atmosphere of a year ago has given way to increasing optimism in most countries. Companies and consumers have realised that the worst-case scenarios envisaged in late 2008 and early 2009 are unlikely to materialise, and are adjusting their behaviour accordingly. Massive monetary and fiscal stimulus continues to play a key role in supporting demand in many economies.

How long can it last? Inventory changes can sharply boost GDP growth at the beginning of a recovery, but the effect is inherently temporary. Once businesses think their inventories are at the correct level again, changes in levels of stocks will stop being a source of economic growth. Equally, policy stimulus has its limits. Many governments have become vastly more indebted as a result of stimulus spending. They face increasing pressure to reduce budget deficits and simply cannot afford—either financially or politically—to keep stimulus going for much longer.

For the recovery to keep going beyond 2010, therefore, other drivers of growth will have to take up the slack. As yet, it is unclear how or whether this will occur. Some optimists point to emerging markets as a source of demand, but these economies have also become heavily dependent on policy support. Meanwhile, private demand in the developed world will remain subdued, as households and companies still have much to do to repair their balance sheets. Government support has masked some of these problems thus far, in effect shifting liabilities from the private to the public sector. But this has merely postponed, rather than avoided, a much-needed adjustment. As these imbalances come to the fore again from late 2010, we expect a significant slowdown in the US and some other developed economies in 2011. However, our core scenario sees this “double dip” entailing a softening of growth rather than a renewed contraction in GDP.

Developed world

Most recent indicators suggest the US is recovering, but we believe the upswing is built on a wobbly foundation. Further small fiscal measures are likely this year, but there is no political appetite for another big package on the scale of the US$787bn programme introduced in February 2009. As a result, fiscal policy will soon in effect turn from expansionary to neutral. Just as importantly, monetary policy will quietly become tighter as the Federal Reserve ends unorthodox credit-support programmes, even though benchmark interest rates won’t rise until the third quarter or even later. As a result, GDP will grow by 2.5% this year, but we expect a slowdown to 1.4% in 2011.

Elsewhere, Japan’s recovery from one of the developed world’s most brutal recessions remains patchy. Companies are reluctant to invest, and the deflation that characterised Japan’s “lost decade” has re-emerged. A strong yen is exacerbating both problems. We expect real GDP to grow by only 1.5% in 2010, slowing to 1% in 2011.

In the euro area, likewise, the economy is improving but looks set to remain sluggish for some time. Several factors are to blame. There are still large imbalances from the boom years to be absorbed. Western European banks’ heavy exposure to borrowers in eastern Europe will continue to restrict lending, thus impeding economic recovery. Job subsidies that have partially shielded countries like Germany from the effects of the recession will end. Fiscal policy is also set to tighten throughout the region in 2010 and 2011. We think the economy will grow by only about 1% in both years.

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Emerging markets

With some exceptions, emerging markets are recovering much more rapidly than developed economies. Asia is leading the way, thanks both to large stimulus programmes and the fact that most countries entered the global crisis in relatively good economic shape. The global recovery is beginning to revive demand for Asia’s exports, a key driver of growth for many countries. The Chinese economy, in particular, is accelerating, though rapid lending growth is raising concerns about potential asset bubbles. Our forecast of 9.5% growth in China in 2010 marks a slight upgrade from 9.3% in our previous report.

Elsewhere, the outlook for beleaguered eastern Europe is improving at last, though the region will still underperform other emerging markets in 2010. Fiscal problems loom large for many countries, and business and consumer sentiment remains fragile. The region as a whole will grow by 2% this year, after an estimated contraction of 6% in 2009.

Meanwhile Latin America is now clearly recovering. Indeed the region has withstood the global crisis remarkably well, and has been much less severely affected than in previous downturns. Countries (mainly in South America) with greater exposure to Asian markets are further ahead in the recovery process, benefiting from strong Chinese demand for raw materials and the consequent rise in commodity prices.

The outlook for the Middle East and Africa is also improving. Higher oil prices (compared with the average in 2009) will support economic growth in much of the region, while North African countries will also benefit from the weak recovery in the EU, which will boost exports and workers’ remittances.

Exchange rates

The US dollar appreciated a bit against the euro in early January, in part reflecting concerns about Dubai’s debt problems. However, we think the dollar will remain under downward pressure in the short term. The continued firmness of commodity prices suggests a relatively high degree of risk tolerance on the part of investors, who are therefore likely to keep putting their money into assets other than the dollar. As a result, we expect the greenback to fluctuate around US$1.45-1.50 to the euro in the first half of 2010, although there will be some appreciation after that as investors anticipate a rise in US interest rates.

We expect little substantive change to China’s exchange-rate regime. The authorities will allow the renminbi to strengthen a bit against the US dollar again from mid-2010, but they will resist international pressure for stronger action such as a large one-off revaluation. There remains a high risk of greater political tension over the US dollar:renminbi exchange rate.


We expect oil to cost an average of US$78 a barrel in 2010, up from US$62 last year. Global demand for oil has started to recover following two consecutive years of falling consumption. However, the impact of the economic stimulus packages in many countries will fade in the second half of 2010, leading to a renewed downturn in OECD demand for oil and a consequent build-up in stocks. This suggests that prices will ease to around US$73/b in 2011.

In other commodities, we have revised up our forecasts for base-metal prices to reflect strong buying from China and renewed investor interest. Thus, we now think aluminium will cost an average of US$2,341 a tonne in 2010 (up from US$1,951 in our previous forecast), while copper will cost 324 US cents a pound (previously 290 US cents).

World economy: Forecast summary
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Real GDP growth (%)
World (PPP exchange rates) a 4.4 5.0 5.0 2.8 -1.0 3.6 3.5 3.9 4.0 4.2
World (market exchange rates) 3.6 4.0 3.8 1.7 -2.3 2.7 2.4 2.8 3.0 3.1
US 3.1 2.7 2.1 0.4 -2.5 2.5 1.4 2.0 2.2 2.3
Japan 1.9 2.0 2.3 -1.2 -5.5 1.5 1.0 1.1 1.0 0.9
Euro area 3.8 3.0 2.6 0.6 -4.0 0.9 1.0 1.5 1.8 2.0
China 10.4 11.6 13.0 9.0 8.3 9.5 8.3 8.5 8.2 8.2
Eastern Europe 5.7 7.3 7.4 4.7 -6.0 2.0 3.5 4.3 4.3 4.3
Asia & Australasia (excl Japan) 7.2 8.0 8.7 5.5 4.3 6.6 6.3 6.5 6.5 6.5
Latin America 4.9 5.6 5.5 3.9 -2.5 3.2 3.5 4.1 4.1 4.1
Middle East & North Africa 6.5 6.1 5.6 5.9 1.5 4.2 4.5 4.8 4.7 4.9
Sub-Saharan Africa 6.8 6.7 7.0 4.9 0.3 4.1 4.5 4.9 4.8 4.8
World trade growth (%) 7.5 9.1 7.5 3.6 -9.4 5.2 4.9 5.7 5.7 5.9
World inflation (%; av) 3.0 3.2 3.4 4.9 1.5 2.6 2.6 2.9 3.1 3.2
Commodity prices
Oil (US$/barrel; Brent) 54.4 65.4 72.7 97.7 62.0 78.0 73.0 80.0 82.5 89.5
Aluminium (US$/tonne) 1,899.5 2,594.0 2,661.2 2,620.9 1,706.8 2,341.3 2,374.8 2,400.0 2,450.0 2,500.0
Copper (US cents/lb) 166.8 305.6 322.3 316.2 233.6 324.3 322.5 300.0 305.0 310.0
Exchange rates (annual av)
¥:US$ 110 116 118 103 94 88 87 86 85 85
US$:€ 1.25 1.26 1.37 1.47 1.39 1.42 1.40 1.42 1.44 1.45
a PPP = purchasing power parity
Source: Economist Intelligence Unit.