Outlook world economy 2009

Negative economic growth in 2009; tentative recovery in second half of the year

Global recession inevitable

The major economies of the industrialised world (US, UK, Euro zone and Japan) have sunk into recession and will experience negative growth in 2009. Global economic growth is expected to dip below 2%. Growth in emerging markets as a whole, forecast at 3.5%, may compensate for the contraction in the developed countries.

Confidence crisis

The credit crunch developed into a confidence crisis in 2008. The correlation between financial market sentiment and consumer and business confidence in the real economy has risen to an all-time high in the second half of the year. Since sentiment in the stock markets has collapsed to a level that can best be described as a depression, there is also considerable concern about a depression scenario in the real economy, like the one in the 1930s. There is consequently a danger that investor pessimism will become a self-fulfilling prophecy. We expect a (very modest) economic recovery in 2009, provided confidence also rallies.

It’s up to the policy makers

Unlike the situation during the Great Depression of the twentieth century, today's policy makers (governments and central banks) are very much aware that they need to take all possible steps to prevent a new depression. They have already demonstrated this, including by injecting enormous amounts of capital into the financial system and cutting interest rates dramatically. Their main task in 2009 will be to stimulate domestic demand and improve financial conditions. Central banks will continue to cut interest rates. They have the leeway to do so because of the rapid ongoing fall in inflation. We expect the US and Japanese central banks to cut their interest rates to zero, while the ECB and the Bank of England is expected to trim their rates to 1%.

Consumers and businesses need support

The biggest burden for stabilising the economy rests on governments' shoulders. They need to take fiscal measures to ease the situation for consumers and businesses. Consumer confidence has plummeted and spending by US consumers has been declining for some months. Their capital has been eroded by the slump in house and share prices. And unemployment is rising sharply as well, while the banking crisis has made it much harder to borrow money. The US consumer, accustomed to waving a credit card, will have to get used to saving a much greater proportion of his income. This means that consumer spending will not pick up to any great extent for the time being and so cannot contribute to an economic recovery. We note, however, that real incomes are getting support from the decline in inflation stemming from the sharp fall in energy prices.

The business community is also under pressure. Exports are weakening owing to the global slowdown, which means it is important to stimulate domestic demand. Stricter credit terms are depressing investment. Small businesses, which are generally more dependent on external funding, are having a particularly difficult time. Companies that are dependent on discretionary consumer spending (e.g. luxury goods producers) and on capital expenditure by industry are being hit the hardest. The number of bankruptcies will therefore shoot up. Unlike in the previous recession of 2001/2002 and in comparison with the (US) consumer, companies are in a fairly good state as far as their balance sheets are concerned. The Financial sector is naturally an exception.

Government spending up

The above factors mean that the government must increase its expenditure further. We therefore expect that US President-elect Barack Obama will be in a hurry to fulfil his elections promises. The consumer will be helped by tax breaks on low and middle incomes, and by job creation, particularly in 'green' industries, which can also count on government support. Spending on the infrastructure will increase sharply as well. The Euro zone, too, needs government stimulation. It is important that this is coordinated because the Euro zone economy is divided into many much smaller open economies. In that context, the European Commission recently proposed a package of measures worth EUR 200 billion, equal to 1.5% of the Euro zone's gross domestic product. Member states have announced their own plans, too.

Support from emerging markets

Emerging markets can also boost the global economy. The increasing importance of domestic consumption in the emerging market economies has made them less dependent on exports to the west in recent years. They naturally are also feeling the knock-on effects of the recession in the developed markets. Commodity exporters, particularly South American countries like Brazil, but also Russia, have seen their income shrink dramatically owing to the decline in commodity prices. Countries with a large current account deficit have also come under pressure because foreign investors have withdrawn their cash. Emerging markets have become a very diverse group and it is important to distinguish between strong and weak countries. Countries with large foreign exchange reserves and a high current account surplus -found mainly in Asia (China) - have a lot of scope to stimulate their domestic economy in their fiscal and monetary policy.

Tentative recovery in 2009

To sum up, 2009 will be a year of negative economic growth in the western economies. Government support actions, in particular, should lead to a gradual and modest recovery in the second half of the year. This recovery will be modest because of the debts that the financial sector and also the US consumer will need to pay off in the years ahead.

Source: ING Investment Management, reference date 1 December 2008.