March 2013 2013- A Strategic and Thematic View of the World Economic Outlook Emerging Markets Continue to Drive Growth and Capital Flows William Lee Managing Director [email protected] +1-212-816-2621 See Appendix A-1 for Analyst Certification, Important Disclosures and non-US research analyst disclosures Published: 3/6/2013 Citi Research is a division of Citigroup Global Markets Inc. (the "Firm"), which does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Table of Contents Global Growth Remains Tepid 4 High Leverage and Weak Housing Markets Continue to Dampen Growth 9 UK and Ireland Recoveries Stall 14 US Recovery Coming Despite Fiscal Cliffs 21 Euro Area Uncertainties Heighten Global 28 Macro/Financial Risks and Vulnerabilities Banking Sector Crisis 33 External Imbalances Crisis 36 Selected Policy Prescriptions for Euro Area 40 Middle East North Africa—Tale of Two Regions 42 Global Capital Flows, Dutch Disease, 47 and Capital Controls 2 Global Growth Modest as Risks and Vulnerabilities Persist UK recovery stalls • Headwinds from de-leveraging and the EMU crisis • Monetary policy limited by inflation targeting objective US growth strengthens despite high unemployment and fiscal uncertainties • Housing and consumer spending (autos) respond to Fed easing • Low energy prices and prospective energy independence spur optimism and investment spending Euro Area complacency rampant despite structural vulnerabilities • Italian elections dampen upbeat mood from “Draghi Put” (Outright Monetary Transactions) • High debt burdens press on domestic demand as de-leveraging stalls • Structural and Political Impediments to viable currency union loom large Emerging Market growth model shifts focus to domestic demand • China’s transformation slows GDP growth and changes Asian supply chain • Smart urbanization helps overcome demographic drag • Surging capital inflows fan EM policymakers’ fears of “Dutch Disease” and raise prospects of more capital controls 3 Source: Citi Research Improving Global Indicators Point to Modest Global Growth Exports and Mfg Turning Up (?) Moderate Growth for US and China 30 68 6.0 10 Global Export Volume China 20 62 4.0 7.5 10 56 United States Oct 0 50 2.0 5 Expansion Global PMI:Manufacturing Dec = Percent, YoY Percent, YoY 50+ m onth Change Percent - -10 44 12 0.0 2.5 -20 38 Euro Area -2.0 0 -30 32 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Sources: Netherlands Bureau for Economic Policy Analysis, Markit, and Citi Research. 11:Q1 11:Q2 11:Q3 11:Q4 12:Q1 12:Q2 12:Q3 12:Q4 13:Q1 13:Q2 13:Q3 13:Q4 14:Q1 14:Q2 14:Q3 14:Q4 4 Bank Credit Supports Emerging Market Growth 5 Global Growth Leadership Continues to Rely on China and EM Contributions to Global GDP Growth, Annual Real GDP Growth By Region, 2000-17F Averages, 1998-2017F 6 Global Economic Forecasts Overview GDP Growth (%) CPI Inflation (%) 2012 2013 2014 2012 2013 2014 Global 2.5 2.6 3.2 2.8 2.8 3. 0 US 2.2 1.9 3.1 1.7 1.5 2.1 Japan 2.0 1.3 1.2 0.0 -0.3 1.9 Euro Area -0.5 -0.6 -0.4 2.5 1.8 1.5 y Germany 0.9 0.5 0.5 2.0 2.0 2.3 y France 0.0 -0.2 0.2 2.2 1.3 1.7 y Italy -2.1 -1.4 -1.4 3.3 2.1 1.3 y Spain -1.4 -2.2 -2.0 2.4 1.1 0.3 y Greece -6.1 -6.5 -11.5 1.0 0.3 16.8 y Ireland 0.5 0.5 1.5 2.3 1.2 1.4 y Portugal -3.1 -3.7 -2.8 2.8 1.7 0.9 y Netherlands -1.0 -0.9 0.3 2.5 2.6 1.7 UK 0.1 0.4 0.7 2.8 2.9 2.3 Switzerland 1.0 1.4 1.2 -0.7 -0.9 -0.6 Sweden 1.1 1.0 2.5 0.9 0.4 1.7 Emerging Markets 4.7 5.2 5.5 4.4 4.6 4.7 China 7.8 7.8 7.3 2.6 2.8 3.6 India 5.4 6.2 6.9 7.5 7.0 6.0 7 Source: Citi Research Market Rates Forecasts Avge Avge Avge Current Mid-13 End-13 2014 2015 2016 US Fed Funds 0.25 0.25 0.25 0.25 1.10 2.10 ECB Refi Rate 0.75 0.50 0.25 0.25 0.25 0.31 Japan Call Money 0.10 0.10 0.10 0.13 0.10 0.10 UK Base Rate 0.50 0.50 0.50 0.50 0.50 0.50 10 Yr US Treasury 1.82 1.95 2.50 2.80 3.25 3.50 10 Yr Euro (Bund) 1.55 1.55 1.50 1.44 1.50 2.00 10 Yr BTP-Bund (bp) 266 350 375 350 400 300 10 Yr OAT-Bund (bp) 57 70 100 90 120 80 10 Yr JGB 0.73 0.95 1.05 1.00 1.38 1.50 10 Yr Gilt 2.00 1.80 1.80 1.75 1.75 2.50 USD/EUR 1.33 1.34 1.32 1.31 1.32 1.35 YEN/USD 90 95 95 92 88 86 EUR/GBP 0.84 0.83 0.82 0.81 0.80 0.80 USD/GBP 1.59 1.61 1.61 1.62 1.65 1.69 USD/CNY 6.22 6.14 6.09 6.07 6.05 6.06 8 Source: Citi Research EM Fiscal Easing Helps Sustain Domestic Spending Fiscal stance in EM is relatively loose, and generally …and despite expansionary fiscal positions since 2007 (upper looser than it was a year ago… right quadrant) modest debt levels suggests more room to ease Much5 Public debt and deficits: 2012 vs 2007 Tighter 25.0 Czech R Higher debt (ppt S. Africa 20.0 RO 4 Hungary Somewhat GDP) Taiwan Romania CZ Poland Tighter 15.0 PE Colombia ZA HU India Brazil 10.0 TW Unchanged3 PO Argentina Mexico Chile Sri Lanka TH MX 5.0 Russia China KO CL HK IL RU 0.0 Somewhat2 Indonesia Korea BR TU Looser Philippines Israel CN -5.0 Thailand Kazakhstan PH IN Fiscal Stance TodayFiscal vs A Year Ago Venezuela Peru 1 -10.0 ID Much PE Bigger deficits Turkey Looser (ppt GDP) Ukraine -15.0 AR Vietnam 0 -20.0 012345Very Somewhat Neutral Somewhat Very -4.0 -2.0 0.0 2.0 4.0 6.0 8.0 10.0 Expansionary Expansionary Contractionary Contractionary Current Fiscal Stance Source: Citi Research Source: Haver Analytics, Citi Research 9 High Leverage and Weak Housing Markets Dampen Growth in Advanced Economies 10 Percent of GDP 11 100 125 150 175 200 -75 -50 -25 25 50 75 Private SectorLeverageRemainsHigh 0 Sources: Eurostat and Citi Research Germany % Czech Slovakia Poland 2001-12 Change Total Peak 2006-10 2001to From Change Peak 2006-10 Since Change Neths France Austria Italy US Sweden Belgium Lithuani Norway Greece Finland Slovenia Portugal UK Denmark Estonia Romania Spain Latvia Hungary Cyprus Bulgaria Ireland Private Sector Deleveraging Has Stalled in Europe and UK Change in Private Debt/GDP Ratios In This Shortfall in Real GDP Versus Pre-Crisis Trend Crisis After Banking Crises Compared to Historical Experience % % 100 10 Shaded area denotes interquartile US EMU range of historic output losses 5 80 Average +/- UK one standard 0 deviation 60 -5 40 -10 -15 EMU 20 US -20 Historic Average Output Loss for 0 UK Average in 12 Countries With Systemic -25 Banking Crisis Countries Banking Crisis* -20 -30 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 -101234567 Distance in Years from First Year of Crisis Distance in Years from First Year of Crisis Note: We date start of current crisis for EMU, US, UK as Q4-08. Sources: IMF and Citi Research * These crisis are: (Chile 1981, Finland 1991, Indonesia 1997, Japan 1997, Malaysia 1997, Mexico 1994, Nicaragua 2000, Norway 1991, Philippines 1997, Sweden 1991, Thailand 1997, Uruguay 2002) Sources: Datastream and Citi Research 12 Deleveraging is a Drag on the Recovery GDP In Recessions and Recoveries 150 (Indexed to 100 at the Start) 145 Stylised Normal Trend GDP Growth of 2.5% YoY 140 135 Stylised Normal Recession 130 125 . 120 Typical Path for Countries With 115 Systemic Financial Crisis 110 105 100 -8-6-4-202468 Distance in Years from First Year of Crisis Note: We date start of current crisis for EMU, US, UK as Q4-08. * These crisis are: (Chile 1981, Finland 1991, Indonesia 1997, Japan 1997, Malaysia 1997, Mexico 1994, Nicaragua 2000, Norway 1991, Philippines 1997, Sweden 1991, Thailand 1997, Uruguay 2002) Sources: Datastream and Citi Research 13 Weak Housing Markets Slow Consumption Spending Selected Countries: Real House Prices, Selected Countries: Correlation between (Index, 1Q 1997=100) House Prices and Private Consumption 300 SPA UK 90% 280 US IRE NL 80% 260 70% 240 60% 220 50% 200 40% 180 30% 20% 160 10% 140 0% 120 UK US ITA IRE SPA FRA AUS DEN GER NOR SWE 100 NETH 1997 1999 2001 2003 2005 2007 2009 2011 Sources: Eurostat, Citi Research 14 UK and Ireland Recoveries Stall 15 U.K.