The world economy was battered by a number of unexpected shocks in 2011:
- A surge in political turmoil in North Africa and the Middle East that sent oil prices soaring
- Higher global food prices aggravated by extreme weather conditions
- A disastrous earthquake in Japan that led to a massive disruption of global vehicle and electronic equipment production
- The debt-ceiling debacle in the US that ended with the US losing its AAA credit rating
- Supply chain disruptions in the Asian region as a result of severe flooding in Thailand
- Heightened sovereign and banking crisis in the Euro-area.
Of these issues, the European crisis remains the biggest threat in 2102
The European outlook
Nine European countries joined the United States on Standard & Poor's list of weakened sovereign debt issuers on 13 January this year. The rationale was partly on fiscal grounds but S&P also expressed concern that European policymakers had made little progress in addressing the broad array of stresses in the euro zone.
In particular, they pointed to tightening credit conditions, slowing economic growth, and disputes between European policymakers over how best to address Europe's economic and fiscal challenges. The round of downgrades means borrowing costs could go up. However, thus far, downgrades have not triggered a significant increase in financing costs.
Holding the Union together
Resolving the euro-area financial crisis remains extremely complex. After the EU summit on 8 and 9 December 2011, EU leaders announced the establishment of a new "fiscal compact", which aims to better enforce fiscal discipline within the region.
However, the details of the new treaty are still vague. This means that there is a significant risk that the financial markets will remain relatively volatile, especially if growth rates continue to soften. There is also a real concern that the higher cost of refinancing sovereign debt will derail the ability for key governments (especially Italy) to effect the necessary fiscal discipline.
Italy needs a break
Under the leadership of Mario Monti, Italy has adopted a severe austerity package aimed at eliminating its budget deficit by the end of 2014. Italy requested that Germany assist with lowering Italian bond yields so that their debt repayments are lower. The motivation is that without some incentive, it will be difficult to sell austerity to the Italian people.
The EU will break up without support from the public, and the public needs a reason to remain part of the Union. The Italian 10-year bond yield is, fortunately, below 7%. Italy has to pay €440 billion just to service its debts in 2012, with about €130 billion in the first quarter.
Should Italian bond yields rise, the increased cost of borrowing could start to swamp the budget and undermine the government’s ability to implement a managed and orderly path to fiscal discipline.
Deciding on the length of the Greek haircut
The Greek private sector bail-out is still unresolved and Greece could still default. The Greek government, and private-sector creditors are meeting this month to agree on a debt-swap deal that may see private banks agreeing to well in excess of a 50% write-down of their holding of Greek government debt.
The US outlook
As the American economy moves into 2012, the growth-rate outlook reflects more of the same. The economy is expected to experience low growth of around 2% this year. There are indications, though, that the US is on the road to better times:
- Recent economic data out of the US appear a bit more promising but the urgent need for the US to start to consolidate its fiscal position in 2012, in other words cut back on government spending, will tend to dampen its economic performance.
- Consumer spending will most likely continue to drive some growth and real income gains will benefit from slower inflation and steady employment.
- Fixed investment is likely to continue supporting growth
- Inflation is set to slow down as commodity and producer prices moderate and labour costs rise only moderately.
- Interest rates are expected to remain low for most of the year.
- Significant progress has been made in reducing private (household) debt.
There are still, of course, big risks especially the risk is that the euro-zone crisis could derail the budding US economy.
Emerging world outlook
Economic conditions in many emerging economies (China, India and Brazil) remain reasonably favourable, mainly as a result of their relatively sound economic fundamentals, including low government debt.
The growth in fixed-investment activity in emerging economies has also consistently out-performed that of the developed world. While the rate of growth in most emerging economies is expected to significantly out-perform that of the major developed economies in 2012, the emerging world has not decoupled from the developed world. Rather, the world economy is more inter-connected than ever. The near-recession conditions in a number of developed economies will no doubt continue to have a negative impact on growth in emerging-market economies.
Nigerian unrest
Nigeria was recently struck by civil protests by labour and the general public against the hike in fuel prices resulting from the removal of subsidies. This lead to some concerns about stability in Nigeria and investors are worried that the removal of the subsidies would jeopardise the consumer-inflation outlook.
Transport has a 6.5% weighting in the Nigerian inflation basket. In November 2011, transport inflation rose to 10.4% year-on-year. The removal of the fuel subsidy applies only to petrol, not diesel which is used for most trucks and buses in the country. Subsequently, the Nigerian authorities have succumbed to civil pressure and have cut fuel prices again.