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December 2015 G20/20 Vision Opportunities and challenges for 2016 Table of contents Introduction2 Activity4 1. Size of economy—GDP 4 2. GDP/Capita4 3. GDP growth 4 4. Industrial production 4 Prices 5. CPI inflation 6. House prices 7. Wage growth 5 5 5 5 Labour6 8. Unemployment rate 6 9. Youth unemployment 6 Financial markets 10. Equity market 11. Currency market 12. Official interest rates 13. Long term interest rates 7 7 7 7 8 Demographics9 14. Population growth 9 15. Life expectancy 9 Government10 16. Budget balance 10 17. Public debt 10 External11 18. Exports11 19. Current Account 11 20. Foreign exchange reserves 11 G20 Country details 12-31 Conclusion32 1 Introduction In 1999, in the aftermath of the Asian Financial Crisis, the group of the 20 largest countries in the world was formed. The purpose of the group was to seek agreement on ways to strengthen the global economy, reform international financial institutions, improve financial regulation and implement key economic reforms that are needed to raise the potential growth rate of its members. In the 16 years since its formation, the G20 has had to deal with a number of colossal events including, but not limited to, the technology boom and bust, major terror attacks in the US, Bali, Madrid, London, and Paris, wars in Iraq, Afghanistan and Syria, the global financial crisis, the Greek debt crisis, and the European sovereign crisis. As its Chair in 2014, Australia set an objective to lift G20 economic growth by an additional 2% over five years. The G20:20 Report, now in its second year, analyses the past trajectory and future challenges of the G20 through the lens of 20 macroeconomic indicators with a view to assessing how the G20 is tracking against the goal set by Australia. A number of interesting themes that relate to the ability of the G20 to achieve its growth goals have emerged from this years’ report: Theme 1: Dealing with divergence. Last year, almost 25% of the G20, on a GDP weighted average basis, eased monetary policy. Just 7% of the G20 tightened monetary policy. Over the next 12 months, that divergence is expected to widen with almost 40% of the G20 expected to tighten policy while almost 45% are expected to ease monetary policy. remained broadly unchanged. With divergence comes volatility in what may become an all-out currency war. Currency risk management will become more important over the next 12 months. Theme 2: Less is the new normal In the past 12 months, the G20 economies managed to record growth of 2.3%. In the 12 months prior to that G20 GDP growth was 2.5%. Slower growth has been driven by weaker growth in China and by association those economies reliant on commodities including Australia, Brazil and Canada. Inflation is also lower across the G20. In the last 12 months, 69% of the G20 economies by GDP weight had an inflation rate of 1% or less. This compares with 30% in the 12 months prior to that. Slower economic growth and lower inflation means real interest rates will be lower. For investors, this means expected returns, which work off real interest rates as their starting point, will also be lower. Achieving target returns will be more difficult going forward. Investors will either need to revise down their target returns to match the lower expect return environment, chase returns by taking on more risk, or be more dynamic in their asset allocation—taking profits early and often. One of the key investment implications of divergent monetary policy is increased volatility. In terms of idea generation this means directionality will be difficult to determine. Relative value positions will become a more important driver of return. In terms of portfolio construction, nimble asset allocation underpinned by clarity of investment process; having clear investment review levels and knowing when to take a profit will become even more important. Theme 3: Peak reserves The decision by the US Federal Reserve to raise interest rates for the first time in nine years will have significant ramifications for a world that has for so long relied on a weaker US dollar. The tide is going out on emerging market currencies and with it the benefits of low inflation and low interest rates. G20 currencies have fallen significantly against the US dollar in the last 12 months. Rapidly declining emerging market currencies is putting upward pressure on inflation, and on their central banks to respond with higher interest rates. Many of these central banks have responded by intervening in the market to defend their currencies. This intervention is not without cost. According to the IMF, foreign exchange reserves globally peaked in the middle of last year and have been declining ever since. In recent years, currency volatility has been relatively muted, as interest rates in most major economies have China and the emerging G20 economies led the build-up in reserves in the wake of the 1997 Asian Financial Crisis 2 to a peak of more than $8.2 trillion last year. Of this, 81% sat in emerging G20 central banks. G20 reserves have since declined to $7.7 trillion. into financial assets. Upward pressure on US bond yields may affect the operation of monetary policy and hamper the ability of other countries such as Europe and Japan, to exit unconventional monetary policy. Slower economic growth out of China, still weak commodity prices, a strong US dollar and higher US interest rates and still weak global trade are all reasons to suggest we have seen a peak, at least for now, in global foreign exchange reserves. Whilst setting a growth goal is admirable, it appears clear that achieving it will be a challenge. One of the implications of peak reserves would be less demand for sovereign bonds from a key non-profit maximising buyer. A large proportion of foreign exchange reserves are invested in sovereign bonds, mainly US Treasuries. The effect is equivalent to a quantitative tightening because it means less liquidity being pumped Tracey McNaughton Executive Director Head of Investment Strategy Global Investment Solutions—Asset class attractiveness. Unattractive Overall Neutral USA Australia Equities Attractive Japan Emerging UK Eurozone Switzerland Fixed Income UK High Yields EMD local Corporates Currencies NZD Positive EMD $ US Switzerland Australia EMU Japan CAD EUR AUD USD CHF GBP JPY Negative As of October 31, 2015 Based on UBS Asset Management views with a 12-18 month time horizon. 3 Activity 1. Size of economy—GDP Global GDP, the total value of all goods and services manufactured and produced in one year, amounted to approximately 77 trillion US dollars in 2014. G20 GDP amounts to around 79% of global GDP. The United States, Europe and China alone make up 56% of G20 GDP. The remaining 44% of the group is made up of 17 countries. 3. GDP growth The latest annual growth rates for each of the economies in the G20 when compared with their 10 year average growth rate reveal some interesting trends. First, the commodity countries of Australia and Canada have moved from outperforming their 10 year average last year to underperforming it this year. The emerging markets are currently growing below their 10 year average growth rate. This is particularly evident for Russia where economic sanctions combined with a significantly lower oil price has pushed the economy into a deep recession. Finally, the remaining developed economies (the US, Germany, the UK, the EU, France, Japan and Italy) are currently growing at rates above their 10 year average. For France and Japan this is a turnaround from last year. Chart 1: G20 GDP (% share) GDP Growth (yoy%) Chart 3: GDP Growth (yoy %) The G20 grew by 2.3% most recently, down from its 2.5% pace of the previous 12 months and lower than its 10 year average pace of growth of 2.9%. Indeed, the world economy recorded its slowest 3 year average pace of growth in 2014 since 2002. 10.0 Australia 2% US 24% India 3% 6.0 4.0 Russia 3% 2.0 Brazil 3% 0.0 (2.0) France 4% China 14% (4.0) Source: Bloomberg, as at 30 September 2015 (USD, 2014) Aust US Canada Japan Germany France UK EU Italy S. Kor Saudi Arabia Argentina Russia Brazil Turkey Mexico China South Africa Indonesia India Italy Japan EU France UK US Germany Mexico 4. Industrial production Brazil and Japan remain the weakest performers in terms of industrial production. Industrial production grew by 8.5% most recently in Turkey, driven by the manufacturing sub-sector and supported by growth in the European Union economies. Industrial production growth in China has declined from an average annual pace of 6.1% last year to 5.9% currently. Industrial activity remains lacklustre across most of the developed G20 economies reflecting the decline in global trade. It has weakened in the US where the strength in the dollar has undermined its international competitiveness. Manufacturing activity is struggling in emerging markets as reflected in the decline in global trade. Industrial production (latest, yoy %) Chart 4: Industrial production (latest, yoy %) 2014 2013 0 10,000 20,000 30,000 Source: Bloomberg, as at 30 September 2015 40,000 50,000 60,000 70,000 Turkey India China Indonesia Australia Germany UK France Canada South Korea Mexico Italy Russia Argentina US EU South Africa Japan Brazil (9) (7) (5) (3) (1) Source: Bloomberg, as at 30 September 2015 4 Canada Australia South Africa Brazil Russia Turkey South Korea Argentina Source: Bloomberg, as at 30 September 2015 2. GDP/Capita Comparing the gross domestic product of a country to the number of inhabitants produces GDP per capita. GDP per capita rose in most countries compared to last year. The exceptions were Australia, Canada, Japan, Argentina, Russia, and Turkey. These countries have either struggled under the weight of significantly lower commodity prices, or, as is the case with Japan, the translation effect from a stronger US dollar has had a significant impact. G20 GDP/Capita (USD) Chart 2: G20 GDP/Capita Saudi Arabia EU 18% India Japan 6% Indonesia (6.0) Germany 5% China UK 4% Latest 8.0 Canada 2% Italy 3% 10yr avg other 1 3 5 7 9 Prices 5. CPI inflation As was the case last year, consumer prices are increasing most significantly in Russia, Brazil and Turkey. These emerging market economies are suffering from substantial devaluations in their exchange rates which is putting upward pressure on import prices. A large proportion of imports into these countries is food which has a disproportionately large weight in the CPI basket for many emerging economies (on average a weight of 27%). defaults, legal proceedings usually take five to seven years. Investing in the Italian housing market is made even more unattractive due to rental controls and other restrictions. Real house price growth Chart 6: Real house price growth (Index Jan 09 = 100) 160 150 140 130 Consumer prices have risen significantly in Russia since the imposition of economic sanctions by the European Union and the US. 120 110 100 90 09 The effect of lower oil prices is clearly evident among the oil importing nations with headline inflation now below 1% in 68% of the G20 economies. This is up from 30% of the G20 last year. Headline inflation is currently zero in the US, Germany, France, and Japan. Deflation is already evident in the EU and the UK. The US recorded one of the most significant declines in inflation compared to last year as the strength in the dollar added to the deflationary effects of a lower oil price. 10 Aust 2 4 6 8 10 12 14 12 13 Indonesia 14 15 Brazil Canada 11 Mexico 12 France 13 Russia 14 Korea 15 Italy Source: Bloomberg, as at 30 September 2015 7. Wage growth Not surprisingly, wage growth is greatest in the emerging G20 economies where inflation is also the highest. This includes Brazil, Russia and Mexico where wages are growing in excess of 4% annually. Elsewhere, wage growth remains subdued and is even in decline in Australia, Germany, Italy, and the US. Russia Brazil Turkey Indonesia South Africa India Mexico Saudi Arabia China Australia Canada South Korea Italy Japan US Germany France UK EU 0 10 Japan CPI (latest, Chart 5:yoy%) CPI (latest, yoy %) (2) India 110 105 100 95 90 85 80 75 70 65 60 09 For emerging market economies, the issue is more one of inflation, rather than deflation. Headline inflation has increased over the last 12 months in Russia, Brazil and Indonesia. Sharp depreciations in the local currencies has put upward pressure on imported inflation. 11 US 16 Source: Bloomberg, as at 30 September 2015 6. House prices Since the global financial crisis, real house prices have increased by over 50% in India and Brazil with Canadian house prices up almost 40% in real terms over the same period. Brazilian house prices increased on average by 16% per year in real terms between 2009 and 2011 as the domestic economy benefited from a strong currency and low interest rates. More recently the pace of growth has declined to an annual average of just 0.3%. Real house prices have remained relatively stagnant in Japan, Mexico, France and South Korea and have fallen in Russia and in Italy. The mortgage market in Italy is small due to the length and cost of the loan recovery process, making Italian banks cautious to lend. From the time a borrower Weak wage growth may in part be a result of a structural shift in some economies away from manufacturing and toward the lower paying services sector. This certainly may be the case in Australia and the US where wage growth has been surprisingly weak despite improving labour markets. Another key driver may also be the shift toward part-time and temporary work. The International Labour Organisation recently highlighted the growing incidence of workers without a permanent contract. The occurrence was particularly evident in Indonesia, India, and China. Wage growth (latest, yoy%) Chart 7: Wage growth (latest, yoy %) China Brazil Russia Mexico UK Argentina Australia Canada US EU Germany South Africa France Italy Japan South Korea -2 0 2 4 6 8 10 12 Source: Bloomberg, as at 30 September 2015 5 Labour 8. Unemployment rate Among the G20, the economy with the highest unemployment rate continues to be South Africa, with an unemployment rate little changed from last year at 25.5%. The G20 economy with the lowest unemployment rate is Japan, closely followed by South Korea. The unemployment rate has fallen across most G20 economies compared to this time last year. The exceptions are Brazil, Russia and Canada, all of whom entered into a recession in 2015, and South Africa. The unemployment rate has risen in Brazil to 7.6% currently from 4.9% this time last year. In most G20 economies, the current unemployment rate is below its 10 year average. The exception to this is the commodity-driven economies, Australia, Brazil and Canada, where the current unemployment rate is above their 10 year average. Relative to its 10 year average the unemployment rate has fallen in the US, followed by Germany and Argentina. The greatest amount of deterioration in the unemployment rate relative to its 10 year average occurred in Italy. Unemployment Rate (latest, %) Chart 8: Unemployment rate (%) Chart 9: Youth unemployment rate (%) Youth (15-24) unemployment rate (%) South Africa Italy Saudi Arabia France Indonesia EU Turkey Argentina Brazil Russia UK Canada Australia India US Mexico South Korea Germany Japan 2015 2014 0 Japan South Korea China Mexico US Russia UK Saudi Arabia Australia Germany Argentina Canada Indonesia Brazil India EU Turkey France Italy South Africa 10 20 Source: Bloomberg, as at 30 September 2015 0 5 10 Source: Bloomberg, as at 30 September 2015 6 9. Youth unemployment Youth unemployment remains elevated across the G20 although it does appear to have declined since last year. The exceptions to this are South Africa, where the rate is the highest among the G20 and growing at 51.5% compared to 48.2% last year. Among the developed economies, youth unemployment is exceptionally high in Italy at 40.5%, just shy of its all-time high of 43.7% reached in March 2014. 15 20 25 30 30 40 50 Financial markets 10. Equity market The best performing equity markets over the past 12 months were China and Russia, with 29% and 16.4% growth respectively, followed by India and Japan, with 9.3% and 6.4% growth respectively. The worst performing markets, down by more than 10%, were Argentina, Indonesia, Brazil and Canada. Most developed market G20 equity markets are still well below their pre-GFC peak. This particularly applies to Italy, France and Australia, each more than 20% below their peak. In contrast, most emerging G20 equity markets are currently well above their pre-GFC peak. This is most evident for Argentina, South Africa, Indonesia and India, each more than 30% above their pre-crisis peak. The US and Germany are the only developed market G20 economies to have their equity markets above their respective preGFC peak, up 25.8% and 19.7% respectively. China Russia India Japan South Korea Germany Italy South Africa France Turkey US Australia Mexico UK Canada Brazil Indonesia Argentina (20) (10) 0 10 20 Japan Turkey Argentina Brazil Mexico Russia South Africa Indonesia Canada EU France Australia India Germany Italy South Korea UK US China Saudi Arabia (40) (20) 0 20 40 Source: Bloomberg, as at 30 September 2015 12. Official interest rates Official interest rates are still highest among the emerging G20 economies. Interest rates are above 10% in Argentina, Brazil and Russia and above 7% in Indonesia, India and Turkey. Interest rates are the lowest among the developed G20 economies with the US, Europe, Japan, the UK and Canada all having rates at or below 0.5%, in total representing 49% of the G20. Monetary policy has been eased in the past 12 months in China, India, South Korea, Australia, Canada and Turkey. In contrast, monetary policy has been tightened in Argentina, Brazil, Russia and South Africa—all of whom are fighting imported inflation from recent currency depreciations. Chart 10: Equity market growth (latest, yoy %) (30) Chart 11: Currency markets (% deviation from 15yr Real effective echange rate (% deviation from 10-year average) average) 30 Source: Bloomberg, as at 30 September 2015 11. Currency market Most emerging market currencies have fallen significantly in the past 12 months. Among the G20, the Brazilian real is the worst performer, falling 30% in real effective exchange rate terms over the past 12 months. The Russian rouble has declined by 26% and the Mexican peso has fallen 15%. The Mexican peso is the most liquid emerging market currency which can be traded 24/7. Mexican assets will therefore suffer in a risk-off environment even if the country is fundamentally stronger than many other emerging economies. The only G20 currencies that saw appreciations were the US dollar (+13.4%), the Saudi Arabian riyal (+13.0%) and the Chinese yuan. Official rates (latest, %) Chart interest 12: Official interest rates (%) Argentina Brazil Russia Indonesia Turkey India South Africa China Mexico Saudi Arabia Australia South Korea UK Canada US Japan Italy Germany France 2015 2014 0 5 10 15 20 Source: Bloomberg, as at 30 September 2015 Relative to their 10 year average, the largest declines in the real effective exchange rate have been for the Japanese yen and the Turkish lira. The largest appreciations were in the Saudi riyal (+37.0%) and the Chinese yuan (+31.2%). 7 13. Long term interest rates Long term interest rates, as measured by the yield on 10 year government bonds, have generally moved lower over the last 12 months among the G20. The exception to this is Brazil, Russia, Indonesia, Turkey and South Africa. Long term interest rates currently sit at 15.4% and 10.7% in Brazil and Turkey respectively, posing a funding challenge for the sizeable current account deficit each emerging market faces. In the past year, the European Central Bank’s Quantitative Easing program has had a dampening effect on euroarea bond yields. In Germany, 10 year bond yields are approaching the levels seen in Japan while yields in Italy and France are below 10 year yields in the US and UK. Chart Government 13: 10 yearbond bond yields (%) 10-year yield (latest, %) Brazil Russia Turkey Indonesia South Africa India Mexico China Australia South Korea US UK Italy Canada France Germany Japan 2015 2014 (4) 1 Source: Bloomberg, as at 30 September 2015 8 6 11 16 Demographics 14. Population growth There are currently around 7.3 billion people in the world, growing at the rate of around 2 people every second. Between 2010 and 2015 populations have grown in every G20 economy with the single exception of Japan where it declined by 0.12%. In the past year alone, the population in Japan has shrunk by one million people. The fastest growing population is Saudi Arabia, where immigration levels are the highest in the G20 (see Chart 28). Immigrants make up 31.4% of the Saudi national population. Among the advanced G20 economies, Australia has one of the fastest population growth rate at 1.4%. Chart 14: Population growth (latest,%) yoy %) Population growth (last 12 months, Saudi Arabia Italy Russia South Africa Australia Indonesia India Canada Turkey Mexico Argentina Brazil US UK China France Germany South Korea Japan 15. Life expectancy Population growth is slowing as the birth rate declines but people are living longer thanks to new technology and healthier lifestyles. The economy with one of the biggest improvements in life expectancy among the G20 is China. A child born in China in 1990 could be expected to live to on average to the age of 68. This compares with a child born in China in 2013 could expect to live on average 8 years longer to 76. In Shanghai life expectancy is now 83—on par with Switzerland. While Japan tops the league tables for the highest life expectancy, South Korea has the fastest ageing population. South Korea’s population of 65+ has almost tripled within one generation. At the other extreme is the US, whose 65+ population has increased just 16% compared to 1981 (see Chart 25). -0.5 0 0.5 Source: Bloomberg, as at 30 September 2015 1 1.5 2 2.5 90 85 80 75 70 65 60 55 3 50 South Africa India Russia Indonesia Brazil China Turkey Saudi Arabia Argentina Mexico US Germany UK South Korea Canada France Australia Italy Japan Chart 15: Longest Longest lifespanlifespan (years)(years) Source: Bloomberg, as at 30 September 2015 9 Government 16. Budget balance Generally speaking, most G20 economies are currently running a fiscal deficit. The exceptions are South Korea, which is running a surplus of 1.6% of GDP, and Germany, which is running a small 0.3% surplus. In the past 12 months, fiscal balances have generally deteriorated, particularly in Brazil, Russia, and Saudi Arabia. The deterioration in commodity prices has been particularly harmful for government revenue in these economies. The fiscal balance has improved for a number of economies over the last 12 months, particularly for Canada, the UK and Japan. Compared to its 10 year average, the fiscal position for the US has improved significantly, from a deficit of 4.9% to a deficit of 2.4% currently. Germany and the UK have also had, though less significant, improvements in their fiscal positions compared to their 10 year average. Fiscal Balance (latest, %GDP) (% GDP) Chart 16: Fiscal balance South Korea Germany Saudi Arabia Argentina Turkey Canada China Indonesia Australia US Russia Italy Mexico France UK India Japan Brazil Chart Public debt (% GDP) Public17: debt (latest, % GDP) Japan Italy France Canada UK Germany US Brazil India South Africa Mexico Argentina Turkey Australia South Korea Indonesia China Russia Saudi Arabia 0 50 100 Source: Bloomberg, as at 30 September 2015 (10) (8) (6) Source: Bloomberg, as at 30 September 2015 10 17. Public debt Public debt levels have generally improved across the G20 over the past 12 months. This is particularly the case for Saudi Arabia, Argentina, China and Germany. Public debt levels have increased in the last 12 months as a share of GDP in Canada, Japan, Russia and Mexico. Public debt as a percentage of GDP now stands above the critical level of 90% in Japan, Italy, France and Canada. Saudi Arabia has taken over from Russia as the least indebted G20 economy. (4) (2) 0 2 150 200 250 External 18. Exports South Korea remains the most open economy in the G20 with 50.6% of its GDP in exports. The least open economy remains Brazil with just 11.5% of GDP in exports. The structure of the G20 economies has changed significantly over the past 10 years. The export sector has become far more important for economies such as South Korea, Germany, Mexico, and India. In the case of Mexico this is a deliberate strategy given the number of Free Trade Agreements it has signed in that time. For others, such as Indonesia, China, Argentina, Canada and Russia, the export sector has shrunk as a share of the economy. Chart Exports Exports18: (latest, % GDP)(% GDP) Chart 19: Current account Current Account Balance (%GDP)balance (% GDP) Saudi Arabia Germany South Korea Russia China Japan Italy France India Argentina Mexico US Canada South Africa Indonesia Brazil Australia UK Turkey (8) South Korea Saudi Arabia Germany Mexico Canada South Africa Italy France Russia UK Turkey Indonesia India China Australia Japan Argentina US Brazil (6) (4) (2) 0 2 4 6 8 10 12 Source: Bloomberg, as at 30 September 2015 100% 90% 3.5 USD, trillion (LHS) 3.0 As % GDP (RHS) 80% 70% 2.5 60% 2.0 50% 1.5 40% 30% 1.0 20% France Argentina Germany US Italy 0% Canada 10% 0.0 Australia 0.5 South Africa Interestingly the trade fortunes of Japan and South Korea have oscillated around each other. For much of the past 10 years, the current account surplus of Japan has been in decline while the surplus in South Korea has been rising. Most recently, the surplus in Japan has once again begun to rise while the current account surplus in Korea has levelled out. 4.0 Indonesia The collapse in commodity prices has been responsible for the deterioration in the current account position for Saudi Arabia, Australia, Canada, Argentina and Brazil. The strength in the US dollar, up 13.7% relative to its long term average real effective exchange rate, has undermined the international competitiveness of US exports resulting in a deterioration in the current account deficit there to 2.4% of GDP from 2.1% of GDP last year. Chart 20: Foreign reserves (USD) Foreignexchange exchange reserves (latest) UK 19. Current account Turkey has the largest current account deficit in the G20 at 5.9% of GDP but this is closely followed by the UK (5.1% GDP), Australia (4.7% GDP), and Brazil (4.2% GDP). Turkey's current account deficit reached a peak of 9.7% of GDP in 2011 and has since declined back to its average level of the last 10 years. Despite the collapse in oil prices, Russia’s current account surplus has improved over the last 12 months. Turkey 60 Mexico 50 India 40 Russia 30 Brazil 20 South Korea 10 Saudi Arabia 0 Source: Bloomberg, as at 30 September 2015 China 2005 Japan 2015 20. Foreign exchange reserves A defining feature of the world economy over the past 15 years was the unprecedented accumulation of foreignexchange reserves. Central banks, led by those in China and the oil-producing states such as Russia and Saudi Arabia, built up an enormous amount of other countries’ currencies. Mid-2014 proved to be the high-point. Since then reserves have dropped by at least $500 billion. China, whose reserves peaked at around $4 trillion in June 2014, has burnt through $300 billion of its holdings to prop up the yuan. Other emerging markets, notably Russia and Saudi Arabia, have also tapped their reserves over the same period for a combined $174 billion. As a share of GDP, however, Saudi Arabia still has the highest reserves in the G20. In an effort to support their currencies and ward off inflation Brazil and Turkey have tapped into their reserves for around $100 billion each over the past 12 months. Source: Bloomberg, as at 30 September 2015 11 Argentina Argentina ranks 19th out of the G20 in terms of its GDP. Its share of world GDP is just 0.7%, down from a 1.0% share this time last year. With a population of 41.5 million people, its GDP per capita is just $13,017 US dollars, down from $14,741 last year. The Argentinian economy reportedly grew at a 2.3% pace in the September quarter, well down on its 10 year average of 4.7%. Inflation reportedly sits at 14.5%, a rate second only to Russia among the G20. Argentina is therefore facing stagflation. One of the biggest drivers of growth is also one of the biggest issues for the economy—public spending. The fiscal deficit has increased significantly despite cheapening energy imports. Argentina spent around 3.5% of GDP on energy-related subsidies in 2014. Under President Kirchner, the state has exercised greater control over the economy, including the imposition of heavy taxes on agricultural exports, which helped swell the public coffers and pay for social programmes during the global commodities boom. The Kirchner administration currently owns around 80% of the media industry, illustrating the lack of transparency and difficulty in defining whether reports on the economy are valid or not. The government has continued with expansionary policies, despite running low on international reserves (currently just around $28 billion). Some containment of capital outflows has been achieved by rationing hard currency. As a result, reserves have actually increased slightly over the last 12 months. The results of the October 25 Presidential election whereby the conservative, business-friendly, opposition candidate Mauricio Macri took a surprise lead, resulted in a run-off election on 22 November. This was the first ever run-off in Argentina, which adopted a two-round presidential election system in 1973. The win for Macri, was a disappointing outcome for Scioli, Kirchners handpicked successor. Not only does Mr Macri want to reduce the state's role in the economy, he is also keen to scrap the country's currency controls, and make it much easier for Argentines to change their local pesos into US dollars—a popular move in a country where hiding dollars under the mattress has traditionally been the preferred way of warding off hard times. 12 Largest debt default in history However, such a policy would probably involve a peso devaluation and would certainly require a substantial increase in the central bank's currency reserves. The only way of doing that in a hurry would be to issue new bonds on the international money markets, which Argentina cannot do while it remains an international pariah because of previous defaults. Challenges to growth The main challenges to growth for Argentina remain uncontrolled government spending, heavy taxes on exports coupled with strict controls on imports and disincentives for foreigners to invest. Recent changes to tax laws have reduced the number of tax evaders, but the proportion is still high at around 25%. Economic growth has picked up on last year and a more business friendly government would be a positive move but issues around a lack of access to global credit markets given the selective default in 2014 (its eighth), rising fiscal indebtedness, excessive regulation, and an overvalued currency limit the ability for this pace to be maintained. Australia Australia ranks 13th out of the G20 in terms of its GDP. Its share of world GDP is 1.9%, down from 2.2% last year. With a population of 23.1 million people, its GDP per capita is $62,934 US dollars, down from $67,558 US dollars last year. Australia has outperformed for the past two decades: GDP has grown twice as fast as its peers (averaging 3.25% since 1998), without a technical recession for 25 years. Per capita income has grown rapidly and is among the highest in the world. The fiscal position compares well to advanced economy peers with net debt only 15% of GDP compared to 79% on average for G20 advanced economies. And net migration has contributed to a rapidly growing population, at 1.5% a year, among the highest in the OECD. However, the biggest mining construction boom in 150 years is now over. Australia’s economy has slowed to a crawl and mining investment as a share of GDP is expected to fall from over 7% to just over 2% by 2016/17. Growth has been below trend for the past two years which combined with poor productivity, low wages, and falling profits means real net disposable income slid 1.2 p.p. in the biggest drop in standards of living since the global financial crisis. Chart 21: Minumum wage (PPP) Australia France Saudi Arabia Germany Highest minimum wage in the G20 rate there is less of a need for reserves and banks’ external liability positions are either in domestic currency or hedged. Lower oil prices have a mild positive effect on the trade balance (net oil imports of 2% of GDP). LNG prices have also declined as they are linked to the oil price with a lag. Over the medium term as Australia becomes a larger exporter of LNG (it is expected to overtake Qatar by 2018), this effect will begin to dominate. The Australian dollar has depreciated sharply against the U.S. dollar. While this should help boost the competitiveness of non-resource exports—and there are signs that services exports are picking up—the real exchange rate still looks high relative to the decline in the terms of trade. Australia has recently signed the Trans-Pacific Partnership Agreement which will create a free-trade area covering 40% of the global economy. This deal follows the free trade deal struck with China in June. Australia is also preparing for a trade deal with the European Union. Australia ranks as the EUs 21st largest trading partner while the EU represents Australia’s 3rd largest trading partner after China and Japan. Canada UK Argentina US South Korea Japan Turkey China Brazil Russia Indonesia India Mexico 0 2 4 6 8 10 12 Source: OECD, 2015 Australia has run a current account deficit for much of its history. Official reserves are relatively small at 4.5% of GDP, but with a strong commitment to a floating exchange Challenges to growth Australia needs to transition from mining led growth and position itself more competitively for an increasingly wealthy, more services-oriented, Chinese market. Australia is the most China-dependent economy in the world with 36.1% of our exports destined for China (see Chart 26). Part of this adjustment requires economic reform to encourage greater business investment. This includes taxation reform. Compared with other nations, Australia’s GST rate remains low too. The OECD average for valueadded taxes (or GST) is 19.5%. Countries with regressive tax codes, like Sweden, have VAT’s as high as 25%. Raising the GST rate to 15% from 10% currently would raise as much as $40 billion in additional revenue each year. 13 Brazil Brazil ranks 8th out of the G20 in terms of its GDP. Its share of world GDP is 3.0%, down from a 3.6% share this time last year. With a population of 201 million people, its GDP per capita is just $11,672 US dollars, up slightly from last year. Most expensive iPhone in the G20 Having recorded average annual growth of 4.5% during the 2004-10 commodity-related boom, the Brazilian economy is in a deep recession with GDP growing at -2.6%. Inflation currently sits at 9.5%, well above the 4.5% target set by the central bank. Inflation is expected to remain elevated due to the weakness of the currency, the effects of high indexation (the minimum wage is linked to nominal GDP) and other economic inefficiencies. Challenges to growth In the last 8 years, Brazil became middle class by its own standards helped by the China-inspired commodity boom and lower interest rates. The country is now seeing a dramatic reversal of those fortunes and is now mired in the middle-income trap. Anaemic investment in traditional infrastructure has become an increasingly heavy drag on productivity, contributing to waste and inefficiency in existing production systems. Just 14% of roads are paved and sewage from almost half of the population goes untreated. Brazil’s private sector borrowed heavily in recent years. As a share of GDP, domestic credit to the private sector has increased to 69.1% from 39.7% in 2006. Banks accounted for most of this increase with an estimated 14% being foreign currency denominated. So far in 2015, the real has fallen by 31% against the US dollar making it the worst performing EM currency. The sharp rise in external indebtedness by Brazilian corporations is a potential threat to growth given this weakness in the currency. Whilst the weakness in the currency will help to boost the international competitiveness of Brazilian exports, its economy is relatively closed. Exports in Brazil represent just 11.5% of GDP, the lowest among the G20. Chart 22: Most expensive iPhones in the world (USD) 1,400 Brazil is caught in a vicious circle of policy tightening and a negative spill-over from political scandal. This is undermining real economic activity, investor confidence and the currency pushing inflation higher as a result. This is putting pressure on the central bank to lift official interest rates, currently at 14.25%. Pressure is therefore rising for the government to reverse course on its fiscal objective and pursue fiscal stimulus. This would trigger even more capital outflows and put greater pressure on the currency and hence external borrowing costs. Brazil suffers from a punitive tax system (where it takes an average mid-sized firm 2,600 hours per year to comply versus 334 hours in Mexico), high levels of bureaucracy and an inflexible labour force. 1,200 The deterioration in Brazils public finances can only be reversed through reform, particularly regarding social security expenditure, which has been rising rapidly in recent years due to its ageing population, overly generous benefits, indexing rules and a low retirement age. 1,000 800 600 400 200 Source: Apple, 2015 14 Canada US Japan Mexico Australia South Korea China Russia UK Germany France Italy Turkey Brazil 0 Canada Canada ranks 12th out of the G20 in terms of its GDP. Its share of world GDP is 2.3%, down from 2.9% this time last year. With a population of 35.4 million people, its GDP per capita is $50,471 US dollars, down slightly from last year. The Canadian economy is currently in a recession with growth of just 0.9%. This is down from 2.6% growth last year and is well down on its 10 year average of 1.9%. The Bank of Canada (BoC) has cut interest rates twice this year leaving them at a record low of 0.5% currently. International trade is important for the Canadian economy with exports representing 31.6% of GDP. The US is by far its largest trading partner, accounting for around 70% of exports and 60% of imports. Canada is the fourth-largest crude oil exporter in the world and is also one of the world’s largest suppliers of agriculture products, especially wheat and other grains. The economy should benefit by being a part of the Trans-Pacific Partnership (TPP) currently being negotiated with 11 other countries. Canada’s government is in a strong fiscal position despite the poor growth record recently. Canada’s budget deficit as a proportion of GDP is low by international standards. Cheapest iPhone in the G20 Challenges to growth As a result of record low interest rates, Canadian households have been taking on greater amounts of debt, much of it housing-related. House prices are now 34% pricier than their long term average when compared to disposable income. Consumer debt is a record 165% of disposable income. Despite the binge, Canadians have remained relatively sober. Only about 5% of Canadian mortgages are subprime, compared with nearly a quarter in the US before the crisis. This self-restraint is encouraged by the limited competition evident in the banking sector. Just twelve banks hold 95% of the assets. Competition among them is not cut-throat and margins are therefore profitable. A Federal election was held on October 19th with the Liberal Party winning under leader Justin Trudeau, son of the former Prime Minister Pierre E. Trudeau. Canada is counting on an ongoing recovery in the US and a devalued currency to boost its exports contribution to growth. The new Prime Minister has promised to run budget deficits for at least three years to finance $C60 billion in infrastructure spending. 15 China China ranks 3rd out of the G20 in terms of its GDP. While its share of world GDP is 13.3%, down from 14.9% last year, in recent years it has been responsible for 45% of global growth. With a population of 1,361 million people, its GDP per capita is just $7,614 US dollars, up from $6,791 US dollars last year. China's economic boom of the past 30 years means it now accounts for 11% of world GDP and around 10% of world trade. In terms of resources, it now accounts for 11% of world oil demand and 40–70% of demand for other key commodities. Its financial system, as measured by broad money supply, is now larger than the U.S.'s. Between 1978 (the year before Beijing began to reform and open up its economy) and 2014, agriculture as a share of the economy has fallen from 30% to less than 7%, while the services sector has doubled to around 50%. As recently as 2000, just 4% of Chinese households were considered middleclass. Today that share has soared to around 70%. Chart 23: Major foreign holders of U.S. treasury securities in 2015 (USD bn) China, Mainland Japan Oil Exporters Brazil United Kingdom India Mexico Korea Turkey Germany Russia Canada France Australia Italy Chinese households still have very little leverage. Likewise, federal debt in China remains low. The issue is local government and corporate debt which has risen sharply and the recent property slowdown has been particularly painful for local government financing. Challenges to growth The ability to transition the economy from the world’s largest producer to the world’s largest consumer without a miss-step will be challenging. Along with the potential for policy mistakes, the Chinese authorities face an impossible trinity—an independent monetary policy combined with a fixed exchange rate and an open capital account. The difficulties this trinity pose to the economy were on display in August and September 2015. China has kept its currency off world markets and restricted buying and selling. That walled off China from boom-and-bust capital flows and kept its goods cheap. Now it has reason to loosen the grip on the renminbi, which means “the people’s currency,” and is better known by the name for its biggest unit, called yuan. To fuel a slowing economy and back rising political ambitions, China is promoting the use of the yuan throughout the world. 0 200 400 600 800 1,000 1,200 1,400 Source: Federal Reserve; US Department of the Treasury As at June 2015 While the manufacturing sector has certainly diminished in size, the government is making big efforts to move Chinas manufacturing capabilities to the next level. Policies such as “Made in China 2025” announced in May 2015 promote advanced industries such as IT, robotics, aerospace, railways and electric vehicles. The “One Belt, One Road” plan announced in late 2013 and highlighted in China’s fifth plenum also aims to not only boost trade but will also provide a new source of demand for commodities such as copper and iron ore. The plan involves the investment of an estimated $US1 trillion of government money to construct a transport system that stretches from Beijing to northern Europe. 16 Largest foreign holder of US Treasuries in the world A key step in this process is the inclusion of the yuan in the basket of reserve currencies the IMF holds for central banks known as Special Drawing Rights (SDRs). Effective October 1, 2016, the yuan will have a weighting of 10.92% in the basket, behind the USD and euro at 41.75% and 30.95% respectively. The yuan’s advance into global markets demonstrates President Xi Jinping’s ambition to challenge the hegemony of the US dollar. A more widely used currency would raise China’s influence in setting prices of commodities from oil to iron ore and give individuals and companies in China more choice with their savings. But as the yuan makes the long march to internationalisation, China will be vulnerable to swings in the currency and money flows that could aggravate its economic slowdown. France France ranks 7th out of the G20 in terms of its GDP. Its share of world GDP is 3.6%, down from 4.4% last year. With a population of 65.8 million people, its GDP per capita is $42,997 US dollars, up slightly from last year. The economic performance of France has improved over the last 12 months. The economy is currently growing at 1.1%, up from 0.2% last year and ahead of its 10 year average of 0.9%. GDP per head is significantly higher in the US, however, despite the fact that output per hour worked in France is on par with the US. The difference is due to the underutilisation of labour in France. France has one of the lowest employment rates in the EU, and also has one of the shortest working hours in the developed world behind Sweden and Norway. The trend rate of GDP growth is set to remain below 1.5% per year as growth in the working age population stagnates and the political will against immigration remains. France had one of the lowest population growth rates in the G20 over the last 12 months (see Chart 14). France’s future growth performance therefore hinges on raising the level of productivity in the economy. There is reason to be optimistic in this regard. Productivity in France’s manufacturing sector has been supported by relatively high levels of spending on research and development. At 2.3% of GDP, spending on R&D is the fourth highest in the OECD. The most taxed country in the G20 Challenges to growth France remains burden by the world’s highest level of payroll tax, which at 43% is far higher than in any other country. Historically, the French have tolerated high taxes as the price of decent public services and a proper universal safety-net. The strain is beginning to show, however. François Hollande was forced to drop the unpopular 75% supertax on those earning above €1m after accusations it was antibusiness. The decision to drop the tax is a personal blow for Hollande and only one of a number of government U-turns since he was elected, fuelling criticism that he is indecisive and lacking authority. Pressure is now on the government to undertake fiscal austerity not through yet higher taxes but rather by cutting government spending. With exports and imports of goods and services together representing 59% of GDP in 2014, France is a very open economy for its size. Yet despite this, the push toward free trade agreements and globalisation has not been as fully embraced as other G20 economies. 17 Germany Germany ranks 5th out of the G20 in terms of its GDP. Its share of world GDP is 4.9%, down from 5.9% last year. With a population of 80.5 million people, its GDP per capita is $47,858 US dollars, up from $45,153 US dollars last year. 18 Source: CIA, 2014 South Africa India Saudi Arabia Mexico Indonesia Brazil Turkey Argentina US China Russia Australia UK South Korea Challenges to growth One of the clear challenges facing the German economy is its ageing demographic. Germany has the oldest population in the G20 (median age of 46.5 years) with 50 45 40 35 30 25 20 15 10 5 0 France While income and social-security taxes are high, corporate taxes have fallen. Median24: ageMedian (years) age (years) Chart Italy Foreign direct investment flows have increased considerably and the favourable economic situation attracted the highest number of skilled migrants since 1995. In addition, helped by higher wages, consumers are increasing their spending, which is quite exceptional given the country’s traditionally very high savings rate and low consumption dynamics. Equally, a severe global economic downturn (caused by a weakening Chinese economy for example) would hit the export dependent German economy very hard. Germany is one of the most open economies in the G20 with almost half of its GDP tied to exports (see Chart 18). China is Germany’s 4th largest export market with around a third of German exports to China in autos. Canada As a result, Germany’s ability to refinance its debt on international capital markets has never been better. Bond yields in Germany hit an all-time low in 2015 of just 0.18% and have averaged 0.5% so far in 2015 compared with an average of 1.2% in 2014. The perception that the last decade’s reforms may have exacerbated inequality has induced a clear change in reform policies. This has become evident in the policy projects of the grand coalition which came to power in 2013. Reforms since then have tended to move the country into the opposite direction of the Hartz reforms. While the Hartz reforms tried to liberalize labour markets, new substantive regulations, such as the general statutory minimum wage, are being introduced. Japan The country’s fiscal performance indicates that the past years of reforms have started to pay off. Since 2012, the public sector has had a balanced budget and the government debt-to-GDP ratio has been reduced. This fiscal performance is the consequence of the employment boom, a relatively disciplined management of expenditures and very favourable interest rates. one of the slowest population growth rates (see Chart 14). While the pension reforms of the past prepared the pension system for the coming substantial aging of the population, recent reforms (e.g., lowering the pension age for workers with a long employment history and additional pensions for mothers) have increased pension benefits as well as increased sustainability risks. Germany The German economy is currently growing at 1.6%, slightly better than the 1.2% recorded last year and up on its 1.4% 10 year average. Germany’s economic structure is characterized by a healthy mix of service and industrial sectors. A decade of reforms has increased Germany’s competitiveness. Employment rates have risen continuously, structural unemployment rates are down, and productivity gains have been strong. Stability during the euro crisis has made it a popular investment destination. Highest median age in the G20 India India ranks 10th out of the G20 in terms of its GDP. Its share of world GDP is 2.7%, up from 2.6% this time last year. With a population of 1,233 million people, its GDP per capita is just $1,676 US dollars, up slightly from last year. India’s GDP is currently growing by 5.3%, about in line with last years’ growth but well down on its 7.3% 10 year average. A pick-up in industries, such as clothing, furniture and cars suggests that India’s bounce-back from a rocky period in 2013 is being led largely by consumer spending. India cannot evade the global challenges, however. A more persistent drag to growth from weak exports is now likely. India is hurt far less than other emerging markets by what is happening in China. Manufacturing supply chains tie Singapore, South Korea and Taiwan to the Chinese economy; India exports little there, by comparison. Just 4.6% of its exports are destined for China comared with 26% for South Korea and 19% for Brazil (see chart 26) Inflation has been relatively stable in India at 4.4%, well below the RBI’s near-term target of 6% and roughly inline with its medium-term goal of 4%. And downward pressure on prices is more welcome in inflation-prone India than in most places. The weight of food in the Indian CPI basket is the highest in the world at 45% compared to 14% and 32% for South Korea and China respectively. While India and China urbanised at about the same rate in the 1950s–1970s, India did not keep pace with China in the 1990s and 2000s. While China is today more than 50% urban, India is barely one-third urbanized. This therefore leaves plenty of potential growth remaining for India. India is a long way from having the sort of muscle to add much to global growth. Its population of 1.25 billion is similar in size to China’s and is much younger (the median age is 26.7 compared to 36.8 in China, see chart 24). But it is also much poorer. At current prices and exchange rates, India’s economy is worth around $2 trillion, whereas China’s is worth more than $10 trillion. Largest youth market in the world Challenges to growth India is not immune to all emerging-market afflictions, however. Exports have been shrinking for eight months. Falling factory-gate prices across Asia have placed additional pressure on firms in heavy industry that are already struggling to service their debts. Imports of cheap steel from China have more than doubled in the past year. India’s economy also suffers from a few locally incubated ailments. Its public sector banks, which account for 70% of outstanding loans, are weighed down with bad debts accumulated in an investment boom in 2008–12. Credit growth is feeble. Recently the government of Narendra Modi, who won an election last year on a pledge to reform the economy, has backtracked on such things as compulsory land aquisitions. Union strikes hope to force a similar backdown on proposals to tidy up India’s Byzantine labour laws and to make it slightly easier for smallish firms to lay off workers. A bill to establish a nationwide goodsand-services tax, to replace a myriad of federal, state and city taxes, is stuck between parliament’s two houses. Even modest changes, such as the privatisation of some airports, have been put on ice. Mr Modi controls parliament’s lower house, but his legislative plans have been thwarted because his party and its allies are a minority in the upper chamber. Oil exporters, such as Nigeria, Russia and Venezuela, have been hurt by the collapse in crude prices. But India imports 70–80% of the oil it uses so benefits greatly from cheap energy. India’s current-account deficit has narrowed to 1.3% of GDP, from a peak of 5.1% in December 2012. 19 Indonesia Indonesia ranks 16th out of the G20 in terms of its GDP. Its share of world GDP is 1.1%, down from 1.2% last year. With a population of 247.4 million people, its GDP per capita is just $3,592 US dollars, up slightly from last year. World's largest archipealgic state The Indonesian economy grew by 4.7% most recently, slightly down from its performance last year and under its 10 year average of 5.7%. Indonesia's economy is struggling against a backdrop of weaker external demand for commodities, delayed infrastructure spending and tight monetary policy. The government has introduced several stimulus packages, but real GDP expansion is still expected to remain sedate in 2016. place. They neither fundamentally change Indonesia’s investment climate nor signal to investors that Jokowi is preparing for bigger reforms. Indonesia’s negativeinvestment list, which details the sectors that are barred to foreign capital, remains sizeable. Hiring foreigners is still a burdensome process: one rule requires businesses to hire ten Indonesians for every foreign worker. Indonesia’s current account deficit requires foreign capital flows to finance it. As with other emerging market economies with large current account deficits, securing the funds has required a cheaper currency. A slight improvement in the current account deficit over last year owes much to generally weaker domestic demand rather than a pickup in exports. Challenges to growth Decentralisation—meaning a huge devolution of power from the national government to the regional level—may have held the country together in the early 2000s, but today it impedes infrastructure development and hinders policy co-ordination. Poor communication from the president compounds these problems. The president, Joko Widodo, lacks the political authority to pursue ambitious structural reforms. Subsidies for petrol and diesel have been cut dramatically by the government in an effort to narrow the current-account and fiscal deficits; local fuel prices now, in effect, track movements in global oil costs. The administration may also move to dismantle some of the barriers imposed on foreign investment, but controls introduced in 2014 over the export of mineral ores are unlikely to be completely liberalised. The pull of protectionism has characterized the presidency of Joko Widodo, who came to power in October 2014 as the country’s second freely elected leader. A rising tide of economic nationalism is threatening to undo the formula that for many years brought much-needed investment to the world’s fourth-most-populous nation and its 250 million people. Indonesia has resisted the temptation to panic in the face of a plunging currency and rising bond yields. It has, for instance, maintained fiscal discipline—aided by a law that caps the budget deficit at 3%. Markets nonetheless seem unconvinced. The rupiah has fallen by 12% against the dollar since peaking in May 2014. Economic growth is at its slowest since 2009. Nobody doubts the new deregulatory measures are better than nothing, but they are hardly game-changing. For the most part, Jokowi’s measures remove regulations that should never have been implemented in the first 20 Italy Italy ranks 9th out of the G20 in terms of its GDP. Its share of world GDP is 2.8%, down from 2.9% last year. With a population of 59.7 million people, its GDP per capita is $35,919 US dollars, down slightly from last year. The most recent reading on GDP has the economy growing at 0.7% which doesn’t seem very strong but is up from -0.5% last year and is well ahead of its meagre -0.5% average pace of the last 10 years. Incredibly, the Italian economy has spent more of the last 10 years shrinking than growing. Fiscal austerity has exacerbated the downturn, and household incomes have shrunk, while unemployment— particularly among the young—remains very high. The failure rate among small and medium-sized enterprises has skyrocketed. Only the export-oriented sectors of the economy did somewhat better than average. The new government is now more focused on formulating economic policies that foster economic growth and competitiveness. The difficult economic situation has worsened one of the problematic features of the Italian labour market: the polarization between protected sectors and those that are largely unprotected and precarious. While older workers in the public sector and in large firms of the private sector enjoy sufficient and, in some cases, even excessive protection, young people and in general those working for small private-sector firms are much less protected. The current Italian government under Matteo Renzi’s leadership is trying to re-invigorate economic growth as it seeks to convince European institutions to shift away from fiscal austerity toward more growth-oriented policies. First country in the world to build a motorway Challenges to growth The Italian tax system continues to be stressed by the need to sustain the combined burden of high public expenditures and payment of interests on the very high public debt accumulated over the past decades. It is also defined by its inability to significantly reduce the very high levels of tax evasion or the size of the black economy. As a result, levels of fiscal pressure have increased over the years. Italy has the second highest level of public debt to GDP in the G20, behind Japan (see chart 17). Although, like Japan, the private sector has relatively high levels of savings and low levels of indebtedness. There is very limited exposure of Italian government bonds to foreign investors (around 34%). Families with children have very limited exemptions. Labour and business are also heavily taxed, which results in fewer new businesses and job opportunities. Italian tax policy provides nearly zero incentives and no compelling reason to declare revenues but instead encourages tax evasion. Should the measures introduced by the Renzi cabinet be sustained, they might go some way toward a much needed correction in the fiscal system. The government has identified a number of significant reform projects. For example, introduced income allowances for lower incomes, reduced taxes for businesses, and introduced a new ambitious labour law reform aimed at stimulating the economy and making the hiring of youth easier. The scheduled labour market reforms, which will also introduce a general unemployment insurance, are ambitious and could lift Italy’s labour market policy to meet average EU levels. 21 Japan Japan ranks 4th out of the G20 in terms of its GDP. Its share of world GDP is 5.9%, down from 8.4% last year. With a population of 127.2 million people, its GDP per capita is $36,175 US dollars, down from $46,855 US dollars last year. The Japanese economy is currently growing at 0.8%, up from -1.4% last year and just ahead of its 10 year average of 0.6%. A strong devaluation of the yen in response to the monetary easing played a considerable role. Corporate profits and share prices have risen significantly. After years of short-lived cabinets (2007 to 2012), the 2012 lower house parliamentary elections led to a stable coalition of the Liberal Democratic Party (LDP) and Komeito (NK). The coalition under Prime Minister Shinzo Abe has also benefited from a majority in both chambers giving it a strong basis to pursue its ambitious economic agenda. During its first year in office, the government began implementing some of its major policy proposals, particularly in the field of economic policy. It initiated a major stimulus program ('three arrows'), which included aggressive monetary easing and additional deficitspending, pursued in conjunction with the Bank of Japan, and structural reform. More work needs to be done on the structural reform front, the 'third arrow'. This includes a sweeping reduction of agricultural protections (which is also a prerequisite for major new trade agreements), a more liberal labour-market regime (in part to make layoffs easier), an effective support of well-educated women (which despite new measures still seems to lack the firm support of the establishment), a much more liberal immigration policy, and social policy reform that better focus on combating hardship. Challenges to growth Ageing demographics and fiscal sustainability are the two major challenges facing the Japanese economy. Japan's over-65s currently make up 24% of the population, something which is forecast to rise to 30% by 2025 and to almost 40% by 2060. Japan also has one of the lowest fertility rates in the world at just 1.4. The so-called 'celibacy syndrome' among the youth is contributing to the demographic challenge facing Japan. 22 World's largest LNG importer While the unemployment rate remains low at the headline level the problem for Japan, as in many other countries, is a significant deterioration in the quality of jobs. Retiring well-paid baby boomers have, more often than not, been replaced by part-timers, contractors and other lower-wage workers. The incidence of non-regular employment has risen strongly; while only 16% of jobs were non-regular in 1985, this ratio had risen to a record 37% in 2014 (70% of which are occupied by females). With the rising incidence of part-time and contract work, one-sixth of Japan’s population, including one-fifth of pensioners, lives in relative poverty. Consequently, consumption has remained flat. Paradoxically, one of Japan’s strengths accentuates these demographic problems. Japanese healthcare is remarkably cheap (10.1% of GDP, just over half as much as the United States) and achieving spectacular results: the average Japanese can hope to live almost 83 years, longer than in any other country (see chart 15). Japan has one of the lowest overall tax-revenue levels among OECD nations. Only around 30% of Japanese firms pay corporate tax, with the rest exempted due to poor performance. Raising the remarkably low consumption tax has been seen as one key to addressing this problem. The government raised the consumption tax rate from 5% to 8% in April 2014, and plans to raise it further to 10% in April 2017. It is no surprise, therefore, that public indebtedness in Japan, amounting to 230% of GDP, is the highest in the world (see chart 17). Japanese governments have been torn between seeking to give the economy new momentum and consolidating the country’s battered public finances. This is likely to worsen as the Japanese population shrinks, the pension and healthcare costs of retirees inevitably grows, and the working-age population declines. South Korea South Korea ranks 14th out of the G20 in terms of its GDP. Its share of world GDP is 1.8%, unchanged from last year. With a population of 50.2 million people, its GDP per capita is $28,095 US dollars, up from $25,987 US dollars last year. South Korea is currently growing at 2.6%, down from its 3.3% pace recorded last year and under its 10 year 3.7% average pace. The economy has lost some momentum in the face of the global downturn in trade since 2012, sluggish domestic demand, increasing household indebtedness and a decline in job growth. In February 2014 the government unveiled a Three Year Plan for Economic Innovation with an ambitious '474' vision, targeting—a 4% GDP growth rate, 70% employment rate and a per capita income of $40,000. The government has announced a $40 billion stimulus package and put pressure on the Bank of Korea to adjust its monetary stance in harmony with the pro-growth fiscal policy. The Bank of Korea eased monetary policy by a cumulative 175 bps between July 2012 and June 2015 to a record low of 1.5%. Along with housing market deregulation measures, the impact on mortgage loans was stark as lending accelerated and household loans surged by KRW 10.1 trillion (USD 1 billion) in April 2015, the highest monthly increase ever recorded. Expectations for a further rate cut have risen due to the weaknesses in export figures over the last several months. With lower interest rates, the upward trajectory of household debt may accelerate. Fastest ageing population in G20 Challenges to growth Economically, South Korea faces major uncertainties with respect to its heavy reliance on exports in the face of weaker global trade. South Korea has the most open economy among the G20 with more than 50% of GDP export-oriented (see chart 18). The economy faces rising competitive threats: from Japan via its policy of quantitative easing putting downward pressure on the yen relative to the won; from China via its move up the valueadded chain; and from Mexico via cheaper wages. South Korea also has a rapidly ageing population (due to low fertility rates and high life expectancy), an immature retirement income system, and a low retirement age on average (most workers retire at the age of 53). While the government fiscal position remains healthy with a surplus the highest in the G20 (see chart 16), this situation can hinder the potential growth rate of the economy and put upward pressure on poverty rates. Chart 25: Fastest ageing within one generation (share of pop aged 65+ in 2011 vs 1981) 3.50 3.00 2.50 2.00 In an effort to rein in household debt growth and allay financial risks, the government in July announced policy measures that encourage borrowers to take out fixed-rate and long-term loans over floating-rate and short-term loans. The government also tightened the screening of borrowers' repayment abilities. 1.50 1.00 0.50 US Russia France Argentina India Germany Australia Canada Italy Turkey China Indonesia Brazil Mexico Japan 0.00 South Korea Currently, South Korea’s household debt-to-disposable income is greater than 160% and exceeds the OECD average of 135% by a wide margin. Mortgage debt accounts for approximately half of household debt in Korea and policymakers face the difficult challenge of slowing the surge in mortgage lending while avoiding a sharp decline in home prices as approximately 70% of household wealth is concentrated in the real estate sector. Source: World Bank 23 Mexico Mexico ranks 15th out of the G20 in terms of its GDP. Its share of world GDP is 1.6%, down from 1.8% last year. With a population of 122.3 million people, its GDP per capita is $10,488 US dollars, up slightly from last year. The Mexican economy grew by 2.2% most recently, in line with last year and just shy of its 10 year average. The general quality of macroeconomic management in Mexico has been good though structural growth is constrained by years of underinvestment in infrastructure, deficiencies in education outputs, low research and development spending, and low levels of lending by the banking sector. On the positive side, a strengthening of the policy environment since the 1994–95 crisis has reversed the excessive external indebtedness and so created a more stable macroeconomic climate. Geographical advantages also provide much scope for developing infrastructure links and becoming a logistical hub between the US and the rest of the Americas as well as a key manufacturing sector. In 2012, Mexico enacted a new labour-reform bill intended to increase market flexibility and reduce hiring costs. Although eventually watered down with regard to union transparency, supporters of the law claim that it has the potential to increase productivity, boost employment, and improve competitiveness. The new law allows employers to offer workers part-time work, hourly wages and gives them the freedom to engage in outsourcing. Chart 26: Sharetoof exports Share of exports China (%) to China (%) 40 2007 35 2013 30 25 20 15 10 5 UK Source: DFAT Trade is an important sector for the economy. Mexico is an export economy tied to the North American market. 24 Mexico Italy Turkey France India Canada Russia Germany US Argentina Indonesia South Africa Saudi Arabia Brazil Japan Australia South Korea 0 Highest level of export dependence on one market in the G20 Exports represent 32.7% of GDP in Mexico, most of which (88%) are manufactured exports. Exports have risen as a share of GDP from 12.5% in 1993, just before the implementation of NAFTA. However, despite Mexico’s extensive network of Free Trade Agreements (FTAs)—it has the highest number of FTAs in the G20 providing access to over 70% of global GDP—80% of export sales were to a single market (the US) in 2014. Increased investment in logistics and more proactive government policies to help producers move up the value chain and develop links with Asia and Europe as well as Latin America should see greater export diversification in come years. Oil revenues make up around 30% of total government revenue. The fiscal surplus from oil is now being squeezed by falling world prices, rising Mexican oil consumption and (slowly) falling oil production. Challenges to growth Fiscal slippage is a concern in the light of rising stock of debt. The deficit has been steadily increasing since the GFC and currently sits at 3.6% of GDP. The government will continue to attempt to bring more of the informal economy into the tax base. Around 58% of the labour force are employed 'off the books'. Efforts will also focus on further reducing red tape and strengthening the capabilities of the revenue collection authority, as well as reducing the government’s budgetary dependency on oil revenue. There is a current commitment to raising capital spending, particularly on infrastructure. Dollar-denominated debt is also a source of concern for Mexico. Mexican corporates took advantage of extremely loose monetary conditions in the US to borrow money at record low Libor rates. Most corporates have dollar revenues to offset this risk but the impact could be significant for unhedged companies. Russia Russia ranks 11th out of the G20 in terms of its GDP. Its share of world GDP is 2.4%, down from 2.9% last year. With a population of 143.7 million people, its GDP per capita is $12,948 US dollars, down from $14,591 US dollars last year. For the first time since 2009—the low point of the global economic slowdown—Russia is in recession. Its economy contracted 4.6% most recently, though Moscow’s $360 billion in cash reserves will cushion the immediate blow. The contraction was driven by sharp falls in household and business spending. Falling oil prices and rapid capital flight led to a steep devaluation in the ruble in November– December 2014. Not-with-standing the devaluation, the ruble-denominated oil price is still down 20% yoy. The fall in the ruble is putting upward pressure on inflation (now at 15.7% up from 8% last year, well above the 4% target set by the Russian Central Bank) and resulting in a decline in real incomes. The fall in oil prices has led to a sharp external adjustment. Export and import volumes have fallen significantly while the income deficit has shrunk as domestic earnings and corporate profits have been squeezed while foreign earnings receive a positive translation effect. Overall, the current-account surplus has increased slightly to 5.0% of GDP from 1.3% last year. Lower oil prices are deeply troubling for Moscow, which relies on oil and gas sales for nearly 50% of its revenues. In 1999, oil and gas accounted for less than half of Russia’s export proceeds; today they account for 68%. Moscow has grown so reliant on energy sales that for each dollar the price of oil drops, Russia loses about US $2 billion in potential sales. Russia’s annexation of Crimea and its confrontation with the West over Ukraine have left Russia’s relations with the West at their lowest ebb in a quarter of a century and resulted in economic sanctions on Russia and retaliatory trade restrictions on the EU imposed in mid-2014. Whilst these sanctions are reviewed every 6 months, they are expected to remain in place until at least mid-2016, impairing growth prospects. Challenges to growth For years, the Kremlin has supported and protected large state-owned companies at the expense of small and Largest diamond producer in the world medium-sized enterprises (SMEs). But those smaller firms are the foundation of any strong and well-diversified economy. SMEs spur innovation and respond effectively to changing times, technologies, and consumer tastes. In the EU, SMEs contribute an average of 40% to their respective countries’ GDP; in Russia, SMEs contribute just 15%. Between 2008 and 2012, Russia’s private sector lost 300,000 jobs while the state added 1.1 million workers to its payroll. Rather than diversifying, Moscow is doubling down on its state-centred approach to economic development. Russians aren’t nearly as productive as they could be. For each hour worked, the average Russian worker contributes $25.90 to Russia’s GDP. The average Greek worker adds $36.20 per hour of work. The average for U.S. workers is $67.40. Endemic corruption costs the Russian economy between $300 and $500 billion each year, or roughly the cost of three Greek bailout packages combined. It’s no surprise then that well-educated Russians are leaving their country in droves. Between 2012 and 2013, more than 300,000 people left Russia in search of greener economic pastures, and experts believe that number has risen since Moscow’s annexation of Crimea last year. Chart 27: Top diamond producers in the World (Carats, million) South Africa 8.1 Angola 9.4 Nambia 1.7 Sierra Leone 0.6 Russia 37.9 Zimbabwe 10.4 Canada 10.6 Australia 11.7 Congo 15.7 Botswana 23.2 Source: Kimberley Process, 2014 25 Saudi Arabia Saudi Arabia ranks 18th out of the G20 in terms of its GDP. Its share of world GDP is 1.0%, unchanged from last year. With a population of 30 million people, its GDP per capita is just $24,875 US dollars, in line with last year. 26 30 25 20 15 10 5 Source: United Nations, 2013 Indonesia India China Brazil Japan Mexico Turkey South Korea Argentina South Africa Italy Russia France 0 Germany Much of the Saudi government expenses, such as wages, are in riyals, but most of its income comes from oil which is priced in US dollars. As such, a devaluation against the USD could provide short term relief for budget pressures and improve the balance of payments. A devaluation however would not provide investors with confidence and my lead to an increase in capital flight. 35 US It is, however, considering cutbacks to investment spending. It is said to be reviewing plans for new infrastructure and may delay or scale back some projects. Chart 28: Immigration as % national population UK The kingdoms wealth gives it the capacity to absorb the fiscal shock of lower oil prices. In the past year it has burned through over $80 billion of foreign reserves, leaving it still with $650 billion remaining (equivalent to 88% of GDP, see chart 20). Public debt, which was around 100% of GDP in 1999 is now around 2%. The region is therefore not expected to raise taxes or relax fuel subsidies. The Saudis are essentially betting that their FX reserves are large enough to allow the kingdom to ride out the self-inflicted pain from persistently low crude prices on the way to bankrupting the US shale industry. But the battle for market share comes at a cost, especially when ultra-easy monetary policy in the US has served to keep capital markets open to heavily indebted drillers, allowing otherwise insolvent producers to remain in business longer than they otherwise would. Canada As the price of oil has collapsed, so has government revenues. The result is a budget deficit that is expected to exceed 20% of GDP this year (after running a surplus of 12% just three years ago) and the first Saudi currentaccount deficit in more than a decade. This is putting downward pressure on Saudi’s sizeable foreign exchange reserves. The decline in reserves to fund the fiscal deficit has been tempered somewhat by the issuance of sovereign debt for the first time since 2007. But Saudi Arabia is a difficult place to do business— restrictions on foreign ownership, tough labour regulations and cumbersome bureaucracy with regulations that are unpredictably enforced—and faces rivals in the form of the United Arab Emirates. Not surprisingly, after more than 40 years of development plans aiming to diversify the economy, oil is still by far the main engine of growth. Australia Saudi nationals and citizens of Gulf Cooperation Council countries pay no income taxes, but net worth is subject to a 2.5% religious tax. Foreigners (31% of the population, see Chart 28) pay income taxes, and non-Saudi companies pay a 20% corporate tax. Tax revenue equals 3.7% of domestic income, and public spending amounts to 35.7% of domestic output. Challenges to growth The government is encouraging the diversification of the economy away from oil with efforts focussing on tourism, power generation, telecommunications, natural gas exploration, plastics and petrochemicals. Manufacturing is just 10% of GDP. The government is investing more than $70 billion in building up to six new 'economic cities' with modern infrastructure and business-friendly regulations. Saudi Arabia The Saudi Arabian economy grew by 3.8% most recently, up from 2.4% last year but down on its 10 year average of 3.8%. The oil sector makes up 45% of GDP; 90% of fiscal revenues; and about 85% of export revenue. Highest immigration in G20 South Africa South Africa ranks 20th out of the G20 in terms of its GDP. Its share of world GDP is 0.4%, down from 0.5% last year. With a population of 53 million people, its GDP per capita is just $6,600 US dollars, unchanged from last year. Economic growth in South Africa remains subdued growing at just 1.2% in the most recent period, down from 1.6% last year and the 2.8% average over the last 10 years. South Africa’s current account and fiscal deficits are elevated and the unemployment rate is among the highest in the world. About 1 in 4 South Africans is out of work; among the youth that ratio is 1 in 2. The current environment of low oil prices and falling inflation actually provides an opportunity for South Africa to address some of these challenges. Lower oil prices are helping to reduce inflation, now down to 4.6% compared to its 10 year average of 6.2%, and the current account deficit, now at 3.1% compared to a 10 year average of 5.1%. Mining is regarded as the bedrock of the South African economy responsible for 60% of exports. South Africa has fallen in the rankings of gold producers from number one in the world to number eight currently (see chart 27). Labour unrest has contributed to a decline in production levels. Chart 29: Gini Coefficient—measure of income Gini Coefficient - measure of income inequality inequality (where 0=perfect equality; 100= perfect (where 0=perfect equality; 100= perfect inequality) inequality) 70 65 60 55 50 45 40 35 30 25 Source: World Bank Challenges to growth Job creation is South Africa’s most pressing challenge. South Africa has a high unemployment rate of 25%, compared to an average of 6.5% for the G20 countries Australia Germany Sth Korea India France Canada Italy Indonesia UK China Japan Turkey US Russia Argentina Brazil Mexico Sth Africa 20 The most unequal society in the G20 (see Chart 8). One third of South Africa’s labour force is either out of work or not looking for a job, a challenge that has arisen because of the low rate of job creation. Employment opportunities shrank in agriculture, mining and manufacturing, traditionally labour intensive sectors that employ unskilled workers. Together, these three industries now account for 19% of total employment, down from about 30% in 2000, while the services sector now accounts for 72% of total employment. New laws that discourage the hiring of temporary workers have added to unemployment. While a black middle class has grown up in the past 20 years, the average white household still earns about six times the average black household, and inequality within the African population has increased. This inequality is also reflected in access to education. The public schools system is ranked among the world’s worst, leaving millions of youths without marketable skills. Improving electricity availability is of paramount importance. The government’s failure to add power plants as it connected millions of black households to the electrical grid led to rolling blackouts that have hit manufacturing hard. The government is making efforts to strengthen the financial position of Eskom and improve its efficiency. Greater private sector participation in the sector and in infrastructure development could also help. The government of President Jacob Zuma is lurching from one crisis to the next. The economy is hamstrung by a shortage of electricity, a hangover from decades of underinvestment in new generation capacity. Prices of gold and platinum—vital exports—have plunged. The government increased personal income taxes to avoid having the country’s credit rating cut to junk. Mounting discontent is manifest in violent street protests and strikes. While the ANC shows no signs of losing power nationally—it won 62% of the vote in last year’s elections—party support is slipping in the cities amid charges of corruption and incompetence. 27 Turkey Turkey ranks 17th out of the G20 in terms of its GDP. Its share of world GDP is 1.0%, down from 1.2% last year. With a population of 76.7 million people, its GDP per capita is just $10,424 US dollars, up slightly from last year. Turkey took over the G-20 presidency for 2015. The Turkish economy is currently growing at 3.8%, up on the 1.8% pace of last year but just below its 10 year average pace of 4.1%. The unemployment rate remains high, currently 9.8%, as does inflation at 8.0%, well above the central bank target of 5%. The country’s slowdown since 2012 has been partly due to the ongoing global financial crisis, and partly to Turkish policymakers’ desire to slow the economy in order to bring the current account deficit under control. Moreover, regional Turkish export markets such as Syria and Iraq, which had boomed in the past, were themselves suffering from setbacks due to political instability and war. The government has stalled on pushing through reforms. Social welfare is very generous and the labour market is very inflexible. Looking ahead, it seems that Turkey must settle for a period of modest growth as higher global interest rates constrict external financing and lower economic momentum among its trading partners. This, combined with growing geopolitical tensions, will cause a fall in demand for Turkey’s exports (currently representing 28% of GDP). 28 Second largest oil pipeline in the world Challenges to growth Turkey’s most significant economic problems relate to its external imbalance. The current account deficit currently sits at 5.9% of GDP, the highest among the G20. With Turkey’s 10 year bond yield sitting at 10.7% currently, financing this deficit is expensive. The countries vulnerability to volatile financial market conditions is heightened by the fact that it has limited foreign exchange reserves, just 13% of GDP (see Chart 20). Foreign investors are growing increasingly concerned about the apparent rise in authoritarianism exhibited by the incumbent government. Since the government crackdown on mass protests in 2013, indicators of democratic freedom such as rule of law, freedom of speech, judicial independence, and media freedom have come into question. This is reflected in corruption indices. Freedom House downgraded Turkey from 'partly free' to 'not free' in 2014. Rising political risk make Turkey, a member of the 'fragile five' (along with India, Indonesia, Brazil and South Africa) even more vulnerable to volatile, external market conditions. In anticipation of a rate rise in the US, the Turkish lira fell to a record low against the US dollar this year and is down 20% year-to-date. UK The United Kingdom ranks 6th out of the G20 in terms of its GDP. Its share of world GDP is 3.8%, up from 3.5% last year. With a population of 63.9 million people, its GDP per capita is $46,039 US dollars, up from $39,472 US dollars last year. The UK economy is growing at a 2.3% pace currently, down from 2.9% last year. This compares favourably to its long run average of 1.4%. Currently the growth picture for the UK is holding up well. Fiscal austerity has worked to cut the budget from a deficit of over 7.5% in 2013 to a deficit of 4.6% currently. British PM David Cameron promised an in/out referendum on the UK’s membership of the EU before the end of 2017 after winning the general election in May 2015. Cameron will support the 'stay' campaign but only if he can loosen the UK’s ties with Brussels, cut red tape and secure an opt-out of the EUs core goal of 'ever-closer' union. Most polls have support for staying in the union at 44% compared with 39% backing the level campaign. After labour-market flexibility was increased through deregulation and the lowering of secondary-wage costs, the unemployment rate fell significantly from 8.3% at the end of 2012 to 5.4% currently. The UK labour market continues to attract substantial numbers of economic migrants. Chart 30: Gasoline price per litre in selected countries—September 2015 (USD) UK Italy Turkey France Germany Argentina South Korea Japan China India Brazil Australia Canada South Africa Mexico Indonesia US Russia Saudi Arabia Highest petrol prices in the G20 Challenges to growth The biggest uncertainty hanging over the institutional and economic make-up of the UK is its relationship with the EU. The UK is a highly trade dependent economy (exports represent 28.4% of GDP) hence why the issue of EU membership is so important to the economic outlook for the economy. Those for Brexit argue it requires Britain to apply rules it has no say in making—and to pay for the privilege. Those against argue that the EU takes almost half of British exports whereas Britain takes less than 10% of the EUs. Moreover, Britain in search of greater freedom to form free trade agreements with other countries would lose the bargaining clout of being part of the worlds’ largest single market. For example, Britain would be excluded from the Transatlantic Trade and Investment Partnership (TTIP) currently being negotiated between EU and the US. One of the biggest economic issues facing the UK is the level of productivity. Between the early 1990s up to 2008 the economic performance of the UK improved relative to many of its regional peers (notably France and Germany). This improvement was driven in large part by a rise in labour utilisation. Since then, however, levels of labour productivity have lagged behind those of the US, Germany and France. Key to this is improving the quality of infrastructure for land transport (the UK has the second most crowded road network in the G20) and relaxing its strict planning regulations. The fiscal deficit remains large by G20 standards (see Chart 16). In 2010 Prime Minister Cameron initiated a five year austerity program aiming to reduce the deficit from 11% to 1% by 2015. The growth drag from fiscal austerity is expected to ease in 2016. 0 0.5 1 1.5 2 Source: www.globalpetrolprices.com 29 US The United States ranks 1st out of the G20 in terms of its GDP. Its share of world GDP is 22.4%, down from 23.6% last year. With a population of 317.3 million people, its GDP per capita is $54,898 US dollars, up from $52,947 US dollars last year. The US economy grew by 2.0% most recently, down from 2.9% last year but up on its 10 year average of 1.5%. The Federal Reserve has held interest rates at historically low levels and, at least until September 2014, reinforced the effect with large-scale bond purchases. The balance sheet of the Fed has swelled as a result from less than $1 trillion US dollars to $4.5 trillion currently. The unemployment rate has fallen from a peak of 10% in December 2009 to just 5.0% currently. The decline reflects the flexibility of the labour market. The US has one of the least regulated and least unionized labour markets in the OECD, with less than 7% of private-sector workers and 40% of public-sector workers holding union membership. However, many discouraged workers have left the labour force, the proportion of low-paid and part-time jobs is rising, and incomes have been stagnant for a decade. While exports are a relatively small part of the US economy, just 13% of GDP, the Trans Pacific Partnership being negotiated mostly with Asia and the Transatlantic Trade and Investment Partnership (TTIP) with Europe are significant given these are the first multi-lateral free trade agreement the US has negotiated in 20 years. Largest oil producer in the world Challenges to growth Like the UK, the US has been undergoing fiscal austerity to reign in its budget deficit. Currently, the fiscal deficit sits at 2.4% of GDP, down from over 10% in 2009. Longer term structural challenges pose an ongoing threat to the deficit, however. Not least of which are deteriorating infrastructure and rapidly rising medical and pension costs associated with an ageing society. The U.S. tax system does not produce enough revenue to reduce the deficit, tax policy is highly responsive to special interests (resulting in extreme complexity and differing treatment of different categories of income) and the redistributive effect of the tax system is very low. The long-term debt picture has serious implications for monetary stability, and reduces business confidence. U.S. treasury bonds have not regained their AAA rating from the Standard & Poor’s rating agency, although the bond market has not shared the agency’s alarm. Addressing this will require cooperation between the President and Congress. The 113th Congress (2013–2014) narrowly avoided being the least productive Congress in the modern era according to the Pew Research Centre. Oil production in selected countries 2004 Chart 31: Oil production selected countries 2004 and 2014 (in 1,000 barrels in per day) and 2014 (in 1,000 barrels per day) United States Saudi Arabia Russia Canada China Mexico Brazil 2014 India Indonesia 2004 UK Argentina Australia Italy 0 Source: BP 30 5,000 10,000 15,000 In short, U.S. budget policy provides too little current stimulus to promote robust growth; seriously fails to balance revenues and spending over a 10 to 20 year period; and yet underfunds most government services— from infrastructure and border security to aged care, environmental regulation and R&D. European Union The European Union ranks 2nd out of the G20 in terms of its GDP. Its share of world GDP is 17.2%, down from 17.9% last year. With a population of 332.9 million people, its GDP per capita is $40,260 US dollars, up from $38,300 US dollars last year. Top trading partner for 80 countries Broadly speaking the European Union is recovering better than expected from the financial crisis. This is particularly the case for Spain and Portugal where economic growth is the fastest. Manufacturing activity is improving helped by the weak euro and bank lending is rising. Lower oil prices, while putting downward pressure on headline inflation, is providing a stimulus to consumers. ECB already provides lending of last resort facilities and access to central bank liquidity; additional features the banking union will provide include common regulatory supervision, a common resolution mechanism and a crossborder deposit guarantee system. Fiscal imbalances in the EU have largely been corrected through prolonged austerity. Labour market conditions have improved and the unemployment rate has fallen from a peak of 11% to 9.3%, its lowest level in almost 6 years. However, inflexible labour markets means the unemployment rate still remains too high at more than twice that of the US. Politics remains the major uncertainty for the EU but the short history of the euro tells us that the exit threshold for a single member is very high—Greece faced three weeks of forced bank closures and the Greek Government had to make a U-turn on its reform stance after acknowledging what was at stake; Cyprus faced a significant bail-in of depositors’ wealth and still chose to stay in the euro. Italy, Portugal and Spain accelerated labour and product market reforms in the wake of the financial crisis by cutting complex and costly regulatory processes, improving legal institutions, and promoting training, selfemployment and entrepreneurship, and eased hiring and firing restrictions. One of the most obvious weaknesses of the union that was revealed by the financial crisis is the EU’s extensive reliance on banking-sector financing. About 80% of financing in Europe comes from the banking sector, with the rest coming from capital markets. By contrast in the US, capital markets are much more developed and account for around 70% of lending. Both equity and debt markets in Europe are under-developed relative to the US. Challenges to growth It was said by the founding father of the EU, Jean Monnet that “Europe will be forged in crisis, and will be the sum of the solutions adopted for those crises.” The crisis’s the EU has gone through in past seven years have provided the motivation and incentive to further evolve the EU. Many of the challenges that the EU currently face are as a direct result of the single currency union being an unfinished project. The most pressing challenges in the short-term are to complete the banking union, fast-track reform of the labour and product market, and move towards a capital markets union. The decision to create a banking union in 2012 was a watershed moment for the union as it served to ease any immediate doubts about the future of the euro area. The 31 Conclusion Seven years on from the Global Financial Crisis and a lot of progress has been made by the G20 economies in moving toward a more sustainable growth path. G20 GDP growth has increased from a low of -3.0% in March 2009 to 2.3% currently. The unemployment rate has declined from a peak of 8.0% in December 2009 to 6.5% currently. And equity markets have recovered on average by 135% for emerging G20 economies and by 75% on average for developed G20 economies from their crisis-lows. A number of challenges remain, however, some of which are structural in nature. The G20 economies are hamstrung by deteriorating demographics; inadequate and inefficient infrastructure due to years of under-investment; and a depletion in political capital resulting in populist, myopic-policy making, hampering structural reform efforts. Equally challenging, particularly for emerging G20 economies, global trade is heading for its worst year since 2009. Whilst there is some question as to what role structural factors are playing in this decline, there is little disagreement that the majority can be explained by weaker global GDP growth. Weaker trade will challenge the growth outlooks for emerging economies, particularly as their domestic demand weakens as a result of tightening in financial conditions. While significant deleveraging has taken place among some households and governments, corporate sector debt has become more of an issue. The increase in corporate debt of nonfinancial firms has been particularly acute among major emerging economies where it has risen from about $4 trillion in 2004 to well over $18 trillion in 2014. The biggest increases have been seen in China, Turkey, Brazil and India. This makes emerging market economies even more vulnerable to rising interest rates and or an increase in global risk aversion. In our view, Australia’s goal of lifting G20 growth by 2% by 2019 will be a difficult one to achieve. At the very least, however, it is serving to focus effort and attention on the key issues and challenges that need to be addressed. 32 Wholesale Sales NSW/ACT NSW Edward O'Neill National Sales Manager Associate Director T: 02 9324 3196 M: 0416 090 782 [email protected] Amanda Freeman National Sales Manager T: 02 9324 3502 M: 0404 716 706 [email protected] VIC/WA VIC/SA/TAS QLD James Tomkins, OAM National Sales Manager Director T: 03 9242 6389 M: 0449 852 637 [email protected] Marcus Cleary David Redford-Bell, CFA National Sales Manager Director T: 07 3136 4428 M: 0417 148 075 [email protected] Alistair Dunne Head of Wholesale Sales Executive Director T: 03 9242 6445 M: 0452 605 504 [email protected] Ina Krasteva Business Development Associate T: 02 9324 2734 [email protected] Website www.ubs.com/am-australia Client Services toll free 1800 023 043 National Sales Manager Director T: 03 9242 6510 M: 0419 200 666 [email protected] Alycia Vassallo Consultant Relationship Manager Associate Director T: 02 9324 2248 M: 0477 473 400 [email protected] Adam Muston ETF Capabilities Manager Associate Director T: 02 9324 3003 M: 0401 625 388 [email protected] Address Level 16, Chifley Tower 2 Chifley Square Sydney NSW 2000 © UBS 2015. The key symbol and UBS are among the registered and unregistered trademarks of UBS. All rights reserved Disclaimer: Nothing in this document is to be taken as specific financial product advice. We have not taken into account any individual investor’s investment objectives, tax and financial situation or particular needs. Any opinions expressed in this document are subject to change without notice. Investors should seek professional advice before investing. UBS managed funds are issued by UBS Asset Management (Australia) Ltd (ABN 31 003 146 290) (AFS Licence 222605). PGIS1313