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The Economic Grand (Inter)National Enrico Longoni RBS Group Economics October 2012 Back to recession… UK GDP (GBP bn, 2008 prices) 375 370 365 360 355 350 345 340 2005 2006 Source: Office for National Statistics 2007 2008 2009 2010 2011 2012 Austerity not to be blamed UK Q2 2012 GDP – output approach (%q/q) GDP -0.5 Government & other 0.3 Business services & Finance -0.1 Services -0.1 Manufacturing -0.9 Production -0.9 Agriculture Construction Source: Office for National Statistics -2.6 -3.9 Worse than the great depression? UK GDP during the Great Depression and the Great Recession (q/q) 105 Output since start of downturn (= 100) 100 Great Depression 95 Great Recession 90 t t+1 t+2 t+3 t+4 t+5 t+6 Source: Bank of England and Office for National Statistics t+7 t+8 t+9 t+10 t+11 t+12 t+13 t+14 t+15 t+16 UK labour market puzzle 600 Employment: Private vs Public Sector 500 400 300 200 100 0 -100 -200 -300 Q1 2010 Q2 2010 Q3 2010 Public Sector Source: Office for National Statistics Q4 2010 Q1 2011 Q2 2011 Private Sector Q3 2011 Q4 2011 Q1 2012 Cumulative net change Q2 2012 Deficit reduction…a long way to go 1 0 -1 -2 -3 -4 -5 10-11 Source: Office for Budget Responsibility 12-13 14-15 16-17 Most of the pain is still to come Share of fiscal tightening still to be implemented after April 2012 (%) 100% 94% 88% 90% 80% 88% 75% 70% 66% 60% 50% 40% 27% 30% 20% 10% 0% All fiscal tightening Tax increases Source: The Institute for Fiscal Studies Total spending cuts Investment cuts Benefit cuts Other current spending cuts Corporates to the rescue? 5 Net Surplus of Private Non-Financial Corporations (cumulative % of GDP) 4 3 2 1 0 -1 -2 -3 -4 Bureau of Labor Statistics 20 12 20 10 20 08 20 06 20 04 20 02 20 00 19 98 19 96 19 94 19 92 19 90 19 88 19 86 19 84 19 82 -5 Bernanke to the rescue? US labour market 300 9.5 250 9 8.5 (%) (000s) 200 150 8 100 7.5 50 7 Fe bM 11 ar -1 Ap 1 rM 11 ay Ju 11 n1 Ju 1 lAu 1 1 gSe 11 p1 O 1 ct N 11 ov D 11 ec Ja 11 nFe 12 bM 12 ar -1 Ap 2 rM 12 ay Ju 12 n1 Ju 2 lAu 1 2 gSe 12 p12 0 Change in non-farm payrolls (lhs) Source: Bureau of Labour Statistics Unemployment rate (rhs) US approach to fiscal policy $100 $10,000 $1,000,000 $100,000,000 $1,000,000,000 $1,000,000,000,000 Walking along the “Fiscal Cliff” A lot could happen GDP (%y/y) Unemployment No fiscal cliff 2.5% 8.6 1 Full fiscal cliff -1.0% 10.1 2 75% of cliff -0.1% 9.7 3 Only tax cuts implemented 0.6% 9.4 4 50% of cliff 0.8% 9.3 5 Only spending cuts implemented 1.5% 9.0 6 25% of cliff 1.7% 9.0 Source: Group Economics (%) Super Mario to the Eurozone rescue? “…All it takes to save the €…” 8.0 OMT announcements LTROs 7.5 7.0 6.5 6.0 5.5 Italy (6.6% - 5.1%) Spain (7.6% - 6%) 5.0 4.5 Jan Feb Mar Source: Bloomberg & Group Economics Apr Ma Jun Jul Aug Sep Something’s changed Contribution to Global GDP Growth (Past and Present) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 2001-2008 Advanced Economies 2010-2011 2012-2016 Developing and Newly Industrialised Asia Source: Datastream & Group Economics calculations Other This slowdown is the start of a structural change China GDP annual growth 16 14 12 10 GE forecast 8 6 4 2 0 2004 2005 2006 2007 Source: Group Economics calculations 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Still plenty of investment left to go in China Road Density (km per sqkm) Length of Railway (km) 1.5 1 0.5 0 US China OECD 0 50,000 100,000 150,000 200,000 250,000 Central Western China China Capital Stock ($ trn) Underground Transport 100 China Eastern Average China China 50 US 0 Cities with population over 5 million Number of those cities with a subway 0 10 20 30 40 50 UK fiscal policy – Plan A2,B, C Monetary policy – rates low for how long? 7 UK Bank rate and expectations 6 5 4 Feb 2011 3 2 Aug 2011 Feb2012 1 Aug 2012 0 Source: Bank of England & Group Economics calculations The UK remains a world leader Wealthy AAA rated Highly skilled workforce 10th largest exporter of goods 7th largest economy Innovative Attractive for foreign investment 6th largest manufacturer 3rd largest exporter of services World class education 8th most competitive economy UK economic growth in the long run 6.4 Spot the Great Depression 6 5.6 5.2 4.8 Source: Bank of England; RBS Group Economics 2008 2002 1996 1990 1984 1978 1972 1966 1960 1954 1948 1942 1936 1930 1924 1918 1912 1906 1900 4.4 “Great things are not done by impulse, but by a series of small things brought together." ~Vincent van Gogh~ Thank you and keep in touch! Internet www.rbs.com/economics E-mail www.rbs.com/economics/registration Social media @rbs_economics A word from our lawyers This material is published by The Royal Bank of Scotland plc (“RBS”) which is authorised and regulated by the Financial Services Authority for the conduct of regulated activities in the UK. It has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments, other financial instruments or related derivatives (“Securities”). It should not be reproduced or disclosed to any other person, without our prior consent. This material is not intended for distribution in any jurisdiction in which its distribution would be prohibited. 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RBS accepts no obligation to provide any advice or recommendations in respect of the information contained in this material and accepts no fiduciary duties to the recipient in relation to this information. What is happening in the labour market? Cumulative change in private employment (000s) 600 500 400 300 200 100 0 -100 2011 Q1 2011 Q2 Employees FT 2011 Q3 Employees PT 2011 Q4 Self employ FT 2012 Q1 2012 Q2 Self employ PT Source: ONS UK growth: the long and winding road GDP following recessions, start of recession = 100 115 1990s recession/recovery 110 105 100 Current recession/recovery 95 90 0 1 2 3 4 5 6 7 Years since start of recession Typical UK recovery Recovery so far RBS forecast Source: Datastream and Group Economics calculations Fiscal rebalancing: a good start, but still far to go Net borrowing as % of GDP 12 OBR forecast 10 8 6 4 2 7 16 /1 6 15 /1 5 14 /1 4 13 /1 3 12 -1 /1 2* 20 11 1 10 /1 0 09 /1 9 08 /0 8 07 /0 7 06 /0 6 05 /0 5 04 /0 4 03 /0 3 02 /0 20 01 /0 2 0 Source: Office for Budget Responsibility Would a Plan B work? There is some additional debt capacity, but unquantifiable risks Public sector net debt:GDP, UK forecast & selected countries in 2012 100% 80% Public sector net debt as % of GDP IMF recommended debt:GDP ceiling Reinhart & Rogoff say growth falters above this level Debt:GDP likely unsustainable 60% 40% 20% 0% 12-13 13-14 14-15 15-16 16-17 Ireland Italy Spain Portugal High levels of household and public debt constrain growth Household debt as a % of income 170 70 160 Public sector net debt as % of GDP, excluding financial sector interventions 60 150 50 140 130 40 120 30 110 20 100 10 90 80 1990 0 1995 2000 2005 2010 2015 2003 2005 2007 2009 2011 Source: Datastream & Group Economics calculations Main economic problem facing the UK 39 61 Q2 10 43 57 Q3 10 48 47 50 51 51 52 53 50 49 49 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11 The lack of economic growth - we need to spend and lend more to create jobs & keep business going The size of the debt burden - we need to borrow less & save more to ensure we keep interest rates low Corporates have the cash…. Flow of funds financial surplus/deficit 2011 (% of GDP) 9.0% 8.0% Rest of the World, 1.7% 7.0% 6.0% Households, 1.4% 5.0% Government , 8.3% 4.0% Non-financial companies, 3.6% 3.0% 2.0% 1.0% Financial companies, 1.7% 0.0% Financial deficit Government Financial companies Financial surplus Non-financial companies Households Rest of the World Source: Office for National Statistics Drastic times, drastic measures? Increase demand (symptom) Reduce debt (cause) Massive fiscal stimulus QE max Liquidity unbounded “Use it or lose it” deposit tax PFI v2.0 Beg to China (Big) “bad bank” Debt forgiveness Financial repression Monetise debt Raise interest rates Outright default China’s growth is slowing, should we be worried? China - Loan Growth and Industrial Production - Y/Y Change Source: Datastream & Group Economics calculations 2 b1 Fe -1 1 D ec -1 1 -1 A ug Ju n1 1 1 A pr -1 1 Fe b1 -1 0 D ec 0 -1 O ct 0 -1 A ug 0 n1 Ju A pr -1 0 Industrial Production 1 Loan Growth O ct 24 22 20 18 16 14 12 10 Emerging markets: huge export opportunity 70% % share of global GDP 65% 60% Emerging Economies 55% 50% 45% Developed Economies 40% 35% 30% 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 Source: Datastream & Group Economics calculations Source: IMF Trade headwinds UK export market share & growth 14.0 Major markets (1) 12.0 Share of UK exports (%) (2) EZ problem markets 10.0 (3) 8.0 Emerging markets (4) 6.0 (6) (5) 4.0 (8) (9) (7) (11) (10) 2.0 (20) (15) (27) 0.0 -5.0 0.0 5.0 10.0 15.0 20.0 25.0 2011 Y/Y growth in exports (%) Source: Datastream & Group Economics calculations Source: IMF 30.0 35.0 40.0 45.0 Exports heading to the wrong places – for now UK 2010 exports – by destination and growth rates 50 45 40 35 30 25 20 15 10 5 0 Export growth (%y/y) Source: Office for National Statistics Market share (%) EZ imbalances, more than fiscal Unit labour costs: Germany vs. the PIIGS 150 140 130 120 110 100 90 80 70 1995 1997 Germany 1999 Italy 2001 2003 2005 2007 2009 2011 Greece Spain Portugal Ireland Source: Datastream & Group Economics calculations