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Moody's investor Services-Global Macro Outlook 2013-14 by riteshbhansali

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									FEBRUARY 12, 2013                                                                                                                     CREDIT POLICY




SPECIAL COMMENT                                  Global Macro Outlook 2013-14:
                                                 Downside Risks Have Diminished
Table of Contents:                               Executive Summary
EXECUTIVE SUMMARY                         1      After deteriorating during the past year, global economic prospects appear to have stabilized
FORECASTS FOR 2013-14: DOWNSIDE
RISKS HAVE DIMINISHED                     2
                                                 in recent months. Financial market conditions have been relatively benign, compared with
  Global synthesis                        2      the turmoil seen during the first half of 2012, and there are encouraging signs that growth
  Continued weak growth in advanced              could strengthen in the world’s three largest economies during the course of this year.
  economies                               3
  Prospects for emerging markets are
  broadly unchanged                       8
                                                 In the G-20 advanced economies, survey evidence continues to suggest a gradual
DOWNSIDE RISKS TO THE FORECASTS                  strengthening in growth prospects. However, European economies continue to lag behind
HAVE DIMINISHED                          10      the US, and only Japan has announced significant policy stimulus. While business
  The risk of a deeper than currently            confidence should strengthen as the economic situation improves, fiscal consolidation and
  expected recession in the euro area    11
  Weaker-than-expected growth in major
                                                 high unemployment will continue to impede recovery. Overall, we expect real GDP growth
  emerging markets                       11      in the G-20 advanced economies of around 1.4% in 2013, followed by 2.0% in 2014.
  An escalation of geopolitical tensions 12      Growth during the coming year is expected to be a little weaker than we previously thought,
MOODY’S RELATED RESEARCH                 13      reflecting recent poor data outturns.

Analyst Contacts:                                We continue to expect growth in the G-20 emerging economies to outpace other G-20
                                                 members. But there is limited prospect of a swift return to the strong pace of expansion seen
NEW YORK                     +1.212.553.1653     during 2010 and 2011, despite encouraging developments in China, as emerging economies
                                                 continue to rebalance away from external demand in the face of weak world trade growth.
Elena Duggar                   +1.212.553.1911
Group Credit Officer - Sovereign Risk            Overall, we expect real GDP growth in these economies to be a little over 5½% in 2013,
elena.duggar@moodys.com                          followed by a modest pickup towards 6% in 2014. This forecast is broadly unchanged from
Richard Cantor            +1.212.553.3628        November 2012.
Chief Risk Officer
richard.cantor@moodys.com                        Given the relative stability of our forecasts since November, the most notable change to our
Bart Oosterveld              +1.212.553.7914     global outlook is that downside risks to growth appear to have significantly diminished. In
Managing Director - Sovereign Risk               particular, the full scale of the potential disruption to the US economy from the so-called
bart.oosterveld@moodys.com
                                                 fiscal cliff was avoided, financing stresses in the euro area have somewhat eased, and there are
Madhi Sekhon            +1.212.553.3780
                                                 increasing signs that key emerging markets will manage to avoid an overly sharp slowdown in
Associate Analyst
madhi.sekhon@moodys.com
                                                 growth. Yet despite these developments the risks to our forecasts remain skewed to the
                                                 downside, stemming in particular from the following scenarios:
LONDON                     +44.20.7772.5454

Colin Ellis                +44.20.7772.1609      »   A deeper than currently expected recession in the euro area accompanied by deeper
Senior Vice President                                credit contraction, potentially triggered by a further intensification of the sovereign debt
colin.ellis@moodys.com
                                                     crisis.
Antonio Garre           +44.20.7772.1089
Associate Analyst                                »   Weaker-than-expected growth in major emerging markets after the recent slowdown.
antonio.garre@moodys.com
                                                 »   An escalation of geopolitical tensions, resulting in adverse economic developments.
                                                                                                                                           CREDIT POLICY




                                    Moody’s Global Macro Outlook underpins our universe of ratings, providing a consistent benchmark
                                    for analysts and investors. This report is an update to our November 2012 Global Macro Risk
                                    Scenarios report. 1 It reviews key recent developments, provides an update on our baseline forecasts for
                                    2013-2014 and discusses the key risks around our forecasts.


                                    Forecasts for 2013-14: Downside Risks have Diminished

                                    Global synthesis
                                    Global economic growth has shown signs of stabilization in recent months. Most advanced economies
                                    are still seeing very slow recoveries or further declines following the recessions of 2008/9, reflecting
                                    gradual adjustments to excesses built up prior to the financial crisis. As such, our overall outlook for
                                    economic growth is broadly unchanged from three months ago. We still expect relatively weak growth
                                    to persist for several economies over the next few years, but we now see fewer potential stumbling
                                    blocks on the path to global recovery . In particular, US policymakers avoided the full scale of fiscal
                                    tightening implied by the so-called ‘fiscal cliff’, and there have also been encouraging signs of
                                    improvement in some major emerging markets, most notably China. Also, financial markets, most
                                    notably in the euro area, have experienced a period of relative calm, which contrasts with the
                                    turbulence they saw during the first half of last year. However, these factors are unlikely to spur
                                    economic activity significantly, with private sector deleveraging and public sector austerity still the
                                    dominant impediments to growth.

                                    As a result, our forecasts are little changed from those in our previous Global Outlook. We expect real
                                    GDP growth in the G-20 economies (weighted by nominal GDP at market exchange rates) to be
                                    around 2.9% in 2013, followed by 3.3% in 2014. These growth rates remain materially lower than the
                                    pace of expansion in 2010 and 2011.

                                    The risks to our forecasts have significantly diminished since the November 2012 update, but remain
                                    skewed to the downside despite recent positive developments. Moody’s believes that the three most
                                    immediate risks are: i) the risk of a deeper than currently expected recession in the euro area
                                    accompanied by deeper credit contraction, potentially triggered by a further intensification of the
                                    sovereign debt crisis; ii) slower-than-expected recovery in major emerging markets following the recent
                                    slowdown; and iii) an escalation of geopolitical tensions, resulting in adverse economic developments.

                                    We present our central scenario in Exhibit 1 but highlight the following:

                                    »    We express our forecasts for annual GDP growth and unemployment as a range of one percentage
                                         point (ppt) to avoid spurious precision and to focus on significant changes that could potentially
                                         influence rating decisions.
                                    »    We indicate the level of uncertainty for our central forecast. We present ranges from the forecasts
                                         that we survey and compare them to the historical standard deviation of the countries’ real
                                         growth. The blue shading in Exhibit 1 denotes countries with somewhat greater forecast
                                         uncertainty relative to historical GDP volatility.




1
    Update to the Global Macro Risk Outlook 2012-14: Slow Adjustment to Weigh on Growth (146944), 12 November 2012.




2      FEBRUARY 12, 2013                                                       SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED
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                        EXHIBIT 1
                        Moody’s Central Forecast Scenarios for 2013-14
                                                   Past growth                     2013F                          2014F                Forecast uncertainty measures
                                                                           Growth         Unemp't         Growth         Unemp't         2013           2014          GDP
                         Countries
                                                 2011       2012 (E)       central         central        central         central       growth         growth       volatility
                                                                            range           range          range           range       range [2]      range [2]        [3]
                         Argenti na               8.9          3.2         3.0/4.0            --          3.0/4.0            --            1.1            1.3           6.4
                         Aus tra l i a            2.1          3.5         2.5/3.5         4.5/5.5        2.5/3.5         4.5/5.5          0.7            1.1           1.0
                         Bra zi l                 2.7          1.5         3.0/4.0            --          3.5/4.5            --            2.4            2.2           2.4
                         Ca na da                 2.4          1.8         1.5/2.5         6.5/7.5        2.0/3.0         6.5/7.5          0.6            0.5           2.0
                         Chi na                   9.2          7.8         7.5/8.5            --          7.0/8.0            --            0.9            1.2           1.8
                         Euro a rea               1.4          -0.5        -0.5/0.5           --          0.5/1.5            --            0.9            0.8           1.9
                         Fra nce                  1.7          0.2         -0.5/0.5      10.0/11.0        0.5/1.5       10.0/11.0          0.6            1.0           1.7
                         Germa ny                 3.1          0.7         0.0/1.0         5.0/6.0        1.0/2.0         5.0/6.0          1.0            0.6           2.3
                         Indi a                   6.8          5.4         5.5/6.5            --          6.0/7.0            --            0.7            0.8           2.0
                         Indones i a              6.5          6.0         5.5/6.5            --          6.0/7.0            --            0.7            0.5           4.9
                         Ita l y                  0.4          -2.4        -1.0/0.0      11.0/12.0        0.0/1.0       11.0/12.0          0.6            1.2           2.1
                         Ja pa n                  -0.8         1.8         0.5/1.5         4.0/5.0        1.0/2.0         4.0/5.0          1.0            1.2           2.4
                         Mexi co                  3.9          3.8         3.0/4.0            --          3.0/4.0            --            0.6            0.9           3.8
                         Rus s i a                4.3          3.5         3.0/4.0            --          3.5/4.5            --            1.0            0.5           3.3
                         Sa udi Ara bi a          7.1          6.5         3.5/4.5            --          3.5/4.5            --            0.7            0.8           4.9
                         South Afri ca            3.1          2.5         3.0/4.0            --          3.5/4.5            --            1.0            1.0           2.6
                         South Korea              3.6          2.0         2.5/3.5            --          3.0/4.0            --            0.9            1.5           1.9
                         Turkey                   8.5          3.0         3.5/4.5            --          3.5/4.5            --            1.3            1.5           5.1
                         UK                       0.8          0.0         0.5/1.5         7.5/8.5        1.5/2.5         7.0/8.0          0.6            0.5           2.2
                         US                       1.8          2.2         1.5/2.5         7.0/8.0        2.0/3.0         6.5/7.5          0.6            1.7           2.0
                         G-20 All                 3.3          2.8         2.5/3.5            --          3.0/4.0            --             --             --            --
                         G-20 Advanced            1.4          1.5         1.0/2.0            --          1.5/2.5            --             --             --            --
                         G-20 Emerging            6.7          5.2         5.0/6.0            --          5.5/6.5            --             --             --            --

                        Notes: Green shading denotes improvement from the November 2012 update, orange denotes deterioration. Blue shading denotes considerable
                        forecast uncertainty relative to historical GDP volatility. Growth figures for 2012 are estimates where official data have not yet been published. [1] G-
                        20 All includes nominal USD GDP-weighted data for the 19 individual countries that comprise the G-20. G-20 Advanced includes Australia, Canada,
                        France, Germany, Italy, Japan, the UK, and the US. [2] The percentage point difference between the highest and lowest forecasts of sources such as the
                        IMF, WB, OECD, Eurostat, JPMorgan, Barclays, and Moody’s. [3] The standard deviation of real GDP growth over the 15 years to 2011. [4] In February
                        2012, the IMF approved a decision that calls on Argentina to implement specific measures to address the quality of reported GDP and Consumer Price
                        Index data; on 1 February 2013, the IMF’s Executive Board found that progress had not been sufficient and issued a declaration of censure against
                        Argentina under its Articles of Agreement.



                        Continued weak growth in advanced economies
                        The outlook for advanced economies is little changed from three months ago, with many countries
                        still struggling with the legacy and fallout from the financial crises and recessions of 2008/9. The long,
                        painful process of deleveraging in parts of the private sector still has much further to run, and fiscal
                        consolidation remains a priority for many governments. Confidence is relatively weak, and there is still
                        considerable uncertainty around the global economic outlook, despite the dissipation of some
                        downside risks. Without strong impetus from external demand, this picture of a weak appetite for risk
                        in the private sector , alongside declining government support as deficits are cut, implies a slow,
                        gradual process of adjustment and weak economic growth in many advanced economies. This gradual
                        pace suggests that the crisis will leave lasting scars on many economies, and in some instances national
                        incomes may struggle to make up the lost ground implied by pre-crisis trends. It also means that we




3   FEBRUARY 12, 2013                                                           SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED
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                                      are unlikely to see a rapid return to more ‘normal’ growth rates in many economies, let alone the sort
                                      of above-trend rates that are often seen once recessions have ended.

                                      We expect the G-20 advanced economies to grow by around 1.4% in 2013, followed by 2.0% in
                                      2014. One positive development over recent months has been the stabilization of financial markets,
                                      spurred by the ECB’s announcement of its Outright Monetary Transactions (OMTs) programme in
                                      September. This stabilization should reduce uncertainty and aid the process of recovery in many
                                      advanced economies, but any positive impact on growth will probably be small. Fundamentally,
                                      households are still hesitant to spend given high unemployment and debt levels, and the uncertain
                                      economic outlook continues to weigh on firms’ hiring and investment decisions. One positive factor is
                                      that commodity price pressures still appear to be relatively contained (Exhibit 2). The spot price of
                                      West Texas Intermediate (WTI) crude oil has picked up slightly since November, standing at around
                                      $96/barrel at the start of February, but remains significantly lower than its 2008 peak. The price of
                                      Brent crude has also risen over the past three months. Moody’s central macroeconomic scenario is
                                      consistent with oil prices rising gradually from these levels over the next two years.

                                      EXHIBIT 2                                                          EXHIBIT 3
                                      Selected commodity prices                                          WTI spot oil price and futures curve
                                      Jan 2008-Jan 2013; 1 January 2008 = 100                            Jan 2008-Dec 2014
                                                           Corn              Soybean
                                                                                                                              WTI spot price            WTI forward curve (a)
                                                           Gold              Silver
                                                                                                           160
                                         350
                                                                                                           140
                                         300
                                                                                                           120
                                         250
                                                                                                           100
                                         200
                                                                                                            80
                                         150
                                                                                                            60
                                         100
                                                                                                            40

                                          50                                                                20

                                           0                                                                  0
                                            2008         2009     2010      2011        2012      2013         2008     2009 2010 2011           2012   2013    2014
                                                                                                         (a) At 8 February 2013.
                                      Source: Haver Analytics.                                           Sources: Haver Analytics and CME Group.


                                      The US economic outlook remains one of subdued growth during 2013. While politicians managed to
                                      avoid the full extent of the so-called ‘fiscal cliff’, the package passed by both houses of Congress on 1
                                      January still encompassed fiscal tightening of around 1½% of GDP this year. In addition, expenditure
                                      cuts that may be decided on in the coming months could also still impede US growth. As such,
                                      although the 1 January package mitigated much of the fiscal drag associated with the ‘cliff’, it did not
                                      eliminate it altogether. Fiscal policy will weigh on US activity this year, and policymakers still need to
                                      agree on further fiscal measures that lower future deficits and stabilize US government debt dynamics
                                      over the longer term. 2

                                      Further fiscal tightening will weigh on US growth, as was evident in the advance reading of GDP for
                                      Q4 2012. The US economy stagnated at the end of last year, with GDP falling 0.1% on an annualized
                                      basis, with the weakness reflecting large drops in inventories and defense spending. However, that
                                      weak outturn followed upwardly revised growth of 3.1% in Q3. During 2012 as a whole the US
                                      economy expanded by 2.2%, the fastest pace of growth in the G7 (Exhibit 4), and the prospects for
2
    See US Fiscal Package Has Limited Positive Credit Implications, 10 January 2013.




4      FEBRUARY 12, 2013                                                               SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED
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                                       private sector activity are brightening. New housing starts have continued to increase, reaching the
                                       highest level since June 2008. US energy production is also likely to jump significantly in coming
                                       years, following the discovery of vast reserves of shale oil, providing a boost to the domestic economy
                                       and limiting US reliance on foreign oil imports. In addition, although the unemployment rate edged
                                       up to 7.9% in January (Exhibit 5), non-farm employment increased by 157,000, continuing the
                                       strong pace of job creation seen during the second half of 2012.

                                       EXHIBIT 4                                                              EXHIBIT 5
                                       G7 GDP growth                                                          US housing starts and unemployment
                                       2012 (a)                                                               Jan 2007-Jan 2013
                                            3
                                                   Percentage change                                                       Housing starts (LHS)           Unemployment rate (RHS)
                                                   on previous year                                            Thousands
                                            2                                                                                                                             Per cent
                                                                                                                of units
                                                                                                                 1600                                                         12.0
                                            1
                                                                                                                 1400
                                                                                                                                                                              10.0
                                            0                                                                    1200
                                                                                                                                                                              8.0
                                                                                                                 1000
                                           -1
                                                                                                                  800                                                         6.0
                                           -2                                                                     600
                                                                                                                                                                              4.0
                                           -3                                                                     400
                                                                                                                                                                              2.0
                                                                                                                  200
                                                                                                                     0                                                        0.0
                                                                                                                      2007     2008      2009     2010   2011   2012   2013
                                       (a) Estimates where official data are not yet published.
                                       Sources: Haver Analystics and Moody’s estimates.                       Source: Haver Analytics.


                                       All told, the greater impetus from the US private sector is likely to broadly offset the drag on activity
                                       from more restrictive fiscal policy, so that GDP growth in 2013 is likely to remain close to 2%.
                                       Thereafter, we expect the US economy to expand at a somewhat faster pace than is likely this year,
                                       closer to its long-run average pace of growth.

                                       In contrast, economic conditions in the euro area have continued to deteriorate. Euro area GDP
                                       declined by 0.1% in Q3 2012 compared with the previous quarter, marking a return to technical
                                       recession following the decline of 0.2% in the second quarter. The euro area economy is also likely to
                                       have shrunk in Q4, following the revelation that German GDP declined by around 0.5% during that
                                       period. During 2012 as a whole, euro area GDP is likely to have fallen by around 0.5%. 3

                                       Among member states, peripheral economies continue to be hit hardest. Portuguese GDP has now
                                       fallen by more than 5% since the current decline started in late 2010, while Spain and Italy have now
                                       both seen five consecutive quarters of economic decline (Exhibit 6). Although data quality is poor, the
                                       Greek economy has undoubtedly suffered the most, and has probably now shrunk by more than a
                                       quarter since the start of the debt crisis. The necessary structural adjustments in these economies have
                                       included painful cuts in prices and wages – often termed ‘internal devaluations’ – in order to regain
                                       competitiveness and close external imbalances. At the same time, austerity programmes designed to
                                       stabilize sovereign debt dynamics have amplified declines in GDP and rises in unemployment, while
                                       continued dislocations in credit markets mean that finance is still more expensive in Italy and Spain
                                       than in Germany or France (Exhibit 7).



3
    The first estimate of Q4 2012 growth is scheduled for publication on 14 February.




5      FEBRUARY 12, 2013                                                                      SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED
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                        EXHIBIT 6                                                        EXHIBIT 7
                        Euro area GDP levels                                             Non-financial corporations’ cost of
                        Q1 2008-Q3 2012, Q1 2008 = 100                                   bank funding (a)
                                                                                         Jan 2007-Dec 2012
                                                                                                           Germany                           Spain
                                             Germany          France            Italy
                                                                                                           France                            Italy
                                             Spain            Portugal
                            104
                                                                                            Annualised agreed rate (%)
                            102                                                             7
                            100                                                             6
                             98                                                             5
                             96                                                            4
                             94                                                             3
                             92                                                             2
                             90                                                             1
                             88                                                            0
                                  2008        2009     2010       2011      2012                2007   2008       2009      2010      2011       2012

                                                                                         (a) New business excluding revolving loans and overdrafts.
                        Source: Haver Analytics.                                         Source: ECB.


                        While progress has been made in addressing structural imbalances the necessary adjustments have
                        much further to run, and the decline in German national income at the end of 2012 is consistent with
                        the idea that weakness in the periphery is being transmitted throughout the rest of the currency union.
                        The aggregate unemployment rate reached 11.7% in November and December 2012, a new record
                        high. Short-term indicators such as retail sales and industrial production suggest that the euro area
                        economy as a whole could contract further in the first half of 2013. And the scope for further policy
                        support appears limited.

                        Against this discouraging backdrop, the period of relative calm in financial markets has been
                        accompanied by further positive developments. Long-term government bond yields for Italy and Spain
                        have fallen further since November (Exhibit 8), boosting the likelihood that these governments may
                        not need to enter explicit aid programmes. Concerns about deposit outflows from peripheral banking
                        systems have eased as levels have evened out (Exhibit 9). And there have also been signs of stabilization
                        in survey indicators such as the European Commission’s economic sentiment indices and the
                        Purchasing Managers’ Indices (PMIs), raising hopes that the current recession will prove to be
                        relatively shallow and brief compared with the deep recession in 2008/9. However, it remains to be
                        seen whether this stabilisation will presage improvements in confidence and orders; and indeed
                        whether any improvement in the survey data will be reflected in official figures.




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                                     EXHIBIT 8                                                           EXHIBIT 9
                                     Ten-year government bond yields                                     Banking system deposits (a)
                                     Jan 2009-Jan 2013                                                   Jan 2007-Dec 2012; Indices, January 2007 = 100

                                                          Germany        France               Italy                           Spain                   Greece

                                                          Spain          Portugal             Ireland                         Ireland                 Portugal
                                        Per cent                                                             160
                                        20
                                                                                                             150
                                         18
                                         16                                                                  140
                                         14                                                                  130
                                         12
                                                                                                             120
                                         10
                                          8                                                                  110
                                          6                                                                  100
                                          4
                                                                                                              90
                                          2
                                          0                                                                   80
                                           Jan-09         Jan-10    Jan-11          Jan-12      Jan-13             2007   2008        2009   2010      2011       2012

                                                                                                         (a) Non-MFIs (monetary and financial institutions) excluding
                                                                                                         central government.
                                     Source: Haver Analytics.                                            Source: Haver Analytics.


                                     In light of these mixed developments, the euro area economy as a whole is likely to broadly stagnate
                                     during 2013, with positive growth in the likes of Germany and Ireland offset by further declines in
                                     national income in Spain, Italy, Portugal and Greece. While our central view is that positive growth
                                     will resume during 2014 for several peripheral member states, the main downside risk to our global
                                     forecast is that the current euro area recession proves to be longer and deeper than expected.

                                     After a strong GDP reading in the third quarter, boosted by temporary factors, the UK economy fell
                                     back at the end of 2012. The preliminary estimate of UK GDP growth was -0.3% in Q4 2012, raising
                                     the potential prospect of triple-dip recession, and the economy saw zero growth during 2012 as a
                                     whole. In the absence of effective policy stimulus, we have again revised down our growth profile. The
                                     broad outlook for the UK economy remains one of slow and bumpy recovery over the next two years,
                                     with GDP growth likely to remain below-trend in both 2013 and 2014.

                                     The Japanese economy shrank by 0.9% in Q3 2012 compared with the previous quarter. The scale of
                                     this sharp contraction was unanticipated, and suggests that underlying weaknesses in the world’s third-
                                     largest economy could be more pervasive than previously thought. In the near term, Japanese growth is
                                     likely to strengthen during 2013 and 2014 following Prime Minister Abe’s announcement of a new
                                     fiscal stimulus, which is aimed at boosting GDP by around 2%. However, previous fiscal stimuli have
                                     failed to have much lasting impact on Japan’s economic performance. As such, changes to the
                                     monetary policy regime could have a more durable effect, particularly if the Bank of Japan (BoJ)
                                     successfully meets its new 2% CPI inflation target. The BoJ’s recent announcement that it will pursue
                                     open-ended purchases of government debt starting in January 2014 suggests that it is prepared to shift
                                     to a more aggressive policy stance. This is a critical step in order to raise inflation expectations, which
                                     in turn is a pre-requisite condition for meeting the new inflation target over the longer term. At the
                                     same time, the steps taken by Prime Minister Abe could intensify Japan’s credit challenges, in
                                     particular the need to reduce the budget deficit in order to prevent deterioration in creditworthiness to
                                     a level that could induce a funding crisis. 4



4
    See Japan’s New Leader Faces Intensifying Credit Challenges, 18 December 2012.




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                        Prospects for emerging markets are broadly unchanged
                        Alongside our relatively stable expectations for advanced economies over the past three months, our
                        forecasts for emerging markets are also broadly unchanged. We continue to expect real GDP growth in
                        the G-20 emerging economies of a little over 5½% in 2013, followed by a modest pickup towards 6%
                        in 2014. This significant growth still represents a notable deceleration from the robust growth rates
                        seen during 2010 and 2011, following the financial crisis and accompanying recessions in advanced
                        economies.

                        The Chinese economy appears to have adjusted well during 2012. Although exports to the EU
                        declined last year, and exports to the US also decelerated in the second half of the year, China
                        managed to grow its Asian export market, diversifying its customer base. However, trade growth
                        during 2012 as a whole fell back to single-digit levels after the more rapid expansion in Chinese trade
                        during the preceding two years. Against this backdrop, the domestic economy has shown signs of
                        improvement, with short-term indicators such as retail sales and industrial production suggesting a
                        recent gentle acceleration in activity (Exhibit 10). According to the National Bureau of Statistics,
                        Chinese GDP grew by 7.9% over the four quarters to Q4 2012, a pick up from the corresponding
                        figure of 7.4% in Q3. Some of this near-term momentum could persist into the first half of this year,
                        as the lagged effect of past policy loosening is still felt. However, we expect the Chinese authorities to
                        shift to a more neutral policy stance over the course of 2013. Such a change would be consistent with a
                        more moderate pace of growth compared with the rapid expansion seen in recent years.

                        EXHIBIT 10                                                              EXHIBIT 11
                        Chinese retail sales and industrial production                          Emerging market composite PMIs
                        Jan 2008-Dec 2012                                                       Jan 2008-Jan 2013, Indices (50 = no change)
                                      Industrial production        Wholesale and retail sales                        Brazil            China
                           Percentage changes on a year earlier                                                      India             Russia
                                                                                                   70
                            45
                                                                                                  65
                            40
                            35                                                                    60
                            30                                                                     55
                            25                                                                    50
                            20
                                                                                                  45
                            15
                                                                                                  40
                            10
                             5                                                                    35

                             0                                                                    30
                                 Jan-08     Jan-09       Jan-10   Jan-11      Jan-12                    Jan-08    Jan-09      Jan-10     Jan-11   Jan-12   Jan-13

                        Source: Haver Analytics.                                                Source: Haver Analytics.


                        Other major emerging economies have struggled to match China’s recent shift towards more
                        domestic-led growth. Indian industrial output has been volatile, partly reflecting the timing of the
                        Diwali holiday, but has slowed with the deceleration in world trade. The trade deficit may have peaked
                        towards the end of last year, but the persistent current account deficit indicates that the economy is
                        still struggling to rebalance towards domestic demand. Survey indicators such as the PMIs also suggest
                        some recent improvement (Exhibit 11), but the mapping between these surveys and official data is
                        often imprecise at best. After several disruptions, the Indian government has taken steps designed to
                        foster both short- and longer-term growth by boosting infrastructure investment, including a new bill
                        to speed up land acquisition and more certainty around project timescales. However, the economic




8   FEBRUARY 12, 2013                                                       SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED
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                                      impact of these measures remains to be seen. Overall, the Indian economy still looks unlikely to see a
                                      swift pickup in growth to the pace seen during 2010 and 2011.

                                      After GDP growth slipped to a three-year low of around 1% in 2012, the Brazilian economy should
                                      see some acceleration in economic activity during the current year. The slower pace of world trade
                                      growth has hit Brazilian exports, with little sign of domestic sales growth making up the difference. In
                                      part, the weakness of domestic demand last year reflected relatively high CPI inflation hitting
                                      households’ spending power. Inflation is set to remain high in the near term, but should ease
                                      somewhat over the course of 2013. The infrastructure spending associated with the 2014 Football
                                      World Cup and 2016 Olympics should also provide some boost to activity, although the full impact is
                                      likely to materialize only gradually. In the meantime, residual concerns about energy supply could
                                      weigh on businesses’ appetite for expansion, undermining growth in the face of relatively weak external
                                      demand.

                                      Smaller emerging economies generally continue to exhibit steady growth compared with advanced
                                      economies. Emerging European countries have been most affected by the euro area debt crisis, with
                                      uncertainty and private sector retrenchment hitting confidence and capital flows. 5 But growth in other
                                      emerging markets, most notably developing Asia and Africa, continues to hold up relatively well. 6 We
                                      expect this process to continue, thereby further closing the gap – albeit slowly – between per capita
                                      income levels in advanced and emerging economies. One challenge will be balancing the growing
                                      desire among emerging economies to control potentially destabilizing capital flows against their other
                                      monetary policy objectives: Box 1 discusses this in more detail.

                                      Box 1: Monetary policy in emerging economies
                                      Over the past few years, central banks in a number of advanced economies have cut policy rates to
                                      record lows, and then expanded their balance sheets in order to provide further monetary stimulus. 7
                                      This has posed something of a challenge for central banks in emerging markets, with some accusations
                                      that the US and other advanced economies have been debasing their currencies or ‘exporting inflation’
                                      to the rest of the world. This box examines the recent role and impact of monetary policy in emerging
                                      market economies.

                                      Many emerging markets are relatively small, open economies. In the absence of other policy
                                      instruments, this means that monetary policy can do one of two things: it can either seek to maintain a
                                      certain exchange rate, vis-à-vis some other currency; or it can seek to control domestic inflation.

                                      Importantly, by itself monetary policy cannot achieve both aims. Exchange rates are relative prices, so
                                      by anchoring their currency to the US dollar, for example, the monetary authorities essentially have to
                                      mirror developments in US monetary conditions. Given the substantial expansion of the Federal
                                      Reserve’s balance sheet, any central bank wishing to peg its currency against the US dollar would have
                                      had to similarly loosen policy, potentially leading to overheating in the domestic economy. In contrast,
                                      an inflation-targeting central bank would probably have let its currency appreciate against the US
                                      dollar in order to contain the upward pressure on prices that would have arisen from maintaining an
                                      artificially low exchange rate.




5
    See Central & Eastern European 2013 Sovereign Outlook: Subdued Macro Picture Tempers Credit Strengths, 15 January 2013.
6
    See for example Asia-Pacific 2013 Sovereign Outlook: Resilient to Global Headwinds, 11 January 2013.
7
    See Box 1 in Update to the Global Macro Risk Outlook 2012-14: Slow Adjustment to Weigh on Growth (146944), 12 November 2012.




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                         These contrasting outcomes are visible in the recent experience of some emerging economies.
                         Cambodia, for instance, has seen a relatively stable exchange rate against the US dollar since 2005, but
                         relatively large increases in consumer prices. In contrast, countries like Malaysia and Peru have seen a
                         less pronounced pace of inflation, while at the same time their currencies have appreciated significantly
                         against the US dollar. Other emerging economies have seen their currencies depreciate against the US
                         dollar, and have seen very substantial increases in consumer prices as a consequence (Exhibit B1).

                         EXHIBIT B1
                         Changes in emerging market exchange rates and consumer prices
                                      Percentage change in CPI (2005 to 2012)
                             400
                             350
                             300
                             250
                             200
                             150
                             100
                              50
                                0
                                    -80               -60               -40                -20                 0                 20     40              60
                                                                           Percentage change in domestic currency vs US dollar
                                                                                            (2005 to 2012)

                         Sources: IMF and Moody’s calculations.


                         This trade-off has led some emerging economies to return to alternative policy instruments, in
                         particular the re-introduction of capital controls. These controls regulate capital flows into and out of
                         an economy, which have been a concern for many emerging economies in the wake of the large capital
                         inflows seen in recent years, and can stabilize currency movements. However, the efficacy of capital
                         controls is uncertain, particularly short-term measures. They can also have knock-on implications for
                         other economies and potentially impede the efficiency of global capital markets. Ultimately, emerging
                         market policymakers still face a difficult balance in using the instruments at their disposal to foster
                         sustainable increases in real incomes.


                         Downside Risks to the Forecasts Have Diminished

                         The main downside risks to our forecast have diminished from three months ago, and stem from the
                         following:

                         »      A deeper than currently expected recession in the euro area accompanied by deeper credit
                                contraction, potentially triggered by a further intensification of the sovereign debt crisis.
                         »      Weaker-than-expected growth in major emerging markets following the recent slowdown.
                         »      An escalation of geopolitical tensions resulting in adverse economic developments.
                         The crystallization of any one of these risks would pose a threat to the outlook for global growth.




10   FEBRUARY 12, 2013                                                          SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED
                                                                                                                           CREDIT POLICY




                         The risk of a deeper than currently expected recession in the euro area
                         Our central view is that the euro area economy will start growing again during the second half of 2013.
                         However, there remain considerable downside risks to this forecast. In particular, there is substantial
                         uncertainty about the potential impact of the further austerity that we expect in peripheral euro area
                         member states over the next few years: some peripheral countries are only likely to achieve balanced
                         primary budgets by 2015 or even later. These deficit-cutting processes will weigh on growth, and fiscal
                         multipliers may be significantly larger than first thought.

                         With peripheral countries likely to be mired in austerity over the medium term, there is a clear risk
                         that this process acts as more of a drag on aggregate euro area growth than we have assumed in our
                         central forecasts. Intra-euro trade is still critically important for many members states, and prolonged
                         weakness in the periphery could spread to core countries. If Spain and Italy, in particular, were to see
                         further declines in GDP through to 2015 instead of a return to growth next year, that would weigh
                         significantly on the region as a whole, driving unemployment even higher and threatening the fragile
                         political consensus between European leaders.

                         At the same time, any relaxation in governments’ commitments to get their debt dynamics under
                         control could trigger renewed market disruption and financial pressure. Throughout the crisis, the
                         willingness of European policymakers to undertake painful yet necessary reforms has waxed and waned
                         as market pressure has intensified and subsequently eased. As such, although market conditions
                         currently appear relatively benign, the situation remains very fragile. Investors are currently giving
                         policymakers the benefit of the doubt, but that could change rapidly if concerns about sovereign
                         refinancing profiles resurfaced against the backdrop of further falls in GDP and employment. The risk
                         of a disorderly outcome to the European debt crisis, which would result in significant financial market
                         dislocation and trigger a much deeper and sharper downturn in the European economy, remains the
                         key downside risk to the global economy.

                         Weaker-than-expected growth in major emerging markets
                         The second serious threat to the global recovery is the possibility of slower-than-expected growth in
                         key emerging markets. During 2012, our concerns about a possible ‘hard landing’ in emerging markets
                         originally centred on China, but spread to other major emerging economies such as Brazil and India,
                         which were also exhibiting decelerations in activity.

                         Recent data suggest that China, in particular, may have managed to avoid a sharp and uncontrolled
                         decline in its pace of economic growth. But short-term indicators can be volatile, and the modest
                         recent improvement in retail sales and production growth could prove partly ephemeral. In addition,
                         the Chinese government is likely to put economic policy on a more neutral footing in the coming
                         months, following the introduction of various stimulus measures to cushion the downturn in growth.
                         The recent robust growth in non-bank financing, for instance, is unlikely to be tolerated indefinitely
                         by regulators. Even if the growth cycle has turned, China will not expand at the rapid pace that was
                         seen during 2010 and 2011.

                         This has implications for Brazil and India, which to date have not seen the same strengthening in
                         domestic conditions as in China. These economies are still struggling to make up for subdued export
                         demand in the wake of the deceleration in world trade. Given the weak outlook for advanced
                         economies and the moderation in China, growth in India and Brazil could take longer than expected
                         to bounce back from the slowdown seen last year. Indian policymakers’ previous efforts to liberalise
                         the economy have been somewhat sporadic, and it remains to be seen whether recent developments act




11   FEBRUARY 12, 2013                                         SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED
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                                      as a spur to growth. Meanwhile, although Brazilian GDP growth picked up to 0.6% in Q3 2012
                                      (from 0.2% in the second quarter) that was still a relatively weak pace of expansion. Industrial
                                      production and retail trade both subsequently fell in November, suggesting that the Brazilian economy
                                      is still struggling to regain momentum.

                                      In summary, while the possibility of a hard landing in key emerging markets looks to have been
                                      averted, the near-term balance of risks to growth in these economies remains on the downside. With
                                      most advanced economies likely to see only sub-trend growth over the next two years, key emerging
                                      economies will continue to act as an important driver of worldwide economic activity. Weaker-than-
                                      expected growth in these major emerging markets could therefore have a significant impact on global
                                      growth.

                                      An escalation of geopolitical tensions
                                      Another key risk to our forecasts is the potential economic fallout from growing geopolitical risks.
                                      Conflicts in Syria and parts of Africa could spill over into neighbouring nations, and tensions
                                      elsewhere could also damage global growth prospects. There are two scenarios in particular that are of
                                      significant concern.

                                      First, tensions in the Middle East could potentially trigger a supply-side oil shock, resulting in a
                                      significant jump in prices. Such an increase, if sustained, would weigh on growth in most large
                                      economies. While the recent discovery of US shale oil could reduce the impact of Middle East supply
                                      disruptions over the longer term, for now oil supply remains highly concentrated within the region.
                                      The direct impact of an increase in oil prices on growth is likely to be much less pronounced than in
                                      historic episodes, given the reduced energy-intensity of economic activity in many advanced
                                      economies. Nevertheless, the global recovery remains relatively fragile and the impact of a sudden
                                      supply-led increase in oil prices could be more significant than would be the case if the economic
                                      backdrop were stronger. Options prices currently suggest roughly a 20% chance that the price of WTI
                                      oil could increase by $20 a barrel or more over the coming year. As such, Moody’s continues to believe
                                      that this risk remains a high severity tail event with significant global implications. 8

                                      Second, the dispute between China and Japan over the Senkaku-Diaoyu islands also poses a particular
                                      threat to global growth. The likelihood of outright conflict remains relatively low, but recent
                                      escalations in rhetoric and military presence indicate the seriousness of this disagreement. Given the
                                      US defence guarantee to Japan, the dispute has the potential to embroil the world’s three largest
                                      economies in a damaging struggle. Even if direct military action is avoided, as still seems most likely,
                                      there are already signs that it could significantly disrupt trade developments in Eastern Asia, most
                                      notably the trilateral free trade negotiations between China, Japan and South Korea that began in May
                                      last year. 9 A further escalation of tensions could potentially undermine growth in these economies and
                                      more broadly in Developing Asia, one of the few regions to come through the recent financial crisis
                                      relatively unscathed.




8
     For more detail and past analysis, see Update to Our Global Macro-Risk Outlook 2012-2013: Modest Growth and Resurfacing Oil Price Risks, April 2012 and Global
     Macro-Risk Scenarios 2011-2012: Oil Price Supply Shock Downside Scenario, April 2011.
9
     See In Japan-China Island Dispute, Both Sides Have Something to Lose, 20 December 2012.




12      FEBRUARY 12, 2013                                                           SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED
                                                                                                                           CREDIT POLICY




                         Moody’s Related Research

                         Recent Global Macro Risk Scenarios:
                         »   Update to the Global Macro Risk Outlook 2012-14: Slow Adjustment to Weigh on Growth,
                             November 2012 (146944)
                         »   Update to the Global Macro Risk Outlook 2012-13: Euro Area Debt Crisis Continues to Pose the
                             Greatest Risk, August 2012 (145035)
                         »   Update to Our Global Macro Risk Outlook 2012-13: Modest Growth and Resurfacing Oil Price
                             Risks, April 2012 (141580)
                         Sovereign Related Research:
                         »   Argentina’s Six Years of Underreporting Inflation is Credit Negative, January 2013 (149310)
                         »   Brazil’s regulation to extend duration in fixed-income portfolios is credit positive, January 2013
                             (148993)
                         »   Central & Eastern European 2013 Sovereign Outlook: Subdued Macro Picture Tempers Credit
                             Strengths, January 2013 (148700)
                         »   Ireland’s Bond Issue Is a Step Toward Regaining Full Capital Market Access, January 2013
                             (148994)
                         »   Asia-Pacific 2013 Sovereign Outlook: Resilient to Global Headwinds, January 2013 (148774)
                         »   US Fiscal Package Has Limited Positive Credit Implications, January 2013 (148908)
                         »   In Japan-China Island Dispute, Both Sides Have Something to Lose, December 2012 (148574)
                         »   Japan’s New Leader Faces Intensifying Credit Challenges, December 2012 (148472)
                         »   Debt Sustainability Remains a Concern Following Greece’s Second Default, December 2012
                             (148288)
                         »   Italy’s Political Turmoil Has Limited Credit Implications for Sovereign, December 2012
                             (148250)
                         »   Moody’s downgrades France’s government bond rating to Aa1 from Aaa, maintains negative
                             outlook, November 2012
                         »   European Commission’s Upward Revision of Spain’s Deficit Targets is Credit Negative,
                             November 2012 (147509)
                         »   No Detrimental Effect from Sandy on US Sovereign Creditworthiness, November 2012 (147013)
                         Selected Banking and Corporate Sector Research:
                         »   Rising Risks, Receding Government Support, Cause Shift in Bank Credit Profiles, December
                             2012 (147334)
                         »   EU Single Supervisory Agreement Is Credit Positive for Banks and Sovereigns, December 2012
                             (148351)
                         »   Liikanen Group Proposals for Tougher EU Bank Regulation Are Credit Positive, October 2012
                             (145993)




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                                                                                                                                        CREDIT POLICY




                         »    Spanish Banks’ Upcoming Recapitalization is Credit Positive, but May Be Insufficient, October
                              2012 (145834)
                         »    EU Sovereign Crisis Poses Growing Risks For Some European Non-Financial Companies, July
                              2012 (143282)
                         »    London 2012 Olympics Provide a Short-term Boost, But No Gold Medal for Corporates, May
                              2012 (141487)
                         »    Euro Area Debt Crisis Weakens Bank Credit Profiles, January 2012 (139781)
                         To access any of these reports, click on the entry above. Note that these references are current as of the date of publication of
                         this report and that more recent reports may be available. All research may not be available to all clients.




14   FEBRUARY 12, 2013                                                 SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED
                                                                                                                                                CREDIT POLICY




                         Report Number: 149555



                         Author                                                                  Production Associate
                         Colin Ellis                                                             Sarah Warburton




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15   FEBRUARY 12, 2013                                          SPECIAL COMMENT: GLOBAL MACRO OUTLOOK 2013-14: DOWNSIDE RISKS HAVE DIMINISHED

								
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