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Introduction
Stubbornly high energy prices, volatile financial markets, weak credit conditions, and a continuing downturn in the U.S. housing market have combined to produce the economic equivalent of a perfect storm for the year 2008. As a result, uncertainty clouds the economic prospects of both the U.S. and world economies. A possible recession looms for the U.S. in 2008, which must be considered against a history of past U.S. recessions usually, coinciding with significant reductions in global growth. Since the U.S. economy for the past decade has represented 30.0 percent of the world total, as measured at market exchange rates, (1) the slowdown of the U.S. economy will result in the slowing of the world economy to an annual growth rate of 4.75 percent, down from its more robust expansion of 2007. Although appreciably slowed from their strong expansion rates of 2007, China, India, and emerging market economies will continue to provide the momentum for overall world economic growth in 2008, and whether they will remain relatively unscathed from the effects of the marked slowdown in U.S. growth will depend upon the nature of the spillover effects from the U.S. economy. (2)
China, India, and Other Emerging East Asian Markets
The International Monetary Fund (IMF) expects emerging market economies to continue to expand strongly, although growth is projected to slow from the rapid pace of the last two years. The Chinese economy will grow between 9.0 percent and 10.0 percent in 2008, and growth will remain buoyant in other emerging markets. For the first time, China and India are making the largest country-level contributions to global economic growth. However, this outlook for strong economic growth must be tempered by the uncertainty surrounding the severity of the U.S. economic slowdown. Generally speaking, past U.S. recessions have been accompanied by declining GDP growth rates in most other countries. In industrial countries, growth rates have, on average, declined by 2 percentage points as the result of a U.S. recession, roughly half of the U.S. average decline in growth during the same period. If the U.S. economic downtown expands beyond U.S. sectoral corrections in housing and manufacturing and spreads broadly to common factors such as equity and consumer expenditure declines, emerging market economies, which are heavily dependent upon exports to the U.S., may be more severely impacted. (3)
Chinas export growth is likely to slow in 2008, but the domestic economy will be driven by steady growth in income and overall GDP. Continuing strong domestic growth may result in further increases in interest rates by the Chinese central bank due to concerns about economic overheating. The central bank may also raise the required reserve ratio if Chinas foreign exchange reserves continue to soar. (4)
Export growth of close to 20.0 percent in 2008 is expected, while household income and home consumer demand are likely to continue to grow at a double-digit pace in 2008. (5) However, the impact of the 2008 Olympic Games on consumption is not expected to be significant at the national level as any impact will be confined to the few major cities hosting the games. The renminbi (yuan) exchange rate should continue to move higher against the U.S. dollar, with the pace of appreciation likely to accelerate in 2008. (6)
The real gross domestic product of India is projected to grow between 8.1 percent and 8.6 percent as compared to 8.5 percent and 9.0 percent in 2007. (7) With domestic forces driving demand, India has been and will continue to be relatively unaffected by the U.S. credit turmoil. However, India continues to see very rapid growth in energy consumption and therefore may be hindered by oil prices remaining at high levels for a sustained period in 2008. Additionally, India's record surge in foreign investment has resulted in a sharp appreciation of the rupee, which is already hurting exports, especially earnings of the highly profitable outsourcing industry.
Other emerging East Asian economies include South Korea, Hong Kong, Yaiwan, Brunei, Cambodia, Indonesia, Laos, Malaysia, Myanmar, Philippines, Singapore, Thailand, and Vietnam. For these economies, economic expansion will moderate to 6.1 percent in 2008 from 6.3 percent in 2007 according to the Pacific Economic Cooperation Council (PECC). This moderation in growth is a result of possible fallout from the U.S. subprime crisis.
Japan
Japan's economy has largely recovered from the problems of the late 1990s and the early years of this decade. Real GDP grew 2.0 percent in 2007, and economic growth is forecast to average 1.5 percent a year for the period between 2008 and 2012, driven primarily by private consumption and investment. However, Japan has significant export exposure to the U.S. economy, making it vulnerable to the impact of a severe U.S. economic downturn.
Japan is the fourth largest economy in the world in purchasing power parity and the second largest in terms of GDP at market exchange rates. Although it boasts one of the world's largest markets, with a population of just less than 130 million, the Japanese market will remain a challenging one, which is a reflection of the high quality demanded by Japanese consumers and the difficulties of doing business in an environment that remains opaque. (8)
Europe, Emerging European Economies, and the UK
Growth should be slow in the next several quarters in the euro area, with full-year growth expected at 1.6 percent. (9) Annual economic growth for the U.K. is forecast at 1.8 percent. Both the euro zone (with a combined GDP representing 15.0 percent of total world GDP) and the U.K. are forecast to grow significantly slower than during the previous couple of years. (10) The International Monetary Fund (IMF) indicates that strong underlying fundamentals should allow the European economy to weather the current financial turbulence relatively well. Additionally, emerging European economies have remained largely unscathed by the financial market volatility. (11) Emerging European economies include Bulgaria, Cyprus, Czech Republic, Hungary, Malta, Poland, Romania, Slovak Republic, Estonia, Latvia, and Lithuania. However, this optimism should be tempered by the fact that the 2001 U.S. recession was accompanied by growth declines in most industrial economies and most of emerging Europe.
Other European Region Economies
Russia is unwinding large, oil-driven surpluses and is forecast to experience real GDP growth of 6.5 percent in 2008. Albania will grow by 6.0 percent; Belarus, 6.4 percent; Bosnia, 6.5 percent; Turkey, 5.3 percent; and the Ukraine, 5.4 percent. (12)
Africa
Although growth in industrial countries, Asia, and Europe has tended to decline during U.S. recessions, the impact on growth in Africa and the Middle East has been fairly small. Among developing economies, growth in Africa strengthened in 2007 and is expected to increase at a rate above 6.0 percent in 2008, according to the United Nations LINK Global Economic Outlook. (13) The growth in the region has been driven by high domestic demand, booming mining and gas production, and broad-based recovery in a number of countries from a long period of economic decline. However, there are significant disparities among individual countries as growth continues to be impeded by political and social tensions, limited access to external funding, and adverse climate conditions.
Growth continues to be strong in Africa's five largest economies. The Egyptian economy continues to grow domestically as a result of large cuts in taxes and wealth effects from rising asset prices. The South African economy is growing as a result of increasing public spending on infrastructure. Economic activity will pick up slightly in Algeria and Nigeria, driven by rapidly growing public investment and strong performance in non-hydrocarbon sectors. GDP growth will decelerate in Morocco, however, as a result of a significant decline in agricultural output.
Agriculture-dominated economies, including Burkina-Faso, Ethiopia, Kenya, and Tanzania, have benefited from booms in construction, manufacturing, and services. Mining-dependent Sierra-Leone and oil-producing Angola will continue to experience a sustained recovery. The Central African Republic (CAR) will experience modest economic recovery as a result of aid flows and growing investment. Much stronger growth is expected in 2008 for Guinea and Togo for similar reasons. GDP will likely contract in Chad and Zimbabwe in 2008 as a result of the strained security and social situation. (14)
Latin America
As the U.S. economy slows down, Latin America is likely to encounter a significant impediment to growth in 2008, with expected combined growth in the region of 4.9 percent, down from 5.3 percent in 2007. The link between Mexico and the U.S. is strongest in manufacturing, and with a slowdown forecast for the U.S., Mexico's growth is forecast to slow to 2.6 percent in 2008 from 3.2 percent in 2007. (15)
Brazil is expected to grow at 4.3 percent in 2008, down from 4.9 percent in 2007. A slowing global economy may translate into less demand for regional commodities such as copper from Chile and iron from Brazil. Venezuela will benefit from continued high oil prices.
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Inflation
Inflationary pressures will increase in 2008. In the past, surges in oil prices (as well as food prices) have moderated relatively quickly and were temporary rather than permanent "shocks." As a result, monetary authorities have traditionally focused on "core" inflation, which does not consider the effects of movements in energy and food prices. However, the current escalation in oil and food prices has continued far longer than normal. Additionally, food price shocks, which are usually contingent upon regional weather conditions and are not usually synchronized across countries, are currently a major source of inflation in a large number of countries. Therefore, "core" inflation may now underestimate the risk to price stability in a number of countries. (16)
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