(ITUB), released their outlook for the next 8 years on key markets around the globe. The boom days are over.
Global Growth Forecast 2020
The investment banking arm of Brazil’s biggest private bank, Itau Unibanco (ITUB), released their outlook for the next 8 years on key markets around the globe. The boom days are over. In Itau’s view, sluggish growth will persist in the U.S. and China’s economy — once it shifts to a more domestic focused economy– will finally see potential GDP average around 7% or below. In addition, older demographics means lower growth than in the last ten or twenty years. However, Itau doesn’t think that slower growth is a bad thing. A decline in fixed asset investment is potentially more dangerous, and how China manages that change will depend whether it is successful in soft landing the economy.
No. 2 China might be slowing down, but so is the No. 1. According to Itau, the U.S. economy will struggle to grow above 2% next year, and for a good three years afterwards. Whoever is elected president in November will oversee a steady, but slow, U.S. economy.
Here are some takeaways from the 25 page report by chief economist Ilan Goldfajn and his economic team at Itau in São Paulo.
U.S.A (Avg. 2014-2020 growth potential: 2.1%)
Even after an 18-month recession that saw, from peak to trough, a 5% drop in GDP, the U.S. economy has grown at an annual pace of only 2.5%, despite fiscal and monetary boosts. It is a weak recovery compared to previous recessions. The country’s potential growth is also slowing due to a slow down in labor growth (demographics), lower growth in capital stock to 2.8% from 3.7% and lower gains in total factor production to 0.6% from 0.7%.
The U.S. economy actually amassed an output gap in recent years and, theoretically, could grow beyond the 2.1% trend for a few years. However, we do not believe that demand will be strong enough to close the output gap before the end of the decade. The fiscal adjustment will likely be taking place in an unfavorable external-demand environment, particularly in Europe. Monetary policy, with interest rates already near zero, will be limited to nonconventional tools. Even if private spending improves somewhat as balance sheets gradually adjust, it should not be enough to generate substantial demand growth.”
Eurozone (Avg. 2014-2020 growth potential: 1.1%)
Goldfajn wonders if Europe can use all of its powers to stop Greek contagion throughout southern Europe. Portugal is the worst off, but still in much better shape than Greece, with more political cohesion. Greece is unsustainable. And while it will unlikely leave the eurozone this year, it’s outlook is similar to that of Argentina in the early 2000s when it defaulted on debt. The country remained and investment pariah for more than a decade and ceded its status to its northern rival Brazil. Europe’s days as a Western powerhouse are dwindling. Growth will stagnate. The eurozone must not only reestablish fiscal sustainability and competitiveness in peripheral economies –which tends to reduce investment and thus create a demand gap for a few years– but it must also face unfavorable demographic dynamics. Europe’s potential growth is hindered somewhat by a shrinking labor pool and migration. On the other hand, there is potential for increased capital stock by 1.8% and total factor productivity to rise by 0.6% thanks to higher investment.
The key European leaders are committed to the euro. There are currently no alternatives but to continue to support Greece. As we stated previously, however, this strategy does not seem sustainable in the medium term. Therefore, within that horizon, the future of the euro depends much more on the possibility of avoiding contagion than on Greece‘s actual capacity to adjust without leaving the monetary union.”
China (Avg. 2014-2020 growth potential: 7.3%)
It is unlikely that China will be able to keep flooding the country with fixed asset investment. That will be one of the main causes of a Chinese slowdown. Itau’s Goldfajn anticipates a retreat in potential growth to 6.5%-7.0% by the end of the decade. Effective growth should be below potential in 2012 and 2013 and return to potential from 2014 onwards. The three main reasons for below-average growth include a decline in fixed asset investment, an economic shift away from productive sectors of the economy in favor of service sector jobs, and an aging population.
One of the main risks for this scenario is poor capital allocation. Huge investment volumes at low interest rates and government guidance of the economy may lead to a significant buildup of badly-allocated capital, which could result in a prolonged hard landing. The other risk is the possible materialization of a severe global economic crisis. In order to offset the external shock, the government could repeat and intensify the fiscal stimuli for investment that were adopted in 2008 and 2009 as a response to the last crisis. Consequently, capital allocation could deteriorate further.”
Brazil (Avg. 2014-2020 growth potential: 4.1%)
The biggest obstacle in Brazil at the moment is a lack of workers and a low national savings rate. The labor factor will not contribute as intensely as in recent years. From 2003 to 2011, the unemployment rate fell to 6% from 13%, with skilled engineers becoming harder to find as Brazil builds out, goes more high tech, and needs to develop new technologies for its massive deep water oil discoveries. Annual population growth, at 1.5% in mid-1990, is expected to drop to 0.6% by the end of the decade, while expansion in the labor force is projected to slide to 0.9% in 2020, from 2.3%. Productivity gains should remain at current levels, given the absence of structural reforms in recent years. In other words, Brazil is not going to suddenly become a productivity powerhouse like China. The additional source of growth will have to be an increase of the capital stock. However, in order to attain it, the country must increase its savings rate.
The public sector will have three main ways to increase its savings. The first is an increase in tax revenues. Formalization among workers and companies is likely to continue for some time to come. This should help widen the tax base and keep revenues growing above GDP. Another source of higher revenue will be, in our scenario, greater taxation of the commodity sector, as is the case in other Latin American nations. Finally, the decline in neutral interest rates should continue to reduce interest payments on public debt.”
Latin America
Goldfajn’s base-case scenario for the other Latin American countries, investment rates will be sustained at high levels and productivity will advance at a pace similar to the one observed in recent years. Even with less-favorable demographic trends than in recent years, the drop in potential growth in the region should be modest. Foreign direct investment and government investment will be highest in Peru in terms of investments per GDP.
Chile and Colombia will come in a close second and third. However, in relation to the average of the last decade, Colombia will likely have the largest increase in investment rate. This is a direct result of the reduction in crime rates and of reforms adopted in recent years, especially in the energy sector.
We expect growth in the total productivity of factors to remain close to what we saw in recent years in Latin America. The exception is Argentina, where a less open, more controlled economic environment should continue to hurt productivity. We forecast that growth in total productivity throughout the decade will be higher in Peru, and that Mexico will continue to post the lowest productivity growth in the region as a consequence of low competition in many economic sectors.”
Commodities: Tamer Bulls
Commodity prices climbed 51% in real terms over the last decade, from 2000 to 2010. Significant global economic shifts occurred during that period, from fast growth in Asia to the dissemination of commodities as an asset class for investors. While the first factor contributed to a much higher need for production of those products, the latter increased liquidity and the speed of transmission of changes in demand to prices in real time. Going forward, growth in emerging nations will probably be the most important factor for commodity prices in the next years. GDP growth brings more investment and industrialization, increasing demand for fuels and metals.
Itau expects the next 10 years to see a significant hike in commodity consumption, but with higher marginal production costs than at the beginning of the last decade. “Therefore, we forecast a nominal commodity price increase of about 40% until 2020, translating into a real gain of at least 10% in the period,” the Itau report states. Within that universe of commodities, oil demand is seen rising by 10% over the next 8 years, with basic metals demand slowing to more sustainable levels of around 3% growth in the same period. |
