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Risks to the Global Outlook: Insights from the Oxford Global Economic Model
Rain Newton-Smith
October 2010
Co
rpo
rate
rec
ove
ry
Financial sector recovery
Outlook still highly uncertain
Co
rpo
rate
rec
ove
ry
Financial sector recovery
Outlook still highly uncertain
Oxford forecast■ Gradual rise in business confidence
encourages corporates to invest ■ But weak banks combined with excess
capacity limit scale of investment recovery
■ Consumer spending recovery limited by pace of job growth and fiscal retrenchment
■ But recovery strong enough that fiscal crisis remains contained
Co
rpo
rate
rec
ove
ry
Financial sector recovery
Outlook still highly uncertain
Renewed global boom■ Strong corporate liquidity feeds into new
investment boom■ Faster growth boosts business and
consumer confidence, and trade multiplier magnifies upturn
■ Bank balance sheets improve quickly and credit growth resumes
■ Strong growth boosts tax revenues/cuts social security payments, helping fiscal consolidation
Oxford forecast■ Gradual rise in business confidence
encourages corporates to invest ■ But weak banks combined with excess
capacity limit scale of investment recovery
■ Consumer spending recovery limited by pace of job growth and fiscal retrenchment
■ But recovery strong enough that fiscal crisis remains contained
Co
rpo
rate
rec
ove
ry
Sub-par recovery■ Business optimism remains low and
corporates continue to hoard cash■ Investment and job growth is modest as
capacity is underutilised■ Monetary policy supports banking sector
but fiscal coffers are empty■ Easier credit conditions mean benefits of
loose monetary policy feeds through to a stronger housing and consumer recovery
Financial sector recovery
Outlook still highly uncertain
Renewed global boom■ Strong corporate liquidity feeds into new
investment boom■ Faster growth boosts business and
consumer confidence, and trade multiplier magnifies upturn
■ Bank balance sheets improve quickly and credit growth resumes
■ Strong growth boosts tax revenues/cuts social security payments, helping fiscal consolidation
Oxford forecast■ Gradual rise in business confidence
encourages corporates to invest ■ But weak banks combined with excess
capacity limit scale of investment recovery
■ Consumer spending recovery limited by pace of job growth and fiscal retrenchment
■ But recovery strong enough that fiscal crisis remains contained
The Oxford Global Economic Model – Overview
The Oxford Global Economic Model is the most widely used commercial International Macro Model, with clients including international institutions, Ministries of Finance and central banks around the word, and a large number of blue-chip companies.
It provides a rigorous and consistent structure for forecasting and scenario analysis.
The Model covers 46 economies in detail, including many emerging markets, and provides headline forecasts for another 30 countries.
Forecasts 5, 10 and 25 years ahead are updated each month.
Oxford Economics’ powerful user-friendly software is very easy to use.
Oxford Economics provides telephone and e-mail support, and runs regular training workshops for clients.
Linkages between country models
Trade
Competitiveness
Interest rates and exchange rates
Equity markets
Oil & commodity prices
World price of manufactured goods
Capital flows
Extensions following the global financial crisis Despite the good performance of the Oxford Global Economic Model,
the global financial crisis did highlight areas for enhancements:
■ Interest rates – expanded coverage to include key corporate and consumer lending rates, as well as interbank rates and bond yields
■ Credit conditions – introducing levers to account for tightness/looseness of bank lending that are not reflected in interest rates. This analysis is based on research by Prof. John Muellbauer of Oxford University
■ Balance sheet coverage – expanded to cover financial and non-financial corporates as well as households and governments
■ Credit ratings – Reflecting the impact of sovereign debt ratings on interest rate spreads for government bonds
■ Feedback effects – from unemployment/insolvencies on credit conditions
Model extensions
Credit conditions
Interbank spreadsOfficial policy rates &
Government bond yields
Lending spreadsAvailability of
credit/other lending criteria
Lending rates
Household Corporate
Consumer spending
Housing investment/
prices
Business investment
GDP
Household wealth/ equities
Government finances
Corporates are key
200
250
300
350
400
450
500
550
600
650
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base
Renewed boom
Sub-par recovery
Source: Oxford Economics
$2005 billions
US: Business investment
Scenarios for the global economy
2009 2010 2011 2012
Oxford Forecast (45%)US -2.6 2.7 2.6 3.5Eurozone -4.0 1.5 1.4 1.8China 9.1 9.7 9.0 9.2World -0.7 4.4 4.3 5.0
Renewed boom (20%)US -2.6 2.9 3.8 4.2Eurozone -4.0 1.7 2.5 2.9China 9.1 10.4 10.7 10.4World -0.7 4.7 5.6 6.0
Sub-par recovery (25%)US -2.6 2.5 1.9 2.2Eurozone -4.0 1.2 0.9 1.0China 9.1 8.8 7.2 7.5World -0.7 4.0 3.4 3.8
Alternative GDP growth forecasts
Co
rpo
rate
rec
ove
ry
Sub-par recovery■ Business optimism remains low and
corporates continue to hoard cash■ Investment and job growth is modest as
capacity is underutilised■ Monetary policy supports banking sector
but fiscal coffers are empty■ Easier credit conditions mean benefits of
loose monetary policy feeds through to a stronger housing and consumer recovery
Financial sector recovery
Outlook still highly uncertain
Renewed global boom■ Strong corporate liquidity feeds into new
investment boom■ Faster growth boosts business and
consumer confidence, and trade multiplier magnifies upturn
■ Bank balance sheets improve quickly and credit growth resumes
■ Strong growth boosts tax revenues/cuts social security payments, helping fiscal consolidation
Oxford forecast■ Gradual rise in business confidence
encourages corporates to invest ■ But weak banks combined with excess
capacity limit scale of investment recovery
■ Consumer spending recovery limited by pace of job growth and fiscal retrenchment
■ But recovery strong enough that fiscal crisis remains contained
Co
rpo
rate
rec
ove
ry
Renewed crisis■ Threat of double-dip means renewed
slump in asset prices as Eurozone sovereign debt crisis re-emerges
■ Pressure to cut budget deficits rapidly in all major economies
■ Rising unemployment and business failures feed back into banking
■ Limited scope for monetary policy offset
Sub-par recovery■ Business optimism remains low and
corporates continue to hoard cash■ Investment and job growth is modest as
capacity is underutilised■ Monetary policy supports banking sector
but fiscal coffers are empty■ Easier credit conditions mean benefits of
loose monetary policy feeds through to a stronger housing and consumer recovery
Financial sector recovery
Outlook still highly uncertain
Renewed global boom■ Strong corporate liquidity feeds into new
investment boom■ Faster growth boosts business and
consumer confidence, and trade multiplier magnifies upturn
■ Bank balance sheets improve quickly and credit growth resumes
■ Strong growth boosts tax revenues/cuts social security payments, helping fiscal consolidation
Oxford forecast■ Gradual rise in business confidence
encourages corporates to invest ■ But weak banks combined with excess
capacity limit scale of investment recovery
■ Consumer spending recovery limited by pace of job growth and fiscal retrenchment
■ But recovery strong enough that fiscal crisis remains contained
Eurozone sovereign debt crisis
The Eurozone sovereign debt crisis will have a significant impact on economic growth over several years, with this impact operating through a number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone states have been driven up by higher default risk and in some cases liquidity squeezes have also taken place in the banking sectors of weaker states as foreign funds have fled. These developments have driven up borrowing costs and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling growth prospects have also created negative wealth effects on business and consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
Set against these negative effects, there are also potential positives such a lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
The Eurozone sovereign debt crisis will have a significant impact on economic growth over several years, with this impact operating through a number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone states have been driven up by higher default risk and in some cases liquidity squeezes have also taken place in the banking sectors of weaker states as foreign funds have fled. These developments have driven up borrowing costs and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling growth prospects have also created negative wealth effects on business and consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
Set against these negative effects, there are also potential positives such a lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
-3 -2 -1 0 1 2 3 4 5 6 7 8
Germany
Finland
Austria
Netherlands
France
Italy
Belgium
Portugal
Spain
Ireland
Greece
20102011
Fiscal plans for 2010 and 2011
Change in cyclically adjusted budget balance % GDP
Source : IMF/Oxford Economics
Eurozone sovereign debt crisis
The Eurozone sovereign debt crisis will have a significant impact on economic growth over several years, with this impact operating through a number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone states have been driven up by higher default risk and in some cases liquidity squeezes have also taken place in the banking sectors of weaker states as foreign funds have fled. These developments have driven up borrowing costs and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling growth prospects have also created negative wealth effects on business and consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
Set against these negative effects, there are also potential positives such a lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
0.0
2.0
4.0
6.0
8.0
10.0
12.0
Jan-2008 Jul-2008 Jan-2009 Jul-2009 Jan-2010 Jul-2010
Greece Spain
Portugal Ireland
Italy
Eurozone: Credit spreads% spread of 10-year bonds over German bunds
Source : Oxford Economics/Haver Analytics
Eurozone sovereign debt crisis
0
50
100
150
200
250
300
350
400
2007 2008 2009 2010
Ireland
Portugal
Spain
Greece
Eurozone: ECB lending to 'periphery'€ billion
Source : Oxford Economics/Haver Analytics
Eurozone sovereign debt crisis
The Eurozone sovereign debt crisis will have a significant impact on economic growth over several years, with this impact operating through a number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone states have been driven up by higher default risk and in some cases liquidity squeezes have also taken place in the banking sectors of weaker states as foreign funds have fled. These developments have driven up borrowing costs and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling growth prospects have also created negative wealth effects on business and consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
Set against these negative effects, there are also potential positives such a lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
The Eurozone sovereign debt crisis will have a significant impact on economic growth over several years, with this impact operating through a number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone states have been driven up by higher default risk and in some cases liquidity squeezes have also taken place in the banking sectors of weaker states as foreign funds have fled. These developments have driven up borrowing costs and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling growth prospects have also created negative wealth effects on business and consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
Set against these negative effects, there are also potential positives such a lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by investors and a lower euro which should benefit exports.
‘North’ Eurozone’s trade exposure
0%
2%
4%
6%
8%
10%
South* China UK US
North*
Germany
Trade spillovers% total exports, 2007-09
Source : IMF, Oxford Economics
* North = Ger, Fra, Neth, Bel* South= Spa, Gre, Por & Ire
Eurozone sovereign debt crisis
The Eurozone sovereign debt crisis will have a significant impact on economic growth over several years, with this impact operating through a number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone states have been driven up by higher default risk and in some cases liquidity squeezes have also taken place in the banking sectors of weaker states as foreign funds have fled. These developments have driven up borrowing costs and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling growth prospects have also created negative wealth effects on business and consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
Set against these negative effects, there are also potential positives such a lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
The Eurozone sovereign debt crisis will have a significant impact on economic growth over several years, with this impact operating through a number of channels –
■ Fiscal cutbacks – higher taxes and lower government spending and investment will tend to depress economic growth
■ Higher interest rates/restricted credit – bond yields in the weaker Eurozone states have been driven up by higher default risk and in some cases liquidity squeezes have also taken place in the banking sectors of weaker states as foreign funds have fled. These developments have driven up borrowing costs and limited the availability of credit to the wider economy.
■ Wealth effects – higher interest rates, lower capital inflows and dwindling growth prospects have also created negative wealth effects on business and consumers.
■ Trade effects – weaker growth in the ‘peripheral’ Eurozone countries will hit the exports of the stronger ‘core’ countries.
■ Confidence effects – on households and companies, as well as markets.
Set against these negative effects, there are also potential positives such a lower interest rates in the ‘core’ countries due to a ‘flight to quality’ by investors and a lower euro which should benefit exports.
Eurozone sovereign debt crisis
0
1
2
3
4
5
6
1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
%
Eurozone: Interest rates
Bunds (10-year yields)
Euribor(3-month rates)
90
100
110
120
130
140
150
Dec-05
Jul-06 Jan-07
Jul-07 Jan-08
Jul-08 Jan-09
Jul-09 Jan-10
Jul-10
Nominal effective rate
Dollar/€
Dec 30 2005=100
Eurozone: Exchange rates
£/€
Scenarios on the sovereign debt crisis
Baseline
Eurozone muddles through
Government debt & deficits surge
in peripheral Eurozone
Rise in investor concerns about medium- term
creditworthiness
Rise in sovereign spreads
Fiscal consolidation & IMF/EU support
Scenarios on the sovereign debt crisis
Baseline
Eurozone muddles through
Peripheral Eurozone Sovereign Debt Crisis
Government debt & deficits surge
in peripheral Eurozone
Rise in investor concerns about medium- term
creditworthiness
Rise in sovereign spreads
Fiscal consolidation & IMF/EU support
Bank funding costs and lending
rates rise
Local banks cut lending
Markets continue to fear default and sovereign spreads surge
Other banks lose confidence in peripheral EZ
banks
Peripheral Eurozone Sovereign Debt Crisis
0
1
2
3
4
5
6
7
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base EZ Peripheral Crisis
Source: Oxford Economics
%
Eurozone-Med*: Government bond yields
*Greece, Portugal, Spain & Italy0
1
2
3
4
5
6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base EZ Peripheral Crisis
Source: Oxford Economics
%
Germany: Government bond yields
Peripheral Eurozone Sovereign Debt Crisis
-6
-5
-4
-3
-2
-1
0
1
2
3
4
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base
EZ Peripheral Crisis
Source: Oxford Economics
% year
Eurozone-Med*: GDP
*Greece, Portugal, Spain & Italy
-6
-5
-4
-3
-2
-1
0
1
2
3
4
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base
EZ Peripheral Crisis
Source: Oxford Economics
% year
Eurozone: GDP
Scenarios on the sovereign debt crisis
Baseline
Eurozone muddles through
Peripheral Eurozone Sovereign Debt Crisis
Growth in peripheral EZ hit hard, limited contagion
Government debt & deficits surge
in peripheral Eurozone
Rise in investor concerns about medium- term
creditworthiness
Rise in sovereign spreads
Fiscal consolidation & IMF/EU support
Bank funding costs and lending
rates rise
Local banks cut lending
Markets continue to fear default and sovereign spreads surge
Other banks lose confidence in peripheral EZ
banks
Scenarios on the sovereign debt crisis
Baseline
Eurozone muddles through
Peripheral Eurozone Sovereign Debt Crisis
Growth in peripheral EZ hit hard, limited contagion
European Banking Crisis
Government debt & deficits surge
in peripheral Eurozone
Rise in investor concerns about medium- term
creditworthiness
Rise in sovereign spreads
Fiscal consolidation & IMF/EU support
Bank funding costs and lending
rates rise
Local banks cut lending
Markets continue to fear default and sovereign spreads surge
Other banks lose confidence in peripheral EZ
banks
European banks face large losses
Banks sell assets and euro plummets
Credit conditions tighten across
Europe
Interbank rates rise
European Banking Crisis
0
1
2
3
4
5
6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base
EZ Peripheral Crisis
EU Banking Crisis
Source: Oxford Economics
%
Eurozone: Government bond yields
European Banking Crisis
0.0
1.0
2.0
3.0
4.0
5.0
6.0
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base
EZ Peripheral Crisis
EU Banking Crisis
Source: Oxford Economics
%
Eurozone: Interbank rates
European Banking Crisis
-6
-5
-4
-3
-2
-1
0
1
2
3
4
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base
EZ Peripheral Crisis
EU Banking Crisis
Source: Oxford Economics
% year
Eurozone: GDP
European Banking Crisis
-5
-4
-3
-2
-1
0
1
2
3
4
5
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base
EZ Peripheral Crisis
EU Banking Crisis
Source: Oxford Economics
% year
US: GDP
European Banking Crisis
-3
-2
-1
0
1
2
3
4
5
6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Base
EZ Peripheral Crisis
EU Banking Crisis
Source: Oxford Economics
% year
World: GDP
Scenarios on the sovereign debt crisis
Baseline
Eurozone muddles through
Peripheral Eurozone Sovereign Debt Crisis
Growth in peripheral EZ hit hard, limited contagion
European Banking Crisis
Europe falls into recession and global growth slows
Government debt & deficits surge
in peripheral Eurozone
Rise in investor concerns about medium- term
creditworthiness
Rise in sovereign spreads
Fiscal consolidation & IMF/EU support
Bank funding costs and lending
rates rise
Local banks cut lending
Markets continue to fear default and sovereign spreads surge
Other banks lose confidence in peripheral EZ
banks
European banks face large losses
Banks sell assets and euro plummets
Credit conditions tighten across
Europe
Interbank rates rise
Scenarios on the sovereign debt crisis
Baseline
Eurozone muddles through
Peripheral Eurozone Sovereign Debt Crisis
Growth in peripheral EZ hit hard, limited contagion
Global Financial Crisis European Banking Crisis
Europe falls into recession and global growth slows
Government debt & deficits surge
in peripheral Eurozone
Rise in investor concerns about medium- term
creditworthiness
Rise in sovereign spreads
Fiscal consolidation & IMF/EU support
Bank funding costs and lending
rates rise
Local banks cut lending
Markets continue to fear default and sovereign spreads surge
Other banks lose confidence in peripheral EZ
banks
European banks face large losses
Banks sell assets and euro plummets
Credit conditions tighten across
Europe
Interbank rates rise
Dramatic rise in financial market
stress
Global credit conditions
tighten
Asset prices fall further
Households and businesses
retrench sharply
Global Financial Crisis
0
1
2
3
4
5
6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
BaseEZ Peripheral CrisisEU Banking CrisisGlobal financial crisis
Source: Oxford Economics
%
Eurozone: Government bond yields
0
1
2
3
4
5
6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
BaseEZ Peripheral CrisisEU Banking CrisisGlobal financial crisis
Source: Oxford Economics
%
US: Government bond yields
Global Financial Crisis
-6
-5
-4
-3
-2
-1
0
1
2
3
4
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
BaseEZ Peripheral CrisisEU Banking CrisisGlobal financial crisis
Source: Oxford Economics
% year
Eurozone: GDP
Global Financial Crisis
-6
-4
-2
0
2
4
6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
BaseEZ Peripheral CrisisEU Banking CrisisGlobal financial crisis
Source: Oxford Economics
% year
US: GDP
Global Financial Crisis
-3
-2
-1
0
1
2
3
4
5
6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
BaseEZ Peripheral CrisisEU Banking CrisisGlobal financial crisis
Source: Oxford Economics
% year
World: GDP
Scenarios on the sovereign debt crisis
Baseline
Eurozone muddles through
Peripheral Eurozone Sovereign Debt Crisis
Growth in peripheral EZ hit hard, limited contagion
Global Financial Crisis
All major economies slide into a deep recession
European Banking Crisis
Europe falls into recession and global growth slows
Government debt & deficits surge
in peripheral Eurozone
Rise in investor concerns about medium- term
creditworthiness
Rise in sovereign spreads
Fiscal consolidation & IMF/EU support
Bank funding costs and lending
rates rise
Local banks cut lending
Markets continue to fear default and sovereign spreads surge
Other banks lose confidence in peripheral EZ
banks
European banks face large losses
Banks sell assets and euro plummets
Credit conditions tighten across
Europe
Interbank rates rise
Dramatic rise in financial market
stress
Global credit conditions
tighten
Asset prices fall further
Households and businesses
retrench sharply
Eurozone debt crisis scenarios
2009 2010 2011 2012 2013
Oxford ForecastUS -2.6 2.7 2.6 3.5 3.8Eurozone -4.0 1.5 1.4 1.8 2.0China 9.1 9.7 9.0 9.2 8.8World -0.7 4.4 4.3 5.0 5.0
Peripheral Eurozone Sovereign Debt CrisisUS -2.6 2.7 2.5 3.6 3.9Eurozone -4.0 1.5 1.0 1.7 2.1China 9.1 9.7 8.9 9.2 9.0World -0.7 4.4 4.2 5.0 5.0
European Banking CrisisUS -2.6 2.6 1.7 2.9 3.9Eurozone -4.0 1.4 0.0 1.2 1.6China 9.1 9.7 7.9 8.6 9.4World -0.7 4.4 3.4 4.4 5.0
Global Financial CrisisUS -2.6 2.5 -0.9 0.0 3.4Eurozone -4.0 1.3 -1.2 -0.4 0.9China 9.1 9.6 5.4 5.8 9.5World -0.7 4.2 1.8 2.4 4.4
Alternative GDP growth forecasts
Policy response to Eurozone debt crisis
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
4.5
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
BaseEZ Peripheral CrisisEU Banking CrisisGlobal financial crisis
Source: Oxford Economics
%
Eurozone: Refi rate
US rates in Eurozone debt crisis scenarios
0
1
2
3
4
5
6
2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
BaseEZ Peripheral CrisisEU Banking CrisisGlobal financial crisis
Source: Oxford Economics
%
US: Fed Funds rate
Co
rpo
rate
rec
ove
ry
Renewed crisis (10%)■ Threat of double-dip means renewed
slump in asset prices as Eurozone sovereign debt crisis re-emerges
■ Pressure to cut budget deficits rapidly in all major economies
■ Rising unemployment and business failures feed back into banking
■ Limited scope for monetary policy offset
Sub-par recovery (25%)■ Business optimism remains low and
corporates continue to hoard cash■ Investment and job growth is modest as
capacity is underutilised■ Monetary policy supports banking sector
but fiscal coffers are empty■ Easier credit conditions mean benefits of
loose monetary policy feeds through to a stronger housing and consumer recovery
Financial sector recovery
Outlook still highly uncertain
Renewed global boom (20%)■ Strong corporate liquidity feeds into new
investment boom■ Faster growth boosts business and
consumer confidence, and trade multiplier magnifies upturn
■ Bank balance sheets improve quickly and credit growth resumes
■ Strong growth boosts tax revenues/cuts social security payments, helping fiscal consolidation
Oxford forecast (45%)■ Gradual rise in business confidence
encourages corporates to invest ■ But weak banks combined with excess
capacity limit scale of investment recovery
■ Consumer spending recovery limited by pace of job growth and fiscal retrenchment
■ But recovery strong enough that fiscal crisis remains contained
New Basel III rules
The new Basel III rules provide for tighter definitions of tier one capital, increased liquidity requirements for banks and ceilings on bank leverage.
■ Banks may only make up 15% of their tier one capital from ‘lower quality’ items such as deferred tax assets, stakes in related institutions and mortgage servicing rights
■ Liquidity – the rules propose the introduction of a ‘net stable funding ratio’ to reduce banks’ reliance on short-term funding and minimum liquidity levels specified based on a stress test involving a freezing of financial markets for a given period
■ Leverage – the minimum tier one capital/total assets ratio set at 3% (e.g. maximum leverage 33 times). Off balance sheet items and securitisations must also be included but banks can net out derivative positions
New Basel III rules
The Basel Committee also proposes to increase bank minimum capital requirements
■ Capital requirements for trading assets will roughly double by alteration of risk weightings.
■ Minimum requirement for common equity will rise from 2% of risk-weighted assets (RWA) to 4.5% by 2015. Minimum Tier 1 capital (which includes other qualifying instruments) to rise from 4% to 6%.
■ On top of this a ‘capital conservation buffer’ of a further 2.5% of RWA to be implemented by 2019 taking total common equity minimum to 7% and Tier 1 minimum to 8.5%
■ A countercyclical capital buffer of 0-2.5% made up of common equity also to be implemented for use as a macroprudential tool – this buffer to come into effect in periods of excess credit growth.
Modelling the impact of bank regulation
Credit conditions
Interbank spreadsOfficial policy rates &
Government bond yields
Lending spreadsAvailability of
credit/other lending criteria
Lending rates
Household Corporate
Consumer spending
Housing investment/
prices
Business investment
GDP
Household wealth/ equities
Government finances
Bank regulation
Capital requirement
s
Liquidity requirement
s
Bank levies
The costs of tighter bank regulation
The potential costs and benefits of new regulations for the global banking sector have been explored in a number of studies. Of critical importance is the impact of bank regulation on lending rates and estimate vary:
■ BIS: 1% rise in capital ratio raises loan spreads 13bp, new liquidity standards by 25bps.
■ The IIF claimed the Basel III rules outlined last December increase bank loan costs by 130 bp in the US.
■ University of Harvard & Chicago studies – even a 10% rise in capital ratios would only raise weighted cost of capital for banks by 25-35 basis points.
■ McKinsey estimates quite small rise in loan costs to the economy from the Basel III changes - mostly around10-20 basis points, up to 50-60 for short-term loans, covered bonds, illiquid securities.
There are also benefits from reducing the risk of banking crises
Interest rate impact
-0.8
-0.6
-0.4
-0.2
0.0
0.2
0.4
0.6
0.8
1.0
US EZ UK
Lending spreadsPolicy rates
Impact on interest rates of tighter regulation%
Source : Oxford Economics
GDP impact
-1.4 -1.2 -1 -0.8 -0.6 -0.4 -0.2 0
UK
EZ
US
With monetary policyresponse
Without monetary policyresponse
World: Effect of bank regulations% difference in GDP from base
Source : Oxford Economics
Concluding remarks on bank regulation
There is a wide variation in costs of regulation found by different studies reflecting significant differences in underlying assumptions and model design.
Some studies may over-estimate the impact. It is more expensive to fund assets with equity than debt or deposits, so initially this implies higher bank funding costs and loan rates. But –
■ Equity only accounts for around a fifth of the cost of a loan.
■ Lower bank riskiness from higher equity levels ought to reduce the cost of both debt and equity
■ Competitive pressures from the non-bank sector might limit the pass-through from bank funding costs to loan rates
■ The length of the transition matters – a rapid phase-in of new standards could see balance sheet shrinkage by banks, longer one allows banks to accumulate earnings and issue equity. Brookings Institute estimates US banks could raise most of the extra capital needed by retaining two years’ earnings
■ Banks might settle for a lower ROE than previously, reducing the need to pass on higher funding costs
■ Banks could cut administrative and other costs to increase profits
China: Growth slows but risks of a bust after the boom?
We expect China to grow strongly as consumption picks up the slack from weaker investment and the impact yuan appreciation, while authorities successfully manage price pressures
However, significant risks remain that could lead to a sharp downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ A rise in non-performing loans following the credit boom
■ Contingent liabilities from lending to local government investment vehicles
China: Growth slows but risks of a bust after the boom?
We expect China to grow strongly as consumption picks up the slack from weaker investment and the impact yuan appreciation, while authorities successfully manage price pressures
However, significant risks remain that could lead to a sharp downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ A rise in non-performing loans following the credit boom
■ Contingent liabilities from lending to local government investment vehicles
Government is reining in credit…
-4
-2
0
2
4
6
8
10
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
5
10
15
20
25
30
35
40
45
China: Inflation and money supply% year
Source : CEIC
M2: +6 months(RHS)Inflation
(LHS)
% year
M1: +6 months(RHS)
…leading to slowing investment growth
0
10
20
30
40
50
60
1998 2000 2002 2004 2006 2008 2010
% year
Source: Oxford Economics
China: Total RMB loans and investment
RMB loans
Investment in fixed assets
China: Growth slows but risks of a bust after the boom?
We expect China to grow strongly as consumption picks up the slack from weaker investment and the impact yuan appreciation, while authorities successfully manage price pressures
However, significant risks remain that could lead to a sharp downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ A rise in non-performing loans following the credit boom
■ Contingent liabilities from lending to local government investment vehicles
And slowing price inflation but is it heating up again?
-10
-5
0
5
10
15
20
25
Jul-05 Jul-06 Jul-07 Jul-08 Jul-09 Jul-10
China: House price inflation%
Source : CEIC
Annual rate
Monthly rate (annualised)
China: Growth slows but risks of a bust after the boom?
We expect China to grow strongly as consumption picks up the slack from weaker investment and the impact yuan appreciation, while authorities successfully manage price pressures
However, significant risks remain that could lead to a sharp downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ Accumulation of non-performing loans following the credit boom
■ Contingent liabilities from lending to local government investment vehicles
Official NPLs are low but vulnerabilities may lurk beneath
0
2
4
6
8
10
12
14
2005 2006 2007 2008 2009 2010
0
400
800
1200
1600
2000
China: Non performing loans
Source: CEIC
RMB bn%
% of loans (LHS )
Value(RHS )
China: Growth slows but risks of a bust after the boom?
We expect China to grow strongly as consumption picks up the slack from weaker investment and the impact yuan appreciation, while authorities successfully manage price pressures
However, significant risks remain that could lead to a sharp downturn:
■ Excessive monetary tightening
■ Housing market bubble
■ A rise in non-performing loans following the credit boom
■ Contingent liabilities from lending to local government investment vehicles
China: A loan crisis triggered by housing collapse
Authorities bring forward monetary tightening and introduce further measures to slow over-heating in the housing market
This bursts the bubble in the property market which leads to a rise in non-performing loans in the banking sector
Central government lowers current spending on health and education and scales back investment
Investment and consumption growth is weaker
Imports decline sharply
Emerging market premia rise and stockmarkets in Asia are particularly affected, and global growth hit
China: A loan crisis triggered by housing collapse
Authorities bring forward monetary tightening and introduce further measures to slow over-heating in the housing market
This bursts the bubble in the property market which leads to a rise in non-performing loans in the banking sector
Central government lowers current spending on health and education and scales back investment
Investment and consumption growth is weaker
Imports decline sharply
Emerging market premia rise and stockmarkets in Asia are particularly affected, and global growth hit
Sharp fall in house prices in 2010 Q4 and 2011 Q1
-20
-15
-10
-5
0
5
10
15
2007 2008 2009 2010 2011 2012 2013 2014
China: House prices% year
Source : Oxford Economics
China loan crisis
Base
China: A loan crisis triggered by housing collapse
Authorities bring forward monetary tightening and introduce further measures to slow over-heating in the housing market
This bursts the bubble in the property market which leads to a rise in non-performing loans in the banking sector
Central government lowers current spending on health and education and scales back investment
Investment and consumption growth is weaker
Imports decline sharply
Emerging market premia rise and stockmarkets in Asia are particularly affected, and global growth hit
China: A loan crisis triggered by housing collapse
Authorities bring forward monetary tightening and introduce further measures to slow over-heating in the housing market
This bursts the bubble in the property market which leads to a rise in non-performing loans in the banking sector
Central government lowers current spending on health and education and scales back investment
Investment and consumption growth is weaker
Imports decline sharply
Emerging market premia rise and stockmarkets in Asia are particularly affected, and global growth hit
Contributes to credit crunch & weaker investment
-5
0
5
10
15
20
25
2007 2008 2009 2010 2011 2012 2013 2014
China: Investment growth% year
Source : Oxford Economics
China loan crisis
Base
And subdued consumption growth
0
2
4
6
8
10
12
14
16
2007 2008 2009 2010 2011 2012 2013 2014
China: Consumption growth% year
Source : Oxford Economics
China loan crisis
Base
China: A loan crisis triggered by housing collapse
Authorities bring forward monetary tightening and introduce further measures to slow over-heating in the housing market
This bursts the bubble in the property market which leads to a rise in non-performing loans in the banking sector
Central government lowers current spending on health and education and scales back investment
Investment and consumption growth is weaker
Imports decline sharply
Emerging market premia rise and stockmarkets in Asia are particularly affected, and global growth hit
Weaker domestic demand lowers import growth
-7
-6
-5
-4
-3
-2
-1
0
1
2007 2008 2009 2010 2011 2012 2013 2014
China: Import Volumes% difference from base
Source : Oxford Economics
China loan crisis
China: A loan crisis triggered by housing collapse
Authorities bring forward monetary tightening and introduce further measures to slow over-heating in the housing market
This bursts the bubble in the property market which leads to a rise in non-performing loans in the banking sector
Central government lowers current spending on health and education and scales back investment
Investment and consumption growth is weaker
Imports decline sharply
Emerging market premia rise and stockmarkets in Asia are particularly affected, and global growth hit
…pulling down growth in Asia…
0
2
4
6
8
10
12
2007 2008 2009 2010 2011 2012 2013 2014
Asia: GDP growth% oya
Source : Oxford Economics
China Loan crisis
Base
…and in the US
-5
-4
-3
-2
-1
0
1
2
3
4
5
2007 2008 2009 2010 2011 2012 2013 2014
US: GDP growth% oya
Source : Oxford Economics
China Loan Crisis
Base