Bullish sentiment out of the North Atlantic has ebbed over the past six weeks.

• The impact of the ECB’s sizeable liquidity injections is fading on concerns about Spain’s finances and recession — unemployment reached 24% in March (Chart 10).
• The eurozone recession looks to be deeper than first thought, with credit remaining tight as banks deleverage (Charts 3 & 9).
• Moderate US employment and GDP data are a reminder that the US recovery will proceed gradually. Political discord is also re-emerging as a threat. The economy will approach a ‘fiscal cliff’ — Chairman Bernanke’s term — in 2013 if implementation of a range of tax increases and spending cuts is not slowed (Chart 11). Adding to the policy uncertainty, the government may hit another debt ceiling in late 2012, around the time of the November presidential elections.

Signs suggest that the slowing in Chinese GDP may be close to bottoming, as policy becomes more supportive (Chart 12). If realised this should buoy commodity prices (Chart 6).

Disappointing though the recent data may be, the IMF upgraded its growth forecasts a touch in April from January (Chart 2). World growth is forecast to be 3½% in 2012 (2.7% at market exchange rates), and 4% in 2013. But these forecasts are still lower than the historical average and the outlook remains ‘fragile’.

In other news, the Egyptian economy remains highly unstable owing to a foreign reserve drain and fragile politics (Chart 13). Vietnam’s economy is rebalancing, reducing the threat of a crisis, but this good news has come at the expense of growth (Chart 14). Finally, the nationalisation of energy company YPF in Argentina risks placing further pressure on the peso (Chart 15).

The views expressed in this Economic chartpack document are EFIC's. They do not represent the views of the Australian Government. The information in this document is current at 1 May 2012.

• Growth in the volume of world trade has accelerated in recent months. 
• It rose by 3.1% over the year to February, up from 2% over the year to December 2011.  
• Asian exports and imports have also expanded, indicating that the slowdown in the trade-dependent Asian economies may have ended.
• Despite apparent strength in Asian imports, Australian export values have fallen by 11% since the start of the year.
• The weakness has been concentrated in iron ore and coal exports, and probably reflects temporary volatility due to the lunar new year rather than significant weakening in Asia’s demand for commodities (Chart 6).
• The IMF expects world trade volumes to grow by 4% in 2012 and 5½% in 2013 – well below the 2003-2007 average of 7-8%.

• In April, the IMF forecast that world growth would ease to 3½% in 2012 from 4% in 2011. This is slightly higher than its January forecast, but weaker than its forecasts in September 2011 before the eurozone crisis intensified (see dashed lines).  
• World GDP growth is expected to accelerate through the forecast period, but remain below pre-GFC rates in both the emerging and developed economies. In 2013, world growth is expected to be 4%.
• In 2012 and 2013, Australia’s major trading partner growth is forecast to be 1%pt stronger than world growth due to Australia’s close trade ties with emerging Asia and Japan (where growth is rebounding following the 2011 disaster).
• The three main downside risks are the eurozone, oil prices, and an approaching ‘fiscal cliff’ in the US (Chart 11). 
• The IMF also fears that growth in the emerging markets could turn out lower than forecast due to unwinding credit booms and weaker exports — they have over-predicted growth in these markets since the GFC.

• The JP Morgan/Markit global purchasing managers’ index (PMI) suggests that world GDP growth strengthened in the March quarter.
• The global PMI is consistent with world GDP growth of 3% pa (market exchange rates) — above recent growth rates and forecasts.     
• But more recent, April ‘flash’ estimates for the eurozone are weak, suggesting that output is slumping, order books shrinking, and unemployment rising (Chart LHS). 
• Germany has not been immune:  according to the PMI, manufacturing output fell at its fastest rate since the GFC in April.  Other indicators, albeit lagging ones, are more positive with unemployment reaching its lowest level since 1991 in March.
• The ‘flash’ PMI suggests continued manufacturing weakness in China.  But this reading should be treated cautiously.  The official PMI, which is more correlated with GDP, suggests output has strengthened, consistent with PMIs from other Asia.

• The NAB business survey suggests Australian business confidence is below its long-run average. 
• According to NAB, the gyrations in the world economic outlook and high A$ are the main factors weighing on confidence. 
• Actual business conditions are stronger than sentiment, and appear to have stabilised around long-run averages — consistent with an economy growing near trend (~3½%),
• But there are large divergences in conditions across industries — and capex plans outside of the mining sector are weak despite improving access to finance. 
• According to the Australian Industry Group’s PMI activity in the manufacturing and service industries is soft, and has been since the GFC.

• Spreads on US$ emerging market bonds have risen slightly over the past month.  
• Markets are most concerned with Ukraine, Pakistan and Egypt.  
• In other markets absolute US$ borrowing rates are relatively low compared to historical averages.
• In ratings news:
• The OECD has upgraded Indonesia to a 3 from a 4 — in line with Fitch and Moody’s investment grade ratings.  However, S&P kept its rating at BB+/positive over concerns that the reform drive is faltering.
• S&P has downgraded Spain to a BBB+ from A and kept it on watch for further downgrades (Chart 10).
• S&P has put India's investment grade rating under negative watch due to large ‘twin’ deficits (fiscal and external) and political gridlock.

• Concern over a pronounced slowing in China weighed on some industrial commodities in April.  
• Coal prices have also fallen sharply, although this partly reflects a return to normal rates of production in Queensland, with prices back to levels before the 2011 floods.
• The Bureau of Resources & Energy Economics (BREE) predicts that Australian commodity prices have peaked and will decline over coming years.
• But this does not mean an end to the resource boom. BREE estimates that rising volumes will more than offset the fall in prices, so export values will continue to rise.  
• For the boom to end, the slowdown in China would have to be sharper than currently foreseen (Chart 10). Current and forecast prices are well above operating costs for most existing coal and iron ore mines and gas fields, and appear to be above operating and capital costs for most major new projects.

• Business credit growth has picked up, but remains lacklustre, with the stock of credit increasing by 3.4% pa over the three months to March. 
• The low rate of credit growth reflects weak non-mining investment — the level of non-mining investment was unchanged over 2011 relative to 2010.  Mining investment is being financed mainly outside the banks. 
• Surveys of business intentions suggest that non-mining investment will remain sluggish for some time yet.  
• Interest rates have become more supportive to investment with the RBA cutting the cash rate 50bp to 3.75% in May. Inflation was close to 2% pa in the March quarter — near the bottom of the target band.
• Financial markets are predicting a cash rate of 3¼% by year-end.   Interestingly, 3¼% is close to the 3% cash rate the RBA classified as the ‘emergency rate’ during the GFC.

• The A$ is off recent peaks, but continues to trade at high levels.
• In nominal trade-weighted terms it is 28% above its post-float average.  
• Falls in Australia’s terms of trade and interest rate expectations would suggest a weaker A$ than is currently the case.  But large purchases of Australian financial assets by Asian central banks are reportedly neutralising depreciation pressures. 
• Central banks (and other public investment vehicles) have increased their allocation of FX reserves to Australia to benefit from Australia’s AAA credit rating and relatively high domestic interest rates compared to other OECD economies. 
• Foreign holdings account for 80% of commonwealth government securities on issue and one-third of state government debt.
• These inflows (together with lower inflation) have driven yields on 5-year government bonds to 3.1%, the lowest level in 60 years.

• The ECB’s long-term refinancing operations (LTROs) in December and February have eased bank funding strains and lowered sovereign bond yields by encouraging carry trades.   
• But their impact appears to be wearing out on rising concerns about Spain’s public finances (Chart 10).
• Eurozone banks are also struggling to expand credit, in contrast to US banks.  This is leading to market gaps in trade and project finance (where EU banks play a large role globally).  
• The ECB’s April lending survey found that credit standards tightened further in the March quarter.
• According to UBS, only 4% of the liquidity provided by the LTROs flowed into new lending. 
• The IMF estimates that EU banks may need to shrink their balance sheets by US$2.6 trillion by end-2013, equivalent to 7% of assets — a quarter through lower lending. 

• The Spanish government is embarked on the thankless task of balancing its budget in a slumping economy. As a first step, it wants to cut the deficit from 8½% of GDP in 2011 to 5.3% in 2012. 
• There are two problems with that. First, the fiscal tightening will deepen the slump. Second, the slump will hinder the fiscal tightening.
• There could be another two knock-on effects. If the economy falls into a downward spiral, resistance to austerity will mount. And far from assuring the 'bond market vigilantes', such a spiral might panic them.
• A deep and long recession also risks weakening bank loan books, increasing the government’s potential liability and restricting credit availability.  Private, not public, debt was the cause of the Spanish crisis; at 300% the private debt/GDP ratio is near the highest in the world. 
• Non-performing loans have risen to 8% of total loans, due to a 20-30% fall in house prices and 24% unemployment.

• Employment growth slowed to 120,000 in March, raising questions about the durability of the recovery. 
• Dragging jobs growth down was feeble GDP growth in the March quarter of 2.1% y/y.  One drag is fiscal austerity which has cut ¾%pt from growth in the past two quarters. 
• Fiscal policy risks become a much larger drag in 2013. Under current law, Bush era tax cuts, temporary payroll tax cuts, and additional jobless benefits are all set to expire at end-2012. Spending cuts of $1,200b over 10 years, due to the failed debt ceiling deliberations, will also kick in.
• If political discord between the major parties does not head off these developments, the economy will approach a ‘fiscal cliff’ — Chairman’s Bernanke’s term — in which fiscal tightening could cut growth by 2½%pts and push the US back into recession.  
• Adding to policy uncertainty, the government may hit another debt ceiling late in 2012, around the time of the presidential elections.

• Chinese GDP growth slowed to 8.1% over the year to the March quarter — the slowest since the GFC.
• The slowdown reflects weak export growth, withdrawal of fiscal policy stimulus, and new measures to cool the overheated property market. 
• Indicators suggest the slowdown may be bottoming. 
• Monthly IP, retail sales and steel production data suggest output accelerated through the March quarter.  New loans also rose indicating recent policy easing may be flowing through to credit. 
• The government has become focused on boosting growth — in April Premier Wen noted that ‘fine-tuning of policies should be rolled out quickly’.
• Downside risks include property, the eurozone, the US, and inflation. High inflation reduces the ability to loosen monetary policy to offset economic weakness.

• Three issues are clouding the Egyptian outlook. 
• First, the external position continues to deteriorate. At end-March liquid FX reserves were just US$11b, 2 months’ imports. 
• Second, IMF financing has been delayed.  The leading political party, the Muslim Brotherhood, is unwilling to support an IMF loan while the army remains in charge. 
• Three, tensions between the Muslim Brotherhood and army are rising.  The two sides are at odds over who will be the next president.  In addition, liberal, secularist and minority religious parties have withdrawn from the constitutional reform process, over concerns about Islamist domination.  
• A balance of payments crisis looks possible: the 12-month non-deliverable forward market predicts a 20% drop in the pound.  

• Vietnam’s economy is showing signs of stability, after sizeable ‘twin deficits’, falling FX reserves, and double digit inflation threatened to derail its economy.  
• Inflation dropped to 10% pa in April 2012, FX reserves rose to US$18b in March (from a low of US$13b in mid-2011), and the current account has become broadly balanced thanks to slowing import growth.    
• Underpinning this stabilisation has been tighter fiscal and monetary policy. 
• But it is doubtful the economy can safely return to the 7-8% pa growth seen in 2000s anytime soon.    
• Stability has come at the cost of slowing GDP growth — down to 4% y/y in March quarter 2012.
• FX reserves are still only equivalent to 2 months’ imports, leaving the country vulnerable to shocks.  
• Banks are stressed, due to reduced liquidity, sharp falls in asset prices, and large exposures to loss-making SOEs.   

• The government has seized a 51% stake in energy company YPF — Argentina’s largest private company.  The stake will be taken from the 57% share that Spanish energy company Repsol owns.  
• The government argues that YPF has underinvested in oil and gas production, leaving the country with a rising energy trade deficit (Chart LHS).  
• The nationalisation will damp business confidence and put further pressure on the peso and the fragile balance of payments.  
• Since the nationalisation, the gap between the official US$/ARS rate and various unofficial rates has widened.  The black market rate is 14% lower; the ‘blue chip swap rate’ (implied from assets that can be sold overseas) is 30% lower.