Swedbank's Global Economic Outlook, 2011 March

Global Economic Outlook
by Cecilia Hermansson 29 March 2011
The global recovery has gained a footing –

but the risk of a backlash remains
The global recovery economy strengthened last year. We have revised our GDP
forecast upward by a total of 0.3 percentage points to 4% per year in 2011 and
2012. This still represents a slowdown compared with last year’s strong 4.7%.
Tighter economic policies, higher commodity prices and rising inflation at the
consumer price level will lead to slower activity during the period. Emerging
markets will remain growth engines.
Our risk outlook can be compared with the last lap of a 3000 m hurdle race. The
hurdles that have to be jumped include Japan's disaster, political turbulence in
the Middle East, rising commodity prices and their impact on inflation and interest
rates, the debt crisis in advanced economies (water jump) and, lastly, the need
for changes in the world order to avoid imbalances and new financial crises.
We give our main, positive scenario – which assumes that the recovery will
continue and policymakers manage the debt crisis in Europe and the increasingly
difficult policy mix to simultaneously tighten financial and monetary policy
reasonably well – a combined likelihood of 50%. Two stronger scenarios (one
sustainable and one less so) have a likelihood of 20%, and two weaker
scenarios, with stagflation and a worsening debt crisis, have a likelihood of 30%.
The challenges to economic policy are growing. We urge that budget
consolidation in Europe continue and begin as soon as possible in the US, and
that monetary policy is allowed to remain expansive a little longer while tighter
fiscal policies slow growth. Quantitative easing, on the other hand, should be
phased out to speed up debt consolidation and increase the focus on much-
needed structural reforms. It is also important to break the vicious cycle between
public debt crisis and banking crisis, which – in addition to budget consolidation –
requires more ambitious stress tests and capitalisation of banks in Europe.
Cecilia Hermansson
Contents:
1. Favourable conditions in the global economy 2
2. In our main scenario the recovery continues 4
3. Many hurdles must be jumped 6
4. Our assumptions about commodity and financial markets 11
5. The optimal economic policy 17
6. Regions/countries: Most are downshifting 19
7. Conclusions for our home markets 35
Economic sekretariatet, Swedbank AB (publ), 105 34 Stockholm, tfn 08-5859 7740

E-post: ek.sekr@swedbank.se Internet: www.swedbank.se Ansvarig ugivare: Cecilia Hermansson, 08-5859 7720
Magnus Alvesson, 08-5859 1031,Jörgen Kennemar, 08-5859 7730, ISSN 1103-4897
1. Favourable conditions in the global
economy
In 2010 the global economy grew more strongly than we had Last year the global
forecast. The difference can be explained by higher activity in economy grew faster
emerging countries, particularly the BRIC countries, which than expected
accounted for two thirds of global GDP growth.1 The positive
trend was also due to a surprisingly strong recovery in developed
countries such as Japan, Germany and Sweden. On the other
hand, GDP growth in the US and other euro zone members
largely met our expectations at the beginning of last year.
Contribution to global GDP growth by various countries/regions, 2010

2,00
1,80
1,60
1,40
1,20
1,00
2010 PPP
0,80
2010 US dollars
0,60
0,40
0,20
0,00
US Euro UK Japan China India Brazil Russia
zone
Seen through the rear view mirror, global economic development

was generally positive, and current conditions are characterised
by cautious optimism driven by strong global trade, relatively high
profits and increased access to credit in the corporate sector,
which as a whole should lead to investments and new jobs.
Conditions in many crisis-ridden economies are still weaker than But the situation in
normal with respect to the housing, labour and credit markets. crisis-ridden
Despite improvements, there are remaining problems of a more economies is weaker
long-term, structural nature, which take time to resolve. than normal
The economic stimulus is still a having positive impact on the
economy. In emerging countries, stimulus programs have gone
too far, raising the possibility of an overheating. Here, policy has
to be tightened more than has been the case so far in order to
slow growth to more sustainable levels going forward. In
developed countries, monetary policies have remained expansive
while financial policies are being tightened, which will eventually
impact growth prospects more negatively.
The major differences in how developed countries and emerging
economies have handled the crisis are clearly evident in the
diagram below, which compares industrial production in various
countries/regions. The US and Europe are now back to
producing slightly more than their 2000 levels, while Japan is on
1
The BRIC countries refer to Brazil, Russia, India and China. Refers to GDP growth
weighted with purchasing power parity (PPP). In dollar terms, the BRIC countries
accounted for nearly half of global growth.
2 Swedbank’s Global Economic Outlook • 29 March 2010

its way to the same level. On the other hand, less is produced
today than levels before the financial crisis. After a brief dip,
production in emerging countries has continued to grow strongly,
more than doubling the level of 2000, at the same time that the
production increase compared with before the crisis is more than
20%.
Industrial production in various countries/regions, Index 100 = 2000

350
Total
300 US
Japan
250
Euro zone
Emerging markets
200
Asia
150
100
50
2000m01 2002m01 2004m01 2006m01 2008m01 2010m01
There has been a lot of talk of a “two-speed world economy”. It is Two-speed

quite natural that emerging economies grow faster than world economy
developed countries, since they are beginning from a lower level
often with higher growth in productivity and the labour supply.
What is different from previous periods is that the rate of growth
in emerging countries has risen, while it has fallen in developed
countries.
The latter have a number of Achilles heels, which are slowing

development, including problems in the financial sector, which
are curtailing lending and investments; higher public debt, which
requires tighter fiscal policies; and higher private debt, which
must be cleaned up and is keeping consumption in check. That’s
in addition to the structural problems in many labour and housing
markets.
In summary, global economic conditions are better than

expected. Growth is being driven mainly by countries in Asia,
Latin America, the Middle East and Africa, while many developed
countries are struggling with structural problems. The economic
stimulus could cause overheating in emerging countries and
must be phased out, at the same time that developed countries
are entering a period of austerity. This will make it difficult to
exceed the 2010 global growth rate.
Swedbank’s Global Economic Outlook • 29 March 2010 3

2. In our main scenario the recovery
continues
Our previous view that the global economy is “muddling through”
still remains a likely main scenario. The recovery won’t stall, but
growth is slowing after last year’s rebound. Global GDP growth
will fall from 4.7% last year to 4% this year and next.
Global GDP forecast

Spring Forecast January Forecast
GDP growth (%) 2010 2011 2012 2010 2011 2011
US 2,9 3,0 3,0 2,8 2,6 2,7
Euro zone: 1,7 1,5 1,5 1,8 1,6 1,5

of which: Germany 3,6 2,4 1,9 3,6 2,5 2,0
France 1,5 1.5 1,6 1,6 1,6 1,5
Italy 1,1 0.9 1,0 1,1 1,0 1,1
Spain -0,1 0.3 1,0 -0,4 0,3 1,0
UK 1,4 1,5 2,0 1,7 1,8 2,0
Japan 4,0 0,6 3,0 3,2 1,5 1,3

China 10,3 8,8 8,4 10,1 8,5 8,1
India 9,1 8,0 7,5 8,8 8,2 7,5
Brazil 7,5 4,3 4,0 7,5 4,8 4,5

Russia 4,0 4,6 4,5 4,0 4,3 4,5
Global GDP in PPP 4,7 4,0 4,0 4,6 3,9 3,8

Global GDP in US dollars 3,8 3,1 3,3 3,7 3,1 3,0
Source: National statistics and Swedbank’s forecasts. Note: These countries

represent 75% of the global economy. To arrive at total GDP growth, approx.
0.3 percentage points should be added. The World Bank’s weights from 2009
have been used.
This represents a slight upward revision from our January We have revised our
forecast. In the US, the recovery has gained a firmer footing at January forecast
the same time that the country has been reluctant to face up to upward by a total of
its need for tighter fiscal policy and appears to be more focused 0.3 percentage points
on next year's presidential election. The euro zone and the UK for 2011 and 2012
are being adversely affected by higher inflation and their
upcoming decision to tighten monetary policy earlier.
Japan’s GDP growth will decline this year due to the catastrophe,
but will increase next year when reconstruction begins. Russia is
benefitting from the rise in oil prices, but at the same time is
struggling with higher domestic inflation. China, India and Brazil
continue to grow strongly, but have slowed compared with last
year now that their policies are no longer stimulating the
economy to the same extent. On page 19 we go into more detail
on developments in individual countries.
The main factor that is driving global growth is continued strong

global trade, not least due to high demand in Asia. Despite fears
of increased protectionism, trade has not declined and the key
supply chains in our globalised world remain intact. Corporate
profits have risen at the same time credit has become easier to
come by and interest in new investments to expand existing

capacity is growing. New hirings are on the rise, which means
that labour markets in developed countries are gradually, though
still slowly, improving. With more people employed and wage
growth slightly higher, private consumption is rising from low
levels.
In our main scenario, we assume that the economy and There are several
politicians will be able to handle the challenges of the Japanese reasons why the global
disaster, the wave of democratisation in the Middle East and the economy is slowing
debt crisis reasonably well. The question in this case is why the compared with 2010
global economy won’t manage to maintain last year's GDP
growth?
First, the inventory build-up, which had contributed strongly to

growth, will have a less positive, neutral or maybe even negative
effect.
Secondly, the impact of previous economic stimulus programs in

the form of interest rate cuts, quantitative easing and the boost to
demand from lower taxes and higher public spending is fading.
What had been positive contributors will instead become
negative contributors when fiscal policies are tightened in many
developed countries, especially in Europe.
Thirdly, commodity prices have increased more than previously

expected, which will raise inflation at least temporarily in our main
scenario (but if commodity prices continue to rise, inflation will
stick around longer). This means that higher energy and food
prices – as well as higher mortgage rates as central banks raise
interest rates earlier than expected – will leave households with
less in than their wallets for other consumption.
Fourthly, the growing public debt in many developed countries is

creating uncertainty. In the euro zone, it is looking very much like
Portugal may soon need a rescue package, while Spain faces
continued uncertainty whether it will be able to obtain financing
through ordinary financial markets. In the US, the inability to
address medium-term budget problems is creating uncertainty.
Solid corporate earnings have benefitted stock markets around

the world, in turn helping the recovery in the financial sector and
reducing the risk of bankruptcies among banks. Uncertainty
whether Greece and Ireland will have to renegotiate their debts
despite rescue packages is also putting stress on European
banks, where stress tests so far haven’t been ambitious enough.
In summary, the recovery is continuing, but growth will slow to

4% this year and next. Despite various challenges in terms of
natural disasters, the Middle East, commodity markets, public
debt and their impact on economic policy, crisis management,
banks and demand, the global economy continues to muddle
through.

3. Many
M hu
urdles must
m be jumped
j
In th
he uncertain n world we live in, ou ur main sce
enario has to be
comp plemented by alterna ative scenaarios. There are a large
numb ber of risks, some of which
w ave discussed and assumed
we ha
that they can be manag ged reasonably well. Of course e, this
doessn't necessa arily have to
o be the casse.
Forecast risks have

h so farr focused on n conditionss in the fina
ancial It'ss importantt to
sectoor, deflationn, a new recession
r (
(double dip), protectio
onism, disscuss foreccast risks
curreency tension ns and the debt crisis in the public c sector. Seeveral annd alternativve
of the
ese hurdless have been n overcome e, but could pop up again. It sccenarios
took several years
y beforre deflationn became evident in n the
Japaanese economy after the t financia
al crisis in the
t early 1990s.
The current deb bt crisis, wh
hich has led d to tighter economic
e p
policy,
couldd still create
e a new reccession and d deflation in several crisis-
c
ridde
en countriess, though no ot yet the en
ntire global economy.
The risks can be e compared d with a 300

00 m hurdle
es race. Eacch lap
has five hurdle es, the fourrth of whicch is a water jump th hat is
espeecially hard to leap. Wee summarizze the risks below based on
the challenges
c t
that global economic
e players must overcome.
Firstt obstacle: Japan’s ca

atastrophe
e
The earthquake e, tsunami and

a nuclear crisis mainly affect Japan
J Att this point iti is still
and its population. The ecconomy will initially shrink due to t the too early to assess
a the
loss of production and de emand, but will later growg fasterr than full dimension ns of the
norm
mal when re econstructio
on begins and
a is fully implementted. It Ja
apanese dis saster, but
may take manyy years beffore the region recove ers. The co ost to they should be b modest
d up the re
build egion, at le
east USD 3003 billion, will add to
t the for the globall economy
natio
onal debt, but
b at 5% of GDP th his is negliigible given n that
Japaan’s current debt hass reached around 20 00% of GD DP. A
political crisis in the wa ake of the catastrophe remaiins a
posssibility, espe
ecially conssidering tha
at oversight of the nu uclear
powe er disaster has
h been le ess than sattisfactory.
The global eco onomy is affected be ecause Japan is a major

econnomy and trrading partn ner, especia na, and has a big
ally for Chin
impa
act on the global
g supplly chain, inccluding in th he case of autos
and electronics.
e . While the effects are likely to be felt by indivvidual
comp panies, it shouldn't threaten the t global recovery. The
reconnstruction could alsso benefitt certain companie es in
consstruction annd commod dities, for in nstance. Co ommodity prices
p
and interest
i rate
es will initiallly fall as de
emand from m Japan decclines,
6 Swedbank’s Gllobal Economic Outlook • 29 March

M 2010
but then rise when the need for raw materials and capital once
again increases. The strength of the Japanese yen continues to
frustrate, but can't be rectified by interventions.
The nuclear disaster affects the need for other energy sources as Public opinion about
well as public opinion about nuclear power and investments in nuclear power could
new plants. It is also affected the political debate in Germany change entirely
after losses by the CDU and FDP in the regional election in
Baden-Württemberg, owing in large part to the nuclear power
issue. Several countries now want to delay any expansion to
further evaluate safety concerns. In the long-term uncertainty
about nuclear power could lead to higher energy prices and new,
innovative technologies.
Second hurdle: Political turbulence in the Middle East
The wave of democratisation in the Middle East could continue The rise of
for several years, affecting the region’s economy, geopolitical democracies in the
security and global oil supplies. The upheaval that began in Middle East will
Tunisia and Egypt and has spread to Libya, Bahrain, Yemen and eventually create new
Syria will hurt growth prospects short-term, but could create business opportunities
higher growth potential over time, which would also benefit
investors in other parts of the world.
The focus at them moment, however, is whether unrest will

spread to major oil-producing countries, especially Saudi Arabia,
but also Qatar, Kuwait and the United Arab Emirates. The Middle
East accounts for about a third of oil production, but has around
60% of oil reserves. These oil producers have the financial
resources to offer concessions that will alleviate some of the
concerns of their citizens. Energy and food subsidies are already
high in the region, and to buy more time those in power are
raising public sector salaries. This could contribute to even higher
inflation pressures, which will not be kept in control by higher
interest rates, since many currencies are pegged to the dollar. As
a result, there is a risk of greater political instability in the wake of
rising consumer prices.
The effects on the global economy are mainly tied to the price of At this point the focus
oil. The West would like to see democratisation, but is most is on the region's role
concerned about the predictability of oil production. There are as an oil producer
political risks as well, such as NATO's involvement in the civil war
in Libya as well as relations with China and Russia. Furthermore,
Israel’s position in the region is affected by the new power
structure in Egypt. The rivalry between Saudi Arabia and Iran
could also rise to the surface and create tensions in the oil
market. Political instability in the Middle East makes investors in
other emerging countries cognizant of the political risks they face.
“Stable” China in particular could be affected by increased risk
aversion.
Third hurdle: Rising commodity prices and inflation, central

bank actions, including overheating in emerging countries
Even before the democratisation process in the Middle East

began, commodities had risen significantly in price. This was due

to the stronger economy, which has increased demand for raw
materials, as well as supply problems in connection with droughts
and fires, which have reduced food production, the quantitative
easing, which has increased liquidity and investor interest in
commodity markets, and concerns about higher inflation and the
decline in the dollar, which are driving up the prices of metals
such as gold. The weaker dollar is also contributing to higher
commodity prices, since sellers are demanding compensation for
the currency effect. Oil supplies have not yet been affected by
concerns in the Middle East, but prices have risen because of
expectations of future shortages. Psychology is obviously an
important factor as well.
If oil prices rise above current levels and reach USD 120-150 a The more oil prices
barrel, there is a greater risk that other commodities, inflation rise above the current
expectations and inflation at the consumer price level will all rise level, the greater the
as well, in addition to earlier-than-expected increases in policy risk to global growth
interest rates and slower growth. Higher cost pressures on
companies reduce their ability to invest and recruit. Households
will see their wallets shrink, which will hold back consumption.
In the developed world, the policy mix for crisis-ridden countries

that have to clean up their finances has become more
complicated. There were expectations that monetary policy would
remain expansive a little longer, so that the budget consolidation
wouldn’t threaten growth. Policymakers in key central banks in
the US and Europe may feel that they have to avoid the second-
hand effects of higher import prices, however, which could mean
that a period of interest rate hikes is nearing closer.
In emerging markets, higher commodity prices have contributed

to signs overheating for some time. Central banks have been
slow to tighten monetary conditions, however. Large capital flows
in the wake of the quantitative easing have strengthened
currencies, which has worried policymakers, since it could mean
weaker export prospects. There is now a greater risk of a hard
landing for countries that won’t or can’t slow inflation.
Higher commodity prices, inflation and benchmark interest rates

are certainly among the biggest negative forecast risks for the
global economy. The situation affects many people and threatens
growth, jobs and inflation. There is also the risk of stagflation in
certain countries.
Water jump: Debt crisis in the advanced economies
The effects of higher commodity prices could threaten the global A public debt crisis
recovery. At the same time we regard the debt crisis in the connected to the
advanced economies as a more difficult hurdle to overcome. The banking sector could
impact could be felt in both the short and longer term. Risks can create a new financial
be tied to politics, to the economy and to financial markets. This crisis and recession
could give rise to new recessions and deflation, and once you
have fallen into the water jump it can be hard to get up.
Debt restructuring in the private sector, among households,

businesses and banks, is far from over. When economic stimulus

programs are phased out and a period of austerity takes over,
new risks could arise for the private sector and pose further risks
to the banking system. The IMF estimates that banks in Europe,
Asia and the US need around USD 500 billion in new capital.
Debt restructuring in the public sector has just begun in Europe,

mainly in the UK and crisis-ridden euro members. They have to
get their debt down to 60% of GDP from nearly 85%, which could
take many years, especially since demographics and increased
healthcare expenditures are making it more difficult.
In the US, the national debt is nearing 100% of GDP, yet the The longer the US
country seems to have put off any comprehensive measures, waits to seriously
probably until after the presidential election in 2012. The budget tackle its debt, the
deficit exceeds 10% this year. The longer the US waits to agree greater the risks
to a more ambitious medium-term plan across party lines, the
greater the risk for the dollar, for long-term interest rates and for
confidence in the US economy.
Expectations are that Portugal will be the next country to need a

rescue package. Our main scenario includes this assumption. If
Spain finds itself in a similar situation, there will not be enough
capital in the European Financial Stability Facility (EFSF).
In addition, Greece and Ireland’s lenders are expected to have to

take responsibility for their less-than-accurate risk assessments,
i.e., to write off or renegotiate a portion of the debt they hold. This
could put pressure on the euro if the results of the stress tests of
the banking system that are announced in June show that there
is not enough capital and that national governments will have to
take over more banks, e.g., in Germany, Spain and France.
Too high of a public debt ratio – around 100% of GDP or more –

could affect growth. The possibility of crowding out the private
sector is contributing to this. Competition for capital is increasing.
Debt restructuring is already slowing GDP growth by about half of

a percentage point for every per cent of GDP that is being sliced
from government budgets. In Europe, the day is coming, but in
the US it could take a little while before people feel the effects of
austerity. If politicians do not handle the debt crisis correctly,
there will be an increased risk of turbulence in financial markets
and a greater impact on growth and employment.
Fifth hurdle: The global order – the global political and

financial system
Reforming the current global order is another long-term New financial crises
challenge. If it doesn’t happen, new financial crises could arise are a greater
more quickly and with a greater impact than otherwise would be possibility if the world
the case. There is still a lack of efficient institutions to detect, order isn't working
manage and coordinate measures in the event of a crisis.
Countries are acting out of national interests, and rarely are
regulations created that work equitably across national borders.
The G7 countries, G20 countries, International Monetary Fund
(IMF), World Bank, World Trade Organization (WTO) and

Financial Stability Board (FSB) could all serve as crisis monitors
and coordinators. The lack of strong institutions to manage
currency tensions, large capital flows, protectionism and financial
crises is exceeded only by the even weaker institutions available
to tackle climate change and environmental issues.
Emerging countries led by China and India are demanding new The global order has to
international alliances. China would prefer not to see the dollar as adapt to new global
a reserve currency any longer, but hasn’t yet taken responsibility players like China and
as a growing economy for developing a viable currency that can India
be used outside its borders. With continued currency tensions
and many emerging currencies rigidly pegged to the dollar, there
is a risk that savings imbalances could again create financial
crises. This hurdle, the last on the track, will take time to
overcome. If it isn’t, the global economy won't reach the finish
line!
Alternative scenarios:
Below we summarise the alternatives to our main alternative for

2011-2112. The probabilities we use are anything but scientific
and merely provide an approximate risk level.
• Main scenario (see page 4) 50% probability

• Stagflation (weaker scenario) 15% probability
Higher commodity prices, inflation and interest rates could
slow growth primarily in developed countries. Our
stagflation scenario contains high inflation and
unemployment, and little or no growth.
• Worsening debt crisis (weaker scenario) 15% probability
If policymakers cannot manage the debt crisis and it

worsens, there is a risk of slower growth and financial
instability. A rescue package for Spain is included here.
• Faster balancing of growth (stronger scenario) 5% probability
If China can transition to a consumption-driven economy

at the same time that the US gets its growth from
investments and exports, savings balances will decrease
and growth, though not significantly higher, will at least be
more sustainable.
• Further stimulus despite the risk of overheating (stronger

15% probability
scenario)
GDP growth could be stronger than we have predicted if

emerging economies fail to slow down at the same time
that the US supports another round of quantitative easing
(QE3) and other stimulus measures. This higher growth
rate is not sustainable, however.

4. Our assumptions about the commodity
and financial markets
Price trends in financial and commodity markets are difficult to
predict. It is more a question of making reasonable assumptions
that support the forecast for the real economy.
Commodity markets
Commodity prices have risen markedly in the last half year. One There were several
reason is the stronger economy, which is raising demand for raw reasons for the rise in
materials. Another is supply problems. Droughts and fires have commodity prices
reduced food production. A third reason is quantitative easing,
which has increased liquidity and investor interest in
commodities. A fourth reason is that inflation concerns have
driven up the price of gold and other metals. The relatively weak
dollar is also contributing to higher commodity prices, since
producers are demanding compensation for the weaker dollar.
Lastly, the democratisation process in the Middle East has
created uncertainty about future oil production, which has raised
oil prices despite that supplies haven’t yet decreased.
In our January forecast we assumed that oil would reach USD 85 We assume an oil
this year and USD 90 next year. We expect the current price of price of USD 105 this
USD 115 a barrel to drop when uncertainty about the Middle East year and USD 98 next
eases, the pace of the global recovery slows slightly and the year
temporary effects of the cold weather subside. Our forecast is
that the price of oil will reach an average of USD 105 this year
and fall to USD 98 next year. The risk in these assumptions is on
the upside, since concerns about oil production in the Middle
East could be deeper and more long-lasting than we have
assumed. Replacing nuclear energy with gas, oil and coal could
prove necessary after the catastrophe in Japan, and could lead
to a continuation of the upward trend in oil prices.
Commodity prices, total, food prices and commodity prices excluding oil (index)
175
Total commodity price, excl oil
150
125
Index
100 Total commodity price
75
50 Food prices
25
00 01 02 03 04 05 06 07 08 09 10
Source: Reuters EcoWin
The long-term price trend should point upward, since many low
and middle income countries are growing quickly and expanding
their infrastructure. The question, however, is whether we will see

any pioneering energy innovations to replace oil. The nuclear
crisis in Japan is creating new incentives for innovations in
environmentally friendly energy sources.
We expect metal prices to continue to rise in 2011 and 2012, but

not as quickly as in 2010. A slightly lower global growth rate
suggests this, when the impact of the rebound is no longer as
dominant.
Food production has been affected by weather conditions, which Metal and food prices
could occur again in future years, although we see signs that new continue to rise, but
agricultural acreage is now being added to boost supply, which not as quickly as last
reduces the risk that food prices will increase as quickly. As with year
metal prices, we expect food prices to continue to rise but at a
slower rate. The risks are how much of food production can
replace energy production and – like always – weather impacts.
Inflation and interest rates

The upward commodity price trend raises inflation expectations
at the consumer price level (CPI), but could also affect growth
prospects by raising costs for businesses and reducing their
ability to invest and hire new workers, and by weakening real
disposable household income, leaving them less for other
consumption after paying for more expensive energy and food.
It is also critical whether commodity prices continue to rise at the

same rate, or if they rise faster or slower. A one-off effect on
inflation would lead to fewer interest rate hikes than if prices rise
for a longer period and accelerate.
Inflation (CPI) in a number of countries, 2008-2011
17,5
15,0 India
12,5
10,0 China
Percent
7,5
Brazil
5,0
2,5 UK
US
0,0 Germany
Japan
-2,5
08 09 10
Inflation problems are and have been most evident in emerging

countries. Energy and food account for a larger share of
household spending there as well.
In India, weak monsoon rains caused food shortages and

substantially higher prices at the same time that import prices
rose. Economic policy has been expansive as well. Inflation is

now headed lower, but the levels will remain relatively high
throughout the forecast period.
China has had problems with drought as well, in addition to China’s high inflation
higher import prices on the heels of rising global commodity rate is due to both
prices. The inflow of capital as well as negative real interest rates domestic and external
and rapid credit growth have also driven inflation, which for many factors
is considerably higher than official figures show. The
administration is now trying to mitigate the price increase, but has
been tardy in its attempts to tighten monetary policy. A stronger
currency appreciation would help to slow the rise in import prices,
but should be in real rather than nominal terms by increasing
wages and prices faster than in the rest of the world. This raises
the risk of higher inflation through the labour market. Inflation will
exceed China’s comfort level of 3% throughout the forecast
period.
In Brazil, large capital inflows and higher import prices have

contributed to inflation problems, which are now being managed
with the help of higher interest rates and tighter fiscal policies. A
slowdown in inflation was noted in March, but concerns about
high inflation still remain.
In February consumer prices rose rapidly in developed countries,

exceeding inflation targets of at or below 2%. On an annual basis
the increases were as much as 6.2% in the US, 4.4% in the UK
and 2.4% in the euro zone.
To date the UK has been concerned about higher inflation, The policy mix is
despite weak domestic demand. Rising import prices, a weaker becoming especially
pound and VAT hikes are driving the price increases. Inflation will difficult in the UK
subside, but it could take time and require interest rate hikes
earlier than desirable from the standpoint of the economy’s
recovery.
The euro zone’s inflation will slightly exceed the target in 2011.
The ECB is expected to begin raising its benchmark rate as early
as this spring, which could put the recovery at risk in a region
where structural debt and financial sector problems weigh
heavily.
The US is also seeing rising energy and food prices, but core
inflation remains low. This will give the Federal Reserve a respite
for its monetary policy, which the administration in particular is
hoping for, when the quantitative easing (QE2) runs its course
this summer.

Inflation projections measured according to the annual increase in CPI (%)
2010 2011 2012
US 1,6 2,3 1,8
Euro zone 1,6 2,2 2,0

UK 3,3 4,1 2,6
Japan -0,7 0,2 0,7

China 3,3 5,0 4,2
India 9,2 8,5 6,8
Brazil 5,9 6,2 4,9

Russia 6,9 9,9 9,3
Global CPI 2,8 3,7 3,1
Source: National statistics and Swedbank’s forecasts.
To date only a limited number of central banks in developed Major central banks
countries have begun raising their benchmark rates, including haven’t raised rates
Australia, Canada, New Zealand, Norway, Poland and Sweden. yet …
The Federal Reserve (Fed) in the US, European Central Bank
(ECB), Bank of England (BOE) and Bank of Japan (BOJ), on the
other hand, have taken a wait-and-see approach. Among
emerging countries, all the BRIC countries have raised theirs, but
to a lesser extent than what would have been needed to quickly
mitigate inflation.
Benchmark interest rates 2000-2010

8
Norway Australia
7
6 Euroarea UK
Percent
5
4
3
2
1 US Sweden
Japan
0
00 01 02 03 04 05 06 07 08 09 10 11
The ECB has signalled that its first rate hike will come in April. Its … but the ECB is
main concern is that higher inflation expectations and the expected to begin
second-hand effects of higher import prices could create raising as soon as
problems further down the road. To a lesser extent it is worried April
that the recovery will lose steam in debt-laden countries. By
raising rates, the ECB is also placing greater pressure on
countries to implement structural reforms.
The next central bank to ease off the gas should be the BOE,
which will raise rates after the summer to tame uncomfortably

high inflation despite relatively weak domestic demand. If the
recovery fizzles before then, the BOE may wait a little longer.
We expect the Federal Reserve to put off any rate hikes until
next year, probably the spring. Its focus is on how the phase-out
of the quantitative easing (which we expect in June) will affect
various markets. The key is to ensure that economic recovery is
firmly entrenched. Late last fall its rhetoric changed to prepare
the market for the first rate hike a few months later.
Policy Interest rates 28-mar-11 30-jun-11 31-dec-11 30-jun-12 31-dec-12
Federal Reserve 0,25 0,25 0,25 1,00 1,50
ECB 1,00 1,25 1,75 2,25 2,50
Bank of England 0,50 0,50 1,00 1,50 2,00
Bank of Japan 0,10 0,10 0,10 0,10 0,10
The BOJ will have to continue (and intensify) its expansive

phase. Excluding the effects of higher import prices, the price
trend in Japan is still deflationary. Depreciating the yen is likely to
be a great priority in the short term.
Long-term interest rates have trended higher since Fed Long-term interest
Chairman Ben Bernanke announced a second round of rates have trended
quantitative easing (QE2) last fall. The intended aim was to higher since last fall –
reduce interest rates, but that hasn't been fully achieved. Instead despite the Fed's
the focus has shifted to inflation and the declining dollar. A Treasury purchases
continued recovery and generally higher inflation in the global
economy as laid out in our main scenario, as well as the
continued need to finance relatively large budget deficits in
several countries for a while longer, would suggest that long-term
interest rates will continue to track higher.
The Basel III rules, which raise banks’ capital adequacy

requirements, along with high government debts and a growing
need for investment to expand business capacity, could increase
competition for capital in the years ahead, pushing interest rates
higher.
Long-term interest rates (10-year government bonds)

6,0
5,5
UK
5,0
4,5
4,0
Percent
3,5 Germany
3,0 US
2,5
2,0 Japan
1,5
1,0
0,5
06 07 08 09 10 11

Currency trends
Compared with a year ago most currencies have appreciated
against the dollar. Among the exceptions are Hong Kong,
Pakistan and Egypt. Some currencies have risen more than
others, particularly the Japanese yen.
Nominal exchange rates in relation to the US dollar, index 9 August 2007 = 100
170
160
Brazilean Re
150 Swedish Krona
Korean Won
140
Euro
130
120
110
100
Yuan
90 Swiss Franc
80
Yen
70
05 06 07 08 09 10 11
We expect that slightly stronger growth momentum in the US During the forecast
than in Europe and Japan will strengthen the dollar in 2011-2012. period the dollar could
While the ECB will begin to raise its rates earlier, investors are appreciate, but the risk
likely to be less optimistic about the euro zone when fiscal and that it could decline is
monetary tightening reduces growth. greater in the slightly
longer term
With quantitative easing ending, concerns about inflation and a
further decline in the dollar will diminish, strengthening the
dollar’s position. We believe, however, that there is a risk of a
bigger decline in the dollar in the medium term, and the longer
the US avoids dealing with its financial issues, the greater the
risk of a hard landing for the dollar.
FX 28-mar-11 30-jun-11 31-dec-11 30-jun-12 31-dec-12
EUR/USD 1,41 1,45 1,30 1,25 1,25
RMB/USD 6,56 6,40 6,25 6,10 5,95
USD/JPY 82,4 81 90 95 95
China continues to appreciate the renminbi against the dollar by

4-5% per year in nominal terms, but in real terms the
appreciation is even stronger. Efforts to internationalise the
renminbi continue, including through a pilot project in Hong Kong,
but the pace remains relatively slow.
The Japanese yen is weakening in the wake of a shrinking trade The yen should
surplus and growing interest rate differential against Europe and weaken, even without
the US. We expect that current pressure on the yen will decline interventions
when expectations of a massive capital repatriation fade. Our
assumption that the US will end QE2 without replacing it with
QE3 should also contribute to a weaker yen.

5. The optimal economic policy
In an uncertain world it is difficult to determine an optimal
economic policy. What is clear, however, is that global financial
stability isn’t assured and that there are a large number of policy
challenges left to tackle.
A significant risk is the interplay between public and private debt

on the one hand, and weak banks on the other. A more severe
debt crisis in the euro zone, the US or Japan could create
turbulence in financial markets through a fragile financial system,
which would affect the real economy negatively. This potentially
vicious cycle has to be broken.
So what would be reasonable to do when the recovery isn't

robust yet and too much austerity could lead to a new recession?
In Europe, the financial markets have helped to create a greater The euro zone’s crisis-
push for budget consolidation through higher CDS spreads and ridden countries have
financing costs. There are few choices for Portugal, Ireland, no alternative to tighter
Greece and Spain (PIGS) other than to implement austerity to fiscal policies
balance their budgets and reduce government debt. The UK
doesn't face the same pressure right now, but without austerity
the sentiment could have quickly turned negative in the financial
market. The ECB is now expected to begin raising interest rates
as early as this spring, which would make monetary policy less
expansive.
In the US and Japan (before the catastrophe), more fiscal The US and Japan, on
stimulus has been introduced in 2011 despite that little impact on the other hand, have
growth is expected. In addition to procyclical fiscal policies, they been able to continue
are maintaining highly expansive monetary policies: quantitative to stimulate their
easing and low interest rates that are not expected to be raised economies – but with
until next year. significant risks
A number of conclusions can be drawn from this policy:
• It is not unreasonable that European countries improve

their fiscal position. This would ease pressure on the
banking sector and stop the increase in government debt,
which would potentially slow growth for years to come.
• The focus has probably shifted too much to cutting Structural reform
spending and raising tax revenue. There is a risk that should go hand in
those worse off will have to bear a disproportionate share hand with budget
of the burden. Politically influential interest groups that consolidation
oppose structural changes, e.g., Greek pharmacies that
are resisting competition, are often protected. Instead,
deregulated markets could contribute to lower consumer
prices. Structural reforms must complement the budget
consolidation in order to raise long-term growth potential.
• The euro zone – through Germany – is advocating a

package of measures to bolster Europe’s
competitiveness, although the contents don’t seem to
focus on competitive strength; instead it seems more like

a negotiating ploy to even out competitive advantages
between countries. It would be preferable if the focus
were on structural reforms that make labour, goods,
services and financial markets more efficient while also
strengthening productivity, entrepreneurship, education
systems and pensions.
• In addition to reducing the risk from public finances, the

banking system has to be strengthened through more
ambitious stress tests that actually lead to measures that
bolster European banks.
• The ECB probably needn’t be in such a rush to raise

interest rates. Inflation is only marginally above the target,
and weaker domestic demand shouldn't lead to much
underlying inflationary pressure.
• Constantly being a step behind the financial markets in Staying a step behind
managing the crisis in the euro zone is far from an optimal the financial market is
economic policy. It would be preferable if national far from optimal
interests were set aside and that the measures taken
matched the supposedly political commitment to the euro.
The temporary crisis fund and permanent fund should
both be designed to reduce concerns about insufficient
liquidity. At the same time the responsibilities of lenders
must be clearly spelled out, so that they can reasonably
assess their risks when lending to countries that
potentially face a crisis.
• Irresponsible financial policies in the US create a risk that

the dollar will fall and market interest rates will rise in the
longer term, which would also adversely affect the rest of
the world.
• US finances are in worse shape than the euro zone’s,

with a higher budget deficit and national debt. The effects
of demographics and higher healthcare spending will
eventually exacerbate the situation. The US is creating a
heavy burden for future generations to bear.
• Debt restructuring in the private sector has been slow, Quantitative easing
which can also be explained by access to liquidity through and low benchmark
low benchmark interest rates and quantitative easing. interest rates have
Cranking up the printing presses has also played a part in delayed debt
manipulating pricing in various markets and cannot restructuring in the
continue. Quantitative easing cannot serve as a private sector
replacement for structural reforms, as in the case of
mortgage reform in the US.
• In summary, budget consolidation, stress tests, structural

reforms, the phase-out of quantitative easing and the
postponement of interest rate hikes in regions with weak
domestic demand are a more optimal economic policy
than further fiscal stimulus, higher debt ratios, cranked-up
printing presses and a lack of reform.

6. Regions/countries: Most are downshifting
Despite the relatively high growth rate in the global economy,
there has been a slowdown in both emerging and developed
countries. Still, the prospects of increased global trade,
production and living standards in the world as a whole are
relatively good.
GDP on an annual basis (%) in several major countries/regions
China
12,5
7,5
India
Percent
Brazil
2,5 US
-2,5 Eurozone
UK
-7,5
Japan
-12,5
06 07 08 09 10
The challenges in the form of overheating risks in emerging It is unusual that US

countries as well as the debt crisis and stagflation in developed unemployment is
countries continue to create uncertainty, however. This is in higher than Germany’s
addition to the remaining structural problems in many crisis-
ridden countries. The US housing market remains in recession.
Unemployment has fallen slightly and is significantly higher than
in Germany, which is benefitting from previous reforms and the
economic recovery.
Labour market in several OECD countries (%)

13 France Germany
12
Euro zone
11
US
10
9
Percent
8
7
6
5
4
3 Japan
2
92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11
Given that corporate earnings continue to rise, though not as

quickly as last year, there is room for more investment and new
hiring. The private sector must be able to assume the role of
growth engine as the public sector shrinks due to the debt crisis
and phase-out of stimulus programs.

US – Stronger growth but budget concerns
• Employment is rising, but the weak labour and housing
markets, and higher energy prices, are affecting the
economic outlook negatively.
• Slight upward revision of GDP growth to 3% in 2011 and

2012. No austerity until after the presidential election.
• Forecast risks include public finances, which in the long

term put currencies and interest rates at risk, even globally.
The US economy strengthened more than expected at the end of

last year. Domestic demand grew with the help of monetary and
fiscal stimulus as well as an improved job market. As a result, we
are adjusting GDP growth upward in our spring forecast.
We project that GDP will grow by 3% this year and next. This is Decent growth despite
actually less than what would be expected after a recession, big structural problems
when there are latent consumption and investment needs.
However, the US is wrestling with major structural problems in its
housing, labour and credit markets, which is hampering the
recovery. Moreover, higher energy and food prices are keeping a
lid on consumer confidence and spending.
The labour market has improved, but slowly. The decline in

unemployment from 9.8% in November of last year to 8.9% in
February is due to job growth and a lower labour supply. The
weak job market is creating difficulties for debt-laden, low-income
households. Demand is affected for small businesses, which are
vital to job growth. This is a vicious cycle that is difficult to break.
Labour market trends, 1980-2011

12,5
Unemployment
10,0
7,5
Procent
5,0
2,5
0,0
-2,5
Labour supply Employment
-5,0
80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10
After trending downward for five years, the housing market is not
yet showing signs of having reached bottom. The zigzagging
trend in new and existing home sales has been driven by
stimulus measures. In April, when tax credits for home buyers
expired, sales fell markedly. A recovery began after that, but
sputtered when households became worried about rising gas

prices, higher mortgage rates and weak job growth. A
stabilisation is on the way, but it will take time before home sales,
home construction and home prices rise robustly.
Housing market trends, 1990-2011

8 275
7 250
Number of (millions)
6 225
Sales of new homes
5 200
Index
4 175
Case/Shiller
3 Sales of existing homes house prices for 150
10 cities--->
2 125
1 100
Residential construction
0 75
90 92 94 96 98 00 02 04 06 08 10
Domestic demand is now continuing to grow. Business

investment is on the rise, especially in technology. A relatively
weak dollar continues to help exports, but at the same time
stronger consumption and investments are leading to higher
imports, so net exports are contributing little to growth.
The administration's fiscal stimulus, which was approved in It is vital that a budget
December, is designed to increase investment and job growth. At agreement is reached
the same time the effects of previous stimulus programs are now for both short and long
fading, which especially affects households that haven't yet term to avert another
finished eliminating their debt and may want to increase their government shutdown!
savings. A policy transition from stimulus to austerity has begun.
The Republicans, with a majority in the House of
Representatives, are pushing for spending cuts, which are
opposed by the Democrats, who have their sights set on growth
and next year's presidential election. On March 17 Congress
passed a three-week budget extension, but there is still a risk
that the federal government won’t have a budget beyond that.
Congress has to pass a budget for the rest of the fiscal year,
which ends in September, and for 2011-2012. The US also has
to reduce its medium-term debt. President Obama’s proposal
aims to slash the budget deficit by USD 1.1 trillion over a 10-year
period, which is less ambitious than his own bipartisan
commission, which would cut close to USD 4 trillion. This means
that debt will remain a major risk in the long term, which could
hurt the dollar and interest rates.
Inflation as measured by the CPI is now rising, but core inflation,

excluding energy and food, is a modest 1-1.5%. This gives the
Fed a respite, and we don't expect its first rate hike until next
year. The latest quantitative easing (QE2) is scheduled to wind
down this summer, and we don't expect a third program given
that the markets should remain stable when liquidity declines.

Japan – Reconstruction is beginning, but
will take time
• Japan’s economy is weakening in the short term, but
growth will benefit from the reconstruction, which we expect
will take time.
• GDP growth will slow to just over 0.5% this year, but could
rise to 3% next year driven by investment.
• Risks include the overall impact of the disaster, the

stronger yen and political indecisiveness.
Before the earthquake and tsunami broke out on March 11,

Japan had already seen a slowdown in economic activity due to
the strong yen, among other reasons. The disaster, which is
complicated by the nuclear crisis, will now cause a double dip
recession in Japan.
We project that GDP will shrink during the first and second
quarters. The factors that are limiting activity are electricity
shortages, production disruptions, the loss of exports, increased
energy imports and slower consumption due to immediate
concerns and damaged confidence. The scope of the disaster is
hard to fathom, with over 27 000 dead or missing and 260 000
people left homeless. For those who lost everything, the shortage
of water, fuel and food remains the biggest challenge.
Still, the reconstruction will eventually begin. We expect it to take Lower growth this year
many years, possibly an entire decade. Growth could turn but higher next year –
positive during the second half of this year, driven by public and other factors are far
private investment. GDP will grow by just over 0.5% this year more important
before reaching 3% in 2012. Reconstruction costs are estimated
at 25 trillion yen, or USD 300 billion, about 5% of GDP, which
should be spread out over a period of 5-10 years. The large part
will probably come in 2012 and 2013, however. Major nuclear
problems are not included in this calculation.
Stock prices and exchange rates

15000 115
14000 110
13000 105
USD/JPY
12000 100
USD/JPY
Index
11000 95
10000 90
9000 85
8000 Nikkei, 225 80
7000 75
mar jul nov mar jul nov mar jul nov mar
08 09 10 11

The Japanese yen has risen in the wake of the catastrophe
owing to expectations that capital invested abroad will return to
Japan and be used in the reconstruction, and because less
capital will be exported going forward. In light of Japan’s current
account surplus, these expectations seem slightly overblown,
since Japan has enough capital to use.
An intervention by the G7 countries has weakened the yen

slightly, but not enough to make much difference. Because of the
central bank’s expanded financial asset purchases, quantitative
easing and liquidity to facilitate the financial system, monetary
policy has become more expansive than before. This is
reasonable since Japan is struggling with deflation problems and
a debt ratio that was already rising significantly (estimated at
250% by 2015 before the catastrophe).
We expect the Japanese central bank to delay any rate hikes

during the forecast period. This, in combination with a shrinking
current account surplus, is weakening the yen slightly.
The government and opposition must reach an agreement to

increase the budget deficit and issue more government bonds to
jumpstart the reconstruction of the devastated northeast region.
Even before the catastrophe, credit rating agencies had begun to
downgrade Japan's debt, but the question is how far they will go
now that debt will increase even more.
There are significant risks in analysing Japan. For one thing, it The crisis isn’t over yet
has not been possible to assess the full effects of the disaster on – the nuclear crisis
the economy. For another, we still don't know what the complicates the picture
consequences of the nuclear crisis in Fukushima will be in terms
of the rescue efforts, whether people will be able to return to the
region, export prospects for seafood and agricultural products,
energy supplies throughout Japan and their impact on prices, etc.
If economic policies were to become highly expansive, which we

don't expect, the reconstruction would go faster, the yen would
weaken and deflation would be replaced by inflation.
Another uncertainty concerns the political leadership during crisis The political risk is far
and how well the government and opposition are able to work from negligible – and a
together. Confidence in Prime Minister Naoto Kan was low before government crisis
the crisis and probably hasn't grown much, although it hasn't before the end of the
fallen either. The opposition isn't unlikely to gain any ground year is likely
either for defending decisions that lead to a faster reconstruction.

China – Lower credit growth will lead to a
soft landing
• The Chinese economy is decelerating, but the growth rate
still exceeds the targets set in the five-year plan.
• Tighter economic policy will reduce the risk of overheating

and accompanying political instability.
• Forecast risks include high inflation, real estate prices and

difficulties achieving more sustainable growth.
At the end of 2010 China’s economy was surprisingly strong, and

GDP growth for the full-year reached 10.3%. We now expect
China to grow more slowly in 2011 and 2012, mainly due to lower
credit growth, higher inflation and less of a net contribution from
exports as imports grow due to higher oil prices. Our forecast
calls for growth of 8.8% in 2011 and 8.4% in 2012.
China recently concluded its National Party Congress, where the Chinas party congress
GDP growth target was set at 7% in 2011-2015. During the is over and ambitious
previous five-year period, 2006-2010, the goal of 7.5% was new goals have been
surpassed by a wide margin at 11.3%. A contributing reason for set – but can the
the large margin of error was the global financial crisis and Chinese achieve
recession, which forced the Chinese administration to stimulate them?
the economy, resulting in strong growth in exports and
investment.
In the new five-year plan growth is concentrated more on

household consumption. The goal is also to reduce income gaps,
protect the environment, improve quality in manufacturing and
reduce inflation in consumer and real estate prices.
Trends in the credit market, 1998-2011

30
25
Credit Growth
20
Percent
15
10 and in large
Reserve requirements in small banks
banks
5
Lending rate 6 months
Deposit rate 6 months
0
98 99 00 01 02 03 04 05 06 07 08 09 10
The question, however, is whether the country's efforts to reduce

GDP growth are sufficient. There are few economic tools
available centrally that will have much of an impact, including
interest rates, since lending is often local, and many state-owned
companies and other important interest groups have access to

low-interest loans. Local and regional politicians are pushing to
raise growth, including by buying up and expropriating land and
constructing new commercial and private property.
The high rate of credit growth in recent years has led to

overheating in the real estate market, which has been difficult to
slow despite various administrative measures such as mortgage
caps and increased bank reserve requirements. Credit growth
has now been brought down to lower levels, however, and
reserve requirements are historically high. On the other hand,
real interest rates are still negative.
The goal to strengthen households means that wages will

increase more than before, which by itself could add to existing
inflation problems. On the other hand, the yuan will appreciate
more quickly in real terms, which will speed up the process of
raising domestic demand and reducing global savings
imbalances. China's current account surplus is expected to
decline as imports become more expensive and global demand
cools slightly. In nominal terms we expect the yuan to appreciate
by about 5% against the dollar per year.
Households are being hurt by the high rate of inflation, which has Higher inflation is
fluctuated around 5% on an annual basis in recent months, but in hurting the economy,
reality is considerably higher for many people, since food and but could also create
energy prices have risen substantially. High inflation could lead to political instability
political instability, and the administration has no choice but to
fight inflation.
Inflation has risen partly because of supply problems stemming

from droughts and higher international commodity prices, but just
as importantly because several years of economic stimulus
through the banking sector have created overheating. The latter
can be influenced, and the lower credit growth which has been
achieved and has been permitted to reach 14% this year is a
step in the right direction.
China’s transition to slightly weaker growth was evident this Is the slowdown
quarter not only in credit growth but also retail and auto sales and temporary or will it
among leading indicators. It is too early to say, however, how last?
sustainable the slowdown will be. Not until the effects of the new
year’s celebrations and the cold weather ebb can it be
determined, for example, whether the trade deficit was temporary
or indicated the beginning of a structural shift.
Despite a goal to increase domestic consumption, high inflation

could mean that investments will remain the biggest contributor
to growth in years ahead.

India – Slowdown due to supply problems
• Demand is growing quickly, but supply can't keep pace and
the government’s reform fatigue is affecting investment.
• A slight downward revision in our GDP growth estimate to

8% this year and 7.5% next year presumes that the high
rate of inflation will be checked.
• The forecast risks are access to foreign capital, the rupee

and fiscal and monetary policy, including the pace of
reform.
India’s economy grew quickly last year. After a high rate of

investment compensated for the slowdown in consumption in the
first half of 2010, investment declined late in the year. We are
revising our GDP growth forecast downward to 8%, then see it
declining further to 7.5% in 2012.
The reasons why activity in the Indian economy will grow

somewhat slower going forward are lower capital inflows, inflation
– which remains high but is declining slightly – and economic
austerity.
Many companies in the manufacturing and service sectors will Companies are feeling
face higher costs due to oil prices. Increases in other commodity the effects of higher
prices are also affecting growth, at the same time that interest cost pressures and
rates and salaries are rising, the exchange rate is appreciating in capacity shortages
real terms, and access to international capital is declining. In the
business sector, a tailwind is being replaced by a headwind.
Growth in the economy and in various price indexes

20,0
CPI industrial workers
17,5
CPI agricultural workers
15,0
12,5
GDP-growth
Percent
10,0
7,5
5,0
2,5
0,0
Wholesale prices
-2,5
05 06 07 08 09 10
In rural areas, the government continues to provide subsidies to

offset rising cost pressures, which is stimulating demand.
In urban areas, previous salary increases have contributed to

strong growth in auto and other durable goods purchases. Higher
inflation, mainly through higher gas prices, could slow this trend
slightly. The middle class is still growing, however, and we expect
it to continue to contribute strongly to growth, though slightly less

so than in 2010. When consumption grows faster than
investment, the risk of shortages and higher inflation increases.
A faster pace of reform in the Indian economy would help to drive A faster pace of reform
investment. This is especially true with respect to taxes and would contribute to
competition in the agricultural and retail sectors. higher investment and
reduce cost pressures
Policies remain focused on subsidising demand in rural areas to
reduce the stress of higher producer and consumer prices. India
is far too dependent on oil, and the subsidies are leading to
higher budget and current account deficits.
Interest and currency rate trends

9,0 80
8,5 Policy Interest rate EUR/INR 75
Rupie to Euro och US dollar

(right)
8,0 70
7,5 65
Percent
7,0 60
6,5 55
6,0 USD/INR (right) 50
5,5 45
5,0 40
4,5 35
05 06 07 08 09 10 11
Smaller capital flows and larger current account and budget

deficits are reducing appreciation pressure on the rupee. Since
monetary policy is likely to remain the principal economic tool, we
expect that the Reserve Bank of India (RBI) will have to further
tighten this year. If oil prices increase beyond our assumptions,
there is a risk that monetary policy will be even tighter, which will
impact growth.
Major political developments include corruption scandals (MP Political scandals and
bribery, Commonwealth Games, telecom licenses) and a number corruption could affect
of state elections next month. Even if Prime Minister Singh interest among foreign
retains his position (no successor is evident) and the Congress investors
Party stays in power, uncertainty about scandals and the
reluctance to institute reforms could affect interest among foreign
investors. If capital inflows dry up, it could speed up deregulation
of the retail sector for foreign investors.

Brazil – aiming at more sustainable growth
• Higher inflation and tighter economic policies are slowing
growth to a more sustainable 4-4.5% this year and next.
• Tighter fiscal policy is expected after last year's elections at

the same time that the central bank is again being forced to
raise its benchmark interest rate.
• Risks are focused on global developments, including

commodity prices, and measures to prevent overheating.
Last year the Brazilian economy grew strongly by 7.5% after

falling by 0.6% in 2009. The growth rate slowed during the
second half of last year as a result of tighter economic policies, a
stronger currency and higher inflation. This trend has continued
this year and suggests a more modest growth rate during the
forecast period. We have revised our GDP growth forecast
downward to 4.3% this year and 4% in 2012, i.e., to a more
sustainable rate.
Demand-based GDP growth, annual rate (%)

50
Investments
40
30 Import
Private
Percent
20
Consumption
10
0
GDP
-10 Export
-20
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
05 06 07 08 09 10
Of course, there is no shortage of challenges facing Brazil’s new Plenty of challenges

president, Dilma Rouseff, who succeeded Lula da Silva on face Brazil’s new
January 1 after defeating José Serra on October 31 of last year. president
Aside from the political and social challenges, there are
economic issues to deal with as well.
Large capital flows have strengthened the currency, the real,

which has worried policymakers in the government and central
bank. Last year Financial Minister Guido Mantega coined the
term currency war and criticised China and the US. Inflation is
significantly higher than the central bank's target of 4.5%, and
higher benchmark interest rates could increase capital flows and
reduce the growth rate.
Against the US dollar, the real is back at levels from before the
crisis, but in real effective terms the currency is considerably
stronger, partly as a result of higher costs in Brazil versus

abroad. The measures that have been taken, including taxes and
tariffs on capital inflows, have not had enough impact.
The strong currency is helping to increase domestic

consumption, since imports become less expensive. As a result,
consumer prices are accelerating and in combination with higher
international commodity prices are raising inflation. While a
stronger currency is easing import prices, it is not enough to
compensate for strong domestic demand. The rate of wage
increases now significantly exceeds inflation expectations, which
is putting further pressure on prices.
The benchmark interest rate has been raised by three Benchmark interest
percentage points since April of last year to 11.75%, and we rates are high – but
expect further rate hikes during the year totalling at least 1 further rate hikes are
percentage point. At the same time the government wants to expected during the
tighten fiscal policy – by about 1% of GDP down to a deficit of year
2.5% of GDP – to reduce pressure monetary policy and restore
public finances after the election year’s excesses.
Interest rate, currency and inflation trends

20,0 180
17,5 170
Policy interest 160
15,0 Real effective
exchange rate 150
12,5
Percent
140
Index
10,0 USD/BRL Index
2008 aug =100 130
7,5
120
5,0 110
2,5 100
CPI
0,0 90
05 06 07 08 09 10 11
High commodity prices have also benefitted Brazil’s economy as

a major commodity producer and exporter. As in many other
large emerging countries, the service sector is developing into a
more important growth engine. Value-added in production
generally has to be improved, however, since the trade surplus is
now based solely on price effects, not volume effects.
Global developments pose the greatest risk to the Brazilian Weaker global growth,
economy on both the up- and downside. Strong demand, high, trade and commodity
stable commodity prices and modest capital inflows are prices are Brazil’s
benefitting the country. A trade war and protectionism would biggest risks
adversely affect the outlook, however. It would be positive if
Brazil’s economic policy could successfully reduce inflation and
interest rates. If not, there is a risk of a hard landing later on, with
an overheated domestic market and an inflated currency. How
well exit strategies in other major economies are managed will
also be critical for Brazil. If changes are made too quickly, it could
endanger stability in Brazil.

Euro zone – Inflation concerns are hurting
growth
• The recovery continues within the euro zone, but higher
inflation and interest rates are slowing GDP growth slightly.
• The debt crisis and weak institutions could still affect

growth and financial stability.
• The euro zone has to consolidate budgets, but that it also

needs to strengthen competitiveness through reforms.
After rebounding during the first half of 2010, GDP growth tailed Higher inflation and
off during the second half of the year. The reasons were the cold interest rates have
weather, the stimulus phase-out and a slight global slowdown. contributed to a slight
The outlook for 2011 and 2012 is slightly less positive than in our downward revision of
January forecast, despite a stronger global recovery, including growth
higher demand from the US. Commodity price increases have led
to higher inflation at the consumer level, due to which the
European Central Bank (ECB) signalled that a period of higher
benchmark interest rates would begin as early as this spring
(April). Owing to tighter monetary conditions, together with tighter
fiscal policy in a number of countries, we are shaving a tenth of a
per cent from our previous GDP forecast. GDP growth is now
estimated at 1.5% this year and next. The financial crisis and
recession have affected countries differently. Germany, with its
competitive advantages, has regained its status as a strong
growth engine, while countries in Southern Europe and Ireland
are in need of major structural adjustments, which is inhibiting
growth.
GDP growth (%), inflation (%) and government debt (% of GDP)

4 85,0
Inflation
3 82,5
2 80,0
1 77,5
Percent
Percent
0 GDP Growth 75,0

-1 72,5
Soveriegn debt, % of GDP
-2 70,0
-3 67,5
-4 65,0
Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3 Q1 Q3
06 07 08 09 10
Although the euro has been relatively strong, exports remained

an important growth engine. Investments are gradually taking
over, but higher cost pressures could delay more balanced
growth. If anything, our forecast of a weaker euro could
strengthen net exports.

The big challenge for the euro zone is to combine debt
restructuring in the private and public sectors with tighter
monetary conditions without threatening growth in domestic
demand. Private debt restructuring means capitalising banks and
trimming their balance sheets, along with cutting household debt
ratios. Public debt restructuring is a question of balancing
budgets and reducing the public debt-to-GDP ratio, which is
headed toward 100%.
The financial markets used to treat the euro zone’s members First risk premiums
collectively with nearly the same risk premium on lending until were too small – and
differences arose in connection with the financial crisis in 2008. now they’re too big?
Premiums rose substantially in 2010 in connection with the crisis
first in Greece and then Ireland. These countries have sought
and received help from the EU, ECB and IMF. Next in line is
politically unstable Portugal, which is expected to seek help,
especially if attempts to finance its debt in April and June prove
too costly. The financial markets still expect that Greek and Irish
loans will have to renegotiated. The impact on European banks is
unclear, but will be better understood when the results of the
stress tests are reported in June (assuming that the tests are
ambitious enough this time). There are also expectations that
Spain may need a rescue package, although that seems to have
died down lately as Spain has reduced its dependence on
financing from the ECB. The question is how the euro zone’s
institutions can manage these expectations. Will the decisions
made most recently on March 24-25 suffice?
Differences between German and other European countries’ 10-year government

bonds, percentage points
10
9
Greece
8
7
6
Ireland
Percent
5
4 Spain Portugal
3
2 Italy
1
0
-1 UK France Belgium
jan maj sep jan maj sep jan maj sep jan maj sep jan
07 08 09 10 11
There is still not enough financing available through the Important details about
European Financial Stability Facility (EFSF), since its lending the euro zone’s crisis
capacity, now at 250 billion euros, would be insufficient if Spain, funds are still lacking
for example, should need help. There is an agreement to
increase the fund to 440 billion euros, but no details on how this
will be done.
The permanent fund to replace EFSF in 2013, the European

Stability Mechanism (ESM), has a lending capacity of 500 billion
euros. There is uncertainty how it will be financed, since it will
include five instalments in 2013-17, part of which are guarantees
(by the most creditworthy countries) and part are cash payments

that will impact national budgets (and which debt-ridden
members may find difficult to afford). The reason that the
payments are spread out over five instalments is that Germany
couldn’t convince its voters to finance it in one lump sum.
Last year Germany’s GDP grew by 3.6%, which was its highest Good momentum in
level in many years and at the same time was a result of the big the German economy
decline in the previous year, as well as stimulus measures.
Domestic demand, including inventory build-up, was the biggest
contributor to growth, which also benefitted other countries in the
euro zone. We expect GDP growth to slow to 2.4% this year and
1.9% next year. Less of a contribution from inventory will slow the
growth rate at the same time that the improving job market could
give a further boost to domestic demand. A higher inflation rate
could worry price-sensitive consumers, however, and in
combination with slightly weaker income growth produce only
modest consumption. Nevertheless, Germany's economic
development has been positive: its budget deficit is expected to
be below 3% as early as this year (rather than next year, as
predicted), it remains a competitive force and growth is
considerably higher than its potential of around 1-1.5%.
France’s GDP fell by 2.5% in 2009, which was followed by weak No ambitious French
growth of 1.5% in 2010 – the same rate we expect during the recovery, but no
forecast period. After net exports had been the driving force budget consolidation
behind growth, private consumption took over. We anticipate that either
investments and consumption will be the most important drivers,
although exports could benefit from Germany's strong
development. Unemployment remains relatively high at just over
9%. As a result, consumption growth and domestic inflation
remain in check. Rising import prices are contributing to higher
inflation, however. To date France has had a less ambitious
budget consolidation goal, with a deficit estimated at 6% this year
and not reaching 3% until 2013. The risk is that weak growth and
a lack of strong action will delay the budget consolidation.
Italy’s GDP growth was just over 1% last year, and unlikely it will Political uncertainty
surpass that in 2011, when exports are slowed by weak demand could affect the pace
in the euro zone – Italy’s most important export market – at the of reform and growth
same time that competition from emerging countries may lead to rate
the loss of market share. A weak labour market, low confidence
and political instability, and economic austerity, are expected to
stifle private consumption. Italy’s reforms have been slowed by
political concerns, and a new election can't be ruled out this year.
Spain has managed to calm the financial markets somewhat by Expectations of a

reducing its dependence on support from the ECB, although Spanish rescue
there are still concerns that a rescue package will be needed, not package have dropped
least due to the country's many weak banks (cajas). Since it has
yet to resolve its crisis management needs in the short term,
Spain has to continue to address its budget issues and introduce
structural reforms, mainly to strengthen the labour market and
pension system. We predict marginal growth this year, followed
by a slight improvement to 1% next year, driven mainly by the
export sector.

UK – Austerity is slowing growth
• The recovery in the British economy could get sidetracked
when interest rates are raised at the same time that fiscal
policy is sharply tightened.
• We still expect the economy to grow by 1.5% in 2011 and

1.8% in 2012, but the risks are on the downside.
• We anticipate that the BOE will not raise its benchmark rate
until after this summer. Inflation could rise further before it
starts to fall.
The British economy is in tough shape in terms of both business

conditions and economic policy. GDP grew by 1.4% in 2010, but
shrunk at the end of the year on a quarterly basis partly due to
the cold weather, which adversely affected the construction
sector.
The driving forces during the recovery have been the public The recovery isn’t
sector, inventory build-up and higher industrial production and robust, inflation is
exports on the heels of a weaker pound and competitive rising and the budget
improvements. At the same time households have been hurt by must be slashed
weaker labour, housing and credit markets. They are still trying to
restructure their debt at the same time that the public sector is
making cuts to reduce budget deficits and the national debt.
This, in combination with rising inflation, poses a difficult

challenge for policymakers, who have to begin tightening
monetary policy at the same time that the budget consolidation
intensifies. As a result, the risk of the double dip recession has
increased. We still expect GDP to grow, but by a modest 1.5% in
2011 and 1.8% in 2012.
Labour trends, 1992-2010
30 6,3
Total employment
Person (millions)
Person (millions)
28 6,1
26 5,9
Public sector --->
24 5,7
22 <---- Private sector 5,5
20 5,3
18 5,1
92 94 96 98 00 02 04 06 08 10
Employment was still lower at the end of last year than before the
crisis in 2008. The expansion in the public sector continued until
last year, with a million more public workers than at the beginning
of year. The austerity package that has now been proposed calls

for the elimination of up to a half-million public sector jobs. Many
British are worried about cuts to healthcare, education and
welfare, and demonstrators have taken to the streets in protest.
The goal is to balance the budget in 2014-15, compared with the The pace of
current deficit of around 9% of GDP. The cuts will intensify this consolidation seems
month, reaching about 2% of GDP this budget year, followed by reasonable – but
austerity cuts of 1.4% in 2012-2013 and just over 1% in each of structural reforms are
the budget years 2013-2014 and 2014-2015. Some critics have needed
claimed that too many cuts will come at the beginning, before the
recovery is robust enough. On the other hand, the government
has wanted to avoid a crisis similar to what the PIGS countries
are experiencing. Although outstanding government bonds have
a relatively long maturity of 14 years, the debt is owned largely by
foreign investors, which makes the UK more vulnerable than
Japan, for instance.
Inflation and interest rates, 2005-2011

6
Policy interest CPI
5 rate
CPI - services
4
Procent
CPI with
3 unchanged
taxes
2
1
CPI, excluding energy, food, alcohol and tobacco
0
05 06 07 08 09 10 11
BOE chief Mervyn King has written several letters to Chancellor

George Osborne explaining why the inflation rate of 4.4% is more
than double the target of 2%. VAT rate increases in January
2010 and 2011 were mentioned, as was the previously weak
pound and substantially higher commodity prices. However, all
CPI measures are above the inflation target, including underlying
measures.
If monetary austerity begins as the negative effects of the fiscal It is reasonable not to
policy become evident, there is a greater risk that the recovery rush into rate hikes
could fizzle. This would make it difficult to defend the latest
“budget for growth” which was recently presented and could live
up to its name by gradually reducing the corporate tax rate to
23% by 2015 as announced. The government has probably
expected to receive the support of the central bank through a
continuation of its expansive monetary policy. We expect the
central bank to sit tight during the spring and not begin a period
of cautious rate hikes until the fall. Inflation will slow, but it could
take time.

7. Conclusions for our home markets
A continued recovery, with higher but manageable inflation, is
benefitting businesses and households in our home markets,
Sweden and the Baltic countries.
Nevertheless it makes sense to prepare for the alternative The worst growth
scenarios such as stagflation or renewed financial turbulence, scenarios require
which would affect demand in the real economy. The stagflation measures to raise
scenario would require companies to deal with higher costs, productivity
including by raising productivity and efficiencies through cheaper
purchasing solutions and smarter logistics. They wouldn't be
wrong to re-evaluate their business models in times of
uncertainty about costs and growth prospects. Many will have to
prepare for higher costs when competition for capital increases.
Households have to think through their debt-to-equity ratios.
Further reducing debt would give them better flexibility later on
when interest rates are higher.
Uncertainty also increases the importance of market analysis.

Continuously analysing external risks allows companies to
sharpen their strategic thinking.
Countries that are now in crisis are implementing structural While others are
reforms, which will eventually make them more competitive. Even implementing
if this takes several years, countries that are now out front could structural reforms, it is
quickly find themselves left behind after years of failing to easy to get passed by
institute reforms. A structural transformation is under way, – despite better
especially now that smaller emerging countries that have been in conditions
crisis can strengthen their positions, which increases competition
at home in segments where it hasn’t been as strong to date, i.e.,
higher up the value chain.
An optimal economic policy means creating sound competitive

conditions by combining efforts to strengthen or consolidate
government finances with structural reforms that make markets
more efficient. In Sweden, the focus is mainly on public finances,
while reforms have lost steam. The labour market in particular
has major structural problems that must be addressed, including
youth and long-term unemployment.
Another conclusion is that it is important to strengthen We benefit ourselves if

competitiveness throughout Europe – and not in accordance with all of Europe becomes
the divisive competitive pact now being discussed. What is more competitive
needed instead are measures to strengthen integration in the
region’s various product markets and capitalise on its advantages
in labour division and specialisation, especially in the service
sector, which is undeveloped from a regional perspective.
Countries that rank high in terms of competitiveness, like Sweden
and Estonia, have a lot to offer to speed up the pace of reform in
Europe.
Cecilia Hermansson

Swedbank
Economic Research Department Swedbank’s Global Economic Outlook is published as a service to our customers. We
SE-105 34 Stockholm, Sweden believe that we have used reliable sources and methods in the preparation of the analyses
Telephone +46858597740 reported in this publication. However, we cannot guarantee the accuracy or completeness of
ek.sek@swedbank.se the report and cannot be held responsible for any error or omission in the underlying
www.swedbank.se material or its use. Readers are encouraged to base any (investment) decisions on other
Legally responsible publisher material as well. Neither Swedbank nor its employees may be held responsible for losses or
Cecilia Hermansson, +46858597720 damages, direct or indirect, owing to any errors or omissions in Swedbank’s Global
Economic Outlook.
Magnus Alvesson, +46 858593341
Jörgen Kennemar, +46858597730
ISSN 1103-4897

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Global Economic Outlook

by Cecilia Hermansson 29 March 2011

The global recovery has gained a footing –

Economic sekretariatet, Swedbank AB (publ), 105 34 Stockholm, tfn 08-5859 7740

Contribution to global GDP growth by various countries/regions, 2010

Seen through the rear view mirror, global economic development

2 Swedbank’s Global Economic Outlook • 29 March 2010

Industrial production in various countries/regions, Index 100 = 2000

There has been a lot of talk of a “two-speed world economy”. It is Two-speed

The latter have a number of Achilles heels, which are slowing

In summary, global economic conditions are better than

Swedbank’s Global Economic Outlook • 29 March 2010 3

Global GDP forecast

Euro zone: 1,7 1,5 1,5 1,8 1,6 1,5

Japan 4,0 0,6 3,0 3,2 1,5 1,3

Brazil 7,5 4,3 4,0 7,5 4,8 4,5

Global GDP in PPP 4,7 4,0 4,0 4,6 3,9 3,8

Source: National statistics and Swedbank’s forecasts. Note: These countries

The main factor that is driving global growth is continued strong

4 Swedbank’s Global Economic Outlook • 29 March 2010

First, the inventory build-up, which had contributed strongly to

Secondly, the impact of previous economic stimulus programs in

Thirdly, commodity prices have increased more than previously

Fourthly, the growing public debt in many developed countries is

Solid corporate earnings have benefitted stock markets around

In summary, the recovery is continuing, but growth will slow to

Swedbank’s Global Economic Outlook • 29 March 2010 5

Forecast risks have

The risks can be e compared d with a 300

Firstt obstacle: Japan’s ca

The earthquake e, tsunami and

The global eco onomy is affected be ecause Japan is a major

6 Swedbank’s Gllobal Economic Outlook • 29 March

Second hurdle: Political turbulence in the Middle East

The focus at them moment, however, is whether unrest will

Third hurdle: Rising commodity prices and inflation, central

Even before the democratisation process in the Middle East

Swedbank’s Global Economic Outlook • 29 March 2010 7

In the developed world, the policy mix for crisis-ridden countries

In emerging markets, higher commodity prices have contributed

Higher commodity prices, inflation and benchmark interest rates

Water jump: Debt crisis in the advanced economies

Debt restructuring in the private sector, among households,

8 Swedbank’s Global Economic Outlook • 29 March 2010

Debt restructuring in the public sector has just begun in Europe,

Expectations are that Portugal will be the next country to need a

In addition, Greece and Ireland’s lenders are expected to have to

Too high of a public debt ratio – around 100% of GDP or more –

Debt restructuring is already slowing GDP growth by about half of

Fifth hurdle: The global order – the global political and

Swedbank’s Global Economic Outlook • 29 March 2010 9

Below we summarise the alternatives to our main alternative for

• Main scenario (see page 4) 50% probability

• Worsening debt crisis (weaker scenario) 15% probability

If policymakers cannot manage the debt crisis and it

• Faster balancing of growth (stronger scenario) 5% probability

If China can transition to a consumption-driven economy

• Further stimulus despite the risk of overheating (stronger

GDP growth could be stronger than we have predicted if

10 Swedbank’s Global Economic Outlook • 29 March 2010

100 Total commodity price

Swedbank’s Global Economic Outlook • 29 March 2010 11

We expect metal prices to continue to rise in 2011 and 2012, but

Inflation and interest rates

Swedbank's Global Economic Outlook, 2011 March

Swedbank's Global Economic Outlook, 2011 March