A Collective Sigh of Relief - Deloitte

A Deloitte Research publication | 2nd Quarter 2012
Eurozone
Could this be the
turning point?
United States
Why the euphoria?
United Kingdom
The outlook brightens
Japan
New risk factors
India
A delicate balance
Trade patterns of
the future
Waking up and
smelling the coffee
A Collective
Sigh of Relief

2
Global Economic Outlook
Q2 2012
We’re several months into the year 2012, and things are beginning to look less dire than
the last few months of 2011. In Europe, a second bailout of Greece has at least postponed
disaster. Plus, action by the European Central Bank may have averted a deeper downturn.
In the United States, growth continues at a modest pace, but signs of trouble have not
completely gone away. And in China, the economy appears likely to avoid a hard landing.
While there is no cause for celebration, business leaders can at least utter a collective sigh
of relief that things are not worse.
In this issue of the Global Economic Outlook, we take a close look at the factors driving
the global economy. We begin with Dr. Alexander Börsch’s analysis of the Eurozone.
The title of his article — “Could this be the turning point?” — draws attention to the fact
that things are not as bad as some had predicted. He notes that four major decisions in
Europe in recent months have improved the outlook, reduced the risk of catastrophe, and
moderated the severity of the recession. In addition, Alexander takes a close look at what
may be required in order for Greek membership in the Eurozone to be sustainable.
Next, Carl Steidtmann maintains his relatively pessimistic stance on the U.S. economy. He
says that some of the data points that appear to herald improvement are really rather
ephemeral. For example, he notes that economic activity has been boosted by good
weather, temporary tax incentives, and inventory rebuilding — hardly the stuff of sustainable
recoveries. He also points out some of the unintended consequences of the Fed’s
monetary easing. Finally, while Carl acknowledges that modest growth can continue for
some time, he cautions that there are many “fat tail” geopolitical risks that could pull the
United States into another downturn. Also included in Carl’s article is an analysis of oil
prices and their impact on economic activity.
In our third article, I take a look at China’s economic outlook. I discuss how Chinese
government policy has been effective in partially offsetting the negative external
headwinds faced by China’s export sector. The result is likely to be a soft landing this
year. However, China continues to face longer-term challenges, some of which are being
pushed further down the road by the failure to address them in the short term.
Next, Ian Stewart examines the UK and concludes that the economy is doing far better
than earlier thought, but its performance in 2012 is still expected to be relatively poor.
Ian examines the Deloitte UK CFO Survey and finds that business leaders have significantly
improved their perceptions and expectations. This should have a tangible effect on
economic activity. Ian also notes that a combination of easier monetary policy and the
lessening of crisis in Europe will likely help the UK to avoid recession in 2012.
Siddharth Ramalingam then provides his outlook for the Indian economy. He notes that
the central bank is caught between a rock and a hard place. That is, the central bank must
worry about uncomfortably high inflation as well as decelerating growth. In addition, a
large fiscal deficit means that the government has few policy options to deal with a dete-

iorating situation. Siddharth concludes that an easing of
monetary policy will likely be the eventual outcome.
My outlook for Japan begins by discussing problems
related to Japan’s trade balance, fiscal policy, and currency.
Given these issues, it would seem natural to expect
economic weakness. Yet I conclude that things will likely
get better in 2012 for several reasons: a more aggressive
monetary policy, a weaker yen, higher inflation, and more
government spending on reconstruction.
In the outlook for Brazil, I note that although Brazil
has experienced a deceleration, growth is expected to
rebound later this year. A loosening of monetary policy
and a boost to investment in infrastructure and energy
should help to offset the negative external headwinds. I
also discuss Brazil’s complaints about the impact of U.S.
and EU monetary policy on the Brazilian exchange rate
as well as global concerns about Brazil’s protectionist
policy initiatives.
In my outlook on the Russian economy, I note that there
are several conflicting factors influencing growth in Russia,
and that the economy in 2012 is likely to grow more slowly
than in 2011. I also discuss the uncertainty surrounding
the future of Russian economic policy and how the choices
made by policymakers will determine future growth.
Next, Pralhad Burli offers a view on the economy of
Indonesia, the world’s fourth most populous nation and
one that has lately attracted much attention for its strong
growth and positive prospects. Pralhad discusses the
resilience of this interesting economy and how, despite a
variety of obstacles, it is likely to see strong growth in the
coming years.
Finally, Neha Jain and Satish Raghavendran look at global
trade patterns. They note how, with rising wages and a
rising currency in China, the world’s most populous nation
may no longer be the “world’s factory.” Rather, global
trade patterns are changing in interesting ways. Of most
interest is the rising role of Africa and the Middle East in
global trade.
Dr. Ira Kalish
Director of Global Economics
Deloitte Research
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Global Economic Outlook
published quarterly by
Deloitte Research
Editor-in-chief
Ira Kalish
Managing editor
Ryan Alvanos
Contributors
Pralhad Burli
Alexander Börsch
Neha Jain
Satish Raghavendran
Siddharth Ramalingam
Carl Steidtmann
Ian Stewart
Editorial address
350 South Grand Street
Los Angeles, CA 90013
Tel: +1 213 688 4765
ikalish@deloitte.com
3

Global Economic Outlook 2nd Quarter 2012
4
Geographies
Contents
6 12 20 22
6 Eurozone: Could this be the turning point?
In recent months, four major decisions in Europe have improved the outlook, reduced the risk of catastrophe, and
likely moderated the severity of the recession. After restructuring Greece’s sovereign debt, Europe will need to pursue
structural reforms to stimulate growth.
12 United States: Why the euphoria?
Recent data that appears to herald economic improvement is anything but the stuff of sustainable recoveries.
While modest growth may continue for some time, myriad geopolitical risks threaten to pull the United States into
another downturn.
20 China: Soft landing now, uncertainty later
Recent policy decisions have been effective in partially offsetting negative external headwinds faced by China’s export
sector. The result is likely to be a soft landing this year. However, China continues to face longer-term challenges.
22 United Kingdom: The outlook brightens
The UK economy is exceeding previous expectations, but its performance in 2012 is likely to be relatively poor. A
combination of easier monetary policy and the lessening of crisis in Europe will likely help the UK to avoid recession
in 2012.
26 India: A delicate balance
India’s central bank continues its efforts to strike a balance between growth and inflation. Its large fiscal deficit means
that the government has fewer policy options to deal with a deteriorating economic situation.
30 Japan: New risk factors
Problems pertaining to trade balance, fiscal policy, and currency would suggest economic weakness in Japan, but the
country’s economic performance is likely to improve in 2012 because of a more aggressive monetary policy, a weaker
yen, higher inflation, and more government spending on reconstruction.

32 34 36 40
32 Brazil: Worried about capital inflows
Brazil experienced a deceleration, but growth is expected to rebound later this year. A loosening of monetary policy
and a boost to investment in infrastructure and energy should help to offset the negative external headwinds.
34 Russia: Conflicting influences
Several conflicting factors in Russia may result in slower growth in 2012. The country’s growth prospects will hinge on
choices made by Russian policymakers.
36 Indonesia: Unlocking potential
Indonesia’s performance has been nothing short of stellar, and despite a variety of obstacles, there are plenty of
reasons to be excited about Indonesia’s prospects in the coming year.
Special Topic
40 Trade patterns of the future: Waking up and smelling the coffee
With rising wages and a rising currency in China, the world’s most populous nation may no longer be the “world’s
factory.” Rather, global trade patterns are changing in interesting ways.
44 Appendix
Charts and tables: GDP growth rates, inflation rates, major currencies vs. the U.S. dollar, yield curves, composite
median GDP forecasts, composite median currency forecasts, OECD composite leading indicators
5

Dr. Alexander Börsch
is Head of Research,
Deloitte Germany
EUROZONE
6
Eurozone: Could this be
the turning point?
by Dr. Alexander Börsch
After a turbulent 2011, the first months of 2012 were
comparatively promising for the Eurozone. The downward
cycle of fragile financial markets, vulnerable banks, a
slowing real economy, and weak sovereign debtors is
subsiding. Optimists consider this a turning point in the
Eurozone’s crisis, but it could prove to be little more than a
lull in ongoing economic instability.
Several recent developments are kindling cautious
optimism. The risk of a chaotic default by Greece seems
to have faded. Bond yields of countries in the Eurozone’s
periphery fell substantially, while Italy and Spain — the two
large countries that have experienced significant financial
market pressures — are introducing substantial economic
reforms. On top of that, early indicators suggest
that the Euro area is experiencing only a mild
recession. This rosier outlook of the Eurozone
was supported by four decisions that
helped reassure
markets; most of these decisions are
unprecedented in European economic history,
illustrating just how desperate the crisis was.
Decision 1. Injecting liquidity into the markets
The European Central Bank (ECB) completed the second
tranche of its longer-term refinancing operation in late
February. Bank borrowing in the first and second tranches
amounted to more than €1 trillion and has been set for
an exceptionally long period (three years) at 1 percent
against a wide array of collateral. More than 800 banks
participated in the February tranche. This is, by far, the
biggest injection of liquidity in the history of the ECB. It
helped ease pressure on the Eurozone’s banking sector
and sovereign debt markets as banks used part of the new
liquidity to buy sovereign bonds. The yields on Spanish and
Italian 10-year government bonds fell below 5 percent in
March from around 7 percent in December. However, in

Figure 1. Use of ECB's deposit facility
(EUR millions)
900,000.00
800,000.00
700,000.00
600,000.00
500,000.00
400,000.00
300,000.00
200,000.00
100,000.00
0.00
Eurozone
Deposit facility
Geographies
11/14/07 6/1/08 12/18/08 7/6/09 1/22/10 8/10/10 2/26/11 9/14/11 4/1/12
Source: European Central Bank
mid-March, yields started to rise again. In mid-April, Italian
bond yields stood at 5.5 percent, and Spanish yields stood
at 5.9 percent.
While injecting massive amounts of additional liquidity
was at least temporarily successful in reassuring markets
and helping buttress asset prices, it is no panacea for the
European crisis. First, it increases medium-term inflation
risks. Second, the new liquidity has not
succeeded in restoring the operability
of European interbank markets. One key
indicator for tension on interbank markets is the ECB’s
deposit facility, which Eurozone banks use in normal times
to park excess cash overnight at low interest rates. Banks
dramatically increased their use of this facility during the
recent crises. In mid-March, the volume stood at €750
billion, almost 50 times more than a year ago (see figure
1). The fact that banks prefer the safety of an ECB deposit
over higher margins on the interbank market suggests
that the uncertainties plaguing the European banking and
financial systems are lingering.
7

Global Economic Outlook 2nd Quarter 2012
8
In the short term, growth prospects for the
Eurozone look better than many feared in the
beginning of the year when a severe recession
was widely expected.
Decision 2. Signing the fiscal compact
The treaty on stability, coordination, and governance
— the fiscal compact — was signed by 25 of the 27 EU
leaders as an intergovernmental agreement; the United
Kingdom and the Czech Republic did not join. The key
point of the treaty is a balanced budget rule, which
mandates that annual structural budget deficits cannot
exceed 0.5 percent of GDP. The rule must be incorporated
into national law, preferably at the constitutional level. The
EU Court of Justice will oversee the rule’s transposition and
will have the power to impose severe sanctions. Promoted
by Germany and other northern European governments,
the rule is supposed to prevent unsustainable future
government debt.
The fiscal compact is intended to significantly constrain
government spending in the future. Whether or not it will
solidify public finances will depend on its implementation
and therefore on politics at both the national and
European levels.
Decision 3. Restructuring Greek private debt
Finally realizing that it has taken on more debt than it can
realistically ever expect to pay back, Greece undertook the
biggest sovereign-debt restructuring in history. It is the first
time in six decades that a developed country has defaulted
on its debt. Technically, private investors will receive new
government bonds with long maturities, which amount
to a loss of 53.5 percent. Some 86 percent of Greece’s
private debtors agreed to participate in the €206 billion
bond swap. Through the use of collective action clauses,
the government will force reluctant investors who own
bonds to participate in the swap under Greek law.
The program decreases Greek debt by €100 billion. As a
result, Greek debt — currently 164 percent of GDP — is
supposed to stand at 120 percent of GDP by 2020. After
the successful swap, the European Union agreed to a
second bailout package, which amounts to €130 billion in
credits until 2014.
While the acceptance of the bond swap by private
investors averted the threat of an uncontrolled default,
two uncertainties remain. The first is whether the goal of a
120 percent debt-to-GDP ratio can be achieved. Given that
the Greek economy is shrinking far more than expected,
this is questionable. The second is that 120 percent of GDP
still amounts to an enormous mountain of debt, and there
are many doubts that the Greek economy will be able kickstart
itself again while laboring under this burden.
Decision 4. Reforming Italy and Spain
Meanwhile, Italy and Spain — two large Eurozone
economies that were endangered last year — are introducing
substantial economic reforms. The Italian technocratic
government, headed by Mario Monti, redesigned
Italy’s pension system, increased the retirement age, and is
opening sheltered sectors. The government also plans to
liberalize employment protection.
Spain’s new conservative government is reforming its labor
market by introducing greater flexibility in a system that
is characterized by a two-tier structure. Older employees
with unlimited contracts enjoy a high degree of protection,
while younger employees tend to be on limited contracts.
This is one of the key factors contributing to the huge
social problem of the youth unemployment rate in Spain,
which now stands at an unprecedented 51 percent.
This fact raises the question of whether or not these
austerity programs are sustainable in a political sense.
The programs introduce short-term pain for large parts of
the population while promising gains mainly in the long
term. This could lead to a circle of austerity fatigue in the
population, lobby group pressure, and protests, which can
become an explosive combination. Radical parties opposed
to austerity and reform policies might become stronger
in elections, along with an increasing appetite for change
in government.
Since the beginning of the Euro crisis, governments have
changed with remarkable frequency. Examples include
Greece, Italy, Ireland, Portugal, and Spain. So far, changes
in government have not worked against the reform
programs. Nevertheless, the implementation of reform
programs faces serious political risks.
The short-term outlook is two-tiered
In the short term, growth prospects for the Eurozone
look better than many feared in the beginning of the year
when a severe recession was widely expected. Looking
back, the Eurozone as a whole achieved a growth rate of

Figure 2. Economic Sentiment Indicator
120
100
80
60
40
20
1.4 percent in 2011. In the last quarter of 2011, it experienced
a negative growth of 0.3 percent. The European
Commission expects a negative growth rate of 0.3 percent
for the Eurozone in 2012, with a recovery of growth in the
second half of the year.
Current expectations, measured by the Economic
Sentiment Indicator (ESI), are moderately optimistic.
Economic sentiment is still considerably below its
long-term average of 100, but it is recovering nonetheless
(see figure 2). The ESI rose for a second consecutive month
in February to 94.5, before decreasing by a marginal 0.1
points in March. Beneath the surface, however, developments
point to deepening growth differentials in the
Eurozone. While Germany’s ESI stands at 104, the expectations
for troubled Eurozone economies are still grim.
Spain’s ESI is 91, Italy’s is 89, and Greece’s is 76.
Germany’s situation is mirrored in the results of Deloitte
Germany’s first CFO survey. German CFOs feel that macroeconomic
and financial market uncertainty is unusually
high. They are also highly doubtful about the current and
Eurozone
0
Jan ’07 Jan ’08 Jan ’09 Jan ’10 Jan ’11 Jan ’12
Source: European Commission
future stability of the Eurozone as well as the effectiveness
of the Eurozone’s political crisis management. However,
they show moderate optimism when it comes to their own
business outlooks.
Growth differentials and two-tiered economic performance
are dangerous because they reinforce the substantial
difference in competitiveness between Eurozone nations.
While the European Monetary Union was meant to lead
to convergence in economic performance, the reverse has
actually occurred, and economic performance and expectations
continue to diverge. Neither growth patterns nor
unit labor costs, one of the main indicators for competitiveness,
have shown convergence in the Eurozone in the
last decade (see figures 3 and 4).
Greece: Too much debt, not enough growth
Until a few years ago, Greece was one of the fastestgrowing
European economies. From 2001 to 2007, its GDP
grew on average by 4.1 percent per year. The Eurozone
as a whole grew by 2 percent, and Germany grew by only
1.4 percent. As it turned out, after the financial crisis, this
Geographies
Germany
France
Euro area
Spain
Italy
Greece
9

Global Economic Outlook 2nd Quarter 2012
Figure 3. Unit labor cost index
(2000 = 100)
140
135
130
125
120
115
110
105
100
Figure 4. Annual GDP growth
(% change year on year)
8
6
4
2
0
-2
-4
-6
-8
10
95
90
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: OECD
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Source: Eurostat
growth performance was overwhelmingly based on high
consumer and government spending, which resulted in the
current debt spiral.
Greece currently exemplifies two of the Eurozone’s key
problems, even if it is the by far the most extreme case:
too much debt and not enough growth. For 2012, Greece
faces the prospect of a fifth consecutive year of negative
growth. Last year, the Greek economy shrank by almost
7 percent.
The debt restructuring and the second EU bailout package
bought time for Greece and the Eurozone as a whole
by averting the threat of a disorderly Greek default, at
least in the short run. However, this is not a solution
in itself. Without addressing its economy’s underlying
Greece
Italy
Spain
France
Euro area
Germany
Germany
France
Euro area
Spain
Italy
Greece
problems and introducing structural growth policies,
Greece will continue to have a bleak long-term outlook.
Greece has a structurally weak economic base, which
spills over to its creditworthiness on the financial markets.
Investors need to be convinced that the Greek economy
can generate resources to repay its debts in the future.
Even achieving a debt-to-GDP ratio of 120 percent by
2020 requires substantial growth and primary budget
surpluses. Greece needs to tackle both components of its
debt-to-GDP ratio.
Restoring Greek competitiveness
Any new Greek government entering office after the
coming elections needs to tackle the economic structures
hindering growth and competitiveness. After all, economic

competitiveness is based on productivity, and economic
policy can contribute to growing productivity by fostering
the business environment.
Looking at the structures of the Greek economy and
its business environment, two characteristics are
particularly noteworthy:
• Economic structure: The structure of the Greek
economy is different from the average EU country. For
example, the share of agriculture is high, and the share
of manufacturing low. What manufacturing industry
exists is biased toward the production of food and basic
goods, such as wood processing or paper production
for local markets. The average size of Greek enterprises
is exceptionally small, which implies lower productivity.
Tourism is the main pillar of Greece’s economic
structure; it is slightly more important for the economy
than manufacturing.
• Economic openness: As a rule, smaller European
countries tend to have a high export ratio. Greece is
an exception. In fact, Greece has the lowest export
ratio of all EU countries. Greece’s exports of services
are focused on tourism and transportation, especially
shipping, while comparative advantages in tradable
goods are hard to detect. It even runs a trade deficit in
food products. Manufacturing exports primarily consist
of low-technology products.
Greece’s economic structure and openness imply that
Greek firms have little engagement in global competition,
resulting in negative consequences for productivity. Key
indicators on how conducive the Greek business environment
is for growth and productivity are not encouraging.
Regarding corruption, in Transparency International’s
Corruption Perceptions Index, Greece ranked 80 out
of 182 countries. In the World Bank’s Ease of Doing
Business Ranking, which measures how business-friendly
the economic environment is, Greece ranked 100. Its
labor markets are highly regulated and so are its product
markets. In fact, according to the OECD, it is among the
most highly regulated product markets in the OECD world.
Growth and structural reforms
The status quo of the Greek economy implies that
restoring competitiveness needs to include more than
cost competitiveness. A new growth model needs to
go beyond the important questions of prices, costs, and
wages. It should consider Greece’s advantages as well
as the areas it should develop. There is a strong need to
substantially improve business conditions and modernize
the Greek economy, thereby boosting productivity.
Improving productivity is a long-term project that involves
structural reform on many levels. Some policies — for
Eurozone
example, upgrading systems for education and innovation
— are crucial, but these improvements will mainly bear
fruit in the long term. Other structural reforms, like labor
market reforms, may have substantial transition costs.
However, some structural reforms have positive short- and
long-term effects.
Reforming product markets is one main example. It can
improve the functioning of markets by removing barriers
for services and entrepreneurship. Such reforms tend to
be associated with boosting long-term productivity and
labor utilization as well as with positive employment gains
in the short run. This goes especially for labor-intensive
sectors with pent-up demand such as retail, trade, and
professional services.
Stimulating growth by removing entry barriers and
product-market restrictions, especially in
services, is not only relevant for
Greece but for the European
Union as a whole.
The internal
market
has
been
a great
success
story over the
last 20 years. A
further deepening,
especially in the area
of services, promises
substantial economic
benefits. With short-term
fiscal stimulus becoming
extremely difficult under
Europe’s current fiscal
situation, growth needs
to come from structural
reforms. The future of
the Eurozone depends not
solely on the financial markets
but at least as much on the
real economy and its future
growth performance.
Geographies
References and
Research Sources:
European Commission, “Interim
Forecast February,” Directorate
General for Economic and
Financial Affairs, 2012.
Karl Brenke, “Greek Economy
Needs Growth Strategy,” DIW
Wochenbericht, German Institute
for Economic Research, 2012.
OECD, “Going for Growth,”
2012.
11

Dr. Carl Steidtmann is
Chief Economist at
Deloitte Research
12
USA
United States: Why the
euphoria?
by Dr. Carl Steidtmann
The stock market has forecasted nine of the past
five recessions.
— Paul Samuelson
The opposite is equally true; the stock market has also
forecasted nine of the past five recoveries. The S&P 500
hit its all-time high in March 2000 at 1,527. The economy
fell into a recession a year later. Growth since then has
been less than spectacular, and total employment is no
higher today than it was in 1999. The index managed to
briefly break above its old high in mid-October 2007, only
to slip into a deep recession that started in December. At
its current level, the S&P 500 is still below its old highs set
4 ½ and 12 years ago. The tech-heavy NASDAQ’s performance
has been even worse.
The stock market has been partying like it’s 1999. We have
seen an impressive rally since the lows of October 2011.
But then we saw an impressive rally in the previous year,
which was followed by less-than-impressive GDP growth in
the United States and contracting growth in no less than
22 countries around the world in the fourth quarter of
2011, including Japan, Germany, and the United Kingdom
— respectively the third-, fourth-, and sixth-largest
economies in the world. So, why the euphoria?

USA
Geographies
13

Global Economic Outlook 2nd Quarter 2012
Figure 1. Growth in central-bank balance sheets from January 2007
to February 2012
(Percentage change)
10-year
Treasury yield
5.5
5.0
4.5
4.0
3.5
3.0
2.5
2.0
1.5
600 700 800 900 1,000 1,100 1,200 1,300 1,400 1,500
S&P 500 daily closing price
14
250%
200%
150%
100%
50%
2007 - present Last 12 months
0%
ECB U.K China Japan U.S. Swiss
Source: European Central Bank, Bank of England, People’s Bank of China, Bank of Japan, U.S.
Federal Reserve, and Swiss National Bank
Figure 2. The S&P 500 and 10-year Treasury yield
Daily data
2007-Sept 2011
Linear (2007-Sept 2011)
Oct 2011 - March 2012
Linear (Oct 2011 - March 2012)
Source: European Central Bank, Bank of England, People’s Bank of China, Bank of Japan, U.S.
Federal Reserve, and Swiss National Bank
Central banks are pumping liquidity
Quantitative easing (QE) is not just for the U.S. Federal
Reserve. Around the world, we have seen unprecedented
efforts by all of the major central banks to buy assets,
expand their balance sheets, flood the banking system
with liquidity, depress interest rates, and give a boost to
asset prices (see figure 1).
In the past six months, the biggest contributor to global
liquidity unquestionably has been the European Central
Bank (ECB), whose two-tranche €1.02 trillion Long-Term
Refinance Operation (LTRO) program has expanded its
balance sheet by 50 percent and taken fears of potential
European bank failures due to a lack of liquidity out of
the markets.
Since mid-December, the actions of the ECB have sent
equity prices up and the interest rates on sovereign bonds
down. They also had a positive impact on commodity
prices, with copper and oil prices up 20 percent while
wheat, soybeans, and corn have risen more than 10
percent. It was the rise in commodity prices in spring 2011
that contributed to the Arab Spring protests throughout
the Middle East and did so much to undermine real growth
in the rest of the world in the summer and fall of 2011.
While the ECB has been re-liquefying the European
banking sector, the U.S. Federal Reserve has been engaged
in Operation Twist, a very successful effort to drive down
long-term interest rates by shifting Fed bond purchases
from the short end of the Treasury curve to the long end.
The effects of that policy, which went into effect last fall,
can be seen in figure 2.
Interest rates and stock markets tend to move in the same
direction. A rising stock market is generally accompanied
by rising rates as money flows from bonds into stocks.
That has not been the case over the past six months.
As the stock market has risen, longer-term interest rates
have fallen. Rates on the U.S. Treasury’s 10-year note are
roughly 200 basis points below the level based on their
historical relationship. While some might see this as the
best of all possible worlds, the Fed’s efforts to keep interest
rates depressed have unintended consequences.

Figure 3. Average price of regular gasoline — all formulations adjusted for dollar weakness and inflation
($ per gallon)
4.50
4.00
3.50
3.00
2.50
2.00
1.50
1.00
0.50
$0.00
2001 2003 2005 2007 2009 2011
Source: Energy Information Administration, St. Louis Federal Reserve
QE works by raising equity prices, lowering interest rates,
and reducing the value of a country’s currency. Higher
equity prices create a wealth effect, inducing consumers
to spend more and businesses to increase investment.
Lower interest rates reduce the cost of borrowing, encouraging
consumers to purchase big-ticket items like cars and
houses and businesses to take more risk. Finally, a lower
exchange rate gives a boost to exports while encouraging
consumers and businesses to buy domestic as opposed to
more expensive imported products.
Unintended consequences
The problem with QE is that it has unintended consequences
that offset its intended positive effects. A falling
dollar does more than just give a boost to exports. It also
gives a boost to the price of globally traded commodities
— in this case, oil. Oil prices rose sharply in spring
2011, following QE2 in the United States. They are rising
again following Operation Twist and the ECB’s LTRO. In the
United States, gasoline prices are pushing $4 a gallon (see
figure 3). In Europe, where energy taxes are much higher,
gasoline prices are approaching $10 a gallon.
Oil prices — when adjusted for changes in the consumer
price index and the declining value of the dollar — started
rising only three months ago, and they increased only
modestly in the last decade.
USA
Second, while low interest rates are great for both
consumer and business borrowers, they represent a significant
challenge for savers and pension funds. Businesses
with defined benefit pension funds have to put more
funds aside to fund these benefits when interest rates
are low. Likewise, savers and retirees receive significantly
less income from interest payments when interest rates
fall. Interest income in the United States has fallen $447
billion or 31.5 percent since its peak in August 2008,
just before the first round of QE. Risk-averse retirees are
being forced to take on more risk in order to fund their
own retirements.
The most worrisome aspect of QE is that it enables businesses,
consumers, and governments to take on more debt
and risk when the problem that the economy is trying to
come to grips with is an excess of debt. Low interest rates
Geographies
Price of gasoline
Price adjusted for
dollar weakness
Price adjusted for dollar
weakness and inflation
15

Global Economic Outlook 2nd Quarter 2012
16
If debt cannot be reduced through the process
of deleveraging, the only other alternative is a
reduction of the debt burden through inflation.
encourage leverage and put off the adjustment process
of deleveraging, distorting the economy and making the
eventual day of reckoning all the more severe.
Debt declined slightly during 2008 and 2009 (see figure
4). The decline was due largely to the sizable reduction in
mortgage debt that has come about through the foreclosure
process. Banks have also been forced to reduce
debt through a tightening of the regulatory process.
Nonfinancial businesses have seen their debt grow
modestly, and government debt growth has risen sharply.
Over the past year, total debt has increased by $781
billion. Nominal GDP grew by just $566 billion. Debt is still
being accumulated faster than GDP is growing.
Figure 4. U.S. total debt
(In trillions of dollars)
55.0
50.0
45.0
$40.0
2006 2007 2008 2009 2010 2011
Source: U.S. Federal Reserve
If debt cannot be reduced through the process of deleveraging,
the only other alternative is a reduction of
the debt burden through inflation. The rise of debt over
the past year greatly increases the future risk of much
higher inflation.
Curb your enthusiasm: Just the facts
The disconnect between equity markets and the real
economy can be seen in myriad different statistics. Here
are the most troubling of them:
1. Globally, real GDP growth contracted in no less than
22 countries in Q4 2011, including Japan, Germany, Italy,
Spain, the United Kingdom, Thailand, Singapore, Taiwan,
Indonesia, and Portugal. Purchasing managers’ indices
throughout Europe in the first quarter of 2012 show the
decline continuing and deepening.
2. In the United States, employment growth is mainly
in lower-paying jobs and temporary employment. The
economy still has 5.3 million fewer jobs than when the
recession started in December 2007.
3. The primary target of quantitative easing in the United
States was housing. It was hoped that lower mortgage
rates would stimulate borrowing. In mid-March, the
Mortgage Bankers Association’s index for new mortgage
applications had declined eight weeks in a row.
4. Despite unseasonably warm weather across the United
States in February, which should have boosted housing
activity, new home sales fell 1.6 percent, existing home
sales fell 0.8 percent, pending sales of existing homes
fell 0.5 percent, and housing starts fell 1.1 percent. It is
difficult for the economy in the United States to recover
without a recovery in housing. A robust housing market
gives a lift to new home construction, real estate, financial
services, and retail.
5. In addition to a decline in home sales, home prices
are also falling. Despite multiple predictions that housing
has finally started to recover, home prices continue to fall.
The most recent Case-Shiller Home Price Index was down
3.8 percent from a year ago and remains at its lowest level
since the peak in home prices in March 2007.
6. Business investment in information technology
has been weak. New orders for computers and related

Figure 5. Equally weighted coincidental indicator
(Percentage change — year-over-year)
10
8
6
4
2
0
-2
-4
-6
USA
Geographies
-8
1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010
Source: Bureau of Economic Analysis, Department of Labor, Bureau of Census and Federal Reserve
equipment were down three of the past four months from
October to February, for a total decline of 14.9 percent.
Shipments fell just 12.8 percent as the backlog of unfilled
orders contracted.
7. U.S. energy consumption is declining sharply. Gasoline
supplied to retail outlets is down 6.7 percent from a year
ago in March. Oil consumption is down 4.5 percent. These
are the largest year-over-year declines in more than 20
years, exceeding the declines that occurred during the
2007–2009 recession.
8. Shipping is showing multiple signs of distress. Trucking
and rail indexes are both declining. The American Trucking
Association’s truck tonnage index was down 4.1 percent
in February from its reading in December. North American
railcar loadings for the month of February were down 2.9
percent compared to January and down 1.9 percent from a
year ago. The Baltic Dry Index, a measure of global shipping
rates, collapsed from October to February, dropping from
2,173 to 647 before rebounding in recent weeks to a stilldepressed
908. As recently as June 2010, the index was
above 3,800.
9. Income from interest payments is again declining.
Operation Twist, which was designed to depress long-term
interest rates in hopes of stimulating housing, has had an
ill effect on interest income. While housing continues to
flounder, interest income has been declining. After a very
brief recovery in 2011, in January, interest income was
down 2.8 percent from a year ago.
10. Federal tax revenues are slumping. Over the past three
months ending in February, revenues are up just 0.6 percent
from a year ago when revenues were depressed by the
initiation of the temporary Social Security tax cut, which
was extended through this year.
11. Real income excluding government welfare payments
is still down 3.9 percent from its 2008 peak. Government
transfer payments now account for 19.5 percent of all
household income. Real disposable income was up just
0.5 percent in January. Real disposable income including
transfers is up just 0.5 percent from a year ago.
Where we are: Coincidental indicators
Since the end of World War II, there have been 14 cases
where real GDP growth from the previous year fell below
2 percent. In 11 of those cases, a recession followed. You
can build a coincidental indicator of the economy using
real disposable income, employment industrial production,
and real consumer spending, and you get largely the
same picture.
Over the past 50 years, when this coincidental indicator fell
below 2 percent for more than two consecutive months, a
recession followed (see figure 5). The indicator has correctly
anticipated all eight post-1960 recessions, including the
17

Global Economic Outlook 2nd Quarter 2012
18
recessions of 1960, 1969, 1973, 1979, 1981, 1990, 2000,
and 2007. In 1986, the indicator fell below 2 percent for
three nonconsecutive months as the collapse in oil prices
took its toll on the oil-producing regions of the country.
In December 1995, the sharp fall in real income sent
the indicator just below 2 percent. In December 1994,
Microsoft issued a massive one-time dividend that sent
incomes up in 1994 and down on a percentage basis
in 1995.
The recent performance of the indicator has not been
encouraging. Three of the four components of the
indicator (income, spending, and production) are decelerating.
The indicator has been below 2 percent for eight
of the past nine months. There has never been a previous
time when the indicator has performed in such a manner
and a recession has not followed.
Conclusions and observations: It’s the dismal
science, after all
It was Thomas Carlyle who labeled economics the dismal
science after reading Reverend Thomas Malthus. The
business cycle remains alive and well. The current cycle has
grown long in the tooth despite its young age. The U.S.
economy has struggled over the past nine months, despite
a soaring equity market. Growth has been given a boost
by inventory building, tax incentives that shifted activity
from late 2011 to early 2012, and unseasonably warm
weather. These are not the foundations upon which to
build a recovery.
Central banks around the world have been engaged in
aggressive quantitative easing for more than three years
now. There are limits to QE that are determined by its own
set of unintended consequences. QE distorts market prices.
The most obvious of these is the price of oil. Last spring,
rising oil prices offset the positive effects of the Fed’s
QE2 and left the economy with weak growth and rising
inflation. This spring, we once again have a rising stock
market and hopes of a stronger economy, this time as a
result of the European Central Bank’s first round of QE,
only to run into the same problem of rising energy prices.
The U.S. economy very well may be able to muddle along
for another year or two with subpar growth and rising
inflation. The risk, however, is from one of the many
fat-tail geopolitical risks, including a reemergence of the
European debt crisis, a harder-than-expected economic
landing in China, or a disruption of oil from Iran or
elsewhere. With inflation rising and so little margin for
error, there seems little reason for euphoria in the equity
markets or elsewhere.

Energy prices and consumer behavior
Wars are fought over it. Business cycles rise and fall around it. Political
elections are won or lost because of it. There are few prices in the
world that have a bigger impact on individuals, businesses, and even
governments than the price of oil. After falling steadily since the spring
of 2011, the price of oil reversed course in late December and has risen
sharply. The increase has been all the more surprising given the unseasonably
mild winter much of the United States is experiencing. Warm
winter weather traditionally puts downward pressure on energy prices
because demand for heating falls as the temperatures rise.
The spot price of West Texas Crude rose from $93 a barrel to $110
between mid-December and early March. Prices for Brent Crude in
Europe went from $102 a barrel to $126 over the same period of time.
Rising oil prices have taken the price of gasoline at the pump higher by
more than 50 cents a gallon in the United States.
Oil consumption began declining in April 2011 when oil prices peaked
and has accelerated over the past year even as prices declined in the
latter half of 2011. As of March 2012, oil consumption was down 4.5
percent from a year ago (see figure 6). Drops of this magnitude usually
have been associated with recessions. The decline in oil consumption
could be due to a number of factors. Energy productivity traditionally
rises in the face of rising prices and continues to rise for several years
following a price spike. Warmer winter temperatures are also holding
down consumption of heating oil, contributing to some of the decline.
The biggest decline, however, has come in gasoline.
Gasoline is both economically and politically important. It is a
commodity that most households purchase on a regular basis. It
directly affects consumer confidence and approval of current political
leadership even though that political leadership generally has very little
to do with the actual price. It can also have a signficant impact on
consumer behavior.
Every penny increase in the price of gasoline costs U.S. consumers an
extra $3.8 million a day. An increase of 50 cents a gallon translates to
$190 million a day, $5.7 billion a month, and $68.4 billion a year. In
January, household income, after adjustment for taxes and inflation,
was up just $60 billion from a year ago. Higher prices for gasoline are
showing up in two places: lower gasoline consumption and fewer
miles driven.
Gasoline consumption is down 6.7 percent from a year ago on a threemonth
moving average basis, an even greater drop than the demand
for oil (see figure 7). The drop is even more surprising given the severity
of last winter when compared to this year’s mild weather. Milder
weather should have prompted more driving.
The drop in gasoline consumption represents a combination of
improved energy efficiency coupled with a significant decline in driving.
Total miles driven on a 12-month moving average basis fell 1.2 percent
in 2011 from a year ago (see figure 8).
Over the past 40 years, there have only been three periods of time
when the number of miles driven declined. All three were associated
USA
Geographies
with deep recessions and sharply higher gasoline prices. While high
gasoline prices limit driving, there are several others at work as well.
Internet shopping continues to climb, taking share away from store
purchases and reducing the number of shopping trips. Telecommuting
has become a much more common practice and probably accounts for
some of the decline as well.
Rising energy prices have been a major factor in six of the past seven
recessions since the first major oil price spike back in 1973–1974.
Improved energy productivity, higher gas mileage, and greater use of
the Internet for both shopping and work has reduced but not eliminated
the exposure of the U.S. economy to current and future rises in
the price of oil. As was the case in the spring of 2011, the United States
and the global economy are once more at risk from rising energy prices.
Figure 6. U.S. petroleum products supplied
Three-month moving average, year-on-year change through March 2012
15
12
9
6
3
0
-3
-6
-9
-12
1970 1975 1980 1985 1990 1995 2000 2005 2010
Source: U.S. Energy Information Administration
Figure 7. Gasoline supplies delivered
13-week moving average, year-on-year change through March 2012
8
6
4
2
0
-2
-4
-6
-8
1993 1996 1999 2002 2005 2008 2011
Source: U.S. Energy Information Administration
Figure 8. Total miles driven
12-month moving average, year-on-year change through December 2011
8
6
4
2
0
-2
-4
1971 1975 1979 1983 1987 1991 1995 1999 2003 2007 2011
Source: U.S. Department of Transportation
19

Global Economic Outlook 2nd Quarter 2012
ChINA
20
China: Soft landing now,
uncertainty later
by Dr. Ira Kalish
The Chinese economy grew 9.2 percent in 2011, and it is
widely expected to grow significantly slower in 2012. The
questions is how much slower. The Chinese government
recently revised its own forecast for 2012 growth from
8 percent to 7.5 percent. Such growth would be widely
seen as a “soft landing.” It is the result of slower growth
overseas having a negative impact on export growth.
On the other hand, the central bank has eased monetary
policy in order to boost domestic demand to offset the
decline in exports.
The details
As of now, the economy is gradually moving in a negative
direction. In the first two months of 2012, there was a
decline in exports and a decline in the flow of foreign
direct investment into China. As of March, there have
been four consecutive months of declining manufacturing
activity, according to a survey of purchasing managers
conducted by the private sector. Investment in both
residential and commercial property has tailed off, and
government spending on infrastructure has slowed down.
In addition, Chinese demand for commodities has decelerated,
boding poorly for industrial output.
All of this was due largely to the slowing of economic
activity outside of China, principally in Europe. In response
to this slowing, China’s central bank has twice lowered
the required reserve ratio for commercial banks with the
intention of boosting liquidity and credit market activity.
Still, the combined drop in the reserve ratio of 100 basis
points does not come close to offsetting the 600 basis
point increase that took place over the past two years.
That tightening of monetary policy had taken place in
order to fight inflation, a fight that has largely been a
success. That is why the central bank is now comfortable
engaging in a gradual easing of monetary policy. More
is expected.
The success of the easing of monetary policy is evident
by the gradual nature of the slowdown — often called
a “soft landing.” Indeed, the Conference Board’s index
of leading economic indicators for China actually rose in
January, suggesting that prospects in the months ahead
are fairly good.
In addition, government policymakers have signaled a
willingness to take new action to offset the negative
headwinds facing China. For example, the government is
trying to boost first-time home ownership by providing
first-time buyers with incentives in the form of low interest
rates and small down payments. This is at a time when the
government continues its efforts to puncture the housing
bubble and discourage speculative activity in the housing
market. The government has also targeted the rural sector
for an easing of credit market conditions.
In addition, recent government actions have been
designed to boost consumer purchasing power as well
as alleviate income inequality. In Beijing, Shenzhen, and
Shanghai, the minimum wage has substantially increased.
In the last week of February, the minimum wage in
Shanghai rose 13 percent. This follows an average 22
percent increase in the minimum wage in 2011 in 24
major cities. The idea is to boost consumer spending,
enable factory workers to improve their standard of
living, reduce income inequality, and reduce the risk of
social unrest.

Longer term
Recovery overseas will eventually lead to a revival of strong
growth in China. Or will it? The problem is that, although
China seems destined to avoid a “hard landing” for now,
there are reasons to worry about this further down the
road. The ability of China to maintain growth in the wake
of the crisis in 2008–2009 was due to massive government
support for investment. This investment now represents
48 percent of GDP, widely viewed as unsustainable as
has been discussed on these pages in the past. That is
why there has been much discussion lately about reform
in China.
The government recently cooperated with the World Bank
in producing a report titled China 2030, which offers ideas
on how China can sustain growth going forward. The
report says that China’s current economic model is not
sustainable and must be changed. It calls for more privatization
of state-run enterprises, more reliance on market
forces, the end of restrictions on internal migration, a
boost to the social safety net in order to encourage more
consumer spending, more transparent capital markets in
order to funnel capital to the most profitable investments,
and better fiscal controls for local governments that are
currently laden with debt.
It is not likely that these or other reforms will be enacted
this year. That is because 2012 is a year of transition to
new leaders. The outgoing Premier, Wen Jiabao, has
spoken out about the urgent need for reforms. Incoming
Premier Li Keqiang said that China must “deepen reforms
on taxes, the financial sector, prices, income distribution,
and seek breakthroughs in key areas to let market
forces play a bigger role in resource allocation.” Yet, there
China
has been nothing more specific than this. Consequently,
there is some uncertainty as to nature and timing of
future reforms. Failure to reform could allow imbalances
to fester, leading to a crisis in the future. Reforms, on the
other hand, could be disruptive and might challenge the
interests of those that benefit from the current system.
As such, China has no easy path. Meanwhile, the leadership
debates the proper role of government, the growing
problem of income inequality, and the degree to which
changes in the political system are needed to ensure
economic reform. Stay tuned.
Kicking the can down the road
In a year when political power will be transferred, the
government is evidently keen to avoid major disruption
to the economy. As such, it is likely that the government
will utilize fiscal tools to boost economic activity if the
economy faces even greater headwinds from abroad. In
addition, the government has shown a desire to avoid, or
at least postpone, the turmoil that might come from the
unwinding of imbalances. Specifically, as discussed in this
publication recently, local governments have accumulated
about $1.7 trillion in debts that many analysts deem unsustainable.
Moreover, a loss of revenue from weak land sales
has exacerbated the problem of servicing this debt. Many
analysts had recently been concerned about the possibility
of an imminent crisis if banks were forced to write down
these debts. Instead, the government has instructed banks
to roll over the local government debt, thereby postponing
the day of reckoning. Thus, there will probably not be a
crisis any time soon.
Geographies
21

Ian Stewart is Chief
Economist at Deloitte
Research in the United
Kingdom
22
UK
United Kingdom: The outlook
brightens
by Ian Stewart
Our last article about the United Kingdom, which was
written in late-December during a time of pessimism
about the outlook for the euro and for European growth,
concluded, “What will be the signal to turn more bullish
on UK growth and risk assets? For us, it is a marked easing
Figure 1. Deloitte financial stress index
300
250
200
150
100
50
0
of financial and sovereign stress in the Euro area.” Three
months of financial and sovereign stress has, indeed,
eased significantly (see figure 1), and with it, the outlook
for the UK has brightened.
2006 2007 2008 2009 2010 2011 2012
The Deloitte Financial Stress Index is an arithmetic average of the ratio of the three-month LIBOR to base rates, the ratio of yield
on high yield bonds to yield on government bonds, the VIX index, the ratio of total market return to banking stocks return and
the ratio of yield on long-term government bonds to yield on short-term bonds.

UK
Geographies
23

Global Economic Outlook 2nd Quarter 2012
Figure 2. Financial prospects
Net % of CFOs who are more optimistic about financial prospects for their company now than
three months ago
More optimistic
70%
24
50%
30%
10%
-10%
-30%
-50%
-70%
Less optimistic
Figure 3. Consensus GDP growth forecasts for 2012
3.5%
3.0%
2.5%
2.0%
1.5%
1.0%
0.5%
0
-0.5%
-1.0%
2007 2008 2009 2010 2011 2012
Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1
Source: Deloitte CFO Survey
Mar-11 Jun-11 Sep-11 Dec-11 Mar-12
Source: Consensus forecasts from The Economist
US
Japan
Britain
Euro area
Changes in the outlook are often seen first in survey
data, and a number of surveys point to a bounce in
business confidence. The first quarter Deloitte UK CFO
Survey shows that confidence among Chief Financial
Officers about their own firms’ finances has risen at the
fastest rate since 2007, taking it close to levels last seen
in late 2010 (see figure 2). The worries about the risk
of recession and a breakup of the single currency that
dominated the air waves and newspapers at the end of
last year have eased. On average, CFOs now assign a 30
percent probability to the UK economy seeing a double
dip recession, down from 54 percent in December. In the
Euro area, the extensive provision of liquidity to banks by
the European Central Bank and a further debt bailout for
Greece has reduced fears of an early breaking of the single
currency. Last December, UK CFOs, on average, saw a 37
percent probability of one or more members of the single
currency leaving the euro in 2012, and this clearly weighed
on business confidence. By March, this probability of
secession fell to 26 percent.
Easier policy has also helped confidence and boosted
financial risk appetite. The United States, UK, Japan and
Switzerland have been busy pushing money into the
system through quantitative easing. Stronger financial
conditions, reflected in rising global equity markets, seem
to be benefiting larger UK companies, with CFOs reporting
an increase in credit availability in the first quarter. This
more than unwinds the deterioration in credit availability
seen in December, which at the time, some feared could
be the start of a second credit crunch. And, as a very open
economy, the UK has also benefitted from the growing
mood of optimism about the U.S. economy over the last
few months.
It would be a premature to suggest that the UK economy
is out of the woods. UK GDP growth in the first half of
2012 is likely to be anemic at best. While the Bank of
England thinks the UK should be able to avoid a recession,
the OECD reckons the UK entered a technical recession
in late 2011. And, of course, the future remains unpredictable.
The deterioration in UK and European growth
prospects in the second half of 2011 (see figure 3) derailed
what, in early 2011, seemed like a solid recovery. That
episode underscored how macroeconomic risks can
escalate. Those risks may have receded, but they have

hardly been eliminated. From the high oil price to the
recent focus on Spain’s debt problems, the risks to the
recovery are changeable and numerous.
In the background is the worry that rates of UK GDP
growth could remain anemic for years to come. On
average, economists expect UK growth over the next few
years to run at significantly lower levels than were seen in
the years before the recession. Current near-record levels
of UK corporate cash may well be a manifestation of
caution on the part of corporates — and insurance against
a volatile, slower-growth world in which the availability of
capital can shift quickly.
Yet, it is the corporate sector’s hiring, exports, and
capital spending that are widely expected to drive the
UK recovery. A rebound in corporate sector activity may
be later in arriving than previously thought (see figure
4). In the last six months, the UK’s official, independent
forecaster, the Office of Budget Responsibility, has cut its
forecast for capital spending in 2012 from 7.7 percent to
just 0.7 percent.
Figure 4. UK private and public sector job growth (thousands)
400
300
200
100
0
-100
-200
-300
Source: ONS
2007
Q1
Q2 Q3 Q4
2008
Q1
With the UK in its third year of a seven-year program
of fiscal austerity, government spending will make no
contribution to the recovery. Households face a multi-year
deleveraging and rising unemployment, but, after a double
dip recession for the consumer last year, things are looking
up. Falling inflation should support real incomes. UK
consumers’ days of free spending are over, but household
spending should make some modest contribution to GDP
growth in 2012.
Overall, 2012 is likely to be a year of erratic, sluggish UK
growth, which is likely to come in at well under 1.0 percent
for the year as a whole. Hopes for a more robust recovery
now reside toward the end of the year and in 2013.
Whether that recovery materializes depends as much on
financial and economic conditions outside the UK — and
especially in the Euro area — as it does on the actions of
UK policymakers.
Private sector job growth
Public sector job growth
Q2 Q3 Q4
2009
Q1
Q2 Q3 Q4
2010
Q1
UK
Geographies
Q2 Q3 Q4
2011
Q1
Q2
25

Siddharth Ramalingam is
an Assistant Manager at
Deloitte Research, India
INDIA
26
India: A delicate balance
by Siddharth Ramalingam
Growth is slowing down, investment is falling, and
business sentiment is on the decline. The recent Union
Budget and policy announcements by the central bank
have not mollified fears of possible economic slowdown.
All quarters of the economy are hoping for more — in
terms of measures to ensure long-term inflation stabilization,
reduction of the fiscal deficit, and a drop in
interest rates.
All is not well in the workhouse
For the last several months, the Indian economy has
been torn between controlling inflation and maintaining
robust economic growth. In order to control skyrocketing
inflation, the Reserve Bank of India chose to sacrifice
growth in order to rein in inflation. The 20-month period,
until October 2011, of rising interest rates has slowly but
surely put the brakes on economic growth. Industry is
increasingly worried about the high cost of capital, and the
manufacturing sector is showing signs of stagnation.
GDP growth in the third quarter of the current fiscal year
came in at a woeful 6.1 percent, marking a sharp drop
from 7.7 percent growth in the first quarter, and 6.9
percent in the second quarter. Manufacturing growth
slipped to 0.4 percent from 7.2 percent and 2.7 percent
in the first and second quarters respectively. The seventh
successive quarterly slowdown and the slowest growth in
three years have triggered fears that the economy slowed
down further in the last quarter of the current fiscal
(January–March 2012) and that overall growth for the
fiscal year could fall short of the downwardly revised target
of about 7.0 percent. Furthermore, despite the finance
minister’s exhortation that the economy will grow at about
8.0 percent in the next fiscal, it is possible that growth will
stagnate at a “new normal” of about 6.0 percent unless
significant efforts are made toward improving credit conditions
and resurrecting investments in the coming months.

India
Geographies
27

Global Economic Outlook 2nd Quarter 2012
28
Growth data from India’s eight core infrastructure sectors,
although showing improvement in February after a disappointing
January, provide no cause for cheer. The core
sectors expanded 6.8 percent in February, compared
to January’s growth of just 0.5 percent. Growth in the
factory sector slowed down for the third month in a row
in March as new orders continue to fall and raw material
prices headed north. The HSBC manufacturing Purchasing
Managers’ Index fell to 54.7 in March from 56.6 in
February and 57.5 in January.
India’s exports grew 4.2 percent in February, the slowest
pace of growth in three months. Imports, on the other
hand, grew 20.6 percent, translating into a trade deficit of
$15 billion. The commerce secretary recently expressed his
concern over the burgeoning trade deficit as weak demand
from Western markets and global political developments
are likely to exert a drag on exports in 2012.
Inflation: The artful dodger
Although inflation dropped to a 26-month low in January,
it seems unlikely that it will stabilize at the current level,
casting doubts on whether the central bank can really
afford to reduce interest rates at this time. Headline
inflation accelerated in February after five months to about
7 percent. Core inflation, or inflation minus the effects of
food and fuel prices, fell to 5.8 percent in February. While
this does mean that demand-driven inflation is falling, it
could also imply that demand for manufactured goods
is actually on the decline, adding credence to fears that
the manufacturing sector is heading toward stagnation.
Conversely, the fall in core inflation also implies a rise in
food and fuel prices. After hitting near-zero inflation in
January, food prices rose about 6 percent in February.
Recent announcements by meteorologists predict a
below-average rainfall this year, and absent any removal
of supply-side bottlenecks in the agriculture sector, food
inflation could spiral upward in 2012, taking overall
inflation well above the government’s target level of about
7.0 percent for the rest of the year.
The fiscal deficit continues to be a cause for concern.
Notwithstanding last financial year’s fiscal deficit of 5.9
percent of GDP instead of the planned level of 4.6 percent,
the government has set a “realistic” target of 5.1 percent
for the current fiscal in the recently unveiled budget. Not
only may the target be unsustainably high, the credibility
of the target for the current fiscal year has already been
called into question by market commentators. A large
fiscal deficit surely does not bode well for inflation.
Policy fears
The government stressed that reining in fiscal, revenue,
and current account deficits while controlling inflation
were the main aims of the recently unveiled budget. The
proposed debt-to-GDP ratio is 45.5 percent, down from

At a time when the government can ill afford
deterioration in its current account deficit,
recent policy proposals seem, at the very least,
badly timed.
last year’s 50.1 percent. The finance minister also proposed
to reduce outlay on subsidies to below 2 percent of GDP
from the current level of 2.5 percent. However, skeptics
believe that the targets and measures proposed are neither
spectacular nor attainable. It has been argued that the
government has neither the political desire nor support
to reduce subsidies on food, fuel, and fertilizers, apart
from pushing through important policy reforms that are
important for fostering growth. Furthermore, the Goods
and Service Tax, the much-vaunted plan for fiscal consolidation,
is pending the resolution of key issues regarding
the division of revenues between the center and the states.
In the run up to the budget, foreign investors had looked
to the government for policies that would aid investment
in India. However, post budget, there is increasing worry
that recent government stances on foreign investment
may not be tolerated by foreign investors. The government
introduced a proposal that will allow tax authorities to
crack down on companies that may have structured deals
to avoid taxes. Firms, Indian and foreign, that have routed
their investment in India through Mauritius are potentially
under scrutiny. Another proposal to tax cross-border deals
involving the transfer of Indian assets, with retrospective
effect stretching back until 1962, is worrying current and
potential investors. At a time when the government can
ill afford deterioration in its current account deficit, recent
policy proposals seem, at the very least, badly timed.
India
Few policy options
Inflation, the barb that had threatened to derail India’s
growth for several months, had been on the decline over
the last several weeks. Inflation dropped to a 26-month
low of 6.5 percent in January after remaining above 9.0
percent for much of 2011. However, inflation is on the rise
again, and it is likely to stay in the 7.0–9.0 percent range
in the coming months. The central bank cannot afford
to conclude that the inflation will stabilize in the medium
term. In fact, the central bank has announced that it
would be “premature” for it to start reducing interest
rates without seeing any abatement of inflationary threats
exerted by the high fiscal deficit and global energy prices.
Thus far in 2012, the central bank has already eased the
reserve requirements for banks, infusing liquidity into the
economy. It is likely that further liquidity could be infused
into the economy in the coming months. Measures to
ease liquidity may, however, not be enough to provide
a much-needed fillip to the economy. Growth is slowing
down, investment is falling, and business sentiment is
on the decline. Absent any credible government action,
the central bank may not be able to stave off calls for
reducing the interest rate for too long. In the final analysis,
questions about whether or not the interest rate will be
reduced are giving way to when and how dramatically it
will be cut.
Geographies
29

Global Economic Outlook 2nd Quarter 2012
JAPAN
30
Japan: New risk
factors
by Dr. Ira Kalish
Worrying about trade and debt
For some time, pundits have bemoaned the fact that
Japan’s sovereign debt is roughly 200 percent of GDP,
which is widely viewed as an unsustainable number that
puts Japan at risk of a financial crisis. However, other
observers remain unalarmed because Japan runs a current
account surplus. In other words, Japan saves so much
that the savings exceeds the funds needed to service
government debt and fund domestic investment. There is
still money left over to lend to or invest in the rest of the
world. Thus, Japan’s massive government debt should not
be viewed as a problem because of its formidable savings.
Yet, that is only true as long as Japan runs a current
account surplus.
That assumption is now being brought into question. In
January, Japan ran a trade deficit. The current account
balance is the trade balance plus net interest payments.
Those interest payments are so large that Japan still had
a current account surplus in January. Yet, the fact that
Japan ran a trade deficit raised eyebrows. If continued, it
could ultimately lead to a current account deficit. If that
were to happen, servicing the large sovereign debt could
be problematic. If markets perceived that to be so, they
could push up the yield on Japanese government bonds,
further exacerbating the problem of bringing the debt to a
sustainable level.
Why did Japan run a trade deficit? The main reason is that,
following the earthquake, most of Japan’s nuclear power
plants were idled. Thus, Japan had to import massive
quantities of oil and natural gas in order to generate
electricity, so the import bill rose. At the same time, a high
valued yen conspired with weak demand in Europe to
cause exports to falter. Moreover, rising oil prices could
worsen the situation. The good news is that there was a
trade surplus in February. Still, the stage is not yet set for a
sustained improvement in the trade balance.
Aggressive monetary policy
One of the problems for exporters has been the high
valued yen. However, in recent months, the yen has
declined somewhat, thereby boosting the competitiveness
of exports. This shift was mainly due to a change in
monetary policy. The Bank of Japan (BoJ) has implemented
two rounds of asset purchases (often known as quantitative
easing), the second of which was announced in
February and involved 10 trillion yen ($130 billion). The
effect of this was to boost liquidity, boost expectations of
inflation, and put downward pressure on the yen. Indeed,
the yen fell from roughly 77 yen per dollar to 83 yen
per dollar.
Now there is talk of another round of asset purchases.
There are two reasons for this. First, inflation remains close
to zero even though the BoJ set an explicit inflation target
of 1.0 percent. While the program of asset purchases
ended deflation and created a bit of inflation, it may not
be sufficient. Second, there is concern that the yen could
bounce back as long as the Japanese currency is seen as a
safe asset in a world of risk. Further financial market stress
in Europe or a stumbling of the U.S. economy could cause
the yen to shoot up.
Fiscal issues
Meanwhile, the Japanese government is determined
to put Japan on a sustainable fiscal path. Japan faces
several problems. First, the debt is already very large
and higher bond yields would make the situation worse.
Second, Japan’s economy has grown very slowly, thereby
generating modest revenue gains. Third, deflation meant
that incomes were declining or stagnant at best, thus
suppressing government revenue. Finally, the aging population
means that future spending on pensions and health
is likely to increase substantially. Many observers worry
that, without a plan to create fiscal probity, Japan could
face a serious crisis in the not-too-distant future.

The solution, according to Prime Minister Noda, rests
in raising the sales tax from the current 5 percent to 10
percent by 2015. This plan has become hugely unpopular,
and it is not clear that it will pass the Parliament. If it
doesn’t pass, confidence could be undermined, leading to
higher bond yields. If it does pass, however, the effect on
growth could be negative. Thus, Japan is caught between
a rock and a hard place. Moreover, failure to pass Noda’s
legislation would be indicative of a larger problem of
political gridlock. This means that passage of other reformoriented
legislation would be less likely.
Growth outlook
Given the fiscal, trade, and energy situations, one could
be forgiven for expecting poor economic performance.
However, the reality is likely to be somewhat different —
at least in the short run. There are a number of factors
that should boost growth in the coming year. That would
be welcome, given that Japan’s economy shrank by 0.9
percent in 2011. Moreover, GDP declined in the fourth
quarter at an annual rate of 2.3 percent. That was largely
due to a decline in inventories and a drop in exports.
The latter was due to the temporary effect on Japanese
supply chains emanating from the floods in Thailand. The
Japan
good news is that the factors hurting growth in the fourth
quarter were temporary.
In 2012, growth should resume for several reasons. First,
Japan’s government is expected to continue to spend
massively on reconstruction, thereby boosting domestic
demand. Second, the Thai floods are over, and supply
chains have resumed. Third, the aggressive monetary
policy has suppressed the yen, which should help export
competitiveness. Fourth, the aggressive monetary policy
has also boosted expectations of inflation, which have
the effect of cutting real interest rates. This should help
boost credit demand. Fifth, higher inflation could stimulate
consumers to spend more. Sixth, following the depletion
of inventories in the fourth quarter, businesses are likely
to engage in inventory rebuilding in early 2012. Finally,
the rest of the world is not doing as badly as previously
expected. This should help to stabilize exports.
Thus, a reasonable expectation for 2012 is that the
Japanese economy will grow between 1.0 and 2.0 percent,
inflation will be positive, and the yen will not resume
its appreciation.
Geographies
31

BRAZIL
Global Economic Outlook 2nd Quarter 2012
32
Brazil: Worried about
capital inflows
by Dr. Ira Kalish
At a meeting of the BRICS countries in India in late March,
the Brazilian delegation sought a statement criticizing
the monetary policies of Europe and the United Sates.
The statement never happened, but the fact that Brazil
sought such a statement indicates what is top-of-mind
for Brazilian policymakers. The low interest rate policies of
Europe and the United States have led investors to look
elsewhere for higher returns. Naturally, Brazil has become
a favored destination for funds in search of return. After
all, Brazil currently has among the highest interest rates in
a stable country. The inflow of funds threatens to increase
the value of the currency enough to seriously damage
export competitiveness.
In addition, the Brazilian government says the country
is awash with cheap imports. As such, Brazil intends to
complain to the WTO that the 35 percent tariff ceiling that
it authorized is too low. This could alarm China, which is
Brazil’s largest trading partner. It could also alarm other
members of the WTO that are concerned about Brazil’s
potential tilt toward protectionist policies.
One solution, of course, is for Brazil to cut interest rates,
and indeed, this has been happening. The problem is that
Brazil’s inflation is lingering above the central bank’s target
of 4.5 percent. Cutting interest rates too quickly, while
beneficial to the currency, could lead to higher inflation.
Moreover, higher inflation would lead to higher labor
costs, thereby damaging the competitiveness of exports
even more. On the other hand, failure to sufficiently cut
rates could result in an increase in the value of its currency.
This would be troublesome, given that exports are already
faltering due to the economic slowdown in Europe. So, like
many other countries, Brazil is in a difficult position.
Interestingly, Brazilian policymakers complain about the
inflow of capital, even as Brazil needs an inflow of capital.
Since Brazil is running a current account deficit, meaning
that the country is a net borrower, capital inflows are
needed to finance the deficit. Otherwise, Brazil would have
to borrow from abroad. Of course, the best kind of capital
inflow would be foreign direct investment (FDI) rather
than the portfolio flows now entering the country. That is
because FDI is more stable and less vulnerable to the mood
swings of global investors. When investors get spooked,
they can withdraw their cash more easily than a factory.
The current situation and the outlook
After four 50 basis point interest rate cuts in the last four
months, the Brazilian central bank surprised markets by
cutting the benchmark rate by 75 basis points in March
and another 75 in April. The benchmark rate stood at
9.0 percent as of the end of April. This follows news that
Brazilian industrial production fell in January at its steepest
pace in three years. Not only is the central bank trying to
boost economic activity, it is also trying to reduce upward
pressure on the currency, which has risen 5 percent
this year.
In the coming year, it is likely that interest rates will
continue to be cut further in order to stimulate a relatively
dormant economy. This expectation is based on the statements
of Brazil’s central bankers. Brazil may err on the
side of stronger growth rather than containing inflation.
However, it is not likely that Brazil will allow inflation to get
out of hand.
Economic growth, which was strong in 2010, decelerated
considerably in 2011. Indeed, Brazil’s economy stalled
in the third quarter of 2011, a far cry from the rapid
growth of 7.5 percent experienced in 2010. All sectors of
the economy were down except for exports. Consumer
spending, which accounts for 60 percent of GDP, declined.
This may represent the end of the debt-fueled consumerspending
boom. Business investment also dropped. Exports

grew, but at a slower rate than in the previous quarter.
Agricultural output increased at a good pace, but industrial
output was down. Clearly, the end of growth was not only
due to the Eurozone crisis. Rather, the lagged effects of
tight monetary policy, which subsequently reversed, may
have had an impact.
The government, keen to boost growth, will probably
increase fiscal spending in the coming year, financed by
borrowing. In addition, the government is expected to
continue its auction of assets to stimulate private sector
investment in infrastructure. It has already auctioned the
right to operate several airports. The intended result is
for investment spending to contribute to growth, the
auctions to contribute to public finances, and the actual
investments to boost longer-term growth prospects by
improving productivity. Moreover, infrastructure investments
will be critical to the preparation for the 2016
Olympics in Rio.
Brazil
Another major area of investment is energy. Brazil sits
astride massive ocean-based reserves of oil. Petrobras, the
state-run energy company, intends to double production
by the end of the decade. To do this, it may engage in
more capital spending over the coming decade than any
other company in the world.
The bottom line is that growth in 2012 may gradually
recover, assuming that outside events don’t conspire to
throw a monkey wrench in Brazil’s plans. Such events
could include a deeper Eurozone recession, a steeper
increase in the global price of oil, or a global financial crisis
that could lead to capital flight.
Geographies
33

Global Economic Outlook 2nd Quarter 2012
RUSSIA
34
Russia: Conflicting influences
by Dr. Ira Kalish
Russia’s economy is performing reasonably well, but
it faces some obstacles going forward. In 2011, the
economy grew 4.3 percent. This included consumer
spending growth of 6.4 percent and investment growth
of 6.0 percent. However, growth is likely to be somewhat
slower in 2012, given global headwinds. Slower growth
in Europe and China will have a negative impact on the
volume of exports. About two-thirds of Russia’s exports
are energy related, and energy demand may decline in
these markets. In China, for example, which is Russia’s
largest single export market, demand for energy is
expected to dampen considerably. On the other hand,
there has been a significant increase in the global price of
oil lately, largely the result of political risk. This will boost
Russian export revenues and contribute to continued
trade surpluses.
Influences on growth
There are other factors that will influence growth in
2012. First, credit market conditions in Russia have
been good. Credit for consumers and construction has
grown rapidly, fueling a boom in consumer spending and
construction activity. Moreover, stabilization of European
financial markets — the result of massive ECB lending
to commercial banks — bodes well for Russia. Although
Russia runs a current account surplus, making it a net
creditor nation, it has a deficit in net interest payments.
Consequently, Russian access to global credit markets
is important. With Europe evidently stabilizing, Russian
credit market conditions are likely to remain relatively
good.
Second, wages have been rising faster than inflation.
This increase in real wages has also contributed to
rising consumer spending. It is largely due to a sudden
and unexpected decline in the rate of inflation. Lately,
prices are up only 4.3 percent over a year ago. This
low inflation, in turn, is partly due to the government’s
decision to postpone increases in a tax on energy, which
was originally scheduled to be implemented in January
of this year, but instead was postponed to July. Thus,
inflation was temporarily suppressed. In addition, a
rising value of the currency recently had a disinflationary
impact. On the other hand, there is concern in the
market that inflation is likely to rise in the coming year.
Unless nominal wages keep up, consumer purchasing
power might be negatively influenced. In addition, rising
inflation is likely to constrain the central bank in its ability
to operate an easy monetary policy. Thus, interest rates
might not come down any further. The expected rise in
inflation is due to the imminent rise in energy taxes, the
impact of rising oil prices, and the lagged impact of an
easy monetary policy.
Third, fiscal policy has lately been expansionary in
anticipation of the recent presidential election, thus
contributing to economic growth. It was made possible
by higher-than-expected oil prices, which have boosted
government revenues. The result, interestingly, has been
a budget surplus when the government had originally
anticipated a deficit in the year that just ended. In the
coming year, government expenditures are likely to
continue growing in areas such as defense, public sector
compensation and pensions, infrastructure, and social
spending. Again, this is feasible given the relatively high
price of oil. On the other hand, it is estimated that if
elevated spending is maintained, Russia will require an
oil price of about $120 per barrel in order to balance
the budget. As recently as 2007, an oil price of $55 was
sufficient to balance the budget. The risk for Russia is

that if the price of oil were to decline, then fiscal probity
would be thrown into question. The government would
then face a choice of fiscal contraction, which would have
a negative impact on GDP growth, or continued borrowing
and spending. Given that the currently high price of oil is
largely related to a political risk premium, the possibility of
a drop in the price cannot be dismissed.
Fourth, capital flight remains a problem and reflects
a dearth of confidence in Russia’s immediate future.
Capital flight diminishes business investment from what it
otherwise would be. Interestingly, capital flight is taking
place at the same time that foreign direct investment is
increasing. The latter reflects increased investment in the
energy sector, especially as the government has lately
taken a more open attitude toward foreign involvement in
energy development. Despite capital flight, the currency
recently rose in value, reflecting the rise in oil prices.
Longer term issues
Vladimir Putin was recently elected president for the third
time, replacing outgoing President Medvedev. He will now
serve a six-year term. His margin of victory was substantial
and, therefore, sufficient to quash skepticism. Although
Russia
we know who will lead Russia, the policy regime remains
somewhat murky. It is not known whether Mr. Putin will
move toward market orientation or support a more statist
set of policies.
Notably, Mr. Putin has cited China and South Korea as
examples of favorable growth environments. China, in
particular, has relied heavily on state direction of the
economy, while South Korea relied on state protection of
favored industries in the early stages of its industrial development.
As such, Putin’s comments suggest a good deal
of government involvement in economic management.
On the other hand, Russia is set to join the World Trade
Organization (WTO) this year. Membership will require
more openness on trade-related issues.
The most pressing challenge that Mr. Putin will face in the
coming years is the level of investment as a share of GDP.
Currently, it is inadequate for generating strong growth.
Moreover, the level of investment in the energy industry,
while rising, remains insufficient to substantially boost
production. Boosting investment, in part by generating
more foreign direct investment, will be critical.
Geographies
35

Pralhad Burli is a
Senior Analyst at
Deloitte Research, India
36
INDONESIA
Indonesia: Unlocking potential
by Pralhad Burli
While several European economies are reeling under the
shadow of a worsening debt crisis, Indonesia’s performance
has been nothing short of stellar. In 2011, the
economy grew at its fastest pace in over 15 years. Robust
economic growth backed by fiscal prudence prompted
rating agencies to raise Indonesia’s sovereign credit rating.
Moreover, Indonesia’s economy has shown remarkable
resilience following the currency crisis of the late 1990s,
and it is currently better positioned to handle external
shocks. As a result, economists, finance specialists, and
international investors have plenty of reasons to be excited
about Indonesia’s prospects.
A macroeconomic mixed bag
With nearly 240 million people, Indonesia is the fourth
most populous country in the world. Furthermore, more
than half the population is under the age of 30. At over
$3,300, Indonesia’s per capita income is over twice as high
as India’s. While there is a huge disparity in income levels,
the gap is expected to narrow. In addition, Indonesia
is likely to experience a significant shift in its consumer
market as a large portion of its population enters the
middle class. As a result, Indonesia is a very important
consumer market, and domestic consumption remains an
economic mainstay. International retailers, as a result, can
make a strong case for entering or expanding operations
in Indonesia over the next few years.
If the government’s plan to roll back fuel subsidies takes
effect, private consumption growth will likely shrink in
2012. Given the subsidy cut, consumption may not attain
its pre-crisis growth rate anytime soon. On the other hand,
a delay in implementing the fuel subsidy cut will boost
disposable income and consumption in the near term.
Meanwhile, Indonesia’s reliance on exports is much lower
than its regional peers. However, surging commodity
prices turned Indonesian exports into a significant driver
of economic growth, and resource-hungry nations such
as India and China provide ready markets for Indonesian
commodities. Moreover, Indonesia’s strategic location has
led to strong trade relations with additional countries in
Asia and Oceania.
Exports supported economic growth during a period
of subdued domestic demand, but ongoing reliance on
export-led growth could make its economy vulnerable
to external shocks. A weak recovery in the United States
and the potential exacerbation of the Eurozone crisis pose
significant downside risks. Furthermore, an economic
slowdown in China coupled with cooling commodity prices
could result in substantially shrinking export revenues.

A step in the right direction
Indonesia’s parliament passed the land acquisition bill
in December 2011, and it now awaits the president’s
approval. The land acquisition bill, if approved and implemented
expeditiously, has the potential to spur additional
economic growth. The bill will likely reduce bottlenecks
in land acquisition for infrastructure projects by streamlining
the mechanism for compensating land owners,
significantly reducing bureaucratic interference. The bill
is expected to allow the government to fast-track infra-
Indonesia
structure development and also attract private sector
participation. These developments are favorable as the
lack of adequate infrastructure is often touted as the most
important impediment to Indonesian growth.
However, as of now, Indonesia’s prospects are comparatively
positive. The recent sovereign rating upgrade could
spur foreign investors and lead to a surge in foreign
inflows in 2012. As Indonesia embarks on an ambitious
plan to boost spending in infrastructure development,
Geographies
37

Global Economic Outlook 2nd Quarter 2012
38
foreign capital can play a critical role in bridging the
investment gap. Furthermore, the government’s push to
develop value-added industries, if successful, could benefit
the economy over the medium and long term. Indonesia’s
economic fundamentals are robust. Policies that leverage
Indonesia’s strengths can potentially catapult the economy
to achieve GDP growth rates beyond 7 percent.
Smaller is better
As the developed world struggles with huge deficits and
debt, Indonesia’s strength lies in its low debt profile and
small budget deficit, which was a mere 1.1 percent of GDP
in 2011. The government’s expenditure on subsidies was
higher than anticipated, but strong revenues combined
with lower spending on capital projects and social initiatives
offset these additional costs. Given robust GDP
growth, tax revenues will likely remain strong in 2012.
Current projections peg the deficit at 1.5 percent of GDP in
2012. However, if the government is unable to implement
its rollback on subsidies and oil prices shoot up due to
geopolitical uncertainty, Indonesia’s budget deficit will,
in all likelihood, be higher. Despite this downside risk,
Indonesia’s budget does not pose a significant challenge to
its economy. On the contrary, Indonesia’s problems stem
from unspent allocations for public projects.
Meanwhile, fiscal prudence put a lid on inflation, allowing
the central bank sufficient leeway in pursuing an easy
monetary policy. The Bank of Indonesia has been fairly
proactive in its policy actions. In the Board of Governors’
meeting in February, the Bank of Indonesia cut its interest
rate by 25 basis points to 5.8 percent. The move came as
a surprise, but it underscores Indonesia’s concern about
growth prospects in the weak global macroeconomic
environment. The rate cut also highlights the confidence
of the Bank of Indonesia in implementing a countercyclical
monetary policy while maintaining its inflation targets and
exchange rate. The country has benefitted from ebbing
inflation, but this trend will likely reverse during the latter
half of the year if subsidies are rolled back. The Bank of
Indonesia is expected to uphold its policy stance in the
near term and remain vigilant to emerging risks. A further
interest rate cut is unlikely. However, the looming risk of
a worsening global economy will ensure that monetary
policy is not tightened prematurely.
In addition, robust GDP growth and limited borrowing
requirements will reduce the debt-to-GDP ratio to below
24 percent in 2012. Indonesia’s outstanding public debt
— 24.3 percent of GDP in 2011 — is much lower than
the emerging market average of 37.8 percent. Moreover,
contingency proposals that allow the government to draw
on deposits accumulated through excess borrowing in the
past provide a buffer. If conditions deteriorate, resulting in
smaller revenues or larger expenses, the government has
the means to stimulate the economy.

Persistent challenges
Pervasive corruption is a major impediment to Indonesia’s
growth prospects. Bureaucratic bottlenecks, political
interference, and judicial inefficiencies weigh on foreign
investment and private sector participation in Indonesia.
Of late, the government has initiated several anticorruption
measures to improve governance. Several offenders have
been prosecuted and even jailed. The recent crackdown on
corruption has also resulted in bureaucratic reluctance in
spending money — even on worthwhile projects. Yet, new
cases of tax evasion and bribery continue to be the order
of the day.
Corruption and bureaucratic delays also weigh on
Indonesia’s competitiveness. Indonesia’s poor performance
on global comparison metrics such as days required to start
a business, cost to start a business, number of procedures,
etc. are a significant deterrent to investors. Together, these
factors result in less-than-favorable conditions for global
manufacturers to invest in Indonesia. The country also
fares poorly in terms of diversification of industries and a
dearth of value-added industries. Furthermore, poor labor
laws result in frequent labor union strikes, road blockages,
and production disruptions. As a result, Indonesia’s labor
advantage remains underutilized. The government faces
the uphill task of strengthening institutions, ushering labor
reforms, and altering Indonesia’s image in the eyes of
potential investors.
Indonesia
Moreover, the country lacks adequate infrastructure to
support its growth aspirations. Infrastructure inadequacies
result in connectivity breakdowns, adding to transportation
and distribution costs and eventually higher inflation.
Indonesia’s ports and airports are in need of improvement
and cannot cater to high-capacity vessels. While
the government has indicated its desire to remove infrastructural
bottlenecks, whether the plan will be backed by
credible action remains to be seen.
A slowing world economy will definitely impact Indonesia’s
growth prospects in one way or another. Slowing
commodity prices could drive down export revenues
and result in economic deceleration. However, domestic
demand could partially offset the decline in external
demand. Growth in Indonesian tourism has been curtailed
by instances of terrorism. Notwithstanding the downside,
Indonesia’s economy has significant potential. Foreign
investment could increase if investors make long-term
investments by pursuing high returns in Indonesia.
Furthermore, private investment will likely increase if
authorities can establish legislative certainty. Overall, the
economy is expected to grow by 6.5 percent in 2012.
However, if the government succeeds in eliminating bottlenecks
that hold back Indonesia’s growth, the economy
could outperform consensus expectations.
Geographies
39

Dr. Satish Raghavendran
is Vice President at
Deloitte Research, India
40
Neha Jain is an Analyst at
Deloitte Research, India
Trade patterns of the future:
Waking up and smelling the coffee
by Dr. Satish Raghavendran and Neha Jain
It is becoming apparent that China may be losing its status
as the “factory of the world.” Cost economics that long
worked in China’s favor have come full circle; domestic
wages are on the rise, eroding much of the cost arbitrage
offered to foreign companies. Even Chinese companies are
affected as improving living conditions in the hinterland
discourage potential migrants from seeking work in urban
coastal provinces. Furthermore, an aging population in
the next decade will likely weigh down labor supply and
impact wage competitiveness. As Chinese production
moves up the value chain, workers are demanding higher
wages, better working conditions, and added welfare
benefits. Thus, rising labor costs, along with pressure to
loosen control on its exchange rate, could pose a serious
threat to China’s international competitiveness if productivity
does not correspondingly improve.
Economists have already begun speculating the end of
“cheap China,” beckoning some companies to reassess
their Chinese footprint and proactively explore other
low-cost geographies in emerging trading networks.
While China may lose its sheen as the factory of the
world, companies could benefit from leveraging the
emerging Asian networks for low-tech, labor-intensive
trade and production. Rapid-growth economies such
as Bangladesh and Vietnam are catching up quickly,
providing cheap alternative destinations. Today’s supply
chains mimic complex webs involving minute levels of
intermediate production rather than locally produced
finished goods. This structure presents immense opportunities
for emerging markets to develop specific capabilities
and capture a bigger share of the supply chain. From a
company’s perspective, an emerging trade network with
a wide portfolio of capabilities allows for diversification of
the supply chain rather than extreme reliance on a single
country whose competitiveness may be decreasing.
Nonetheless, China will remain an important, if not
dominant, player in the future. The country’s burgeoning
middle class is set to become more affluent and boost
consumption levels in the next decade. It is estimated
that urban household disposable income will grow almost
twofold between 2010 and 2020, fueling discretionary
spending. The government itself is strategically envisaging
a shift away from a reliance on exports in favor of a more
consumption-driven economy in the future. China’s 12th
Five-Year Plan for 2011–2015 calls for higher minimum
wages, income tax reform, and increased welfare schemes,
all of which will likely boost consumption in the future.
The Plan further highlights the government’s ambition to
move away from just being the world’s factory to transforming
China’s coastal regions into hubs of research and
development or high-tech manufacturing. Thus, as China
moves up the value chain from “made in China” to “made
for China,” it will likely leave room for other emerging
economies to gain a larger share of global trade. The most
obvious contenders are India and other APAC economies
within China’s trading network. However, China and

India’s recent economic interest in Sub-Saharan Africa and
the Middle East is a testament to the growing alliance
between these regions, which could significantly alter
trade patterns of the future.
Silk road to Africa
Trade linkages between China, India, and Africa date
back centuries to the era of the Silk Road, which primarily
involved the trade of silk, tea, porcelain, spices, and
other luxury goods. However, the 21st century has seen
a newfound interest in trade with Africa, which is evident
from the proliferation of not just goods and services but
also massive foreign investment, technology transfer, and
the movement of human capital. In recent years, Africa’s
trade with Asia has been booming, surpassing trade
volumes with the European Union and the United States,
Africa’s traditional trading partners. During 2003–2010,
Africa’s exports to China and India surged by about 31–32
percent per year, with the bulk going to China. During
the same period, imports from China grew at an almost
Trade patterns of the future: Waking up and smelling the coffee
identical pace of 32 percent, and imports from India grew
at 28 percent per year. Thus, these countries are growing
their trade relationship.
With vast natural reserves and ample availability of arable
land, Africa came under the Asian radar as a source of
energy and food security. The voracious appetite of Asian
Tigers drove them to import high volumes of resource
commodities from Sub-Saharan Africa. However, China
and India’s industrial capabilities have become more
sophisticated, requiring more diversified, labor-intensive
imports such as light manufactured goods and household
consumer goods from Africa. Consequently, the Asian
interest in African exports has expanded beyond traditional
oil and food imports to manufactured goods and services.
Multinational firms are increasingly recognizing the
long-term growth prospects of Africa. By 2020, more
than 50 percent of Africa’s population will have discretionary
income (beyond basic needs); meanwhile, the
Topics
41

Global Economic Outlook 2nd Quarter 2012
42
labor force will be steadily expanding too. The African
continent constitutes almost 60 percent of the world’s
arable yet uncultivated land that is waiting to be tapped.
Furthermore, the heterogeneity of African countries offers
the advantage of diverse capabilities across the value chain
to foreign firms. Although political stability and infrastructure
bottlenecks present challenges, many countries have
taken credible steps toward regulatory reform, improved
macroeconomic stability, and trade liberalization. China
and to some extent India are key participants in African
infrastructure development and have invested a significant
amount into the sector in exchange for a larger share
of Africa’s natural resources. This growing partnership
between Asia and Africa is representative of a strength-
ening trade network and mutual dependence. As China
moves up the value chain, Africa will likely offer an attractive
alternative for low-cost production, supported by its
booming domestic consumer markets.
Middle East rising
Countries in the Middle East, especially those in the
Gulf (Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and
UAE), are proactively forging trading alliances with Asian
countries, reflecting their collective aspiration to diversify
their domestic economies beyond oil exports. The composition
of trade patterns from the Gulf Cooperation Council
(GCC) reflects a significant increase in trade flows with
BRIC countries (19.4 percent) compared to those with

Trade patterns of the future: Waking up and smelling the coffee
As economies in Sub-Saharan Africa and the
Middle East develop and open up to trade, links
between Asia, the Middle East, and Africa are
expected to flourish.
NAFTA (8.9 percent), revealing a more diversified export
basket. Statistics reveal that Gulf exports to Asia, particularly
China, cover a range of products like plastics, electronic
equipment, and vehicles, while exports to the United
States predominantly comprise oil and oil products.
The strategic partnering of the GCC countries with China,
India, and other economies focuses on building manufacturing
bases in order to produce a wide array of products
of varying complexity and to develop skills in critical areas
such as water desalination, digital infrastructure, and
education. The GCC has engaged China to assist with
setting up telecom networks and developing knowledgebased
economies. The investment in these areas has the
potential to transform the Gulf into a preferred destination
of global supply chains that offer world-class infrastructure
as well as access to talent and domestic consumer
markets. A robust and well-diversified manufacturing base
will be critical in driving prosperity of this region. The key
enabler for this transformation could potentially be the
policy reforms that facilitate economic integration and
lower barriers for businesses. Another important influencer
of strategic investments is the GCC’s deployment
of sovereign wealth funds, which stand at $1.1 trillion.
The GCC governments are committed to developing
their strengths in areas like energy and services while
enhancing allied sectors. This trend is likely to continue
as the GCC governments proactively seek and incentivize
foreign business.
Emerging trade hubs
As economies in Sub-Saharan Africa and the Middle East
develop and open up to trade, links between Asia, the
Middle East, and Africa are expected to flourish. Economic
integration between these regions and the emergence
of South-South trade will likely result in the formation
of influential trade hubs. The trade of the future will be
determined by the availability of cheap resources and the
destination of final demand itself. Some firms in developed
economies have already begun to question whether the
challenges of outsourcing their production processes
outweigh the benefits of producing locally.
In this respect, Africa and the Middle East offer both
low-cost production capabilities as well as a rapidly
growing domestic market. While there are political and
economic risks, a burgeoning consumer base will likely
induce foreign business to navigate these markets and
leverage locally available resources in a more cost-effective
way. Supply chain disruptions following the earthquake
in Japan also have highlighted the challenges of extreme
specialization and reliance on a few economies. Another
advantage that the Middle East and Africa offer is the
close proximity to European markets. Thus, the emergence
of Africa and the Middle East as new trade hubs is likely
to play a pivotal role in connecting people, products,
and technology.
Topics
References and research
sources:
OECD, “Going for Growth,”
2012.
43

Global Economic Outlook 2nd Quarter 2012
Appendix
GDP Growth Rates (YoY %)*
1.8
1.7
1.6
1.5
1.4
1.3
1.2
1.1
Source: *Bloomberg
44
8
6
4
2
0
-2
-4
-6
-8
-10
-12
4
3
2
1
0
-1
-2
-3
Q1
07
Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
07 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11
Jan 09 May 09 Sep 09 Jan 10 May 10 Sep 10 Jan 11 May 11 Sep 11 Jan 12
USD-Yen
100
1
Jan 09 Jul 09 Jan 10 Jul 10 Jan 11 Jul 11 Jan 12
95
90
85
80
75
20
15
10
-5
-10
-15
12
10
8
6
4
2
0
-2
-4
5
0
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11
U.S. U.K. Eurozone Japan
Brazil China India Russia
U.S. U.K. Eurozone Japan
Major Currencies vs. the US Dollar*
GBP-USD Euro-USD USD-Yen (RHS)
GDP Growth Rates (YoY %)*
India's fiscal year is April-March
Inflation Rates (YoY %)* Inflation Rates (YoY %)*
Inflation data for India is based on the WPI
6
16
5
14
Jan 09 May 09 Sep 09 Jan 10 May 10 Sep 10 Jan 11 May 11 Sep 11 Jan 12
Brazil China India Russia

Yield curves (as on April 6, 2012)*
U.S. Treasury
Bonds & Notes
UK
Gilts
Eurozone Govt.
Bencmark
Japan
Sovereign
Brazil Govt.
Benchmark
China
Sovereign
Appendix
India Govt.
Actives Russia‡
3 Months 0.01 0.00 0.09 0.10 8.98 2.75 8.92 6.06
1 Year 0.07 0.45 0.28 0.10 8.93 2.84 8.26 6.33
5 Years 1.01 1.07 0.77 0.33 10.73 3.14 8.72 7.51
10 Years 2.18 2.21 1.79 1.00 11.29 3.52 8.78 8.16
Composite Median GDP Forecasts (as on April 6, 2012)*
US UK Eurozone Japan Brazil China Russia
2012 2.2 0.6 -0.4 1.54 3.4 8.3 3.5
2013 2.4 1.75 1.05 1.49 4.5 8,4 3.7
2014 2.85 1.95 2.4 1.1 4
Composite median currency forecasts (as on January 9, 2012)*
Q2 12 Q3 12 Q4 12 Q1 13 2012 2013 2014
GBP-USD 0.83 0.83 0.83 0.83 0.83 0.82 0.81
Euro-USD 1.29 1.3 1.31 1.33 1.31 1.31 1.29
USD-Yen 82 83 84 84.5 84 87.5 94
USD-Brazilian Real 1.78 1.75 1.74 1.75 1.74 1.75 1.75
USD-Chinese Yuan 6.25 6.21 6.12 6.08 6.12 5.96 6
USD-Indian Rupee* 51 50 49 48.13 49 47 46
USD-Russian Ruble 29.65 29.7 29.6 29.7 29.6 29.75 33.49
OECD Composite leading indicators (Amplitude adjusted)†
U.S. UK Eurozone Japan Brazil China India Russia
Mar 10 99.9 104.1 103.2 99.9 103.3 102.5 103.4 98.4
Apr 10 100 103.9 103.4 100 103.4 102.1 103.2 98.9
May 10 100 103.5 103.5 100.1 103.3 101.6 102.9 99.3
Jun 10 99.8 103.2 103.5 100.1 103.1 101.2 102.6 99.9
Jul 10 99.6 102.9 103.6 100.1 102.9 100.9 102.3 100.5
Aug 10 99.6 102.7 103.6 100.2 102.8 100.9 102.2 101.2
Sep 10 99.8 102.6 103.7 100.5 102.9 101.1 102.1 101.9
Oct 10 100.1 102.6 103.9 100.8 103.2 101.4 101.9 102.6
Nov 10 100.6 102.6 104.1 101.3 103.4 101.6 101.7 103.1
Dec 10 101.2 102.7 104.2 101.9 103.5 101.8 101.4 103.6
Jan 11 101.7 102.7 104.3 102.3 103.2 101.8 100.9 103.7
Feb 11 102 102.6 104.1 102.6 102.8 101.7 100.2 103.8
Mar 11 102.1 102.5 103.8 102.6 102.2 101.5 99.3 103.5
Apr 11 102 102.2 103.3 102.3 101.4 101.2 98.3 103.2
May 11 101.7 101.8 102.6 102 100.3 101 97.3 102.8
Jun 11 101.3 101.3 101.7 101.7 99.1 100.8 96.4 102.5
Jul 11 100.8 100.7 100.8 101.4 97.7 100.6 95.7 102.2
Aug 11 100.4 100 100 101.2 96.5 100.4 95.2 101.9
Sep 11 100.4 99.4 99.2 101.2 95.5 100.2 94.9 101.8
Oct 11 100.6 99 98.7 101.3 94.6 99.9 94.9 101.7
Nov 11 101.1 98.7 98.5 101.6 93.8 99.5 95.4 101.8
Dec 11 101.8 98.7 98.5 102.1 93.4 99 96 101.9
Jan 12 102.5 98.9 98.7 102.6 93.2 98.4 96.7 102.1
*Source: Bloomberg
‡MICEX rates
†Source: OCED
Note: A rising CLI reading points to an economic expansion if the index is above 100 and a recovery if it is below 100. A CLI which is declining
points to an economic downturn if it is above 100 and a slowdown if it is below 100. Source: OECD
45

Global Economic Outlook 2nd Quarter 2012
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