Global Economic Outlook and Strategy - Kadin Indonesia

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February 28, 2008 Global Economic Outlook and Strategy economic policies. However, economic policies in Taiwan and Thailand could show significant improvement following the elections, generating an important macroeconomic turnaround in these two sluggish economies. Slowing exports may harm some emerging economies. Reduced capital flows are hurting countries that rely on external financing. However, financial stability remains a concern in a number of emerging European economies thanks to a sustained decline in risk appetite, together with concerns about the risks to net exports in the context of a slowdown in the Eurozone. The export shock will be felt most acutely in central Europe, particularly in Hungary, Czech Republic, and Slovakia, whose economies are highly dependent on exports, and whose recent growth rates have benefited considerably from Eurozone demand. Poland, by contrast, should be relatively insulated because it is a more closed economy reliant on domestic spending growth. The decline in capital flows is naturally proving most painful to those economies heavily dependent on external financing: Romania, South Africa, and the Baltics are key examples. The clearest expression of risk aversion in these countries has been the continued rise in sovereign credit (particularly CDS) spreads. The rise in spreads has been noticeably large even in countries with very low public debt burdens like Kazakhstan (6% of GDP) or Romania (16% of GDP). In addition, currency volatility has increased in a number of countries, particularly in South Africa and Romania. ...But Inflation Remains a Concern Rates have risen in countries at risk to higher inflation. Oil exports also are experiencing rising inflation. The decline in capital flows and the rise in exchange rate volatility complicate the inflation outlook in many countries, particularly in the context of higher global food prices. Interest rates are under upward pressure in South Africa, Romania, Hungary, the Czech Republic, Poland, and Egypt, among other countries. Our interest rate forecasts are subject to the risk that we have underestimated food price shocks in the region. Inflation is also a key issue for many of the “surplus” economies, notably the Gulf Cooperation Council and Russia. For these economies it remains the case that currency appreciation will be the most reliable disinflationary tool. Policymakers remain fearful in many cases that stronger nominal exchange rates will hurt competitiveness. In time we expect this dilemma to be resolved mostly in favor of local currency revaluation against the dollar. Figure 8. United States — Spreads for Indexes of Credit Defaults Swaps and Leveraged Loans (Basis Points), Jan 07-26 Feb 08 Figure 9. United States — S&P 500 and S&P Financials Equity Price Indexes (May 2007=100), Jan 07-26 Feb 08 180bp 800bp 110 110 160 140 CDX-IG5 (left) CDX-HY5 (right) LCDX (right) 700 600 100 FOMC Inter-Meeting Interest Rate Cut 100 120 500 90 90 100 400 80 300 80 80 60 40 FOMC Inter-Meeting Interest Rate Cut 200 100 70 S&P 500 S&P Financial Index 70 20 0 60 60 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Source: Citi. Source: Haver. 8
February 28, 2008 Global Economic Outlook and Strategy Rising global food prices... ...complicate monetary policy. Food inflation has become a key challenge in a number of economies, including China, Hong Kong, Singapore, Taiwan, and Vietnam. This has led to tightening monetary policies, including faster appreciation of Asian currencies, especially the Taiwanese dollar and Vietnamese dong. In other economies where inflation is less of a challenge, monetary policy easing is likely to continue following the Fed actions, especially in Thailand, the Philippines, and Korea. While inflation complicates macroeconomic policymaking, we think the chances of stagflation remain remote, as slowing activities should help ease inflation rates, especially core rates. But food prices could stay high in coming months, suggesting that tightening biases may continue in a number of economies. Given the high share of food in the typical CPI basket in Latin America, inflation pressures should remain a concern for most regional central bankers in the coming month. Interest rate markets reflect a lower risk of rate hikes in Brazil, and they are now pricing in cuts in Mexico. But the central banks of Chile, Colombia, and Peru remain under pressure to tighten further, as inflation rates continue to print well above their targets. Our current forecasts show the region shifting into a current account deficit of 0.2% of GDP in 2008 on the back of rapidly growing imports. However, we believe that sky-high commodity prices place our forecast at risk, and may lead to higher-thanexpected reserves accumulation again this year. 9
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