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Country Forecast

Global outlook

March 2017

The Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom

Key changes since January 17th

• The Economist Intelligence Unit's forecasts for global growth are little changed from last month. In 2017 we expect global growth at market exchange rates to quicken to 2.5% from 2.2%, lifted by a stronger performance in both developed and emerging markets.

• Although our central forecast for 2017 is benign, the election of Donald Trump as US president introduces an unusual degree of uncertainty to the outlook, and downside risks dominate. Mr Trump is already in conflict with US courts over his plans to bar certain nationalities from entering the US. One of the biggest risk to the global economy stems from his support for protectionist policies.

• Higher oil prices, together with wage pressures in the US, are contributing to a welcome increase in inflation and inflation expectations. We expect the world inflation rate to rise to 4.3% this year, the highest since 2011.

• Expectations of reflationary policies in the US have given added impetus to an upward trend in global bond yields that began in mid-2016. We believe that bond yields reached the bottom in mid-2016 but expect them to remain low by historical standards, a view supported by a retracement of US bond yields since the start of 2017. Monetary policy in Europe and Japan will remain extremely accommodative throughout 2017-21.

• Global growth will slow in 2018-19. In 2018 we expect China to experience a sharp, policy-induced slowdown as the government takes measures to rein in credit growth. In 2019 we forecast a business-cycle recession in the US. Global growth will pick up in 2020-21.

• In the light of a quicker than expected recovery in US shale oil output, we have shaded down oil price forecasts for 2017-19, but leave forecasts for 2020-21 unchanged. We have raised our 2017 price forecast for industrial raw materials, which we now expect to increase by 14.6%.

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Global outlook 1

Country Forecast March 2017 www.eiu.com © The Economist Intelligence Unit Limited 2017

Contents

2 World growth and inflation

9 Regional summaries

30 Exchange rates

33 World trade

35 Commodity prices

38 Global assumptions

Editors: Cailin Birch; John Bowler; Felix Delbruck; John Ferguson; Danielle Haralambous; Mike Jakeman; Charlotte King; Joey Lake; Robert Powell; Robert Wood

Editorial closing date: February 13th 2017 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: To request the latest schedule, e-mail [email protected]

2 Global outlook


World growth and inflation (Forecast closing date: February 13th 2017)

World summary (% change)

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021Real GDP growth (PPP exchange rates) World 3.4 3.4 3.5 3.3 2.9 3.4 3.2 2.9 3.5 3.6 OECD 1.4 1.5 2.0 2.3 1.7 1.9 1.8 1.4 1.8 1.9 Non-OECD 5.2 5.1 4.7 4.1 4.0 4.5 4.2 4.2 4.7 4.7Real GDP growth (market exchange rates) World 2.3 2.4 2.6 2.7 2.2 2.5 2.4 2.1 2.6 2.6 OECD 1.3 1.4 1.9 2.3 1.7 1.9 1.7 1.3 1.7 1.8 Non-OECD 5.1 4.9 4.4 3.7 3.5 4.2 3.9 3.8 4.5 4.4 North America 2.2 1.7 2.4 2.5 1.6 2.3 2.1 1.1 2.0 2.0 Europe 0.2 0.8 1.8 1.9 1.7 1.6 1.6 1.6 1.8 1.8 Euro area -0.8 -0.2 1.2 2.0 1.7 1.5 1.5 1.4 1.5 1.4 Asia & Australasia 4.4 4.6 4.1 4.2 4.0 4.0 3.2 3.3 3.7 3.8 Latin America 3.0 2.8 1.3 0.2 -0.7 1.1 2.0 1.9 2.8 2.9 Middle East & North Africa 3.9 2.1 2.6 2.6 2.4 2.6 3.5 3.0 3.7 3.8 Sub-Saharan Africa 4.1 4.7 4.5 2.9 1.1 2.5 3.4 2.9 3.1 3.7Inflation (av) World 4.0 3.8 3.6 3.2 3.8 4.3 3.8 3.0 3.1 3.0 OECD 2.2 1.6 1.6 0.5 1.0 2.2 2.0 1.6 1.8 1.9 Non-OECD 6.2 6.7 6.1 6.7 7.4 6.9 6.1 4.8 4.6 4.5Trade in goods World 3.5 3.9 4.3 2.8 1.6 2.6 2.7 2.0 2.9 3.1 OECD 2.1 2.4 4.2 4.5 1.9 2.5 2.4 1.6 2.6 2.5 Non-OECD 4.6 5.2 3.5 -0.3 0.9 2.7 2.7 2.7 3.5 3.6

Source: The Economist Intelligence Unit.

The initial market reaction to Donald Trump's election as US president and the Republican party maintaining control of both houses of Congress was to price in a reflation of the US economy on the basis of tax cuts, spending on infrastructure and deregulation. This fuelled a rally in US equities to new record levels, pushed up bond yields and bid up the dollar. The initial exuberance has abated since the start of 2017. US equities have paused for breath. US bond yields have fallen back, although, at around 2.4% for ten-year bonds, they remain much higher than the level of around 1.8% just before the election. The dollar has given back part—and, against some currencies, all—of the gains that it made in the last two months of 2016. Although the market expectation remains that Mr Trump's policies will be positive for economic growth, investors have started to pay more heed to downside risks under a Trump administration, notably those stemming from protectionist trade policies and potentially aggressive and erratic actions in the sphere of foreign and defence policy.

The Economist Intelligence Unit remains sceptical about the reflation story. The US economy is now running close to capacity. Fiscal stimulus could push up inflation, but, in that case, the US Federal Reserve would raise the policy interest rate more quickly, curbing any gains in output. Moreover, small-government Republicans will oppose a big public spending programme on infrastructure unless it is fiscally neutral. We therefore maintain our US growth

A more sober assessment of prospects under a Trump administration

Global outlook 3


forecast of 2.3% in 2017. There are upside risks to this forecast. But there are also downside risks, and these are potentially large: for example, if the US were to raise tariffs on Chinese imports, which could set off a trade war between the world's two largest economies. Our forecast assumes that the Trump administration will adopt some protectionist measures but that these will be targeted at specific sectors, and will not seriously undermine relations with China. Mexico is the most vulnerable country in the event that Mr Trump follows through on a pledge to renegotiate the North American Free-Trade Agreement (NAFTA). A Republican proposal for a corporate tax reform including a border adjustment tax would have huge implications for the world economy as well as for the dollar. But such a complex proposal would attract much opposition from large importers, and we expect that Congress would fail to pass such contentious legislation.

On foreign policy, Mr Trump will govern according to his "America First" stance. This is a rejection of the notion that the US has a responsibility to cement and uphold its values around the world. Instead, his administration is likely to reduce its international commitments, creating a space for other countries, such as China and Russia, to step into. This will be evident even in areas where there is already a high level of risk, such as in the South China Sea and Syria. Japan and South Korea will have to shout louder for attention. However, Russia, Israel and Turkey may find the US more co-operative. We consider that political risk in the global economy has risen significantly with Mr Trump's election. His decision to speak on the telephone with Tsai Ing-wen, the president of Taiwan, shows that he is not afraid of riling China and upsetting the current world order. There had previously been no correspondence between the heads of state of Taiwan and the US since diplomatic relations were severed in 1979.

Mr Trump's election victory was part of a broader trend in Western democracies. Like the UK's decision to leave the EU and the rejection of a referendum on parliamentary reform in Italy in December, it saw voters rebel against an establishment that they perceived to be pursuing the wrong course. Some of these political changes were the culmination of a long-term decline of popular trust in government institutions and political parties. They also signify unhappiness with stagnant incomes. Above all, they demonstrate that society's marginalised and forgotten voters are demanding a voice—and if the mainstream parties will not provide it, they will look elsewhere.

Of particular significance in the coming months is the presidential election in France. The unpopular Parti socialiste incumbent, François Hollande, is not running for a second term. The election is a two-step process. The two candidates with the most votes in the first round then face a run-off. Marine Le Pen of the far-right Front National (FN) will almost certainly reach the run-off, where she will face either François Fillon of Les Républicains or Emmanuel Macron, a former economy minister running as an independent. Mr Fillon had emerged as the favourite but his standing has diminished following allegations that he misused public money. Although Ms Le Pen has succeeded in dragging FN into the political mainstream, we believe that either Mr Fillon, if he stands, or Mr Macron would attract sufficient support from the centre ground to keep her from power. Ms Le Pen is ambivalent about France's membership of the EU and would favour France withdrawing from European economic and monetary

The French presidential election represents populism's next opportunity

4 Global outlook


union (EMU), factors that have contributed to a pronounced widening of spreads between French and German bonds. Were she to win—we put her chances at 40%—a period of turbulence in global financial markets would be in prospect.

The surge in US bond yields since November was a continuation of an already established trend that was amplified but not triggered by Mr Trump's election victory. Bond yields in the US and other developed markets bottomed-out in mid-2016 and have been on an upward trend since, possibly signalling the end of a three-decade-long bull market in government bonds. The rise in bond yields has coincided with an increase in inflation in the developed world, in part but not wholly related to the recovery of oil prices from the lows plumbed in early 2016. We forecast global inflation of 4.3% in 2017, the highest rate since 2011.

Although a rise in market interest rates will inevitably cause some casualties among overleveraged borrowers, on the whole it is a welcome development, marking another milestone in the slow recovery from the global financial crisis of 2008-09. It will provide relief to financial institutions whose profitability has been undermined by very low, and in some cases negative, interest rates. The recovery process is most advanced in the US where a tight labour market has been exerting upward pressure on wages for some time. Europe, which is several years behind the US in the recovery process, was the region that appeared to benefit most from low oil prices. But the economic recovery in Europe now appears to be sufficiently well established to withstand higher oil prices, inflation and market interest rates. To the extent that positive inflation becomes entrenched and lifts nominal GDP, it should alleviate concerns about the sustainability of the heavy debt burdens faced by several countries in the euro zone periphery as a legacy of the crisis.

Spreads of ten-year bonds against ten-year German bonds(basis points)

Source: Haver Analytics.

0.0

10.0

20.0

30.0

40.0

50.0

60.0

70.0

80.0Netherlands-Germany spreadFrance-Germany spread

FebJan17

DecNovOctSep2016

Although bond yields touched bottom in mid-2016 and are now on a rising trend, we expect them to remain low by historic standards. Similarly, policy rates will remain very low. We expect only a further 100-basis-point increase in US policy rates in the current cycle and we expect policy rates to remain at zero in both the euro zone and Japan in 2017-21. These forecasts would create a reasonably benign interest-rate environment for emerging-market borrowers (notably corporates) with hard-currency debts to refinance. But payment

Global inflation and market interest rates set to rise in 2017

Global outlook 5


stresses could arise from other sources, for example a renewed surge in the dollar or a new downturn in commodity prices related to a fall-off in Chinese demand.

The health of the Chinese economy remains the biggest risk to the global economy. In 2016 it grew by 6.7%, in line with the official target, despite persistent inefficiencies in the state sector and recessionary conditions in the industrial north-east. However, this was achieved at the cost of a further increase in indebtedness, accompanied by a property bubble in some cities. The build-up in debt, particularly in the corporate sector, is unsustainable and we think that once the president, Xi Jinping, has consolidated his power at a party conference in the autumn, he will sanction policies to rein in credit. Firms in the construction and real-estate sectors will be hit hardest. As a result of these policies, we forecast that growth will slow sharply in 2018, to 4.2%, from 6.2% in 2017. This kind of shift is unprecendented in modern China and will come at a time when the global economy is still weak and—with monetary policy already accommodative—with limited scope to react.

Given China's importance as an engine of global growth and demand, the ripple effects will be felt around the world. Worst-hit will be those countries that depend on exporting commodities to China, such as Australia, Chile and Mongolia. Next will be countries that have deep and broad trading relationships with China, such as South Korea and Taiwan. The rest of the world will feel a chill through turbulence in financial markets and declines in consumer and business confidence.

Our forecast is for a relatively benign outcome, given China's extreme level of indebtedness. Other economies whose paths China is tracking, such as Japan in the 1980s and Spain in the 2000s, were brought to their knees by systemic crises. We do not foresee this for China, partly because state involvement in the banking sector will ensure that no major lenders will go under. Moreover, the slowdown will be policy induced, so it will be managed rather than disorderly. The credit bubble will deflate rather than burst. However, the balance of risk is still tilted to the downside, and it is possible that the government may not be able to exert the level of control over the economy that it would like. With the economy entering uncharted waters, a range of responses are plausible.

On the assumption that Mr Trump makes only modest adjustments to US trade policy, the outlook for emerging markets in 2017 is reasonable, with growth quickening to 4.5% from 4% in 2016. Brazil and Russia, the third- and fourth-largest emerging economies, will both emerge from lengthy recessions. Overall, emerging markets will benefit from the upturn in commodity prices. Furthermore, as mentioned above, we expect financing conditions to remain relatively benign, albeit subject to occasional episodes of volatility.

Conditions will become more difficult in 2018, when China slows sharply, and in 2019, when Chinese growth will remain subdued and we expect the US to experience a mild business-cycle recession. Our forecasts assume that emerging markets will withstand these shocks relatively well, but there are clear downside risks to our emerging-market growth forecasts in both those years. We forecast stronger growth for both emerging markets and the developed world in 2020-21. The US will rebound from recession, and growth in China

Slow monetary tightening in the US will give emerging markets breathing space

Chinese growth will slow in 2018 as the government reins in credit

6 Global outlook


will strengthen, although, at an average of 5% in 2020-21 it will be some way below current rates, reflecting the economy's transition to one in which consumption rather than investment is the main driver of growth.

Risk scenarios

Events may diverge from The Economist Intelligence Unit's forecast in ways that affect global business operations. The main

risks are represented by the following scenarios.

Very high risk = greater than 40% probability that the scenario will occur over the next two years; high = 31-40%; moderate = 21-30%;

low = 11-20%; very low = 0-10%.

Very high impact = change to global annual GDP compared with the baseline forecast of 2% or more (increase in GDP for positive

scenarios, decrease for negative scenarios); high = 1-1.9%; moderate = 0.5-0.9%; low = 0.2-0.5%; very low = 0-0.1%.

Risk intensity is a product of probability and impact, on a 25-point scale.

Negative scenario—China suffers a disorderly and prolonged economic slump

High risk; Very high impact; Risk intensity = 20 We expect China to experience a sharp economic slowdown in 2018, with growth slowing to 4.2%, from 6.2% in the previous year. The political reshuffle in the upper echelons of the Chinese Communist Party scheduled for late 2017 will enable the president, Xi Jinping, to alter economic policy in 2018. The primary focus of this policy shift will be to slow the rapid growth in credit that has been a feature of government policy since the global recession in 2008-09 and has caused the country’s debt stock to surge to over 200% of GDP. Despite the scale of the economic slowdown, we anticipate that it will be policy-induced and therefore easier for the authorities to manage (reflecting in part the state's deep integration with China's banking system). As a consequence, we do not expect it to result in a rise in unemployment and social unrest on a scale that would threaten the established order. However, there are substantial risks to this outlook. The bursting of credit bubbles elsewhere has usually been associated with sharper decelerations in economic growth, and, if accompanied by a house-price slump, the government may struggle to maintain control of the economy—especially if a slew of China’s small and medium-sized banks (which are more reliant on wholesale funding) hit the wall. If the Chinese government is unable to prevent a disorderly downward economic spiral, this would lead to lower global commodity prices, particularly in metals. This would have a detrimental effect on the Latin American, Middle Eastern and Sub-Saharan African economies that had benefited from the earlier Chinese-driven boom in commodity prices. In addition, given the growing dependence of Western manufacturers and retailers on demand in China and other emerging markets, a prolonged deceleration in Chinese growth would have a severe global impact—far more than would have been the case in earlier decades.

Negative scenario—One or more countries withdraw from the euro zone

Moderate risk; Very high impact; Risk intensity = 15 The resignation of the Italian prime minister, Matteo Renzi—who in December saw his efforts to overhaul the constitution defeated in a referendum—once again refocused concerns on the health of the euro zone’s third-biggest economy and its fragile banks. Although in December the Italian government pledged €20bn (US$21.4bn) in state support for the embattled banks, the accompanying bail-in means that creditors will be hit, which could swell support for the populist Movimento 5 Stelle (M5S) and the anti-immigrant, eurosceptic Lega Nord. Indeed, M5S has explicitly called for a referendum on Italy remaining in the euro zone. Elsewhere, focus on Greece’s frailties has also increased lately, with the IMF warning in February that the country’s debt burden could become “explosive” unless debt relief were offered by the euro zone—a contention firmly rejected, however, by most of Europe’s leaders. Taken together, the economic difficulties across southern Europe have shown the fundamental difficulties posed by a single currency zone without a concurrent fiscal union. The risk is rising that the euro could become a focus for populist politicians. This is particularly clear in France, where one of the leading candidates in the forthcoming presidential election, Marine Le Pen, has proposed a return to a system where national currencies exist alongside a common currency, similar to the European Currency Unit (ECU) basket of currencies—a switch that would in reality constitute a sovereign default. If one or more countries were to leave the euro zone, the global economy would be destabilised. Countries leaving the zone under duress would suffer large currency devaluations and be unable to service euro-denominated debts. In turn, banks would suffer huge losses on their sovereign bond portfolios, and the global economy could be plunged into recession.

Global outlook 7


Negative scenario—Beset by external and internal pressures, the EU begins to fracture

Moderate risk; Very high impact; Risk intensity = 15 The UK's decision in June 2016 to become the first country (excluding Greenland) to leave the EU has raised concerns about the future viability of the union. Although the UK has long had an ambivalent attitude towards Europe, the hostility of the UK Independence Party towards the EU is mirrored by other European “insurgent” parties, such as the Freedom Party in the Netherlands and Front national (FN) in France. With this in mind, there is a risk that the establishment parties in the EU will consider offering a referendum in order to siphon off support from populist parties. Among others, Ms Le Pen has made such a referendum a key plank of her party’s manifesto. Although the UK’s fate may deter other European leaders from employing a similar tactic, in reality the arguments pushed by the Brexit campaigners—focused on immigration and loss of sovereignty—chime with much of Europe. The failure of the EU to agree a united response to the refugee crisis, which led to the reintroduction of migration barriers across Europe, and the deep resentment in some Mediterranean countries towards the austerity measures imposed by the EU have contributed to the rise of nationalist sentiment among the region's politicians. With no cogent roadmap in place for the future of the "European project", there is a growing risk of an existential crisis in the EU that could culminate in its eventual fracturing. In the event that the EU were to begin to fracture and land borders were reimposed, trade flows and economic co-operation would be hindered, weighing on growth in the world’s largest single trading bloc. More widely, the area’s slew of international trade deals would need to be renegotiated as the bloc began to disintegrate, and the probable fracturing of the euro zone would translate into enormous currency volatility globally.

Positive scenario—Global growth surges in 2017 as markets rally

Moderate risk; Very high impact; Risk intensity = 15 In the months since Donald Trump was elected as the US's next president, financial markets have responded vigorously, with the Dow Jones Industrial Average surpassing 20,000 and the UK’s FTSE 100 hitting record highs. Meanwhile, consumer confidence in the US has hit a 15-year high and the unemployment rate is below 5%. Elsewhere, the strong US dollar has provided a major fillip to Japan and other Asian exporters, and Chinese growth has continued to slow smoothly. Concurrently, the OPEC (and subsequent non-OPEC) deal in November has contributed to a sharp rise in oil prices, which should provide a major liquidity boost for oil-exporters across the Middle East and Sub-Saharan Africa. Governments in these countries will also be able to ease fiscal austerity. Although higher global interest rates risk dampening the more positive picture, there is a possibility that these trends will propel global growth at market-exchange rates as high as 4% in 2017. This would be the highest level since 2010, when the global economy was awash with post-crisis stimulus. A broad-based acceleration in growth would not only provide welcome relief to slow-growing euro zone countries, which are heavily reliant on export demand, but could also assist in China's economic rebalancing. An improvement in global demand would provide further support for commodity prices, boosting commodity exports in Latin American, Middle Eastern and African commodity exporting countries.

Negative scenario—Currency depreciation and higher US interest rates lead to an emerging-market corporate debt crisis

Moderate risk; High impact; Risk intensity = 12 The possibility of a more rapid monetary tightening cycle in the US following the election of Mr Trump, coupled with the renewed strengthening of the US dollar and our expectation of a Chinese hard landing in 2018, has increased the risk of large outflows of capital from emerging markets to safer investments. The countries most vulnerable to tighter US monetary policy are those with wide fiscal and current-account deficits; those viewed as lacking political and policy credibility; and those heavily reliant on commodity exports. (In the case of Venezuela, all three, combined with policy shortcomings, have raised the prospect of hyperinflation and default.) Those countries most exposed may be forced to raise their own policy interest rates in order to avoid destabilising capital outflows and currency depreciation. Also vulnerable are emerging-market corporates, especially in Asia, which in recent years have eagerly taken advantage of the hunt for yield. Since the global financial crisis in 2008, emerging-market corporate debt has risen from 50% of GDP to close to 75%, and Chinese private-sector credit is still growing at three times the rate of nominal GDP growth. This exposure to rising interest rates would be exacerbated if local currencies were to weaken, which would push up the cost of corporates' foreign-currency borrowings. Any rolling emerging-market debt crisis would cause panic across the global capital markets and may require governments to step in to shield their banks from the fallout.

8 Global outlook


Negative scenario—The rising threat of jihadi terrorism destabilises the global economy

Moderate risk; High impact; Risk intensity = 12 The threat of jihadi terrorism has moved up the international policy agenda after a series of devastating attacks in Turkey, Lebanon, Egypt, France, Belgium and Indonesia—as reflected in the US administration’s move to ban immigration from seven Middle East countries. Despite losing considerable territory in Iraq and Syria, a jihadi group, Islamic State (IS), remains an especially challenging group to counter. First, this is because of its self-declared, albeit diminishing, "caliphate" in Syria and Iraq, which provides both an operational base and a propaganda tool; and second, because of the ease with which it can recruit and motivate attackers around the world. Taking advantage of its decentralised nature—which allows individuals to operate under its banner anywhere in the world without prior contact with the group—IS has been able to strike a wide variety of targets across multiple continents. Besides its ability to win new adherents, IS's other success has been to garner the backing of internationally established jihadi organisations, such as Ansar Beit al-Maqdis in Egypt and Boko Haram in Nigeria. The spread of IS and its influence poses a dilemma for global policymakers, who are under pressure to intervene militarily to suppress the group in its strongholds in the Middle East (especially as hundreds of thousands of Syrian refugees are seeking sanctuary in Europe). However, they risk reprisals in their home countries by radicalised sympathisers of IS, which is seeking to retain influence—in the wake of its territorial losses in Iraq and Syria—via more terrorist attacks abroad. Should this spiral of attack and counter-reprisal escalate, it would begin to dent consumer and business confidence, which in turn could weigh on US and European stockmarkets.

Negative scenario—Chinese expansionism leads to a clash of arms in the South China Sea

Moderate risk; High impact; Risk intensity = 12 Competing territorial claims in the South China Sea, which have intensified in recent years as China has sought to turn uninhabited reefs, atolls and rocks into artificial islands (and, in some instances, military bases), could take an unpredictable and dangerous turn following the election of Mr Trump in November. Notably, his rhetorical baiting on Twitter of China (which he has accused of, among other things, currency manipulation), and his ambivalence towards the “One China” policy on Taiwan, could destabilise the delicate diplomatic balance within the region. In response, there is a risk that China may take an even more aggressive approach to exerting its claimed historical rights to the sea areas demarcated by its so-called nine-dashed line, which encompasses around 85% of the South China Sea. This could include an acceleration of its island reclamation measures or declaring a no-fly zone over the disputed region. Although this might not necessarily result in a military confrontation—China’s bilateral tensions with the Philippines, for example, have eased, since the election of Rodrigo Duterte—it is worth noting that China remains mired in multiple island disputes elsewhere, including with South Korea and Japan. As a result, there is a risk that any Chinese military build-up in the region will raise the danger of an accident or miscalculation that might lead to a wider military escalation. Any worsening of the row could undermine intra-regional economic ties, interrupt global trade flows and depress global economic sentiment more broadly.

Negative scenario—The US introduces the Border-Adjustment Tax

Low risk; Very high impact; Risk intensity = 10 In the US, the Republican Party (which has a majority in both houses of Congress) is working to pass the largest programme of tax reform in more than three decades. It wants to eliminate the 35% federal corporate income tax and replace it with a 20% destination-based cashflow tax. Central to this reform is the introduction of the Border-Adjustment Tax (BAT), under which US exports would not be subject to the tax but imports would, and imported raw materials would not be tax deductible. Overall, tax would be levied on goods and services where they are sold rather than where they are produced. Supporters of the BAT argue that destination-based taxation is better suited to the modern economy, where patents and software represent a growing share of assets and can be moved across borders to avoid taxes. Such a big change, however, comes with a great deal of risk. A tax on imports would raise the price of petrol, clothes and food in the US, and this inflation would hurt those who are economically vulnerable. Advocates maintain, however, that the US dollar would appreciate to offset the BAT, and this would prevent an increase in imported inflation. However, an appreciating US dollar would have significant consequences for the rest of the world. The dollar surged across most currencies in the weeks following the presidential election in November 2016, reaching a 14‑year high on a trade-weighted basis. Some studies project that the BAT would lead to a further appreciation, of 20‑25%. This would increase the cost of servicing dollar-denominated debt and could trigger financial instability, particularly in emerging markets. In addition, it is possible that the border adjustment tax would run afoul of World Trade Organisation (WTO) rules. It could also incite retaliatory measures by the most affected countries (such as Mexico and China), which could spiral into a trade war.

Global outlook 9


Negative scenario—UK fails to reach agreement with the EU and reverts to WTO rules

Moderate risk; Low impact; Risk intensity = 6 Following the UK vote to leave the EU in June 2016, the current government, led by Theresa May, is facing the thorny task of attempting to negotiate a departure from the EU. In order to control immigration from the EU and end the jurisdiction of the European Court of Justice, the UK will leave the single market. In order to negotiate bilateral trade deals with other countries, it may also have to leave the customs union and pursue a comprehensive free-trade agreement. This will aim to retain some access to the single market on a sector-specific basis and will be phased in over a number of years in order to ensure a smooth transition to the new EU-UK trading arrangement. However, there are downside risks to this forecast. Political exigencies on both sides will reduce the scope for an amicable divorce. If negotiations break down and no extension of the deadline is offered, the UK would leave the EU in 2019 without any arrangement in place—the so-called “WTO option”, under which the UK’s trading rules would be aligned with those of the WTO. This would probably result in an abrupt depreciation in the value of the pound and a sharp economic slowdown in the UK, leaving the economy some 3% smaller than under our baseline forecast. This slowdown would also harm the EU itself, given that the UK is one of the few relatively fast-growing economies in Europe and is an important trade partner for countries such as Ireland, in particular, and Spain (notably in tourism).

Negative scenario—A collapse in investment in the oil sector prompts a future oil price shock

Very low risk; High impact; Risk intensity = 4 The response of the world’s oil companies to low prices in 2015-16 should raise concerns about the long-term impact on future energy supplies. Oil and gas projects worth up to an estimated US$1trn have been deferred or cancelled (a process that started before the decline in oil prices began), despite the fact that a global energy consultancy, Wood Mackenzie, estimates that over 20m barrels/day of new capacity needs to be brought on stream by 2025 to offset declining output in ageing fields and meet new demand. History provides repeated warnings of the long-term impact of oil-price slumps: the surge in oil prices to close to US$150/barrel in 2008, for example, can be traced back to the investment freeze across the industry in the wake of the oil-price collapse in 1998. In addition, the OPEC (and non-OPEC) oil production cut from January will accelerate any market rebalancing and, in turn, exacerbate the impact of the investment downturn. Meanwhile, contrary to historical precedent, oil prices are still not taking into account geopolitical risks to supplies, ranging from war in the Middle East to political ructions in Venezuela and outages in Nigeria. Nevertheless, we believe that the risk of an oil-price spike in 2017-21 remains low, reflecting the new output coming on stream from low-cost producers such as Iraq (and post-sanctions Iran) and the short timeframe for the OPEC quota deal, as well as signs that US shale oil producers are reviving drilling activity rapidly in the wake of the nascent price recovery.

Regional summaries North America growth and inflation (% change)

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021Real GDP growth US 2.2 1.7 2.4 2.6 1.6 2.3 2.1 1.1 2.0 2.0Canada 1.7 2.5 2.6 0.9 1.3 2.0 2.0 1.1 1.9 2.0Inflation US 2.1 1.5 1.6 0.1 1.3 2.4 2.1 1.3 1.7 1.9Canada 1.5 0.9 1.9 1.1 1.5 1.9 2.0 1.3 1.8 1.9


The US faces a period of heightened political uncertainty centered on an unpredictable and unpopular president. The Republican candidate, Donald Trump, won a comfortable majority in the electoral college in November 2016. This averted the risk of a contested election result, but his victory exposed the deep divisions that exist across the country. He lost the popular vote by 2.1%, or almost 3m votes, and assumed office on January 20th with the lowest approval rating of any new president in modern times.

Republican Party has a mandate for sweeping policy change

10 Global outlook


The Republican Party will dominate most levels of the American political landscape for at least the next two years. It will have more power than the Democrats in state legislatures, state governorships and Congress. The election of Mr Trump, combined with Republican congressional majorities, will make passing legislation easier than it has been for the current administration: this is the first time since 2010 that one party controls the executive and the legislature. In theory, this should make the passage of Mr Trump's policy agenda smooth. In reality, Mr Trump's political philosophy differs considerably from that of many Republican representatives in Congress. As a result, there will be an internal power struggle over which measures to pursue. Given that sections of the Republican Party are highly ideological, clashes between the executive, the legislature and the judiciary are likely.

There is little prospect of the Democratic Party diminishing Mr Trump's powers at the 2018 mid-term elections. The Republicans have a comfortable majority in the House of Representatives (the lower house), which is reinforced by gerrymandering. In the Senate, the Democrats will be defending 25 of the 33 seats up for grabs in 2018. Although the party that holds the White House is often pummelled in mid-term races, the Republican Party starts with a hefty advantage and should be able to hold onto majorities in both houses.

The biggest question raised by the election of Mr Trump is the extent to which he will implement his campaign promises. He is an impulsive and unpredictable decision-maker, and the high degree of policy uncertainty cannot be overstated. Although they have control of the presidency and majorities in both houses of Congress, Republicans will not be able to take unilateral action and will have to compromise on their agenda.

Mr Trump will take action across the range of areas that he campaigned on, including immigration, healthcare, trade and energy. Barack Obama's executive orders protecting undocumented immigrants will be overturned and access to US visas will shrink for some countries.

The January executive order, which temporarily restricts entry from seven Muslim countries, shows that Mr Trump wants to deliver on his populist and protectionist promise to put "America First". However, Mr Trump will not accomplish the mass deportation of immigrants. He is more likely to weaken key planks of the Affordable Care Act (Obamacare) than instigate a huge legislative fight to repeal it altogether.

The Republican Party is working to pass the largest programme of tax reform in more than three decades. It wants to eliminate the 35% federal corporate income tax and replace it with a 20% destination-based cashflow tax. Tax would be levied on goods and services where they are sold (their destination) rather than where they are produced (their origin). The tax would be border adjusted, which means that exports would not be taxed, but companies would no longer be able to deduct the cost of imported raw materials and other inputs from taxable income. The goal is to encourage domestic production over imports. This could lead to a substantial strengthening of the US dollar. The Economist Intelligence Unit expects that Republicans will be forced to compromise and are more likely to tinker with the tax code at the margin, reducing personal and corporate tax rates, rather than pass a landmark reform.

An unpredictable president means an uncertain outlook

Global outlook 11


US: tax revenue(revenue as % of GDP, 2015)

Source: OECD.

0 1 2 3 4 5 6 7 8

Value-added taxCorporate tax

Germany

France

US

UK

Canada

Japan

Corporatetax rate

32.1

26.7

20.0

39.0

38.0

30.2

The election of Mr Trump has provoked uncertainty about the direction of foreign policy. His America First campaign was run largely beyond the purview of the Republican Party and often broke with party ideology. Mr Trump's protectionist rhetoric is a large risk but we expect targeted measures on certain goods from some countries rather than a broad increase in tariffs across the board: symbolic, certainly, but not a reversal of decades of globalisation.

The relationship between the US and China is likely to deteriorate. Mr Trump's protectionist rhetoric will leave little room for strategic co-operation. His decision to speak on the telephone with Tsai Ing-wen, the president of Taiwan, shows that he is not afraid of riling China and upsetting the current world order. Sino-US economic and political relations could both become icy, with dangerous implications for global security and the world economy.

Mr Trump was the preferred presidential candidate for Russia. He is less convinced of the value of US alliances in Europe and Asia, and may be more open to allying with Russia to defeat an extreme jihadi group, Islamic State (IS), in the Middle East. We believe that Mr Trump will relax at least some of the current sanctions on Russia. However, there is no guarantee of a sustained improvement in bilateral relations. Mr Trump's agenda of strengthening the military, increasing defence spending and modernising nuclear weaponry could cause tensions with Russia. Without an institutional or strategic basis to US-Russian co-operation, the two leaders might come into conflict during an international crisis.

An executive order signed by Mr Trump in January that banned visitors from seven Muslim countries will define US-Middle Eastern ties in the early months of his presidency. His anti-Muslim stance puts Arab allies in a predicament but will not derail co-operation against IS. Indeed, Mr Trump's animosity towards Iran will provide some relief to monarchies in the Gulf—particularly in Saudi Arabia, which was alarmed by the Iran nucear deal.

Mr Trump has inherited an economy that is in good shape, especially in comparison with the immediate threats that faced his predecessor in 2008. The economy grew by 1.9% on an annualised basis in the fourth quarter of 2016, but the underlying performance was better than the headline figure suggests. Rapid employment growth, rising wages and strong consumer spending are all

The US is set for three more years of economic expansion

What does “America First” look like?

12 Global outlook


contributing to the acceleration. Business investment is also turning a corner. It slumped on the back of weak investment in the energy sector because of low global oil prices. But it is showing signs of rebounding: non-residential fixed investment growth was 2.4% in October-December, the highest rate in more than one year. This will improve further in 2017 as higher oil prices boost investment in oil and gas.

Seven years into the recovery from the global financial crisis, it is nevertheless clear that, without a significant boost to productivity or a broad improvement in the global economy, economic growth of around 2% is the new normal for the US. We continue to forecast average real GDP growth of 2.2% in 2017-18. There is a significant upside risk to this forecast, given Mr Trump’s loose stance on fiscal policy, but there is also a significant downside risk if his protectionist agenda were to lead to retaliatory actions from other countries and evolve into a trade war. Private consumption growth will remain strong, supported by rising incomes, but gradual increases in market interest rates will prevent a faster acceleration in consumer spending.

The Democrats' best hope for 2020 may lie in the medium-term economic outlook. We forecast a mild recession in 2019 as the economy contracts for two consecutive quarters, with average growth for the year at around 1%. We expect this downturn to be triggered by a combination of factors: slower economic growth in China, which will damage global sentiment (causing falls in US equity markets and reducing US consumer and business confidence), and higher borrowing costs resulting from a modest tightening cycle by the Federal Reserve (Fed, the central bank). Domestic and external demand will therefore soften in 2019 and cause the US’s first technical recession for ten years. Nevertheless, we expect the economy to recover relatively swiftly, and annual real GDP growth will rebound to an average of 2% in 2020-21.

Although our central forecast is that the business cycle will end in 2019, an external shock could bring it to a halt sooner. Unprecedented Fed policies have inflated asset prices, and a turn in investor sentiment—especially if the new administration gets off to an uncertain start—could harm consumer and business confidence. Other serious external risks include a sharp downturn in emerging markets and a break-up of the euro zone.

Expectations of reflationary policies under the Trump administration have given added impetus to an existing upward trend in US and global bond yields. Although bond yields will continue to rise, they will remain low by historical standards. This view is supported by a temporary retracement of US bond yields since the start of 2017.

Monetary policy will remain accommodative and the domestic economy will be able to withstand a gradual increase in borrowing costs. We expect the Federal Reserve (Fed, the central bank) to raise rates twice in 2017 and twice in 2018. If Mr Trump succeeds in passing a large fiscal spending package, the Fed may move more quickly. If inflation remains below target, the Fed will hold back. The modest tightening cycle will last until early 2019, after which the Fed will cut the policy interest rate to almost zero once more in order to support the economy. It will slowly begin to raise rates again in 2021.

US policy interest rates will return to the zero lower bound

When is the next recession?

Global outlook 13


The Liberal Party, led by Justin Trudeau, is reshaping Canadian politics in dramatic style, after it won a majority at the parliamentary election in October 2015. Passage of legislation is proving straightforward. The two opposition parties, the Conservatives and the New Democratic Party, will choose new leaders in 2017 and will subsequently pose a stronger challenge to the Liberals' dominance of the political scene. Much can change over the next three years, but we think that the Liberals will have a strong policy record on which to win re-election in 2019.

We forecast that real GDP growth will accelerate from 1.3% in 2016 to an annual average of 2% in 2017-18. The government will continue to support the economy through additional spending, oil production will rise in line with higher global energy prices and low interest rates will encourage consumers to spend. Nonetheless, households will not be able to take on much new debt. Consumers are financially stretched. The bulk of debt is mortgages, and bubble-like conditions have formed in some housing markets. These two connected risks represent the biggest threats to the financial system.

Europe growth and inflation (% change)

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021Real GDP growth Europe 0.2 0.8 1.8 1.9 1.7 1.6 1.6 1.6 1.8 1.8EU28 -0.4 0.3 1.7 2.2 1.8 1.6 1.5 1.4 1.6 1.6Euro area -0.8 -0.2 1.2 2.0 1.7 1.5 1.5 1.4 1.5 1.4Russia 3.5 1.3 0.7 -3.0 -0.6 0.9 1.3 1.5 1.7 1.6Inflation Europe 3.1 2.4 2.0 2.9 1.8 2.8 2.6 2.4 2.4 2.5EU28 2.6 1.5 0.5 0.0 0.2 1.7 1.8 1.7 1.8 1.8Euro area 2.5 1.4 0.4 0.0 0.2 1.5 1.5 1.6 1.7 1.8Russia 5.1 6.8 7.8 15.5 7.0 5.4 4.4 4.6 4.7 4.6


We expect that the UK will leave the EU's single market in 2019. The consequences of the UK's vote on June 23rd to leave the EU will remain at the forefront of European politics in the coming years. The UK prime minister, Theresa May, is committed to triggering Article 50 of the Lisbon treaty by the end of March 2017. The parliamentary bill on triggering Article 50 passed easily through the House of Commons (the lower chamber of parliament) and we do not expect the House of Lords (the upper chamber) to block the Brexit process. Lack of trust in institutions, including parliamentary institutions, has been a long-standing feature of UK politics, and any attempt by parliament to subvert the Brexit vote would risk deepening the trust deficit.

Mrs May stated soon after the Brexit vote that control over immigration and ending the jurisdiction of the European Court of Justice would be priorities for the UK in redefining its trading relationship with the EU. Both are incompatible with membership of the EU's single market. Acknowledging this fact, Mrs May announced in a landmark speech on January 17th that the UK would relinquish its membership but negotiate the fullest possible access to the trading area as a non-member. Mrs May has said that she would like the UK to have tariff-free access to EU markets, but full customs union membership would mean a com-

The UK will leave the single market

The Canadian economy will bounce back from the oil-price-led slowdown

14 Global outlook


mon external tariff and, crucially, would prevent the UK from negotiating trade deals with other countries. The latter is a key part of the government's plan to make a success of Brexit, and so the UK's departure from the EU customs union is a strong possibility. If the UK does end up leaving the customs union, the government will probably pursue a comprehensive free-trade agreement (FTA).

Article 50 sets a two-year deadline to negotiate a withdrawal agreement. The Article 50 deadline can be extended only if all European Council members agree. If negotiations fail and no extension is agreed, the UK would leave the EU without any agreement in place and revert to World Trade Organisation (WTO) trade rules. This would mean a rise in tariff barriers that would be damaging to both sides. However the government is aiming to have reached a deal on the new UK-EU trading relationship by the close of the two-year window for negotiations.

It is feasible that the broad framework for an FTA will have been drawn up by the time the UK formally withdraws from the EU, in early 2019, leaving the precise terms of the deal to be phased in gradually. However, this will require talks on the withdrawal agreement to take place alongside talks on a new trade agreement, and will depend on how comprehensive this agreement is. The UK's access to the single market may be further limited by domestic pressure to roll back EU product regulations and minimise contributions to the EU budget. However, the prospect of trade barriers should be a sufficient economic incentive to ensure that UK sectors with the closest ties to the EU market can maintain them at a low cost. Whatever the new trading arrangement, UK-EU ties are likely to remain close, particularly given security challenges faced by the region. However, political exigencies on both sides reduce the scope for an amicable divorce, and negotiations could fail before the deadline is reached.

Consumer spending has held up well in the face of Brexit-related uncertainty. This, along with the resilience in forward-looking survey-based indicators (particularly the purchasing managers' indices), suggests that the UK economic downturn in 2017 will not be as sharp as we initially expected. High frequency indictors of activity suggested that economic momentum remained firm in early 2017, and we revised up our forecast for full-year real GDP growth from 1.2% to 1.7%. We forecast that the depreciation in sterling will push inflation up to 2.8% this year. The UK government has made a concerted effort to address the causes of persistently weak productivity in the UK. We expect these policies to tackle some, but not all, of the root causes of weak UK productivity, and a recent deterioration in official forecasts for the public finances is likely to constrain the government's ability to expand them.

The Brexit referendum, followed by Mr Trump's victory in the US presidential election, will provide a boost for anti-establishment and anti-EU political forces in many countries, and the departure of other member states cannot be ruled out. A sense of malaise among large sections of the population is fomenting the rise of populist, anti-establishment parties that challenge the legitimacy of the EU. Political systems are becoming more fragmented, with national elections resulting in gridlock, making the formation of stable governments challenging. The year 2017 will be a test case for these trends, with elections coming up in the Netherlands, France and Germany. In all three contests populist parties will

At the end of complex Brexit talks, UK-EU ties should remain close

Anti-establishment forces will make gains across Europe

Global outlook 15


play a large role. We do not expect any of these to win or gain power, as establishment forces are likely to unite against them. However, we expect further political fragmentation, with parties of the traditional centre-left and centre-right struggling to gain enough support to govern effectively. This will weaken the ability of governments to deliver coherent policy changes or undertake structural reform. The EU is already poorly placed to respond to the multiple policy and geopolitical challenges that it faces, including migration, high unemployment, and fraught relations with Russia.

In France, the far-right Front national (FN) has seen its Eurosceptic, anti-immigrant and anti-Islam platform boosted by the UK's vote to leave the EU, and by three large-scale terrorist attacks in 2015-16. Marine Le Pen, the FN leader, has pitched herself as the champion of the working classes against the elitism of the right and the internationalism of the left. Ms Le Pen has been largely successful in the "de-demonisation" of her party, which under the previous leadership of her father (Jean-Marie Le Pen) was beyond the political pale. The FN nevertheless remains anathema to many voters because of the original pro-Vichy, pro-Nazi and anti-Semitic proclivities of its founders, its anti-Muslim and anti-immigrant views, and, significantly, because of its plans to take France out of the euro zone.

François Fillon, the front-runner in France's April/May 2017 presidential election, has been enmeshed in a public funding scandal. Mr Fillon, the candidate of the centre-right party, Les Républicains, built his reputation on honesty and his presidential campaign on austerity, so allegations about the questionable employment of his wife—and the sums involved—are damaging. Should Mr Fillon remain in the race without successfully rehabilitating his reputation, he would be unlikely to reach the second round. A credible alternative choice with the support of Les Républicains would still have a strong chance to win the presidency, but Emmanuel Macron, a centrist independent, stands well placed to benefit from the debacle and has already risen in the polls.

Regardless of whether Ms Le Pen faces the eventual Républicain candidate or Mr Macron in the second round, we expect centre-left and centre-right voters to rally round the non-far-right choice. There are, however, risks to this view: another scandal among her opponents or another major terrorist attack could play into Ms Le Pen's hands. Overall, we think that there is a 40% chance that she will prevail.

Another important country to watch is the Netherlands. Our baseline forecast for the parliamentary election on March 15th is a narrow victory for the People's Party for Freedom and Democracy (VVD) of the current prime minister, Mark Rutte. However, there is also a realistic possibility that the right-wing populist Party for Freedom (PVV), led by Geert Wilders, will gain the largest share of the vote, running on an anti-immigration and anti-European platform. Political fragmentation has become a permanent fixture of the political landscape in the Netherlands, with the traditional mainstream parties losing support in favour of populist alternatives on both the left and the right. However as just about all other parties, including the VVD, have ruled out forming a coalition with the PVV, it is highly unlikely that the PVV will manage to gain a place in government. We expect the VVD to take the lead in coalition

In France, the far-right will probably fall short of taking the presidency

Votes in the Netherlands and Germany will also see the far-right make gains

16 Global outlook


negotiations following the election, but any governing coalition is likely to require a relatively large number of parties (four or five), leading to a protracted period of political instability.

Meanwhile Germany faces a number of important elections this year. On February 12th Frank-Walter Steinmeier, the minister of foreign affairs and a member of the Social Democratic Party (SPD), was elected president, and there will be elections in three of the federal states in March and May. These are likely to be dominated by local dynamics and thus only provide limited guidance to the federal election, scheduled for September 24th. We expect this election to result in another grand coalition of the centre-right Christian Democratic Union (CDU)/Christian Social Union (CSU) and the centre-left Social Democratic Party (SPD), under the continued leadership of the chancellor, Angela Merkel.

The popularity of both the CDU and the SPD has, however, fallen since mid-2015, and the clearest beneficiary has been the anti-euro, anti-immigration Alternative for Germany (AfD). Polls indicate that the AfD's support at the national level has more than doubled since the last general election, to about 12%. This makes it the third most popular party in Germany and it is likely that it will reach the 5% threshold needed to enter the Bundestag (the lower house of parliament). Although entry to parliament will be an important milestone for the AfD, the party's prospects should not be overstated. For the moment, at least, no other party would be willing to enter into a coalition with the AfD. Moreover, Germany remains an exception in the region, for historical reasons, regarding voters' willingness to vote for right-wing populist parties (although it might simply be lagging its regional peers in this respect).

Following the resignation of Matteo Renzi in response to the outright rejection of his flagship constitutional reform on December 4th, Paolo Gentiloni, the foreign minister in the outgoing government, became Italy's new prime minister. Mr Gentiloni leads an interim administration that has a limited remit to keep the public finances stable, manage the troubles in Italy’s fragile banking sector and direct the recovery effort after a series of deadly earthquakes. The government will be vulnerable to political wrangling among the main political parties, which will be particularly intense as leaders seek to harmonise the voting systems in the two houses of parliament, following a ruling on January 25th by the Constitutional Court declaring parts of the lower house’s electoral law unconstitutional. The president has stated that voting laws should be made uniform before the next general election. The most likely timetable for a general election is early 2018, at the legislature’s natural conclusion, but there is strong pressure to vote in mid-2017. In late December the government approved a recapitalisation and liquidity fund that will be used to shore up Monte dei Paschi di Siena—Italy's third-largest bank—and is sufficient to assist several other lenders that may also struggle to raise capital. Although politically acrimonious, the rescue package is likely to improve confidence in Italy's banking sector modestly, and we maintain our view that a banking crisis will be averted.

Former foreign minister leads Italy's interim government

Global outlook 17


Europe: economic activity in the euro zone(seasonally adjusted)

Sources: Eurostat; European Commission; The Economist Intelligence Unit.

-3.0

-2.0

-1.0

0.0

1.0

2.0

3.0

85

90

95

100

105

110

115

Economic Sentiment Indicator(long-term average=100); right scale

Real GDP (% change, year on year);left scale

Q4Q3Q2Q116

Q4Q3Q2Q115

Q4Q3Q2Q114

Q4Q3Q2Q113

Q4Q3Q2Q112

Q4Q3Q2Q12011

Despite this political uncertainty, the euro zone economy is actually showing increasing momentum. At the start of 2017 most economic sentiment indicators for the euro zone paint a positive picture. We expect a healthy expansion in the region's economy, reflecting a continuation of the current cyclical upturn, although the pace of real GDP growth is likely to ease slightly after a relatively strong expansion in 2015-16. The European jobs market has made steady progress, with the unemployment rate across the 19 euro zone member states averaging 10% in 2016, down from 10.9% in 2015 and a peak of 12% in 2013. Nevertheless, we expect further progress in bringing down the rate of joblessness to remain slow. Some of the pain that the euro zone's weaker economies have endured can be expected to deliver lasting benefits. Structural reforms that have been passed across the euro area, especially in countries such as Spain and Portugal, should support private-sector activity in the medium term. Unit labour costs have fallen significantly in these countries. This has boosted companies' competitiveness and, crucially, these countries' external positions. Regulatory reform has improved the business environment, for example by increasing labour-market flexibility, boosting investment incentives and opening closed professions. However, there has been a clear slowdown in the breadth and depth of reforms since the peak of the euro zone crisis.

Nonetheless, the European Central Bank (ECB) is continuing to pursue an exceptionally accommodative monetary policy, with major policy interest rates at or below zero, a series of so-called targeted longer-term refinancing operations (TLTROs) aimed at pushing banks to lend more money, and an €80bn (US$85bn) per month quantitative easing (QE) programme, which will fall to €60bn per month from April until the end of 2017. The ECB's president, Mario Draghi, stressed that the reduction in the pace of QE was designed to sustain the bank's presence in the market for a longer period than if purchases continued at the current rate, and should not be viewed as "tapering", which would signify a winding-down of the programme.

We expect tapering to begin in 2018, but downside risks to global growth during that year, including our forecast for an economic slowdown in China, suggest that the pace at which the ECB unwinds its accommodative policy will be gradual. Moreover, although a partial rebound in energy prices has started to push inflation higher in 2017—notably in Germany, where there have been calls

Cyclical upturn in the euro zone economy will continue

ECB QE programme will run to end-2017

18 Global outlook


for the ECB to tighten policy—this influence will pass, and core price pressures are likely to remain relatively stable amid subdued domestic demand. We forecast that the ECB will not tighten policy rates before the end of our five-year forecast period, in 2021.

By contrast, we expect much of central and eastern Europe to face a challenging environment during the 2017-21 forecast period, particularly for countries that have benefited from EU funding. A deadline at the end of 2015 for fund drawdowns from the EU's 2007-13 fiscal period brought an end to a surge in investment spending. Funding inflows for projects under the EU's 2014-20 funding period have not gained the same kind of momentum. Growth in Germany—a key market for these countries—will remain steady, averaging 1.5% in 2017-21, although an economic slowdown in China will dampen external demand. Nonetheless, a shift in the German economy towards greater investment and private consumption will provide a boost to central and east European countries with strong trade links to their larger neighbour.

Nonetheless, within central and eastern Europe there will be significant divergences. The Visegrad states—the Czech Republic, Slovakia, Hungary and Poland—will see slower but still decent growth rates in 2017-21, with low oil prices, trade integration with Germany, generally weighty and competitive external sectors, and a lessening fiscal drag all acting to support growth rates.

By contrast, low oil prices, tight fiscal policy and western sanctions are weighing heavily on the Russian economy, which will have contracted for two consecutive years in 2015-16. We expect a return to real GDP growth in 2017, but this will be weak. Russia's fiscal policy remains contractionary as the government struggles to keep the budget deficit under control. The weak banking sector and high political risk will depress investment, although external financing conditions for companies that are not subject to sanctions should start to improve as oil prices recover, helping the rouble to stabilise. Structural weaknesses will keep trend GDP growth in Russia below 2% a year in the medium term. The country's economic potential will remain constrained by supply-side factors, including outdated capital stock, low investment, a high dependence on natural resource sectors and manifold institutional weakness.

Tight financial conditions in Russia will continue to have a negative effect on the economies of other Commonwealth of Independent States (CIS) countries, with which Russia has strong links through trade, finance and remittances. In Kazakhstan and Azerbaijan low oil prices will depress export earnings and high inflation will weigh on household spending. In Ukraine, after two years of deep contraction in 2014-15 and a year of modest growth in 2016, we forecast a stronger pick-up from 2017. The forecast assumes that there is slow but steady progress in reforming the economy and stabilising the political system, and that there is no return to all-out war in eastern Ukraine.

In Turkey, there has been some stabilisation following the attempted coup by parts of the military on July 15th 2016. Although the coup enjoyed no public support and was quickly suppressed, it was a severe shock to the Turkish state. It will have long-lasting implications for Turkey's domestic political outlook. The president, Recep Tayyip Erdogan, is using it as a pretext to go after his

Central and east European countries face a tough year

The failed coup in Turkey will have lasting implications

Global outlook 19


opponents in the military, the judiciary, the police force and academic institutions, and is pressing ahead with even greater determination to implement his plan to establish a strong executive presidency. We expect Turkey to hold a referendum in early April 2017 to approve a package of constitutional reforms designed to establish a presidential system of government. A "yes" vote is our baseline forecast, but there is a considerable chance that the reforms will be rejected. The new system would come into force in 2019.

Economic activity has recovered only moderately since the attempted coup, and currency volatility has increased, with the lira depreciating sharply against all major currencies since late 2016, fuelling a renewed acceleration in inflation. The fallout from the coup attempt will hurt the economy in the medium term if it dampens investor confidence or if institutional capacity is severely weakened.

Asia and Australasia growth and inflation (% change)

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021Real GDP growth 4.4 4.6 4.1 4.2 4.0 4.0 3.2 3.3 3.7 3.8 ASEAN 5.9 5.0 4.4 4.4 4.5 4.7 4.1 4.2 4.7 4.8 China 7.9 7.8 7.3 6.9 6.7 6.2 4.2 4.3 5.2 4.8 India 5.7 6.7 7.2 7.5 6.5 7.0 8.0 7.5 7.5 7.9 Japan 1.5 2.0 0.2 1.2 0.8 1.0 0.6 0.8 0.2 0.7Inflation 3.5 3.7 3.5 2.2 2.1 2.6 2.5 2.4 2.8 2.7 ASEAN 3.8 4.4 4.4 3.2 2.3 3.2 3.7 3.0 3.2 3.7 China 2.6 2.6 2.1 1.5 2.1 2.0 1.6 1.9 2.7 2.5 India 9.4 9.9 6.7 4.9 4.9 5.1 5.2 4.9 4.9 4.8 Japan -0.1 0.3 2.8 0.8 -0.1 1.2 0.9 0.9 1.2 0.7


In the next five years the global economy will continue to shift eastwards towards Asia. However, growth in the region will be slower and more uneven as the need for internal rebalancing weighs on some of its biggest economies. These imbalances are of particular concern in China, which has seen a spectacular build-up in leverage since the global financial crisis of 2008-09. According to the Bank for International Settlements, total credit to non-financial corporations in China rose from 119.9% of GDP at the end of 2009 to 167.6% of GDP in June 2016. We expect problems stemming from these imbalances to come to a head in 2018, resulting in a sharp slowdown in Chinese growth. The effects will ripple through Asia, and growth in demand for Asian exports from the US and Europe will fail to compensate. The next five years will reveal which Asian corporates have been prudent at a time of cheap credit: there are likely to be some casualties.

However, for much of 2017 our central view is that the external environment will remain broadly supportive of growth. There will be periodic bouts of capital market volatility caused by uncertainties around US policy, European politics and concerns about the Chinese economy. But many commodity prices are past the bottom of the cycle, which has improved market sentiment regarding exporters like Indonesia, even as importers such as India continue to enjoy relatively cheap fuel and construction materials. Since the start of 2017, financial markets have lowered their expectations for aggressive US fiscal

Volatility is on the horizon for Asian economies

20 Global outlook


stimulus, and many Asian currencies have regained ground against the US dollar. Monetary policy tightening in the OECD will be extremely gradual, allowing Asian policymakers to maintain interest rates that are low by historical standards.

Next to China's imbalances, the major threat to economic growth and stability in Asia is the US government's newly protectionist stance. For now, however, we believe that Mr Trump will prefer measures with high symbolic impact but relatively limited practical consequences. For example, a blanket tariff on Chinese goods is possible, but we believe that the negative fallout on US consumers from the resulting increase in the cost of imported goods would dissuade Mr Trump from this step. It is more likely that the US administration will brand China a currency manipulator, despite abundant evidence that it is intervening to prevent renminbi depreciation rather than to keep the renminbi undervalued. We also expect that the US government will initiate a series of anti-dumping and anti-subsidy cases against China.

This type of approach would invite retaliation by China, such as tariffs targeting a narrow range of US exports, the cancellation of orders for some large items or greater regulatory scrutiny of US firms operating in China. Any serious attempt by the US to question what the Chinese leadership sees as the country's core interests, such as its claim to sovereignty over Taiwan and territory in the South China Sea, would have more serious consequences. It is not our central scenario, but the risk of a military clash between the world's two dominant military (and nuclear-armed) powers is significantly higher than it was under the Obama presidency.

Asia: China-US trade(US$ bn)

Sources: IMF, Direction of Trade Statistics; The Economist Intelligence Unit; Haver Analytics.

0

50

100

150

200

250

300

350

400

450Imports from USExports to US

1514131211100908070605040302012000

The outlook for China continues to be the key determinant of our Asia forecast. Real GDP rose by 6.7% in 2016; we estimate that the economy will slow only modestly in 2017, to 6.2%. However, we are much more cautious about the medium-term outlook. Debt, notably in inefficient, state-owned corporates, is already at dizzying levels and is growing at three times the rate of nominal GDP. At the same time, the government's progress on economic reform has been disappointing, and the structural maturation of the economy is weighing on growth. We expect economic growth to average just 4.6% a year in 2018-21.

China's slowdown will dominate Asia's outlook for years

An external threat?

Global outlook 21


Our forecast diverges significantly from the official China growth target of at least 6.5% a year. This suggests that the government will either need to revise down its projections quickly or deploy unsustainable levels of stimulus. There are dangers to both options. Bringing down growth targets would imply a lack of control over the economy, a damaging admission for a government with a pronounced authoritarian streak. But relying on the traditional tactic of stimulating the economy through public investment and a further expansion in credit raises the risk of an even harder economic adjustment in future.

We believe that the reckoning will come in 2018, and forecast that real GDP growth will slow to 4.2% as the worsening debt dynamics force the government to tighten monetary policy. The government will be reluctant to act before this. The Chinese Communist Party will conduct a reshuffle of its top decision-making body, the seven-member politburo standing committee, at the party congress in late 2017. It will do everything in its power to ensure that the run-up to the congress is smooth, including maintaining rapid economic growth in order to shore up social stability. At the meeting, the president, Xi Jinping, will strengthen his hand by appointing favoured allies. He will then feel emboldened to recalibrate economic policy.

Importantly, we do not expect the slowdown to affect all parts of the economy equally. It will be concentrated in production and investment in the industrial sector: investment growth will average just 2.7% a year in 2018-21 (compared with 6.5% a year in 2013-17), while industrial production growth will be 4% (compared with 7.1% in 2013-17). Household consumption and government spending will hold up better. This means that the Chinese slowdown will be felt most by Asian economies, such as Australia and South Korea, which supply Chinese heavy industry with raw materials.

There is a risk that the Chinese slowdown will be sharper and more broad-based than we expect. The state's deep integration with the banking system should give it the ability it to resolve financial strains relatively smoothly, but the bursting of credit bubbles elsewhere has usually been associated with sharper decelerations in growth, and a recession in China is not inconceivable. Given China’s central role in global supply chains, this scenario represents the most serious risk to the global economy. However, even our relatively benign central forecast will cause growth in the region as a whole to slow to 3.2% in 2018, from an average of 4% in 2016-17.

With China losing momentum, India will be Asia's fastest-growing large economy over the next five years, expanding at an average annual rate of 7.6%. However, the Indian economy is also going through a painful shakeout. A lending spree earlier this decade saddled state-owned banks with bad loans and created excess capacity in heavy industry. Furthermore, a currency reform announced in November 2016 as part of a drive against the black market has proven extremely disruptive, causing a severe cash crunch during the wedding, harvest, festival and tourist seasons. The cash shortage began to ease in January, and disruption to the sowing of the winter crop appears to have been limited. However, the negative economic effects could persist for some months yet. We expect GDP growth in fiscal years 2016/17-2017/18 (April-March) to average just 6.8%, compared with 7.5% in 2015/16. (Owing to the challenges of measuring India's vast informal economy, the GDP figures are likely to understate the disruption.)

India has a bright future if it can get through painful reforms

China will slow abruptly in 2018

22 Global outlook


We expect the ambitious reform programme led by the pro-business prime minister, Narendra Modi, to show greater benefits in subsequent years. The demonetisation scheme will help to expand the formal economy and widen the tax net, while a nationwide goods and services tax, set to come into effect in July 2017, will move India closer to being a genuine single market. There will be significant progress on upgrading physical infrastructure. Perhaps most impressively, there has already been genuine progress on macroeconomic reform. The monetary policy framework has improved and the government has shown a commitment to reducing the fiscal deficit. Over time, inflation and fiscal targets will help to hold policymakers to account and support macroeconomic stability. Improvements to the regulatory and business environment will be slower and more piecemeal. Overall, although India's economic growth outlook in 2017-21 is impressive in the international context, it is still well below what we regard as India's potential.

Growth will remain buoyant in emerging South-east Asian economies, averaging at least 6.5% a year in Vietnam, Cambodia, Laos and Myanmar (the last of these is expected to be the fastest-growing economy in Asia, at an average of 8.5% a year in 2017-21). These economies will benefit from relatively low wage costs, an advantageous geographic location and comparatively stable governments. They will also continue to benefit from Chinese investment under the "One Belt, One Road" initiative, which we do not expect China's economic slowdown to derail.

By contrast, the ebbing of Chinese demand will come at a time when Asia's industrial powerhouses, Japan and South Korea, will still be struggling to rekindle their economies. Monetary policy in Japan may have reached its limit in terms of its ability to stimulate growth. Consumer price inflation has persistently fallen short of the projections made by the Bank of Japan (BOJ, the central bank); the BOJ's latest strategy is to use a flexible programme of asset purchases to keep ten-year government bond yields at zero while preventing the yield curve from flattening excessively. At its January meeting the central bank revised up its forecast for real GDP growth to 1.4% in fiscal year 2016/17 (April-March), but the majority of the policy board does not expect that inflation will reach the target of 2% until sometime in 2018/19. We expect growth to average just 0.7% a year in 2017-21, well short of the BOJ's expectations and the government's target of 2% growth.

Demographic factors are a major reason for the shortfall. Abenomics, the economic strategy of the prime minister, Shinzo Abe, is delivering some benefits. Mr Abe's personal popularity may make it easier for him to deliver future reforms; in October 2016 his Liberal Democratic Party (LDP) agreed to change its rules to allow him to extend his tenure to 2021, setting Japan up for an unprecedented period of political stability. However, achieving 2% growth would require an overhaul of social policies such as immigration, which neither the government nor the electorate is willing to consider.

There is also little scope for aggressive fiscal stimulus, given the government's avowed intention to bring its debt under control. Indeed, at this stage there is no sign that the consumption tax increase planned for October 2019 will not go ahead. Without a greater willingness on the part of the government to issue more debt, the ability of the BOJ to deliver monetary stimulus by buying up government debt will become increasingly limited.

Demographic trends will weigh on growth in Japan and South Korea

Global outlook 23


Latin America growth and inflation (% change)

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021Real GDP growth 3.0 2.8 1.3 0.2 -0.7 1.1 2.0 1.9 2.8 2.9 Brazil 1.9 3.0 0.5 -3.8 -3.5 0.5 1.8 2.1 2.2 2.3Inflation 7.0 7.9 10.0 11.9 18.4 14.9 12.0 7.3 5.2 4.7 Brazil 5.4 6.2 6.3 9.0 8.7 5.0 6.0 4.6 4.6 4.6


Following a regional contraction of 0.8% in 2016, Brazil's emergence from a difficult two-year recession will help to lift the regional growth rate back into positive territory in 2017. But growth will continue to disappoint as the region's two largest economies struggle. We maintain our forecast of growth of just 0.5% for Brazil and 0.9% in Mexico in 2017. Sluggish growth in both countries will cap the region's growth outlook over the medium term. Brazil's economy is expected to begin its recovery in the first quarter, with a mild sequential expansion, gathering pace later on. On a more positive note, the cycle appears to have turned already in Argentina. Fourth-quarter data (output in October and November grew by 0.4% and 1.2% respectively, year on year) are indicative of a recovery in activity after four consecutive quarters of contraction beginning in the third quarter of 2015. We will probably revise up our forecast for Argentina's GDP growth in 2017 by 0.1 percentage points to 2.6%, with the upturn continuing in 2018.

Although social and economic ties between the US and most Latin American countries will remain strong, the risk of tension and a deterioration in relations under a Trump administration will be high. The policies pursued by the president in areas such as trade and migration will have an important bearing, particularly on Mexico, although our forecasts assume that Mr Trump will not follow through on some of his more radical campaign pledges and that the renegotiation of the North American Free-Trade Agreement (NAFTA) that he announced after taking office will lead to adjustments rather than its "termination" if he fails to get a better deal.

In the US, the election of Mr Trump initially pushed up market expectations that fiscal stimulus and cuts in regulations would be reflationary and spur US growth, although markets have begun to reconsider the impact somewhat more recently. This would benefit Latin America's exporters and countries for which the US is an important source of remittances. If stronger US growth leads to a sustained rise in US interest rates and a further rally in the dollar, this could revive concerns about the region's capacity to service its hard-currency debt. But with the exception of the Mexican peso, which remains under pressure because of concerns about Mr Trump's trade policy, Latin American currencies have recouped at least part of the losses sustained against the dollar in the weeks following the US election.

The region's terms of trade stabilised in 2016 as the bear market in commodities abated and prices rallied, in many cases finishing the year well off their lows. In addition, capital flows into the region picked up as accommodative monetary policy and record low bond yields in the G3 led investors to search for yield in emerging markets and other risky asset classes. This region suffered

Latin currencies recoup losses following a sell-off after Mr Trump's victory

Sovereign bond issuance was notable in January

24 Global outlook


renewed outflows in November following Mr Trump's victory in the US presidential election, but the recovery in Latin American currencies since December suggests that this may be a transitory phenomenon and that the region will again attract capital inflows in 2017. Indeed, bond issuance by several of the region's sovereigns, including Argentina, Honduras and Ecuador, in January was quite heavy, reflecting investors' appetite for high-yield paper. US trade and investment policy will be a factor. In January a US car manufacturer, Ford, bowed to pressure from the US president-elect and cancelled a planned US$1.6bn investment in a new factory in San Luis Potosí, Mexico. The decision appears to be a harbinger of US attempts to prevent jobs from relocating south of the border, some of which we believe will be successful.

Latin American export data have shown signs of recovery following last year's collapse in Chinese import demand, and this has been reflected in a narrowing of the region's current-account deficit, which we estimate at US$110bn (2.1% of GDP) in 2016, down from US$177bn (3.3% of GDP) in 2015. We expect the region's deficit to narrow slightly in 2017 to US$102bn (1.7% of GDP). Moderate gains in commodity prices will support the region's terms of trade in 2017, before a softening in prices in 2018 linked to a sharp slowdown in China.

A change in risk appetite was an important factor in the 2016 rally in several of the region's currencies (the Mexican peso being an exception), which recouped part of the losses sustained during the sell-off of 2014-15. In addition to renewed inflows of portfolio capital, increased foreign direct investment inflows have supported many of the region's currencies. We forecast that US bond yields will not rise much further and that, following a 25-basis-point increase in December, the Fed will raise rates only twice in 2017 (50 basis points in total). On these assumptions we expect the currencies of the larger countries in the region to depreciate slightly against the dollar in nominal terms from current levels but to appreciate moderately in real effective terms on an annual average basis. They are likely to come under renewed pressure in 2018 owing to the ramifications of China's slowdown.

The outlook for monetary policy in the region is mixed. In December Banco de México (Banxico, the central bank) made its fifth 50-basis-point rate rise in 2016, bringing the policy rate to 5.75%. In December Banxico also intervened in the currency markets to try to steady the peso. These policy steps have been undertaken to alleviate inflationary pressure stemming from a weakening currency but have failed to stop the depreciation of the peso, which breached the Ps21:US$1 for the first time in January. Banxico responded to the inflationary spike (4.8% in January) caused by a petrol price increase by tightening by a further 50 basis points on February 9th. We expect Banxico to take its cue from the Fed and US bond markets in respect of the scale and speed of future rate rises, but not to be as aggressive as in 2016, given the limited impact that those increases had in preventing peso weakening, as well as the fact that further tightening is likely to have a discernible impact on growth. Until there is more clarity about what action, if any, Mr Trump will take with respect to NAFTA, the peso will remain vulnerable. We have revised our forecast and now expect the peso to weaken to Ps24.2:US$1 by year-end (compared with Ps21:US$1 previously).

A mixed outlook for monetary policy in the region

Global outlook 25


Elsewhere in the region we expect rates to fall in 2017, although this will be contingent on currencies not weakening excessively in response to higher US rates. In the light of weak economic activity in the fourth quarter and faster than expected disinflation, Banco Central do Brasil (BCB, the central bank) increased the size of cuts in the policy rate to 75 basis points in January, following two 25-basis-point cuts since the start of the easing cycle in October. We now expect the Selic policy rate to fall to 10% (or possibly below) by end-2017. Argentina began an easing cycle in April 2016 after sharp interest-rate increases following the December 2015 devaluation. In response to inflationary pressures, the BCB has kept rates on hold at 24.75% in recent weeks. Conflicts over the pace of monetary easing led to the firing of the finance minister, Alfonso Prat-Gay, in December. Amid stubborn high inflation, we expect the central bank to maintain a cautious bias to rate cuts in 2017, but that rates will fall towards 20%. Colombia started an easing cycle with a 25-basis-point cut to 7.5% in December, but left rates unchanged at its January meeting. Further rate cuts are in prospect later in the year as inflation (5.3% in January) eases towards the 2-4% target range. Chile and Peru did not have to raise rates as much as other countries did during the adjustment to weaker commodity prices and dollar strength. The Banco Central de Chile (BCCh, the central bank) cut its policy interest rate by 25 basis points in January, to 3.25%, the first reduction in two years. In the context of slower inflation and sluggish economic activity, we expect the BCCh to cut the benchmark interest rate by a further 50 basis points, to 2.75%, over 2017. In Peru, with inflation still slightly above the 1-3% target range, we expect the Banco Central de la República del Perú (BCRP, the central bank) to keep rates on hold, adopting a "wait and see" strategy until the US raises interest rates again when a tightening bias is likely.

In the face of large budget deficits, governments in the region had little scope in 2016 to loosen fiscal policy to stimulate demand, but a cyclical improvement in the public finances from 2017 will ease pressures. In 2020-21 we forecast average regional growth of close to 3%. The 2015-16 downturn has exposed the region's enduring structural weakness of commodity dependence and the need for policies to diversify economies and encourage productivity gains if the region is to free itself from boom-bust cycles. The build-up in indebtedness (particularly hard-currency borrowing by the private sector) during the commodity boom is a source of risk and a constraint on growth prospects.

As expected, in mid-December the Brazilian Senate approved a constitutional amendment that freezes public spending growth in inflation-adjusted terms (reducing its share of GDP once economic growth returns). But for this to become operational in practice it will require complementary social security reforms. The government has submitted its proposals to Congress and we expect their approval, albeit in somewhat diluted form, by mid-2017. The election in early February of the new leaders of the lower and upper houses of Congress who are closely allied to the Temer government has improved the outlook for reforms. In the event of reforms being blocked by Congress, investors would once again become jittery over Brazil's fiscal adjustment path. Our current forecasts assume sufficient fiscal consolidation to stabilise the public debt/GDP ratio in 2018-19 at just over 85%, but the risk of slippage is growing.

Attention turns to the approval of pensions reform in Brazil's Congress

26 Global outlook


We keep our 2016 GDP growth estimate for Brazil unchanged (at -3.5%). For the time being we maintain our 2017 forecast of just 0.5% growth. Given a high negative carryover from 2016, this still means that quarter-on-quarter rates will average 0.5%. We expect the recovery to be mild in the first half, gathering momentum later in the year. We expect the BCB to ease monetary policy aggressively, taking the Selic policy rate to 10% (or possibly lower) by the third quarter, as inflation (5.4% in January) converges more closely with the 4.5% mid-point target than previously expected. We maintain our medium-term forecasts broadly unchanged for the time being. Brazil's recovery will face headwinds in 2018-19 owing to the slowdown in China and the recession in the US. Our forecasts for 2019-21 are based on the expectation that the government that takes office following the October 2018 elections will pursue orthodox policies and take some steps to introduce other pro-growth reforms.

In Mexico, a survey showing a plunge in consumer confidence in January, in addition to the impact of sharp gasoline price rises on disposable income, points to a soft outlook for household consumption in 2017, supporting our GDP growth forecast of only 0.9% in 2017 and 1.8% in 2018. This forecast does not fully factor in risks of a severe deterioration in the US-Mexico relationship such as a materially adverse outcome to the renegotiation of NAFTA, with, for example, the US applying special tariffs on key Mexican manufacturing exports in addition to taxes or fines on more US companies moving jobs and production to Mexico. Such a scenario could push Mexico into an outright recession in 2017-18.

Mexico: consumer confidence(Jan 2003=100)

Source: Instituto Nacional de Economía y Geografía.

65

70

75

80

85

90

95

100

105

Jan17

SepMayJan16

SepMayJan15

SepMayJan14

SepMayJan13

SepMayJan12

SepMayJan11

SepMayJan2010

A loss of political capital will hinder the efforts of the president, Enrique Peña Nieto of the Partido Revolucionario Institucional (PRI), to enact the structural reforms passed in 2013-14 and will leave the PRI in a vulnerable electoral position in 2018; we do not expect it to retain the presidency. After a dip to 1.5% in 2019, owing to a slowdown in the US, GDP growth will average 2.8% annually in 2020-21, which is below potential, as institutional weaknesses and regulatory challenges impede the implementation and dilute the impact of structural reforms.

Risks in Mexico from possible changes in US trade policy

Global outlook 27


Middle East & Africa growth and inflation (% change)

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021Real GDP growth Middle East & North Africa 3.9 2.1 2.6 2.6 2.4 2.6 3.5 3.0 3.7 3.8Sub-Saharan Africaa 4.1 4.7 4.5 2.9 1.1 2.5 3.4 2.9 3.1 3.7Inflation Middle East & North Africa 9.2 11.3 7.3 6.7 6.6 8.0 7.8 6.9 6.6 6.5Sub-Saharan Africaa 9.0 6.8 6.7 6.9 10.5 10.1 8.1 7.0 6.7 6.8

a Angola, Botswana, Cameroon, Côte D'Ivoire, Equatorial Guinea, Ethiopia, Gabon, Ghana, Kenya, Malawi, Mauritius, Mozambique, Namibia, Nigeria, Senegal, South Africa, Tanzania, Uganda, Zambia and Zimbabwe.


The Middle East and North Africa (MENA) region continues to be buffeted by social unrest, war and terrorism. As these difficulties have intensified, the region's problems have spilled over its borders, exemplified by the flood of refugees into the EU and the growing global threat posed by an extreme jihadi group, Islamic State (IS), despite its recent territorial losses in Syria and Iraq. With the US now looking set to pare back its role in the region following the inauguration of Mr Trump as president, internal and external actors will be encouraged to step in to fill the breach—a process that in turn will sharpen intra- and extra-regional rivalries and exacerbate sectarian tensions.

If, as appears likely, Mr Trump abdicates US leadership in the region, the ongoing regional power-play between Iran and Saudi Arabia will escalate. Both countries’ relations with the US have taken sharply divergent directions since Mr Trump became president. The Saudi king, Salman bin Abdel-Aziz al-Saud, enjoying a cordial telephone conversation with Mr Trump in January; however, in contrast, the US imposed new sanctions on Iran in February after the latter conducted a ballistic missile test. Nonetheless, and despite Mr Trump’s stated hostility to the international nuclear deal with Iran, we expect that Iran's continued adherence to the Joint Comprehensive Plan of Action, combined with its obvious economic appeal, will keep EU, Russian, Indian and Chinese firms engaged (even if most US firms will be deterred).

We expect an improvement in the MENA economic outlook in 2017-21, reflecting the resultant sharp rise in growth in Iran (the second-biggest economy in the region) to above 5% and a recovery in oil prices more generally. Besides Iran, other energy exporters will enjoy a partial reprieve in 2017-18 owing to slightly higher oil prices. Coupled with the positive impact of a concerted drive to improve these countries' business environments in 2015-16, this will push economic growth up. However, despite an easing of fiscal austerity measures, the rise in oil prices will not be sufficient to enable MENA oil exporters to restore the expansionary fiscal policies that dominated in 2011-14 (several countries had fiscal break-even oil prices above US$100/barrel prior to the oil price collapse). Therefore, persisting fiscal restraint and subdued public investment will weigh on the non-oil economy's performance, which, combined with lower oil production in 2017 (reflecting OPEC strictures), will mean that overall economic growth will remain modest.

MENA growth will be hindered by fiscal restraint

Saudi and Iranian rivalry will dominate geopolitics in MENA

28 Global outlook


We expect to see some improvement among MENA's non-oil exporters, assisted by IMF-linked economic reform programmes (notably in Egypt, which floated its currency in November 2016). Trade- and investment-related inflows from the region's oil producers into these countries will remain subdued, but they will benefit from a small improvement in global economic conditions. Furthermore, although commodity prices will rise, they will remain low by historical standards, and this will keep inflation in check and support non-energy and food-related consumption. On balance, we forecast that MENA economic growth will accelerate from 2.4% in 2016 to 2.6% in 2017 and 3.7% a year on average in 2018-21. Despite the improvement on 2016, this will be well below the levels witnessed in the decade prior to the Arab Spring, when the region's annual real GDP growth averaged 5.1%.

With the price of dated Brent Blend, the international benchmark, forecast to hover around US$60/b—only around half its 2014 peak, when prices briefly reached more than US$120/b—economic policy within the MENA region will continue to be dominated by governments' efforts to reduce their reliance on oil. In an indication of the scale of the challenge, we estimate that every country in the region posted a fiscal deficit in 2016, with oil exporters returning an average shortfall of 9.2% of GDP. As a consequence, governments will seek to diversify economic activity and revenue away from oil. However, resistance from vested interests, an opaque business environment and reluctance to reform rigid and discriminatory labour laws (to protect the local workforce) mean that progress will be very slow. As a result, the fortunes of most Gulf Co-operation Council (GCC) countries and other MENA oil producers will continue to be driven primarily by the oil market in 2017-21.

Another major obstacle to progress in the Gulf states is the slow improvement in increasing tax revenue (although a GCC-wide value-added tax is scheduled to come into force in 2018). This partly reflects policymakers' wariness about inciting unrest, and means that governments will favour privatisation programmes to replenish state coffers. We do not, therefore, expect current policies to trigger any major social upheaval in the GCC, although there may be a rise in labour militancy.

Following a dismal performance in 2016—when we estimate that Sub-Saharan Africa's rate of economic growth fell to just 1.1%, the lowest pace of expansion for at least 20 years—we are slightly more optimistic about prospects for 2017. This reflects our expectation that average prices for most of the region's export commodities—including oil—will increase, as well as the likelihood of more favourable weather conditions following the El Niño-related weather shock in 2015-16. Coupled with some modest domestic policy improvements, this will lift regional growth in 2017 to 2.5%.

Progress on structural and policy reforms will largely disappoint, however. For example, despite Nigeria implementing some market-oriented reforms—notably axing domestic fuel subsidies and adopting a more flexible foreign-exchange policy—the administration still appears to be half-hearted in its attempts at the sort of reforms that would boost outside investment. Notwithstanding some liberalisation of the naira, foreign-exchange restrictions remain in place, and in some cases have been tightened. Similar policy inconsistencies are in place in

Growth in Sub-Saharan Africa will recover from 2017, but not significantly

Governments are intensifying reform efforts in response to low oil prices

Global outlook 29


other countries and weigh heavily on the region's economic prospects, especially when the external environment is less supportive than it was during much of the past decade. Hence, although growth will accelerate in 2017, it will remain weak in the historical context and far below the level required to boost living standards significantly.

We expect regional growth to pick up slightly in 2018, driven by gradual economic recoveries in the region's two largest economies, Nigeria and South Africa, and steady growth trends across a number of mid-tier economies. Economic growth in Nigeria will be spurred by some pro-business policy reforms, as well as another modest rise in oil prices. In South Africa, real-term pay rises will boost aggregate demand, while the weaker rand will support export growth. Elsewhere, we expect infrastructure investment and expansionary fiscal policies to drive growth in East Africa (the fastest-growing subregion), while agricultural commodity exporters will benefit from relatively stable, albeit weak, prices in 2018. However, anticipating a sharp slowdown in Chinese growth in 2018, economic expansion in Sub-Saharan Africa will be constrained by depressed demand for industrial commodities and weak global confidence. This will also probably translate into a drop in trade, investment and credit flows between China and Africa from 2018. Coupled with the mild US recession that we expect in 2019, this is likely to lead to a renewed down-turn in growth that year, once again exposing the structural flaws that plague most African economies and weaken their ability to withstand external shocks.

The medium- to long-term growth constraints are varied. Policy mismanage-ment weighs heavily on the outlook for many countries, including the regional heavyweights, South Africa and Nigeria, as well as smaller—and previously fast-growing—economies such as Mozambique and Zambia. Domestic supply constraints, such as tight labour markets and infrastructure shortcomings, also reduce potential growth while adding to inflation and exacerbating current-account imbalances. The private sector will continue to be held back by difficult operating environments. Government bureaucracy and corruption will continue to be tough challenges. In the light of these constraints, as well as the likelihood of subdued prices for the region's main exports over the medium term, the growth rate in Sub-Saharan Africa is forecast to average less than 3.5% per year in 2018-21, compared with an annual average of 5% in 2000-15.

Sub-Saharan Africa: real GDP growth and working age population growth

Sources: World Bank, UN, Economist Intelligence Unit forecasts.

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

2.20

2.25

2.30

2.35

2.40

2.45

2.50

2.55

2.60

Working age population growth (age 15-64);right scale

Real GDP growth;left scale

21201918171615141312111009080706050403022001

Weak external demand will weigh on Sub-Saharan Africa in 2018-19

30 Global outlook


With a high dependency on subsistence farming and rain-fed agriculture, Sub-Saharan Africa will remain heavily exposed to weather-related shocks. The impact of these on inflation will be compounded by currency weakness. Nevertheless, assuming more favourable weather conditions than in 2016, when the region was hit by a severe El Niño-related drought, we expect food supply to improve. This will help to push down average regional inflation from an estimated 10.5% in 2016 to below 7% towards the end of the 2017-21 outlook period.

The political fortunes of Sub-Saharan Africa remain mixed. Elections have become more common, with major elections due in 2017 in Angola, Kenya and Senegal, among others. However, incumbents often use their time in office to stifle the opposition, weaken institutions meant to check the powers of the executive and skew the election process in their favour. As a result, peaceful changes at the ballot box will be rare. The peaceful transition in Ghana, where the incumbent administration was defeated in the general elections held on December 7th, confirmed its standing as one of the continent's strongest democracies. Coups d'état will be rare but conflict, failed governments, crackdowns on political freedoms and human rights violations will remain relatively widespread. In addition, the threat from radical Islamist factions—which include Boko Haram in Nigeria, Niger, Chad and Cameroon, al-Shabab in Somalia, and al-Qaida in the Islamic Maghreb, which operates across the Sahel—will persist. There is also a risk that porous borders and constraints on regional governments' fiscal resources will allow these groups to expand their influence beyond their current core areas of operation.

In the context of slow economic growth, weak job creation and rising urbanisation, the risk of social instability will continue to increase, and there is precedent for this to spill over into significant violence. In addition to frustrations over the lack of economic opportunities, frequent restrictions on political freedoms will further fuel discontent and rising internet usage will make it easier and quicker to share information. Even so, anti-government movements in Sub-Saharan Africa will remain fairly localised, which limits the prospects of an Arab Spring-style uprising and reduces the risks that protests will be scaled up to a level that could affect governments' hold on power. Moreover, the determination of African consumers to seek higher incomes in a more stable environment—coupled with the fact that stronger, if still fragile, democracies have taken root over the past decade—will further limit the extent and duration of protests in Sub-Saharan Africa.

Exchange rates The US dollar surged across most currencies in the weeks following the presidential election, reaching a 14-year high on a trade-weighted basis, on the premise that fiscal loosening under the administration of Donald Trump would reflate the economy. This also led investors to price in the possibility that the Federal Reserve (Fed, the US central bank) would tighten monetary policy more aggressively than previously thought, pushing up US bond yields. Given the lingering uncertainty about the direction of policy in many areas under the incoming administration, The Economist Intelligence Unit has refrained from

Risk of social unrest and terrorist attacks will remain high

Foreign-exchange markets price in a benign outlook for the US under Trump

Global outlook 31


making significant changes to its US macroeconomic forecasts. We have made some adjustments to our forecasts for the dollar against both the euro and the yen to reflect the dollar's gains against the two majors in the last two months of 2016. However, we do not forecast sustained dollar appreciation against the majors in 2017. This view is supported by a retracement of part of the dollar's gains against the euro and, notably, the yen in the first six weeks of the year.

Although yield differentials will favour the dollar in 2017-18, we believe that much of this is already priced in to the foreign-exchange market, which leaves the dollar vulnerable to any disappointment on growth, not to mention possible shocks emanating from erratic policymaking under the Trump administration in areas such as trade and migration. Changes to the tax system may encourage US companies to repatriate part of the large cash pile that has accumulated offshore but, as most of the cash is already denominated in dollars, this should not have much impact on the exchange rate. A Republican proposal for a border adjustment levy that would tax imports but not exports would have important implications for the dollar, pushing it higher, at least in the short term. But the proposal is complex and will attract opposition from large importers. We do not factor it into our forecasts.

Over the medium term we maintain the view that the dollar will weaken moderately against the euro and the yen, as we expect the Fed to ease monetary policy in 2019 in response to recessionary conditions, taking the policy rate back near the zero lower bound.

The euro's depreciation against the US dollar since Mr Trump's election has revived talk of it breaching parity against the dollar. The euro fell below US$1.04:€1 in December following the rejection of the Italian referendum on proposed constitutional amendments and the subsequent resignation of the prime minister, Matteo Renzi. However, it has rallied off its lows in the new year, suggesting a resilience to shocks that has also been in evidence previously, including after the Brexit vote in June. This resilience will again be tested in 2017 when anti-establishment, anti-EU parties will contest elections in the Netherlands, France and Germany, although we do not expect them to gain power. At present we maintain our forecast that the euro will not reach parity with the dollar, and we expect it to trade in a narrow range close to the current level of US$1.07:€1 in 2017-18. The European Central Bank will reduce its quantitative easing programme from €80bn a month to €60bn a month in March. We do not expect it to start tapering until 2018, but the anticipation of this should lend support to the euro ahead of time. The euro will continue to derive structural support from a large current-account surplus (4% of GDP in 2016). Over the medium term we expect the euro to strengthen against the dollar, moving towards but not reaching its estimated fair value of US$1.20:€1 by the end of the forecast period in 2021.

The yen had been among the best-performing currencies in the first nine months of 2016, fulfilling its customary safe-haven role in a context of investor nervousness. It gave up a large part of its gains against the US dollar in the last quarter of the year but has rebounded since late December and is currently trading at ¥112: US$1. As the Bank of Japan (the central bank) remains committed to a very loose monetary policy (targeting 0% yields for ten-year

The euro shows resilience in response to the "no" vote in the Italian referendum

32 Global outlook


government bonds), the yen (even more than the euro) is a natural funding currency for carry trades. But, as in the case of the euro, lax monetary policy is offset by the structural support of a large current-account surplus. We expect the yen to appreciate against the US dollar in the medium term as its safe-haven appeal again comes to the fore during the slowdown in China in 2018 and the US recession in 2019.

The renminbi, which is pegged to a basket of currencies, weakened markedly against the dollar in the month following Mr Trump's election victory. It reached Rmb6.94:US$1 at year end, compared with Rmb6.50:US$1 at the start of the year and Rmb6.78:US$1 before the US elections. It has strengthened slightly against the dollar since the start of 2017. The currency has been under pressure since the middle of 2016, as strong domestic credit growth has created excess liquidity in the financial system and bond yields in the US have risen. The People's Bank of China (the central bank) has been selling reserves to contain the fall. Reserves fell by US$320bn in 2016 while the renminbi weakened by over 6% against the dollar, the biggest decline since 1994. Following a further US$12bn decline in January, reserves dipped below US$3trn for first time in six years. A sizeable part of the decline is explained by valuation adjustments rather than dollar sales. Even so, there is clear pressure from rising capital outflows, given the loss of foreign-exchange reserves at a time when China is running a sizeable current-account surplus (an estimated US$194bn in 2016). Although the authorities may view a weaker currency as desirable and natural at a time of broad dollar strength, they will be wary of the risks of too rapid a depreciation, as this would spur further capital outflows—hence the introduction of tougher capital controls. These include tighter controls on foreign acquisitions, particularly in the property and entertainment sectors, and restrictions on offshore lending by banks. On the assumption that US bond yields are unlikely to rise much further, pressures on the renminbi should ease. But if this proves not to be the case, and further restrictions on capital outflows do not work, there is a risk that the authorities may make another one-off adjustment in the exchange rate, similar to the one in October 2015. This would be destabilising, particularly for other emerging-market currencies. It would also complicate relations with Mr Trump, who has accused China of devaluing its currency to "steal jobs" from the US and pledged during his campaign to impose large tariffs on Chinese imports.

Broad emerging-market currency strength against the majors was a theme in the first half of 2016, reflecting investors' search for yield amid highly accommodative monetary policy in the G3 and record low bond yields. The rally faltered in the middle of the year as bond yields in developed countries edged up, and went into reverse in November following Mr Trump's election win as US bond yields rose smartly (accompanied by less marked rises in Europe and Japan). But the sell-off proved short-lived, as capital inflows recovered in December and—with some exceptions—emerging-market currencies recouped most of the losses that they had sustained against the dollar in November. Turkey, Malaysia and Mexico are among the countries whose currencies have failed to rebound, in each case as a result of country-specific risk factors.

Emerging-market currencies bounce back

Fears of a renminbi devaluation revive

Global outlook 33


In the event of further increases in US bond yields in 2017, emerging-market currencies would again be vulnerable. But on our assumption that US bond yields are unlikely to rise much further—a view that may be supported by a decline in yields since the start of the year—the outlook should be more stable, at least in the first half of 2017. Yields on emerging-market local- and hard-currency debt are still relatively attractive, and most emerging-market currencies remain cheap. Renewed pressures are likely in 2018, and possibly as early as the second half of this year, stemming from the sharp slowdown in China and the softening in commodity price growth that we expect. In 2019 emerging-market currencies will face countervailing forces, suffering from a drop in external demand as the US goes into recession, but possibly benefiting from cuts in US interest rates as the Fed eases monetary policy to support the economy.

World trade World trade (% change; goods)

2012 2013 2014 2015 2016 2017 2018 2019 2020 2021World trade 3.5 3.9 4.3 2.8 1.6 2.6 2.7 2.0 2.9 3.1 OECD 2.1 2.4 4.2 4.5 1.9 2.5 2.4 1.6 2.6 2.5 Non-OECD 4.6 5.2 3.5 -0.3 0.9 2.7 2.7 2.7 3.5 3.6


The Economist Intelligence Unit expects a modest recovery in global trade in 2017, but significant downside risks have emerged following Donald Trump's US presidential win. With the Republican Party maintaining its majorities in Congress, Mr Trump could enact some of his protectionist campaign pledges, such as withdrawing the US from the North American Free-Trade Agreement (NAFTA). We assume that, faced with the reality of governing, Mr Trump will backtrack on his most extreme trade positions. We expect NAFTA to be renegotiated between the US, Canada and Mexico, and this may have some benefits; the agreement is 23 years old and an update could include better protections on labour standards and the environment, and a reduction in red tape for workers in new industries like the digital economy. Another campaign promise, the imposition of high tariffs on Chinese imports, could trigger a trade war between the world’s two largest economies. We do not expect Mr Trump to adopt a large blanket tariff increase on imports from China. This is possible—Mr Trump has shown a willingness to take drastic action—but we think that the negative fallout for US consumers from a sharp increase in the price of imported goods would dissuade him from this. The US will, however, probably initiate a further series of anti-dumping and anti-subsidy cases, which would lift barriers for some Chinese firms exporting to the US.

Although the downside risks have increased, we expect global trade growth to accelerate from an estimated 1.6% in 2016 to 2.6% in 2017 and 2.7% a year on average in 2018-21. This forecast is relatively cautious. First, we assume that a slight rise in protectionism will inhibit trade in 2017-21. Governments around the world have introduced a slew of protectionist measures over the past couple of years and we expect this pattern to continue. Second, this forecast assumes that the prospects for any major multilateral trade deal like the Trans-

Global trade growth will improve in 2017

34 Global outlook


Pacific Partnership (TPP) are dead. Third, this forecast incorporates a structural slowdown in global trade as the integration of global supply chains abates. Finally, on the demand side, we expect a significant slowdown in the Chinese economy in 2018, followed by a mild recession in the US in 2019, both of which will be a drag on global trade growth.

The backlash against trade liberalisation happening in many countries has wrecked the mega-regional trade deals that had the potential to boost trade and growth. The proposed agreement between the US and the EU, known as the Transatlantic Trade and Investment Partnership, is now dead in the water in the face of public opposition on both sides of the Atlantic. The other mega-regional trade deal involving the US, the TPP, will not be ratified by the Trump administration, essentially signalling the end of the proposed agreement. Efforts by some signatories of the TPP agreement to save the trade pact appear futile. There is speculation that Japan, the second-largest economy in the TPP, will lead the push, after recently winning lower house approval for the enabling legislation. We are sceptical, however, of Japan’s ability to convince the other TPP partners of the depth of its commitment to push this forward. Any reinvigoration of the TPP, therefore, will take place in the distant future, if at all.

With the US turning away from trade liberalisation, China now has the opportunity to help to set the rules of engagement for south-south trade, at least. As in the case of Japan, we are doubtful that China can take on the free-trade mantle for now. Although an agreement in 2017 on the Regional Comprehensive Economic Partnership (RCEP) is planned, we believe that completion is a long way off. Talks are continuing on the RCEP, which would cover more than 3bn people when completed, rivalling the size of the TPP. The proposed agreement includes the ten Association of South-East Asian Nations (ASEAN) member states and six partner countries (Australia, China, India, Japan, New Zealand and South Korea). Even if agreement is reached on RCEP, the benefits would not be felt until the 2020s at the earliest. In the short term we expect a proliferation of smaller trade deals, which could eventually lead to a new region-wide agreement.

The only new transatlantic trade deal that will come into force in 2017-21 (partially and provisionally), is the EU-Canada Comprehensive Economic and Trade Agreement (CETA), which Canada and the EU signed in Brussels in October 2016 after seven years of negotiations and a stumble over the finishing line. With less public scrutiny, it is also possible that a trade agreement will be completed between the EU and Japan. We believe that there is appetite for more trade liberalisation among Asian countries despite the likely collapse of the TPP.

Although China continues to run a large trade surplus with the US and the EU, its overall trade surplus has shrunk. The current-account surplus, which peaked at 10% of GDP in 2007, has been declining steadily ever since, and we now expect it to fall to 1.6% of GDP by 2021. Elsewhere, low oil prices are having a transformative effect on the current-account positions of oil-producing countries, which ran huge surpluses during the era of high prices. In Saudi Arabia, for example, the current-account balance moved to a surplus of 17.4% of GDP a year on average in 2010-14 to an annual average deficit of 7.4% of GDP in

Few major trade deals will come into force in 2017-21

Structural changes in global trade will ease global imbalances

Global outlook 35


2015-16; by 2021 the current account will return to a moderate surplus, of 1.4% of GDP. These changes will reduce global imbalances, one of the causes of the global financial crisis of 2008-09, but also curb excess global liquidity and the accumulation of foreign-exchange reserves.

Commodity prices Commodity price forecasts 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021Oil prices Brent; US$/b 112.0 108.9 98.9 52.4 44.0 56.0 60.0 59.9 61.3 64.0Non-oil commoditiesa Total -10.3 -7.2 -5.2 -17.3 -2.8 7.8 -1.1 -1.1 -1.7 2.3 Food, feedstuffs & beverages -3.5 -7.4 -5.2 -18.7 -3.5 3.1 1.7 0.7 -1.7 1.5 Beverages -20.1 -12.2 21.5 -10.3 -1.4 0.8 1.7 2.8 -1.6 1.6 Grains 0.5 -5.9 -12.0 -20.4 -11.1 4.1 4.1 0.7 -4.2 3.7 Oilseeds 4.8 -5.8 -9.0 -21.9 3.0 2.8 -0.8 -0.9 1.2 -1.8 Sugar -17.1 -17.9 -3.9 -21.0 34.4 9.9 -3.3 -0.9 5.3 2.5 Industrial raw materials -19.4 -6.8 -5.1 -15.2 -1.9 14.6 -4.9 -3.6 -1.7 3.4 Metals -13.2 -6.6 -1.6 -17.3 -5.5 14.4 -4.0 -4.5 -1.6 4.4 Fibres -31.5 -0.1 -3.5 -5.0 8.1 3.3 -1.3 -1.8 -0.9 0.8 Rubber -27.9 -15.7 -25.8 -19.2 2.1 40.9 -15.5 -1.6 -3.6 3.2

a % change in US dollar prices.


The OPEC production cut agreement reached in November 2016 appears to be holding in early 2017. This marks a major reversal of the "free-for-all" market-share strategy that Saudi Arabia and other Gulf Arab states had adopted in 2014 as they sought to combat the rise in US shale production, which had weakened OPEC's share of global production. Provisional data show that OPEC members achieved roughly 90% of their pledged production cuts in January, and officials from Saudi Arabia have indicated that the country may be willing to make even deeper cuts in order to keep output at desired levels. For the duration of the six-month agreement, OPEC members plan to trim crude oil output by about 1.2m barrels/day (b/d) from October levels to 32.5m b/d, extendable by another six months. The pain is designed to be shared equally: most OPEC members are to reduce output by around 4.6%. However, Nigeria and Libya are exempt, and Iran was granted a 90,000-b/d increase in its quota from October production levels. Boosting the deal's impact, a group of 11 non-OPEC producers agreed to join the effort, reducing output further by a combined 558,000 b/d. Around half of this total is meant to come from Russia.

The immediate, sentiment-driven boost to prices stemming from OPEC's commitment has been sustained thus far. On December 5th dated Brent Blend, the international benchmark, topped US$55/barrel for the first time since mid-2015—up by more than 20% from a low in November of US$45/b—and prices remained within a relatively tight band of US$55-57/b in January and early February. The Economist Intelligence Unit remains of the view that annual average oil prices will be higher in 2017 than in 2016, driven by a modest rebalancing of the oil market. Greater OPEC restraint will be the primary factor in this rebalancing, even assuming only partial implementation of the quotas.

Compliance with OPEC production cuts was fairly strong in January

The OPEC deal is having a modest effect on oil markets and prices

36 Global outlook


Nonetheless, OPEC's actions will not trigger a return to the sky-high prices seen earlier in the decade. Indeed, given the rapid build-up of global oil stocks in recent months—for example, crude oil stocks in the US climbed to over 66 days of average consumption in January, an increase of nearly 14% from the 2011-15 average of 58 days, according to the International Energy Agency (IEA)—we expect the cartel's effort to make only a small dent in the market.

We have trimmed our oil price forecast slightly to US$56/barrel in 2017 and US$60/b in 2018 (from US$56.5/b and US$60.5/b previously), as we expect other factors to partially offset the impact of OPEC production cuts. We now expect US output to rise on an annual average basis in 2017, by 1.5%, from a mild contraction previously. The sustained rise in prices in late 2016 and early 2017 has encouraged US shale drillers, pointing to a revival (the US oil-rig count, compiled by Baker Hughes, jumped from a low of 316 active rigs in May 2016 to 566 on January 27th). The prospect of higher US shale oil output, coupled with above-average crude stockpiles in the US, is likely to weigh on price growth in 2017.

We remain sceptical that other non-OPEC producers will respect their commitment to lower their production quotas. Russia's offer was vague and came with caveats. In contrast with its counterparts in many OPEC countries, the Russian government has no established mechanism for restricting oil output, and senior figures in the industry are known to be opposed to cutting production. Russia pumped an estimated 11.1m b/d in January 2017, 100,000 b/d fewer than in December, but it remains unclear whether this was due to compliance with the OPEC deal or a consequence of the cold winter weather. Considering production more broadly, a number of new oilfields are due to come on stream in 2017, which, all else being equal, will push production higher. It is possible that some firms may temporarily reduce the level of new drilling, resulting in a decline in output from some mature fields. At most, however, we expect this to hold output at its 2016 level.

The lack of policy clarity under the new US president, Donald Trump, is also a key risk to our price forecast. Energy policies in the US that favour domestic oil producers may, by boosting supply, exacerbate downward pressure on prices. However, if Mr Trump chooses to take the US out of the 2015 Paris Agreement on climate change, stronger demand for fossil fuels would be supportive of oil demand, and therefore prices. A relaxation of sanctions against Russia would be a gift to its oil producers, but the impact on global supply could be offset by a reintroduction of sanctions on Iran.

The price rally will lose steam in 2018 as some countries ease their production limits in order to take advantage of higher global prices, leading to an unravelling of the OPEC deal. In addition, we expect Chinese consumption to soften in line with an abrupt slowdown in industrial production and investment growth there, which will have negative knock-on effects on other economies and weigh on sentiment globally. As a result, we expect Brent crude prices to rise only modestly, to an average of US$60/b in 2018. It will fail to rise much higher in 2019-20 amid continued output growth from OPEC countries and, in 2019, a recession in the US. Prices will begin to edge up only in 2021,

Weaker demand in China, and then the US, will weigh on prices in 2018-19

A lack of clarity on US energy policy will see oil prices fluctuate in the short term

US shale production is set to rise in 2017, narrowing the market deficit

Russia's compliance with production cuts remains uncertain

Global outlook 37


rising to US$64/b. Steady demand growth and slower increases in OPEC production will provide support, and the effect of several years of low investment will be felt more markedly in higher-cost producers.

After years of oversupply and falling prices, tightening supply-demand balances have triggered rapid increases in the prices of several commodities. However, the rebalancing process is far from complete, reflecting a sluggish supply response to the low price environment (mostly related to producers cutting costs), and, for some industrial commodities, insufficient demand from China. We believe that the prices of industrial and agricultural commodities are unlikely to break away from recent lows in 2017-21; for those that do see substantial growth in 2017, this is unlikely to be sustained in 2018 as China's economic slowdown takes hold. Many agricultural prices remain under down-ward pressure from record stocks accumulated through successive bumper harvests.

Hard commodities: Industrial raw materials (IRM) prices remain volatile, but we expect the prices of all six base metals that we track on the London Metal Exchange (LME) to rise in 2017, the first such co-ordinated increase since 2011. This will be driven by recovering demand across emerging markets, and further supported by higher oil prices. However, the tide will turn again in 2018, especially for metals that are most vulnerable to China’s investment and industrial cycles and for which China’s relative weight in global consumption is greatest, such as copper and aluminium. On balance, we expect industrial commodity prices to rise by 14.6% in 2017, largely driven by the sharp rise in the price of base metals, as markets tighten and stocks are gradually worked through. Prices will slip back in 2018, by 4.9%, amid falling demand from China.

Soft commodities: Despite the negative impact on output of El Niño- and La Niña-related weather disruptions in 2015-17, we do not forecast an agricultural price shock. This reflects subdued demand (in historic terms), record-high inventories following several bumper harvests and several large grains outturns in the 2016/17 season. Nonetheless, our food, feedstuffs and beverages (FFB) price index will rise by 3.1% in 2017, an upward revision from our previous forecast of 0.8% after global wheat prices had appeared to reach their bottom at end-2016. Unlike IRM prices, agricultural commodity prices will remain on a modest upward trend in 2018, despite the economic problems in China, underpinned by rising populations and incomes, as well as rapid urbanisation and changing diets. However, price growth will be limited by ample stock availability.

Non-oil commodity prices will fail to recover significantly in 2017-21

38 Global outlook


Global assumptions (Forecast closing date: February 13th 2017)

Global forecast 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021Real GDP growth (%) World (market exchange rates) 2.3 2.4 2.6 2.7 2.2 2.5 2.4 2.1 2.6 2.6 US 2.2 1.7 2.4 2.6 1.6 2.3 2.1 1.1 2.0 2.0 OECD 1.3 1.4 1.9 2.3 1.7 1.9 1.7 1.3 1.7 1.8 Japan 1.5 2.0 0.2 1.2 0.8 1.0 0.6 0.8 0.2 0.7 Euro area -0.8 -0.2 1.2 2.0 1.7 1.5 1.5 1.4 1.5 1.4 China 7.9 7.8 7.3 6.9 6.7 6.2 4.2 4.3 5.2 4.8World (PPP exchange rates)a 3.4 3.4 3.5 3.3 2.9 3.4 3.2 2.9 3.5 3.6 OECD 1.4 1.5 2.0 2.3 1.7 1.9 1.8 1.4 1.8 1.9 Non-OECD 5.2 5.1 4.7 4.1 4.0 4.5 4.2 4.2 4.7 4.7World trade growth (%) Goods 3.5 3.9 4.3 2.8 1.6 2.6 2.7 2.0 2.9 3.1Consumer price inflation (%; av) World 4.0 3.8 3.6 3.2 3.8 4.3 3.8 3.0 3.1 3.0 US 2.1 1.5 1.6 0.1 1.3 2.4 2.1 1.3 1.7 1.9 OECD 2.2 1.6 1.6 0.5 1.0 2.2 2.0 1.6 1.8 1.9 Japan -0.1 0.3 2.8 0.8 -0.1 1.2 0.9 0.9 1.2 0.7 Euro area 2.5 1.4 0.4 0.0 0.2 1.5 1.5 1.6 1.7 1.8 China 2.6 2.6 2.1 1.5 2.1 2.0 1.6 1.9 2.7 2.5Export price inflation (%) Manufactures (US$) -0.9 -0.3 -0.1 -4.6 -2.0 -0.1 3.0 5.8 3.7 4.4Commodity prices Oil (US$/barrel; Brent) 112.0 108.9 98.9 52.4 44.0 56.0 60.0 59.9 61.3 64.0 % change 0.9 -2.8 -9.1 -47.1 -15.9 27.1 7.1 -0.2 2.3 4.5World non-oil commodity prices (US$, % change) -10.3 -7.2 -5.2 -17.3 -2.8 7.8 -1.1 -1.1 -1.7 2.3 Food, feedstuffs & beverages -3.5 -7.4 -5.2 -18.7 -3.5 3.1 1.7 0.7 -1.7 1.5 Industrial raw materials -19.4 -6.8 -5.1 -15.2 -1.9 14.6 -4.9 -3.6 -1.7 3.4Main policy interest rates (%, end-period) Federal Reserve 0.13 0.13 0.13 0.38 0.63 1.13 1.63 0.38 0.38 0.63Bank of Japan 0.08 0.07 0.06 0.07 0.07 0.07 0.07 0.07 0.07 0.07European Central Bank 0.75 0.25 0.05 0.05 0.00 0.00 0.00 0.00 0.00 0.00Bank of England 0.50 0.50 0.50 0.50 0.25 0.25 0.25 0.25 0.25 0.25Exchange rates (av) US$ effective (2010=100) 98.0 99.1 101.2 113.8 119.1 124.0 124.8 123.5 120.8 117.9¥:US$ 79.8 97.6 105.9 121.0 108.8 116.1 105.9 100.5 100.2 99.9US$:€ 1.29 1.33 1.33 1.11 1.11 1.06 1.07 1.11 1.13 1.15Rmb:US$ 6.31 6.20 6.14 6.23 6.64 7.03 7.30 7.44 7.23 7.08US$:£ 1.59 1.56 1.65 1.53 1.35 1.19 1.17 1.20 1.21 1.24¥:€ 102.6 129.6 140.7 134.3 120.4 123.4 112.8 111.3 112.9 114.9£:€ 0.81 0.85 0.81 0.73 0.82 0.89 0.91 0.92 0.93 0.93Exchange rates (end-period) ¥:US$ 86.6 105.3 119.9 120.3 116.8 112.5 101.9 100.1 100.1 99.7Rmb:US$ 6.29 6.10 6.12 6.49 6.94 7.17 7.40 7.47 7.04 7.07US$:€ 1.32 1.38 1.21 1.09 1.05 1.06 1.08 1.12 1.14 1.17

a The 122 countries for which The Economist Intelligence Unit publishes five-year forecasts.


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