Simply put, Standard & Poor's Ratings Services thinks the current US slowdown is much less critical than it would have been a decade ago. The rise of Asia and an improving picture elsewhere have reduced overall dependence on the US as the leader for global growth. Even if the US slips into a recession (as we think it has), industrialised and emerging countries will likely keep growing in 2008, though most will do so more slowly. Still, a protracted slowdown in the US will have an effect.
The best news continues to come from emerging markets, which are still expanding at a solid pace regardless of the significant weakness in the US and the financial market turmoil. Overall, domestic demand and regional strength will be large factors in determining how other economies fare during the US slump. In particular, the industrialised countries that are more closely tied to US fortunes will need to rely more heavily on spending at home.
Where the US appears to be heading
The US economy has clearly hit a rough patch. Real GDP increased just 0.6% in the fourth quarter 2007 after a strong 4.9% in the third quarter. S&P expects GDP to drop in the first half of 2008 and then rise through the second half as monetary and fiscal stimulus kicks in. We expect GDP to rise 1.2% this year, 1 percentage point less than in 2007. The odds of an actual recession have risen to 70%. But even if there is no downturn officially, it will feel like one to most Americans. Housing will likely keep depressing the expansion through 2008. However, the longer term outlook remains upbeat, with growth probably returning to close to 3% by the second half of 2009.
The US reliance on foreign capital is a major danger point. While improving from the record current account deficit reached in 2006, the current gap is a still-high 5.4% of GDP. Private money was almost entirely financing it ù at very low interest rates. Now foreign investors have lost confidence in US securities and the US dollar, and money is not so easy to come by. If investors outside the US continue to worry about the risk of a dollar decline, the result could be both a sharp drop in the dollar and a sharp rise in US interest rates, extending the recession.
It is, however, unlikely that foreign central banks would allow this. They have intervened to slow the dollar's fall in 2007, though not as much as they did in 2003 and early 2004. They aren't doing this to help the US financial markets but rather to protect their own countries' trade surpluses, which depend on bilateral surpluses with the US. More important, since August 2007 foreign and US investors have panicked about credit risk, which has sharply increased borrowing costs. Because of the US subprime mortgage problems and related instabilities in the international capital and financial markets, central banks have taken dramatic action to stabilise global markets.
However, business conditions could continue to erode and bring about a much harder landing in the US than we currently expect. That would increase recession risk abroad.
Regional overviews
The following is a quick summary of the outlooks for the major regions.
In Canada, growth is poised to slow in 2008 to 2.0%, less than the 2.6% rate seen last year. Shrinking exports are likely to weaken overall growth, as a strong Canadian dollar and soft growth for Canada's major trading partners stymie demand. Continued weak business conditions will also hamper growth. However, consumer strength will remain a support, though less than before since a more tentative mood among homebuyers will cut into purchases, particularly big-ticket items.
We expect that European economies will escape a recession, though growth will slip to 1.7% in 2008, 1 percentage point less than last year's strong performance. Consumers across Europe will play a large part in determining how big the slowdown will be.
Japan's growth should be just 1.6% in 2008, after seven years of expansion. Two main engines of Japanese growth in recent years ù corporate investments and net exports ù will continue in that role. However, a stronger yen and a soft US economy add downside risk to export revenues.
Although Europe and Japan face hurdles, for the first time since 2001 economic growth in both will outpace that of the US in 2008. However, Europe and Japan, which together constitute about one-quarter of the world's GDP, contributed just 12% to worldwide GDP growth in 2006, the same contribution as the US alone.
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