Global Growth Outlook 09/2018

September 2018 GLOBAL GROWTH OUTLOOK

The Trump Risk Trade and currency disputes threaten world economic growth



The trade disputes between the United States and the People’s Republic of China, the EU and other countries have substantially increased investment uncertainty and risk aversion on the financial markets. This puts global economic growth at risk.



Worst hit by Trump’s trade measures have been the external value of the Renminbi, the Shanghai stock market, the global steel and aluminium industry, and the business prospects of companies worldwide. An escalation of the dispute with China or the EU could disrupt a wide range of industries and production networks.



The Federal Reserve is currently tightening its monetary policy, with the ECB cautiously following suit. Fiscal policy in many industrialised countries outside Europe is facing consolidation problems, while the situation in the EU is gradually improving. The risks in Italy however have soared.

In the event of a new recession, the leeway for monetary and fiscal policy would be extremely limited.



We expect the global economy to grow by four percent in 2018. A shortterm surge in the U.S. and robust growth in China, Japan and Europe will be bolstering the economy in the second half of the year. In emerging countries, the wheat is separating ever more from the chaff. While the Asia-Pacific region and most oil exporters are expanding, growth is sluggish in Latin America. Argentina and Turkey are both in economic crisis.

The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Content Trade disputes threaten growth and recovery....................................................................................... 3 Pattern of global growth divided in the first six months ......................................................................... 8 World trade .......................................................................................................................................... 14 Foreign direct investment .................................................................................................................... 14 Strong U.S. growth, but pro-cyclical fiscal policy and U.S. protectionism harbour risks ..................... 14 China: Growth remains solid ............................................................................................................... 16 European economy past cyclical peak ................................................................................................ 18 Japan sees slight drop in momentum ................................................................................................. 20 Regional outlook: widely divergent economic trends .......................................................................... 21 Global industrial production continues to rise ..................................................................................... 22 Rising debt weighs on financial stability .............................................................................................. 24 Consequences for Germany ............................................................................................................... 25 Sources ............................................................................................................................................... 26

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Trade disputes threaten growth and recovery The global economic and economic policy drivers would all be securing a steady continuation of economic growth, if it were not for the foreign policy and foreign economic policy of the United States. The series of fundamental about-turns in U.S. policy and many of the trade measures the administration has implemented or is threatening to implement have shaken confidence in the future of the global economic order and are leading to a re-evaluation of risks in the individual markets around the world.

The extent of the threat, however, is difficult for anyone to evaluate at present, as both the economic impact of the various dispute scenarios and the short and long-term consequences are not easy to estimate or quantify.

Nonetheless, it would be completely misguided to play down the impact that is already being felt or to lose sight of the risks a conflict escalation would have on the global economy. The world’s large economies, banking systems and financial and property markets may well be more stable now than they were before the major crisis of 2007, but this does not mean they can take every economic policy aberration in their stride. This applies both on the smaller scale for a disorderly Brexit and on the larger scale for an abandonment of the multilateral trade order by the United States (Posen 2018). The international economic organisations have therefore rightly underlined the economic risks involved (OECD 2018, ECB 2018, IMF 2018a). Before looking at the global economic situation in detail, we first need to focus on the picture as a whole to assess the multifaceted effects of these turnarounds.

Global economic recovery not self-sustaining but vulnerable We should first bear in mind that the global economy only really started recovering in 2017 with a moderate synchronous upturn across all large economies and a reanimation of investment activity and world trade. This return to “normal” growth rates of four percent only succeeded on the back of prolonged extraordinary monetary stimulus measures and unusual macroeconomic conditions, a U.S. fiscal policy out of line with its economic situation and continued excessive lending momentum in the People’s Republic of China (Summers 2018). Europe and Japan also maintained an expansionary policy.

Long-term real interest rates, for example, are still negative in Europe and Japan, close to zero in China and only gradually returning to positive in the U.S.. Interest rates in a healthy macroeconomic state would lie between two and three percent. Even though monetary policy is still providing much needed and comfortable support to the economy, core inflation rates are only rising gradually and marginally worldwide, while oil prices are causing higher short-term inflation rates and dominating the headlines. Monetary policy still has a little leeway for reacting to shocks despite near-zero interest rates, but the usual drastic cuts in interest rates of several percentage points made to combat recession are simply not possible currently and the alternative strategy of expanding quantitative policy measures is, depending on the country, either not feasible or would not be very effective.

Inflation in the United States, measured both as an overall indicator and as a core rate excluding oil and food prices, has now climbed to over two percent, causing the Federal Reserve to continue its course of successive interest rate hikes. While raising interest rates may be an appropriate move for the U.S. economy, this generally increases the risks for dollar-indebted countries and companies around the world and often puts pressure on emerging countries. The economically weaker countries in particular are already feeling the impact. Domestic problems in Argentina, Turkey, Brazil and Mexico compound the situation there.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

U.S. monetary policy is also having ever greater effects on the global financial markets, as the correlation particularly to stock markets has sharply increased (Jorda et al. 2018). The relative appeal of bonds and securities is now largely influenced by U.S. monetary policy. At the same time, the resulting growing divergence in interest rates (both official interest rates and capital market yields) is leading to a rising U.S. dollar. Monetary policy is expected to become less expansive in the euro area, while the Japanese central bank has signalled a continuation of its expansionary course for the next few years.

All the same, the economic recovery has weakened in Europe, Japan and some emerging countries in the first six months of the year, so we can no longer speak of a synchronous recovery in summer 2018.

Fiscal policy in the major economies, particularly the three largest ones, is under substantial consolidation pressure. Due to the steeply increasing public debt ratio in the United States, China’s persistently highly expansive fiscal course with deficits of over ten percent of economic output 1 and a continued high public debt ratio in Japan and some European countries,2 the scope for economic stabilisation measures is much more limited than it was ten years ago. There is therefore every reason to remain alert to possible risks and how to contain them.

Short and long-term risks The risks can basically be divided into those with a short-term impact and those whose impact will be felt in the longer term. It is clear and generally agreed that the move of the U.S. away from multilateral trade rules and an escalation of trade disputes pose a threat to foreign trade, foreign direct investment in the U.S., global value chains, especially in the Asia-Pacific region, productivity growth, import prices (and thus inflation rates) and the purchasing power of consumers, not least in the U.S.. The trade disputes between the U.S. and China do not just affect farmers in the U.S. and exporting companies in China, Mexico, Canada or the EU, but businesses across the world. A disruption to value chains or the introduction of high import duties on the export of end products produced by transnational corporations in one major region to another major region – for example for some German carmakers who partly produce in the U.S. and sell on the Chinese market – will have a detrimental effect not only on the country the measures are targeted at but on a global scale. The uncertainty caused by the disputes on access prospects to the world’s largest markets is also curbing global investment activity. Economic mood indicators have accordingly clouded over.

The short-term risks of U.S. trade policy should also not be underestimated even though they do not receive as much coverage in the media. U.S. agricultural exports in individual product groups are also suffering from counter measures taken by the targeted trade partners of the U.S.. European, Mexican and Canadian steel and aluminium products have all been hit by U.S. sanctions. The current U.S. policy mix will step up the foreign policy and fiscal deficits of the U.S., which the current administration is likely to respond to by exacerbating the trade disputes still further.

The IMF regularly estimates the so-called “augmented” public deficit of China. According to its most recent Article IV Report, the IMF has not been able to identify a reduction in the general government debt in the last few years, but rather a lateral movement at slightly over ten percent (IMF 2018b). This is roughly the nominal growth rate of the Chinese economy and ties in with a slight increase in the public debt ratio.

2 The public debt ratio as defined by the Maastricht Treaty in 2017: Belgium 103 percent, France 97 percent, Greece 179 percent, Italy 132 percent, Portugal 126 percent, Spain 98 percent, United Kingdom 88 percent, see OECD (2018: Annex, p.48).

1

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Direct investment in the U.S. has taken a tumble in 2018, on a scale similar to that in Brexit-shaken UK, which reflects the level of uncertainty among businesses (Posen 2018b). The recent U.S. tax reforms reducing the tax burden on corporate profits by more than ten percentage points and the impending tightening of U.S. regulations for inflowing foreign direct investment should really have triggered the opposite effect in the U.S..

U.S. policy is unsettling investors around the world. Since autumn 2017, international investors have generally adopted a wait-and-see attitude and are showing a lower risk-taking propensity overall (Roubini 2018). The global stock markets are trending sideways despite strong corporate figures and earnings. The trade dispute with the U.S. has put substantial selling pressure on the stock markets in Shanghai and Hong Kong. The slowdown in industrial production, exports and, above all, business prospects through U.S. sanctions on China have already overshot their mark and induced the Chinese leadership to ease its monetary policy and soften its fiscal stance so as not to endanger the 6.5 percent growth target.

The currency and oil markets have been most strongly affected. The Chinese renminbi has been particularly hard hit, dropping drastically in the space of a few weeks in response to the trade disputes and the anticipated reductions in Chinese exports and losing the ground it had gained against the U.S. dollar since summer 2017. The mix of increased demand, production bottlenecks and risk premiums resulting from the dispute between the U.S. and Iran has triggered a sharp rise in oil prices, which will drive up inflation in oil-importing countries (ifo 2018).

Overall, in the context of an analysis of global economic development it should therefore be said that U.S. trade policy is already having a tangible impact on investor confidence and risk-taking propensity on the capital markets, on real investment activity, foreign trade, the stock markets and production levels. Should the trade and currency disputes continue to escalate, we can expect the real effects, above all in the economic relations between Asia and the U.S., to increase. A continuing spiral of disputes and economic nationalism could suffice to plunge the global markets into recession. It does not always take a financial crisis to trigger a recession – misguided policy can be enough. The vulnerabilities then automatically come to light. Despite these risks, we currently still expect global economic growth of four percent in real terms this year. This pace of growth could be maintained into the next year as long as smouldering hotspots do not flare up. Phases of monetary tightening in the U.S. are typically linked to higher risks for emerging countries, and this is also the case this time around.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

The main tariffs imposed by the Trump administration and countermeasures of trading partners

U.S. tariffs on steel and aluminium, imposed under Section 232 of the Trade Expansion Act of 1962

Date

Party

Main products affected

Tariff rate and affected import volume, in U.S. dollars 1

23.3.

U.S.

Steel and aluminium

10/25% on 48 billion (prior to all exceptions)

Counter measures of the trading partners 2.4.

China

Scrap metal and pork, fruit and nuts

15/25% on 2.4 billion

5.6. & 5.7.

Mexico

Pork, cheese, steel and other agricultural products

10-25% on 2.6 billion

21.6.

Turkey2

Cars, whiskey, tobacco, coal, cosmetics, machinery, paper, petrochemical products

4-70% on 1.8 billion

22.6.

EU

Steel and aluminium, agricultural products, consumer goods

25% on 3.34 billion (2.8 billion euros)

1.7.

Canada

Steel and aluminium, consumer goods and foods

10/25% on 12.8 billion

6.7.

Russia

Construction machinery, fibre optics, metal processing machinery, oil and gas industry

25-40%3

19.7.

EU

Global safeguard tariff on steel imports; once quota reached (average import volume 2015-2017) imports taxed an additional 25%

tbd

EU

Various products4

10-50 % on approx.

4.2 billion (3.6 billion euros)

Threatened global U.S. tariff on imports of cars under Section 232 of the Trade Expansion Act of 1962

Date

tbd

Party

U.S.

Main products affected

Tariff rate and affected import volume, in U.S. dollars

Cars and car parts

20-25% on up to 350 billion6 (EU included in calculation despite deal)

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

U.S. tariffs on Chinese imports under Section 301 of the Trade Act of 1974 and Chinese countertariffs on U.S. imports Tariff rate and affected import volume, in U.S. dollars 8

Date

Party

Main products affected 7

6.7.

U.S.

Intermediates, capital goods; incl. aircraft parts, battery technology, plastics, medical equipment, semiconductors

25% on 34 billion

6.7.

China

Agricultural products and foods (particularly soy), intermediates, transport vehicles

25% on 34 billion

23.8.

U.S.

Intermediates, capital goods; incl. aircraft parts, battery technology, plastics, medical equipment, semiconductors

25% on 16 billion

23.8.

China

Diesel, coal, steel products, medical technology, motorbikes, plastics

25% on 16 billion

tbd

U.S.

Intermediates, capital goods, consumer goods, incl. computers, computer parts, car parts, mobile telephones, furniture

10 or 25% on 200 billion

tbd

China

tbd

5/10/20/25% on 60 billion

1

The listed volumes generally correspond to the figures given by the respective governments. Due to numerous exceptions and changes in implementation, actual volumes may differ.

2 The current escalation of the dispute between Turkey and the U.S. has not been factored in here, nor have the security-related U.S. sanctions against Russia and Iran.

3 Unknown. Damages to the sum of 0.538 billion, only 0.088 billion in return. The Russian government has not published any further information on this point.

4 Implementation only after positive WTO decision. Part 2 of the tariffs of 22 June (implementation scheduled for 23 March 2021 or earlier).

5 Announced and notified to the WTO, but not yet implemented, application has been made to WTO to extend period set for implementation.

6 Bown (2018).

7 The lists have partly been continuously updated – the figures should therefore be seen as indicative and do not claim to be exhaustive or up-to-date.

8 Listed volumes generally correspond to the figures given by the respective governments.

Source: BDI

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Pattern of global growth divided in the first six months Growth prospects intact, but divergence increases In the first six months of the year, global economic growth has roughly maintained its course towards four percent. The U.S. recorded strong growth which should pull its growth up to three percent this year. China moved sideways up to June and is set to expand by between 6.5 and 6.75 percent. The upward forces in Japan and some European economies tailed off slightly, but we still expect a good four percent in real growth for the year overall. Growth could also be one to two tenths of a percentage point lower depending on further developments in the trade disputes and due to the slight slowdown in Europe. Industrialised countries will grow solidly, at just over 2.5 percent, while growth in developing and emerging countries should increase slightly to reach just over five percent. Despite the heightened risks for global trade, the IMF is likewise anticipating global economic growth of 3.9 percent for 2018/19, while the OECD expects 3.8 percent in 2018 and 3.9 percent in 2019 (IMF 2018, OECD 2018).

Oil prices picking up Global economic growth had already pushed up oil trading prices in the second quarter by a good 15-20 percent by June; Brent was trading at just over 75 U.S. dollars in early August (following 65 U.S. dollars at the start of the year), and West Texas Intermediate climbed from below 60 U.S. dollars at the start of the year to just shy of 70 U.S. dollars. Disruptions in production in Venezuela and other countries and the policy adopted by OPEC also played a small part in this development. There is no sign of prices letting up in the short term. The higher oil prices have, in turn, helped boost inflation in the U.S. and in Europe, while also improving the situation in the oil exporting countries. The dampening impact on industrialised countries through the resulting lower purchasing power is likely to remain limited.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Forecast summary: Growth in real GDP 2017/18/19 in percent 2017

2018

2019

IMF1

OECD2

EUCOM3

IMF1

OECD2

EUCOM3

IMF1

World

3.7

3.74

3.7

3.9

3.84

3.9

3.9

3.94

3.9

USA

2.3

2.3

2.3

2.9

2.9

2.9

2.7

2.8

2.7

China

6.9

6.9

6.9

6.6

6.7

6.6

6.4

6.4

6.3

Japan

1.7

1.7

1.7

1.0

1.2

1.3

0.9

1.2

1.1

EU

2.4*

OECD2

2.1*

EUCOM3

2.0*

Euro area

2.4

2.6

2.4*

2.2

2.2

2.1*

1.9

2.1

2.0*

Germany

2.5

2.5

2.2*

2.2

2.1

1.9*

2.1

2.1

1.9*

France

2.3

2.3

2.2*

1.8

1.9

1.7*

1.7

1.9

1.7*

Italy

1.5

1.6

1.5*

1.2

1.4

1.3*

1.0

1.1

1.1*

Spain

3.1

3.1

3.1*

2.8

2.3

2.8*

2.2

2.1

2.4*

UK

1.7

1.8

1.7*

1.4

1.4

1.3*

1.5

1.3

1.2*

India

6.75

6.5

6.4

7.35

7.4

7.4

7.55

7.5

7.6

Brazil

1.0

1.0

1.0

1.8

2.0

2.4

2.5

2.8

2.6

Russia

1.5

1.5

1.5

1.7

1.8

1.7

1.5

1.5

1.6

1: IMF (July 2018) 2: OECD (May 2018) 3: European Commission (May 2018; *July 2018) 4: Forecast on basis of 70 percent world GDP (PPP of 2013) 5: Information on India for the fiscal year in current prices

Domestic components still robust, little impetus from foreign trade A general trend across most economies is that, despite the pick-up in global trade – which should grow a good five percent this year in terms of volume – net exports (exports minus imports) will only be making marginal contributions to growth in all major economies. The lion’s share of the upward forces is likely to come from private consumption, i.e. an increase in the purchasing propensity of private households. This has been buoyed by the positive trend in employment, and to a very limited extent, the slight increase in wages; real wages in the triad will rise by an estimated average of 1.2 percent (U.S.), 0.6 percent (euro area) and 1.3 percent (Japan) between 2017 and 2019. Private consumption will be particularly supportive in the U.S., China and Europe. Although investment activity did not increase quite as much as expected early in the year, it remains robust in the major economies. Indications do however suggest that we have already passed the peak of the recovery. Within the OECD, gross fixed capital formation rose sharply, going from a meagre two percent in early 2016 to a robust

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

four percent in the first quarter 2018, although it is likely to drop to just under four percent in the next few quarters (OECD 2018). The public sector is not playing a major role in most countries. Overall, domestic demand is the dominant factor supporting growth (IMF 2018).

Investment activity in the major regions is more difficult to predict. While it has picked up slightly in the U.S., the mood indicators and first hard data for Europe are on the moderate side, although the high global demand, the overall economic situation and utilisation should really have triggered more momentum. Many companies are evidently reviewing their investment plans in light of the uncertainty now surrounding sales prospects even though current business is robust. As the second German chancellor Ludwig Erhard already said, economics is fifty percent psychology, and it seems that at present, the psychological situation is not quite right. Which comes as no surprise.

Industrial production and export orders were also slightly disappointing. Furthermore, the purchasing manager indices for manufacturing are pointing down, although from a high level. Services are currently trending slightly more positively.

Picture far from rosy in some emerging countries Among the emerging countries there are three countries in particular that have not performed as well as expected in the first six months of the year. The worst hit is Argentina, which is on the brink of recession with inflation at over 20 percent and a devaluation of the peso of over 30 percent since the start of the year. Argentina’s central bank drastically increased interest rates to over 40 percent and the Macri government agreed on an aid programme with the IMF to the sum of 50 billion U.S. dollars to put the brakes on Argentina’s sharply rising external debt. However, the government does not have the parliamentary majority required to introduce a set of painful fiscal measures designed to bring the current budget deficit of just over four percent back down to zero by 2020. A drought is additionally burdening production and exports. Twin deficits in the budget and in the trade balance have driven investors out of the country following the interest hikes of the FED, especially as the rate, floating since 2015, remained overvalued.

Turkey has also strayed into difficult waters due to a number of factors. Buoyed by private consumption, the Turkish economy concluded 2017 with growth at over seven percent, but the Turkish lira took a huge tumble in late July 2018 through high inflation, most recently at over 15 percent, an overdue hike in official interest rates that had been postponed due to elections, a high trade balance deficit of more than five percent, and the political dispute with the U.S.. The rating agencies had already downgraded Turkey and, in view of the high level of dollar debt of Turkish companies, foreign trade is still the country’s Achilles’s heel despite the vigorous trend in exports. Whether Turkey will be able to stabilise its macroeconomic situation without an IMF aid programme remains to be seen.

The Brazilian currency also suffered noticeably and lost just over nine percent against the U.S. dollar in the first six months of the year. However, the country remains on a moderate growth path despite strikes and political disputes, and could still reach 1.8 percent according to the IMF. Higher oil and commodity prices could have a positive effect here.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Macroeconomic policy The international organisations regard the course of fiscal policy worldwide as slightly expansionary.

This is largely based on the United States and Germany, as no major decisions are expected from China or Japan this year. In view of the high debt levels and current economic situation in many countries, a more restrictive course would be preferable. Only very few countries still have scope in their fiscal policy to support productivity-boosting expenditure.

In general, monetary policy around the world is still moderately expansionary. The U.S. Federal Reserve last increased the core interest rate on 13 June to a threshold of 1.75 to two percent and has announced three further interest rate hikes (25 base points) for next year. This is to be expected given the already normalised inflation rate, utilisation rates on the labour market, and the unduly expansive financial policy. As the official interest rate has also already climbed to over two percent and wages have followed suit recently, the FED is likely to have little scope to pursue a softer path. It is not only the IMF that fears that the financial markets are underestimating the extent and the speed of the interest rate increases and that capital market yields are likely to rise clearly above the current level of 2.85 percent over the year.

The Chinese central bank, the People’s Bank of China, most recently responded to the growing tensions and economic concerns with expansionary measures, including lowering the high minimum reserve requirement for commercial banks, even though this runs counter to the course taken over the last year towards financial consolidation and curbing corporate debt. The extent to which the trade disputes are affecting Chinese exports and the country’s current account balance, which was negative for the first time in the first quarter (dropping the equivalent of 21 billion U.S. dollars), remains to be seen. Given the continuing expansionary course of China’s fiscal policy with a cyclically adjusted deficit of more than ten percent of GDP and increased lending, also to the tune of ten percent on an annual basis (IMF 2018b), the Peking leadership will be trying to maintain a fine line in the coming quarters between consolidation on the one hand and stabilising economic output on the other.

The Bank of Japan brought an end to market speculations on a possible change in monetary policy with its decision at the end of July to continue on its current course. The decision against a change in course was prompted by the disappointing trend in inflation and a slight flattening in economic activity.

Nominal and real wages, which are rising substantially, could finally build up the price pressure the central bank has been hoping to see for the last two years.

In the second quarter, the European Central Bank adapted its monetary policy to the improved economic situation and the brighter outlook for prices, announcing a change in its asset purchase programme. The ECB will be reducing its purchase programme to 15 billion euros a month until the end of the year and then the programme will terminate. The interest rate policy will be maintained for much of 2019. In view of the unemployment rate in the euro area, which still remains high, real short-term yields of minus two percent and real long-term returns of just below zero are still an appropriate way to support the financing conditions of the real economy until the labour market has stabilised fully and price trends have normalised. The renewed appreciation of the U.S. dollar against the euro at least enables the ECB to maintain this course even though the slowdown in growth in the euro area in the first half of the year triggered by temporary and cyclical factors give reason for caution. In early August, the Bank of England raised interest rates for the first time since the financial crisis.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Financial markets and exchange rates The increased international risks have so far only affected individual segments of the financial markets.

Yields on the global bond markets are drifting further apart. In the U.S., yields for ten-year government bonds recently topped the three-percent mark and are expected to rise further towards 3.5 percent in the second half of the year on the back of the FED’s monetary tightening. Weighted yields in the euro area had risen to 1.2 percent by the middle of June. German government bond yields, on the other hand, rose just marginally at the start of the year reaching slightly over 0.5 percent in February, only to drop to around 0.3 percent by the end of June. French yields moved between 0.75 and one percent.

Italian bonds first dropped from around two percent to 1.8 percent, but then climbed back to over 2.8 percent in June. The capital markets are evidently on edge here due to the unexpectedly flat economic growth and continuing problems in the new fiscal policy of the new government, which has been debating high additional expenditures instead of ensuring the budget consolidation of several billion euros this year and over ten billion euros in 2019 to conform to EU requirements. Spanish yields, in contrast, only rose marginally to around 1.4 percent. UK yields were at over 1.5 percent. The moderate pace of economic growth in the euro area is set to curb the increase in yields which would otherwise be triggered by the somewhat less expansionary monetary policy of the ECB. Japanese yields are being kept at zero percent by the Bank of Japan as part of its yield curve control policy. Yields in many of the major emerging countries are rising substantially on account of pressure on currencies, inflation, current account balance and tighter monetary policy measures (Argentina, India, Indonesia, Mexico, Turkey).

Bond yields 4

3

2

1

0

-1 Jan 2016

Germany

Jul 2016

France

Jan 2017

Italy

Spain

Jul 2017

U. Kingdom

Jan 2018

USA

Jul 2018

China

Japan

Source: Macrobond

On the corporate bond markets, the level of new issues has remained robust even if the quality has suffered somewhat. The risk mark-ups between high-interest corporate bonds and government bonds have trended sideways overall in the U.S. and the euro area since summer 2016, moving between 300 and 400 basis points despite rising capital market yields (OECD 2018). Corporate debt as measured against economic output has only risen notably in China, Japan and Turkey in the last decade and involves increased risks; the debt levels of companies in France have risen markedly.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

On the stock markets, the main indices in the U.S. recorded single-digit increases in the first six months of the year. Only financial institutions suffered slight drops. In Europe, the shares of nonfinancial companies increased slightly while banking shares averaged a drop of over ten percent. The Nikkei trended sideways. Shanghai had the largest tumble with falls of more than ten percent. Stock markets in emerging countries came under pressure overall.

On the foreign exchange markets, the renminbi and some currencies from emerging countries (the Argentinian peso, Brazilian real, Russian rouble, Turkish lira, South African rand) were particularly hard hit. While the U.S. dollar appreciated by five percent (on a real, trade-weighted basis) buoyed by good economic data, interest rate hikes and the ensuing capital flows, the yen, the pound and the euro trended laterally. The Chinese leadership is taking measures to stabilise the renminbi and prevent it dropping below an exchange rate of seven renminbi to the U.S. dollar. The external value of the euro bobbed up and down gently against the 38 most important partner countries in the first half of the year (on a real, trade-weighted basis). After increasing slightly in the first quarter, the euro dropped by around the same amount in the second quarter only to rise again from July onwards. Against the U.S. dollar, the euro increased by around three percent in the first quarter before losing five percent in the second quarter. The exchange rate accordingly increased from 1.20 euros to the U.S. dollar to 1.25 euros in mid-April, before losing ground again and dropping to around 1.15 in early August. This pattern primarily reflects the diverging economic trends and the steadily growing and unusually high interest rate spread between U.S. and European bonds.

Exchange rates against the U.S. dollar

1,30 1.30

0,85 0.85

120

0,80 0.80

115

0,75 0.75

110

7,0 7.0 6,9 6.9

1,25 1.25

6,8 6.8

1.20 1,20

6,7 6.7 6,6 6.6

1.15 1,15 0,70 0.70

105

0,65 0.65

100

6,5 6.5

1.10 1,10 1,05 1.05

6,4 6.4 6,3 6.3

1.00 1,00

0,60 0.60

Euro (left axis) Pound Sterling (right axis)

6.2 6,2

95

Renminbi (right axis) Yen (left axis)

Source: Macrobond

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

World trade According to International Monetary Fund estimates from July, world trade last year increased by 5.1 percent over the previous year. For the first quarter of 2018, preliminary figures from the Netherlands Bureau for Economic Policy show a robust rise in world trade, going up by 3.9 percent over the previous quarter. This growth at the start of the year was driven primarily by a rising demand for imports from industrialised countries. Exports to emerging and developing countries benefited from this development in equal measure. The RWI/ISL Container Throughput Index, which measures the volume of global trade based on the capacity utilisation of key container ports around the world, dropped slightly in July 2018 (down to 132.7 index points). According to the RWI/ISL, the drop may already be a result of the higher tariffs imposed by the United States.

Foreign direct investment In 2017, global investment fell by 23 percent (flows) over the previous year, according to UNCTAD (UNCTAD 2018). This trend is contrary to the upward global trend in world trade and global production.

The most significant reduction here was the decrease in takeovers of 22 percent, although forwardlooking greenfield investment also declined (down 14 percent). UNCTAD points to the global decrease in the profitability of foreign investment in the last few years and the stepping up of investment screenings in countries including the United States (CIFUS), the EU, Germany and Italy as the reasons for the downward trend in investment. Furthermore, political uncertainties such as U.S. trade policy, Brexit and the conflict between the United States and Iran are diminishing investor confidence. The 37 percent drop in investment flows into industrialised countries was particularly pronounced. The biggest decrease was investment into the United Kingdom (down 92.2 percent), although it should be noted that the investment flows in the previous year were especially high due to several large takeovers.

Strong U.S. growth, but pro-cyclical fiscal policy and U.S. protectionism harbour risks The anticipated surge in growth following the U.S. tax reform has now reached the economy six months after its adoption. The Bipartisan Budget Act, passed in February, which will increase public expenditure by a further 1.5 percentage points of U.S. GDP, is additionally underpinning this revival.

After growing 2.2 percent in the first quarter, the U.S. economy expanded by an annualised 4.1 percent in the second quarter according to the advance estimate of the U.S. Bureau of Economic Analysis (BEA). This is the highest quarterly growth seen since 2014. The main contributors to growth in the fourth quarter were private consumption, nonresidential fixed investment, exports and public spending on all levels (federal, state and local). Private inventory investment residential fixed investment and higher imports, on the other hand, had a dampening effect on growth. The IMF and other organisations are maintaining their forecasts of high growth. In July, the IMF forecast annual growth for the U.S. economy of 2.9 percent in 2018 and a slightly lower 2.7 percent in 2019. The difference between these figures and the 2.3 percent for 2018 and 1.9 percent for 2019 predicted before the tax reform is substantial. The rate of investment, measured as private investment in proportion to GDP, dropped in the second quarter 2018 from 17.7 down to 17.5 percent for the first time after having risen moderately but steadily for nearly two years, climbing from 16.8 percent (Q3/2016) to 17.7 percent (Q1/2018).

Although the U.S. economy is currently in a period of strong growth, it can be expected that growth will flatten out and the U.S. dollar will lose value from 2020 onwards, as the economic cycle of the U.S. economy is already very advanced.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Pro-cyclical fiscal policy raises budget deficit Although the tax reform has injected short-term momentum into the U.S. economy, such pro-cyclical measures tend to be regarded with criticism. The IMF has pointed out that private consumption expenditures were already high before the reform and unemployment was at a near historic low (IMF 2018a). The facilitated repatriation of the foreign assets of U.S. multinational corporations under the reform enables further investment and will additionally boost GDP. The positive economic data and interest hikes have pushed up the value of the U.S. dollar in the course of the year, making imports less expensive. The interest hikes of the Fed have additionally buoyed the appreciation of the U.S. dollar, while other key central banks are still hesitating to follow suit. As investment and private consumption expenditures will continue to rise as a result of the tax reforms, we can expect to see the U.S. trade deficit increase further.

The tax revenue lost through the tax cuts will exacerbate the U.S. budget deficit. Although the increased public spending and lower tax revenue resulting from the Bipartisan Budget Act will fuel the economy by around one percentage point in the next few years, these factors will, at the same time, increase the budget deficit and government debt (World Bank 2018). The budget deficit finished 2017 at 3.5 percent of GDP and could well rise to just over five percent by the end of 2019. Gross federal debt at the end of 2017 was at 105.4 percent of GDP (White House 2018).

Protectionist trade policy is a risk to global and U.S. growth The unknown variable in current economic forecasts is the protectionist trade policy of the U.S. president, the real consequences of which are gradually becoming evident in the global economy. In response to the additional tariffs that the U.S. has imposed on certain imports, the key trading partners of the U.S. have taken various retaliatory actions, which will affect around 60 billion dollars worth of U.S. exports by 6 July at the latest. In addition, the U.S. trade dispute with China is threatening to escalate should the United States really impose additional import duties of between ten and 25 percent on more Chinese imports. Even if a further escalation of the transatlantic trade dispute appears to have been averted for the time being, the trade dispute between the United States and China harbours incalculable risks for the economies of both countries and for the global economy. The IMF estimates that the punitive tariffs could cost the global economy 0.5 percent of its potential up to 2020 (IMF 2018a). Should all WTO members increase their tariffs to the maximum limits set by the WTO, the World Bank has calculated that the volume of global trade would fall by nine percent. The slump would thus be of comparable measure to the last financial and economic crisis (World Bank 2018).

Unemployment at near historic low Buoyed by the country’s strong economic growth, the U.S. labour market is close to full employment.

Unemployment has now reached a near historic low, measuring 3.9 percent in July 2018 according to official figures. In May it had been as low as 3.8 percent, putting it lower than it has been since the 1960s. The number of long-term unemployed – classified as individuals who have been unemployed for at least 27 weeks – was at 1.44 million in July. One year previously, in July 2017, there were 1.76 million long-term unemployed. In July 2018, the proportion of the unemployed who are long-term unemployed was 22.7 percent. The average period of unemployment was 23.2 weeks, down from 23.6 weeks in July 2017. The expanding economy and the growing labour market have only triggered moderate increases in wages and productivity. The productivity of the U.S. economy rose by a mere 0.4 percent in the first quarter 2018, but it then managed a 2.9 percent rise in the second quarter. The U.S.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

economy has been expanding since the end of the crisis in 2009. Compared to previous periods of expansion, the increase in wages of around 20 percent overall since 2009 is low (World Bank 2018).

It remains difficult to estimate how scarce the supply of labour actually is. The labour market participation rate, or the proportion of the population that has a job or is actively seeking work, was at 62.9 percent in July 2018. Since the end of 2013, the participation rate has been almost constantly at just under 63 percent. In contrast to the rate of unemployment, which has been on the decline for years, the participation rate has remained relatively stable at well below pre-crisis levels of around 66 percent (2007). This indicates that a section of the population has withdrawn from the labour market and is not benefiting from the current upturn.

An unexpected risk for the U.S. labour market is once again the trade agenda of the U.S. president. It has been calculated that the import tariffs on steel and aluminium alone, including retaliatory measures by the trading partners of the U.S., are putting up to 400,000 jobs at risk in the U.S. (Francois et al.

2018). The threatened tariffs on car imports could affect up to 624,000 jobs if all trading partners introduced retaliatory measures on the same scale as the U.S. tariffs (Robinson et al. 2018). The escalation of the trade dispute between China and the United States could threaten an as yet inestimable number of jobs.

China: Growth remains solid Even after 40 years of “reform and opening”, the Chinese economy continues to perform strongly, recording stable growth of 6.8 percent in the first six months of 2018, with momentum just tapering off slightly in the second quarter down to 6.7 percent. Growth remains above the target threshold of 6.5 percent. The primary industry grew by 3.2 percent, the industrial sector by 6.1 percent and services by 7.6 percent. Alongside growth, Beijing is focusing primarily on structural changes on the labour market and financial stability.

In real terms, economic output is set to grow at a slightly more modest pace of 6 ¾ percent, levelling off at 6.5 percent in the medium term, provided no major external effects intervene. The government is responding as usual to moderate fluctuations. Following the introduction of more stringent regulations for non-financial sector debt, the People‘s Bank of China has already lowered the required reserve ratio for banks three times in 2018 and injected huge sums of money into the banking system. Monetary reactions to the latest announcements by the Fed in the U.S. cannot be ruled out for this year, but China’s benchmark interest rate has remained at a stable 4.35 percent so far. Regarding fiscal policy, China’s State Council announced a mix of tax cuts and infrastructure spending in the middle of the year. The renminbi continued to gain ground against the U.S. dollar in the first months of the year, then weakened considerably in the middle of the year. The Chinese stock market has lost more than 20 percent in value since the start of the year.

Indicators mainly positive Investment in property, plant and equipment increased by six percent, with the share of private investment growing by 8.4 percent and thus gaining momentum slightly. Investment in high-technology production rose by a substantial 13.1 percent. Investment in real estate still registered growth of 9.7 percent, but the government is taking action to cool the overheated sector down.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

The business climate had largely recovered by the middle of the year. In June, the official Purchasing Managers’ Index (PMI) was at 51.5 points for manufacturing and 55 percentage points for services, which reflects a continuing expansion of business activity in both sectors. Industrial production rose by 6.7 percent overall, with the public sector alone expanding by 7.6 percent. Growth was particularly strong in energy and advanced technologies with 10.5 percent and 11.6 percent respectively. Profits increased by as much as 16.5 percent.

Strategic emerging industries, supported by the Made in China 2025 plan, increased by 8.7 percent.

The production of new energy vehicles, mainly electric and hybrid models, soared 88.1 percent with the start of the new NEV quota system. The production of industrial robots climbed by 23.9 percent and integrated circuits by 15 percent.

Services were also very strong, growing eight percent. Growth was particularly robust in information services, software and leasing. Private consumption racked up real growth of 6.7 percent with per capita income increasing by 6.6 percent in real terms. Retail sales of consumer goods increased by 9.4 percent. Online sales surged up 30.1 percent.

Inflation at two percent remains well below the target inflation rate. Producer prices for industrial products rose by 3.9 percent, with purchase prices for industrial producers up by 4.4 percent.

Foreign trade (calculated in RMB) increased by 7.9 percent, with exports going up 7.9 percent and imports by 11.5 percent. The current trade tensions are likely to cause disruptions here.

Stability, reforms and new growth impetus With the “new normal” firmly established, concerns about a hard landing have long died down. While in the last years, the government has focused on stimulating infrastructure, it is now targeting domestic consumption and the Belt and Road Initiative to generate further growth. It remains to be seen whether the initiative will bring the desired results. There has been strong criticism from many countries. Several ongoing projects have been renegotiated and particularly smaller countries are straining under their debt burden. The supply-side structural reforms are still focused on eliminating surplus capacities, excess housing stocks and cutting corporate debt. Plans are to increase production efficiency with a stronger focus on more complex components and advanced technologies. The reform of state-owned enterprises is only progressing slowly due to the potential social consequences and excess capacities have not been fundamentally reduced so far. The trend towards centrally steered mergers is continuing among state-owned enterprises in an effort to further consolidate the public sector and produce “national champions” to compete on the international markets. More large-scale mergers in coal, telecommunications, energy supply and chemicals have been announced for 2018.

Debt remains a problem Despite regulatory intervention and continued financial discipline, total debt is still rising. According to the various estimates, it currently stands at between 250 and 300 percent of GDP. As a large proportion of the debt is concentrated on secondary banks in the domestic business and the state is both lender and borrower in many cases, the government has a wide scope for intervention. In the private sector, non-performing loans and the resulting snowball effects during a downturn could become a systemic risk and thus also impact on foreign trade and financial flows. This would have global repercussions, not least for the German economy which has close ties to China. The high foreign currency reserves

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

have a positive effect, in contrast, and have again grown to over three trillion U.S. dollars since the end of 2017.

Market economy reforms still lacking The Communist Party emphasised at its last congress that it will seek to further control the economy, dampening hopes for market economy reforms. It remains to be seen whether the state interventions in the market and on corporate decision-making have a negative impact on the investment climate.

The government has taken first steps to follow through on its pledges to increase free trade and further open up its markets. It has, for example, reduced tariffs in the automotive sector and consumer goods sector and published a new negative list for foreign investment. Structural market reforms, however, are not yet on the horizon. Alongside tariffs and investment restrictions, non-tariff trade barriers are becoming an increasing problem for foreign companies.

The U.S. as a risk factor The new U.S. policy approach against China has added a major risk factor. The U.S. trade deficit has increased further despite repeated attempts at negotiations and escalating tariff rounds. Alongside the barriers to trade and investment, the main points of criticism held against China by the U.S. are the non-tariff trade barriers and subsidies that distort the global markets. Forced technology transfer as a condition for market access is also a major point of contention and has been brought before the WTO by the U.S. and the EU. The overall economic impact of the trade tensions has so far been limited but in the medium term, investor sentiment could deteriorate and global trade and financial flows shift to the detriment of China.

European economy past cyclical peak In 2017, the EU and the euro area reached their cyclical economic peak with 2.4 percent growth each (European Commission 2018a). The first two quarters of 2018 already saw considerable slowdowns.

Growth in real GDP in the Eu in percent 3

2

2.3

2.3

2.1 1.7

2.1 (P)

2.0

1.8

1 0.3 0 -0.4 -1 I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV I

II III IV

2010

2011

2012

2013

2014

2015

2016

2017

2018

change over previous year quarter

change over previous quarter

change over previous year

Source: Macrobond

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

After growing between 0.6 and 0.7 percent in all quarters in 2017 over the previous quarter, the economy started off 2018 with lower growth of 0.4 percent in the first two quarters. Among the major economies, the performance of France and Italy was particularly disappointing with a meagre 0.2 percent growth in the second quarter 2018. The United Kingdom had a good second quarter growing by 0.6 percent, while the German economy continued expanding above potential at 0.5 percent. Spain also recorded above average growth at 0.6 percent. The major institutions have downwardly adjusted their forecasts for 2018 overall by several tenths of a percentage point following the mixed results of the first six months of the year. In July, the European Commission (2018) adjusted its forecast for the EU and the euro area down to 2.1 percent growth (0.2 percentage points down from its May forecast). In June, the ECB (2018) also predicted 2.1 percent growth for the euro area for 2018. The international organisations are (OECD 2018, IMF 2018a) forecasting slightly higher growth of 2.2 percent for 2018, followed by lower growth of somewhat under two percent in 2019 and onwards. In the economic cycle, Europe is now in a period of slower growth. In 2017, the EU grew by 2.4 percent, significantly above potential growth of 1.7 percent (European Commission, 2018b). The output gap appears to have closed. In contrast to previous periods of high economic activity, the labour markets did not overheat in 2017. The main reasons for this are persistent underemployment, particularly in some southern countries, and the weak growth in productivity of under one percent.

Investment and consumption supporting growth, foreign trade remains volatile Growth in 2018 will be driven by consumption and investment. Consumption should rise by around 1.5 percent and contribute around one percentage point to overall growth. Investment is set to grow by four percent and thus contribute somewhat less than one percentage point. The trend in foreign trade is difficult to predict due to the tensions in global trade discussed at the beginning of this report. The latest figures have been disappointing with extra-EU exports dropping by 2.7 percent in May 2018 compared to May 2017 and imports decreasing by 1.4 percent. The contribution of foreign trade to GDP is likely to be slightly positive at most this year.

Factors boosting consumption are rising employment and moderate wage increases. Real wages are expected to increase by just about one percent in line with labour productivity growth (European Commission, 2018b) and the propensity of households to spend remains high. The unemployment rate in the EU at 6.9 percent is almost at pre-crisis levels, while in the euro area unemployment is around one percentage point higher than the pre-crisis level at currently 8.3 percent. The gradual slowdown in economic activity is not yet visible on the labour market. Price increases in real estate and securities are further factors boosting consumption.

The upward trend in investments has been set in motion by the high capacity utilisation rate of just over 84 percent. This brings the EU close to the 85-percent threshold that has never been exceeded so far since data records began in 1980. Although sentiment indicators have clouded over since the first quarter, capital build-up remains robust. Both the ifo Business Climate Index for the euro area and the Purchasing Managers’ Index have lost ground since reaching record levels at the start of 2018.

Industrial production in June 2018 was 2.6 percent higher than the same month one year previously in the EU and 2.5 percent higher in the euro area. Bottlenecks on the labour market in numerous industries and countries are curbing growth momentum here.

While growth has slowed down somewhat in the EU, synchronism between the member states is increasing. In 2018 growth rates will lie between 1.5 and 5.5 percent.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

The United Kingdom and Italy will be bringing up the rear, with Malta and Rumania taking the lead with over five percent growth.

Range of growth rates* in the EU 12 Highest

8

Average

4 0 Lowest -4 -8 -12 -16 2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

*Range of growth in real GDP in the EU (highest, lowest and average growth rate in the EU), Ireland not included on account of statistical outliers Sources: Macrobond, AMECO

Downward risks prevail The global trade tensions are placing particular strain on the export-oriented EU economy. Even though a further escalation of the trade and tariff dispute with the U.S. was successfully averted in summer 2018, the latent risk remains. Uncertainties are dampening production and investment activity. The probability of a disorderly exit of the United Kingdom from the EU has also increased over the last few months. In many areas, a hard Brexit seems to be the most realistic scenario now. Progress in the deepening of the Economic and Monetary Union since the summit in June 2018 has been limited and major decisions will not be made until December. In its annual Article IV Consultation for the euro area, the IMF (2018b) records that significant progress has only been achieved in the European Banking Union. Macroeconomic imbalances remain high and there are no policies in place to reduce them. In the medium to long term, the turnaround in monetary policy will produce challenges, less for corporate financing than for public budgets. The persistently high debt levels of some countries combined with rising interest rates and low growth are a volatile combination.

Japan sees slight drop in momentum Following a period of unusually strong economic performance in 2017 (up 1.7 percent year on year) Japan will probably just about reach the one-percent threshold in growth this year. First-quarter growth was even negative. At least the second quarter closed at half a percent up from the previous quarter, according to preliminary estimates from the Japanese Statistics Bureau, which is a much better result than the market had anticipated. In the first six months overall, growth was a mere 0.2 percent higher compared to the same period last year. Private consumption was reasonably robust, although momentum here has dwindled over the last year from quarter to quarter, most recently down to only 0.7 percent over the previous quarter. Prospects for the second half of the year are lower still. At least the hoped-for recovery in wages is gradually setting in. In the second quarter, nominal wages increased

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

by more than four percent for the first time since 1994 (up 4.3 percent year on year), and real wages by 3.8 percent. Private capital expenditure has so far increased slightly, but construction activity has been weakening for some quarters as has public sector investment. The appreciation of the yen against the U.S. dollar and the impact of trade restrictions have caused foreign trade to stagnate, so net exports did not provide any significant impetus; the contribution of net exports in the second quarter was minus 0.1 percent (Deutsche Bank 2018).

Regional outlook: widely divergent economic trends Global growth in the emerging and developing countries in the first six months of 2018 was characterised by increasing divergence. Although the outlook for this group of countries overall is still on target for five percent growth for the year overall, individual groups of countries are particularly affected by the increasing oil prices and bond yields, currency rate fluctuations and trade disputes. While India has stepped up its growth rate compared to last year, the ASEAN countries continue to record solid real growth in excess of five percent and the oil exporting countries in the Middle East are expected to grow by a good one percentage point (to around 3.5 percent), no less than four heavyweights in Latin America (Argentina, Brazil, Mexico and Venezuela) are each in their own troubled waters. This will curb growth in the region overall to a moderate 1.5 percent. In Sub-Saharan Africa, increased commodity prices are boosting growth which is set to reach 3.5 percent, with particularly strong performances in South Africa and Nigeria. Economic growth in Russia and the CIS states is satisfactory – Russia should expand by a good 1.5 percent.

Regional economic outlook* 2018 South America

1.7

Central America

3.9

Caribbean

3.8

Asia-Pacific, advanced economies1

2.1

Asia-Pacific, developing economies2

6.5

CIS-States3

2.2

Middle East, North Africa, Afghanistan, Pakistan

3.5**

Israel

3.3

Sub-Sahara Africa

3.5**

1Japan, South Korea, Taiwan, Singapore, Hong Kong, Australia, New Zealand, Macau 2 including China and India 3 Russia, Ukraine, Georgia, Turkmenistan, Caucasian und Central Asian States * Growth of real GDP over previous year in percent Source: IMF (April 2018 und **July 2018)

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Global industrial production continues to rise First quarter growth rate not sustainable After growing by an average of 3.5 percent in 2017, industrial production continued to expand robustly at the beginning of 2018. According to the figures of the Netherlands Bureau for Economic Policy Analysis (CPB), industrial production was up four percent in the first quarter of 2018 compared to the previous year. The pace of growth was thus much stronger than in late 2017. Things then slowed down slightly in the second quarter 2018. Growth rates were driven down to only 3.6 percent mainly due to the decreasing level of industrial activity in the advanced economies. In the emerging countries, the growth in production at 4.2 percent over the previous year was still considerably robust. The somewhat slower pace is set to continue for the rest of the year. The Purchasing Managers’ Index for global industry dropped in July for the third consecutive time, to just over two index points lower than its record high of December 2017. At 52.7 index points we still expect global industrial production to continue to expand.

Industrial production in advanced economies US industry currently main driver Industrial production in advanced economies did not increase quite as steeply in the first quarter of the current year as it did in the last quarter of 2017. At 3.5 percent, first quarter growth nonetheless exceeded last year’s annual average growth of three percent. In the second quarter, industrial output rose slightly less in comparison to the previous year, going up 2.9 percent. For the first six months, production thus expanded at a rate above the annual average of 2017. The pace of growth is likely to flatten out somewhat in the further course of the year. In July, the Purchasing Managers’ Index for manufacturing dropped for the third time in a row in July, but at 54.1 index points is still indicating a further increase in production. . other advanced economies

Industrial production* in advanced economies

Euro area Japan

5

USA

4 3 2 1 0 -1 -2 2014

2015

2016

2017

2018

*Production index: two-month average, after calendar and seasonal adjustments, in percent, year on year Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis (CPB)

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

At the start of 2018, the United States industry became the main driver of the advanced economies, taking over from Japan and the Euro area. With growth rates of 3.4 percent in the first quarter and 3.6 percent in the second quarter, U.S. industry expanded more vigorously than it has for the past four years. The Euro area industries only recorded 2.8 percent growth in the first six months of the year.

Industry in Japan only managed a 2.5 percent increase in production in the first quarter and 1.9 percent in the second quarter, which is considerably lower than one year ago. In the other advanced economies industrial production expanded at an above-average pace, growing by 4.4 percent in the first quarter and 3.5 percent in the second quarter. Industrial production in these countries has now been on the rise for 20 quarters in succession.

Industrial production in emerging countries Asia is on a stable growth path, while Latin America disappoints Industrial production in the emerging countries exhibited stronger growth in the first quarter of the current year than for the last five years, going up 4.5 percent year on year. Second quarter growth, at 4.2 percent was also high. In the first six months of the year, growth in production far exceeded last year’s average annual growth rate of 2.9 percent. In the further course of the year, however, it is expected to lose a little steam judging by the development of the Purchasing Managers’ Index for manufacturing for emerging countries. The latest figures put the index at its lowest level since July 2017. Output is still expected to grow as the drop was not that pronounced and an index value of 51 still points to expansion.

Africa/Middle East

Industrial production* in emerging economies

Latin America Central and Eastern Europe Asia

5 4 3 2 1 0 -1 2014

2015

2016

2017

2018

*Production index: two-month average, after calendar and seasonal adjustments, in percent, year on year Sources: Macrobond, Netherlands Bureau for Economic Policy Analysis (CPB)

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

The Asian emerging countries contributed substantially to the expansion of production. Production increases of six percent and more in two consecutive quarters were last seen in 2014. In the countries of Central and Eastern Europe industrial production in the first quarter 2018 increased by three percent compared to the previous year, following a weak final quarter last year. Growth dropped slightly to 2.8 percent in the second quarter. Industrial production in Africa and the Middle East is also expanding. After rising 2.4 percent in the first quarter, industrial production growth dropped to 1.3 percent in the next quarter. In Latin America, industrial production is highly likely to drop for the fifth year in a row. After slightly recovering at the start of the second half of the previous year, production slipped down 0.7 percent at the turn of the year 2017/2018 and by 1.3 percent in the second quarter 2018.

Rising debt weighs on financial stability The expansionary monetary policy adopted in the aftermath of the crisis played a decisive role in the recovery of the global economy. But the process of stabilising growth and the financial markets also involved considerable risks. Without the right mix of fiscal, structural and macro-prudential policy, low and negative interest rates can lead to an excessive build-up of debt. Public sector debt has risen significantly in almost all economies since 2008. The development of public sector and corporate debt has been divergent, however, with total debt trending very differently in the major economies. While in the U.S., Italy and the United Kingdom, debt levels are stuck at around 250 percent of GDP, Germany has been cutting its debt since 2010 and is now at 175 percent. France’s debt increased by 70 percentage points between 2006 and 2016, going up to 285 percent of GDP. Debt is surging even more dramatically in China, where debt levels increased by over 100 percentage points in the same period, taking total debt to 230 percent.

Development of total debt 300 275 250 225 200 175 150 125 2006

2007 Germany

2008

2009 France

2010 Italy

2011

2012

2013

U. Kingdom

2014

2015

USA

2016 China

*Government, private household and non-financial sector corporate debt as a percentage of GDP Source: Macrobond

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

High debt does not necessarily have a direct impact on the financial stability of these countries but it does make them more vulnerable to shocks. The high level of corporate debt in China, at 150 percent of GDP, is certainly problematic. The combination of excess capacities, low growth and weak productivity is practically asking for turbulences on the financial markets. China still keeps close control of the lending and capital markets. However with the opening up of the Chinese economy, market forces are likely to lead to a correction. The frequently discussed “hard landing� of China in the transition from an investment-based economy to a consumption-based economy remains a distinct risk.

Consequences for Germany No large or medium-sized industrial economy in the world is as globally interconnected as the German economy. Protectionist measures in general are therefore dangerous for Germany and pose a direct and indirect threat to the prosperity of the country. The impact of the protectionist measures implemented so far remains limited but the possibility of an escalation is already dashing the business prospects of some companies.

Economic output is still trending positive despite these difficulties. Good growth was registered in the first six months of the year, with the German economy growing by more than two percent year on year.

Foreign trade did not contribute to growth, the main driver instead was domestic demand. A weakening of momentum from foreign trade could set in in the further course of the year and pull down prospects for production and exports for the next year by bringing down incoming orders. In the short term, the German growth engine is still on track and performing above potential.

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World Bank (2018). Global Economic Prospects. The Turning of the Tide?. Washington, D.C. June.

White House (2018). Historical Tables.

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The Trump Risk | Trade and currency disputes threaten world economic growth 13/09/2018

Imprint Bundesverband der Deutschen Industrie e.V. (BDI) Breite Straße 29 10178 Berlin T: +49 30 2028-0 www.bdi.eu Authors Dr. Klaus Günter Deutsch T: +49 30 2028 1591 k.deutsch@bdi.eu Dr. Wolfgang Eichert T: +322 792 10 14 w.eichert@bdi.eu Julia Howald T: +49 30 2028 1483 j.howald@bdi.eu Thomas Hüne T: +49 30 2028 1592 t.huene@bdi.eu Wolfgang Krieger BDI-Vertretung, Peking T: +86 1085 3258421 w.krieger@bdi.eu Dr. Stormy-Annika Mildner T: +49 30 2028 1562 s.mildner@bdi.eu Dr. Christoph Sprich T: +49 30 2028 1525 c.sprich@bdi.eu Editorial / Graphics Marta Gancarek T: +49 30 2028 1588 m.gancarek@bdi.eu

This Global Growth Outlook is a translation based on „Globaler Wachstumsausblick“ as of 28 August 2018.

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