Global Growth Outlook 02/2020

February 2020 GLOBAL GROWTH OUTLOOK

A sluggish Economy Moderate global economic growth restrains the German economy

▪

We again expect weak global economic growth of a mere three percent this year. There will be no tangible recovery. Global trade remains weak, we anticipate an increase of only 1.5 percent (previous year: one percent). Risks for German foreign trade remain high, including the uncertain conclusion of a trade agreement with the United Kingdom following Brexit.

▪

Rising uncertainty due to spread of the coronavirus. We expect the epidemic to impact on growth in China.

▪

Political ideas to animate long-term growth through structural reform and financial policy incentives are lacking worldwide. Europe does not have the power to compensate the weak precedents set by the United States and China.

▪

Foreign trade will not be contributing to German economic growth. The increase in GDP will again this year be curbed by foreign trade. Only domestic demand generated by construction activity and private consumption will keep growth above zero.

▪

The BDI calls for domestic financial policy to switch focus to fostering growth. We advocate increased public investment and more favourable conditions for private investment. This includes cutting corporate tax, digitalising administration and speeding up authorisation procedures.

A sluggish Economy | Moderate global economic growth restrains the German economy 27/02/2020

Content No significant upturn in sight ............................................................................................................ 3 Global Industrial Production Stagnant ............................................................................................. 8 Advanced Economies: United States Returns to Growth Engine Role ................................................. 8 Industrial Production in Emerging Economies ...................................................................................... 9 World Trade........................................................................................................................................ 10 Foreign Direct Investment ................................................................................................................ 11 Monetary Expansion Protecting Global Economy from Recession............................................. 11 Fiscal Policy Momentum in Relatively Few Countries in 2020 ..................................................... 13 Financial Markets and Exchange Rates .......................................................................................... 14 U.S. Economy .................................................................................................................................... 16 GDP Growth ........................................................................................................................................ 16 Foreign Trade Development Shaped by U.S.-Chinese Trade War..................................................... 18 Tariffs Between the United States and China Remain Record High................................................... 19 U.S. Budget and Public Finances ....................................................................................................... 19 Europe’s Economy Continues to Weaken ...................................................................................... 20 Jobs Still Rising Even Amid Weak Growth .......................................................................................... 20 No Signs of Clear Recovery in Latest Indicators................................................................................. 21 Industrial Recession in Germany Looms on the European Landscape .............................................. 21 Slowdown Across Nearly All of Europe ............................................................................................... 23 China: Growth Dropped Steadily Again in 2019 – Risks Could Rise in 2020 .............................. 25 Economic Indicators Weaker in 2019 .................................................................................................. 26 Stability, Reform and Growth Stimulus ............................................................................................... 27 Debt Remains Persistent Problem ...................................................................................................... 28 Structural Market Economy Reforms Currently Unlikely ..................................................................... 28 Japan Faltering Despite Olympic Games ....................................................................................... 28 Regional Outlook ............................................................................................................................... 29 Consequences for Germany ............................................................................................................... 30 Sources .............................................................................................................................................. 31

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A sluggish Economy | Moderate global economic growth restrains the German economy 27/02/2020

No significant upturn in sight Following last year’s disappointing performance, a tangible revival of the global economy is not to be expected this year either. A year ago, we predicted that the global economy would only grow by 3¼ percent in 2019 and the U.S. economy by 2¼ percent rather than the three percent anticipated by the administration, but growth ultimately turned out to be even lower for the global economy and for the United States. However, we did not expect that world trade would practically stagnate since the beginning of the year, instead believing it would increase by a good three percent. The OECD estimates that trade volume increased by only 1.2 percent in 2019 (OECD 2019). The Baltic Dry Index for freight volumes has tumbled since September and now stands at its prior low of March 2019. The RWI Container Index dropped again in November. It was not possible to foresee the full extent of the escalation of the trade dispute between the United States and China, or the impact of the subsequent uncertainty on global investment activity, or the resolute turnaround in monetary policy which, according to IMF estimates, managed to salvage one half of a percentage point of growth for 2019 and 2020. The outlook for this year is not much brighter. While sentiment indicators for the OECD show robust consumer behaviour, companies and the overall index do not suggest any recovery at the current time.

Economic sentiment indicators*, OECD 102

101

100

99 2018 Business Tendency Surveys (Manufacturing)

2019 Consumer Opinion Surveys

Leading Indicator

*seasonally adjusted (Index=100) Source: Macrobond

We expect global economic growth this year to remain at the weak level of only three percent, with global trade gradually picking up, though unlikely to exceed one and a half percent. The figures available so far do not indicate any real improvement. The same goes for investment activity in industrialised countries, which will probably only grow by just over 1¼ percent in 2020 and 2021 (OECD 2019: 22). Industrial production in these countries is likely to maintain its current weak bobbing trend.

The global manufacturing purchasing managers’ index only turned positive three months ago, although for the EU the index is still in contraction territory at 48.1 points.

By taking resolute action, the central banks have at least managed to contain the risk of recession, although anxiety was tangible until the late summer. Economic momentum should begin to pick up slightly from the third quarter 2020 onwards. 2021 is set to be a brighter year for the global economy,

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A sluggish Economy | Moderate global economic growth restrains the German economy 27/02/2020

particularly for emerging countries. However, a renewed escalation of the trade conflict following the elections in the United States is a very possible scenario that would threaten once again to hamper global trade and worldwide investment activity in the course of 2021.

In this gloomy context, growth prospects for the major economies are also lower than in the previous year. The European economy is likely to grow by just one percent, with forecasts dropping to just over three quarters of a percent for the euro area and a quarter of a percentage point for Japan. The U.S. economy is on track for growth of just under two percent and China probably just under six percent (5.8 percent), depending on how fast they manage to get the corona epidemic under control. This is not good news for Germany, as the seismometer of the world economy. We are only expecting half a percent of growth here this year.

Main forecast: Growth of real gross domestic product compared to previous year (in percent) Global economy

3.0

Euro area

0.8

World trade

1.5

EU

0.9

USA

1.9

Germany

0.5

China

5.8

Japan

0.5

Source: BDI

Structural shifts in the world economy continue to burden growth. The ongoing structural transformation in China, the structural transition combined with persistently feeble economic momentum in the global automotive industry, and scarce and feeble economic policy impetus in almost all major economies will be shaping the new year as well. No major economy has any growth programme worth mentioning for 2020, leaving France once again this year as the only big country with the intention of initiating substantial structural reform.

A broad and multilateral opening of markets to foreign trade and investment activity, and international economic integration in other sectors are nowhere to be seen. If no impetus is injected here, growth will continue to fall, particularly in industrialised countries. Economic activity will once again be bogged down this year by continued trade disputes between the United States and China, increasing security tax for cross-border transactions, persistent uncertainty surrounding Brexit and future economic relations between the EU and the United Kingdom, and conflicts in the Middle East that will potentially impact oil prices and the economy.

The recent stimuli generated through monetary and fiscal policy are just about enough to slightly cushion the negative impact from trade policy and go some way to stabilise growth and inflation.

Central banks, in particular, acted together to provide a powerful boost in 2019 and will now wait and see how this pans out during the current year. None of the large central banks are likely to take any major steps in monetary policy, although particularly the ECB and the Japanese central banks are currently falling far short of their targets.

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Forecast summary: Growth in real GDP 2019/20/21 in percent 2019

2020

2021

IMF1

OECD2

EUCOM3

IMF1

OECD2

EUCOM3

IMF1

World

2.9

2.94

2.9

3.3

2.94

3.0

3.4

3.04

3.1

USA

2.3

2.3

2.3

2.0

2.0

1.8

1.7

2.0

1.6

China

6.1

6.2

6.1

6.0

5.7

5.8

5.8

5.5

5.6

Japan

1.0

1.0

0.9

0.7

0.6

0.4

0.5

0.7

0.6

EU

1.4

OECD2

1.4

EUCOM3

1.4

Euro area

1.2

1.2

1.1

1.3

1.1

1.2

1.4

1.2

1.2

Germany

0.5

0.6

0.4

1.1

0.8

1.0

1.4

0.9

1.0

France

1.3

1.3

1.3

1.3

1.2

1.3

1.3

1.2

1.2

Italy

0.2

0.2

0.1

0.5

0.4

0.4

0.7

0.5

0.7

Spain

2.0

2.0

1.9

1.6

1.6

1.5

1.6

1.6

1.4

U. Kingdom

1.3

1.2

1.3

1.4

1.0

1.4

1.5

1.2

1.4

India

4.85

5.8

5.6

5.85

6.2

6.1

6.55

6.4

6.3

Brazil

1.2

0.8

0.8

2.2

1.7

1.5

2.2

1.8

1.8

Russia

1.1

0.9*

1.0

1.9

1.6*

1.4

2.0

-*

1.5

1: IMF (January 2020) 2: OECD (November 2019, *September 2019). Data for Germany without working day adjustment.

3: European Commission (November 2019).

4: Forecast on basis of 70 percent world GDP (PPP of 2013) 5: Information on India for the fiscal year in current prices.

The forecasts of the international economic organisations for this year and the next are therefore all very similar. The International Monetary Fund, however, already sees signs of recovery (IMF 2020, 2019), particularly in some emerging countries, while the OECD, the European Commission and the ECB have all published slightly weaker forecasts for the global economy. The ECB is even forecasting a decline to 1.1 percent growth in the euro area for the current year, with a pick-up in growth and inflation only seeming plausible for 2021 (ECB 2019). We are equally sceptical, particularly as the economic uncertainty, on which the Trump administration has had a massive impact among other factors, has not been contained by any means. The first phase of agreement in the trade conflict with China does little to remedy this as the effective tariff rates of both nations for bilateral trade will remain at around 20 percent and China will be hard pushed to stick to its agreement to sharply increase imports from the United States. OECD estimates suggest that all-in-all, the trade conflict will swipe

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A sluggish Economy | Moderate global economic growth restrains the German economy 27/02/2020

between 0.3 and 0.4 percentage points off global economic growth until 2021 and 2022, along with over two percentage points in investment activity and just over one and a half percentage points in global trade (OECD 2019: 16-17). The IMF expects global trade to be affected to the scale of 0.8 percentage points this year (IMF 2019).

Global trade stagnates*

Exports and imports of the major economies**

128

160 150 140

126

130 120

124

110 100

122 2018 World (exports)

2019 World (imports)

2018 Euro area (exports) USA (exports) China (exports) Japan (exports)

2019 Euro area (imports) USA (imports) China (imports) Japan (imports)

* export and import volumes, global exports and global imports in volume and current prices (USD) ** export and import volumes, seasonally adjusted Source: Macrobond

We are particularly concerned about the development of global trade and industrial production. Global trade practically stagnated in the course of 2019. At the least, the global manufacturing purchasing managers’ index recently returned into expansionary territory. The semiconductor business in East Asia will only pick up in the second half of the year. Industrial production is experiencing a pronounced weak phase in industrialised countries. The auto market will remain weak on a global level, with VDA (German automotive industry association) estimates suggesting that passenger cars will drop from the latest figure of 80 million units down to 79 million. Last year, the Chinese market, a key market for the automotive industry, contracted by eight percent and is only just back on the road to a very gradual recovery. Industrial production in Germany dropped by as much as four percent in 2019, with production in the automotive sector falling nine percent in terms of units. German industrial production may even drop again in the course of this year. Exports of German goods also recorded only moderate growth; at only 0.6 percent more than the previous year as of November 2019, a slight recovery is the best-case scenario on the cards this year.

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Purchasing Managers` Index* World 56

54

52

50

48 2017

2018

PMI Manufacturing

2019

PMI Services

2020

PMI Composite

*PMI Source: Market Source: Macrobond

Purchasing Managers` Indices* 65

65

Germany

Euro area

60

60

55 55 50 50 45 45

40 2017

2018 2019 Manufacturing PMI Gewerbe PMI Verarbeitendes Services PMI PMI Diensteistung Composite PMI gesamt PMI

2017

2020

2018

2019

2020

PMI Verarbeitendes Manufacturing PMI Gewerbe Services PMI PMI Diensteistung Composite PMI gesamt PMI

58

56

USA

China

56 54 54 52 52 50

50 48

48 2017

2018

2019

PMI Verarbeitendes Manufacturing PMI Gewerbe Services PMI PMI Diensteistung Composite PMI gesamt PMI

2020

2017

2018

2019

2020

Manufacturing PMI Gewerbe PMI Verarbeitendes Services PMI PMI Diensteistung Composite PMI gesamt PMI

*PMI Source: Market Source: Macrobond

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Global Industrial Production Stagnant In 2019, global industrial production only increased marginally. According to data from the Netherlands Bureau for Economic Policy Analysis (CPB), industrial production dropped from 1.5 percent in the first quarter 2019 down to 0.3 percent in the third quarter 2019 compared to the same period the previous year. Growth in the final quarter of the year is likely to have been close to zero again bringing the growth in production for the year overall down to just one half of a percent. This would be the lowest rate of growth recorded in the past decade.

In the first quarter 2019, although industrial production in emerging countries increased by 2.2 percent year on year, the rate of growth compared to the previous year had halved. The rise in production tapered off throughout the year going down to just one percent in the fourth quarter. For the year overall, industrial production is nonetheless likely to have increased by 1.5 percent. In the advanced economies, the feeble growth recorded in the first half of the year will fail to compensate for the decline in production that has been ongoing since June 2019. This will be the first drop in industrial production for this group of countries in the last ten years.

The global manufacturing purchasing managers’ index (PMI) has signalled falling production since May 2019. The index did lift slightly from its trough in the middle of the year. The 50.3 and 50.1 index points at last count are the first indications of an expansion ahead.

World: Industrial production* emerging economies advanced economies

5 4 3 2 1 0 -1 -2 2016

2017

2018

2019

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

Advanced Economies: United States Returns to Growth Engine Role Following the euro area and Japan, U.S. industry now also showing cracks The downward trend in industrial production in the Euro area, which began at the turn of the year 2018/19, has continued into the fifth consecutive quarter. Following a fall of 0.7 percent in the first quarter, the downward momentum continued to gather pace in the further course of the year. We

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expect industrial production to have declined by 1.5 percent in 2019 overall. This would be the first decrease in six years. In Japan, industrial production dropped by 1.2 percent in each of the first three quarters of the year compared to the same period the previous year. Production levels faltered severely towards the end of the year bringing the probable annual performance down to negative two percent.

While the U.S. industry revved on in its role as the engine of growth for the advanced economies in the first half of the year, it lost steam in autumn and is expected to have turned negative towards the end of the year. Notching up only one percent growth in total, growth is well below the rate of just over four percent registered the previous year. In the remaining advanced economies, industry started off the year with an increase in production of 1.2 percent in the first quarter. The pace picked up slightly further until the middle of the year, before dropping down to just under one percent in the second half of the year. This group of countries nonetheless took over from the United States as the leading source of growth. We expect industrial production in the remaining advanced countries to have increased by somewhat more than one percent in 2019 overall.

The global manufacturing purchasing managers’ index (PMI) for advanced economies appears to have bottomed out since May 2019. The latest figures for the index even show a slight increase, although it remains below the threshold to expansion of 50 index points.

Advanced economies: Industrial production* other advanced economies Euro area Japan USA

5 4 3 2 1 0 -1 -2 -3 2015

2016

2017

2018

2019

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

Industrial Production in Emerging Economies Growth slows down in Asia; Latin American stuck in fifth year of recession Industrial production in China recorded a sturdy rise of 6.3 percent in the first quarter 2019. In the next two quarters, growth dropped considerably, going down to 5.5 percent and five percent respectively.

The trade spat with the United States is likely to be one of the reasons for the substantially lower rates of expansion. The latest figures do indicate a slight recovery, but we still expect production for 2019 overall to have increased by only 5.5 percent. In the remaining Asian emerging countries, industrial production levels bobbed around zero, with production only increasing slightly in the second quarter 2019. The result for the year overall is expected to be marginally negative. The buoyancy recorded in

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industry in the countries of Africa and the Middle East proved to be short-lived. Industrial production dropped 1.8 percent in each of the first two quarters of the year. In the second half of the year, production then slumped sharply, falling by five percent in the third and fourth quarter. After five years of growth in this region, we estimate an overall drop in industrial production in 2019 of around 3.5 percent. In the countries of Central and Eastern Europe industrial production grew 1.9 percent for the year overall, which though lower than the two previous years was nonetheless the fourth consecutive year of growth. This means that only the industries of this group and China contributed to growth in production in the emerging countries.

The global manufacturing purchasing managers’ index (PMI) for emerging countries has bounced back from its low in June 2019, rising more than one percentage point, and has remained in expansionary territory since then.

Africa/Middle East Latin America Central and Eastern Europe Asia (excluding China) China

Emerging economies: Industrial production* 5 4 3 2 1 0 -1 -2 -3 2016

2017

2018

2019

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

World Trade According to International Monetary Fund estimates from January 2020, world trade last year increased by only one percent over the previous year. This is a sharp decline from the 2018 growth rate of 3.7 percent. Preliminary figures from the Netherlands Bureau for Economic Policy show an increase in world trade in the third quarter 2019 of 0.6 percent compared to the previous quarter. The main factor causing the third quarter increase on the imports side was the growth of demand from industrialised countries (0.9 percent). For global exports, on the other hand, it was the emerging countries that were the driving force of global growth (1.2 percent), with exports from industrialised countries remaining at the same level. 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, registered another drop at last count, in December, following falls in the preceding months (down to 134.1 index points). This is

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no doubt a reflection of the escalation in global trade conflicts. In January the International Monetary Fund downwardly revised its forecast for the current year by 0.3 percentage points, but nonetheless anticipates annual growth of 2.9 percent. Like the OECD, we anticipate a lower rate of growth of one and a half percentage points.

Foreign Direct Investment In January, UNCTAD reported a renewed decrease in global investment flows during the year 2019 (down one percent to 1.39 trillion U.S. dollars). This was the fourth consecutive annual drop. Global FDI movements are still below pre-global financial crisis levels. Again, industrialised countries were the worst hit by the plunge in 2019 with investment to this group going down by a whole six percent.

The global shift in investment towards emerging countries thus continues. The EU was particularly affected, with investment flows into the EU plummeting 15 percent. Foreign investment in the United States meanwhile remained stable. Other notable developments included a 48 percent drop in investment flows to Hong Kong in the course of 2019 in response to the unrest in the country, and a surge in investment in Brazil of 26 percent attracted by the government’s privatisation programme.

In December, UNCTAD published a report confirming this trend and examining the fact that countries are increasingly controlling and preventing foreign direct investment. Since 2011, eleven countries have introduced such measures and 41 countries have tightened up existing measures. During the reporting period from November 2018 to February 2019 alone, 34 percent of global investment policy measures were of a restrictive nature – an increase of over 50 percent compared to the previous reporting period (May to October 2018). The phase of steady market liberalisation for foreign investors seems to be ending as a spiral of investment protectionism that runs counter to prosperity takes hold.

For 2020, UNCTAD is nonetheless still anticipating a marginal increase in global foreign direct investment flows.

Monetary Expansion Protecting Global Economy from Recession In this environment of dwindling economic momentum and falling prospects, labour markets have continued to recover globally, but the upward momentum in prices has suffered considerably. Inflation rates are very low in Europe and Japan but have reached the target set by the Fed in the United States.

In the last six months of 2019, the central banks were busy buying monetary insurance to fend off recession. The Fed, ECB and the Chinese central bank stepped up their expansionary course considerably while the Japanese central bank was able to keep its course unchanged for now, thanks to the fiscal policy adopted by the Abe administration.

In 2019, the Federal Reserve made great efforts to counter a possible slowdown in the US economy and the risks of recession indicated by the financial markets. In a series of steps, the Fed cut key interest rates from a range of 2¼ - 2½ percent to a range of 1½ - 1¾ percent at the end of 2018, thus bringing the yields for ten-year government bonds back to a normal though very flat yield curve. The inflation rate and core inflation stood slightly under two percent at last count (1.5 and 1.6 percent respectively in 2019) and the average medium-term forecast of members of the Federal Open Market Committee for 2020 was 1.9 percent in both cases, so the Fed does not currently see any need for action. However, we expect the U.S. economy to continue to lose steam, which will worry the Fed as price trends are also rather weak and it therefore stands ready to step in with expansionary measures if necessary.

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The European Central Bank also took action in September, increasing its monetary stimulus to buffer the clear downturn in inflation and growth prospects for the euro area. Although this move initially was met with controversy, the objections have meanwhile subsided and in light of the figures, the decision was appropriate. The package of easing measures adopted by the ECB included cutting the interest rate on the deposit facility to minus 0.5 percent and, at the same time, making the conditions for longer term refinancing for commercial banks more favourable and increasing the term from two to three years. It also introduced a tiered system of interest rates for minimum reserves, which considerably reduces the financial burden on banks in countries with excess liquidity such as Germany. The net asset purchasing programme was also restarted as of 1 November to the volume of 20 billion euros per month with plans to continue reinvesting the full yields of the programme. On the tail of these decisions, lending to the private sector rose moderately, going up by 3.5 percent compared to the previous year at last count (October figures). Lending to private households also rose by 3.5 percent in November compared to the previous year, while corporate lending rose 3.4 percent. The lion’s share of corporate lending went to companies from the service sector (ECB 2019b). In spite of these measures, the ECB is only expecting inflation of 1.1 percent this year, with 1.4 and 1.6 percent anticipated for the following two years. Core inflation is forecast to rise from one percent (2019) to 1.3 percent this year and the next (ECB 2019a). No major monetary policy decisions are on the agenda this year, although this doesn’t rule out smaller adjustments in response to economic developments that will probably be weaker than expected.

The new ECB president has initiated a strategic review of monetary policy for this year but has not yet shown any intention to change the current course any time soon. As we believe that industry will continue to dampen overall economic momentum, despite the resilience of the construction industry and, above all, the service sector, it is too soon to sound the all-clear for monetary policy. The outlook in the short term is fragile and the ECB does not expect inflation to have reached a satisfactory level even in 2022. “Low for longer” looks to remain the motto for capital market yields and key interest rates for the foreseeable future.

The Japanese central bank is currently running a neutral course in response to lower growth prospects and has recently hardly used the leverage available to it through its asset purchasing programme, instead focusing on controlling ten-year yields. Core inflation is likely to remain under one percent, which is below target but seems to be acceptable in view of faltering growth prospects. A sideways movement in monetary policy appears appropriate given the country’s high-volume economic package. The Chinese central bank took several smaller-scale expansionary measures last year. In view of the rather high inflation rate of 4.5 percent particularly due to the swine fever and the steep increases in food prices, there is now little room for additional measures. At the beginning of the year, the central bank dropped minimum reserve requirements to 12.5 percent, but clearly indicated that the current interest rate was appropriate. In early February, the central bank even pumped a further 1.2 trillion renminbi into the economy to cushion the contractive effects of the corona epidemic. For the time being, the Communist Party leadership seems satisfied with the fiscal measures taken last year and growth prospects of around six percent.

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Key interest rates in selected countries 3

2

1

0

-1

European Central Bank

Federal Reserve Bank

Bank of England

Bank of Japan

Source: Macrobond

Fiscal Policy Momentum in Relatively Few Countries in 2020 The G20 governments have reacted quite passively to the latest slowdown triggered by the conflict between the United States and China. Only Japan has responded with a high-volume economic package. It is quite astonishing, in a negative sense, how European governments have more or less refused to come up with a constructive solution to counter the slowdown on the horizon. With the exception of France, none of the major EU countries are currently pursuing any kind of discernible structural reform scheme capable of significantly increasing growth, productivity and economic activity in the medium term. Overall, the impact of the fiscal policy of the OECD countries is likely to be too weak despite being on the expansionary side. Reforms are also simply politically impossible in some of the major countries on account of their extremely precarious government constellations.

Fiscal policy will not be playing a key role in global economic development in 2020. In the United States, fiscal policy is marked by substantial deficits across the board despite full employment and growth at slightly above potential (the equivalent budget deficit for 2020 is expected to be at 5.5 percent of economic output, primary deficit at 3.6 percent, cyclically-adjusted deficit at 6.3 percent and primary deficit at 4.3 percent (IMF 2019b). U.S. financial policy will move sideways structurally in the next few years with a neutral effect on economic momentum.

The People’s Republic of China has been pursuing an expansionary fiscal course since 2018 and increased its deficit from 4.8 to 6.3 percent this year, with a similar increase in its primary deficit and a parallel development in the cyclically adjusted figures. Unlike last year, no new stimulus is scheduled for this year, so the impact of Chinese fiscal policy on its economy will be largely neutral.

Korea, Germany, Greece, the Netherlands and Sweden, on the other hand, have adopted an expansionary course. Japan’s economic package from last December is regarded by many experts as

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only mildly expansionary, while the general direction of fiscal policy from 2019 to 2021 is restrictive.

The countries with the most fiscal policy space are Germany and some north-western European countries such as Sweden and the Netherlands (OECD 2019).

Financial Markets and Exchange Rates In the second half of last year, the financial markets showed signs of easing. Stock markets around the world recovered. In September alone, the U.S. S&P 500 index, the broad European index Stoxx 600, Japan’s Nikkei and the main stock market of Hong Kong, the Hang Seng, all grew by more than ten percent. The NASDAQ Composite of technology stocks even rose by just under 20 percent. The Chinese stock market’s performance was slightly weaker (the broad Shanghai Index with 380 stocks increased by around five percent); in early February, markets began again to fall in response to the coronavirus. The Turkish and Brazilian markets in particular benefited from the recovery. However, the stock markets reacted sharply to the escalation of the trade conflict between the United States and China in August 2019. The stock markets have since returned to very high levels, which is rather surprising in view of the subdued global economic outlook. Factors working in their favour include the high share buyback programmes of the United States. The cyclically adjusted price-earnings ratio of S&P 500 has returned to a very high level of over 30, while European stocks, with an average priceearnings ratio of 19 and Japanese stocks of 15, lie moderately above the long-term average.

Price-earnings-ratio of benchmark indices 22

34

20

33

18

32

16

31

14

30

12

29

10

28 2018 STOXX 600-Index

2019

2020

Nikkei 225-Index Shiller-Index (S&P 500), cyclically adjusted(rechte (right axis) zyklisch bereinigt Achse) Source: Macrobond

Yields on bonds dropped steeply until September, but then recovered by around 50 to 70 basis points until December and have since slightly tapered once again. In many countries, including Germany, about half the bonds are still yielding negative. About one fifth of the global market is affected. The synchronised monetary expansion initiated in spring 2019 allayed fears of recession. U.S. ten-year bonds were most recently at 1.7 percent, Italian bonds at 1.25, U.K. bonds at 0.5 and French and Japanese bonds at just under zero, with German bonds at negative 0.3 percent. Since last summer,

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“lo spread�, the yield difference between Italian and German government bonds has halved from over 300 basis points to just over 150 points. For the financial markets, the formation of the coalition government around Conte II greatly improved Italy’s risk outlook. In view of the current weak position of the Cinque Stelle it is not yet certain whether this optimism may not fade again in the course of the year. Other European countries are also benefiting from the substantial narrowing of spreads.

Bond yields* (daily) 5 4 3 2 1 0 -1 -2

Germany

France

Italy

Spain

U. Kingdom

USA

China (monthly)

Japan

*Yields of ten-year government bonds Source: Macrobond

On the foreign exchange markets, large movements only occurred in currencies with a narrow margin. The euro appreciated by two percentage points between May and September on a nominal and trade-adjusted basis against its largest 42 trade partners but has turned down again since the beginning of 2020. This downward trend was triggered above all by the recovery of the strongly fluctuating currencies of some developing countries, including the Turkish lira. In real terms, the euro most recently depreciated by around three percent. The U.S. dollar also initially appreciated by two points in nominal terms since the summer but had lost one point again by the beginning of the year.

The Chinese yuan, on the other hand, stabilised nominally and effectively in the second half of the year following a sharp depreciation in the first half of 2019. The bilateral exchange rate against the U.S. dollar dropped under seven RMB to the dollar for the first time in August but has stabilised since the beginning of the year and stood at just under 6.9 at the end of January. The impact of the coronavirus has taken the exchange rate back to under seven RMB per dollar. The Japanese yen has depreciated by around three percent since September in real and nominally effective terms.

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Trade-adjusted exchange rates* of the U.S. dollar and the euro 130 120 110 100 90 80 2018

2019

Euro, nominal effective exchange rate index, broad Euro, real effective exchange rate index, broad *Index: 2015=100 Source: Macrobond

US-dollar, nominal effective exchange rate index, broad US-dollar, real effective exchange rate index, broad

Exchange rates against the U.S. dollar 1,30 1,25

0,85

120

7,4

0,80

115

7,2

0,75

110

0,70

105

0,65

100

6,4

0,60

95

6,2

7,0

1,20

6,8

1,15

6,6

1,10 1,05 1,00

Euro (left axis) Pound Sterling (right axis)

Renminbi (right axis) Yen (left axis)

Source: Macrobond

U.S. Economy GDP Growth Following a year of strong growth in 2018, the U.S. economy experienced a solid but weaker upward trend in 2019. The positive stimulus from the Trump administration’s tax reform has petered out. The uncertainty surrounding current U.S. economic and foreign policy and the globally faltering economic momentum are increasingly clouding growth prospects here as well.

According to figures from the Bureau of Economic Analysis (BEA), the U.S. economy still registered annualised growth of 3.1 percent in the first quarter 2019. Growth then dropped down to two percent

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in the second quarter and 2.1 percent in the third and fourth quarter. The decline in private investment in tangible assets curbed economic growth in particular. Investment in commercial construction and in plants and equipment dropped most strongly. Investment in software and residential housing, on the other hand, increased. Higher public spending and a substantial rise in private consumption expenditure is presently bolstering economic momentum. Overall in 2019, the U.S. economy grew by 2.3 percent according to the current estimates of the BEA, which is more than half a percentage point lower than in 2018, when growth measured 2.9 percent (BEA 2020a) Contribution to GDP Growth, by Category Quarterly Compared to Corresponding Period in Previous Year, in Percentage Points

Public consumption (government expenditures) Q1 2019 Q2 2019 Q3 2019 Q4 2019

Net exports (goods & services)

Change in private inventories

Fixed investment

Private consumption

GDP -2

-1

0

1

2

3

4

Source: Bureau of Economic Analysis

Other notable developments included a tumble in the import of goods in the fourth quarter as well as a tangible reduction of non-agricultural inventories. In the course of the trade conflict between the United States and China, hamster purchases have increased in attempts to avoid the tariff increases announced for the fourth quarter. These inventories are now being used up, which means that imports are likely to start rising again. As the special tariffs imposed by the United States against China will remain largely in place despite the phase one agreement signed in the middle of January 2020, the corresponding price effects following the dwindling of stocks will have a significant impact on the economy.

The U.S. economy is expected to cool down further in 2020. Stimulating economic policy measures will be of little interest to the Democrats in Congress ahead of the presidential elections in November of this year, considering that a buoyant U.S. economy will increase the president’s chances of reelection.

In its World Economic Outlook of January 2020, the International Monetary Fund (IMF) forecasts growth in U.S. GDP of 2.3 percent for 2019 overall and a further moderate cooling down to two percent in 2020 and 1.7 percent in 2021. The reasons given by the IMF for the downward trend are the expectations that the fiscal impetus will dwindle further, leaving less leverage for monetary easing measures. Factors endangering (global) growth identified in the outlook include geopolitical tensions

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with Iran, trade disputes and tariff hikes, financial market crises and extreme weather events brought about by climate change (IMF 2020). We expect U.S. GDP to grow by 1.9 percent in 2020.

Foreign Trade Development Shaped by U.S.-Chinese Trade War Although the United States, even today, only depends on foreign trade to a relatively small degree on account of the sheer size of its domestic market, the ratio between trade volume (sum of exported and imported goods and services) and GDP rose from 10.8 percent in 1970 to 27.5 percent in 2018. U.S. trade traditionally has a high deficit in the trade of goods and a surplus in the trade of services. Between January and November 2019, the trade deficit amounted to 563 billion U.S. dollars, following on from 567 billion U.S. dollars in the same period the previous year. The deficit results from a surplus in the trade of services of 228 billion U.S. dollars (compared to 240 billion U.S. dollars the previous year) and a deficit from the trade in goods of 791 billion U.S. dollars (compared to 806 billion U.S. dollars the previous year) (BEA 2020b).

This, in turn, resulted from a decrease in goods exports from 1538 to 1521 billion U.S. dollars and an increase in service exports from 758 to 775 billion U.S. dollars. Regarding imports, the import of goods dropped from 2344 to 2312 billion U.S. dollars with service imports increasing from 518 to 546 billion U.S. dollars (BEA 2020b). All comparisons are based on seasonally adjusted figures from January to November 2018.

The Trump administration’s policy of tariff escalation has thus so far not had a major impact on the trade balance of the United States. However, we need to bear in mind a certain one-off factor and other adaption processes. The U.S. tax reform that took effect in 2018 also indirectly impacted U.S. imports and exports through fiscal and competition aspects which has camouflaged the consequences of the trade policy measures. Furthermore, the announcement of tariffs by the U.S. administration triggered hoarding behaviour with purchases brought forward to immediately before the tariffs took effect or where scheduled to take effect. Finally, market adjustments in the supply chains occur with a time lag which explains why U.S. companies, for example, are only gradually substituting the Chinese components that are subject to the duties. The long-term effects of the tariffs on trade flows will only become apparent once data becomes available over the course of 2020.

In a study published in the mid-January 2020, the Bundesbank analysed the economic effects of U.S. protectionism against China. According to its calculations, if the additional duties are retained, they will shave 0.5 percent off U.S. GDP compared to an alternative scenario without additional duties. The costs of the duties will mainly be borne by U.S. companies and consumers. Chinese exporters are apparently not significantly lowering their prices. The Bundesbank study does not find any empirical evidence to support the theory that third countries may be able to benefit substantially from the diversion of trade triggered by the tariff escalation between the United States and China. The global economy, and with it third countries, are much more affected by the negative effects of increased uncertainty. This uncertainty has a particularly negative impact on investment activity. The Bundesbank also warns against an escalation of the trade conflict between the United States and the EU, and the much greater level of economic damage that this would create than the present situation (Bundesbank 2020).

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U.S. trade balance of goods and services in millions of U.S. Dollars 300.000 250.000 200.000 150.000 100.000 50.000 0 -50.000

Trade balance

Exports

2019

2018

2017

2016

2015

2014

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

-100.000

Imports

Source: Bureau of Economic Analysis

Tariffs Between the United States and China Remain Record High The “phase one” deal has eased tensions in the trade dispute between the United States and China.

However, customs duties on imports on each side remain high. According to the cut in tariffs agreed in the phase one agreement, the average U.S. custom duty on imports from China would be at 19.3 percent. Before the first special duties were imposed in July 2018, the average U.S. tariff rate on Chinese imports was 3.1 percent. The average Chinese duty on imports from the United States would be 20.9 percent following the deal, compared to the eight percent level of early 2018 (Peterson Institute for International Economics 2020).

Companies will have to get used to higher custom duties as the “new normal” and make corresponding adjustments to their supply chains. In many cases, U.S. companies will gradually substitute the Chinese components that are subject to the increased duties with non-Chinese products. The other way around things are less certain as China has pledged huge purchases of U.S. products in the deal.

If both sides adhere to the agreement, the probable result will be that China increases its imports from the United States while the United States will reduce its imports from China.

U.S. Budget and Public Finances Since the 1990s, state revenue and expenditure have remained relatively constant at around 20 percent of GDP, with expenditure generally exceeding revenue.

According to figures from the U.S. Treasury, the budget deficit in the fiscal year 2019 was around 984 billion U.S. dollars, which is 4.6 percent of GDP (U.S. Department of the Treasury 2019). In 2018 the deficit was 779 billion U.S. dollars or 3.9 percent of GDP (CRB 2018). The Office of Management

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and Budget in the White House expects the budget deficit to drop in the next few years with the forecast for the fiscal year 2020 at minus 4.9 percent, with minus 4.5 percent for 2021 (OMB 2019a).

The main factor behind the 16 percent increase in the deficit in fiscal year 2019 compared to the previous year – the highest it has been since the recession in the fiscal year 2012 – was the higher expenditure caused by the Bipartisan Budget Act of 2018 and the Consolidated Appropriation Act 2018.

The higher state expenditure and lower tax revenue in conjunction with the 2017 tax reform may have stimulated the economy but has, at the same time, caused the budget deficit and public debt to grow for the long-term. It is also expected that the Bipartisan Budget Act of 2019, which increases the budget threshold for discretionary expenditure, will additionally increase the deficit in the fiscal year 2020. This could push the deficit over the one trillion U.S. dollar mark for the first time since the fiscal year 2012 (Committee for a Responsible Federal Budget 2019).

According to figures from the Office of Management and Budget (OMB), gross federal debt for the budget year 2019 stood at 22.7 trillion U.S. dollars. The (gross) federal debt ratio corresponds to 107 percent of GDP which is slightly over the previous year’s level of 106.1 percent. The Federal debt held by the public was at 79.3 percent of GDP (OMB 2019b).

Europe’s Economy Continues to Weaken Economic momentum in the EU and in the Euro area will to be somewhat weaker again this year than in the previous year, were growth notched up only 1.2 percent. We expect growth of just 0.9 percent (without calendar adjustment) for the EU and 0.8 percent for the euro area with a positive calendar effect of 0.2 percentage points this year. The European Commission is somewhat more positive and expects growth to reach 1.2 percent (European Commission 2019) while the ECB forecasts 1.1 percent, largely due to a brighter estimate for Germany; the forecasts of IMF and OECD are similar.

Jobs Still Rising Even Amid Weak Growth In the fourth quarter of 2019, economic growth in the Euro area was down to only 0.1 percent, following 0.3 percent in the third and 0.2 percent in the second quarter. The economy in the Euro area is split into two. Construction and services are growing at a weak level while manufacturing is still stuck in recession. The labour market remains on a weak upward trend with employment increasing and unemployment declining but momentum is dwindling visibly. Prices are expected to be very low and rise at levels of under 1.5 percent between 2019 and 2021, which is well below ECB targets.

Private consumption should increase again this year by around one percent. Public consumption is also expected to pick up by around one and a half percent year on year. Investment activity, in contrast, will continue to suffer from the persisting industrial recession, declining capacity utilisation, weak domestic and foreign demand and low corporate earnings.

Growth momentum in gross fixed capital formation in the euro area, excluding Ireland, fell from four percent in the first quarter 2019 down to three, then to under one percent in the third quarter 2019, year on year in each case. The Commission anticipates growth here of around two percent year on year this year and next year, which will require the current trend to turn around. Over one half of this growth will be accounted for by the steadily growing level of construction investment while investment in plant and equipment and investment in other assets will rise at a level weaker than seen in the last ten years. Lending to non-financial companies lost momentum despite expansionary monetary stimulus.

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The trade balance is also likely to be negative again as export activity is only likely to pick up very moderately while imports are set to rise somewhat more forcefully. Further aggravating factors in the field are international trade disputes, weak demand for industrial goods and the special problems in the automotive industry. These factors will impact strongly on Germany, the Czech Republic, Slovakia and Hungary and somewhat on Spain, Italy and France, due to the high proportion of domestic gross value added in exports, particularly in the automotive sector (European Commission 2019: 13).

No Signs of Clear Recovery in Latest Indicators Euro area exports have not yet returned to growth and industry’s incoming orders remain weak.

Although foreign orders recently increased, orders from within the euro area declined. The purchasing managers’ index for the euro area reflects this divided trend. While the index for services is still within expansionary territory at around 52 and the construction sector has returned to an upward trend following a dent in summer, the index for manufacturing bobbed about feebly at just over 47.9. The overall index has remained over 50 throughout but is currently just scraping the mark. The results for the economic sentiment indicator and consumer confidence in the EU and in the Euro area do show some stability in consumer expectations but also indicate continued weakness in industry and only moderate confidence among the service sector.

Industrial Recession in Germany Looms on the European Landscape The industrial sector in Germany has already experienced an unusually long lean spell. Only two other recessions in the last 25 years have lasted five quarters, namely the recession of 1995 and of 2008.

In the years 1998 and 2001 (the dotcom bubble), the recession lasted one year in each case and those in 2004 and 2011 only six months, before gross value added turned back to positive. The longer the slowdown lasts, the more likely it is that closely connected member states from eastern Europe, Italy (the automotive and machinery manufacturing sector) and other countries will be dragged down too. It is still too early to give the all-clear, particularly given that some cyclical aspects are exacerbated this time around by structural problems in global trade and in the automotive sector.

Purchasing Managers` Index* Euro area 62 60 58 56 54 52 50 48 46 44 2017

*PMI Source: Market

2018 PMI PMIVerarbeitendes Manufacturing Gewerbe

PMIDienstleistung Construction PMI

PMI PMIBau Services

PMI PMIgesamt Composite

2019

2020

Source: Macrobond

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Business and consumer confidence in the EU and the euro area, seasonally adjusted 20

EU

15 10

120

20

115

15

Euro area

115

10

110

5

120

110

5 105

105

0

0 100

-5

100

-5

-10

95

-10

95

-15

90 2018 2019 2020 Consumers Verbraucher Services Dienstleistungen Industry Industrie Economic Sentiment EU*Achse) (right axis) Vertrauensindiktor derIndicator EU* (rechte

-15

90 2018 2019 2020 Consumers Verbraucher Services Dienstleistungen Industry Industrie Vertrauensindiktor derIndicator EU* (rechte Economic Sentiment EU*Achse) (right axis)

*Services Confidence Indicator Source: Macrobond

Euro area: incoming orders* in manufacturing 116 114 112 110 108 106 104 102 2017

2018

2019

*Index, calendar adjusted Source: Macrobond

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Euro area: Growth in real GDP in percent 3

2.5 2.3

2.1 2

2.0

2.0

1.8

1.7

1.1 (forecast) 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 I II III IV 2010

2011

2012

2013

2014

change over previous year quarter

2015

2016

2017

change over previous quarter

2018

2019

change over previous year

Source: Macrobond

Slowdown Across Nearly All of Europe In a great majority of European countries, economic activity is set to decline slightly this year. The only countries that can expect growth to increase by more than one quarter of a percentage point are Greece and Italy. Momentum will slow down in all other countries. The Spanish economy is again on track to deliver the best performance this year among the major economies. Growth for 2019 is estimated to have been at 1.9 percent and international organisations forecast growth of between 1.4 to 1.6 percent for this year. The pace of growth in private consumption is likely to cool off but investment and exports are expected to pick up by just over 2½ percent (European Commission 2019).

The labour market is still pointing up, but the unemployment rate of over 13 percent is still far too high, topped only by the 15 percent unemployment rate in Greece. The country’s financial policy is moving sideways with public debt still somewhat over three percent in cyclically adjusted and structural terms although only at just over two percent according to the Maastricht definition. It remains to be seen whether the new minority government will take resolute economic policy action. There are plans to increase the minimum wage, for example.

In the first three quarters of the year, the French economy grew between 0.3 and 0.4 percent before strikes slashed growth by a tenth of a percentage point in the fourth quarter. This year France should manage to keep up the pace of about one percent and grow by 1.2 percent. Private consumption is expected to increase by 1.4 percent with state expenditure increasing by only one percent. Investment is likely to pick up by just under two percent. Net exports are most likely to bring the overall result down a little. French industry has been in recession since spring 2019, while construction and services are holding up strong. Following the special measures taken last year, which will have taken the deficit to slightly over three percent, the government is likely to proceed with the consolidation of its public finances and bring the deficit down to just over two percent. The cyclically adjusted and structural deficit is around one half of a percent higher. Over the next few years, the broad range of structural reforms on the labour market, in the tax system and in pensions should have an increasingly positive impact on growth and employment. The planned correction in the current course of fiscal policy with a

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review of state expenditure is a top priority and must contribute to a gradual reduction of the high government debt ratio.

Growth prospects for Europe

2019

2020

2021

Belgium

1.1

1.0

1.0

Germany

0.4

1.0

1.0

Estonia

3.2

2.1

2.4

Ireland

5.6

3.5

3.2

Greece

1.8

2.3

2.0

Spain

1.9

1.5

1.4

France

1.3

1.3

1.2

Italy

0.1

0.4

0.7

Cyprus

2.9

2.6

2.3

Latvia

2.5

2.6

2.7

Lithuania

3.8

2.4

2.4

Luxembourg

2.6

2.6

2.6

Malta

5.0

4.2

3.8

Netherlands

1.7

1.3

1.3

Austria

1.5

1.4

1.4

Portugal

2.0

1.7

1.7

Slovenia

2.6

2.7

2.7

Slovakia

2.7

2.6

2.7

Finland

1.4

1.1

1.0

Euro area

1.1

1.2

1.2

Source: European Commission

After stagnating last year (up 0.2 percent in 2019, minus 0.3 percent in the fourth quarter, both quarter on quarter), economic activity in Italy should pick up slightly in 2020. This depends primarily on the budget agreement with the EU. If the deficit between target and planned figures is financed in full by loans, growth should reach one half of a percentage point, but with complete consolidation, Italy would

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again stagnant (Confindustria 2019). It should be possible to reach a compromise in the middle to leave potential for a good quarter of a percentage point of growth. The Commission is slightly more optimistic and believes 0.4 percent growth is realistic as does the OECD. Private consumption should increase marginally (up ½ percent), state consumption also, along with growth in investment of 1½ percent. Despite a persistently robust performance of exports, net exports are unlikely to contribute to growth. Political instability in the course of the year is a real risk. The Conte I government managed to bring the deficit down to 2.2 percent of GDP. The Conte II government of the Cinque Stelle and PD will take and implement a series of decisions whose overall effect cannot be foreseen clearly at this stage. A return to investment incentives for Industry 4.0, a series of increases in social benefits, more stringent tax regulations and stronger environmental taxation are all on the agenda. The emergency solution agreed with the EU to raise value-added tax in order to bring the budget in line with EU regulations is not very likely to be implemented, but the Italian government will have to launch consolidation measures of up to ten billion euros this year: the exact amount depends on economic developments and interest costs for its public debt. Bond yields have been steadily below 1.5 percent since July 2019 and should enable a reduction in the debt servicing costs. If not, the structural deficit of currently 2.2 percent will rise to three percent and the public deficit to around 2.8 percent by next year.

In the Euro area, Ireland and Malta should grow by more than three percent this year, the Baltic states, Greece, Luxemburg, Slovakia, Slovenia and Cyprus by more than two percent, Portugal by 1.7 percent and all other euro countries (Belgium, Finland, the Netherlands and Austria) by between one and one and a half percent, with the exception of Germany. In the rest of the EU, Bulgaria, Poland and Romania are also expected to grow by more than three percent, Croatia, Hungary and the Czech Republic by more than two percent, and Denmark by 1½ percent. Sweden and the United Kingdom are likely to experience lower growth.

China: Growth Dropped Steadily Again in 2019 – Risks Could Rise in 2020 In 2019, China’s gross domestic product still registered strong growth, rising by 6.1 percent or 14.2 trillion in U.S. dollar (USD) terms. In the third and fourth quarter, growth was down to just 6.0 percent compared to the same period the previous year. Economic momentum has been steadily losing steam. In absolute terms, growth is still huge compared to that of other economic regions.

Beijing’s economic planners have already lowered their target growth corridor to between six and 6.5 percent and are aiming at six percent for 2020. Two thirds of the provinces have already downwardly revised their growth targets for 2020. The primary industry grew by slightly over three percent in 2019 overall, the industrial sector by 5.7 percent and the service sector by 6.9 percent.

Alongside growth, the Beijing leadership is also increasingly concerned about the structural shifts on the labour market, municipal and corporate debt and financial market liquidity. Monetary and fiscal measures to stabilise the economy have been taken, but the available leverage is increasingly sparse.

Large-scale stimuli akin to the steps taken in the course of the financial crisis in 2008 and 2009, or abrupt interventions as seen during the currency and capital turbulences in 2015 and 2016, were largely absent in 2019. Mostly, steps were limited to adjusting the levers of the reserve requirement ratio (RRR) of the central bank and tax breaks to animate domestic consumption. The economy is expected to cool down further in 2020 due to the global economic environment, trade disputes and uncertainty on the domestic market. The government and the central bank will have to prepare further measures to keep growth and the economy on course in these uncertain times. As early as late January

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2020, the Chinese central bank (PBoC) announced that it would inject an equivalent amount of 173.8 billion U.S. dollars into the economy using buyback agreements. On 5 February, China furthermore decided to halve duties on U.S. imports to the value of 75 billion U.S. dollars from the middle of February 2020 as part of the phase-one deal. We expect growth to reach 5.8 percent in 2020 compared to the previous year.

After China and the USA finally managed to conclude the phase-one deal, hopes were that this would lift Chinese economic growth back up slightly. The onset of the coronavirus at the end of 2019 is now an additional factor that will be stifling momentum in 2020. The government will probably have to increase the volume of counter measures substantially in order to stimulate domestic demand sufficiently to meet its declared target of doubling gross domestic product within ten years, in other words by 2021.

Economic Indicators Weaker in 2019 Several factors are currently putting the brakes on the Chinese economy. Top of the list are the persisting tensions with the United States. The phase-one deal will still leave duties to the tune of around 70 to 80 billion U.S. dollars in place, which will undoubtedly prompt further shifts in supply chains. Many companies are now opting for a China+1 strategy to reduce their exposure to risks against China. The Chinese renminbi (CNY) nonetheless regained some stability against the USD towards the end of 2019. However, additional factors are playing into the equation, above all the cyclical and structural components on the domestic market that have become known for some time now as the “new normal”.

Industrial production – defined here as companies with sales of more than 20 million renminbi per year – lost some steam in 2019 but still recorded a stable six percent growth. The high-tech sector, which receives special support from the Made in China 2025 initiative, recorded particularly high growth of 8.8 percent. Services were still going strong with growth at 6.9 percent, and with fields such as information transfer (up 18.7 percent) and software and IT services (up 8.7 percent) doing particularly well. The current development of the 5G infrastructure should keep growth rates as high in 2020.

Retail sales remained relatively robust with annual revenues of consumption goods to the value of around 41.2 trillion CNY and growth of about eight percent. Growth in online sales was down slightly on last year, at 16.5 percent. Overall, online sales of goods and services amounted to a value of about 10.7 trillion CNY. This trend therefore continues to be in line with China’s objective of strengthening domestic demand. Individual industries are nonetheless suffering painful drops. After the dramatic slump in sales in late 2018 in the automotive sector, which makes up more than ten percent of GDP, sales continued to drop in 2019, going down 8.2 percent for passenger cars and amounting to around 25.8 million vehicles. 2020 is set to be another difficult year for carmakers as the central government plans to cut subsidies further and tighten emission targets. By the year 2025, at least one fifth of cars sold are required to be electric or hybrid which will burden manufacturers with additional costs in converting their production.

In 2019 investment in tangible assets increased by 5.4 percent to a total value of 55.2 trillion CNY. The proportion of private investment has lost momentum, with growth down to only 4.7 percent.

Investment in high-technology production remained relatively high at 17.7 percent. Investment in the property market also continued to grow robustly, rising 9.9 percent. In previous years, the government had repeatedly imposed restrictions in this sector to prevent the market from overheating.

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Foreign trade increased by a meagre 3.4 percent in 2019, reaching a value of around 31.6 trillion CNY. While exports still increased by 5.0 percent, the growth of imports dropped off to 1.6 percent.

China’s trade surplus is currently at 2.9 trillion CNY. The largest share of exports was electronic and mechanical products which accounted for 58.4 percent. The EU, the ASEAN countries and the United States remain China’s most important trading partners. Although imports from the United States still increased slightly, going up by 0.5 percent, exports to the United States dropped by 2.8 percent due to the trade war. The imports from and exports to countries of the Belt and Road Initiative (BRI) recorded overproportionate growth of 10.8 percent. The phase-one deal focuses strongly on U.S. exports to China. This is likely to reduce the trade deficit between the two nations and contribute to easing the tensions between them. However, the possibility of negative evasive effects to the detriment of EU countries cannot be ruled out. Tensions here could rise in 2020 if, contrary to expectations, the European Union fails to conclude a bilateral investment agreement with China.

Consumer prices (CPI) increased by 2.9 percent in 2019. African swine fever caused the prices for pork to skyrocket, going up 42.5 percent. Producer prices (PPI), on the other hand, fell by 0.3 percent.

The rate of unemployment in urban areas at 5.2 percent in December was again slightly higher than in the previous year.

The Caixin/Markit manufacturing purchasing managers’ index (PMI) measured 51.3 points in January 2020, returning comfortably to positive territory. In June last year, the index had stood at 49.4 points, under the critical threshold of 50 points between expansion and contraction. The official NBS manufacturing purchasing managers’ index measured 50.0 points in January 2020. The Caixin services purchasing managers’ index dropped a little in December at 52.5 points (previous month 53.5 points) but is still well within positive territory. The central government reacted to the downward trend triggered by the trade conflict by cutting taxes and facilitating lending. These moves have managed to stimulate demand. The official NBS manufacturing purchasing managers’ index recorded a value of 53.5 points in January, and thus remains well within the range of expansion. The outbreak of the coronavirus could however have a negative impact on the figures ahead.

Stability, Reform and Growth Stimulus While concerns that the “new normal” would lead to a hard landing have largely subsided, new factors causing uncertainty have now emerged, namely the trade dispute with the United State and a weakening global economy. In the last few years, the government has mainly relied on infrastructure stimuli to boost the economy, but now it is setting its hopes on domestic demand and the Belt and Road Initiative to fuel growth. The strategy of supply-side structural reform is being upheld and aims at further dismantling surplus capacities in production, excess housing stocks and cutting corporate debt. Plans are to increase production efficiency with a stronger focus on more complex components and high-technology fields.

The reform of state-owned enterprises is only progressing slowly due to the potential social consequences. The economic planners in Beijing are, in fact, ultimately working towards strengthening the public sector. The trend towards centrally planned mergers continues among state-owned enterprises in an effort to further consolidate the economy and prepare national or global champions for competition on international markets. These mergers, however, are mostly not relevant to international competition law, as the business activities of the companies are largely geared to the domestic market.

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Debt Remains Persistent Problem Despite regulatory intervention and continuing fiscal discipline, total debt is still one of China’s big problems. China’s debt ratio is currently around 300 percent of GDP. As a large proportion of the debt is concentrated on second-row banks on the domestic market and the state is both lender and borrower in many cases, the government has a wide scope for intervention. The private sector has lost liquidity due to the more stringent lending practices of the large banks. In a downturn, non-performing loans and the resulting snowball effects could become a risk to the system and thus also impact on foreign economic and financial flows. This would have global effects, not least on the German economy which is so closely intertwined with the Chinese economy. China’s additional moves towards liberalisation in the financial sector could also increase the risk of dragging other regions in the world down if it comes to a correction. On a positive note, the high foreign currency reserves continue to have a positive effect and still have a volume of more than three trillion U.S. dollars.

Structural Market Economy Reforms Currently Unlikely The Communist Party emphasised at its last congress in late 2017 that it aimed to strengthen its control of the economy and focus more on the public sector, thereby further dampening hopes of market economy reforms. But opposition is slowly growing to this approach. Not only do state interventions in the market and on corporate decision-making have a negative impact on the investment climate but they are increasingly upsetting China’s trade partners. The government has, in fact, taken individual steps towards following through on its pledges to increase free trade and further open up its markets.

These include a reduction of import duties in some sectors, a further opening up of the banking sector, and a new negative list and a new law for foreign investment. Structural market reforms called for by the United States and the EU in the course of their trilateral talks are currently not on the horizon. A reform of the World Trade Organisation (WTO) is also making only sluggish progress. Alongside import duties and restrictions on investment, non-tariff trade barriers are a major problem for foreign companies. This primarily includes the Cybersecurity Law, which severely restricts the latitude in the digital market for foreign players. A social points system scheduled for 2020 that is planned to extend to companies and include several “moral” factors is currently causing great uncertainty in the business environment. China is also developing a new export control regime and preparing to introduce a new export control law, possibly this year. Fears are that the vague formulations of the regulation mean it could be used as an instrument for future trade disputes or to protect China’s competitiveness and prevent technology outflows.

Japan Faltering Despite Olympic Games The Japanese economy looks to have ended the year 2019 with a considerable slump in the fourth quarter (around minus one percent compared to the previous quarter) following the VAT hike from eight to ten percent in October. Growth for 2019 overall may still work out at one percent, but this year it is likely to be very modest at only one quarter of a percentage point. The OECD and IMF are somewhat more optimistic and believe one half of a percentage point of growth is within reach for the current year.

Real wages have increased relatively strongly, going up by a good 1.3 percent since 2018. Given that the labour market has been stripped bare, however, the increase is surprisingly low. Nonetheless, private consumption is likely to be close to stagnation, accompanied by a decrease in residential housing investment, while investment in other assets, state expenditure and public investment should increase slightly. Net exports may contribute a little to growth while inventories will weigh growth down.

Despite the VAT hike, public debt will still be slightly over 2½ percent. The level of economic activity in

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Japan is currently following a similar trend to that in Germany. Construction is accelerating, services are holding up, but industrial production is floundering at more than five percent below the average of the last few quarters. In Asia, economic activity is gathering pace slightly and should begin to animate industrial development and foreign trade gradually.

The Abe administration already decided on various measures in 2019 to mitigate the contractive impact of the VAT hike (minus one percent GDP) in October by ½ percent. In response to the general economic slowdown in Asia and the weak demand in the global automotive and electrical and electronics industry, the government saw fit to counteract with a programme of 26 trillion yen. Half of this will be used by the state for public investment with the other half earmarked to stimulate private expenditure. This should bolster the economy by 0.1 to 0.2 percentage points. The Olympic Games are unlikely to have an impact on the overall economy despite all the travelling activity involved. The recent agreement reached between the Abe government and the Trump administration will have a positive effect on bilateral trade relations as Japanese automotive exports will not be subject to new duties in the United States. In Japan, automotive exports have held up better than electrical and electronic exports (see also OECD 2019, Deutsche Bank Research 2019, 2020). Though currently weak, Japan’s economy may yet surprise us positively in 2020.

Regional Outlook Emerging and developing countries had a comparatively weak year in 2019 growing by 3.7 percent, which is a good three quarters of a percentage point below the previous year (IMF 2020). Growth in Brazil, India, Mexico and Russia was particularly low. Growth in industrialised countries fell by half a Regional Economic Outlook*

2019

2020

2021

Europe, advanced and developing economies

1.8*

2.6*

2.5*

Middle East, North Africa, Afghanistan, Pakistan

0.5

2.7

Israel

3.1

3.1

Sub-Sahara Africa

3.3*

3.5*

South America

-0.2

1.8

Central America

2.7

3.4

Caribbean

3.3

3.7

Asia-Pacific, advanced economies1

1.3

1.3

Asia-Pacific, developing economies2

5.6*

5.8*

3.5*

5.9*

1 Japan, South Korea, Taiwan, Singapore, Hong Kong, Australia, New Zealand, Macau 2 including China and India * Growth of real GDP over previous year in percent Source: IMF (October 2019; *January 2020)

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percentage point. The economies of some countries and regions should start to recover slightly in 2020. In the Asian emerging and developing countries growth should pick up slightly to 5.8 percent, and India could well catch up and achieve an equal momentum. Growth in the region of Latin America and the Caribbean overall should increase to just over one and a half percent. Brazil will step up the pace to somewhat over two percent this year and the next thanks to hefty interest rate cuts. Mexico could rise out of stagnation and manage one percent growth. Russia should also get back to growth of just under two percent this year, which will have an animating effect on the whole region. The outlook is similar for the Middle East and sub-Saharan Africa.

Consequences for Germany The slowdown in global economic growth and the fall in the global trade of goods, which is the first since 2009, have significantly curbed economic growth in Germany. As in the previous year, the growth contribution of foreign trade in 2019 was negative. Private consumption, an expansionary fiscal stance despite surpluses and continued robust construction activity supported the economy during the last year and prevented a decrease in GDP. Production in the manufacturing sector, which depends significantly on foreign trade, dropped by 3.6 percent in 2019 according to first estimates from the Federal Statistical Office. There are hardly any indications for a turnaround during the current year, with a bottoming out on the horizon at best. The latest figures at least do not show a further drop in incoming orders for industry. Domestic demand is still weak and the momentum coming from foreign demand is largely due to one-time effects and large orders in other transport equipment. The export of goods should pick up slightly in the course of the year while the import of goods will accelerate somewhat faster fuelled by private consumption and oil prices. Net exports will therefore be curbing growth substantially yet again. Industry is therefore still in recession. The latest figures point towards a slight stabilisation, but its solidity has yet to be proven. The tailwinds of global demand that could bring about a powerful recovery are lacking. In its annual economic report, the federal government upwardly revised its forecast to 1.1 percent of growth, 0.4 percentage points of which will be generated by calendar effects alone. The government expects exports to increase and a slight upward trend in investment in plant and equipment. In view of the current recessionary position of German industry this optimism may prove premature. The smouldering trade disputes which could also spread to the European Union, the persistent underutilisation of capacities in manufacturing and a possible spread of the coronavirus, which is already curbing economic activity in China, mean that the start of an investment cycle could be some time coming. At the same time, the growth prospects of our most important trade partners are very subdued. We therefore expect exports to increase only moderately, by just under one percent, this year.

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--- (2020b). International Trade in Goods and Services. 07 January.

Committee for a Responsible Federal Budget (2019). Treasury: 2019 Deficit was $984 Billion.

25 October.

Congressional Budget Office (2020). The Budget and Economic Outlook: 2020 to 2030.

28 January.

Confindustria (2019). Italian Economic Outlook 2019/2020 and the Economic Policy Scenario. Rome.

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11 December.

---(2019b). Japanese economy in 2020 – Part 2: Economic Policy. Tokyo. 19 December.

Deutsche Bundesbank (2020). Folgen des Zunehmenden Protektionismus. 20 January.

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Frankfurt/M. December ---(2019b). Bulletin. Frankfurt/M. December Internationaler Monetary Fund (2020). Tentative Stabilization, Slugish Recovery? World Economic Outlook Update. Washington, D.C.. 20 January.

---(2019). World Economic Outlook. Global Manufacturing Downturn, Rising Trade Barriers. Washington, D.C.. October.

Peterson Institute for International Economics (PIIE) (2019). US-China Trade War Tariffs: An Upto-Date Chart. 19 December.

U.S. Department of the Treasury (DoT) (2019). Mnuchin and Vought Release Joint Statement on Budget Results for Fiscal Year 2019. 25 October.

White House Office of Management and Budget (2019a). Table 1.2 - Summary of Receipts, Outlays, and Surpluses or Deficits (-) as Percentages of GDP. --- (2019b). Budget of the U.S. Government – Mid-Session Review. 17 July.

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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 Thomas Hüne T: +49 30 2028 1592 t.huene@bdi.eu Lennart Jansen T.: +49 30 2028 1483 l.jansen@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

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