THE UNITED STATES, CHINA, AND INDIA EMERGE AS POLES OF GLOBAL GROWTH
I. GLOBAL ASSESSMENT AND OUTLOOK
Despite adverse geopolitical factors, high oil prices that topped $75 a barrel, and rising interest rates, the world's output is now estimated to have advanced by 5.2 percent in 2006, the fastest pace of growth in the last 33 years. A distinctive feature of the current global business cycle is the key role that the economies of three countries played in driving demand and shaping supply in the global economy.
Of the industrial countries, the United States led the world in technological advancements that accelerated productivity while the U.S. consumer stayed on track at a five-year long buying spree. U.S. real GDP expanded in 2006 by 3.3 percent, contributing 13.5 percent to the world's output growth in combination with the size of the economy.
Of the developing countries, economic expansion in 2006 was predominantly robust in China and India, where real output is estimated to have increased by 10.5 percent and 8.7 percent, respectively, which is about twice the world's average growth rate. Given the relative economic size of the two most populous countries, measured by purchasing power parity (PPP) international dollars, their combined contribution to global economic growth hit an impressive 43.5 percent mark in 2006.
Since the worldwide recession of 2001, the three countries-the United States, China, and India-have emerged as poles of growth by contributing twothirds to the increase in the world's output in the last six years (see Figure 1). U.S. economic growth is forecast to slow down in 2007 and accelerate in 2008, amid the end of the housing correction and the lagging effects of stabilizing interest rates. However, acceleration in European and Japanese economic growth in 2007 will maintain the growth momentum among the industrial countries.
Although economic growth in China and India is forecast to decelerate slightly during 2007-08 as their growth cycle matures, they are expected to outperform the rest of the world and continue to be key drivers of the global economy. The baseline forecast calls for global economic growth to moderate to 4.7 percent in 2007 and 4.6 percent in 2008.
On the inflation front, growth in worldwide consumer prices is estimated to register 3.1 percent in 2006, the same as in 2005. The three poles of global growth have also substantially contributed to the decline of worldwide inflation. China and India have kept a lid on inflation by providing global competitive pricing for firms in industrial countries. In the United States, the advancements in productivity have kept unit labor costs in check despite rising wages. In addition, worldwide anti-inflation monetary polices have helped to end the acceleration in inflation rates despite higher oil prices. Over the forecast horizon, 2007-08, the worldwide inflation rate will slightly decelerate to 2.9 percent from 3.4 percent during 2005-06.
The volume of world trade in goods and services is forecast to go along with projected global demand patterns over the forecast horizon. Following acceleration to a growth rate of 8.9 percent in 2006 from 7.4 percent in 2005, growth in the volume of world trade is forecast to slow down to 7.5 percent in 2007 and bounce back to 8.1 percent in 2008.
II. SHORT-TERM INDICATORS AND FORECASTS
The baseline forecast incorporates major findings of the World Economic Survey conducted by the German Ifo Institute and the Paris-based International Chamber of Commerce in the first quarter of 2007. About 1,000 executives from 90 countries have indicated that the world's economic climate slightly improved in the first quarter of 2007 and remained above its long-term trend. The recent overall reading of the worldwide survey is consistent with a growing global economy at a slightly faster pace than in the second half of 2006. The major findings of the first quarter's survey are as follows:
* Worldwide, executives evaluated the current situation, first quarter of 2007, favorably with overall economic conditions above satisfactory levels. They found economic activity in their countries to be better than in the first quarter of 2006. Regarding the future, executives expect economic conditions in the next two quarters to be better than current economic conditions prevailing in the first quarter of 2007.
* On a regional basis, North American executives assessed the current economic situation to be above satisfactory levels and as good as a year ago. Looking forward, business experts from the United States and Canada expect economic conditions to be worse in the next six months compared to the first quarter of 2007. In Asia, executives appraised the current economic situation as above satisfactory and better than a year ago; they were equally confident about the future, expecting economic activity in the next six months to be better than in the first quarter of 2007. In Western Europe, executives appraisals of current conditions were above satisfactory levels and substantially better than in the first quarter of 2006; expectations of European business executives on future economic conditions signaled an end to the acceleration in economic growth in the third quarter of 2007.
* With respect to prices, survey participants expect average worldwide inflation over the next two quarters to remain slightly above current levels.
* Looking at world trade, the business executives' combined assessment calls for the volume of exports and imports in the next two quarters to be higher than at present, first quarter of 2007.
Using the "soft data" findings of the World Economic Survey, a 90-country composite global business activity index is constructed by e-forecasting to evaluate and forecast the short-term worldwide business cycle. Areading of 50, the flatline, is used as reference in evaluating the wave of alternating booms and busts that mark the global economy. In the first quarter of 2007, our global business activity index advanced to a seven-year high mark of 74 from 73 in the fourth quarter of 2006, indicating a continuation of growth at a pace faster than in the previous quarter. It was the thirteenth consecutive quarter that the index registered a reading above 50, suggesting that the world economy remains firmly in the growth phase of the global business cycle.
e-forecasting 's global activity index tracks quarterly and in a timely way economic conditions around the world. Its historical behavior is consistent with the index of industrial production for a group of 22 leading industrial countries, constructed by "hard data" and maintained by the International Monetary Fund (IMF). However, IMF's index lags our diffusion index in terms of timeliness by two to three quarters. The e-forecasting global activity index is a "real time" indicator providing readings at the end of the last month of the reference quarter.
Historically, changes in our global activity index mirror the growth rate of worldwide industrial production (see Figure 2). Based on the real time behavior of our indicator, growth in industrial activity in the world's leading economics is estimated to have hit a growth peak in the third quarter of 2006.
By modeling business executives' two-quarter-ahead expectations into a dynamic high frequency forecast, we predict growth in the global business activity index to weaken in the first half of 2007. Global industrial production is forecast to experience a soft landing in the first half of this year with a high probability of a hard landing in the third quarter of 2007.
Our composite index of global economic activity also serves as an indicator of worldwide demand and, consequently, its change from a year ago mirrors the year-to-year growth rate in the demand for internationally traded goods and services. Derived from the opinions of about 1,000 business experts from 90 countries, e-forecasting 's composite global activity index has shown a strong performance record in tracking the volume of international trade, measured by global exports adjusted for price changes (see Figure 3). Following solid gains in 2006 at a nearly 10-percent rate, growth in the volume of international trade is estimated to have slowed down in the last quarter of 2006 and the first quarter of 2007. Looking forward, the predictive power of our global activity index suggests that growth in the volume of world trade will continue to weaken in the second and third quarters of 2007.
III. REGIONAL CONTRIBUTIONS TO GLOBAL GROWTH
In our baseline annual forecast, global output-a worldwide composite of 60 countries that account for 94 percent of the world's GDP using as weights each country 's relative GDP converted to international dollars at purchasing power parity (PPP)-is estimated to have grown by 5.2 percent in 2006 from 4.8 percent in 2005. Global real output growth is forecast to decelerate to 4.7 percent in 2007 and 4.6 percent in 2008.
Given the relative economic size and expected output growth in each of the major regional blocs, the contribution of each region to overall global economic growth is computed and presented in Table 2. This unique regional contributions-to-growth analysis helps identify the distribution of worldwide growth and, consequently, the allocation of global demand among geographic areas along with its changing pattern over the forecast horizon.
The baseline forecast calls for the countries in the North American region (NAFTA) to grow by 2.8 percent in 2007 and 3.2 percent in 2008, following 3.3 percent growth in 2006. Thus, economic growth in NAFTA is estimated to have contributed 16 percent to global economic growth in 2006. The contribution of NAFTA to the growth of global demand will decrease to 15 percent in 2007 and jump to 17 percent in 2008. In sum, the three countries of the NAFTA region will contribute about one-fifth to the growth of global demand in 2008.
In the Euro Area, growth in the combined output of the 13 members of the European Union (EU) that use the euro as common currency, accelerated to 2.8 percent in 2006 from a growth rate of 1.5 percent in 2005. Euro Area growth is forecast to moderate to 2.4 percent in 2007 and 2008; as a result, Euro Area's contribution to global economic growth is forecast to stabilize at 8 percent during 2007-2008. In the non-Euro countries of the European Union, output is forecast to increase by 3.6 percent in 2007 and 3.5 percent in 2008, from 4.1 percent in 2006, contributing 5 percent to global economic growth. The rest of the European countries, including Norway, Switzerland, Russia, Ukraine, and Turkey, is forecast to grow by 5.3 percent in 2007 and 5.2 percent in 2008, twice as fast as the output growth in the European Union; its contribution to the growth of global GDP is forecast to average 6 percent.
In the Emerging Asia region-which includes the two most populous and fastest growing countries, China and India-output is forecast to decelerate to 8.2 percent in 2007 and 7.6 percent in 2008 from 9 percent in 2006. The region's economies not only grow faster than any other economic bloc does, but also drive one-half of the projected growth in global demand. The combined output of the advanced economies in the Asia and Pacific Rim region-the group that includes Japan (the world's third largest economy), Australia, New Zealand, and Korea-is forecast to grow by 2.6 percent in 2007 and 2.7 percent in 2008, thus contributing 5 percent to the growth of the world's real GDP. Real output in the major countries of South America is forecast to enjoy solid gains over the forecast horizon growing at an annual rate of 5 percent in both 2007 and 2008, the same rate as in 2006. Given the relative market size of the region in the world economy, South America is forecast to average a contribution of about 5 percent to the growth of global output during 2007-2008.
IV. FINANCIAL MARKETS
The expected weakening of demand in the United States, reduction in oil prices, and rising interest rates have prevented acceleration in inflationary expectations. Long-term rates have begun to stabilize and monetary policy has shifted to neutrality from tightening. The current phase of de-synchronization of monetary policy now favors dollar depreciation. Economic growth, inflation, and interest rates are expected to decline in the United States and increase in Europe in the next two quarters. However, when U.S. growth bounces back at the end of 2007, the time that monetary policy in Europe will shift to neutral from tightening, the dollar will reverse its course leading to a strong appreciation. Table 3 shows features of the financial forecast for major markets and currencies. According to the latest Ifo survey, executives from around the world anticipate the pace of interest rate hikes to slow down in the coming six months for both short-term and long-term rates. Specifically in North America, interest rates are expected to decline in the next six months of 2007. Regarding exchange rate movements over the next two quarters, the experts surveyed assessed the Japanese yen as undervalued, and the euro and British pound were judged as overvalued.
Dr. Simos is Director of Forecasting at e-forecasting.com, a division of Infometrica's Data Center, 65 Newmarket Road, Durham, NH 03824, U.S.A. Web Site: www.infometrica.com, email: firstname.lastname@example.org. This report does not purport to be a complete description of global economic conditions and financial markets. Neither the Journal nor Infornetrica, Inc. guarantee the accuracy of the projections, nor do they warrant in any way that the use of information or data appearing herein will enhance operational or investment performance of individuals or companies who use it. The views presented here are those of the author, and in no way represent the views, analysis or models of Infornetrica, Inc. and any organization that the author may be associated with.…