1. Critical Challenges for the Global Economy ICRIER New Delhi, India April 20, 2007

2. 1 India: Difference Over A Decade (Index, 1996 = 100) U$406 U$797 U$4,159 billion U$1,822 billion U$2.5 billion U$12.4 billion U$41.2 billion U$197.3 billion 25.7 % GDP 48.8 % GDP

3. 2 Critical Challenges for the Global Economy  Coming in for a soft landing?  Bumps in the runway: The U.S. housing market The U.S. housing market Inflation concerns and the oil market Inflation concerns and the oil market Financial risks facing emerging markets Financial risks facing emerging markets  Longer-term Challenges: Unwinding global imbalances Unwinding global imbalances Sustaining global productivity growth Sustaining global productivity growth

4. 3 20062007 Baseline GDP Growth Forecast Remains for Continued Strong Growth (Percent per annum)

5. 4 The Housing Correction Has Cooled the U.S. Economy (Percent change from four quarters earlier) Output Investment Consumption Business investment Residential investment Non-residential construction 2003040506 200304 0506 Exports

6. 5 United States Rest of the World...And the Slowdown Has Had Limited Impact on the Rest of the World (Percent change from four quarters earlier)

7. 6 Spillovers to the Rest of the World from U.S. Slowdowns Have Been Limited (Change in GDP growth; median for region)

8. 7 Impact of Growth Declines in the U.S. and Japan (Shading denotes one standard error confidence interval) Impact of U.S. Growth Declines on Growth in Latin America Impact of U.S. Growth Declines on Growth in Emerging Asia Impact of U.S. Growth Declines on Growth in Other Advanced Economies Impact of Japan’s Growth Declines on Growth in Emerging Asia

9. 8 Investment and Exports are Strong in the Euro Area, But Consumption Lags (Percent change from four quarters earlier) Output Investment Consumption 2003040506 Exports

10. 9 Japan Remains on Track Despite Mid-06 Dip (Percent change from four quarters earlier) Output Consumption Investment 2003040506 Exports (left scale)

11. 10 Sub-Saharan Africa Latin America Emerging Europe Middle East Asia Emerging Market and Developing Country Growth Has Been Strong (Percent; seven-year moving average)

12. 11 Fixed Asset Investment (6-month m.a.; right scale) Real GDP Growth (left scale) Growth in China Continues to Boom (Y/Y percent change)

13. 12 Industrial Production Growth Real GDP Growth Growth in India Also Remains Rapid (Y/Y percent change)

14. 13 Markets Go Up, Markets Go Down (Asset class returns; percent change)

15. 14 But Overall Financial Conditions Remain Supportive of Global Growth Emerging Market Currencies Industrial country equities Major currencies Implied Volatilities (percent; 10-day mma)

16. 15 United States Euro area Japan Credit Markets Are Pricing in a Soft Landing United States Euro area Japan Policy Rates (percent) Futures rates as of 4/10/07 Long-Term Rates (deviations from long-term average)

17. 16 Despite Recent Bad News, Our Forecast For Global Growth Is Now More Evenly Balanced (Percent)

18. 17 Most Global Risk Factors Have Improved Since September (Percentage points of global GDP growth over next 12 months) Downside risk to global growth Upside risk to global growth

19. 18 Critical Challenges for the Global Economy  Coming in for a soft landing?  Bumps in the runway: The U.S. housing market The U.S. housing market Inflation concerns and the oil market Inflation concerns and the oil market Financial risks facing emerging markets Financial risks facing emerging markets  Longer-term Challenges: Unwinding global imbalances Unwinding global imbalances Sustaining global productivity growth Sustaining global productivity growth

20. 19 U.S. House Price Increases Have Cooled Fast (Y/Y percent change; relative to CPI) Existing homes (OFHEO) Existing homes (NAR) New homes

21. 20 Inventories (months of supply) Mortgage Applications for Purchase (index; four week moving average) Starts and Permits (units; millions) Sales (units; millions) Recent Data Paints an Uncertain Outlook for the U.S. Housing Sector

22. 21...But Problems in the U.S. Sub-Prime Mortgage Market Seem Contained Spreads (basis points) Housing Market Delinquencies (percent of total residential loans outstanding)

23. 22 And Household Finances Remain in Good Shape Household Net Assets (ratio to disposable income) Household Liabilities (percent of disposable income) 06: Q4 06: Q4

24. 23 Housing Is The Tail Not The Dog (Percent increase on previous year for foreclosures; percent for unemployment rate; 2006Q4)

25. 24 Critical Challenges for the Global Economy  Coming in for a soft landing?  Bumps in the runway: The U.S. housing market The U.S. housing market Inflation concerns and the oil market Inflation concerns and the oil market Financial risks facing emerging markets Financial risks facing emerging markets  Longer-term Challenges: Unwinding global imbalances Unwinding global imbalances Sustaining global productivity growth Sustaining global productivity growth

26. 25 Inflation Risks Are Down as Headline Inflation Has Moderated (Y/Y percent changes) U.S. (PCE) Euro area (HICP) Japan (CPI) U.S. (PCE) Headline inflationCore inflation Feb. 07

27. 26 Emerging markets Advanced economies World The Elephant in the Room: Rising Levels of Capacity Utilization, Everywhere Output Gap (percent of potential GDP) Non-Fuel Import Prices (December 2005 = 100) Euro area Japan United States

28. 27 U.S. Labor Costs Have Accelerated as Productivity Has Slowed (Non-farm business sector; percent change from four quarters earlier) Unit labor costs Compensation Productivity 1996200004060298

29. 28 Unemployment Rates Are Declining Across the Major Advanced Economies (Percent) United States Japan Euro area 1998 02 06 200004

30. 29 Growth of World Oil Demand and Non-OPEC Supply Are in Better Balance (2002–06)

31. 30 But Global Spare Oil Production Capacity Remains Limited (Millions of barrels a day)

32. 31 Expected Oil Prices Show Continued Potential for a Spike (From futures options; as of April 2 nd 2007; U.S. dollars per barrel)

33. 32 Critical Challenges for the Global Economy  Coming in for a soft landing?  Bumps in the runway: The U.S. housing market The U.S. housing market Inflation concerns and the oil market Inflation concerns and the oil market Financial risks facing emerging markets Financial risks facing emerging markets  Longer-term Challenges: Unwinding global imbalances Unwinding global imbalances Sustaining global productivity growth Sustaining global productivity growth

34. 33 Capital Flows to Emerging Markets Have Been Strong and Spreads Have Continued to Compress 200206030405 EMBI Global Composite (basis points) Emerging Market Financing (billions of U.S. dollars)

35. 34 Emerging Market Corrections Are Getting Smaller (Percent)

36. 35 FDI Flows to the public sector Flows to the private sector excl. FDI But Is It Too Good To Be True? (Billions of U.S. dollars) FDI Flows to the public sector Flows to the private sector excl. FDI Capital Flows – All Regions Emerging Europe and CIS

37. 36 Financial Flows to Emerging Markets (left scale) Industrial Country Liquidity Index 1 (advanced one year; right scale) If Liquidity Conditions Tighten, Will Capital Flows to Emerging Markets Slow? (Billions of U.S. dollars) 1 Computed as the change in base money (measured in U.S. dollars).

38. 37 Large Current Account Deficits May Be A Source Of Vulnerability (Emerging market country current accounts in 2006; percent of GDP)

39. 38 Inward Capital Flows to India and China Are Also Surging (Billions of U.S. dollars) India Emerging Asia excluding China and India China Emerging Asia

40. 39 Critical Challenges for the Global Economy  Coming in for a soft landing?  Bumps in the runway: The U.S. housing market The U.S. housing market Inflation concerns and the oil market Inflation concerns and the oil market Financial risks facing emerging markets Financial risks facing emerging markets  Longer-term Challenges: Unwinding global imbalances Unwinding global imbalances Sustaining global productivity growth Sustaining global productivity growth

41. 40 China Saudi Arabia Euro Area Global Imbalances Have Widened (Percent of GDP) Oil trade Net income Non-oil trade Oil trade Net income Non-oil trade United States Current account Non-oil trade Oil trade Net income Current account Oil trade Net income Non-oil trade Current account

42. 41 U.S. Dollar Has Depreciated, But No Real Appreciation in Key Surplus Countries YenRenminbi EuroU.S. dollar (2000=100)

43. 42 China Saudi Arabia Euro Area Global Imbalances Are Likely to Remain Large (Percent of GDP) Oil tradeNet income Non-oil trade Oil trade Net income Non-oil trade United States Current account Non-oil trade Oil trade Net income Current account Oil trade Net income Non-oil trade Current account

44. 43 Net Foreign Assets (Percent of world GDP) United States Japan euro area Oil Exporters Emerging Asia

45. 44 Foreign official sector Meeting U.S. Financing Needs (Four-quarter moving average; percent of GDP) Foreign private sector

46. 45 Adjustment of Global Imbalances— How Could India Be Affected?  Smooth unwinding led by rebalancing of domestic demand remains the most likely outcome  Potential for “disorderly adjustment”— rapid movement in exchange rates worldwide, volatile financial conditions  Demand rebalancing in the United States could imply a prolonged period of sub-par global growth  Risk of rising protectionist pressures

47. 46 Critical Challenges for the Global Economy  Coming in for a soft landing?  Bumps in the runway: The U.S. housing market The U.S. housing market Inflation concerns and the oil market Inflation concerns and the oil market Financial risks facing emerging markets Financial risks facing emerging markets  Longer-term Challenges: Unwinding global imbalances Unwinding global imbalances Sustaining global productivity growth Sustaining global productivity growth

48. 47 Trend, 1970–2005 World GDP Growth Remains at the Fastest Sustained Pace Since the Early 1970s (Annual percent change)

49. 48 Global Productivity Has Accelerated Led by Emerging Market Countries (Annual percent change; three-year moving average)

50. 49 And China, India, and Emerging Europe Have Been in Front (Annual percent increase; three-year moving average) 1 Excludes China and India.

51. 50 Sources of Growth in Labor Productivity (Percentage points, per year) Global, 1970–presentAsia, Since Growth Takeoff

52. 51 Productivity Growth Has Been Particularly Strong in Industry (Annual percent change) Global, 1980–2004 Asia, Since Growth Takeoff

53. 52 Asia, Since Growth Takeoff: Contribution to Labor Productivity Growth Differential with the United States (Percentage points per year)

54. 53 Asian Industry Is Catching Up—But What About Services and Agriculture? (Percent of U.S. productivity levels; in PPP-terms)

55. 54 Sectoral Productivity Growth Since Takeoff (Annual percent change; decades on x-axis) Agriculture IndustryServices Japan NIEs ASEAN-4 China India Japan ASEAN-4 NIEs China India Japan NIEs ASEAN-4 India China

56. 55 Note: High growth economies = avg. GDP growth >7% 1980–2006 Trade/GDP: World and High Growth Countries (Percent)

57. 56 Sustaining Global Productivity Growth  Domestic market reforms can help to sustain rapid productivity growth in emerging market and developing countries  Further steps to remove trade barriers— both unilateral and multilateral—are also crucial  But greater attention must be paid both in advanced and developing countries to make sure that the fruits of globalization are well distributed

58. 57  Notwithstanding recent volatility and U.S. slowdown, continued robust global growth still looks the most likely outcome.  Policy makers and financial markets around the world need to be ready for surprises.  Take advantage of good times to tackle structural impediments to sustained growth. In Conclusion:

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60. 59 Increasing Trade Integration Has Quadrupled the Effective Global Labor Supply (Index, 1980 = 100) Global Labor Supply Export-Weighted Labor Force by Region 1 1 National labor forces scaled by export-to-GDP ratios.

61. 60 Emerging Market and Developing Countries Set for Continued Expansion (Percent change)

62. 61 Global Savings, Investment, and Current Accounts (Percent of world GDP)

63. 62 Emerging Asia: Balance of Payments and Reserve Accumulation 1 (Percent of GDP) 1 Excludes Hong Kong SAR and Singapore.

64. 63 Savings and Investment in Asia (Percent of each subregion’s GDP) Savings Investment IndiaOther Emerging Markets ChinaEast Asia (excl. China) Current account (right scale) Savings Investment Current account (right scale) Savings Investment Current account (right scale) Savings Current account (right scale) Investment

65. 64 China: GDP and Fixed Asset Investment (Y/Y percent change) Fixed Asset Investment (6-month m.a.; right scale) Real GDP Growth (left scale)

66. 65 Exchange Rate Depreciation Helps to Smooth the Impact of Current Account Adjustment Total Change in REER (percent) Average Change in GDP Growth (percent change)

67. 66 Advanced Economies: Total Change in Real Effective Exchange Rate and Average Change in GDP Growth During Deficit Reversals Greece: 1990 Germany: 1965 Japan: 1974 Canada: 1981 Austria: 1977 New Zealand: 1974 United States: 1987 Finland: 1991 Canada: 1993

68. 67 Advanced Economies: Change in Structural Fiscal Balance During Deficit Reversals (Medians across the two groups of episodes; percent of potential GDP)

69. 68 Episodes of Surplus Reversals in Emerging Markets Hong Kong SAR: 1975 South Africa: 1962 Korea: 1988 Argentina: 2002

70. 69 Emerging Markets: Key Indicators During Surplus Reversals (Medians across episodes) Real GDP Growth (annual percent change) Real Effective Exchange Rate (index, 100 at t = 0) Real Exports (annual percent change) Real Imports (annual percent change)

71. 70 Current cycle Mid-cycle pauses Recessions But the Labor Market Remains Relatively Strong (Change from a quarter ago in nonfarm payrolls)

72. 71 The Trade Channel in Action (U.S. real import growth in percent)

73. 72 Labor Productivity and Employment in the Euro Area are Both Growing (Y/Y percent change)

74. 73 Growth in Advanced Countries Should Ease to Be Broadly in Line with Potential (Percent change)

75. 74 Metals Beverages Energy Food Agricultural Raw Materials Rising Commodity Prices Have Been An Important Support (2002:Q1 = 100)

76. 75 Sources of Growth in Output Per Capita (Percentage points, per year) Global, 1970–presentAsia, Since Growth Takeoff

77. 76 China: Marginal Revenue Product of Capital by Ownership Relative to Domestic Firms (Percent)

78. 77 And 2006 Looks Worse Than 1996 (Emerging market country current accounts in 1996 and 2006; percent of GDP) 19962006

79. 78 Labor Compensation Has Grown Robustly in Advanced and Emerging Countries Emerging Asia: Manufacturing Wages (percent of U.S.; constant PPP) Advanced Economies: Labor Compensation (index, 1980 = 100; weighted)

80. 79 But the Share of Income Accruing to Labor Has Declined Especially in Europe (Advanced economies; income share of labor by country groups; percent of GDP)

81. 80 Technology Had a Bigger Impact on Labor Shares than Globalization (Advanced economies; annual percentage points) Decomposing Changes in the Labor Share Change in the labor share Contribution of technological change Contribution of labor market policies Decomposing the Contribution of Labor Globalization Contribution of labor globalization Contribution of trade prices Contribution of offshoring Contribution of immigration share Contribution of labor globalization

82. 81 Labor Market Reforms Can Help Support the Labor Share (Decomposing changes in the labor share; annual percentage points) Change in the labor share Contribution of technological change Contribution of labor globalization Contribution of labor market policies