Russia - The Future Will Become Clearer
Russia's adventures and geopolitical positioning in 2014 will have knock-on effects in 2015 as gross domestic product looks set to contract sharply from a stagnant level last year. The Russia central bank predicts a contraction of 4.6%, but it could well be much worse than that, depending on developments throughout 2015.
Absent a policy shift in Ukraine or a rise in crude oil prices, the ruble will remain very susceptible to changes in investor sentiment. Escalation on any front would see a further fall and higher inflation which hit double figures at the end of 2014. The emergency 650-basis-point rate hike from the Russian central bank in December set the precedent for further sizeable increases this year. And if reserve levels diminish more quickly than expected, the next hike could be much larger. Knock-on effects for the European Union should be minimal, as trade relationships are not massive. Banks with large Russian exposures will continue to be hit the worst.
China - Decline in Expectations
Beijing has a challenge in managing expectations this year and setting attainable goals without going through too many contortions to do so. The obstacles ahead are not insignificant, but they can be handled if the government is willing to take the hard steps necessary. This will require Beijing to be more aggressive on several fronts and to accept some unpopular consequences.
The Chinese economy has been slowing since 2010 and will likely post annual gross domestic product growth for 2014 below the official target of 7.5%. The target for 2015 is likely to be 7% but could be as low as 6.5% to account for the weak global trade outlook. Managing the composition of growth will continue to be difficult, balancing public investment in labor-intensive sectors with reforming weaker economic sectors. This suggests reducing overcapacity in economically important industries, which would be politically unpopular but potentially crucial to long-term stability.
The People's Bank of China will have a difficult mission in 2015. It will want to lower lending rates to spur credit, maintain a deposit rate supportive of high savings and allow enough of a spread between those rates to avoid significant strain on bank balance sheets. Through all of this, the bank wants to support investor confidence during a time of potential instability - and it might need more tools to accomplish that.
Most important will be a rigorous monitoring of the financial sector, particularly at the provincial level. There is a possibility that some smaller banks might need to be bailed out or consolidated to maintain overall stability. This would be politically controversial and could shake confidence in the banking sector, but a lack of action could be the first step toward sector-wide contagion.
Japan - Abenomics
While not as exciting as 2013, 2014 was definitely a busy year for Japan and its prime minister. The government implemented the first phase of its consumption tax hike, outlined a wide-ranging but yawn-inspiring structural reform package and massively expanded its already-huge quantitative easing program. Yet in spite of all that activity, the economy still found itself in technical recession, and it is likely to show only 0.9% growth in 2015.
On the policy side, the decision to delay the second phase of the consumption tax will almost certainly result in Japan missing its goal of halving its primary deficit by fiscal year 2015. As a result, Japan finds itself in a negative ratings cycle, with Moody's downgrading the sovereign debt rating one notch and downward movement from Fitch considered imminent. However, Japan has more than 90% of debt held locally and is a net external creditor, so its bond yields are relatively insulated from changes in global investor sentiment. In addition, Bank of Japan purchases of government bonds absorb a substantial fraction of new debt issues.
Japan's trade balance will be a bright spot as lower energy prices provide some relief and exports continue the solid recovery witnessed in the latter portion of 2014. The restart of nuclear reactors, which is very likely this year, would reduce oil imports and have a positive impact on the trade balance. A key concern in the external outlook is the economic prognosis from China, which currently takes 18% of Japanese goods exports; continued weakness in its largest trading partner will weigh on a sustained recovery in exports.
Prime Minister Shinzo Abe's triumph in December elections should provide the firepower needed to push through some of his structural initiatives, especially agricultural reform and membership in the Trans-Pacific Partnership. Abe will probably use some of his renewed clout to pressure companies to raise wages - a key to improving consumption. In addition to measures already announced, the government could also inject additional stimulus into the economy if needed.
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