The Crisis is not over—just reaching the next stage

The fundamental reasons for the crisis—mainly excessive credit and global imbalances—have not been addressed

Governments and Central banks will come up with even more aggressive measures

Emerging Markets (including India) seem to be decoupled—but risks remain

Like all crisis this one offers huge opportunities for companies and countries to improve their competitive position

Global Economic Outlook: Opportunities and Challenges for Indian Economy in the Unfolding Global Crisis

September 2010

Just When You Thought That It Was Safe To Get Back In The Water...

Very quick recovery of emerging markets signaling the end of the great recession...

• Recovery of India albeit only small governmental intervention/stimulus

• India with strong domestic market• No Double-Dip expected

... but what about the rest of the world?

... especially India and China with positive

outlook ...

... especially India and China with positive

outlook ...Solid recovery for GDP growth

of emerging markets ...Solid recovery for GDP growth

of emerging markets ...

• India's inflation at ~10%• Slow pace of business reforms

– India only 133th on Doing-Business Ranking (after Yemen, Nigeria, ...)

– Drop in foreign direct investments

... even as the risks remain

... even as the risks remain

-12-10

-8-6-4

-202

468

1012

real GDP growth (%)

Q1 2008

Q1 2009

Q1 2010

China

Russia

India

Brazil

One year ago: On the brink of Great Depression II

%%

Months since peakMonths since peak

%%

Months since peakMonths since peak

%%

Months since peakMonths since peak

April 2008 = 100April 2008 = 100June 1929 = 100June 1929 = 100

World industrial output, 2009 versus

then

World industrial output, 2009 versus

then

World stock markets, 2009

versus then

World stock markets, 2009

versus then

Volume of world trade,

2009 versus then

Volume of world trade,

2009 versus then

"We are in the midst of a once-in-a-century credit tsunami." (Alan Greenspan)

Source: Barry Eichengreen and Kevin H O'Rourke, "A Tale of Two Depressions", April 2009Source: Barry Eichengreen and Kevin H O'Rourke, "A Tale of Two Depressions", April 2009

30

40

50

60

70

80

90

100

110

0 10 20 30 40 50

60

70

80

90

100

110

0 10 20 30 40 50

60

65

70

75

80

85

90

95

100

0 10 20 30 40 50

Avoided thanks to unprecedented stimulus

In June 2009 bailout and stimulus peakedat $13.2T

1. U.S. Department of Housing and Urban Development Note: Consists of government investments, loans, loan programs, debt guarantees, and securities purchasesSource: Bloomberg estimate, December 23, 2009

1. U.S. Department of Housing and Urban Development Note: Consists of government investments, loans, loan programs, debt guarantees, and securities purchasesSource: Bloomberg estimate, December 23, 2009

Total US government bailout exposure is $8.2T (Dec. 2009)

Total US government bailout exposure is $8.2T (Dec. 2009)

Fannie, Freddie, AIG, Bear Stearns Treasury Troubled Asset Relief Program

Fiscal stimulus

Federal Deposit Insurance Corp. bank guarantees Fed Mortgage-backed- Securities Program

HUD1

Fed Asset-backed Debt Program (TALF)

Other Fed lending and government commitments

= $100 billion

$8.2 trillion total(as of Dec. 23, 2009)

Seems to work—really?

Note: Five statements made in February 2010, one made in December 2009 (Börsenzeitung)Source: Press researchNote: Five statements made in February 2010, one made in December 2009 (Börsenzeitung)Source: Press research

Tuesday's figures…mean that the UK is now out of recession.“The recession is

over.“

Yes, the recession is over.“

The recession is over.“

Is the global recession really over?Absolutely!“

I believe that the worst is over.“

Problem No. 1: Start feeding the pig

US consumption share of world GDP 17.5%—China's entire GDP merely 8.5% of global GDP1

1. Year end 2009 when using average market exchange ratesSource: Thomson Financial Datastream; Federal Reserve; Bureau of Economic Analysis; Barron's; Elliot Wave International, The Gabelli Mathers Fund, Financial Times, BCG estimate

1. Year end 2009 when using average market exchange ratesSource: Thomson Financial Datastream; Federal Reserve; Bureau of Economic Analysis; Barron's; Elliot Wave International, The Gabelli Mathers Fund, Financial Times, BCG estimate

Deleveraging need

Deleveraging needUS household debt/GDP (%)US household debt/GDP (%)

0

10

20

30

40

50

60

70

80

90

100

Reverting US household debt to long-term averages means decrease of ~ $2.0–5.5T in debt

Currently ~ 95% of GDP

56% average

1952–2008

69% average

1980–2008

80% of GDP

– $5,500B

– $3,600B

– $2,000B

$13,500B

1952 1960 1970 1980 1990 2000 2009

Problem No. 2: Banks—the new healthy

Source: FT Lex Column, 11 June 2009; NY Times; Wall Street Journal; FT; FTD; BIS, ECBSource: FT Lex Column, 11 June 2009; NY Times; Wall Street Journal; FT; FTD; BIS, ECB

Facts and figuresFacts and figures• Common equity to total assets: 4% • Tier 1 capital to RWA: 7%• Two-thirds of outstanding loans are to consumers, mortgages accounting for 25%, credit cards for 10%• NPL ratio of 12% for mortgages, increased by almost 250 bp versus previous quarter• Off-balance sheet risk

– $93B exposure to off-balance- sheet investment vehicles, eclipsing common equity

– "Level-three" assets—cannot be valued using observable inputs—are equivalent to 126% of tangible common equity

One year later …

ECB estimates writedown volume of €195B for eurozone banks

Worst-case estimates expect further writedowns of €800B for German banks only

BIS warns of zombie banks ever-greening bad loans instead of writing them off

BIS estimates high refinancing needs with bonds worth $3T maturing in next 2 yrs and 60% of long-term debt due over next 3 yrs

BIS doubts sustainability of current bank profits

Problem No. 3: Deleveraging is deflationary

• High debt levels and fundamental deleveraging needs

• Excess capacity and supply of goods

• Low growth of broad money aggregates

• Global imbalances requiring real exchange rate adjustments in deficit countries via lower inflation levels than in surplus countries

• Lower cross-border capital flows• Austerity programs: lower unit

labor costs and demand• Potential slowdown in China would

further drag demand• Limited measures to stimulate

aggregate demand

Deflationary risk levers

• Government bailouts, fiscal stimuli

• Expansive monetary policy• Historically low interest rates• Surging commodity prices• Depreciation of currency leading

to higher import prices• Lack of credible exit strategies

by monetary and fiscal authorities

• Push to inflate away high debt levels

Inflationary risk levers

Source: BCG analysisSource: BCG analysis

Problem No. 4: Rebalancing of trade flows

1. Canada, Kuwait, Norway, Russia, Saudi-Arabia, United Arab EmiratesNote: Changes in deficit countries' current-account balances are allocated to surplus countries in proportion to their GDP; All figures represent current-account balances relative to GDP (2008 data)Source: Economist Intelligence Unit; International Monetary Fund; BCG analysis

1. Canada, Kuwait, Norway, Russia, Saudi-Arabia, United Arab EmiratesNote: Changes in deficit countries' current-account balances are allocated to surplus countries in proportion to their GDP; All figures represent current-account balances relative to GDP (2008 data)Source: Economist Intelligence Unit; International Monetary Fund; BCG analysis

Current-account balances of deficit

countries (%)

Current-account balances of deficit

countries (%)

Alternative scenarios for rebalancing

of deficit countries

Alternative scenarios for rebalancing

of deficit countries ImplicationsImplications

Japan's current-account surplus turns negative

Japan's current-account surplus turns negativeJapan's and Germany's current-account surpluses turn negative

Japan's and Germany's current-account surpluses turn negativeAll surplus countries' current-account balances turn negative

All surplus countries' current-account balances turn negative

Current-account balances of

surplus countries (%)

Current-account balances of

surplus countries (%)

-14-10

-5 -5-2

-20

-10

0

10

63

10

0

5

10

15

Oil ex-porters

Slow rebalancing(rate of inflation only)

Moderately paced rebalancing(2% current-account surplus plus inflation)

Quick rebalancing(4% current-account surplus plus inflation)

0 4 1

-3

4

2 2

-2 -5

2

4

-1-4 -7

-1

2

1

3

Oil exportersDeficit countries

Problem No. 5: Not addressing the problem

Facility of at least €2T required to cover any conceivable combination of EU defaults1

€750B debt stabilization fund on top of rescue package for Greece

€60B exceptional financing

€440B SPV

€250B IMF

ECB ready to purchase public and private debt

EU bailout spurs moral hazard fears.“

Call it the Troubled Conscience Relief Program.

“ If there was not a euro crisis before the weekend bailout plan, there is now.

“1. Willem Buiter1. Willem Buiter

Implication: Executives skeptical about EMUAlready before the recent turmoil

Source: BCG survey "Companies in the Downturn: Expectations, Actions and Preparedness", March 2010, n = 440Source: BCG survey "Companies in the Downturn: Expectations, Actions and Preparedness", March 2010, n = 440

19 16 1322 19 19 26 21

28 27 28

29 3622

2825

40 40 4636 34

45

3837

11 16 9 10 10 14 89

2 5 2 9

0

10

20

30

40

50

60

70

80

90

100

Global

Expectations about EMU breakupExpectations about EMU breakup%%

EMU will not be harmedSplit into stronger and weaker partsExit of weaker countries

EMU breakupNo opinion

Problem No. 6: Reindustrialization—easier said than done

"It's difficult to find people for jobs that require math skills and the ability to read technical

blueprints."2

The US needs to reindustrialize ...The US needs to reindustrialize ...

... but lacks the required skills

... but lacks the required skills

43

23 2118

13

0

10

20

30

40

50

Over-all

Manufacturing output (as % of GDP)Manufacturing output (as % of GDP)

63

63

45

31

27

3

32

0 25 50 75

Respondents who see moderate to seriousshortage across all skills by industry (%)Respondents who see moderate to seriousshortage across all skills by industry (%)

1. Based on a survey of 779 individuals 2. Owner of motor manufacturer quoted in Financial TimesSource: United Nations, Deloitte, Oracle and Manufacturing Institute1. Based on a survey of 779 individuals 2. Owner of motor manufacturer quoted in Financial TimesSource: United Nations, Deloitte, Oracle and Manufacturing Institute

Aerospace & defenseAerospace & defense

Life sciences & medical devicesLife sciences & medical devices

Energy & resourcesEnergy & resources

Industrial productsIndustrial products

Consumer productsConsumer products

AutomotiveAutomotive

All otherAll other

Protecting climate or industries?

Source: Press researchSource: Press research

New US law on maximum fuel consumption

New US law on maximum fuel consumption

• Calculation of thresholds based on wheel base and track width

• Formulae are calibrated in such a way that large US manufacturers exactly meet the guidelines

• Porsche achieved special approval until 2015

• By then Porsche needs to increase cruising range from 27 to 41.1 miles per gallon

This is close to economic warfare!Michael Macht, Porsche CEO

“

Maastrichtcriteria

Outstanding government debt (% GDP)

Deficit 2010 (% GDP)

Problem No. 7: Government credit not unlimited

More dangerous

Deficit too high

Debt too high

Government gross financial liabilities (US$2,500B)

Public-sector debt and deficitsPublic-sector debt and deficits

Japan

0

30

60

90

120

150

180

210

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Note: All data are forecasts for 2010. They include the accounts of central, state, and local governments, social security funds; and non-market, non-profit institutions controlled by and primarily financed by government unitsSource: OECD

Note: All data are forecasts for 2010. They include the accounts of central, state, and local governments, social security funds; and non-market, non-profit institutions controlled by and primarily financed by government unitsSource: OECD

Euro-zone

What are the options?

FrequencyEffectiveness

Postdeleveraging growth

AusterityAusterity Rigorous, simultaneous

austerity programs could reignite recession

High inflation

High inflation

Requires weak or non- independent central banks - unlikely option for Eurozone

Massive default

Massive default

Usually follows a currency crisis

Likely to trigger a domino effect given the inter-connectedness of eurozone

Rapid growth

Rapid growth

Impossible to achieve under current circumstances

Will it work?

Note: Based on episodes of deleveraging since 1950Note: Based on episodes of deleveraging since 1950

US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.

“

Niall Ferguson

Problem No. 8: Demographics

1. Ratio between population of age 65+ and working-age population ( between 15 and 64 years) 2. In percentage points of GDP; age-related spending refers to public pensions and health careSource: United Nations Population Perspectives, "The future of public debt: prospects and implications", BIS Working Paper, March 2010

1. Ratio between population of age 65+ and working-age population ( between 15 and 64 years) 2. In percentage points of GDP; age-related spending refers to public pensions and health careSource: United Nations Population Perspectives, "The future of public debt: prospects and implications", BIS Working Paper, March 2010

Spending on promised retirement/healthcare for elderly will increase but there will be fewer

workers to pay for it

Rapidly aging populations in Western economies ...

Rapidly aging populations in Western economies ...

... will lead to rising and largely unfunded age-

related spending

... will lead to rising and largely unfunded age-

related spending

0,0

0,1

0,2

0,3

0,4

0,5

0,6

0,7

0,8

1970 1990 2010 2030 2050

Old-age population1 Old-age population1

13.5

7.1

3.12.7

5.94.5

1.4

8.1

0

5

10

15

Increase in age-related governmentexpenditure 2011–20502 Increase in age-related governmentexpenditure 2011–20502

JapanJapanUKUKGreeceGreeceItalyItalySpainSpain

GermanyGermanyUSAUSAFranceFrance

1,229639

1,107567

1,633778

1,162662

1,684959

735389PIIGS

Public debt per capita of total population (K$)

Public debt per capita of total population (K$)

Public debt per capita of working age population (K$)

Public debt per capita of working age population (K$)

Implication: By 2040 public debt burden unsustainable

Note: All data based on BIS baseline scenario. All forecasts assume a constant fertility rateSource: BIS; UN; EIU; BCG analysisNote: All data based on BIS baseline scenario. All forecasts assume a constant fertility rateSource: BIS; UN; EIU; BCG analysis

Problem No. 9: It is close to impossible to stopBIS: "Drastic measures are necesary."Public debt/GDP projections 1980–2040Public debt/GDP projections 1980–2040

1980 2000 2020 2040

Gradual adjustment, age related spend held constantBaseline scenario

600

400

200

Source: "The future of public debt: prospects and implications", BIS Working Paper, March 2010Source: "The future of public debt: prospects and implications", BIS Working Paper, March 2010

Implication: "We need a Plan B to curb the debt headwinds."Deleveraging has slowly begun

Increase public and private saving rates

Increase potential growth through structural reforms

Reduce debt levels through bankruptcies or negotiated workouts

Inflate debt away

!

!

!

!

US public debt continues to growUS public debt continues to grow

0%

50%

100%

150%

200%

250%

300%

350%

400%

% of nominal GDP% of nominal GDP

Financial sectorFinancial sectorPublic sectorPublic sectorHouseholdsHouseholdsNon-financial businessNon-financial businessTotalTotal

Q11952Q1

1952Q1

2010Q1

2010

Beginning ofthe crisis

-10

-5

0

5

-10

-5

0

5

-10

-5

0

5

-10

-5

0

5

Increase in real GDP after 1 year (%)

Problem No. 10: Empirical evidencenot encouraging

Quarters (#)

2.1× 1.6×

Change in real GDP (%)Peak to trough)

1.4x

2.1×

Quarters to hitprevious peak (#)

Crisis associated with financial stress and highly synchronised¹ All crises

1. Highly synchronized: 10 or more of the 21 examined advanced economies in recession at the same timeSource: IMF World Economic Outlook, April 20091. Highly synchronized: 10 or more of the 21 examined advanced economies in recession at the same timeSource: IMF World Economic Outlook, April 2009

Global recessions preceded by financial crises are longer,

deeper ...... and slower to recovery

Implication: Only emerging markets return to pre-crisis trend

1. Post-crisis GDP / GDP calculated as an extrapolation of pre-crisis trend growth 2. Cushioned by positive output gaps in 2008 3. CAGR Note: Trend calculated as a various-length OLS regression spanning at least ten years before the crisisSource: Economist Intelligence Unit; Bloomberg; IMF; OECD; BCG analysis

1. Post-crisis GDP / GDP calculated as an extrapolation of pre-crisis trend growth 2. Cushioned by positive output gaps in 2008 3. CAGR Note: Trend calculated as a various-length OLS regression spanning at least ten years before the crisisSource: Economist Intelligence Unit; Bloomberg; IMF; OECD; BCG analysis

1.61.61.61.82.6

1.92.6

3.3

7.3

9.5

0.60.70.71.01.01.11.1

3.1

6.4

7.7

01

23

456

78

910

Euro-zone

Simulation of future growth based on IMF researchSimulation of future growth based on IMF researchOutput gap (%)1 Output gap (%)1

pre-crisistrend growth3

growth2010–20153

Near pre-crisis growth Below pre-crisis growth

-4.32 -2.52 +2.12 -12.8 -10.4 -16.7 -8.7 -11.7 -13.9 -15.7

Executives do not believe in a quick recovery

Note: Because of rounding, numbers may not add to 100Source: BCG survey "Companies in the Downturn: Expectations, Actions, and Preparedness", March 2010 N = 440Note: Because of rounding, numbers may not add to 100Source: BCG survey "Companies in the Downturn: Expectations, Actions, and Preparedness", March 2010 N = 440

52 45 4634

64 57 52

72

46 3

2

33

3

434 39 3953

2425 33

2110 10 13 10 9 14 12

4

0

10

20

30

40

50

60

70

80

90

100

Global

Survey respondents' forecast for the shape of the recoverySurvey respondents' forecast for the shape of the recovery%%

L shapeW shapeU shapeV shape

Emerging markets back to normal

Source: IMF World Economic Outlook, April 2010Source: IMF World Economic Outlook, April 2010

Positive GDP growth of emerging economies

cushioned the drop in world GDP

Positive GDP growth of emerging economies

cushioned the drop in world GDP

Forecasts for 2010 show strong growth in emerging

economies

Forecasts for 2010 show strong growth in emerging

economies

10.59.4

7.1

4.3

6.8

0

5

10

15Real annual GDP growth (%)Real annual GDP growth (%)

-6

-4

-2

0

2

4

6

8

10

2000 2002 2004 2006 2008 2010

Quarterly change from previous year (%)Quarterly change from previous year (%)

WorldWorldAdvancedAdvancedEmergingEmerging

Emer-ging &

developingcountries

Emer-ging &

developingcountries

Why worry?

The old world does still matter• 61% of global GDP in 2009• China (13%) and India (5%) gaining importance—but it will take

time• Key area for exports from the emerging markets

Protectionism is a real threat for China and therefore Asia

Inflation would affect Asia significantly: food and commodities

Investments in developed economies safe?

China: the next bubble waiting to burst?

?

!

?

What India should do...

Keeping a tight eye on inflation, especially food (social unrest), andpossible bubbles in real estate, micro finance, etc.

Economic reforms needed to attract long term Foreign DirectInvestment with sustainable impact on Indian real economy

• India only ranks 133th on World Banks "Doing-Business-Ranking" (behind Yemen, Nigeria, Bangladesh, ...)

• Foreign direct investment decreased in H1 2010 by 18%

Corruption seen as major brake on growth and suffering reputation• Extra 3% GDP growth expected by improving corruption from current level (similar

to Rwanda) to level of South Africa

Continue to master low cost models in various industries (cars, telco ...)

Strengthening exports, especially to Asia, to limit trade deficit due tofuture rise in domestic demand

The years ahead?

Fact....or fiction?