The world economic recovery in 2010 is fragile with the biggest risk to the recovery in developed economies battling soaring government debt levels and sovereign risk, raising the possibility of a “double-dip” recession.

A period of austerity is expected across advanced economies: some governments have already introduced austerity measures while others are expected to do so from 2011. These will weigh significantly on employment, incomes and consumer spending potential.

  • Advanced economies have the highest government debt levels in the world, which the global financial crisis of 2008-2009 exacerbated as governments introduced unprecedented stimulus packages, while tax revenues declined amid rising unemployment and business bankruptcies. Japan’s public debt leads the global rankings at 183.8% of GDP in 2009. Government austerity measures will include a combination of spending cuts and tax rises. Reducing government debt is more urgent in advanced economies because they also face population ageing, which will exert pressure onto public finances and pension systems;
  • In May 2010, Greece had to be bailed out of a sovereign debt crisis by the EU/IMF, which spread fears of contagion throughout the eurozone, particularly in the weaker economies known as the PIIGS (Portugal, Ireland, Italy, Greece and Spain). The emirate of Dubai also faced a debt crisis in 2009 while Argentina is an example of a country that defaulted in 2001-2002 causing capital flight and severe damage to the business environment. Perceptions of sovereign risk (the danger of a government being unable to meet its financial commitments) affect the cost at which governments can borrow as well as investor confidence overall;
  • The UK has one of the highest general government budget deficits of advanced economies at an estimated 11.5% of GDP in 2010. The new coalition government unveiled an emergency budget in June 2010 including a 2.5 percentage point increase in VAT from January 2011. Spain has implemented public sector pay cuts of 5.0% from June 2010 as well as ending a €2,500 payment to new mothers while the Greek government aims to reduce its budget deficit from 13.6% of GDP to 8.1% in 2010 including a public sector pay freeze until 2014. Meanwhile, Portugal introduced a crisis tax from May 2010 in addition to raising VAT. In Romania, public sector salaries have been cut by 25% and pensions by 15%;
  • The business environment will be at risk of industrial strike action while consumer-facing businesses will be hit as consumers continue to cut spending amid an environment of uncertainty. There is likely to be a significant reduction of spending on luxury goods and non-essentials into the medium-term. Furthermore, record low interest rates in many countries are not expected to remain at such levels despite low inflation expectations overall, which will squeeze consumer incomes further. The challenge for many governments will be to cut debt while avoiding a “double-dip” recession;
  • Global real GDP growth of 4.6% is expected in 2010. Emerging economies are leading the world economic recovery with generally more dynamic growth and lower debt and welfare burdens. Investors are looking for safe havens, which may increase the attractiveness of some emerging economies with steady growth prospects and an expanding middle class. However, this will exacerbate the divide in the global economy between advanced economies and emerging regions, with a continuing shift towards developing markets. Higher interest rates still pose a risk to emerging market debt while global export demand will be hit by austerity in many major advanced economies. Advanced economies will look towards externally-led growth while emerging markets will try and increase domestic demand.

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