Fearless forecast: Brace yourselves for the mega 2-year Singapore recession

Emerging Asia Hit: Small and open emerging Asian economies with extensive trade links to the US and China are highly vulnerable to a US “double-dip” scenario. With total US trade equivalent to around 20% of GDP, Singapore, the smallest of the emerging Asian economies, would experience the largest cumulative negative shock to GDP of 4.1pp from 2011 to 2013.

Renewed Recession Risk: Data revisions and a raft of weak economic indicators prompted Fitch Ratings to downgrade its forecasts for US growth to 1.8% in 2011 from 2.6% and 2.3% in 2012 from 2.8%. With the emergence of consumer retrenchment in the context of weak labour and housing markets, and a re-intensification of financial market stress related to the euro area crisis, the chance of the US tipping back into recession has increased.

Scenario Considers Impact: Although a “double-dip” recession in the US is not Fitch’s base case, the agency has simulated the effects of this scenario using an economic modelling tool from Oxford Economics (OE). In the simulation, US growth falls to 1% in 2011, negative 0.6% in 2012, and 1.5% in 2013.

Direct Effect Through Trade: The stress test focuses on the direct effect of a US slowdown through trade channels, and does not seek to quantify second-round effects resulting from heightened risk aversion. Therefore, stress test results reflect the minimum likely impact of a US recession on the global economy. The policy response function in the model is also constrained for major advanced economies (MAEs), with interest rates already low and fiscal policy constrained by higher post-crisis debt.

Growth Deceleration, Oil-Price Drop: The impact of the scenario on the world economy is material. Cumulative GDP over 2011-2013 would be a minimum of 2.1 percentage points (pp) lower compared with Fitch’s baseline scenario, with GDP growth 0.3pp lower in 2011, 1.2pp lower in 2012, and 0.7pp lower in 2013. At the same time, a contraction in global oil demand would lead to a decline in oil prices to around USD90/barrel in 2012 and USD85/barrel in 2013, against the baseline projection of USD100/barrel for 2012 and 2013.

Neighbours Most Vulnerable: Mexico and Canada would be severely affected by slower US growth. From 2011 to 2013, the output loss compared with base case estimates is 4.3pp in Mexico and 3.2pp in Canada. This compares to a cumulative US output loss of 4.9pp against the base case.

Growth in China Slows: In China, GDP would be 2.7pp lower on a cumulative basis (2011- 2013) compared with the Fitch base case, pulling China’s real GDP growth to the below- potential level of 7% in 2012 and 2013, with repercussions extending to the rest of the world.

Other Regions Follow Suit: In central and eastern Europe, growth would weaken mainly as a result of slower euro area growth and heightened global risk aversion, while the Middle East and Africa are adversely affected by the decline in oil and other commodity prices. Latin American economies (most notably Mexico, Central America, and the Carribean) would suffer from deteriorating US trade, and lower tourism and remittances.

Risk for Advanced Economies: On a cumulative basis (2011-2013), the euro area, UK, and Japan slow by 1.6 pp, 0.7 pp and 0.9 pp against the baseline scenario, respectively. But the full effect on MAEs may well be larger due to second-round effects including through inter-dependent financial sectors. With Fitch’s baseline growth projections at below 2% for the euro area and UK in 2011 and 2012, and at 0.5% for Japan in 2011, the risk of a US downside scenario tipping the MAEs into recessions is not negligible.