2Economic Research Global Data Watch August 10, 2018 JPMorgan Chase Bank NA Bruce Kasman(1-212) 834-5515 bruce.c.kasman@jpmorgan David Hensley(1-212) 834-5516 david.hensley@jpmorgan Joseph Lupton(1-212) 834-5735 joseph.p.lupton@jpmorgan consecutive robust US gain (0.7% m/m), and a modest decel- eration inChina (0.3% m/m)—our forecast for 3.5% ar globalIP growth this quarter will be tracking. For manufacturing sector strength to be sustained, our forecastof “constructive regional convergence” also needs to material- ize. We expect the US growth engine to remain strong thisquarter and be complemented by a rebound in Euro area de- mand. This powerful DM locomotive should then lift EMgrowth later this year on the back of an anticipated pickup inDM import growth and Chinese policy stimulus that offsetsthe drag from higher US tariffs (Figure 2). Here the news flowprovides less confidence, as last week’s disappointing 2Q18Euro area GDP report was followed this week by downbeatJune industry readings from Germany. Although retail spend- ing has rebounded and the latest bank survey shows creditchannels supportive, we have yet to see the evidence neededto support our forecast that Euro area domestic final demandis rebounding this quarter.A mixed bag on EM growth It is too early to look for a pickup in EM GDP growth, whichfell to an estimated sub-par 4.4% ar last quarter. China is stillslowing and the effects of policy stimulus should build slow- ly. In addition, we expect a number of countries where finan- cial conditions tightened around domestic political develop- ments (including Brazil, Mexico, Argentina, and Turkey) todeliver sub-par growth this quarter.There is, however, a significant group of EM economies thatare well-positioned to strengthen. The list includes EM Asiaex. China, Central Europe, and smaller Latin American econ- omies. The latest news on these economies has been mixed. InEMAX, an anticipated growth boost from DM demand and a2018 mobile device cycle has yet to materialize. Although theKorean semiconductor sector appears to be picking up, thefollow-through in other Asian economies is not yet apparent.In Central Europe, next week’s 2Q18 GDP readings are likelyto remain strong. But with temporary supports for domesticdemand now fading (evidenced by the slowdown in construc- tion activity) sustaining above-trend growth will require ourEuro area forecast to materialize. In this regard, the region’sJuly PMI reports were disappointing. Aggressive policy action needed in Turkey The more significant EM concern relates to the risk that re- gional underperformance becomes a source of disruptionthrough swings in capital flowsand currencies. Theimmedi- ate focus is on Russia and Turkey, where the introduction ofnew US sanctions and significant currency depreciation arealready translating into a marked tightening of financial con- ditions. However, it would be wrong to ignore other loomingrisks related to Brazil’s election, Mexico’s NAFTA negotia- tions, and India, where domestic and external imbalances arerisingin advance of next year’s election. The situation in Turkey has turned dire with the currency infree-fall in recent days. While the immediate trigger has beenthe intensification of tensions with the US, including threatsofsanctions and tariffs, the weakening of the currency fun- damentally reflects the delay in adequate policy response tothe deterioration in the fiscal and external accounts and inbank asset quality. An easing in the tensions with the US isperhaps a necessary condition for renewal of market confi- dence, but it is unlikely to be sufficient. Not only is Turkey’scurrent account deficit running at 6% of GDP (1Q18), but it isthe only large EM economy where the private sector runs anegative savings-investment balance. Fiscal consolidation willbe necessary, but the private sector will need to bear much ofthe burden of adjustment. And this, in turn, requires monetaryand credit conditions to be tightened significantly and banks’asset-liability currency mismatchto be addressed adequately.Table 1: Foreign bank claims on Turkey Bank claims, immediate counterparty basis 201020151Q18 Total claims % of GDP19.534.828.9 bn USD164.3292.5264.9 …of which in foreign currency99.9183.7183.0 Share of total (%) Spain*……37.6 France19.425.017.5 UK17.914.88.8 US14.511.78.2 Germany14.69.67.8 Italy3.55.67.7 Japan2.37.46.4 Greece22.417.30.1 Source: BIS, J.P Morgan. *Historical data not shown due to breaks in data series [followingSpanish acquisitions of Turkish banks] The government has promised a set of policy measures tostem the rapid deterioration in financial and economic condi- tions, but these measures will need to be announced soon andbe backed by sufficiently credible fiscal and monetary poli- cies, along with steps to address banking sector problems.Almost all the measures needed will likely result in substan- tially slower growth in the near term but they will go a longway in putting the economy on a more sustainable medium- term path. Many EM countries in the past have tried to avoidthis trade-off by imposing capital controls and many in themarket fear that Turkey might do the same, which could wellbe adding to the capital outflow pressures on the currency.3Economic Research Global Data Watch August 10, 2018 JPMorgan Chase Bank NA Bruce Kasman(1-212) 834-5515 bruce.c.kasman@jpmorgan David Hensley(1-212) 834-5516 david.hensley@jpmorgan Joseph Lupton(1-212) 834-5735 joseph.p.lupton@jpmorgan History suggests that a well-designed set of macro-prudentialmeasures and capital controls do provide added policy spacein such crisis-like situations, but they are not substitutes forthe needed reforms and policy measures. The stock of foreign bank claims on Turkey is substantial,totaling about US$265bn or 30% of GDP(Table 1). Theseforeign liabilities are a particular concern considering theslide in the currency. About 70% of this total is in foreigncurrency, mostly euros and US dollars. European banks lentmost of these funds. Spanish banks account for 38% of totalforeign bank claims while French banks have the next largestexposure.China policy looking for a softlanding Facing headwinds from trade frictions and slowing domesticdemand, China has been unwinding some of its previous poli- cy tightening. Combined with the roughly 5% depreciation inthe trade-weighted currency since mid-June, borrowingrateshave tumbled while fiscal restraintis being tempered. Howev- er, these moves remain limited compared to the 2012 and2015 episodes. Although credit growth has slowed this yearand is running wellbelow the targeted pace, we do not expecta significant roll-back in regulatory tightening and see TSFgrowth running closer to 10%oya growth in July (out nextweek) and through 2H18—an outturn that would be 2%-ptsbelow target. Rather than boosting credit indiscriminately, wesee a compositional shift away from short-term loan and billfinancing toward longer-term lending focused on investment.At the same time, fiscal tightening is being dialed back andlending to local governmentsis increasing to support higherspending. Nevertheless, while local bond issuance acceleratedin July (US$757 billion in July vs. a total US$1,400 billion in1H), our 10.9% of GDP forecast for the full-year augmentedfiscal deficit of is still slightly lower than the 11.1% in 2017. With policy support moving cautiously, we see growth mod- erating to 6.3%ar in 2H18, down 0.5%-pt from 1H18. Nextweek’s activity data for July should support this call. We ex- pect monthly IP and retail sales gains to step down to0.3%m/m, sa and 0.6%,respectively. It is probably too earlyto see the imprint of fiscal policies on fixed asset investment and we look for real estate investment to decelerate through2H18. Japan rebounds though 1H was soft overall Japan’s GDP expanded at a 1.9% ar last quarter following adownward-revised 0.9% contraction in 1Q18. While the re- bound is welcome, it was weaker than our forec