Expert Zone
Straight from the Specialists
The hazard of second best
By Mohamed A. El-Erian
(The views expressed in this column are the author’s own and do not represent those of Reuters)
NEWPORT BEACH – The international community risks settling for second best on two key issues to be discussed this month at global meetings in Washington, DC: the lingering (if currently somewhat dormant) European debt crisis, and the selection of the World Bank’s next president. It is not too late to change course, but doing so will require the United States and governments in Europe to resist harmful habits, and emerging countries to follow up effectively on recent initiatives.
In the last few days, European leaders, including French President Nicolas Sarkozy and European Central Bank President Mario Draghi, have declared that the worst of the euro zone crisis is over. Others, like French Finance Minister Francois Baroin, have gone even further, claiming that Europe “has done its part,” and that it is now up to other countries to do theirs.
These announcements should come as no surprise. Having experienced prolonged turmoil, the euro zone is currently in a period of relative tranquility. The courageous reform measures implemented by Mario Monti, Italy’s technocratic prime minister, have eased immediate concerns that Greek dislocations might tip other European countries — much bigger and harder to rescue — into insolvency. Europe’s decision last week to bolster its internal financial firewalls has reinforced the resulting positive impact on market sentiment.
But, as important as these steps are, the recent tranquility has been more borrowed than earned. Since December, the ECB has twice deployed long-term refinancing operations, which provide unlimited three-year financing to banks at 1 pct interest. This has given the banking system more time to increase capital and improve asset quality. It has also reduced several governments’ financing costs. What it does not do, and is not meant to do, is resolve Europe’s twin problems of too little growth and too much debt.
If it is not careful, Europe risks falling into the trap of trying to shift responsibility for its problems onto others, rather than building on recent progress. That temptation is partly reflected in efforts to press officials from around the world to agree this month to a major increase in the International Monetary Fund’s resources, with emerging economies footing a significant part of the bill.
What the Euro means for Asia
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The Euro should not exist. In a perfect world (run by economists) the Euro would never have been created. Sadly, however, the world is not perfect — and it is run by politicians. The result is an entirely dysfunctional monetary union.
The Spanish economy has youth unemployment approaching 50 pct. The Greek economy is in its fourth consecutive year of negative GDP growth and will embark on a fifth year of negative growth later in 2012. Euro area countries have to share a common interest rate and a common exchange rate with Germany — where unemployment is at a 20-year low and growth is positive if unspectacular around 2.5 pct. This is an unworkable situation — what Greece needs is very different from what Germany needs.
Will the Euro break up? We must hope not. The consequences would be devastating (a weak country could see its economy halve in size on exit). The social unrest we have today is minor compared to what could take place if the Euro were to fragment. As the Euro was essentially a political creation, it must be political will that keeps it together — and it would be wrong to underestimate that political will.
So what will happen? Because so much rests on political decision making, the path for the Euro area is hard to determine. But it seems highly likely that there will be a recession this year. How bad that recession is depends on what happens to the banking sector. Euro area banks are increasingly reluctant to lend money — and with all the risks that they have been through over the last six months, this is hardly a surprise. Slower bank lending growth will hit some economies particularly hard.
Fiscal austerity is being urged by Germany. In the wake of France’s downgrade (and with the UK outside the Euro and unlikely to ever join) it is Germany’s voice that is loudest in setting the Euro policy agenda. When the slowing credit creation is combined with further fiscal austerity, the consequence is likely to be negative GDP growth. Not all countries will be negative, of course, but Italy, France and Spain all seem likely to see a drop in economic activity.
So why do the convulsions of the Euro area matter to Asia? There are three reasons why Asian companies and investors need to follow the Euro drama.
long on rhetoric, short on detail
austerity and the ECB have brought the euro down in value, enabling more competitive export-led growth and less debt-fueled consumption
this is the riposte to the deluded who said greece, ireland etc should abandon the euro because they couldn’t devalue their currency
eurozone countries have wealth, innovation and a greater sense of solidarity that contradicted the apocalyptical shrieks from the anglo-saxon wasp media
donovan, your article is more lip-service to forex speculator heartbeats than recognition of the eurozone’s resilience, its institutions and wider sphere of influence
when europe sneezes, the world catches a cold
Fallout of recession in euro zone
(The views expressed in this column are the author’s own and do not represent those of Reuters)
It will not be before February that the euro zone GDP numbers are out. The available information so far indicates the economy is already in recession. This will have serious consequences for all countries, including India.
The data for November is disturbing. Unemployment has hit a new peak of 10.3 pct and is possibly the worst in Spain where it has touched 23 pct. Naturally, consumption expenditure has declined in the euro zone by about 1 pct and will have a depressing effect on GDP growth.
Factory orders are down even in Germany which is the largest euro zone economy. The fall exceeded 4.8 pct although the industry was still flashing positive signals.
Indications are that the euro zone economy is already in recession and growth may have slipped 1.75 pct with some countries diving deeper. The debt crisis and subsequent agreements entered into by EU (excluding the UK), to bring about better fiscal consolidation, have forced a number of countries to cut public spending. While this may reduce fiscal deficit — the original sin — it will deepen recession further.
The recession in the euro zone will have adverse consequences for many countries. In India, the impact of the European debt crisis was visible right from the beginning of 2011 though it intensified since August. India was hit most in comparison to other countries. The stock market lost nearly 20 pct in 2011 in the absence of FII investment which also pushed the rupee down from 45 to 53 to the dollar. Simultaneously, there was a fall in direct foreign investment.
The recession in the euro zone will have a crippling effect on our exports which, presently, account for 21 pct of our total exports. Italy and Spain, which are more prone to debt crisis and recession, together share more than 3 pct of our exports. Already, the export growth is down. It was 4 pct in November.
Stock market under stress
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The first big jolt to the market after the 2008 crisis had come last August when FIIs disinvested 95 billion rupees worth of equity and moved into liquid assets. That brought the Sensex down by 1500 points and pulled the dollar up by 4 rupees.
The FIIs wanted to reduce their risk which had been heightened by the EU crisis. It was not Greece alone but even Italy, the third largest European economy, which was in danger of sovereign debt default. These governments could borrow only at interest rates over 7 pct, about 2 pct more than the average rate for EU countries.
Undoubtedly, the prospects for the Economic and Monetary Union (EMU) were grim and there could have been sheer chaos had a weak state like Greece or a strong state like Germany left the Union. France and Germany did finally persuade other members to accept fiscal consolidation and establish a permanent bailout fund. An early agreement failed mainly because of the veto exercised by Britain. Hence, a new treaty will have to be signed which is not likely before March.
The promise of a new treaty was not enough to create confidence among investors in the solidarity of the EU or the European banking system. For that reason the recovery of world markets did not come through. The BSE Sensex hardly changed its mood and, with the added fear created by the 5 pct fall in industrial production, declined further.
There were triggers that could have kicked up stock prices. A good opportunity for market recovery was lost when the government almost withdrew the earlier amendment to facilitate FDI in retail. With a fractured parliament and undependable allies, it is unlikely that any major reform will come through before the elections in Uttar Pradesh.
The next budget can be a trigger but is unlikely to be one. For, the kind of pressure under which it is at present requires the finance minister to seek approval to borrow another 550 billion rupees, mainly to fund subsidies. As such, it may be difficult to even maintain the fiscal deficit at 4.6 pct as provided in the last budget.
Too many questions, no convincing answers
(Nipun Mehta is an award-winning private banker with many years of experience across Asia. The views expressed in the column are his own and not those of Reuters)
If one were to evaluate global events of the last four years dispassionately, the subprime mess in the U.S. and the imminent debt default by Greece (and four other countries to a lesser extent) and the resultant crisis in the euro zone have virtually held the global economy to ransom.
This generation of bankers, analysts, bureaucrats, politicians or even economists, has not been witness to the kind of convolutions that governments and markets are passing through. All this has also led to credit rating agencies taking some surprising and some highly inexplicable decisions.
The outcome of this extraordinary, though not entirely unexpected, chain of events has been various out-of-the-box decisions and/or suggestions like introduction of a new tax on the rich called the ‘Buffet Tax’, an offer by Brazil to start funding the euro zone deficit (much like the tail wagging the dog), of breaking up of the EU, of easing Greece out of the EU, of issuing a new layer of ‘Euro Zone Bonds’, tranches of quantitative easing by the Federal Reserve, etc. The pendulum of risk aversion has swung so sharply that gold and more recently the dollar are the only asset classes that have performed in the last few quarters.
The uncertainty created by persistent delays in a clear decision within the euro zone has created a lot of volatility across markets and asset classes. The latest potential solution of investors taking a 50 pct cut in their investment in Greek bonds will shave off billions of dollars of assets from a few European Banks’ books and impair their balance sheets by raising a serious question mark on their overall asset quality.
Bank rating downgrades have already happened in Europe and unless governments capitalise some of them soon, an impending banking crisis is brewing in some European countries. Due to their huge exposure to Greek bonds, two of the largest French banks have already been forced to announce a 110 bln euro asset liquidation over the next few years to strengthen their balance sheets. Can you imagine the impact of such a measure on global businesses in various countries?
The kind of volatility across bond, forex, commodity and equity markets that we have seen globally over the last few months has been immense, and unknown to many, with far reaching implications. If a close to 9 pct rupee devaluation (vis-à-vis the dollar) over the last three months can create havoc amongst businesses, imagine the kind of impact on P&L a/cs, of bond price movements on profitability of some global banks, of importer or exporter revenues in case of adverse forex movement. The fact that company budgets have gone awry or government fiscal deficits estimates have increased will be apparent only after a lag. It’s best to be prepared.
