Expert Zone
Straight from the Specialists
Scary oil
(The views expressed in this column are the author’s own and do not represent those of Reuters)
Today’s fragile global economy faces many risks: the risk of another flare-up of the euro zone crisis; the risk of a worse-than-expected slowdown in China; and the risk that economic recovery in the United States will fizzle (yet again). But no risk is more serious than that posed by a further spike in oil prices.
The price of a barrel of Brent crude, which was well below $100 in 2011, recently peaked at $125. Gasoline prices in the U.S. are approaching $4 a gallon, a damaging threshold for consumer confidence, and will increase further during the high-demand summer season.
The reason is fear. Not only are oil supplies plentiful, but demand in the U.S. and Europe has been lower, owing to decreasing car use in the last few years and weak or negative GDP growth in the U.S. and the euro zone. Simply put, increasing worry about a military conflict between Israel and Iran has created a “fear premium”.
The last three global recessions (prior to 2008) were each caused by a geopolitical shock in the Middle East that led to a sharp spike in oil prices. The 1973 Yom Kippur War between Israel and the Arab states led to global stagflation (recession and inflation) in 1974-1975. The Iranian revolution in 1979 led to global stagflation in 1980-1982. And Iraq’s invasion of Kuwait in the summer of 1990 led to the global recession of 1990-1991.
Even the recent global recession, though triggered by a financial crisis, was exacerbated by spiking oil prices in 2008. With the barrel price reaching $145 in July of that year, oil-importing advanced economies and emerging markets alike faced a recessionary tipping point.
The risk that Israel’s threat to attack Iran’s nuclear installations will, in fact, lead to an outright military conflict may still be low, but it is growing. Israeli Prime Minister Binyamin Netanyahu’s recent visit to the U.S. demonstrated that Israel’s fuse is much shorter than the Americans’. The current war of words is escalating, as is the covert war that Israel and the U.S. are allegedly engaging in with Iran (including killings of nuclear scientists and use of cyber-warfare to damage nuclear facilities).
Global Economics: When China is not just China
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The People’s Republic of China’s (PRC’s) relationship with Iran receives a good deal of attention. As the U.S. considers how to stop Iran’s nuclear weapons program short of military action, the PRC is considered vital in ensuring economic sanctions are effective. But it has been difficult to win Chinese cooperation in applying sanctions. One mistake the U.S. may have made is treating China as a unified entity.
It is true, of course, that the PRC has a tightly controlled political system. There is one ruling party, a powerless legislature, and muzzled debate. Even so, distinct interests have emerged.
State-owned enterprises rarely operated internationally a decade ago and, if they did, unfailingly followed the central government line, as when China Unicom was nationalised in 1999. One outcome of state-led development since 2003 is powerful growth by state firms. By some measures, State Grid is the world’s biggest power company, China Mobile the biggest telecom, and ICBC the biggest bank.
The PRC’s global presence is also much greater. Chinese firms are the world’s biggest exporters. From 2005 to 2011, Chinese outward investment exceeded $300 billion, even excluding bonds.
China’s corporate kings are the two largest oil companies, both state-owned: CNPC and Sinopec. Both rank in Fortune’s top 10 globally. They are the two biggest owners of foreign non-bond assets, accounting for more than 25 percent of outward investment — more than $80 billion — by themselves. CNPC and Sinopec own stakes in Canadian oil projects; CNPC sends Venezuelan oil to the U.S. for refining; and Sinopec has just made a sizable U.S. shale deal. They also have made large acquisitions in Europe.
Iran has been an important target, with CNPC and Sinopec each having multibillion-dollar projects. However, there are indications that both, along with smaller cousin China National Offshore Oil, have slowed recent work. Why? It probably wasn’t orders from Beijing. Rather, proceeding with their considerable business in Iran in the face of sanctions would put much more of their global business at risk.
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.
There is no place like home
(Paul Donovan is a Managing Director and Global Economist at UBS. The views expressed in this column are the author’s own and do not represent those of Reuters)
Most economists believe that nearly everything in this life can be reduced to an economic explanation.
This even applies to popular culture. The Wizard of Oz has been explained as a parable of late 19th century economics, as a veiled commentary on the gold standard versus the use of silver that dominated the 1896 presidential election in America. The yellow brick road is gold, the cowardly lion was William Jennings Bryan (a pro-silver politician). The wicked witches represented Wall Street (east) and railroad interests (west). Dorothy had to put on silver shoes to make her way to the Wizard of Oz (the U.S. President). She then learned that she could escape the bizarre, fantasy world of Oz and get back to reality by clicking her heels and repeating “I want to go home”.
Confronted by the bizarre, fantastic world of the Euro today, investors could learn from the Wizard of Oz. Global investors may well want to click their heels and mutter “I want to go home”. After two decades of globalising capital flows, investors may once again feel the urge to have their money at home, or at least closer to home than has been the case hitherto.
Why should investors favour home or regional markets? In a rational world, investors should search for the best risk adjusted returns they can find, and put their money there. However, as the Euro only too clearly demonstrates, we do not live in a rational world.
There are two forces at work here. The first is the fact that political risk is playing a larger and larger role in the world’s financial markets. Governments have an increasing impact through regulation, government debt (and default fears), intervention in currency and bond markets and policy statements.
What this means is that the performance of markets can no longer be interpreted through economic activity alone. Increasingly, one must understand the political environment and the likely changes that that environment may bring to bear on investments. For many investors this is a development that they have not experienced before: political risk was a declining force in financial markets in the two decades that preceded the global financial crisis. The problem is that political risk is very often specific to a country or to a culture.
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.
Asia and the euro crisis
(Paul Donovan is a Managing Director and Global Economist at UBS. The views expressed in this column are the author’s own and do not represent those of Reuters)
The euro should not exist. More precisely, the euro should not exist in its current form, with its current membership.
A monetary union of 17 countries with little in common (beyond geographic proximity and a history of invading each other) was never likely to work. This crisis seems to have been inevitable — I, and most of the rest of the economics profession, have argued against the euro (in its current form, with its current membership) for sixteen years.
So the euro should not exist. However, the cost of breaking it up is hideous. Rough calculations suggest the Greek economy would halve in size if Greece were to exit the euro. That is a far greater cost than anything Asia experienced in the 1997-98 crisis. If Germany were to try to exit, it would cost it a quarter of the German economy. There are also political costs. The economic damage (and unemployment) would be the worst since the 1930s. In extremis that economic pain could provoke anything from widespread social unrest to military government or even civil war.
This leaves Europe trying to work out how to make the euro work. The solution must involve some kind of fiscal confederation. No monetary union has ever survived without a fiscal union alongside it. Unfortunately, the politics of fiscal integration are not playing out smoothly. Euro area politics sometimes seems akin to the politics of the playground. Politicians seem inclined to yell “shan’t” whenever economists ask them to play nicely with one another.
The euro will develop in time. Unfortunately, the process is unlikely to be rapid or easy. The euro area seems set to experience a series of crises in the coming years. Each crisis will be accompanied by uncertainty, market volatility and consequences for Asia.
Why should Asia care about the crisis of the euro area? For two reasons — the current account and the capital account.
Two problems, one strategy for both RBI and the Fed
(The views expressed in this column are the author’s own and do not represent those of Reuters)
The Reserve Bank of India and the U.S. Federal Reserve were confronted with two different problems but used the same monetary strategy for solution. Neither succeeded.
The RBI had to pull down inflation and raised the repo rate in eleven steps in eighteen months by 3.5 percent. The expectation was that the rate rise will curb demand and lower prices. What happened was entirely different.
Headline inflation is still over 9 percent, largely backed by inflation in food, mainly fruits and vegetables, meat and eggs. Interest rate made no difference to food inflation because no one buys food from money borrowed from banks.
But the RBI did succeed in curbing demand for a variety of other products. With the high interest rate, demand for housing declined and construction activity slowed down. With the high interest rate, demand for cars and trucks dropped and production became stagnant and would even shrink. With the high rate of interest many industrial projects became unviable and investment declined. And so on.
All in all, GDP growth in the second quarter was down to 7.7 percent from 8.8 percent y-o-y. This was precisely what the RBI was looking for. But it had also expected that, with lower growth, inflation would fall. That did not happen simply because inflation was not due to over-heating of the economy but shortfall in critical food supply.
The Fed was expecting exactly the opposite to be achieved with the same strategy. The rate of interest was drastically cut and the Bank poured in trillions of dollars to keep that rate in check, hoping that investment and consumption will revive and unemployment will be reduced. Neither took place.
Is “depressing” depression better than “economic boom”?
(The views expressed in this column are the author’s own and do not represent those of Reuters)
Every once in a while, I come across the term — depression. Well, I have heard of recession, contraction, subtraction — so what exactly is “depression”? It is very depressing to say the least. But if you still insist, these are some of the facts.
The Great Depression was an economic state in the U.S. in the 1930s. Some of the stats:
– It started in 1930 and ended after nearly a decade
– It was a period when the economic output (as measured by GDP) was falling year after year
– The U.S. equity index (Dow Jones Industrial Average) fell by 89 pct in the period from the peak to the trough. You heard me right — $100 of equity investments became $11.
– The unemployment rate in the U.S. shot up to 25 pct. This was the percentage of people who were looking for a job but not getting one. This excludes people typically less than 20 or greater than 60. That’s a really high number, right? 1 in 4 people between 20 and 60 were without a job.
Life after the U.S. rating downgrade
(Nipun Mehta is a veteran private banker with many years of experience across Asia. The views expressed in the column are his own and not those of Reuters)
The unthinkable (for some) happened last week when the U.S. economy was downgraded from ‘AAA’ to ‘AA+’ with a negative outlook by Standard & Poor’s, one of the three large global rating agencies.
That led to an interesting situation where European economies like France and the UK are rated higher than the U.S., despite huge concerns about their financial condition. The event would undoubtedly have hurt the American ego, particularly since S&P announced that there could be more downgrades in the offing.
That this was an event that was imminent is accepted by many, but what is in store for the global economy and the Indian economy going forward?
There are several concerns that will keep haunting the central banks, the equity markets and governments around the world. These include:
- What if the UK and France are downgraded too?
- Will the other two rating agencies also downgrade U.S. in a few weeks’ time?
Impact of U.S. debt downgrade
(The views expressed in this column are the author’s own and do not represent those of Reuters)
Standard & Poor’s has cut the U.S. triple-A rating down to AA+ which if one is to go by the technical meaning, says the U.S. is no longer as reliable as it was last week when it comes to repaying its debts.
U.S. debt is now hovering around 100 pct of its GDP ($14-15 trillion).
However, what’s more worrying is the manner in which U.S. politicians driven by short-sighted electoral objectives pushed the country to its reputational edge, making them look very similar to some of the much maligned emerging market leadership which lacks political will to take hard and nonpartisan decisions.
The game was not very different with the Republicans sheltering the rich with lower taxes and wanting to prevent the Democrats playing to their gallery by spending on welfare.
As a lender would put it, the quality of management and ability to deliver the growth agenda while keeping its accounts balanced is in doubt.
This has not gone unnoticed by S&P and has contributed to the downgrade decision which it also says is based on projected growth leading to the debt reaching $21 trillion in ten years.
