The Global Economy No. 5 - June 23, 2011


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The Global Economy No. 5 - June 23, 2011: The global economy is slowing and political risks are becoming even more critical

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The Global Economy No. 5 - June 23, 2011

  1. 1. The Global EconomyMonthly letter from Swedbank’s Economic Research Departmentby Cecilia Hermansson No. 5 • 22 June 2011 The global economy is slowing and political risks are becoming even more critical The global slowdown doesnt have to be dramatic, but the risk of a new financial crisis and recession increases in tandem with political risks. The confidence vote won by the Greek PM is only one of several steps in a multi-year process of political negotiations, reforms and debt restructuring. There will be plenty of opportunity for setbacks if the parties fail to live up to their responsibilities. To avoid turbulence in global financial markets, decision-makers in the US, Japan and Europe have to implement structural reforms and reduce public debt. Stress tests of banks, and their subsequent recapitalisation, are also important to break the link between sovereign debt crisis and financial crisis. During this period the focus has to be on fiscal policy and structural reforms. The role of monetary policy is to ensure price stability, and central banks have to do a better job of safeguarding their independence and public trust, by for example avoiding new quantitative easing. This is especially true of the Federal Reserve, which will have to set a more explicit inflation target.Expectations are revised downward the year. Prospects of slightly weaker growth globally shouldnt have to be so dramatic, since aDisappointment is the defining feature of most normalisation after last year’s rebound was to beeconomic forecasts right now. The chief reason is expected, although conditions could worsen if theeconomic policies, which if off target will increase political risks associated with the debt crisis,the risk of a new financial crisis and recession. structural reforms and exit strategies lead to moreConcerns have risen that economic growth is turbulent financial markets and weaker realslowing too much in Asia, led by China, India and economic growth. If politicians fail to address reformJapan, that the US economy won’t be able to grow issues or make mistakes in phasing out stimulusquickly enough to boost its labour market, that programs, there will also be long-term growth risks.overheating risks will rise in emerging economies,and that Europe is losing momentum as the rest of GDP growth (%) 15,0the world decelerates. Add to that uncertainty in the Chinawake of sovereign debt crises in Greece, Ireland, 12,5Portugal, Spain, the UK and the US. The financial 10,0markets are especially worried about the Greek 7,5 Indiacrisis, which has been exacerbated by the political 5,0 Brazil Percentsituation and lack of consensus in the euro zone. 2,5 US 0,0The recovery has continued since the start of the Eurozone -2,5year, however, despite the Japanese tsunami and UK -5,0nuclear disaster, the Arab Spring and increased -7,5uncertainty about oil production, rising commodityprices and debt problems. We are now seeing a -10,0 Japangrowing number of economic forecasters revise -12,5 06 07 08 09 10their outlook downward compared with the start of Source: Reuters EcoWin Ekonomiska sekretariatet, Swedbank AB (publ), 105 34 Stockholm, tfn 08-5859 1000 E-mail: Ansvarig utgivare: Cecilia Hermansson, 08-5859 7720. Magnus Alvesson, 08-5859 3341, Jörgen Kennemar, 08-5859 7730
  2. 2. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 6 • 22 June 2011How can political risks be reduced? The stimulus being applied through monetary and fiscal policies has to beWe offer a number of examples below of measures combined with structural reforms. If not,that decision-makers in government and central stimulus policies will prove worthless.banks can take or clearly signal they will take toreduce the risk of economic policy miscalculations Brazil and India have to increase capacityin the years ahead. During the financial crisis by making productive investments andeconomic policies were coordinated to a greater thereby reduce the tension between supplyextent. It is again high time that politicians show and demand. Also, credit growth has to bethey will take responsibility for avoiding renewed held in check and monetary policy must beturbulence and economic setbacks. further tightened. Fiscal policy must be focused more on measures that make In the US, politicians have to agree as soon markets more efficient. as possible on a new debt ceiling along with budgets for 2012 and the next 10-year The euro zone has to strengthen the period. It is essential that they prevent the institutions that hold the union together. debt level from rising to 150-200% of GDP Politicians have to explain the logic behind in the decades ahead. Moreover, structural the EMU and why the benefits of rescuing reforms have to be enacted to make the the PIGS countries outweigh the cost of not labour, credit and housing markets more doing so. Better coordinated fiscal policies efficient, so that growth prospects improve. are probably needed as well, especially to The Federal Reserve needs a more explicit reduce the pressure on the European inflation target to strengthen its credibility Central Bank (ECB). Reforms have to be and independence at the same time that implemented in crisis countries to make greater transparency is needed into how it them more competitive and create a plans to manage its balance sheet. A QE3 foundation for fiscal stability, price stability would calm financial markets, but should and financial stability. Stress tests that still be avoided since the marginal return break the link between the sovereign debt towards the recovery and the credit market crisis and the banking system must be would be low. If the objective is to help conducted and have to be ambitious financing the budget deficit, the enough to create confidence in the process. independence of the central bank would be Recapitalisation of the banking system will damaged even further. then have to follow, and will have to exceed both official and unofficial requirements to In China, additional measures have to be avoid renewed fears of financial instability. taken to choke off inflation by raising interest rates (create positive real interest Europe – focus on Greece rates), letting the currency further appreciate and allowing the Chinese to In Europe, GDP growth has been stronger than export capital (invest abroad). Furthermore, expected so far this year, especially in Germany the financial sector has to be made more (where we may have to revise our forecast for 2011 efficient through well-planned measures upward from 2.5%). For the UK and the euro zone that create bond markets and open up the as a whole, budget consolidation continues, and sector to international players, among other unlike the US, where the deficit is rising this year, it things. To speed up the shift in emphasis to will decline to 4.3% of GDP, and reach 3.5% next consumption, knowledge and services, the year, according to the EU Commissions May social insurance system will have to be forecast. expanded. During the first quarter the EU grew by 0.8% Japan has to allow a stimulus in the short compared with previous quarter and by 2.5% at an term to rebuild its destroyed areas, without annual rate. It is worth noting that the countries that raising taxes. In addition, a clearer strategy grew at or above the average included Germany, is needed for medium- and long-term France, Belgium, the Netherlands, Austria, Estonia, budget work to reduce the public debt Lithuania, Poland, Slovakia, Finland, Sweden and, burden. The Bank of Japan could let its surprisingly, Greece. Unlike the other countries in balance sheet further grow by printing more the group, Greece saw its GDP fall on an annual money, which would cause inflation basis, however, by as much as 4.8%. expectations to rise and weaken the yen. 2 (6)
  3. 3. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 6 • 22 June 2011 Annual GDP growth in the euro zone (%) responsibility for writing down debts, but the 7 problem is that all settlements unless they are 6 United Kingdom Germany voluntary and aren’t overly extensive, will be termed 5 Spain “Default”, which in practice means that the benefits 4 of such agreements are outweighed by the costs, 3 since stability is threatened and the debt level isn’t 2 affected sufficiently enough. This is the key issue 1 that will overshadow negotiations going forward. ItPercent 0 would seem reasonable to ask lenders to take -1 Euroarea greater responsibility if the technicalities can be -2 France worked out in a right manner. Italy -3 The Greek austerity package, which includes tax -4 hikes, spending cuts, privatisations and government -5 reforms, could potentially contribute to higher -6 growth, but it will take time, and initially growth -7 00 01 02 03 04 05 06 07 08 09 10 prospects will instead deteriorate. Source: Reuters EcoWin Greece does not have a big impact on growth in theAs we intimated in our last monthly letter, there are euro zone, but it does threaten French and Germannow signs of a slowdown in Europe as the rest of banks in particular, as well as the Greek bankingthe world decelerates. The purchasing managers system. In the long run there is also a risk to theindex is still above 50, but has fallen from the high ECB’s balance sheet if the securities pledged aslevels during the rebound following the financial collateral become worthless should Greece default.crisis/recession. The euro countries have now decided not to lend toInflation in May fell to 2.7% (from 2.8% in April) in Greece unless the parliament in Athens supportsthe euro zone and to 3.2% in the EU (from 3.3%). th the austerity plans (evidence 28 of June). The IMFFood and energy prices have risen, but underlying cannot pay out its share unless the euro countriesinflation remains low. The ECB will continue to raise rd guarantee financing next year (3 of July). Byinterest rates, though cautiously, at the same time giving Greece a new package, European banks willthat its unconventional monetary policies will remain have more time to reduce their positions vis-à-visin place (more or less voluntarily) to support th Greece (11 of July).financial stability in the euro zone. The new Greek government, led by GeorgeThe focus is on financial stability, and thus on the Papandreou and his party Pasok, has won the votePIGS countries and Greece in particular. In light of of confidence after two days of marathon debate.Greece’s current political situation, with a new Now the parliament has to give its support for thecabinet, the confidence vote and the decision on reform package or it is likely, according to sources,the austerity package, the latest loan payment has that the troika of the euro zone, ECB and IMF willbecome a growing concern. If it is not paid, there is deny the next loan payment and any new funds.a risk that the country will default on its payments in There is much at stake, since the troika wants toJuly. There are also worries whether euro zone avoid a Greek default. At this point they can onlypoliticians and citizens will be willing to support cross their fingers!Greece with additional funds, since it will not beready to return to the financial market until next US structural problems are underestimatedyear and needs several years to ease its debtburden, mainly through reforms and privatisations. Expectations among analysts (mainly American) that the US economy would grow by between 3%The Greek crisis is an issue for the country and its and 4% in 2011 again proved overly optimistic.future, an issue for the European banking system After GDP grew by 1.8% at an annual rate (andand, by extension, the international financial 2.3% in real terms) in the first quarter, expectationsmarket, and an issue for the euro alliance. were revised downward to between 2% and 3%. Our 3% projection may have to be slightly revisedGreece has problems with both liquidity and downward in our fall outlook.solvency, although the line between the two can befuzzy. To date programmes have focused on The Achilles heel of the US economy is theliquidity and avoiding missed payments. German interconnection between the labour, housing andpoliticians have demanded that lenders take greater 3 (6)
  4. 4. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 6 • 22 June 2011credit markets. Kick-starting growth will mean that ceiling. The most likely scenario is that agreementshouseholds will have to start borrowing and are reached at the 11th hour, i.e., before August 2,consuming again, but there is probably still a long and that the debt ceiling is raised, albeitway to go before the post-crisis deleveraging is temporarily.complete. Housing prices have not yet hit bottom,and the structural problems in the mortgage sector The Republicans hope to gain by criticising the USthat havent been addressed are delaying the economy leading up to next years election whilerecovery. The rise in inflation at the consumer price the Democrats are trying to pass a stimulus thatlevel is mainly the result of higher gas prices. could improve the outlook. Unemployment, whichUnderlying inflation is still low. Federal Reserve will due to a higher labour supply and weak demand iswait to increase the Fed Funds rate during this 9.1%, is the stumbling block. Since the 1930s noyear. president has been re-elected when unemployment is higher than 7.2%. This doesnt leave much timeThe labour market has been the source of for President Obama. A quick reduction indisappointment. The fact that private consumption unemployment would seem practically impossible.has still held its own is partly because the savingsratio has again dropped, from near the historical US labour market (%)average of just over 8% to nearly 5%. Debt has 12,5declined as a share of disposable income, but Unemploymentprobably has to be reduced further. This means that 10,0the growth in private consumption not yet issustainable. 7,5US household debt and savings in relation to disposable 5,0 Procentincome (%) 17,5 1,3 2,5 Debt ratio---->Savings as a share of disposable income 15,0 <---- Savings 1,2 Debt as a share of disposable income ratio 0,0 12,5 1,1 10,0 1,0 -2,5 Labour supply Employment 7,5 0,9 -5,0 80 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 5,0 0,8 Source: Reuters EcoWin 2,5 0,7 China – the inflation tiger has escaped 0,0 0,6 Chinese politicians are worried that inflation – which -2,5 0,5 60 65 70 75 80 85 90 95 00 05 10 is often compared to a tiger, which is hard to get Source: Reuters EcoWin back in its cage once it has escaped – is becoming too hard to tame. In May inflation reached 5.5%,Exports and investments have to take over more as significantly above the comfort level of 3-4%. Ofgrowth engines to help in the restructuring of the course we have to keep in mind that the Chineseeconomy and improve growth prospects. The risk, are probably undervaluing the real number. Thehowever, is that many long-term unemployed difference between nominal and real GDP growth,become structurally unemployed at the same time for example, exceeds 8 percentage points andthat businesses are saying that they cant find indicates that inflation at the consumer price level isenough skilled labour (the percentage of leading being underestimated. The fact that the authoritiescompanies that say they have recruiting problems, at this point have assigned food a lower weight inaccording to the staffing firm Manpower, has risen the currency basket could be one way to address afrom 14% in 2010 to 52% this year). This is politically sensitive situation.affecting the competitiveness of the export sectoron the global market, similar to what is happening in There are several reasons why inflation is rising:Europe, including Sweden. drought in the south, higher housing costs, higher commodity prices – both food and energy – andThe focus is also on political developments, large capital inflows tied to very high domesticincluding negotiations on the budget and debt liquidity. The Chinese administration is trying to 4 (6)
  5. 5. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 6 • 22 June 2011slow down lending by raising interest rates and Japan – downside biasbank reserve requirements (from 14% to 19% forsmall banks as of 2010 and from 15.5% to 21% for Despite the earthquake, tsunami and nuclearlarge banks). The nominal lending rate is still disaster in March, we forecast in April that GDPinsignificantly higher than the official inflation rate, growth for 2011 would be positive. It is possible wehowever, which in essence represents a continued were too optimistic. Despite that the first quarterstimulus through the financial sector. Compared had only two weeks left after the disaster, GDP fellwith credit growth of around 30% during the crisis, it by 0.7% at an annual rate and by 3.5% in realis now down to 15%, but the question is whether terms,. Underlying growth was already weak, andthis is enough of a slowdown. Decelerating too during the second quarter this trend is likely toquickly could cause a hard landing, forcing continue.authorities to adjust their brakes and gas pedal. In addition, the political situation is growing murkier. Credit growth, cash reserves and interest rates in China Prime Minister Naoto Kan is expected to step down 30 in August, and his second reconstruction budget will likely be put off until then, which is delaying the expected rebound. At that point tax hikes are 25 anticipated, which could weaken domestic demand. Credit Growth For the export sector, the decision to shut down the 20 Hamaoka nuclear power plant is problematic. The auto industry is especially affected. Moreover, the supply chain for electronic components has beenPercent 15 disrupted, which also affects the outlook for the entire economy. and in 10 Reserve requirements in small large banks banks Industrial production and export growth (%) and purchasing managers index 5 50 70 Lending rate 6 months Manufacturing Production SA, Index, 2005=100 [c.o.p 12 months] 40 Purchasing Managers Index 65 Deposit rate 6 months Exports, Total, SA, JPY [c.o.p 12 months] 0 98 99 00 01 02 03 04 05 06 07 08 09 10 30 60 Source: Reuters EcoWin 20 55 Diffusion indexAfter China’s currency reserves rose by nearly SEK 10 50 Percent200 billion in the first quarter, they have now 0 45reached US 3 trillion. China is allowing the renminbito appreciate against the dollar, but in trade-related -10 40terms the rate remains relatively stable. Chinas -20 35slightly higher inflation will allow some appreciationin real terms, however. -30 30 -40 25Another way to choke inflation would be to allow theChinese to invest abroad, which would reduce -50 20capital inflow in net terms – which to date has 02 03 04 05 06 07 08 09 10 11increased when China buys foreign currency to Source: Reuters EcoWinstave off the currency’s appreciation. Industrial production and exports have declinedIt seems clear that China hasn’t yet alleviated its substantially, while the purchasing managers indexproblems with overheating and that the tools has nevertheless remained above 50. This could beavailable at its disposal to reduce the risk of a hard because certain key sectors have been harder hitlanding aren’t effective enough. How inflation in than others (cars, electronics).consumer and real estate prices is handled in thequarters ahead is critical. Our forecast of GDP The Japanese central bank has expanded itsgrowth of 8.8% this year may have to be revised balance sheet by buying securities – a strategy itupward given the relatively strong start to the year, may have to use again. Its benchmark interest ratebut a slightly stronger slowdown cannot be ruled out has been held at zero. The focus should now be onyet. fiscal policy, but there is a lack of political consensus whether to stimulate the economy when the debt ratio exceeds 200%. The political coalition 5 (6)
  6. 6. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 6 • 22 June 2011 that could succeed Kan is likely to resort to tax The factors limiting growth also include the high hikes to finance the post-disaster reconstruction, price of oil, which is an impediment for which could do further damage to the prospects for manufacturers and complicates the budget situation Japans economy. because of subsidies. The fact that foreign investors have gotten cold feet after the Arab India – missing out on growth by not investing Spring has also hurt growth prospects. Our April forecast of 8% GDP growth still looks fairly GDP-growth fell to 7.8% during the first quarter. accurate. Weak investment is the main stumbling block to growth, since insufficient capacity combined with Brazil – overheating risks rise high demand is raising inflation and jeopardising the expansion that otherwise may have been possible. Brazil also faces fears of overheating. Credit growth India’s central bank is expected to raise interest is currently driving the economy, and due to a rates by another 50-100 bp this year to reduce steady stream of interest rate hikes there is an inflation, which is now 9% at the wholesale level. increased risk that households will default on their loan payments. Since the beginning of the year the India’s growth in GDP, investments and private number of loan defaults has grown by just over consumption (%) 20%. By year-end 8% of loans are expected to be 20,0 Investments overdue by at least 90 days. Since 2007 household 17,5 debt has risen by 100%. This is a concern at the Private consumption same time that there are other signs of overheating 15,0 from the housing market, retail sales, auto salesn 12,5 and inflation at the consumer price level. 10,0 Inflation was 6.55% in May, exceeding the central Percent banks target of 4.5% (+/- 1%) and the May target of 7,5 6.5%. The benchmark rate has now been raised to 5,0 12.25% after five hikes this year, and another hike may be necessary. Banks are charging 2,5 considerably more for loans. On average, loan rates 0,0 are 39%. GDP GDP -2,5 Cecilia Hermansson 05 06 07 08 09 10 Source: Reuters EcoWin Swedbanks Ekonomiska sekretariat 105 34 Stockholm Swedbanks Månadsbrev om den Globala Ekonomin ges ut som en service till våra kunder. tfn 08-5859 7740 Vi tror oss ha använt tillforlitliga källor and bearbetningsrutiner vid utarbetandet av analyser, som redovisas in publikationen. Vi kan dock inte garantera analysernas riktighet or fullständighet and kan inte ansvara for eventuell felaktighet or brist in grundmaterialet or bearbetningen därav. Läsarna uppmanas att basera eventuella (investerings-)beslut även Ansvarig utgivare på annat underlag. Varken Swedbank or dess anställda or andra medarbetare skall kunna Cecilia Hermansson, 08-5859 7720. göras ansvariga for forlust or skada, direkt or indirekt, på grund av eventuella fel or brister Magnus Alvesson, 08-5859 3341 som redovisas in Swedbanks Månadsbrev. Jörgen Kennemar, 08-5859 7730 6 (6)