The Global Economy No. 8 - November 30, 2011


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The Global Economy No. 8 - November 30, 2011: The debt crisis in the euro zone – from periphery to core

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The Global Economy No. 8 - November 30, 2011

  1. 1. The Global EconomyMonthly letter from Swedbank’s Economic Research Departmentby Cecilia Hermansson No. 8 • 30 November 2011 The debt crisis in the euro zone – from periphery to core • The inability to resolve the euro zone’s debt problems could create a recession in the region and complicate the global recovery. The crisis is spreading from southern Europe to the euro zone’s core countries. The situation is growing more serious, and even though there is a commitment to save the currency union, there is a lack of agreement which tools to use. • Until the third quarter the global economy was strengthening at a reasonable pace. Leading indicators, purchasing managers indexes and confidence data are now signalling that growth will slow, especially in the euro zone and the UK. An inability to resolve the budget problems in the US and the crisis in the euro zone could drag the US economy into a new recession. If tax cuts are extended, this risk is reduced. Emerging economies are expected to slow, but not at all to the same extent as the euro zone, where fiscal austerity, credit austerity and lower future confidence among businesses and households are hurting the growth outlook.The risk of recession has risen economically and politically fragile US as well as inIn recent months the debt crises in the euro zone export-dependent emerging economies.and the US have escalated. For Europeans, the In the following sections we review prospects forsituation is acute, while Americans are more the euro zone, the US, Japan, China and India. Wefocused on their continued confidence problems argue that the situation is a fiscal and real economicand growing challenges in the medium term. challenge, and analyse how our forecasts have held up. It should be noted that development through thePessimism whether euro politicians can resolve the third quarter was relatively good, but that theeuro crisis has grown. Despite repeated pledges to outlook is now worsening due to fiscal and creditkeep the currency union intact, there is little austerity and declining confidence. Leading OECDagreement which tools to use. indicators suggest a downturn in industrial production, which hasn’t even returned to the 2006The inability to resolve the debt crisis is contributing level and still has far to go to reach the pre-crisisto growing economic pessimism. This is affecting peak of early 2008.the stability of the financial sector and leading toslower growth through a loss of confidence, higher Industrial production and leading indicators in the OECDfinancing costs and increased credit austerity. 15 120Lower confidence in turn means less investment, Index Levelhiring and trade. The situation is serious, but not 10 Production Change (Y/Y) 110hopeless. Time is running out, however, and the 5 100longer politicians wait to make tough decisions –like whether to utilise the ECB as their most 0 90 Percentimportant tool, e.g., by providing lending to theEFSF or directly buying debt from crisis countries – -5 80the more the crisis will spread from the periphery to -10 70the core. Leading Indicators -15 60The euro crisis could lead to a recession in the -20 50region while also endangering growth in an 80 85 90 95 00 05 10 Source: Reuters EcoWin Economic Research Department, Swedbank AB (publ), SE-105 34 Stockholm, tel +46-8-5859 7740 E-mail: Internet: Responsible publisher: Cecilia Hermansson, +46-8- 5859 7720, Magnus Alvesson, +46-8-5859 3341, Jörgen Kennemar, +46-8-5859 7730, ISSN 1103-4897
  2. 2. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 8 • 30 November 2011The euro zone – the global economy’s liquidity in the ECB. Furthermore, the ECB has tobiggest risk provide increased support to banks that lack liquidity, and financial stability is threatened at theConcerns about the euro’s future and the risk of an same time that credit austerity is growing.escalating sovereign debt crisis have grown in thelast month. As a result, euro zone growth forecasts The gap between interbank loan rates and short-termhave been downgraded by a number of analysts. government debt (TED spreads) in the US and EuropeWe suspect we will also have to lower our growth 5,0outlook from 0.8% next year, when growth in 4,5 Percentage PointsGermany and France – though still positive – will be USAconsiderably weaker than the current 1 – 1.25%. 4,0 3,5The most important recent events were the 3,0changes in government in Greece, Italy and Spain,the first two of which are now led by technocrats 2,5who will have to launch reforms and build 2,0confidence in their policies. UK 1,5 Sweden EMUDespite the new governments, the financial 1,0market’s confidence has waned and bond yields 0,5have risen to painful levels of over 7% for Italy and JapanSpain. Confidence in France, Belgium and other 0,0 07 08 09 10 11core countries has declined as well. Worries that Source: Reuters EcoWinthe institutions that were designed to rescue thesecrisis countries will prove inadequate are an While there is probably still a strong commitment toindication of the severity of the problems. keep the currency union intact, there is little agreement on which tools to use. Unless the acuteThe European Financial Stability Facility (EFSF) is crisis is resolved, there is a risk it will spread to thefacing greater difficulty in terms of financing. The core countries, as evidenced by the fact that thefact that Italy and Spain represent over 30% of its Netherlands and Finland have also seen their bondassets, and France another 20%, shows that the yields rise at the same time that only 60% offunds available to guarantee the crisis countries Germany’s latest bund issue was covered (perhapsmay not be enough. 1.98% was too low an interest rate considering the growing risks in the entire euro zone and theThe most pressing need is to expand the ECB’s intensifying debate on eurobonds, which shouldmandate to buy bonds from these countries (not also raise the risk premium for Germany).just banks) or lend to the EFSF, which in turn canprovide guarantees. On the other hand, Italy, France and even Spain all have more stable economies than Greece. PrivateAt the same time the EU Commission has savings are higher and growth dynamics are better.presented three eurobond proposals, which could In addition, their governments are in better fiscalbe part of a solution to the crisis. Germany has also shape, despite that deficits have to be reduced andoffered a proposal for a temporary eurobond reforms have to be implemented more rapidly tosolution where debt exceeding 60% of GDP is stimulate growth, e.g., improving labour marketpooled and paid off over 25 years with the help of efficiencies. Spains high unemployment speaks forhigher taxes. itself: 45% of young adults are now out of work.Germany is demanding closer fiscal cooperation as Although high interest rates are straininga condition for the changes in the ECB’s mandate government finances, the debts of these countriesand the eurobonds, which is reasonable. Moreover, are maturing over time. In Italys case, over moreit is demanding changes to the EU Treaty, which than seven years. It will take a while before it facescould take time to get passed by the 17 member major problems with high interest rates. On thestates. other hand, 33 billion euro has to be refinanced inThe risk of a collapse of the currency union has January and 48 billion euro in February. Thegrown, but still isn’t imminent. The situation in the situation is not as severe as it has been in the casefinancial markets is serious, with rising risk of Greece.premiums. Interbank rates have also risen, becauseof which many banks are placing their surplus 2 (6)
  3. 3. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 8 • 30 November 2011The euro hasn’t weakened in a way that would much will depend on whether the crisis is resolvedsuggest that its time has passed. This is partly and on growth prospects outside the euro zone.because the situation isn’t much better in the debt-ridden US. Both currencies have depreciated in The UK continues to slownominal and trade-weighted terms in the recent In the third quarter the British economy grew byyear. Another possible reason why the euro is 0.5% compared with the second quarter. Althoughmaintaining its strength is that banks in the euro this may not seem too bad, the figure hides azone are now repatriating their assets from couple of inconvenient truths. For one thing, GDPsubsidiaries in Eastern Europe and Turkey, for grew slower than normal in the second quarter dueexample. to the Royal Wedding and the Japanese disaster. For another, third-quarter growth was aided by anA weaker euro isnt a bad thing in this situation, inventory build-up and public spending, while thesince the growth outlook has worsened. It is private sector foundered.important, however, to avoid a collapse of the eurodue to a complete loss of confidence, which would Order bookings have fallen, as has businessmean a similar lack of confidence in the ECB and in confidence. Households are feeling the effects ofthe ability of the countries to resolve the debt crisis. government austerity as their incomes are squeezed by high inflation and a weak job market. ItThe deterioration in the real economy is manifested isn’t strange then that their confidence has declinedby declining orders. The purchasing managers as well. Debts in the household sector have to beindex has now dropped below a reading of 50 in further reduced, and a savings ratio of 7.2% ismany countries. If it continues to decline, it would evidence of the need for debt relief and increasedindicate a new recession in the industrial sector. buffer savings given the increased uncertainty.There are several reasons to downgrade growth Our previous forecast of 1.2% GDP growth for 2011forecasts: 1) credit austerity following in the wake of seems more or less impossible despite recentan unstable financial sector; 2) the effects on progress. Considering that the fourth quarter isgrowth of austerity, which could exceed 1-1.25 likely to be worse, it is more reasonable to expectpercentage points depending on the decisions growth of 0.8-0.9% this year.ultimately made in France, Italy and Spain, wherethe budgets haven’t yet been fully resolved; and 3) In the face of continued austerity and the euroconfidence in the ability of politicians to resolve the crisis, which is affecting both businesses andcrisis has faded, because of which companies and households, we expect a weak fourth quarter andhouseholds are delaying investments and new first half of 2012. At the same time British bankshirings and in the process further fuelling the have lent generously to public and privatedownturn. borrowers in the euro zone, which now means they have to be more cautious (credit austerity) at homeAnnual GDP growth (%) in the euro zone and that customers will pay higher interest 12,0 expenses. 9,5 The UK’s dependence on exports has increased as Spain Greece 7,0 Ireland a result of the crisis at the same time that the Germany financial sector, retail sales and the real estate 4,5 market have diminished in importance. The pound’sPercent depreciation compared with the period before the 2,0 crisis, i.e., from 2007, has helped to improve export -0,5 conditions. Then again with the euro zone Eurozone France struggling, 2/5 of exports are at risk. In October Italy -3,0 business activity declined as measured by the purchasing managers index, which fell to 47.4 in the -5,5 manufacturing sector and 51.3 in the service sector. -8,0 00 01 02 03 04 05 06 07 08 09 10 11 There are risks on both the upside and downside. Source: Reuters EcoWin Inflation below the current 5% would helpIt is not hard to envision another recession in crisis households, and all indications are that it is headedcountries such as Italy and Spain, but it is not as in that direction. The Bank of England will maintainclear that Germany and even France will reach that its benchmark rate at 0.5% at the same time morepoint. They still have some ammunition left, though quantitative easing is stimulating the economy. On 3 (6)
  4. 4. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 8 • 30 November 2011the other hand, public austerity, credit austerity and affected by at least 1.1 percentage points in 2012.the euro crisis could have an even greater impact This is in addition to other measures that expire andon the economy, because of which prospects for will reduce growth by a percentage point or more.2012 and 2013 look even worse. The risk ofanother major recession has risen, but it isn’t yet US Federal revenue and spending as well as Federal debtour main scenario. One or more quarters of slightly through August 2011 15 350negative growth is a likely scenario, however. 14 Total federal 325 debt 13 300Inflation in the UK according to various measures (%) 6 12 275 USD (thousand billions) Policy interest CPI 11 250 rate USD (billions) 5 10 Federal 225 expenditures 9 200 CPI - services 4 8 175 Federal CPI with 7 income 150Procent unchanged 3 taxes 6 125 5 100 2 4 75 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 Source: Reuters EcoWin 1 CPI, excluding energy, food, alcohol and The inability to compromise also affects 0 tobacco negotiations on the Bush tax cuts, which expire at 05 06 07 08 09 10 11 the end of 2012. Growth in 2013 and forward will be Source: Reuters EcoWin affected if they are not extended. The Republicans want to extend them for everyone, while theThe US – a costly budget failure Democrats want to limit the cuts to low and mediumOn November 22 we published our latest US income earners. If they are not extended at all, theanalysis, where we looked at the Super Committee budget outlook would improve by USD 3 300bn infiasco and its impact on growth and the budget. We the next ten years, but at the same time growthstated at the time that GDP growth would probably would decline by 1.5–2 percentage slightly higher than our October forecast of 1.6%for 2011 and 1.9% for 2012, i.e., two or three tenths A new plan to improve the medium-term budget andof a percentage point higher in both years, since the debt outlook isn’t likely to have an effect untilgrowth prospects have improved slightly compared 2014 at the earliest. Since next year is an electionwith the gloominess of the first half-year. year, negotiations won’t be held until 2013 and wont have an impact until following years.At the same time there are a number of risks thatdeserve repeating. Although Black Friday marked However, USD 1 200bn in automatic cuts arethe start of the best shopping weekend since 2007 scheduled to take effect on 1 January 2013, inand exports have improved, the US still faces major addition to USD 917bn agreed to immediately afterchallenges, not least a low household savings rate, the Republicans consented to raise the debt ceilingwhich is far from sustainable. Add to that the risk of by USD 400 + 500bn in fall 2011. These cuts will befurther deterioration in the euro zone and that the implemented over a ten-year period, but will beginUS, through its banking system and real economy, having an effect in 2013 and will hurt growth.could very well find itself in a new recession. Fourof five Americans believe that the country still is in Although we feel GDP growth could be slightlyrecession compared to when it was officially stated higher than seemed to be the case in October,it was over, i.e., June 2009. there is plenty of reason to be cautious considering the budget debacle and euro crisis.A dysfunctional budget process could also hurt theeconomy. The failure of the Super Committee Japan changes strategy to weaken the yenfurther reduces public confidence in Washington GDP grew by 1.5% in the third quarter on aand complicates next year’s budget negotiations. quarterly basis, but compared with the same periodThe key is to reach an agreement on temporary tax last year was practically unchanged. This is slightlycuts and extended unemployment benefits to worse than expected. There are several reasons formitigate the current crisis, especially in the labour the disappointment: weaker international demandmarket. If they arent extended, growth will be owing in part to the debt crises in the US and 4 (6)
  5. 5. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 8 • 30 November 2011Europe, supply problems resulting from the floods stabilised at around 78 yen per dollar during periodsin Thailand and the strong yen. Compared with the when yen demand is unusually high.historical average for the last three decades, theyen is now 60% stronger in nominal terms and 11% China is easing its economic policiesin real terms. Less restrictive economic policies are an indication that the Chinese government is also worried aboutNominal and real exchange rates compared with long-term the crisis in Europe. Cash requirements for someaverage 160 small and medium-sized banks as well as for rural 150 credit unions have been reduced. 140 The fact that interest rates havent fallen could be 130 because there are still concerns that inflation hasnt 120 declined quickly enough or could begin rising again. 110Index 100 Should China worry about slower economic 90 growth? Lower growth is what it projected in the 80 latest five-year plan. 70 60 What would really be worrisome is if export orders 50 Nominal Effective Exchange Rate Index fall in an uncontrolled manner and the real estate Real Effective Exchange Rate Index market cools too quickly. The purchasing managers 40 80 85 90 95 00 05 10 index has dropped below 50, but it will probably Source: Reuters EcoWin have to fall much further to suggest a new recession in the export sector.Industrial production and exports have been weakerthan expected in recent months. As a result, Change in consumer prices and lending (annual percentage)sluggish GDP growth following the tsunami and 35,0 9nuclear power accident will continue. 32,5 8 30,0 7Our forecast for the current year of -0.2% will 27,5 6probably end up a couple of tenths lower, closer to - 25,0 <--- Credit expansion 50.5%. Nor is it likely that GDP will grow by 2.5% Percent Percent 22,5 4next year if the rest of the West continues to 20,0 3weaken. 17,5 2China’s relatively good growth is certainly helping 15,0 1exports, but trade with China will probably slow as 12,5 0well. More important is whether domestic 10,0 Consumer prices ---> -1investments to rebuild the impacted region will 7,5 -2 00 01 02 03 04 05 06 07 08 09 10 11actually get started. Source: Reuters EcoWinThe Japanese central bank has tempered growth Lower sales volume in the property market isand inflation expectations for the current year and is desirable, but could mark the start of a moreforecasting that GDP will increase by 0.3% and that precipitous price decline if the outlook abroad andconsumer prices will stabilise (compared with 0.4% in the domestic Chinese economy worsens.GDP growth and 0.7% inflation in previous Housing prices rose by about 2% at an annual rateforecasts). in Beijing in October, compared with 22% in MayThe benchmark rate is being held at 0–0.1%. 2010. In 2009 prices fell for several months, and itWhats new, however, is that asset purchases are is reasonable to expect another price decline unlessbeing expanded by JPY 5 trillion to JPY 20 trillion in economic policies are further loosened whenorder to stimulate the economy now that downside growth prospects worsen.risks have risen. Whats also new is that instead of India – last rate hikeintervening in the currency market through largepurchases, the central bank has chosen to buy In late October the Indian central bank raised itssmaller amounts more frequently, i.e., every day. benchmark rate for the 13th time since the recentFew experts believe that the value of the currency period of rate hikes began in 2010. Althoughcan be reduced, however. Possibly it can be inflation is still in the double digits, it is pointing 5 (6)
  6. 6. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 8 • 30 November 2011lower. Given weaker global growth prospects, thiswill probably be the last rate hike for a while.Growth has slowed in recent quarters, reaching anannual rate of 7.7% in second quarter, comparedwith 9.4% in the first quarter of 2010.The investment rate has declined. In the firstquarter there was no increase at all, althoughgrowth accelerated slightly in the second quarter. Inlight of the rate hikes and declining confidence inthe global and domestic economy, the investmentrate is likely to continue to slow going forward.Benchmark rate and exchange rates against the euro anddollar 9,0 80 Policy Interest EUR/INR 8,5 75 rate (right) 8,0 70 Rupie to Euro och US dollar 7,5 65 7,0 60Percent 6,5 55 6,0 USD/INR (right) 50 5,5 45 5,0 40 4,5 35 05 06 07 08 09 10 11 Source: Reuters EcoWinChina, India and other emerging economies in Asia,Latin America, the Middle East and Africa continueto grow at a relatively fast pace, but won’t be able toavoid the effects of the slowdown in the Westthrough trade and financial markets. The absenceof major debt problems or similar imbalancesshould limit any decline in their growth rates,however.China and India now have an opportunity to loosenthe reins on their economic policies given thatinflation is slowing, which should remain the casesince the western world faces an increasinglydismal economic future. Cecilia HermanssonSwedbankEconomic Research Department Swedbank’s monthly The Global Economy newsletter is published as a service to ourSE-105 34 Stockholm, Sweden customers. We believe that we have used reliable sources and methods in the preparationPhone +46-8-5859 7740 of the analyses reported in this publication. However, we cannot guarantee the accuracy completeness of the report and cannot be held responsible for any error or omission in underlying material or its use. Readers are encouraged to base any (investment) decisionsLegally responsible publisher on other material as well. Neither Swedbank nor its employees may be held responsible forCecilia Hermansson, +46-88-5859 7720. losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’sMagnus Alvesson, +46-8-5859 3341 monthly The Global Economy newsletter.Jörgen Kennemar, +46-8-5859 7730 6 (6)