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The Global Economy No. 7 - October 31, 2011


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The Global Economy No. 7 - October 31, 2011: A step forward – but several fundamental problems remain

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The Global Economy No. 7 - October 31, 2011

  1. 1. The Global EconomyMonthly letter from Swedbank’s Economic Research Departmentby Cecilia Hermansson No. 7 • 31 October 2011 A step forward – but several fundamental problems remain • The EU’s decision to write down Greece’s debt, recapitalise European banks and leverage the European Financial Stability Fund (EFSF) is a step in the right direction, but with so many outstanding details left to resolve it will take time before the effectiveness of the rescue package can be judged. • We revised our global GDP growth forecast downward in connection with the Baltic Sea Region Report presented on October 19. For the years 2011-2013 we see global GDP growth slipping by 0.6% to a rate of 3.6% per year. • The focus for the euro zone has already shifted from Greece to Italy. With its 10- year bonds now yielding over 6%, Italy’s government has to quickly build confidence that it will take the necessary reforms to improve the country’s growth potential at the same time that the budget consolidation continues. The euro zone’s future is now increasingly dependent on the political process in Italy.The economy is at a standstill – the debt growth of 3.8%, we are now forecasting 3.6% nextcrisis could still worsen the situation year, mainly because the US is growing by just overThe global economy is struggling with two main 1.5%, instead of just over 2%, and GDP growth inconcerns. One is growing economic pessimism, the euro zone has been revised downward fromwhich has caused many forecasters, including us, 1.3% to 0.8%. As a whole for 2011-2013, theto write down our growth forecasts for the next two downward revisions mean that global GDP is 0.6%years. The other is the debt crisis in the West, lower in 2013 than our August forecast.where the focus is currently on the euro zone but GDP growth in a number of countries, annual ratewill increasingly embrace the US as well in the nextmonth. China 12,5 IndiaThese two phenomena are closely related. If the 7,5 Brazildebt crisis worsens, the economy could slow even Percentmore and put all or parts of the West at risk for a 2,5new recession. Weaker confidence among Eurozone -2,5businesses and households, as well as the financial UK USmarkets, is contributing to lower investment and a -7,5lack of new hiring. If the economy worsens, it would Japanmake it even harder to implement the budget -12,5consolidation, which would necessitate tighter 06 07 08 09 10 11austerity with even more of a negative impact on Source: Reuters EcoWingrowth. This could naturally also lead to greaterpolitical turbulence considering how difficult it is to Third-quarter GDP growth in the US was about asfind support for even more massive cutbacks. expected at an adjusted annual rate of 2.5% and an annual rate of 1.6%. To date householdHard and soft (confidence variables) economic data consumption has grown faster than the weak futurefor the US, UK and euro zone have weakened, confidence would indicate. Housing prices are stillwhich was one reason why we revised our global falling, but home sales have provided someforecasts in connection with the recently published glimmers of light. The labour market remainsBaltic Sea Region Report. Instead of global GDP considerably weaker than normal following a 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. 7 • 31 October 2011recession, which is why this balance sheet equation that includes Greece, banks and the EFSFrecession doesn’t offer the same opportunities to still has a number of unknown variables. If any ofkick-start the economy with lower interest rates. them change, the whole equation changes.Small and medium-sized companies have beenespecially troubled by low domestic demand, while First and foremost it is reasonable that Greece’slarge US companies have managed fairly well. debt is reduced to a more manageable level, but the 50% haircut applies only to the private portion.China has also released its GDP data for the third The banks still have to “voluntarily” agree to thequarter. Economic growth slowed compared with settlement. Obviously this is more than the 21%the previous year, but on an annual basis is still agreed to on July 21, but the question is whetherrelatively high at 9.1%. Due to tighter monetary 50% is enough or if we will see further write-downsconditions and slightly lower commodity prices, at a later point. Greece’s national debt is expectedinflation peaked at 6.5% in July, and in September to decline to 120% of GDP (like Italy’s) in a couplethe official rate was 6.1%. The biggest concern of years, instead of the previously predicted 180%.remains housing prices, which, if they fall Growth prospects will have to improve to reach thatsubstantially, could jeopardise municipal level.finances/growth and lead to a substantial increase The recapitalisation of European banks should bein nonperforming loans in the financial sector. seen from the perspective of both short- and long- Consumer prices, annual percentage change term needs. The newer stress tests are more 9 ambitious than those done last summer, when the 8 China shortfall was 2.5 billion euro. Now we are talking 7 about 106 billion euro. However, these calculations 6 do not include a new recession. The amounts would 5 USA rise if the economy worsens. The market valuation 4Percent 3 as of September 30 favours France (which has 2 since seen values decline) and assumes that the UK Germany 1 value of German and French bonds will rise, while 0 bonds from the PIIGS countries will be worth less. -1 -2 Critics claim that overly aggressive recapitalisation -3 06 07 08 09 10 11 requirements could compromise the recovery, since it would further shrink the banks’ balance sheets. A Source: Reuters EcoWinIn Japan and Europe, third-quarter GDP growth credit tightening is in the cards. At the same timefigures have not yet been published. Signals from there is good reason to recapitalise the banks,German analysts (banks, central bank) suggest that which have already had time to foresee this. Thegrowth could be relatively strong at around 0.5% on hardest hit will be banks in southern Europe. Ina quarterly basis. There is considerable uncertainty, Italy’s case, its banks haven’t been responsible forhowever, not least because confidence variables excessive credit growth in recent years; it is more aare beginning to point to a slowdown, which is question of the large exposure against the country’sprobably more likely in the fourth quarter of this bonds.year and first quarter next year. The alternative would have been to listen to France and let the ECB buy more bonds, but there is alsoWith the economy at a standstill it is even more the risk of ruining its balance sheet. This wouldimportant that political leaders take responsibility for mean a recapitalisation of the ECB, which wouldbuilding future confidence. The EU’s meeting last require the consent of the euro zone’s taxpayers.week was a step toward better crisis management,but many fundamental problems remain and are In the end Germany won its battle with France tonow coming to the fore as the crisis package is convince its voters to maintain support for the euroanalysed. Developments in Italy are an especially zone. Moral hazards are the focus of attention, andbig concern. the key is to avoid a new crisis due to a lack of discipline. This approach is likely to reduce growthThe euro zone has taken a step forward – more than France’s, but the risk of a new crisis andbut has to do more escalating inflation are kept in check. BothThe EU countries have reached a possible approaches are risky, and even if the German’s isresolution to the crisis in the euro zone, but a more stable, a new recession could sabotage thesenumber of details have to fall into place first. The efforts. 2 (4)
  3. 3. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 7 • 31 October 2011Another detail is how the stability fund could be reforms now being discussed include raising themade more potent without a bigger contribution retirement age from 65 to 67 by 2026, creating afrom the euro countries. German taxpayers have more efficient labour market and selling off publiclittle interest in providing more money to Italy, for assets valued at 5 billion euro per year in the yearsexample. The leverage achieved by insuring Italian ahead.and Spanish bonds is one possibility, but at thesame time would create two bond markets: one Italy has to stabilise its debt, which has now risen toguaranteed by the stability fund (read Germany and just over 120% of GDP. While the ItaliansFrance) and one that isnt. If the situation reaches themselves own 60% of the debt, the external sharethe point where France – and eventually Germany – in relation to GDP is high at 54%. Only Greece,has problems with its credit rating, the leverage Belgium, Portugal and Austria have highermodel will create new problems and more percentages within the OECD. Although Italy hasturbulence. Similarly, the Special Purpose Vehicles extended the maturity of its bonds to 7.1 years(SPVs) funded by Norway and China, for example, (from slightly over 5 years in the early 2000’s), 300could create uncertainty, since the first losses billion euros (of a total of 1.9 trillion euros) matureswould be taken in accordance with the stipulations next year and has to be replaced. In recent yearsof collateralised debt obligations (CDOs), which Italy has accounted for 30% of the euro zone’splayed a prominent role leading up to the subprime bond market, despite that it generates less thancrisis and in 2008 triggered the largest and most 20% of the region’s financial crisis in history. How much leverage Annual GDP growth in a number of euro countries (%)the stability fund will have and how the details will 12,0be worked out are critical to how effective or riskythe rescue package will be. 9,5 Spain Greece 7,0 IrelandWeak growth is again the focus 4,5 Germany PercentDespite the settlement reached by the EU on 2,0October 26, the financial market’s worries haven’t -0,5subsided. Stocks rose initially, but the interest rate France Eurozone -3,0 ItalyItaly offered at its bond auction after the summit -5,5shows that confidence hasn’t improved much thatthe crisis will be resolved. -8,0 00 01 02 03 04 05 06 07 08 09 10 11The focus has shifted from Greece to Italy. Source: Reuters EcoWinConfidence is lacking in Prime Minister Silvio An interest rate rising to 6-7% would be increasinglyBerlusconi and his coalition government. Even prior difficult to handle unless GDP grows much fasterto the summit, credit rating agencies lowered Italys than the 0.5% per year forecast for the next tworating and, in the case of Fitch, threatened to years. This would mean having to deregulate, raisedowngrade it further after the summit, when the efficiencies in the public sector and academia, andgrowth outlook worsened. The euro zone’s increase the labour supply, which, except for menpoliticians – led by Angela Merkel and Nicolas ages 30-50, is lower than the EU average.Sarkozy, along with the ECB’s outgoing presidentJean-Claude Trichet and his successor, Mario Italy now has to show it is serious aboutDraghi – have publicly demonstrated on repeated consolidating its budget and improving growth.occasions that they lack confidence. Demands have Otherwise there is the chance that the euro zone’snow been made to speed up the reform process. problems will persist, with risks not only to the region but the entire global economy. Italy is not atThe question the financial markets are struggling all as weak economically as Greece, but could facewith is which politicians will carry out the reforms increasing difficulty in the absence of the politicalItaly is now proposing to the euro zone’s resolve to improve its outlook and strengthenrepresentatives. A new election is drawing closer at confidence outside the country.a time when the government and opposition areboth weak. Cecilia HermanssonThe fact that Italys 10-year bond reached 6.06%right after the summit, up from 5.86% a monthearlier and 4% a year earlier, shows the depth ofthe challenges facing economic policymakers. The 3 (4)
  4. 4. The Global Economy Monthly newsletter from Swedbank’s Economic Research Department, continued No. 7 • 31 October 2011SwedbankEconomic Research Department Swedbank’s monthly The Global Economy newsletter is published as a service to our customers. We believe that we have used reliable sources and methods in the preparationSE-105 34 Stockholm, Sweden of the analyses reported in this publication. However, we cannot guarantee the accuracy orPhone +46-8-5859 7740 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) on other material as well. Neither Swedbank nor its employees may be held responsible forLegally responsible publisher losses or damages, direct or indirect, owing to any errors or omissions in Swedbank’sCecilia Hermansson, +46-88-5859 7720. monthly The Global Economy newsletter.Magnus Alvesson, +46-8-5859 3341Jörgen Kennemar, +46-8-5859 7730 4 (4)