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

1. The Global Economy
Monthly letter from Swedbank’s Economic Research Department
by Cecilia Hermansson No. 5 • 22 June 2011
The global economy is slowing and
political risks are becoming even more critical
The global slowdown doesn't 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 shouldn't have to be so dramatic, since a
Disappointment is the defining feature of most
normalisation after last year’s rebound was to be
economic forecasts right now. The chief reason is
expected, although conditions could worsen if the
economic 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 more
Concerns have risen that economic growth is turbulent financial markets and weaker real
slowing too much in Asia, led by China, India and economic growth. If politicians fail to address reform
Japan, that the US economy won’t be able to grow issues or make mistakes in phasing out stimulus
quickly 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 (%)
15,0
the world decelerates. Add to that uncertainty in the China
wake of sovereign debt crises in Greece, Ireland, 12,5
Portugal, Spain, the UK and the US. The financial 10,0
markets are especially worried about the Greek 7,5
India
crisis, which has been exacerbated by the political 5,0
Brazil
Percent
situation and lack of consensus in the euro zone. 2,5 US
0,0
The recovery has continued since the start of the Eurozone
-2,5
year, however, despite the Japanese tsunami and UK
-5,0
nuclear disaster, the Arab Spring and increased
-7,5
uncertainty about oil production, rising commodity
prices and debt problems. We are now seeing a -10,0 Japan
growing number of economic forecasters revise -12,5
06 07 08 09 10
their outlook downward compared with the start of
Source: Reuters EcoWin
Ekonomiska sekretariatet, Swedbank AB (publ), 105 34 Stockholm, tfn 08-5859 1000
E-mail: ek.sekr@swedbank.se www.swedbank.se Ansvarig utgivare: Cecilia Hermansson, 08-5859 7720.
Magnus Alvesson, 08-5859 3341, Jörgen Kennemar, 08-5859 7730

2. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 6 • 22 June 2011
How can political risks be reduced? The stimulus being applied through
monetary and fiscal policies has to be
We 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 to
reduce the risk of economic policy miscalculations Brazil and India have to increase capacity
in the years ahead. During the financial crisis by making productive investments and
economic policies were coordinated to a greater thereby reduce the tension between supply
extent. It is again high time that politicians show and demand. Also, credit growth has to be
they will take responsibility for avoiding renewed held in check and monetary policy must be
turbulence 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 Commission's 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.
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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. It
Percent
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 the
As we intimated in our last monthly letter, there are euro zone, but it does threaten French and German
now signs of a slowdown in Europe as the rest of banks in particular, as well as the Greek banking
the world decelerates. The purchasing managers system. In the long run there is also a risk to the
index is still above 50, but has fallen from the high ECB’s balance sheet if the securities pledged as
levels during the rebound following the financial collateral become worthless should Greece default.
crisis/recession.
The euro countries have now decided not to lend to
Inflation in May fell to 2.7% (from 2.8% in April) in Greece unless the parliament in Athens supports
the euro zone and to 3.2% in the EU (from 3.3%). th
the austerity plans (evidence 28 of June). The IMF
Food and energy prices have risen, but underlying cannot pay out its share unless the euro countries
inflation remains low. The ECB will continue to raise rd
guarantee financing next year (3 of July). By
interest rates, though cautiously, at the same time giving Greece a new package, European banks will
that its unconventional monetary policies will remain have more time to reduce their positions vis-à-vis
in place (more or less voluntarily) to support th
Greece (11 of July).
financial stability in the euro zone.
The new Greek government, led by George
The focus is on financial stability, and thus on the Papandreou and his party Pasok, has won the vote
PIGS 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 the
cabinet, 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 will
become 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 to
July. There are also worries whether euro zone avoid a Greek default. At this point they can only
politicians and citizens will be willing to support cross their fingers!
Greece with additional funds, since it will not be
ready to return to the financial market until next US structural problems are underestimated
year and needs several years to ease its debt
burden, 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 (and
and, by extension, the international financial 2.3% in real terms) in the first quarter, expectations
market, and an issue for the euro alliance. were revised downward to between 2% and 3%.
Our 3% projection may have to be slightly revised
Greece has problems with both liquidity and downward in our fall outlook.
solvency, although the line between the two can be
fuzzy. To date programmes have focused on The Achilles heel of the US economy is the
liquidity and avoiding missed payments. German interconnection between the labour, housing and
politicians have demanded that lenders take greater
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4. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 6 • 22 June 2011
credit markets. Kick-starting growth will mean that ceiling. The most likely scenario is that agreements
households 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, albeit
way 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 US
that haven't been addressed are delaying the economy leading up to next year's election while
recovery. The rise in inflation at the consumer price the Democrats are trying to pass a stimulus that
level is mainly the result of higher gas prices. could improve the outlook. Unemployment, which
Underlying inflation is still low. Federal Reserve will due to a higher labour supply and weak demand is
wait to increase the Fed Funds rate during this 9.1%, is the stumbling block. Since the 1930s no
year. president has been re-elected when unemployment
is higher than 7.2%. This doesn't leave much time
The labour market has been the source of for President Obama. A quick reduction in
disappointment. The fact that private consumption unemployment would seem practically impossible.
has still held its own is partly because the savings
ratio has again dropped, from near the historical US labour market (%)
average of just over 8% to nearly 5%. Debt has 12,5
declined as a share of disposable income, but Unemployment
probably has to be reduced further. This means that 10,0
the growth in private consumption not yet is
sustainable. 7,5
US household debt and savings in relation to disposable 5,0
Procent
income (%)
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%. Of
growth engines to help in the restructuring of the course we have to keep in mind that the Chinese
economy and improve growth prospects. The risk, are probably undervaluing the real number. The
however, 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 and
that businesses are saying that they can't find indicates that inflation at the consumer price level is
enough skilled labour (the percentage of leading being underestimated. The fact that the authorities
companies that say they have recruiting problems, at this point have assigned food a lower weight in
according to the staffing firm Manpower, has risen the currency basket could be one way to address a
from 14% in 2010 to 52% this year). This is politically sensitive situation.
affecting the competitiveness of the export sector
on 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 – and
The focus is also on political developments, large capital inflows tied to very high domestic
including negotiations on the budget and debt liquidity. The Chinese administration is trying to
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5. The Global Economy
Monthly newsletter from Swedbank’s Economic Research Department, continued
No. 6 • 22 June 2011
slow down lending by raising interest rates and Japan – downside bias
bank reserve requirements (from 14% to 19% for
small banks as of 2010 and from 15.5% to 21% for Despite the earthquake, tsunami and nuclear
large banks). The nominal lending rate is still disaster in March, we forecast in April that GDP
insignificantly higher than the official inflation rate, growth for 2011 would be positive. It is possible we
however, which in essence represents a continued were too optimistic. Despite that the first quarter
stimulus through the financial sector. Compared had only two weeks left after the disaster, GDP fell
with credit growth of around 30% during the crisis, it by 0.7% at an annual rate and by 3.5% in real
is now down to 15%, but the question is whether terms,. Underlying growth was already weak, and
this is enough of a slowdown. Decelerating too during the second quarter this trend is likely to
quickly 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 been
Percent
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 index
After China’s currency reserves rose by nearly SEK 10 50
Percent
200 billion in the first quarter, they have now 0 45
reached US 3 trillion. China is allowing the renminbi
to appreciate against the dollar, but in trade-related -10 40
terms the rate remains relatively stable. China's -20 35
slightly higher inflation will allow some appreciation
in real terms, however. -30 30
-40 25
Another way to choke inflation would be to allow the
Chinese to invest abroad, which would reduce -50 20
capital inflow in net terms – which to date has 02 03 04 05 06 07 08 09 10 11
increased when China buys foreign currency to Source: Reuters EcoWin
stave off the currency’s appreciation.
Industrial production and exports have declined
It seems clear that China hasn’t yet alleviated its substantially, while the purchasing managers index
problems with overheating and that the tools has nevertheless remained above 50. This could be
available at its disposal to reduce the risk of a hard because certain key sectors have been harder hit
landing aren’t effective enough. How inflation in than others (cars, electronics).
consumer and real estate prices is handled in the
quarters ahead is critical. Our forecast of GDP The Japanese central bank has expanded its
growth of 8.8% this year may have to be revised balance sheet by buying securities – a strategy it
upward given the relatively strong start to the year, may have to use again. Its benchmark interest rate
but a slightly stronger slowdown cannot be ruled out has been held at zero. The focus should now be on
yet. fiscal policy, but there is a lack of political
consensus whether to stimulate the economy when
the debt ratio exceeds 200%. The political coalition
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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
Japan's 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 sales
n
12,5
and inflation at the consumer price level.
10,0 Inflation was 6.55% in May, exceeding the central
Percent
bank's 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
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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
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