Just three years after the world was plunged into a mercifully short but sharp recession on account of the US sub-prime mortgage market implosion, we face the prospect of another harrowing plunge in the pace of global economic activity. The causes of the downturn this time are superficially similar. But a drastically different political backdrop in Europe, compared to that which prevailed in the US in 2008, means that the recovery from this correction could prove much longer drawn out.
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| An employee at Belgium's Royal Mint scoops up a handful of fifty-euro-cent coins in Brussels. European Union leaders discussed proposals for tighter euro zone integration last week, with the aim of bringing deficits and debt much more strictly into check, a move that may give the European Central Bank room to step up purchases of sovereign bonds and reassure financial markets. REUTERS |
The polite version of a joke doing the rounds in financial markets has it that when Europe has to contend with a German head of the Roman Catholic Church and an Italian head of the European Central Bank, all its historical contradictions will become apparent. That event occurred in October 2011 when Mario Draghi was appointed head of the ECB.
To his credit Mr Draghi has finely balanced thus far the pressures on the ECB to help bail out European debtor nations. On the one hand the ECB has applied a mild economic stimulus, by cutting Euro interest rates twice in two months.
On the other hand it has not thus far caved into demands that he apply drastic measures to print vast amounts of Euros (a.k.a. quantitative easing) in order to buy sovereign bonds issued by European debtor nations and drive their cost of borrowing down from the current very high levels. For instance while Sri Lanka borrowed a billion US dollars in mid-2011 at a 6.25% rate of interest, Italy and Spain are currently having to pay over 7%.
And therein lies the rub.
While Sri Lanka’s economy has the potential to grow faster than 6.5% per annum, investors see no serious threat to its ability to pay a similar rate of interest on its government debt. However, Portugal, Italy, Ireland, Greece and Spain (affectionately referred to as PIIGS in the markets) are probably already tipping into recession, viz. almost zero growth.
Of note is the fact that the PIIGS collectively account for about 25% of the Euro area’s GDP. Thus a slowdown in the PIIGS has implications for Europe’s largest economies including Germany, France and the U.K. A large measure of the growth of the latter nations depend on their exports to the rest of the Eurozone which have grown tremendously since the creation of a customs union among Euro area nations, which abolished the payment of customs duties and other non-tariff barriers at their mutual borders.
If indeed the larger exporting nations of Europe are dragged into a very low-growth or no-growth situation, it will have ominous consequences for the rest of the world. The Eurozone has a combined annual GDP of US$ 16 trillion which exceeds the $14 trillion annual output of the USA. The value of China’s exports to the eurozone have surpassed the value of its exports to the US since 2005.
The US is home to several thousand Eurozone companies which will probably shrink their US operations when their domestic operations stall. US exports to Europe will also slow down dramatically.
Thus the stage is being set for a simultaneous slowdown in the world’s largest economies. This will have a knock-on effect on exporting countries like Sri Lanka which are already impacted by some cancelled charter flights for tourists from Europe and slower tea exports owing to the political turbulence in North Africa.
There is, however, a potential device to stem the slide into global recession. The ECB could start printing Euros and buying the government bonds issued by PIIGS nations, thus emulating the actions of the Federal Reserve Bank in the US during the 2008 crisis. This would instantaneously raise bond prices and lower interest rates and encourage global capital flows back into the Eurozone bond and equity markets.
The confidence engendered by rising bond and equity markets would translate into a broad wealth effect which would induce consumers in Europe to spend more and encourage firms to hire more staff. But this is unlikely to happen in the short-term.
This is because the voters in more successful economies like Germany, Holland and France cannot see why the ECB should bail out profligate over-indebted PIIGS nations and run the risk of causing high rates of future inflation, by virtue of excess money in circulation. Already Eurozone inflation is running at 2.5% which is double the rate of a year ago.
Other solutions include the issuance of Eurozone bonds which will be jointly and severally backed by all Eurozone member states. These bonds could then be swapped by holders to PIIGS debts to replace those holdings. But such a facility has to be ratified by the parliaments of each of the participating 17 member states of the Eurozone and will take several months to happen.
At the time of writing this, the Eurozone heads of state are locked in intense discussions to jointly agree to a fiscal stability pact. The purpose of such a pact would be to apply harsh penalties such as large fines, on member nations that would prevent them over-borrowing to fund lavish government expenditures in the future.
If they did agree and implement such an agreement, it would encourage the ECB to implement a quantitative easing programme on the lines of that envisaged earlier. But the chances of member nations ceding their sovereign right to run budget deficits, to a supra-national body, are currently slim.
As a matter of interest, it is hard to see how such a supra-national body would arrive at consensus on how nations should time the impact of running deficits to counter economic downturns. Economic theory is remarkably ambiguous on the issue of how governments should tackle the cycle of economic slumps and recoveries.
A prime example of the danger of applying inappropriate economic theories to actual circumstances was seen during the Asian economic crisis of 1997/98 when the IMF famously asked stricken governments in the region such as Korea and Thailand, which mostly had balanced budgets, to further tighten government spending.
This only deepened the recession at that time and resulted in the IMF being roundly criticized for its handling of the crisis. A similar debate is building in Europe at the current time on the desirability of imposing severe spending cuts on PIIGS nations. This could tip Europe into a deeper and more prolonged recession than is strictly necessary.
Not surprisingly, most astute policy-makers and economic commentators are predicting doom and gloom ahead. Singapore Prime Minister Lee Hsien Loong has forecast growth in Singapore slowing to 1-3% in 2012 after the blistering expansion of 18% in 2010. And a minority of forecasters in the US see a recession there in mid-2012.
But all is not doom and gloom. Japan, the third largest economy on earth, is busily reconstructing the infrastructure that was ravaged in the March 2011 earthquake and tsunami. China has signaled its intention to ease tight money policies as inflation has fallen in recent months to near 4%, while commencing a massive project to build affordable housing in several cities.
Malaysia, Singapore, Indonesia and Thailand are simultaneously implementing huge public sector projects in all areas of infrastructure including crude oil exploration and refining, railways, real estate and highways.
In short, Asia has the resources and the political will to buck the global downswing as it did in 2009-10. But it will have to move nimbly to offset the outflows of European savings which flooded into Asian capital markets during the preceding two years of economic boom, which are being repatriated to cover losses on bond and equity investments in Europe.
For a small export-dependant economy like Sri Lanka, the message is clear. It has to rapidly re-orient its export and tourism sectors to capture a larger share of the growing affluent consumers across Asia and insulate itself against an economic slowdown.
The Maldives is currently experiencing a boom in arrivals of tourists from China, but there is no evidence of this spilling over into neighbouring Sri Lanka. Efforts should be made to exploit good diplomatic ties and urgently negotiate duty-free tea and garment exports into the fast-growing China market. Ditto for Japan, Korea, Taiwan.
Most important, policy-makers have to ensure that the Sri Lanka Rupee is traded at a competitive rate of exchange against major trading partner nations. There is simply no alternative but for the country to export its way out of a possible economic slowdown in 2012. Grandiose infrastructure projects have to take a back seat to efforts at improving hard currency revenue generation in the year ahead.
(The writer is a former investment manager based in Colombo who once headed the Board of Investment and, is now Managing Director HSBC Private Bank (Suisse) SA, based in
Singapore.) |
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