Tuesday, July 5, 2011

Growth slowing down

The world economy is now at a crucial stage and further consolidation in the 2nd half of the year may put pressure on policy makers.

The economic slowdown has been a fact now, but the question is how long this situation will persist?
In the US, the most known Weekly Leading Index (WLI) Growth indicator of the Economic Cycle Research
Institute (ECRI) declined to 2.0 during the last week of June making it 10 consecutive weeks of decline from
the 11-month interim high of 7.8 for the week ending on April 15. A significant decline in the WLI has been a
leading indicator for six of the seven recessions since the 1960s.
Apart from US, other concerns are the EU debt problem, slowing down of Chinese growth and tightening
policy by central banks in emerging Asia.
Inflation pressures have prompted most Asian central banks to be among the quickest to withdraw monetary
stimulus as growth gather speed following the global recession in 2009. India, South Korea, Thailand and
Taiwan raised their benchmark interest rates further to contain rising prices, while China raised banks cash
reserve requirements.
The recent data shows Asia's economy continues to slow due to tightening policy and staggering growth in
the US & Europe. Comments from Asian central bankers suggest tighter policy will remain a near-term
priority despite growth is slowing down. Purchasing manufacturer indexes for India and South Korea, China
and Taiwan for June slipped, recent data revealed.
However, Asian economies are still at a better shape than that of Europe ex Germany. The high EU debt is a
major concern for the global economy. Rising sovereign yield in most of the EU economies is causing
government debt refinancing difficult. Rating agencies such as S&P, Moody and Fitch has been continuously
downgrading sovereign rating of EU countries.

Most of the EU economies are now violating the Maastricht treaty which formed the EU. As per the treaty
member states must avoid excessive government deficits. Their performance is measured against two
reference ratios- 3% of GDP for the annual deficit and 60% of GDP for the stock of government debt. Apart
from that, inflation should not exceed by more than 1.5 percentage points that of the three best performing
Member States in terms of price stability in the previous year.

Due to rising debt/GDP and high fiscal deficit, government across Europe including UK are tremendous
pressure and most specially from rating agencies. A cut in sovereign rating causes rise in sovereign yield and
resulting government debt financing difficult.
France, Italy, Ireland, Portugal, Spain and Greece have undergone vast reforms in the form austerity
measures to cut down their fiscal deficit and debt to GDP ratio.
French government announced a three-year freeze on public spending which has started from this year. The
Italian government approved austerity measures worth 24 billion euros for 2011-2012 including a three-year
freeze on pay for civil servants, wage cuts for ministers and new taxes for stock options and bonuses.
Ireland adopted two austerity plans in 2009 totaling 7 billion euros. The measures include reduction in social
welfare payments and cuts of between 5 and 15 percent in civil servant salaries. Portugal has announced an
austerity package including a rise in sales tax by one percentage point to 21% and a cut in salaries for public
officials as well as an income tax surcharge for high earners. The Spanish parliament austerity plan includes a
pay cut for civil servants. The cuts are on top of a 50-billion-euroausterity package announced in January.

And most recently, Greek Prime Minister George Papandreou won approval of two bills to authorize his 78
billion-euro ($113 billion) package of budget cuts and asset sales, a key to receiving further international financial aid. The Greek austerity measures adopted are harsh and the country erupted in violence on the day
of the first parliamentary vote. The five-year plan put forward by the Greek Socialist government consists of
public spending cuts of €14.32 billion, tax rises worth €14.09 billion and the raising of €50 billion from
privatizations. The United Nations independent expert on foreign debt and human rights has said that the
austerity measures and structural reforms proposed to solve Greece’s debt crisis may result in violations of
the basic human rights of the country’s people.
The Greek if defaults could have caused significant impact to business and markets. Policymakers seem to
have avoided it as of now.

Germany, France and Italy and UK are the major holders of Greek debt. The bailout of Greece by EU-IMF is
nothing but bailing out of German, Italy and French banks. Despite the bailout event, overall business and
consumer sentiment remains weak in EU.
The recent data shows slowing down activity in manufacturing and services. Consumer confidence remains
weak. Industrial and Services confidence are sliding.
The austerity package is expected to have negative impact on growth yet the economic growth is needed if
the country has to service its debts. In the case of Greece, the country may sooner or later may default. Now
the further question is whether the defaults will end with Greece. Apart from Greece, no other EU countries
have a dirty balance sheet. However, small counties like Portugal and Ireland, whose public debt-to-GDP
levels are between 90% and 100% and that, have fairly bad unemployment levels may get pressure.
Italy’s public debt to GDP ratio is close to Germany, but the economy is far more diverse and resilient; its
unemployment rate, around 9%, is not disastrous. Spain’s unemployment rates are worrying, but at around
60% its debt-to-GDP level is less burdensome.
The euro zone problem does not seem to be a short term issue and it will have a long term impact on growth
of these countries.
Apart from EU, further weakening of economic activity in the US and most especially in China and other Asian
countries may have a serious concern. In such a scenario, we may see further fiscal stimulus and loose
monetary easing by government authorities.

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