We all remember the panic situation during2008 - job cut, tight liquidity, sell off in financial markets, bankruptcy filing by big investment bankers etc. Now, we stand here with a global recovery phase. The world economy has survived from one of the dirtiest phase of downturn called the “.Great recession”.
However, the recovery has been fragile and mostly monetary and fiscal stimulus based. Developed economies such as the US and Europe are still maintaining low rate of interest as the recovery has not been strong. Ben Bernanke- the Fed chairman said that the growth in the US has been frustratingly slow, citing his concern.
The world economy is now at a crucial stage and further consolidation in the 2H may put pressure on policy makers. The graph below shows the slowing down of manufacturing and services in the developed market.
Source- Bloomberg
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. The following table shows present ratings and rating outlook.
| Europe, Debt and Present Ratings | Rating Outlook | ||||||
| Country | Debt Billion | S&P | Moody | Fitch | S&P | Moody | Fitch |
| Italy | 2,342 | A+u | Aa2 | AA- | NEG | -- | STABLE |
| France | 1,902 | AAAu | WR | AAA | STABLE | STABLE | STABLE |
| Germany | 1,810 | AAAu | Aaa | AAA | STABLE | STABLE | STABLE |
| Spain | 940 | AA | Aa2 | AA+ | NEG | NEG | NEG |
| Greece | 498 | CCC | Caa1 | B+ | NEG | NEG | -- |
| Netherlands | 460 | AAAu | -- | AAA | STABLE | STABLE | STABLE |
| Belgium | 452 | AA+u | Aa1 | AA+ | NEG | STABLE | NEG |
| Austria | 279 | AAA | Aaa | AAA | STABLE | STABLE | STABLE |
| Portugal | 212 | BBB- | Baa1 | BBB- | NEG | -- | -- |
| Ireland | 207 | BBB+ | Baa3 | BBB+ | STABLE | NEG | NEG |
| Iceland | 19 | BBB- | Baa3 | BB+ | NEG | NEG | STABLE |
| Hungary | 147 | BBB- | Baa3 | BBB- | NEG | NEG | STABLE |
| Russia | 128 | BBB | Baa1 | BBB | STABLE | STABLE | POS |
Source- Bloomberg
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.
| Major EU Countries | Real GDP YoY | Debt/ GDP ratio | Deficit/Surplus % GDP | Unemployment Rate | CPI YoY | Consumer Confidence |
| Germany | 4.9 | 78.8 | -3.3 | 7 | 2.3 | 109 |
| France | 2.2 | 83.5 | -7 | 9.4 | 2 | -36 |
| Italy | 1 | 118.1 | -4.6 | 8.1 | 2.7 | 105.8 |
| Spain | 0.8 | 63.4 | -9.2 | 20.7 | 3.2 | 74.3 |
| Portugal | -0.6 | 83.2 | -9.1 | 12.6 | 3.8 | -50.7 |
| Greece | -5.5 | 144 | -10.5 | 16.2 | 3.292 | -75 |
| Ireland | 0.1 | 94.2 | -32.4 | 14.2 | 2.7 | 56.3 |
Source- Bloomberg, www.tradingeconomics.com
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. See the Greek Debt holding by major institutions in the table below.
| Company/Govt Institutions | Exposure in Greece Debt | Business |
| Marfin | €2.3 billion | Marfin Investment Group is a Greek investment company |
| Societe Generale | €2.9 billion | Global Financial Service |
| Commerzbank | €2.9 billion | Global Financial Service |
| Generali | €3.0 billion | Italy's largest insurance company. |
| Hellenic Post bank | €3.1 billion | Hellenic Post bank is a Greek savings bank. |
| Dexia | €3.5 billion | Diversified Belgian financial services company. |
| Alpha Bank | €3.7 billion | Greece's second biggest bank. |
| ATE Bank | €4.6 billion | Greek commercial bank |
| BNP Paribas | €5.0 billion | Global Financial Service |
| Bank of Greece legacy loans | €6.0 billion | |
| FMS | €6.3 billion | German bailed out banks Depfa and Hypo Real Estate |
| Euro bank EFG | €9.0 billion | Greek bank, ranking the country's third largest. |
| Piraeus Bank | €9.4 billion | Greek bank with a presence in Eastern Europe. |
| European central banks | €13.1 billion | |
| The National Bank of Greece | €13.7 billion | |
| IMF | €15 billion | |
| Rest of the world's governments | €25 billion | |
| Greek public sector funding | €30 billion | |
| European Union Loans | €38 billion | |
| Euro system SMP | €49 billion | The Euro system SMP (securities market program) is the bond buying program conducted by the European Central Bank and its member banks. |
Source- Business insider, Note-Data are approximate and not exact
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.
Source- Bloomberg
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.
It is the time which will tell us where we are heading- are we going towards another recession like 2009 or it is a small consolidation phase after the “recovery phase”.
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