Slowing down of Growth, EU debt Problem - where we are heading?

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”.

Impact of Greece Default on Institutions and Countries

Impact of Greece Default on Institutions and Countries

 Greece Debt Exposure by countries

Greece Debt Exposure by countries and Institutions 

Chinese Inflation data tomorrow

China is due to release its consumer price inflation data for May. As per median forecast available from Bloomberg News Survey, CPI in the country is expected around 5.5% compared to 5.3% in April. Consumer inflation hit a 32-month high of 5.4% in March. To curb the rising rate of inflation, the PBoC hiked its benchmark interest rates 4 times since October 2010 and raised the required reserve ratio for commercial banks 5 times this year to a record high of 21 %. The government’s target for full year is 4% inflation.

Why Chinese CPI is important?

China, India and emerging Asia has been leading contributor in global recovery after a major recession started from late 2007. Chinese economy is the second largest in the world to replace Japan recently. Chinese economy has been growing at a pace of 9%-11% while the US and EU are growing a pace of 1.8% and 2.5% respectively. Japan is now in a recession with GDP falling 3.5% during 1^st quarter.  Both and US are not likely to cross the 2% mark as indicated by recent data releases.

Now, a rise in inflation is a risk (short term problem) may impact the long term objective of the policy markers. Chinese property bubble is a growing threat for the domestic economy and the same way for the global economy. If inflation level persists then we may see further tightening policy by the PBoC (People bank of China) which may slow down economic activity. The Chinese tightening may impact financial market to a considerable extent leading decline in industrials and energies, deep correction in global stocks.

As per World Bank, inflation control should still be the government top priority.

This lead a bearish mindset for markets

Few Thoughts about market

The Euro and GBP is expected to depreciate against the US dollar on phasing out of US QE2nd. The ECB hawkish comments failed to bring in any rally in Euro as market ignored yield differential and looking at rising yield of PIIGS nations. A concern of public debt is to weigh on the common currency.

Chats of EURUSD looking bearish, expected to test 1.43 and probably 1.41 as well. GBPUSD may drop till 1.60 or 1.58 this time.

Macro economic data across the globe is at poor reading. Globe growth to slow down during the 2^nd quarter. US dollar should appreciate as a safe haven on weak economic data. Apart from end of QE 2^nd may lead to winding up of carry trade in US dollar.

Japanese yen may see some investment interest on risk aversion.

Commodities such as industrials, energies and dollar prices commodities to decline this June

Indian stocks see lower on to see lower move on rate hike prospects due to higher inflation level, weak manufacturing data and global selling in riskier assets.

Weak global PMI, Inflation and end of US QE2nd - Pressure on commodities to build up from June

The starting of June was disappointing from economic data perspective. As per reports released on 1^st June, Manufacturing PMI across Europe, US and Asia fell during May.  

China known as the major consumer for metals and energy has seen manufacturing activity slowing down for second straight month in May. Chinese manufacturing PMI fell to 52.0 in May from 52.9 in April. It is evident that the world's second-biggest economy is slowing marginally but does not point to a sharp slowdown in its vast manufacturing sector. Chinese inflation is still above 5% which may prompt PBoC (People Bank of China) for further monetary tightening. China’s economy has entered a tough period in June, with the drought crisis and power outages. Enduring high inflation pressures and uncertainties in external liquidity also add to the need to combat excessive price gains rather than maintain growth

In Europe, apart from public debt concern from Greece, Portugal, Ireland, Spain and Italy, slowing down of manufacturing activity has a reason for concern. The Inflation in the common area rose to 2.8% above the target rate set by the European central bank. The ECB which has more focus on price stability compared to Bank of England. Fuelled by a spike in energy costs as well as for raw materials, the ECB lifted its benchmark interest rate from 1% to 1.25% with a further quarter-point rise expected over the summer. Rise in rates along with public debt concern may further dampen the manufacturing growth in the common currency area. As per reading of May, EU Manufacturing PMI dropped to 54.6 from 58.0 in April. The fall in the index was the largest since November 2008.

Moving to UK, manufacturing PMI read at 52.1 in May, from a downwardly revised 54.4 in April. Growth in Manufacturing in the UK is the slowest pace in last 20 months. The UK is now witnessing a high level of inflation with CPI slightly below 5%. Inflation expectation are growing in the economy with rise in commodity prices, however the BoE is still very cautious on taking any step towards monetary tightening. UK GDP growth for 1^st quarter is expected at 1.8% as per estimates.

In US, the US Institute for Supply Management's manufacturing index also came lower than the previous month, with a May reading of 53.5 compared April's reading of 60.4. Most of the developed market except Australia and Japan has a reading of 50 in their PMI till now, which shows expansion, otherwise contraction. As inflation is heading up, any monetary tightening may hinder expansion of manufacturing sector and may lead to further softening. We do not see any tightening policy further in US and UK for next 2-3 months, but sentiment may build up in the market as ECB set for rate hike in July meeting.

In emerging Asia, most of the economies are witnessing higher inflation and now with manufacturing slowdown. Headline inflation in Asia ex Japan has been rising rapidly since the second half of 2010, reaching a 29-month high of 5.8% in March 2011. While food inflation has been driving headline inflation higher, core inflation pressures have also been elevated, tracking at a high of 3.9% in March 2011. The process of taming inflation will ultimately be damaging to growth. The results seem revealed now. As per recent data Purchasing Managers’ Indices for India, Korea, Taiwan and Singapore all worsened.

In India, the HSBC Markit PMI based on a survey of around 500 companies, fell to 57.5 in May from 58.0 in April. It was the lowest level since it hit 56.8 in January. The decline was less than those of developed market. South Korea manufacturing growth dropped to its slowest pace in six months, with HSBC's PMI falling to 51.2 from 51.7. Taiwan's had a similar drop with the HSBC PMI falling to 54.9 in May from 58.2 in April. In Singapore, the index dropped 1.7 points to 50.8 in May, from 52.5 in April. In Asia pacific, Australian AIG May PMI fell to 47.7, a contraction for 3^rd Month. Nine out of the 12 manufacturing sub-sectors recorded declines in activity during the month, with the clothing and footwear sub-sector recording the steepest contraction, followed by the chemical, petroleum & coal products sub-sector.

The result suggest pressure on commodity prices as slow down of demand in industrials such as Copper, Nickel, Lead, Zinc, aluminium and Silver and for energies like Crude oil and natural gas. Another critical factor need to be mentioned is the end of Quantitative easing by the Federal Reserve Bank, US which has been a major driver rise in global commodity prices. Last November, the Fed announced that they would buy an additional $600 billion of long term treasuries ($75 billion each month) pumping liquidity in the market and keeping the market rate of interest at lower levels. These purchases are scheduled to be completed by the end of June which will provide a focal point of speculation about the impact on the prices of a wide range of assets, including commodities.

Ultra-loose monetary conditions are particularly helpful for commodity prices because they minimize the opportunity cost of holding assets that do not pay any interest, while increasing demand for hedges against inflation. Global commodity prices do at least appear to have tracked the increases in the Fed’s holdings of Treasuries since early 2009. The end of the Fed’s Treasury purchases under QE2 may become a major turning point for commodity prices, which may lead to US dollar recovery and pressure on dollar prices commodities.

Commodity prices should ease with demand slowdown along with US dollar recovery after the end of QE 2^nd.