Source: The Business Times
Author: Vikram Khanna 30/12/2011
NO, the world is not going to crash in 2012 - although financial markets might just - but it's going to be a bumpy ride.
In 2009 and 2010, we were all transfixed by what America was doing to fix the global financial crisis that blew up there and was unleashed across the globe. In 2011, we were more fixated on the eurozone.
In 2012, it will be the 17-nation grouping again, only even more so than in 2011. And Asian economies will feel the ripples.
To be sure, it will not be all gloom in 2012. There is a fledgling economic recovery underway in the United States, where the unemployment rate has dipped below 9 per cent, the housing market is stabilising and analysts are projecting 2.5 per cent growth. The Japanese economy will also benefit from post-tsunami reconstruction, which will move into full swing in 2012. But these positives could be swamped by the deepening problems in Europe.
Throughout 2011, the eurozone has lurched from crisis to crisis, following a script that has become all too familiar. Nervous bond markets push up yields of eurozone sovereign bonds to levels which, if sustained, would lead to default. In response, eurozone politicians organise periodic summits to fix the problem. They come up with patchwork solutions disguised as rescue plans.
These have included:
•establishing the European Financial Stability Facility - which turned out too small;
•repeated bailouts, first for Greece, then for Ireland and Portugal;
•haircuts of 50 per cent on private banks' holdings of Greek debt, which only led markets to panic about possible haircuts on other sovereign holdings, driving yields higher;
•demands for recapitalisation by banks to protect against possible losses from sovereign defaults, which caused lending cutbacks; and
•repeated pledges of fiscal austerity by heavily indebted countries, even in the face of street protests, which has deepened the recession in these countries, rendering ever more elusive their targets on deficits and debts.
Meanwhile, the European Central Bank (ECB) has steadfastly refused to step in as a lender of last resort, confining itself to providing liquidity to banks and making ad hoc purchases of sovereign bonds when things get really bad, but making clear that it is doing this only reluctantly - which only makes market players ask: if even the ECB doesn't like buying this stuff, why should we?
The latest eurozone leaders' summit of Dec 9-11 was billed as a make-or-break event, one that would finally yield a rescue plan that lived up to the description. It came just days after bond yields for Italy and Spain were at record levels, causing markets to panic about a possible Italian default, which could sink the eurozone. Expectations of a dramatic, game-changing announcement were running high.
In the end what materialised was a so-called 'fiscal compact' championed by German Chancellor Angela Merkel, which commits eurozone members to budgetary discipline under the threat of sanctions. The ECB stayed on the sidelines, making no commitment to act as a lender of last resort, though hinting it might do something different if a fiscal compact comes about.
Assuming that it does materialise - it may still need to be passed by national parliaments - it will essentially condemn the eurozone to a prolonged period of budgetary austerity. As such, it is more a suicide pact than a rescue act. Continent-wide spending cuts and tax hikes will further worsen deficits and debts all around, aggravate financial distress and could even precipitate political revolts.
Denied the option of devaluing their currencies, heavily indebted eurozone countries can regain their competitiveness only through enormous 'internal devaluations' - essentially wage and price cuts. This textbook result is extremely unlikely in practice. Wages and prices are usually not flexible downwards, especially in heavily unionised countries such as those of continental Europe.
On Dec 5, the credit rating agency Standard & Poor's put 15 eurozone members, including France and Germany, on negative credit watch, citing 'deepening political, financial and monetary problems'.
There is now a more than even chance that France, for one, will lose its AAA credit rating by March next year. This will not be a disaster in and of itself, but will complicate matters, as France is a major potential funder of any eurozone rescue facility - the costs of which would rise. A downgrading would also raise the cost of funding for French banks and the French state.
The downgrading of other eurozone sovereigns would raise their funding costs as well - no small matter, given that eurozone sovereigns need to raise some 1.6 trillion euros (S$2.69 trillion) next year.
Thus, a plausible scenario for at least the first quarter of 2012 is repeated bouts of panic in the financial markets - even if punctuated by occasional rallies - as it becomes increasingly obvious that the fiscal compact favoured by the German leadership is not going to work.
Some economists believe that eventually - perhaps when the panic intensifies to the point of a market crash - the ECB will finally be forced to unveil its 'bazooka' - that is, open its monetary spigot full blast - as did the US Federal Reserve after the collapse of Lehman Brothers in 2008. But as at now, the ECB and the German leadership seem determined to wring as much fiscal austerity out of the eurozone as possible before considering other options.
Loans to banks
Meanwhile, however, the ECB has unleashed a 489 billion euro programme of cheap three-year loans for eurozone banks. The new credits, which have been gratefully snapped up, will help banks cope with liquidity strains. However, banks will still be burdened with having to raise more capital to get their core tier-1 capital to 9 per cent by mid-2012 to conform to the directives of the European Banking Authority. With the market not conducive to new equity issuance, banks will seek to achieve this target at least partly by cutting back lending, which in turn will deepen the eurozone recession. If banks are unable to raise enough capital, or experience creditor or depositor panic, some of them could face nationalisation - another trend to look out for in 2012.
For the rest of the world, including Asia, a deeper recession in the eurozone, which accounts for 25 per cent of global GDP, is a dire scenario. While it is unlikely that it would lead to a seizure of credit markets as in 2008-09 - policymakers are wiser to this danger now and the ECB is plugging liquidity gaps - it will mean a loss of exports and jobs, the more so if it also threatens to nip the US recovery in the bud.
Bouts of market turmoil will also mean a withdrawal of funds from Asian asset markets as investors flee to safety - a process that has already started and has been felt most acutely in India, where the stock market has corrected by one-third this year and the currency has dived about 18 per cent against the dollar. Further currency market turmoil could be in store for next year, when the euro, in particular, could come under severe pressure. However, a weaker euro (though not a euro collapse) would, on balance, be a plus for the eurozone, mainly because it would provide a boost for the German economy. This is the only silver lining so far in the sorry prognosis for the 17-member grouping.
China's slowdown
Asia will face additional complications in 2012, coming from within the region. Whereas in 2008-09 China was able to ram through a US$586 billion stimulus package, this time it's a different story. The past stimulus - which was essentially an indiscriminate investment binge - led to the build-up of huge overcapacity, especially in capital good industries. It would be a folly for China to add further to this, and it will probably not. High inflation and a crisis in Chinese local government finances are other reasons to avoid further pump priming.
The Chinese authorities are also coping with a fast-deflating real estate bubble in several cities, the consequences of which will become clearer in 2012. They may not be catastrophic, but they will not be pleasant. The European slowdown will further aggravate China's slowdown, which in turn will reverberate across Asia's supply chain, hitting producers of electronics, machinery, commodities and raw materials. Indeed, commodity prices have already started to weaken.
No surprise then that economists have been downgrading their forecasts for the region, including for the Singapore economy. The latest projection is 3 per cent growth during 2012 - which actually might be a good outcome given the circumstances.
But Singapore might have to work for even that much. During the 2008-09 crisis, it had to resort to unorthodox measures - such as the Jobs Credit scheme and loan subsidies for companies - to see itself through. It would be prudent for policymakers to keep in reserve similar extraordinary measures for possible use in 2012. The state of the global economy is such that we need to prepare for the worst, even if we hope for the best.
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