- Western Europe: consumption and investment continue to slump
- Emerging Europe: deterioration of bank portfolios
The trend toward improvement that emerged in the second quarter has stayed on track with economic stability even growth now expected across the entire region. The timid recovery that began mainly in France and Germany has spread to Italy. But Spain, Iceland, and Ireland are still mired in a significant economic downturn: the shakeout in the property sector has continued with the massive debt of economic actors consequently amplified by the collapse of their net worth. The high leverage of its financial and household sectors still weighs on the United Kingdom's economy. The situation also remains difficult in Finland and Portugal in an unfavourable geographic and sector context.
Consumption continues to benefit from tax measures, particularly car purchase incentives, and the decline in consumer prices. While the destocking process has eased considerably current stock levels are expected to prove insufficient to satisfy demand. A restocking phenomenon will thus likely make a positive contribution to the recovery of production. Foreign trade has been making a positive contribution to the economy with exports experiencing a moderate recovery and imports either stagnant or still in decline. Corporate investment has continued to fall however affected by the collapse of capacity utilisation rates while residential investment is still in the doldrums, the few encouraging signs appearing in the United Kingdom and France notwithstanding.
The overall economic upturn has spawned a slight growth recovery in industry and services but not in construction, particularly non-residential, which has been struggling to find financing. The renewed confidence of economic actors in conjunction with the improvement in order books, particularly for exports, augurs continuation of the overall positive trend.
But appearances can be deceptive. Although there has definitely been a rebound, it remains moderate after starting from very low levels of economic activity. It could thus fade quickly in the face of the obstacles in its path. Confidence level indicators like the IFO and PMI indices bear out this scenario with the improvement they reflect remaining at disappointing levels.
And consumption could indeed be in for some rough going with unemployment continuing to rise and wages put under increasing pressure by companies intent on restoring their profitability. Retail prices will doubtless rise at a faster pace due to the waning impact of the decline in raw material prices. The prospect of increased fiscal pressure in conjunction with the negative wealth effect and the uncertainties surrounding the incipient recovery will doubtless prompt households to reduce their debt burdens, save more, and remain prudent on spending.
Corporate investment will continue to fall notably with the capacity utilisation rate down to only about 70°per cent from the pre-crisis level of 80 per cent.
Exports will hardly be likely to speed up much as a result of a recovery in emerging regions weak on imports and in view of the appreciation of the euro and related currencies. The continued weakening of the pound sterling could, however, bolster the United Kingdom's sales abroad.
In this context, payment incidents have remained commonplace in the region despite the efforts by companies to adjust their costs to the (durable) decline in business activity or, in some cases, to increase their margins where allowed by market conditions. The disparities in the fortunes of regional countries have remained substantial due particularly to differences in their initial profitability levels and the severity of the downturns caused by the crisis. While British and German companies, for example, have in general already restored their productivity levels through cost-cutting, that is not yet the case for their sister companies in Southern Europe.
In Germany (rated A2 since March 2009), the timid recovery that emerged in the second quarter is particularly expected to gain strength from the export stimulus. Economic activity will nonetheless remain far below the level prevailing before the crisis. Beyond the large payment defaults resulting from the announced bankruptcies of Arcandor and Wadan Yards, corporate payment failures have been rising slowly despite the cushioning effect played by their good profitability and low pre-crisis debt levels. As the recovery develops, the greater selectivity exercised by banks in granting loans could particularly affect smaller companies. Austria (A2 since June 2009), where payment incidents have also been rising slowly, will likely benefit from the upturn in Germany and initiate an economic recovery.
In France (A2 since March 2009), after a destocking phase, production is expected to begin to recover albeit at a moderate clip with order books still thin. Amid growing unemployment, a likely upsurge of inflation, and increased unemployment, household consumption will likely remain flat in coming months. Although the financial position of large companies has improved significantly, smaller companies have remained weak while the volume of cash advances continued to shrink. Corporate bankruptcies increased 23 per cent in the twelve-month period ending 31 August with resulting cost to suppliers up 75 per cent for the period.
In the United Kingdom (A3 since March 2009), hope for a very modest recovery this quarter was dashed. Nevertheless, despite the severity of the economic decline, the deterioration of payment behaviour has been successfully kept under control notwithstanding the peaks observed in some sectors like non-food retail, construction, property, plasturgy, business services, wood and paper processing, and transport. Some companies, especially among the largest, acted quickly to adjust to the new level of activity and improve their profitability through drastic cost-cutting.
In Italy (A3 since March 2009), the crisis seems to have peaked with a weak recovery expected to emerge this quarter. But the economy nonetheless remains saddled with major structural problems that existed before the crisis. The payment default rate remains very high.
In Spain (A3 since March 2009), there is no recovery in sight at this juncture. Consumption has suffered greatly from the continued shrinking of the property bubble and will continue to do so in a context of tighter fiscal policy. And exports remain hobbled by a lack of competitiveness. Payment incidents have remained at very high levels with banks exercising increasing prudence.
In Ireland (A3 since March 2009), although the economy stabilised somewhat in the second quarter, the extent of the downturn it has suffered since last year is impressive. Domestic demand, especially residential investment, has continued to slump. Buoyed by gains in competitiveness, exports could make a positive contribution to the economy. And payment behaviour remains poor at this juncture.
In Greece (A3 since March 2009) and Portugal (A3 since June 2009), the contraction of imports in the wake of falling domestic demand has paved the way for reducing the huge current account deficit burdening each country. The two economies will nonetheless continue to suffer from an unfavourable environment in both geographic and sector-specialisation terms with the deteriorated condition of public sector finances moreover depriving the respective governments of room to manoeuvre on measures of economic support.
In Scandinavia, the Netherlands (A2 since June 2009), Switzerland (A1 since March 2009), the economic situation has varied widely, from Norway (A2 since March 2009) where the recession was brief and mild thanks especially to the country's oil resources, to Finland (A2 since June 2009) affected by the problems in nearby Russia and the Baltic States and by the drop in its exports of paper products and telecom equipment, Sweden (A1 since March 2009), the Netherlands, and Switzerland buffeted by the decline in world trade, and Denmark (A2 since March 2009) contending with a slump in domestic demand.
But payment behaviour has nonetheless deteriorated across the region in many sectors: retail (home furnishings, clothing), business services (information technology, temporary work, property, in particular), transport, trading, and automotive repair, catering, paper, printing publishing (CH & NL). The growth expected in these countries this quarter will likely lead to a reduction in payment incidents.
In Belgium (A2 since March 2009), high labours costs and the persistence of tight credit conditions have undermined corporate competitiveness and investment. High public sector debt — over 100 per cent of GDP — has kept the government from taking measures to stimulate domestic consumption. Despite the recession, corporate payment behaviour has been satisfactory.
Although a regional financial crisis has been avoided some countries have remained very weak.
Economic activity continued to slump in the second quarter except in Poland. Although a slight improvement is expected in the second half, the drop in regional GDP will likely come to about four per cent for the full year. The three Baltic States (Estonia and Lithuania: A4 since June 2009, Latvia: B since June 2009) have been hit hardest with their economies shrinking on average 19 per cent year-on-year in the second quarter. For the same period, the declines ranged from seven to nine per cent in Romania (B since March 2009), Hungary (A4 since March 2009), and Turkey (B since March 2009). The Czech Republic (A2 since March 2009), Slovakia (A3 since June 2009) and Bulgaria (B since March 2009), meanwhile, suffered relatively mild contractions of their GDP of about five per cent. It now appears almost certain, however, that Poland (A3 since March 2009) will avoid a recession entirely this year thanks to its large domestic market and the improved economic conditions in Germany. Poland was the only European country to achieve positive growth in both the first and second quarters, up respectively 0.8 and 1.1 per cent.
Despite the first signs that economic activity may be firming up in the euro zone, only very measured optimism remains in order for 2010 in emerging Europe. Many factors will limit the extent of the recovery in the region including the slow pace of the household and corporate debt reduction process, the measured expansion of credit, the limited growth or freezing of wages, and rising unemployment, all compounded by the lack of fiscal room for manoeuvre due to the deterioration of public sector finances. And regional growth will depend heavily on the strength of economic conditions prevailing in Western Europe. Regional GDP growth will thus not be very likely to exceed 1.5 per cent next year.
The tensions in financial markets have begun to subside since March this year reflecting the easing of foreign investor aversion to risk and the massive aid granted by the IMF to regional countries in difficulty. The easing process has continued in the second half spurred by the good news from the euro zone and the reduction in the uncertainties surrounding the strength of China's growth.
Regional banks have in general weathered the financial crisis relatively well thanks to satisfactory solvency ratios and the limited degree of disinvestment by their parent companies, even if further recapitalisations will doubtless prove necessary. The main source of concern at this juncture is the quality of bank portfolios, which deteriorated markedly amid the decline in economic activity and, in countries with floating exchange rate regimes, currency depreciations.
The recession, the deterioration of public finances, and the increased volatility of exchange rates, have considerably reduced the likelihood of the European Union's new member countries adopting the single currency any time soon, a prospect now postponed until 2014-2015 at the earliest.
CIS and Russia: the persistent difficulties experienced by companies and banks have resulted in major defaults in the region.
The financial situation and growth prospects of CIS countries have continued to deteriorate. Despite aid granted by international institutions, the succession of recapitalisations of banks in difficulty, and the many stimulus measures taken by governments, economic activity continued to decline, a trend substantially borne out by indicators of economic activity in the first two quarters this year. Regional GDP is expected to decline about 6.6 per cent for the full current year before rebounding to 2.1 per cent in 2010 thanks especially to the gradual recovery of oil prices and the upturn of world demand.
Russia (C since March 2009) and Ukraine (D since March 2009) have been affected most, suffering recessions in the second quarter of the year down respectively 10.9 per cent and 18 per cent year on year.
The impact of the foreign demand decline, credit crunch, investment downturn, and consumption slump on the Russian economy has been greater than expected this year. The fiscal stimulus measures, the injection of over $80 billion into the economy, and the interest rate cuts made by the authorities since April 2009 have not been enough to stem the contraction of either the credit supply or the economy. The recovery of crude prices will nonetheless take some of the pressure off foreign accounts and public sector finances but will impede any adjustment in the rouble and improvement in Russian competitiveness.
Ukraine has been in even weaker condition and its currency, the hryvnia, has been under severe pressure evidenced by the episodes of depreciation this summer. Exchange rate risk seems likely to persist in the near term and remain highly dependent on capital outflows associated with repayment of foreign debt (particularly that of Naftogaz), developments relative to payment of the fourth tranche of the loan granted by the IMF, distrust of the banking system, and political uncertainties in the run-up to the presidential election scheduled 17 January 2010. All the more so with the government obliged to alleviate the financial difficulties experienced by the state-run gas company Naftogaz, which announced this past 30 September its payment default on $500 billion in Eurobonds that have reached maturity.
Kazakhstan (rated B), meanwhile, seems to be faring better, affected by a relatively mild 2.3 per cent recession in the first half of the year. But Kazakhstan nonetheless continues to grapple with major difficulties associated with its crisis-ridden banking sector and the shaky global economic environment. Despite aid granted by the government, the financial system has remained in very poor shape with economic growth thus expected to contract by one per cent for the full current year. The proportion of non-performing loans continues to rise with Kazakhstan's two largest banks, BTA and Alliance going into default last spring: restructuring of their debt is now imperative. The government, however, with little outstanding debt, was able to avert systemic risk by intervening promptly with the aid of the stabilisation fund to recapitalise or even nationalise the weakest banks. But the government underscored the selectivity of its support, eliminating in consequence banks not in compliance with the new capital adequacy ratios or principles of good governance.
- United States: expected to emerge from recession in the third quarter of the year, but with household debt reduction impeding a strong recovery
- Canada: also expected to emerge from recession in the third quarter with a sustained recovery depending on economic conditions in the United States
United States (A2 since March 2009)
The United States economy stopped deteriorating in the second quarter (down 0.7 per cent Q/Q annualised), driven mainly by public spending and net exports. Consumption, investment, and stocks have continued to undermine growth. The signs of improvement this summer suggest that the economy may be levelling off. The question remains, however, whether these signs can evolve into a sustainable trend capable of generating strong growth in 2010. Our scenario is prudent calling for a soft recovery in 2010 (up 1.3 per cent) for the following reasons:
· Household consumption has benefited from temporary government measures (tax credits, social transfer payments, incentives for car purchase and first-time home buyers, for example) and low inflation.There are still risks that could prompt households to spend less, continue paying off debt (down three per cent since 2008), and replenish emergency savings (4.2 per cent in July). The risks include the still high level of household debt (128 per cent of disposable income), an entrenched deterioration of the job market with the unemployment rate currently 9.8 per cent, the contraction of disposable income associated with resurgent inflation, an ongoing public deficit.
· Housing prices, some recent timid growth notwithstanding, are still very low, down 16 per cent year-on-year in June 2009 and exceeded by household mortgage repayments with payment defaults and repossessions thus expected to continue and the stock of available homes to remain high (8.5 months).
· The recovery of manufacturing production, very dependent on the automotive sector and the cash-for-clunkers programme and on consumer goods sectors could prove to be just a technical recovery, the destocking phase having been of shorter duration than expected and with companies tending, in view of the existing overcapacity, to remain prudent, gearing their stocks and production as closely as possible to current demand.
· Deterioration of the commercial construction sector could ultimately affect bank balance sheets.
· Exports (10 per cent of GDP) have not benefited from the stronger economic activity in Asia, particularly China, with that region only providing a market for 19 per cent of sales abroad including 6.0 per cent for China.
Thanks to some drastic cost-cutting starting in the fourth quarter last year large companies were able to limit the decline in their rate of profit and significantly improve their cash flow-to-capital expenditures ratio (87.4 per cent in 2009 for the rate and 111.6 per cent for the ratio according to Natixis estimates). They are thus in a position to resume investing and create jobs but have not begun to so as yet.
The large-company situation has tended to obscure the difficulties encountered by smaller companies in gaining access to bank credit. According to the Federal Deposit Insurance Corporation, over 400 of the regional banks that are very close to smaller companies are rated high risks. In this context, corporate bankruptcies will likely continue (up 40 per cent in May 2009 compared to May last year) notwithstanding the emergence from recession expected in the third quarter. The sectors hit hardest include automotives (dealers and parts-makers), residential and commercial construction, and consumer staples (clothing, furniture, leisure, and so on). Others like mechanicals and public works, for example, are, however, expected to begin benefiting by year-end from the vast infrastructure remediation programme initiated by the Obama administration and local communities
The fiscal deficit and the federal debt will deteriorate in consequence, increasing respectively to 12.7 per cent and 84.4 per cent of GDP.
Canada (A2 since March 2009)
Recovery is expected this quarter.
Despite the very negative economic fallout from the neighbouring US economy, the deterioration of payment behaviour has been both limited in relative terms and concentrated in Ontario and sectors like export-dependent automotives and in property-related services and the catering industry. With low levels of public and private debt, a speculative property bubble limited to western provinces intoxicated by soaring raw material prices, and a perfectly healthy banking system Canada came into the crisis particularly well-positioned to cope with its effects. The incipient economic upturn across its southern border coupled with the upswing of raw material prices will moreover support the recovery process. An excessive appreciation of the Canadian dollar could, however, hamper the recovery of sales abroad.
Latin America: Central America has fared less well than regional countries to the south
Several Latin American countries have been affected by the global financial and economic crisis, sinking into recession as a result with regional GDP down just over two per cent this year. Unlike their performance in the recent past, however, most regional countries have shown a certain capacity to cope and do not appear seriously threatened by either monetary or financial crises. Some signs of recovery have moreover appeared since mid-year, particularly in Brazil (which has technically already emerged from recession), auguring an economic recovery in the region of about three per cent by 2010 provided the external environment has become more favourable by then.
The disparity in economic fortunes across the region reflects the underlying dichotomy in the foreign trade arena. To the north, Mexico (with a quarter of regional GDP), Central American, and the Caribbean area are heavily dependent on North American demand and have thus been severely affected by the recession gripping the United States: Mexico, for example, with its economy likely to contract an estimated seven per cent this year, is expected to suffer its worst recession in over a quarter century. The southern portion of the region, meanwhile, with its natural wealth making it particularly attractive to Asian countries, notably China, has developed more geographically diversified foreign trade enabling it to cushion the impact of the global crisis.
As a result of the deterioration of public and external accounts, Latin America has large financing needs while the crisis has made liquidity and credit scarcer and access to more volatile international capital markets more difficult. This situation seems manageable, however, for most large economies — Brazil (A4 since January 2009), Chile (A2 since January 2009), Colombia and Mexico (both A4 since March 2009), and Peru (B) — thanks to their relatively healthy economic and financial fundamentals. Mexico and Colombia have moreover strengthened their external positions by concluding agreements with the IMF last April/May for "modular credit lines" intended for countries with strong performance but feeling the crisis effects. And since early this year Brazil and Colombia have successfully floated sovereign bond issues on international financial markets despite competition from massive issues by developed countries. The prevailing conditions for external financing have nonetheless remained troublesome for Argentina°(C) — yet to normalise its relations with its public and private creditors since the restructuring of its debt in 2005 and thus deprived of access to international financial markets — and Venezuela°(C°since June 2009) —– successful in raising funds abroad but on costly terms.
Thanks to the improvement in public sector finances nonetheless achieved in recent years by several Latin American countries, their governments have enjoyed some room to manoeuvre in implementing fiscal stimulus policies warranted by the exacerbation of the global economic crisis. The resulting stimulus measures have come, however, at a cost that will ultimately increase even further an average public debt ratio for Latin America already exceeding the overall emerging-country average. And with the region once again facing a full electoral calendar, the possibility of overly generous tax breaks raises the spectre of slippage in public sector finances.
Presidential elections are notably scheduled this year in Uruguay (B) in October and Chile (December) and next year in Colombia (May) and Brazil (October).
In Argentina and Mexico, gains made by the opposition marked the legislative by-elections held late June and early July this year and the consequent diminished authority of their respective presidents will not be conducive to the exercise of greater fiscal discipline.
Many private companies in the region have been grappling with cashflow difficulties attributable to a range of factors: the reluctance of local banks to grant loans, an increase in the proportion of outstanding debt reaching maturity, the depreciation of some local currencies with the pressure on companies carrying foreign currency debt increasing in consequence. That could lead in turn to an increase in corporate bankruptcies as has been the case in developed countries.
The C rating for Honduras negative watchlisted due to the worsening of the economic and financial situation attributable to the political crisis triggered by the military coup late June this year.
The political situation has remained gridlocked since the removal of President Manuel Zelaya (Liberal Party) from office by the army late June this year, and subsequent nomination on an interim basis of the President of Congress, Roberto Micheletti. This changeover has drawn condemnation from the international community including the Organisation of American States and the United Nations. After the failure of the mediation led by the Costa Rican president Oscar Arias, Mr. Zelaya's return to the country late September has only made the overall situation more inextricable.
Even before that political crisis, the economic outlook in Honduras was very unfavourable due to the recession in the United States, the country's main trading partner and source of expatriate remittances. And with its depressing effect on household consumption and public and private investment, the political turmoil has caused an even more pronounced economic contraction.
The political crisis has also had a profound effect on public finances already in poor shape, on the main exports — coffee and bananas — and on tourism. And the higher cost of oil since Venezuela repudiated the preferential Petrocaribe agreement has made imports more expensive. Furthermore, although most of the very large current account deficit can only be financed by bilateral or multilateral aid, the political crisis has led to the suspension of that aid from its three sources: the World Bank, the American Development Bank, and — subject to negotiations on renewal of the confirmation agreement that expired last April — the IMF.
The country's political, economic, and social stability would become unsustainable if the inflows of aid and the international relations on which they depend are not restored very soon. The current gridlocked situation calls imperatively for a renewal of negotiations to pave the way for breaking out of the crisis.
- Emerging Asia: stimulus measures at the core of the recovery
- Japan: deflationary spiral once again in 2009 and modest recovery in 2010
- Australia: recession averted
- New Zealand: five quarters in recession
After the Lehman Brothers bankruptcy, Emerging Asia was significantly affected by the resulting drop in exports and domestic demand. Foreign demand for medium and high technology manufactured products (automotives, electronics, capital goods) particularly sensitive to global investment cycles contracted as evidenced by the precipitous fall of exports, down 70 per cent in the fourth quarter last year and first quarter this year, which was twice the decline suffered in 2001 as a result of the crisis triggered by the bursting Internet bubble.
And domestic demand was affected by the loss of confidence, rise of unemployment, the credit crunch, and the increase in emergency savings. Indicators for the first half this year nonetheless attest to a gradual recovery, driven by China's rebounding growth, up 7.1 per cent for the period thanks to dynamic domestic demand. The recovery is attributable to three main factors: (1) strong expansionary monetary and fiscal policies in certain countries, (2) resumption of capital inflows and proper functioning of financial markets, thereby paving the way to easing the financial difficulties of small exporting companies and restoring household and corporate confidence, and an (3) industrial rebound notably fuelled by the stock replenishment process.
(1) Support provided by monetary and fiscal policies were instrumental in easing the tight credit conditions and the decline of domestic demand. Central Banks proceeded with interest rate cuts in India, Indonesia, Korea, Malaysia, the Philippines, Taiwan, Thailand, Singapore, thus providing adequate liquidity to the interbank market. In China, the removal of ceilings on loans in conjunction with the low interest rates spurred a strong credit expansion, up 24 per cent in the first half this year. Thanks moreover to the generally sound fiscal situation prevailing in Asia, the fiscal stimulus measures taken there were stronger than in other regions. China has implemented the most ambitious stimulus programme, which could represent as much as five per cent of GDP in 2009-2010. South Korea is a close second with a stimulus programme reaching 4.7 per cent of GDP, followed by Singapore (3.4 per cent) and Malaysia (3.0 per cent). Most of the programmes give priority to spurring consumption, especially in South Korea, and improving infrastructure, as in China.
(2) A new influx of capital to Asia in a context of easing aversion to risk and rebounding stock markets has also been responsible for the economic recovery. Over the first eight months of the year, stock markets were up 65 per cent in ASEAN countries (Indonesia, Malaysia, Philippines, and Thailand), 62 per cent in India, 52 per cent in the four very open economies (Hong Kong, Korea, Singapore, Taiwan), 47 per cent in China. In this favourable context, spreads on corporate debt in Emerging Asia have narrowed by over 250 basis points since January 2009, easing the financial difficulties of companies and households in consequence. The credit expansion has moreover resumed in the very open economies and India thanks to the restoration of adequate liquidity and the sound capitalisation ratios of banks.
(3) The stock replenishment process has also fuelled the recovery. In reaction to the decline of demand in 2008, companies cut back on production and reduced stocks. Since early this year, however, amid a gradual recovery of domestic demand and exports, a stock replenishment process got under way, particularly in Korea and Taiwan.
And the trend toward recovery will likely continue in the second half of the year. The slowdown under way this year in 2009 (with 5.2 per cent growth expected for Emerging Asia down from 6.5 per cent in 2008) will thus be moderate with growth then expected to accelerate in 2010 (up 7.7 per cent) fuelled by the gradual revival of foreign demand.
- China (A3 since January 2009) and India (A3 since January 2005) will be the two economic engines with respective growth rates of 8.5 per cent and 6.0 per cent expected in 2009 and 10 per cent and 8 per cent in 2010. This dynamism is largely attributable to expansionary economic policies expected to foster rapid growth of domestic demand. In India's case in particular, the country's capacity to cope with difficulties derives from its relatively closed economy and the dynamism of domestic demand. And the Congress Party's comfortable victory in the last elections is expected to enable it to initiate the reform process necessary to eliminate economic choke points, particularly in terms of infrastructure. In China, the stimulus implemented via the banking sector, especially the lifting of loan quotas, have been mainly responsible for the economic rebound.
- In South Korea (A2 since March 2009), after bottoming out in the 2008 fourth quarter, the economy achieved positive quarter-on-quarter growth in the first two quarters this year, respectively up 0.1 per cent and then up 2.5 per cent. The recession is thus expected to be limited to down 0.1 per cent for the full current year and the economy could resume rapid growth in 2010 with up four per cent expected thanks to solid fundamentals.
Although the three wide open economies — Hong Kong (A2 since March 2009), Taiwan (A2 since March 2009) and Singapore (A2 since March 2009) — achieved positive quarter-on-quarter growth in the second quarter this year, they remain very export dependent and will be in recession for the full current year, down respectively two per cent, four per cent, and three per cent; which explains why they remain negative watchlisted. A gradual recovery is expected in 2010, however, with the threesome likely to achieve positive growth once again.
- For ASEAN economies the outlooks are divergent. While the open economies, Malaysia (A2 since March 2009) and Thailand (A3 since March 2009) will be in recession in 2009 (down 3.5 per cent expected), the Philippines (B since March 2005), Indonesia (B since March 2004) and to a lesser degree Vietnam (B since June 2008) are expected to achieve strong performance. In 2010, however, all ASEAN countries will achieve positive growth with up four per cent expected overall for the period.
The recovery will not, however, be risk-free. The rapid credit expansion in several countries notably China could lead to over-investment and overcapacity. And the risk of engendering a speculative bubble has grown and the deterioration in the quality of banking-system assets is already noticeable. The government loan-guarantee systems implemented in several countries, like South Korea, could foster excessive risk-taking.
Even with the recovery expected in 2010, Emerging Asian growth will not, however, reach pre-crisis levels (9.5 per cent in 2007 for example) with the timid recovery expected in the United States and Europe dimming the outlook for the region's exports. And an adjustment in the growth regime seems to be under way. Gradual implementation of social security systems, planned as part of several stimulus programmes, could ultimately strengthen the role of domestic demand as an economic engine by paving the way for reductions in emergency savings by households. And reducing the reliance on foreign debt, which will require developing the role of domestic financing, remains moreover a major challenge, particularly in countries like South Korea and India with high debt abroad.
South Korea's A2 rating removed from negative watchlist reflecting the investment-driven growth recovery spurred by expansionary monetary and fiscal policies
China's A3 rating removed from negative watchlist status reflecting the economic recovery driven by a credit boom.
The South Korean economy, very open and integrated into international capital markets, suffered from the global economic and financial crisis in 2008 but recovery is already in progress.
The economy bottomed out in the 2008 fourth quarter. In the first two quarters this year, the country achieved positive quarter-on-quarter growth respectively 0.1 per cent and 2.3 per cent thanks to the won depreciation's favourable impact on exports and to expansionary monetary and fiscal policies. The Central Bank made several reductions in interest rates and legal reserves and the government implemented a stimulus programme — involving income tax reductions, public sector investment, and support for smaller companies and needy households — representing nearly four per cent of GDP. Authorities also withdrew $55 billion from foreign exchange reserves to support the banking system and strengthened the loan guarantees extended to smaller companies.
The trend toward recovery is expected to stay on track in the second half and the recession for the full current year could be limited in consequence with down one per cent expected. The fiscal and monetary stimulus measures will likely foster a gradual investment recovery. Private consumption will remain sluggish, however, amid rising unemployment and tightening credit conditions. And exports will begin to show some dynamism.
In 2010, under the hypothesis of a gradual recovery of global growth, the economy could rebound with four per cent growth expected. South Korea's economic growth rests on solid fundamentals including a diversified industrial base competitive in new technologies, an effective education system, and high R&D spending. Exports could begin to grow again, particularly to China, South Korea's main trading partner. Domestic demand is moreover expected to strengthen gradually in a context of easing aversion to risk and an expected credit recovery.
There are nonetheless persistent weaknesses. Household and corporate debt remains too high. Companies are faced with doubts as to the sustainability of their debt: if a credit crunch develops they would have to make adjustments by improving their profitability and cash flow-to-capital expenditures ratio or else cut back on investments. Companies moreover remain exposed to exchange rate risk. For households, their growing debt burden increases the sensitivity of their net worth to interest rate variations and income shocks.
South Korea remains nonetheless in good financial health. Public sector debt is expected to remain sustainable. In deficit in 2008, the current account is expected to show a surplus this year: South Korea will thus enjoy financing capacity. Foreign debt — with over 80 per cent borne by the private sector — will likely remain stable in absolute terms. Despite the proportion of short-term debt and the high volatility of portfolio investments, the risk of a foreign currency liquidity crisis has been kept under control thanks to large foreign exchange reserves representing nine or ten months of imports.
Although the global crisis severely affected the banking sector, systemic risk is expected to remain limited. After the Lehman Brothers bankruptcy, Korean banks, with substantial short-term foreign debt, suffered from the reduction of credit lines, and they were only able to renew 40 per cent of their short-term debt. To avoid widespread default, the government withdrew $55 billion from foreign exchange reserves to provide banks with swap and credit lines while the Fed granted $30 billion in swap lines to the Central Bank. The government also injected capital into several state-run banks. Thanks to the strenuous measures taken by officials, a systemic crisis was avoided. In 2009-2010, under the hypothesis of a gradual clean-up of bank balance sheets and continued government support for the banking sector, systemic risk will remain limited.
In 2008, the economy slowed due essentially to internal imbalances (overcapacity in the steel, automotive, and construction industries) and restrictive economic policies that remained in force for too long. Exports only began to slump from November 2008. Bankruptcies in industries saddled with overcapacity and among low value-added export companies increased, particularly in the Guangdong region. Over 10,000 factories representing two-thirds of the textile industry closed down. And 3,600 toy manufacturers failed in the first half last year, representing 53 per cent of all toy producers in China. The economy then bottomed out in the 2008 fourth quarter. In that context, the government adopted an expansionary policy mix. The Central Bank reduced interest rates and legal reserves while loan quotas were discontinued. Thanks to the low level of public sector debt (18 per cent of GDP) and a high savings rate, the government was in a position to adopt a $586 billion stimulus programme focused on large infrastructures projects (investments in transport and electricity, reconstruction of area devastated by the earthquake) and on social programmes (education, subsidies to rural populations, housing aid). Late 2008, officials made adjustments in foreign exchange policy intended to make the yuan more stable in support of export sectors in difficulty.
In the first half this year, strong growth resumed (up 7.1 per cent year-on-year) driven by the recovery of domestic demand. Urban investment in particular soared 31 per cent in the first quarter and then 43 per cent in the second, Underpinned by heavy social spending consumption was very dynamic as evidenced by a surge in retail sales, up 16 per cent in the first quarter and then up 43 per cent in the next quarter. Car sales benefited moreover from a reduction in taxes on purchases of small cars. And the property market rebounded with home sales surging 50 per cent in the second quarter.
That trend is expected to stay on track in the second half and in 2010. And economic growth could be as high as 8.5 per cent for the full current year and 10 per cent in 2010. Domestic demand is expected to drive the economy whereas the growth contribution of net exports will likely be close to nil (increases in VAT reimbursements on exported products notwithstanding).
There are, however, persistent weaknesses:
· The strong credit expansion — up 27 per cent from January to August this year compared to up 16 per cent for all of 2008) is not devoid of risk. Possible deterioration of bank assets constitutes a source of concern even if systemic risk will likely remain under control with the government enjoying ample room for manoeuvre to cope with any difficulties that may arise. But the risk of engendering a speculative bubble will bear watching. In the near term, however, an alarmist assessment of conditions in the property and stock markets would be premature. The strength of demand in the property market quite logically puts pressure on prices to the extent that the tight policy pursued by the government in 2007-2008 resulted in the delay, even freezing, of many projects and thus slowed normal development of the supply of property for sale. Demographics, urbanisation, and middle class-family aspirations for better housing will moreover durably underpin China's property market. Likewise, despite the strong stock market recovery since early this year began (up 47 per cent), the composite Shanghai index is still below its October 2007 peak. And the fact that stock market capitalisation in relation to GDP is just 32 per cent in China — far below the 67 per cent ratio for Japan and 87 per cent for the United States — would tend to mitigate the macroeconomic consequences of a crisis.
Japan (A2 since March 2009)
Japan emerged from recession in the second quarter this year with economic growth (up 0.6 per cent quarter-on-quarter) driven by household consumption and a modest upturn. The benefit to Japanese consumers of measures taken by the Aso administration last April to spur car buying and energy-saving consumer electronics contributed to the improvement in the economy. Exports, meanwhile, achieved modest growth due mainly to orders from China for transport equipment, electric appliances, and chemical products. Corporate investment and stocks continued, however, to severely undermine growth. The growth pattern will be largely the same in the third quarter except that the focus of export business will shift from China to the United States, underpinned by the cash-for-clunkers programme through end-August.
Economic growth is thus expected to remain negative for the full current year, down six per cent, and then strengthen considerably in 2010 to a positive 1.1 per cent. Exports will not return to pre-crisis levels as long as households in OECD countries (market for 30 per cent of Japanese sales abroad) continue to focus on reducing their debt and as long as domestic demand in emerging countries, particularly China (16 per cent of exports) continues to be satisfied by local production with little foreign content. The yen's appreciation against the currencies of the main trading partners, if it lasts, will contribute to both undermining the competitiveness of Japanese exports and reducing the prices of imported products. In this context, the rates of profit and cash flow-to-capital expenditures ratios of Japanese companies will likely continue to deteriorate. With the capacity utilisation-rate in the manufacturing sector an estimated 57°per cent, investment will continue to contract.
The labour market is thus expected to continue to deteriorate and wages to trend down. Consumption could, however, gain support from the measures announced by the new Hatoyama government administration (reduction or discontinuation of provisional tax on petrol, bonus for children from June 2010, for example) and the renewal of measures taken by the previous administration. But any resulting improvement in consumption would be limited by the continued deflationary spiral (down 2.4 per cent in August this year compared to August 2008) in progress this year and by the process of replenishing emergency savings which have dropped from 6.8 per cent in 2008 to 3.7 per cent by 2010.
The infrastructure-related spending called into question by the new administration will affect the profits of companies in several sectors including construction, construction-related materials, and metallurgy. Measures directed at households will, however, particularly benefit the retail, food, and people-services sectors.
The ongoing fiscal stimulus programme and the sharp contraction of revenues will widen the public sector deficit (from a negative nine per cent of GDP estimated for 2009 to a negative ten per cent expected for 2010), and the already colossal government debt will grow even more (over 191 per cent of GDP this year and 198 per cent next year).
Australia (A2 since January 2009) The economy is expected to grow 0.5 per cent in 2009 and 1.1 per cent in 2010. Australia has thus far avoided slipping into recession during the global crisis thanks to a range of government measures directed at households (tax rebates, aid to first-time home buyers via the First Home Owner Grant programme) and to companies. Other factors have contributed to the country's staying power: exports of iron ore and coal (34°per cent of sales abroad) with China a major market and cuts in the Central Bank's key rates since September 2008 (down 425 basis points to reach three per cent in April), which benefited consumption by easing household debt service. Unemployment increased moderately with companies giving preference to reductions in working time over layoffs. Household debt has nonetheless remained high at 156 per cent of disposable income, which will likely prompt households to exercise a degree of prudence in making purchases and to replenish emergency savings, especially with the interest rate hikes initiated by the Royal Bank of Australia early October likely to hamper repayment of their property loans. Despite unfavourable exchange rates since last March with the AUD gaining 22 per cent against the currencies of the country's main trading partners, mining sector companies will continue to benefit from the flow of orders from China. The proportion of export sales now absorbed by China (up from 15 per cent to 20 per cent in just two years) nonetheless constitutes a risk of increasing dependence on its great neighbour. Measures taken by the government in support of infrastructure and construction will continue at the same pace as in 2009. The public sector deficit (a negative 3.8 per cent of GDP) could, however, stabilise with the debt increasing only slightly (22.7 per cent of GDP). The bankruptcy rate eased considerably from May to July (up 5.6 per cent).
New Zealand (A1)
Five quarters of recession have fuelled a surge in corporate bankruptcies. The recovery that emerged in the second quarter has thus brought welcome relief. Dairy industry exports have benefited from a favourable regional context (Asia, Australia). Consumption has been moderate in strength with the positive contribution from immigration offset by a still tight employment market, stagnation of incomes, and the growth of savings. The recent moderation has been a timely development, contributing to the trade surplus and the reduction of a current account deficit whose size was a major weakness even before the onset of the global crisis.
Near&Middle East and North Africa: speedier recovery in oil countries
Countries in this region have been affected by the global crisis, particularly oil economies contending with a contraction of oil demand and a decline in barrel prices. The Near&Middle East (ex Turkey) and North Africa will lose an estimated three points of growth this year compared to 2008 down from 5.4 per cent to 2.4 per cent. The global economy has shown signs of improvement likely to benefit the region via a demand recovery and higher hydrocarbon prices in 2010. The region could regain slightly more than two points of growth in consequence.
The decline in both foreign demand and barrel prices has affected the region's oil producing countries. In the six Gulf Cooperation Council countries (Saudi Arabia, United Arab Emirates, Kuwait, Qatar, Oman and Bahrain), the global crisis also led to declines in the securities and property markets. The credit crunch and increased financing costs prompted the cancellation or postponement, in value terms, of 23 per cent of the investment projects planned. But despite the drop in oil revenues most oil exporting countries were still able to pursue expansionary policies and support the non-oil sector thanks to the reserves built up these past years. With oil production down, however, between eight and ten per cent, Saudi Arabia (A4), the United Arab Emirates (A2), and Kuwait (A2) will nonetheless be in recession in 2009, with their economies shrinking between 1.0 and 1.5 per cent. In the United Arab Emirates federation, the Dubai emirate, which boasts the region's most open economy, suffered most from the global financial crisis.
Spreads for credit-default swaps on Dubai's sovereign debt reached 900 basis points last March but eased to 400 bps in August reflecting the financial support provided by the federation. During the same period spreads on Saudi Arabia, Abu Dhabi, and Qatar dropped from 400 to 200 basis points. The narrowing of these spreads can be interpreted as a sign of emergence from the crisis, reflecting the strengthening of oil prices so far this year.
With an average barrel price of $60 expected for North Sea Brent most oil countries will avoid running twin deficits for the current year. Algeria (A4) and Iran (D) will probably run a public sector deficit.
A relatively soft growth recovery is expected next year in step with foreign demand. Barrel prices will thus be moderately higher, around $70 under our preferred hypothesis, a level that will generally make it possible to run larger trade and fiscal surpluses than those recorded in 2009, but nonetheless still below the levels reached in 2008.
The other regional countries also suffered as a result of the global crisis but none of them have been in recession this year. Although they achieved growth of around four per cent, their economies were nonetheless affected by the contraction of foreign demand, emigrant worker remittances, and foreign direct investment. Egypt (B) moreover suffered a sharp decline in Suez Canal traffic, albeit partly attributable to the piracy risk in the Gulf of Aden. While tourism slumped in Egypt and Jordan (B) in particular, it trended up in Lebanon (C) and Syria (C). Lebanon has shown that it has the capacity to cope effectively with the global crisis thanks particularly to a stronger climate of security. But saddled with high debt (particularly Lebanon), large fiscal imbalances (Lebanon, Jordan, and Egypt), and great dependence on foreign capital (particularly Jordan), these countries have little room for manoeuvre to support their economies. Next year may thus still be too soon for the hoped-for economic recovery to materialise.
Israel (A4), meanwhile, although directly affected via the trade channel, has shown signs of recovery with the rate of recession revised to a negative 0.3 per cent reflecting the trend toward positive growth. As in industrialised companies, the recovery expected in 2010 will be moderate (1.6 per cent).
And in Pakistan (D since March 2009), the political situation continues to give cause for concern and cloud the economic outlook despite mobilisation of massive international aid.
Sub-Saharan Africa: affected by a second wave of the global crisis but still afloat
After achieving near six per cent growth these past five years, sub-Saharan Africa will doubtless suffer more than expected this year from the repercussions of the global economic contraction. Between 2008 and 2009, the continent could lose nearly four points of growth with forecasts for 2009 revised downward to under two per cent (compared to five per cent in October last year). Growth is expected to rebound next year (up 4.0 per cent) but will remain below pre-crisis levels.
Oil countries have been among those suffering most with their growth, while remaining positive, plummeting 5.5 points from 6.9 per cent in 2008 to just 1.4 per cent a year later. Most will be unable to offset the decline in prices by increasing production, whether for technical reasons, as in the case of Nigeria (D) contending with the Niger Delta insurrection, or because of OPEC-imposed constraints.
In Angola (C), economic growth is expected to be nil, down steeply from the near 20 per cent growth maintained these past five years. In 2010, oil countries are, however, expected to benefit from the rebound of prices for black gold and achieve 5.5 per cent growth on average.
Although the great majority of African countries benefited from the decline of oil and foodstuff prices in the first half of the year, they all suffered from the drop in their exports in both volume and value terms and from the decline in flows of financing, particularly foreign direct investment and private transfers. With little diversification, African economies suffered directly from the decline in prices and global demand for their main export products, like diamonds for both Botswana (downgraded to A4 in June 2009) and Namibia (A3) or coltan for the Democratic Republic of Congo (D).
But there are a few noteworthy exceptions like the rise of prices for cocoa benefiting Ghana (C) and the higher prices for cotton (associated with drop in production) benefiting Mali (C) and Burkina Faso (C), and the firm prices for gold with its appeal as a safe haven (Ghana, South Africa, Mali). The decline of foreign direct investment in a context of a global liquidity shortage and increased aversion to risk has primarily affected mineral prospecting and production in Zambia, Uganda (both rated C), and the DRC where these activities have become less profitable. And infrastructure, energy, and transport projects have also been subject to many delays. Foreign direct investment is, however, expected to remain dynamic in telecommunications sectors, particularly in Niger, Ethiopia (both rated C), and in agriculture notably in Mozambique (B), and Mali. Even if estimates of the decline are only rough approximations (down 20 per cent), the drop in private transfers has doubtless affected household consumption in Africa, particularly Senegal (B) and Togo (C), with the transfers representing as much as 30 per cent of goods and services exports. And covering financing needs has consequently become even more difficult. And this is especially true in view of the uncertainties over the capacity of developed countries to meet their bilateral commitments on public development aid notwithstanding the measures taken by the IMF to help African countries cope with the global crisis effects notably via a twofold increase in donation envelopes and increases in concessional loans. In 2010, a moderate 3.4 per cent recovery is expected to benefit non-oil countries thanks to a rebound of exports, FDI, and, underpinned by private transfers, household consumption.
The return of political risk to the African scene was borne out by events in 2009 after several years of growing stability marked by the end of major conflicts involving Angola, the RDC, Sierra Leone (D), Liberia (D), and Rwanda (D) and by the progress made, notably by Ghana and Namibia (D), on improving governance. The coups carried out in Madagascar (C) in January 2009, Guinea (D) December 2008, and Mauritania (C) August 2008) underscored the weakness of democratic processes in Africa. Elections continue to be critical milestones capable of derailing a country's socio-political equilibrium as evidenced by the tensions that marred the election in Gabon (B) in September 2009 or the threat of a resurgence of civil war in Sudan (D) in the run-up to elections scheduled next year.
Negative watchlist status has been maintained for the A3 rating of South Africa, which represents 33 per cent of sub-Saharan Africa's GDP. Sluggish household consumption continues to undermine the South African economy despite the 550-basis point reduction made by the Central Bank in its key rate since December 2008. Platinum and mechanical exports have moreover suffered from the slowdown of global demand. And many public investment projects in infrastructure, energy, and transport have been postponed due the tightening of conditions for obtaining financing with the sovereign rating downgraded by rating agencies. South Africa thus slipped into a technical recession in the first half of the year after two consecutive quarters of negative growth. In the end, the economy is expected to contract, down 1.5 per cent for the full current year, with a recovery getting started in the second half, borne out by the rebound of the rand and stock market indices. However, because of the severe household consumption slump exacerbated by a high level of structural unemployment (24 per cent), the recovery next year is expected to remain below the five per cent average growth maintained from 2004 through 2007.
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