After 2008’s banking crisis, the recession in 2009, perhaps the next phase of global economic turmoil will come from public finances.
Our focus will be on Europe, where there has been growing evidence of countries with acute public finance problems. Spain recently had its rating downgraded by moody’s rating agency and Greece was downgraded deeper into junk status. Whilst perhaps the best approach would be that of a discriminating view on the continent, the complication is the use of a common currency. This takes away the flexibility in terms of what can be done to address some of the problems. Because of the use of the Euro as the common currency, the countries can no longer finance by printing money for instance or devaluing their currencies for competitiveness purposes.
European leaders have been working around the clock in managing the crisis. Recently, they increased the size of the bailout Fund (European Financial Stability Facility) to 440 billion Euro and lowered interest rates on the loans to Greece. Further they also revealed that the bailout Fund can now buy bonds directly from the governments in certain circumstances, on condition the countries agree to further stringent measures.
Not withstanding the above measures, there remains a fair amount of concerns on the growth prospects in the zone. That said, we are not prophesying gloom and doom, but below are some of the points for consideration:
Reduction of budget deficits: Given some of the country’s debt levels and borrowing costs, one of the measures and conditions coming with the bailout packages is the reduction on government expenditure. The concern is that reduction in state spending reduces aggregate demand. Capital expenditure by governments will create employment, increase retail participation and the multiplier goes on and on. A good example would from our neighbours South Africa during their preparation for the world cup. The accelerated government expenditure mitigated the impact of the recession in that economy.
Negative confidence for the region: The ability to attract investment is certainly compromised. This is both from a cost of borrowing effect coming from the sharp increases in yield on government paper, which would lead to more stringent borrowing conditions for corporate and households.
Negative equity on assets: The crisis had a significant impact on investments. History has showed the link between rising equity markets and consumer spending. Consumers are generally less inclined to spend if they feel their net worth has been eroded. Again consumption is a big part of the economic equation and a contributor to overall GDP.
The depreciation of the Euro currency: Whilst currency depreciation boosts price competitiveness on exports, it also makes imports very expensive. With the reduction of imports coming into the zone, there would be an increase in the prices of domestic products. This is an inflationary situation and it eats into the purchasing power of the consumer, still resulting to a reduction in consumer spending equation of the economy.
Global Inflation threats: Annual Inflation in the Euro zone came in at 2.4% in February, up from 2.3% in January. Although not significant, what we can see is an upward trend which is likely to be further impacted by the Arab nation’s unrest driven higher oil prices. The European Central Bank has kept interest rates at unprecedented low levels in an effort to stimulate economic activity. With the inflation threat, there might be a reversal to the stance in an attempt to control inflation. This would exacerbate an already fragile situation in terms of the general cost of capital in the region.
High unemployment rate: Although slightly lower than the December level of 10%, the rate of 9.9% is still relatively high. Again, unemployed Europeans cannot really participate in the economy and further create an increased burden to the state.
Given the continents overall contribution to the world GDP, developments in Europe will very much contribute to the overall recovery or lack of in the global economy. From an investment perspective, continued weak fundamentals will continue to impact negatively owing to the high integration and correlations that exist among the developed world markets.
Source: www.observer.org.sz
Our focus will be on Europe, where there has been growing evidence of countries with acute public finance problems. Spain recently had its rating downgraded by moody’s rating agency and Greece was downgraded deeper into junk status. Whilst perhaps the best approach would be that of a discriminating view on the continent, the complication is the use of a common currency. This takes away the flexibility in terms of what can be done to address some of the problems. Because of the use of the Euro as the common currency, the countries can no longer finance by printing money for instance or devaluing their currencies for competitiveness purposes.
European leaders have been working around the clock in managing the crisis. Recently, they increased the size of the bailout Fund (European Financial Stability Facility) to 440 billion Euro and lowered interest rates on the loans to Greece. Further they also revealed that the bailout Fund can now buy bonds directly from the governments in certain circumstances, on condition the countries agree to further stringent measures.
Not withstanding the above measures, there remains a fair amount of concerns on the growth prospects in the zone. That said, we are not prophesying gloom and doom, but below are some of the points for consideration:
Reduction of budget deficits: Given some of the country’s debt levels and borrowing costs, one of the measures and conditions coming with the bailout packages is the reduction on government expenditure. The concern is that reduction in state spending reduces aggregate demand. Capital expenditure by governments will create employment, increase retail participation and the multiplier goes on and on. A good example would from our neighbours South Africa during their preparation for the world cup. The accelerated government expenditure mitigated the impact of the recession in that economy.
Negative confidence for the region: The ability to attract investment is certainly compromised. This is both from a cost of borrowing effect coming from the sharp increases in yield on government paper, which would lead to more stringent borrowing conditions for corporate and households.
Negative equity on assets: The crisis had a significant impact on investments. History has showed the link between rising equity markets and consumer spending. Consumers are generally less inclined to spend if they feel their net worth has been eroded. Again consumption is a big part of the economic equation and a contributor to overall GDP.
The depreciation of the Euro currency: Whilst currency depreciation boosts price competitiveness on exports, it also makes imports very expensive. With the reduction of imports coming into the zone, there would be an increase in the prices of domestic products. This is an inflationary situation and it eats into the purchasing power of the consumer, still resulting to a reduction in consumer spending equation of the economy.
Global Inflation threats: Annual Inflation in the Euro zone came in at 2.4% in February, up from 2.3% in January. Although not significant, what we can see is an upward trend which is likely to be further impacted by the Arab nation’s unrest driven higher oil prices. The European Central Bank has kept interest rates at unprecedented low levels in an effort to stimulate economic activity. With the inflation threat, there might be a reversal to the stance in an attempt to control inflation. This would exacerbate an already fragile situation in terms of the general cost of capital in the region.
High unemployment rate: Although slightly lower than the December level of 10%, the rate of 9.9% is still relatively high. Again, unemployed Europeans cannot really participate in the economy and further create an increased burden to the state.
Given the continents overall contribution to the world GDP, developments in Europe will very much contribute to the overall recovery or lack of in the global economy. From an investment perspective, continued weak fundamentals will continue to impact negatively owing to the high integration and correlations that exist among the developed world markets.
Source: www.observer.org.sz
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