Turmoil in Europe, protectionist pressures may hurt world economy

ASIA is recovering well from the financial crisis but there are still risks to the world economy, including the turmoil in Europe and protectionist pressures in many countries, according to Dr Tony Tan, deputy chairman of the Government of Singapore Investment Corporation (GIC).

Dr Tan told the Swiss Re Forum Singapore yesterday that the global recovery is likely to continue into the next year but at a more moderate pace.

But he cautioned that the rebound is ‘fragile’ and ‘negative shocks could push the global economy towards a recession sooner than expected’.

And while growth prospects are much better for Asia than for the developed world, Dr Tan does not see Asia ‘aggressively challenging’ the global order, which has benefited the region for decades.

‘Asian countries, including China, generally share the view that a multilateral, rules-based international order is critical to their long-term growth and development,’ said Dr Tan. ‘Asia’s rise therefore is not inevitably a zero-sum geopolitical game where the US and Europe must decline as Asian countries grow.’

Dr Tan flagged the turmoil in Europe, saying that growth there should be weaker at around 1 per cent.

According to some analysts, there are growing signs that Europe’s sovereign debt crisis is feeding through into the

euro-area economy in the form of a sharp rise in unemployment and a slowdown in manufacturing recovery.

Dr Tan warned that ‘protectionism also remains a risk despite the recovery, given high unemployment and what seems to be, for the first time in many years, increasing tensions between American and European businesses and the Chinese policy environment’.

Dr Tan’s comments come at a time when investors are increasingly upbeat about Asia’s growth outlook, but less bullish about the global economy.

Earlier this month, the Asian Development Bank raised its 2010 forecast for aggregate growth across Asia – embracing East Asia excluding Japan, South-east Asia, South and Central Asia as well as the Pacific island economies – from 7.5 per cent to 7.9 per cent.

Yet Citigroup forecast global growth to rise 3.7 per cent this year and 3.3 per cent next year, trimming its projections by 0.1 percentage points for each year.

Dr Tan said the post-crisis global economic and financial environment will be affected by three major trends.

The first is that the developed world will take a ‘long time’ to fully heal from the crisis.

The second is the increasing importance of the emerging economies, anchored by Brazil, Russia, India and China.

And the third major trend, as Dr Tan describes it, will be ‘increased vulnerability’ to negative events, and ‘extreme reliance’ on government policies for both support and far- reaching reforms over the next few years.

Dr Tan said: ‘The challenge for policymakers in many developed economies will be to convince markets that they have credible plans to ensure sustainable public finances over the medium to long term, while minimising the negative short-term impact on growth.’

In the emerging economies, policy-makers will have to deal with rising inflation and possible asset price bubbles, he said.

Source: Straits Times, 24 Jul 2010

Dangers to world economy include Europe’s debt turmoil, deleveraging in the United States, and protectionist pressures

A FRAGILE economic recovery could see the world tip back into recession ’sooner than expected’, says Tony Tan, deputy chairman of the Government of Singapore Investment Corp (GIC).

Dr Tan, also GIC’s executive director and chairman of Singapore Press Holdings (SPH), told delegates at the Swiss Re Forum here yesterday that downside risks to the global economy have increased, highlighting three in particular: the debt turmoil in Europe, deleveraging in the United States, and protectionist pressures around the world.

‘It will take a long time for the developed world to fully heal from this crisis,’ Dr Tan said. ‘The economic recovery, while real, is fragile and there is a risk that negative shocks could push the global economy towards a recession sooner than expected.’

Meanwhile, the developing economies will gain in economic importance and will expect more say on world affairs. ‘The shift in economic power to the emerging world will likely increase geopolitical risks,’ he said. ‘Conflicts could also arise over access to natural resources.’

Investors, meanwhile, will have to place a larger proportion of their assets in emerging markets. ‘Far from being a risky and perhaps optional part of their portfolios, emerging markets will become a core and unavoidable asset class in global portfolios,’ he said.

But one major risk investors face is that the global recovery has so far been supported by extraordinarily benign government policies. ‘Changes in policies or mistakes will thus have a significant impact on the global economic and financial environment,’ Dr Tan said. ‘A key challenge for policymakers is to properly time the withdrawal of unprecedented monetary and fiscal policies.’

However, governments will have to juggle exit policies with, in some cases, the pressing need to repair public finances. ‘The challenge for policymakers in many developed economies will be to convince markets that they have credible plans to ensure sustainable public finances over the medium to long term, while minimising the negative short-term impact on growth,’ Dr Tan said.

Asia meanwhile will have its own set of problems. ‘Asia will increasingly face labour, natural resource and commodity constraints to its high-growth strategy.’ As well, growth will have to depend on a more balanced economic model in that case, he said, which should boost Asian currencies and consumption. But policymakers will have to beware asset price bubbles, rising inflation and populist anger in the developed world that could lead to ‘excessive regulation and protectionism’, he warned.

Dr Tan said: ‘Asia is at the cusp of the next stage in its development. There will likely be bumps along the way – perhaps a few crises – but if we learn the right lessons from history, especially those of the recent Great Crisis, Asia will innovate and adapt

Source: Business Times, 24 Jul 2010

ONE of the big surprises in the global economic picture for 2010 so far is how strongly Asian economies have performed, despite lacklustre growth in the G-3 economies of the United States, Europe and Japan.

The International Monetary Fund (IMF) has just raised its 2010 growth forecast for Asia to 7.75 per cent, about 0.5 percentage point higher than it projected as recently as April. Private sector forecasts for the Singapore economy have also been progressively raised as the year has unfolded, with many economists now predicting double-digit growth. The Ministry of Trade and Industry might also raise the official growth forecast following the release of advance GDP estimates for the second quarter.

While all of this may sound like good news, there are reasons to be circumspect. As the IMF has cautioned, Asia is vulnerable to some significant downside risks.

The region’s torrid growth in 2010 so far has been driven both by exports and private domestic demand. Exports have been powered partly by the inventory rebuilding in the advanced economies following the recession of 2008/09, during which inventories were substantially depleted. Private demand has been boosted by massive fiscal stimulus programmes, which were launched across the region, most dramatically in China. However, going forward, both these drivers of growth will be less conspicuous: the inventory restocking process is close to ending, and the impact of fiscal stimulus programmes will also wane from the second half of this year. After that, Asia can no longer rely on temporary growth drivers; it will have to look to traditional sources of growth – namely, demand from the G-3 and, to a lesser extent, sustained domestic consumption.

Unfortunately, neither of these can be taken for granted. While the IMF predicts 3.25 per cent growth for the US economy in 2010, the dismal US unemployment figures suggest that growth will slow in the second half of this year. Ditto for Europe, which is embarking on continent-wide fiscal austerity. There will be negative feedback loops from these developments on Asia’s exports. Exports could suffer further as Asian currencies strengthen against the majors, which is very possible, especially if the Chinese yuan continues to rise. While Asian currency appreciation would have positive effects in boosting domestic consumption and helping to contain asset bubbles, in the short term it will lead to some loss of competitiveness.

Rapid growth also entails costs. In the Singapore context, these could include rising wage and business costs, further exacerbated by increases in foreign worker levies.

Thus, despite the glowing growth forecasts, there are grounds for caution in the months ahead. While Asia’s economies might be on a roll for now, many of them face both internal and external vulnerabilities. Most importantly, the global economy is nowhere near out of the woods. And as we have learnt in 2008 and 2009, that counts for a lot.

Source: Business Times, 14 Jul 2010

(DAEJEON, South Korea) The International Monetary Fund’s chief reiterated yesterday that strong growth in Asia and Latin America made it unlikely that the global economy would suffer a double-dip recession.

Last week, the IMF upgraded its 2010 global economic growth forecast to 4.6 per cent from 4.2 per cent due to robust expansion in Asia and renewed US private demand, but kept its 2011 outlook unchanged at 4.3 per cent.

‘We expect 2011 to be a little lower than the level of 2010. But all this is too far from any kind of double- dip,’ managing director Dominique Strauss-Kahn said.

South Korea’s Finance Minister Yoon Jeung Hyun, who attended the conference too, also voiced confidence in the global economy, saying the recent slowdown in the United States and China was temporary.

The world economy has been recovering this year from its worst downturn in decades, but signs of cooling growth in the world’s largest and third-biggest economies sparked worries that the global upswing could prove short-lived.

‘The recent weak economic data in the US and China is transitory with the end of governments’ stimulus packages. They will be normalised soon,’ Mr Yoon said. – Reuters

Source: Business Times, 14 Jul 2010

Signs from financial markets, real economy point to improving prospects

(PARIS) The signs are growing that Europe may have turned a corner in its struggle to restore financial stability.

The evidence comes partly from financial markets, which are calmer, partly from the real economy, which is perkier, and partly from policy, which is responding at last to some investor concerns.

There are still plenty of risks – lack of faith in planned stress tests of European banks, low or no economic growth, more credit rating agency downgrades of sovereign debt, an eventual Greek default or debt restructuring, weaknesses in eurozone governance, and political resistance to painful reforms.

But on balance, things are starting to look up.

‘The figures we have are not confirming this pessimism,’ European Central Bank president Jean- Claude Trichet said, dismissing analyst predictions of stagnation or even an austerity-induced double- dip recession in the eurozone.

‘There is a tendency among some investors and market participants to underestimate Europe’s ability to take bold decisions,’ Mr Trichet said in an interview with France’s Liberation published on the ECB’s website on Monday.

‘In their defence, I would simply say that the institutional structure of Europe is very different to what they are used to, especially on the other side of the Atlantic.’

Although the Europeans may not have time to arrange the recapitalisation of any banks found vulnerable before the results are published, there is a strong political commitment of governments to do so where necessary, possibly drawing on a newly established eurozone financial backstop, created in May originally to lend to states shut out of credit markets.

The existence of a 440 billion euro (S$766 billion) European Financial Stability Facility (EFSF) guaranteed by eurozone states should reassure investors that any exposed banks won’t be left twisting in the wind, even though it would require a unanimous political decision to use it.

So let’s examine the case for a turning point.

The euro has recovered from lows of around US$1.19 to touch two- month highs above US$1.27 last Friday, partly due to disappointing US economic data.

Spain and Portugal have been able to sell their debt at auctions, albeit paying higher risk premiums.

The ECB withdrew 199 billion euros in crisis liquidity from the market smoothly at the end of June, and the central bank’s emergency purchases of eurozone government bonds have steadily declined. Mr Trichet felt confident enough to highlight that tapering-off last week.

European stock markets have begun to rebound, led by bank shares, on growing expectations that the stress tests will not uncover new horrors.

Governments across Europe are introducing austerity measures to bring down public deficits, and structural reforms designed to address longer-term problems of ageing populations, rigid labour markets and soaring health costs.

Greece, under the whip of a European Union/IMF bailout programme, is pushing through unpopular reforms – cutting pensions, raising the retirement age and reducing layoff payments and notice.

France is raising its retirement age and the contribution years needed for a full pension. Spain is easing hiring and firing laws to try to bring down 20 per cent unemployment.

This will not be smooth or easy, given resistance from labour and interest groups, but the political climate is more permissive for such reforms than at any time in a generation.

At the EU policy level, the Greek bailout and the EFSF are on track and the stress tests are under way.

Governments are broadly agreed on strengthening enforcement of the bloc’s battered budget discipline rules. The EFSF, created as a temporary expedient for three years, may be extended and morph into a permanent crisis resolution mechanism.

Longer-term worries, particularly about Greece’s ability to pay its debts on time and in full, may continue to dog the eurozone, as well as pessimism about the economic growth prospects of ageing and inflexible west European societies.

Protests against austerity and a shrinking welfare state may grow. Governments may fall over unpopular reforms. But for now, it looks as if the worst of the eurozone crisis may just be over. — Reuters, Bloomberg

Source: Business Times, 14 Jul 2010

Credit may turn scarce as lenders seek refinancing for $6.8 trillion owed

FRANKFURT: The sovereign debt crisis would seem to create worry enough for European banks, but there is another gathering threat that has not garnered as much notice: the trillions of dollars in short-term borrowing that institutions around the world must repay or roll over in the next two years.

The European Central Bank (ECB), the Bank of England and the International Monetary Fund have all recently warned of a looming crunch, especially in Europe, where banks have enough trouble raising money as it is.

Their concern is that banks hungry for refinancing will compete with governments – which also must roll over huge sums – for the bond market’s favour. As a result, credit for business and consumers could become more costly and scarce, with unpleasant consequences for economic growth.

‘There is a cliff we are racing towards – it’s huge,’ said Mr Richard Barwell, an economist at Royal Bank of Scotland and formerly a senior economist at the Bank of England, Britain’s central bank. ‘No one seems to be talking about it that much.’ But, he added, ‘it’s of first-order importance for lending and output’.

Banks worldwide owe nearly US$5 trillion (S$6.9 trillion) to bondholders and other creditors that will come due in 2012, according to estimates by the Bank for International Settlements (BIS). About US$2.6 trillion of the liabilities are in Europe.

US banks must refinance about US$1.3 trillion in 2012. While that sum is nothing to scoff at, analysts seem most concerned about Europe because the banking system there is already weighed down by the sovereign debt crisis.

How banks will come up with the money is an open question. With investors worried about government over-indebtedness in Greece, Spain, Ireland and other parts of Europe, many banks have been reluctant or unable to sell bonds, which they typically use to raise money that they lend, on to businesses and households.

The financing crunch has its origins in a worldwide trend for banks to borrow money for shorter periods.

The practice of short-term borrowing and long-term lending contributed to the near-collapse of the world financial system in late 2008 when short-term financing dried up. Banks suddenly found themselves starved for cash, and some would have collapsed without central bank support.

Government bank guarantees extended in response to the crisis also inadvertently encouraged short-term lending. The guarantees were typically only for several years, and banks issued bonds to match.

Other banks took advantage of the gap between short-term and long-term rates, borrowing cheaply from money markets or central banks and lending to their customers at higher, long-term rates.

A study in November by Moody’s Investors Service found that new bond issues by banks during the past five years matured in an average of 4.7 years – the shortest average in 30 years.

Since then, worries about Greek and Spanish debt and whether Europe is headed for another recession have caused new problems. Investors are unsure which institutions are in good shape and which are sitting on piles of bad loans and potentially tainted government bonds.

Bond issuance by financial institutions in Europe plunged to US$10.7 billion in May, compared with US$106 billion in January, and US$95 billion in May last year, according to Dealogic, a data provider. New issues have recovered somewhat since, to US$42 billion last month and US$19 billion so far this month.

Bank stress tests being conducted by European regulators could help if they succeed in convincing markets that most banks are healthy.

Bank regulators plan to release the test results, covering 91 large banks, on July 23.

Mr Sandeep Agarwal, head of financial institutions debt capital markets in Europe at Credit Suisse, predicted that the market could be separated into haves and have-nots, with healthy banks raising money fairly easily but weaker banks being required to pay a premium.

‘There is cash at the right price for many institutions, not all institutions,’ Mr Agarwal said.

That could add pressure on the weakest banks to merge, seek government help, or scale back their activities. Some might even fold.

The Landesbanken in Germany, savings banks in Spain or other institutions that have struggled may be forced to confront difficult choices.

A shortage of bank finance also could create quandaries for the ECB, which appears anxious to wean banks from the cheap cash that it began providing in the heat of the global financial crisis.

If institutions are unable to raise the money that they need on the open market, the ECB would have to decide whether to continue to prop them up.

‘Banks that have trouble tapping new funding sources will have to shrink,’ the BIS said in its annual report late last month. The BIS brings together the world’s main central banks.

Mr Jean-Francois Tremblay, a Moody’s vice-president who has studied the refinancing issue, said that so far banks had managed to roll over debt better than expected.

They have increased customer deposits, drawn on cash from central banks, or simply reduced their lending and their need for new financing – which is exactly what some economists feared.

NEW YORK TIMES

Source: Straits Times, 13 Jul 2010

But euro zone’s debt woes posing threat to recovery, it warns

HONG KONG: The International Monetary Fund (IMF) upgraded its 2010 global growth forecast yesterday, citing robust expansion in Asia and renewed private demand in the United States, but warned the euro area’s debt crisis posed a big risk to recovery.

The IMF said the euro zone’s sovereign financing problems and resulting financial market turbulence were significant challenges, especially with the web of financial and trade links connecting Europe to the world. However, a double-dip world recession was highly unlikely.

The fund raised its global output forecast for this year to 4.6 per cent from 4.2 per cent in April’s review of the global economy, but kept its view for next year unchanged at 4.3 per cent. The world economy shrank 0.6 per cent last year as a result of the global financial crisis.

‘What has happened in Europe is likely to slow down the path to recovery relative to what could have happened, but I think the chances of a double-dip are very small,’ Mr Olivier Blanchard, the IMF’s chief economist, said at a briefing in Hong Kong for the organisation’s latest World Economic Outlook and Global Financial Stability reports.

But in a move that might fuel concern that recovery is fading, the fund lowered its growth forecast next year for China from 9.9 per cent to 9.6 per cent, for Japan from 2 per cent to 1.8 per cent, for the euro zone from 1.5 per cent to 1.3 per cent, and for Britain from 2.5 per cent to 2.1 per cent.

Persistent weakness in the US housing and labour markets, euro zone debt problems and a slowdown in growth of manufacturing activity in Asia have made investors speculate that the global economy will slow sharply for the rest of the year.

While uncertainty about bank regulation has added to investor concerns, the IMF focused the majority of both reports on the implications of the euro zone sovereign crisis.

In the news briefing, Mr Blanchard said the European bank stress test disclosures due on July 23 were an important step towards transparency but underscored that countries must return to a sustainable level of fiscal spending.

Under one scenario – assuming shocks to the global financial system resulting from Europe’s debt problems are as severe as those experienced in the wake of the Lehman Brothers’ failure two years ago – world gross domestic product growth next year would be reduced by 1.5 percentage points, the IMF said.

Asian economies will expand faster than expected this year but ‘downside risks’ have intensified for the region following financial turmoil in the euro zone area, the IMF warned.

The Chinese economy should expand by 10.5 per cent following a strong rebound in exports and resilient domestic demand, the fund said, revising upwards its April forecast of 10 per cent.

India’s growth this year was revised higher to 9.4 per cent from 8.8 per cent as robust corporate profits and favourable financing conditions fuel investment.

With the upward revisions for the world’s two most populous countries, Asia as a whole was forecast to grow by 7.5 per cent this year, up from 7 per cent in April.

However for next year, when stimulus programmes are expected to be withdrawn in several countries, Asia’s growth is expected to settle to ‘a more moderate but also more sustainable rate’ of 6.8 per cent, the IMF said.

Following warnings by the fund earlier this year about the formation of asset bubbles in Asia, such problems in the market had eased, said Mr Jose Vinals, the IMF’s financial counsellor.

But the IMF warned that any stalling in the European recovery could affect Asia through both trade and financial channels, even though the region has only limited direct financial linkages to the most vulnerable euro area economies.

‘Many Asian economies (especially the newly industrialised economies and the Asean economies) are highly dependent on external demand, and their export exposure to Europe is at least as large as their export exposure to the United States,’ the report said.

However, in the event of ‘external demand shocks’, large economies such as China, India and Indonesia could provide a cushion to growth, it said.

REUTERS, AGENCE FRANCE-PRESSE, ASSOCIATED PRESS

Source: Straits Times, 9 Jul 2010

The Greek crisis highlights need for fiscal tightening

THE global economy, led by emerging markets, is still on track for a fairly strong overall recovery this year and in 2011. But the road ahead is strewn with an unusually large number of obstacles and dangers, the International Monetary Fund (IMF) warned yesterday with the publication of its latest World Economic Outlook (WEO) report.

Predicting that world GDP (gross domestic product) growth would be around 4.5 per cent this year (slightly ahead of the 4.25 per cent forecast in April) – slowing slightly to 4.3 per cent next year – the WEO identified the dangers of financial system shocks transmitted via banking systems and over-rapid fiscal consolidation as being among landmines ahead.

The Greek crisis and the market reaction to it have highlighted the need for fiscal tightening around the world, IMF officials said, while cautioning that this is going to require painful adjustments such as ‘reduced social entitlements’ in some countries and the raising of retirement age to take pressure off public pension systems.

‘We are cautiously optimistic (about the global economic outlook) but there are clear dangers ahead,’ said IMF economic counsellor and director of research Olivier Blanchard at a briefing in Hong Kong where the WEO launch was held for the first time outside of IMF headquarters in Washington.

Growth was stronger than expected in the first half of 2010 in economies such as the United States, Europe, Japan, Brazil and India, pushing overall world growth for that period to 5 per cent, Mr Blanchard noted. ‘But most recent indicators point to some slowdown of demand,’ he said, adding that ‘it is too early to assess how significant this will be’.

The WEO expects advanced economies to grow by 2.6 per cent this year and by 2.4 per cent in 2011, while it forecasts 6.8 per cent growth in emerging and developing economies in 2009 falling to 6.4 per cent next year. But this assumes that countries make the right policy responses to global challenges, Mr Blanchard said.

He cautioned that all economies face slowing growth in the short term with fiscal spending cuts. They also face a slowdown in bank lending under the impact of a ‘freeze’ in inter-bank markets in the wake of the Greek crisis and a reallocation of capital flows between advanced and emerging markets.

Fiscal consolidation could ‘derail’ the global recovery if not handled properly, Mr Blanchard acknowledged. ‘While fiscal stimulus was necessary to stem a potentially catastrophic collapse of output in 2008 and 2009, countries must return to a sustainable fiscal path,’ he insisted.

‘The adjustment should start soon, but too much front-loading, too sharp a cut in deficits this year or next year would be counter-productive,’ he suggested. ‘The recovery is still fragile and monetary policy (already very accommodative) cannot yet be used to significantly offset the adverse short run effects of fiscal consolidation.’

Calling Asia a ‘fitting’ place for the first launch of the WEO, and of the IMF’s Global Financial Stability Report, outside the US, because the region is providing ‘momentum for a robust global recovery’, IMF financial counsellor and monetary and capital markets department director Jose Vinals said it would nevertheless be dangerous to assume that Asia is immune to aftershocks from the eurozone crisis.

‘Global financial stability has experienced a setback,’ he noted. ‘Sovereign credit risks in part of the euro area have materialised and have spread to the financial sector there, threatening to spill over to other regions and re-establish the adverse feedback loop with the economy.’

Banks mainly (but not only) in the euro area ‘remain cautious about lending to each other’ in the aftermath of the Greek crisis, Mr Vinals noted. Along with their legacy of bad debts resulting from the global financial crisis, many banks now find that they have problematic assets in the shape of government bond holdings, he said.

Domestic liquidity conditions in Asia have remained calm but ‘European banks are significant providers of liquidity in certain Asian markets’, he noted, without specifying which. The authorities in these markets will need to act quickly to prevent financial contagion from spreading via such mechanisms, Mr Vinals suggested.

Apart from the danger of a liquidity crunch, there is also a danger of ‘crowding out’ of private borrowers as they compete with governments for funding, he said, citing the cases of Japan, Britain, the US and the euro area where around US$4.3 trillion of government debts will need to be rolled over during the second half of this year.

Mr Vinals also warned of disruptive capital flows into Asia, while praising Singapore, Hong Kong and China for taking measures to offset the impact of such flows by introducing ‘prudential measures to dampen real estate price appreciation and (to limit)the share of real estate loans in new bank lending’.

Source: Business Times, 9 Jul 2010

THE global economic recovery will continue but at a slower rate than in the past two quarters and a slide back into recession should be avoided, according to Credit Suisse analysts yesterday.

The Swiss bank’s head of Asia-Pacific research, Ms Fan Cheuk Wan, said that while some economists fear another slump this year following job losses and a decline in world manufacturing, she believed such views are ‘overly pessimistic’.

Many economies hit a speed bump in the first half due to the problems coming out of Europe, said Ms Fan.

But according to the bank’s chief economist for Asia, Mr Joseph Tan, the effect on Asia is ‘next to zero’ because the nations most affected by the crisis – Spain, Portugal and Greece – account for only 4 per cent of Asian exports to Europe.

‘As long as core Europe (France, Germany and the Netherlands) can hold itself up, we should focus on the US and not be overly concerned about Europe,’ he said.

Asia is also protected by its low debt to gross domestic product ratio. Most Asian countries have ratios below 40 per cent while the United States and Europe struggle with ratios of more than 100 per cent.

This allows Asia to consume without worry as it normalises its monetary policy.

Mr Tan also said he anticipates more liquid Asian currencies like the Singapore dollar, Korean won and Australian dollar to appreciate in the near future, towed along in the wake of the rising Chinese yuan.

Credit Suisse believes the yuan’s appreciation reinforces China’s robust growth and advised investors to target commodities such as iron ore.

Ms Fan urged investors to ‘look for value’ and be cautious about investing in downstream goods such as steel and aluminium.

The bank also recommended investing in consumer stocks from firms such as milk company China Mengniu, sports apparel group China Dongxiang, Indofood, Samsung and Shiseido.

Source: Straits Times, 8 Jul 2010

But a clampdown on govt spending may plunge it back into recession, it warns

(LONDON) Britain’s services sector enjoyed its strongest growth for two years over the past three months and manufacturing grew strongly, but tougher times may be ahead as firms are gloomier about the future, a survey suggested yesterday.

The British Chambers of Commerce’s Quarterly Economic Survey showed the private-sector recovery gathering pace. The business lobby’s chief economist, David Kern, said the survey pointed to economic growth of 0.6-0.7 per cent in the second quarter, around double the rate earlier this year.

However, he warned that this growth was unlikely to be sustained, as an impending clampdown on government spending risked plunging the economy back into recession.

‘Although we’re champions of manufacturing, it’s a worry for the whole economy that services are not strong,’ he said, pointing out that private-sector services activity was still half its long-run average, despite the recent pick-up.

‘We now have in place very tight fiscal policy for the next few years. We think it’s necessary, but this means the risk of a double-dip recession is greater and makes it more necessary for the Bank of England to keep interest rates low.’

The new Conservative- Liberal Democrat coalition is planning spending cuts of around 25 per cent across government departments to slash a deficit running close to 11 per cent of economic output.

‘This year we won’t see much impact from the fiscal tightening because the stock cycle is strong and earlier fiscal stimulus is still in place,’ Mr Kern said. ‘But I think the biggest impact on the economy and jobs will come late this year and next year.’

The domestic sales balance for the services sector rose to +12 from +6 in the first quarter, the highest reading since Q1 2008, and the orders balance rose two points over the quarter to +5, also a two-year high.

The manufacturing balances showed a much bigger improvement. The home sales balance shot up to +30 from +1 and orders surged to +19 from -3, both the highest since 2007.

The survey also showed that the long-awaited boost to exports from a past fall in sterling seemed to have materialised, with the manufacturing export sales balance at its highest in almost four years.

However, manufacturers also reported a surge in price pressures, with a balance of +30 in Q2 compared with +8 in Q1, the highest since Q3 2008. The BCC said 80 per cent of firms reported that they were under pressure to raise prices.

That was mainly due to higher raw materials costs, rather than wage costs, and should therefore be less worrying for the Bank of England, as its policymakers largely discount one-off rises in the cost of raw materials when they consider whether to raise interest rates.

‘It’s critical at this point of the cycle to keep rates as low as possible for as long as possible,’ Mr Kern said. ‘Fiscal policy will inevitably increase the deflationary factors in the economy.’

The central bank is widely expected to keep borrowing costs at 0.5 per cent when its meeting concludes tomorrow, although one member, Andrew Sentance, voted for a quarter- point hike last month.

‘Clearly at a time when a higher fiscal contraction policy is imminent, to hike rates is the wrong thing to do,’ Mr Kern said. — Reuters

Source: Business Times, 7 Jul 2010