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European economies
Eurostat, the EU statistical agency, has reported a sharp slowdown in economic growth during the second quarter. Gross domestic product for the European Union as a whole grew at a quarterly rate of 0.2 per cent according to preliminary estimates from Eurostat. It was the weakest growth rate in two years and came after a 0.8 per cent expansion in the first three months of 2011. Economists were expecting growth to have slowed, with many projecting a 0.3 per cent rate in the quarter.
Germany, the largest economy in Europe, nearly ground to a halt in the quarter.
The nation’s GDP grew at a quarterly rate of only 0.1, down from 1.3 per cent in the first quarter. France, the second largest EU economy did not grow at all in the second quarter. The weakness in Europe’s economic powerhouses raises concerns about the ability of stronger EU economies to support struggling members outside the core of the European Union.
In Europe, the decline in output came against a backdrop of turmoil, as the long-running debt crisis in Greece, Portugal and Ireland accelerated in the second quarter. Investors have been rattled by fears that larger economies, including Spain and Italy, may need to be bailed out. That has raised fears about the future viability of the 12-year old currency union. Meanwhile, the governments in Europe have been working to contain the continent’s sovereign debt problems and stabilize the euro. The European Council has announced a new €109 billion rescue package, and agreed to expand the powers of the EU financial stability fund.
European finance officials are stepping up their efforts to slow the rising panic over the euro zone’s debt crisis. Finance ministers from the G-7 — a group of significant world economies – have pledged support for troubled countries. In the face of renewed strains on financial markets, they have agreed to take all necessary measures to support financial stability and growth in a spirit of close cooperation and confidence. The European Central Bank signaled that it was ready to begin buying Italian and Spanish government bonds. Both countries — two of the largest economies in Europe — have been under pressure to speed up budget reforms as investors have demanded higher interest rates for loans.
The European banks are finding it increasingly harder to get cash they need to operate. Exactly three years after the collapse of Lehman Brothers touched off a credit panic, confidence in European leaders is fading as they scramble to head off a default on Greek debt and ease fears that Italy may head for the same fate. According to the International Monetary Fund, after a year and half of failed attempts at a solution, the world economy has entered a “dangerous new phase.” Without collective resolve, the confidence that the world so badly needs will not return.
Germany and France, the last hope of a European bailout, have seen their economies grind to a halt as the crisis widened.
Investors have bailed out of European bank stocks, fearing they could lose large chunks of capital if governments default on the bonds they hold. Some bank stocks are now trading for less than half the reported value of the assets on their books, a sign that investors believe those assets will inevitably have to be written down. European leaders have been working for more than a year to assemble a financial backstop, similar to the response by the US Treasury and the Federal Reserve to the collapse of credit markets in 2008.
East European Economies
The heavily export dependent economies in the region would almost inevitably be dragged down by the rapid slowdown in Europe’s principal economic motor, the German economy. The Czech Republic, Hungary, Slovakia, Bulgaria and Romania all reported slower GDP growth in the second quarter, due in large measure to the disappointing performance of their German neighbour, central Europe’s most important trading partner.
As anticipated, the Hungarian results were especially weak. Analysts had widely predicted inter annual growth of just under 2.5, but in the end the result came in at 1.5 per cent. Even worse, the economy completely failed to grow in the second three months in the year, since quarter on quarter growth was effectively zero.
The increase in industrial activity which accompanied the increased demand for exports was only sufficient to compensate for the drop in internal demand at a time of near record export levels in many European countries. This is doubly worrying since the government, while continuing to reduce the deficit, has appropriated something like nine per cent of GDP from a one off pension move, paying down debt and, in addition, adding some support to this year’s spending programme. Mirroring what just happened in Germany, second quarter GDP growth in the Czech republic slowed from what had been the fastest pace in almost three years achieved in the first three months of the year, to a mere 0.2 per cent, the slowest rate of increase in two years.
Like many economies in the region, the Czech one is now strongly dependent on foreign demand for its products. Exports have surged back up and beyond pre-crisis highs, while industrial output has grown strongly. What makes the Czech case interesting is that neither the private nor the public sector is heavily indebted - public sector debt was only 41.3 of GDP in 2010. The country’s external debt was only 46.7 of GDP. The central bank policy rate is currently 0.75. The Koruna has gained nearly 2.4% against the euro so far this year, as compared with a decline of around 10 per cent in the Polish zloty. Some economists are talking of the Koruna as a potential safe haven alternative to the Swiss franc.
Romania has struggled far longer than any other CEE economy to emerge from recession, only grew by 0.1 in the second quarter, following a 0.7 per cent quarterly rate of increase in the first quarter. Romanian GDP is barely up from one year ago. And indeed is still something like 8.5 per cent below its pre-crisis peak. This is despite the fact that exports have been booming, and are now above the pre-crisis level. As per the regional pattern, domestic demand has not recovered and retail sales are falling. Construction is well down, and is unlikely to return to pre-crisis levels.
But Romania and the other countries suffer from an additional problem - they have significant external debt levels, and despite the activation of the Vienna initiative- they continue to suffer from very tight credit conditions. Total Romanian government debt is only just over 35% of GDP, while external debt is over 70 per cent of GDP. The country continues to run a significant current account deficit (4.2 of GDP in 2010). The inflation rate was exacerbated by a 5% VAT rise in July 2010 and the annual rate has now fallen back from eight per cent in June to 4.9 in July.
Russia
The World Bank has cut its forecast for Russian economic growth this year to 4% from a previously estimated 4.4% as a result of an expected slowdown in the U.S. and the European Union, a decline in oil prices and the euro-zone debt crisis. The bank expects Russia’s GDP to grow 3.8% in 2012. Its 2011 forecast is more pessimistic than the Russian Economy Ministry’s estimate of 4.1% growth this year. The ministry predicts 3.7% growth in 2012. However, the World Bank still expects Russia to grow faster than the global economy as a whole, as global GDP growth is now projected to slow to 2.8% in 2011 before firming up to 3.2% in 2012.Aside from higher budgetary spending, the main risks for Russia lie the outside the country. Relatively high oil prices and low unemployment will help sustain robust growth in domestic consumption, which, in turn, will support overall growth during the second half of 2011. The bank notes that although “Russia’s short-term economic and fiscal situation remains favorable because of high oil prices with an almost balanced budget this year,” the balance of macroeconomic risks “has shifted toward an uncertain growth path as inflation pressures subside and external risks rise sharply.” The bank predicted Russia’s budget will be balanced in 2011 but will show a deficit of 1.6% of GDP in 2012.
However, significant downside risks are associated with global demand and highly volatile oil prices and new expenditure pressures from the planned modernization of the army, spending on infrastructure, and additional social spending, especially during the election period. The balance of payments position is expected to deteriorate towards the end of 2011, while capital flows are likely to remain volatile, reflecting increased global uncertainties. The bank expects surplus on the external current account to amount to about $67 billion in 2011, about 3.8% of GDP, and then to deteriorate to $21 billion in 2012, or 1.1% of GDP. Unemployment is expected to remain below 7% but a further reduction in unemployment will be slow.
The inflation rate may drop to 5 percent to 6 percent next year from a forecast 7 percent to 7.5 percent in 2011, according to the ministry. Russian economic growth may slow more than previously forecast next year as oil prices stagnate and the government uses its energy revenue this year to rebuild the nation’s sovereign wealth funds. The ministry revised down its growth forecast to 3.5 percent in 2012 from the previous estimate for a 3.9 percent increase. Practically all of the increased revenue from higher oil prices is going to the Reserve Fund and the National Wellbeing Fund instead of toward boosting expenditures. The weaker growth forecast signals the world’s biggest energy supplier will struggle to meet President’s target of achieving expansion of as much as 10 percent within five years.
The World Bank currently expects Brent crude to trade at an average of $105 a barrel this year and then drop 9.5% during 2012. That scenario would effectively reduce Russian GDP growth to an annualized rate of 4.0% in 2011 and 3.8% next year.
This is roughly in line with official Russian forecasts of 4.1% and 3.7% growth in 2011 and 2012, respectively. A “severe” shock could push Brent all the way to $45 during the next few months and then back up to an average of $60 in 2012. That worst-case scenario would push Russia’s economy into a deep 1.5% contraction next year. In any event, the Russian economy looks set to grow faster than the rest of the world, whatever happens.
