Recovery Intact but Growth to Moderate

Global outlook for second half of 2010 remains on track despite Europe's crisis

Issue: Jul 2010

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The current financial turmoil in Europe has raised jitters worldwide, as fears of another global crisis have led to bouts of volatility in the financial markets. As we cross over into the second half of 2010, it is perhaps useful for us to take stock of the global recovery and assess growth prospects for the remainder of the year, especially in light of the ongoing European sovereign debt crisis.

Europe’s Crisis

Much of the world emerged from the recession in the past one and a half years on the back of massive government stimulus spending, which has led to a significant increase in deficit and debt levels in several advanced economies, with Europe in particular coming under the spotlight. The sovereign debt crisis that emanated from Greece quickly led to doubts about the government finances of other European governments, triggering contagion fears and strains in the credit markets.

The bailout packages and fiscal austerity plans announced by European governments may have somewhat assuaged fears of a major sovereign default, but doubts remain about their effectiveness and the political will to accomplish them. At the same time, questions are also being raised about the impact of European fiscal austerity on global growth.

But the greatest fear of all has to be the possibility of this episode evolving into a full-blown financial crisis that will plunge the world back into a severe recession. This is due to the massive holdings of European sovereign bonds by many major European banks. A sovereign default could lead to significant bank losses and could once again endanger the smooth functioning of the global financial system.

The signs certainly were troubling when the European crisis first erupted, with bond yields, risk aversion indices and various other financial indicators spiking sharply before showing signs of improvement lately on the back of massive intervention by the European Central Bank (ECB) and Eurozone governments (see Chart 1). However, the general sentiment about this crisis remains one of nervousness and at this juncture, there is still a small probability that the European sovereign debt crisis could evolve into a global financial crisis.

Chart 1: Risk Aversion Indices*

Chart 1: Risk Aversion Indices*
Source: Bloomberg
*Higher readings indicate greater risk averseness.
MOVE Index – Merrill Lynch Option Volatility Estimate Index
VIX Index – Chicago Board Options Exchange Volatility Index

Recovery Intact …

The ongoing European crisis, and the pessimism it has engendered, have led to doubts on whether the global recovery can be sustained going forward. However, if we look at the absolute levels of economic activity worldwide, it can be seen that the economic recovery remains intact and is in fact broadening out in several major economies such as the US and Japan. Levels of retail sales, industrial production and trade have, in general, been trending upwards in most economies since their trough in the middle of 2009. In fact, except for the G3 where the recovery was more tepid, economic output in absolute terms has already surpassed their pre-crisis peaks in the major emerging economies. And despite the outbreak of the European debt crisis in Mar/Apr 2010, the latest 2010 consensus growth forecasts of major economies still remain robust (see Chart 2).

Chart 2: June Consensus Forecast of 2010 GDP Growth

Chart 2: June Consensus Forecast of 2010 GDP Growth
Source: Consensus Forecast 14 Jun 2010

… But Slower Growth Momentum Ahead

Although the economic recovery remains intact, growth momentum is likely to slow going forward. The slower growth rates are also alluded to by the latest composite leading indicators (CLI), which has peaked in many major economies (see Chart 3). This is because several factors that have hitherto helped to boost economic growth rates will lose their positive impact going forward.

Chart 3: Composite Leading Indicators

Chart 3: Composite Leading Indicators
Source: Bloomberg

First of all, a common denominator of the global recovery has been the intervention of governments as they employed fiscal and monetary stimulus to revive their economies. Such stimulus spending, by design, is due to expire or will be withdrawn in the coming months, thus removing an important component of the recovery.

Second, the inventory re-stocking cycle has been a significant contributor of post-recession growth as producers that have previously reduced their stockpiles during the crisis replenish their depleted supplies. By most accounts, these processes are almost complete and will not contribute significantly to growth.

Third, the drastic collapse in world economic output and trade immediately following the 2008 crisis has created a low but favorable base in the first half of 2009 against which growth figures are compared. It is little wonder therefore, that the year-on-year growth for the first half of 2010 had been so spectacular. This favorable base effect will diminish as we move into the second half of 2010.

Fourth, the superlative growth of the Chinese economy, which had played a major part in restoring global investor confidence and kick-starting global growth, is due to moderate. Since the start of this year, the Chinese economy was at risk of overheating and asset-price inflation was a major immediate threat to her economic health. In response, the government has implemented a series of targeted measures aimed at cooling growth, controlling prices and curbing speculation. A consequence of this tightening stance would be a moderation in growth rates for the rest of this year. The slowdown of this major growth pillar would have a cooling effect on global growth. Yet in the context of asset-price inflation, this moderation should be viewed as a positive development for China as she seeks to pursue growth on a stable and sound footing. This change augurs well for the rest of the region that is increasingly tied to the fate of the Chinese economy.

European Austerity a Drag on Growth Going Forward

Growth for the rest of the year may also be dampened by a European austerity drive. European markets serve as an important destination for many countries’ exporters, including the US and China, with each shipping about one-fifth of their exports to the continent. To a lesser and more varied extent, Europe remains a significant market for other Asian export-oriented economies.

Yet it is also worth pointing out that intra-Asian trade has been steadily growing in recent years and had provided a major boost to Asia’s export economies during the recovery. With the continued rise of China and India, Asia will increasingly become the end-destination of its own exports. This will serve to mitigate the negative impact of a cutback in European demand.

Asian Prospects Remain Bright

Despite the potential impact on its exports, Asia is expected to tide through this latest European crisis with its growth prospects largely intact. The resilience of the Asian economies has been well-documented ever since they emerged from recession last year and they should continue to outshine the developed countries for the remainder of this year.

Global Growth Prospects Remain Favorable

The ongoing European sovereign debt issue presents a speed bump in the road to recovery, and has caused policymakers worldwide to review their fiscal positions. As the advanced nations take steps to rein in their fiscal deficits and bring down their debt to more sustainable levels, this could only have a positive impact on the medium term sustainable growth of the world. In the near term, although the growth momentum is likely to slow as we go into the second half of 2010, the global recovery that began since the mid of 2009 remains very much on track.

Article contributed by Andre Lim and Terence Yap of the CapitaLand Economics Unit.

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