Business

Saturday June 18, 2011

A check-up at mid-year

WHAT ARE WE TO DO
By TAN SRI LIN SEE-YAN


My early 2011 columns were set in a rather optimistic mood hoping it will be a stress free year for the world economy. Early in January, the financial crisis seemed to be well contained and the euro sovereign-debt crisis had become less acute. The US economy was poised to be better able to tackle unemployment. Investors began building up their equities and sold some bonds they had bought as cover for troubled times.

The main worry then was to await progress by the major emerging countries in slowing down growth which otherwise was pushing commodity prices further up. But that was not to be.

MENA jasmine revolution

First, came the Arab spring. Few would have imagined that among the many Middle East & North Africa (MENA) unpopular governments, Tunisia would be the first to face a serious attempt to foment a Eastern European style velvet resolution. Since Dec 17 when a jobless youth set himself on fire in protest, spontaneous reactions spread nation-wide. On Jan 11, protests in Tunis galvanised near-moribund opposition into action, bringing about the president of 23 years' dramatic scuttle into exile on Jan 14. Some Egyptians jokingly called it a Tunami. Unknowingly, a Tunisia-tinted jasmine revolution tidal wave soon hit Egypt. The nation-wide protest on Jan 25 turned out to be the largest act of civil disobedience in 30 years of President Mubarak's rule. Mubarak was eventually toppled on Feb 11.

The scent of jasmine spreads next to Libya. After 41 years of violent capricious rule, Gaddafi faced a popular uprising on Feb 22, after a blood-soaked week of unrest. By March 22, the no fly-zone set-up under a UN mandate covered most of the rebel-held eastern coastal region.

Today, the war rages on. What started in Tunisia, has certainly caught fire satellite TV, mobile phones, the internet and Twitter continue to relay giddy news across the Maghreb along the Mediterranean's southern coast, on even through Saudi Arabia to the Gulf and Yemen.

Plainly, many are nervous. Jordan is sullen, Syria defiant, Algeria unstable, and Yemen seething on the verge of civil war. Undoubtedly, the Arab spring puts oil markets on edge. Pinpointing its impact is complicated since oil prices were already rising because of the rosier economic outlook at the close of 2010. Nevertheless, a good part of this year's 25% rise (reaching US$115/barrel for Brent) reflected worries over supply. The rule of thumb holds that a 10% rise in oil prices reduces 0.2% points off global growth. At the start of 2011, global growth was set at 3%-4%.

This implies world growth would fall by at least % point. But that's not all. Crises generate much uncertainty; businesses postpone investments and hiring and investors seek the refuge of bonds at the expense of equities. Oil prices remain hard to predict.

Japan's earthquake & tsunami

Second, the earthquake and tsunami on March 11 and the consequent nuclear accident badly hit the world's third largest economy, which was already hardly growing. Its share of world output has been shrinking, but at 9% it remains big enough for the impact on Japan's growth to noticeably affect global GDP. Moreover, ripple effects on the rest of the world can also be significant since Japan is a critical supplier of components to the global electronic and automotive supply chain from hardened glass on the iPad to vital parts for gearboxes to Volkswagen. As a result, many makers of such parts have had to slow or miss shipments. The collateral damage has been wide and far beyond, causing shutdowns from South Korea to Southern California to the South of France.

This does not include a range of wider, fuzzier costs. The disaster forced the utility to schedule power cuts; if the cuts last, it could depress industrial output by as much as 14%. Most important is the loss of consumer confidence. Most troublesome are harmful rumours and its psychological impact as a result of radiation concerns. Already many hotels and restaurants have stopped importing fresh fish and related food from Japan. Furthermore, the price of memory chips has jumped with chain effects on the cost of end products around the world.

Euro-zone concerns grow

Third, across the Mediterranean, euro-zone's debt crisis came back in full swing. Markets fretted about the long-expected bailout for Portugal, after Lisbon rejected the March 23 austerity measures. Possible write-downs of Irish bank debt by the new government in Dublin were another concern. By the second quarter (Q2) of 2011, fears mounted about euro-zone's debt situation following crushing electoral defeat for Spain's ruling party, compounded by in-fighting in Europe over whether Greek government bonds should be restructured. On May 20, Fitch lopped 3-notches off Greece's rating to “B+” and warned any measure of default would have far reaching implications on financial stability worldwide. Moreover, Standard & Poor's had on June 14 downgraded Greece once again to “CCC”, the world's lowest sovereign credit rating ever. Immediately, Greek 10-year yields jumped to 17%, higher than the Portuguese (10.7%) and the Irish (11.3%). Furthermore, S&P also lowered its outlook on Italy's US$1.9 trillion government debt to negative. Even Germany, Europe's economic powerhouse, is now showing some signs of fatigue.

US economy: worse than it looks

Fourth, my teacher and mentor at Harvard, Prof. M. Feldstein, recently concluded the US economy is in a worse shape than suggested by the first quatter (Q1) of 2011 growth of just 1.8% (3.1% in fourth quatter (Q4) of 2010). He made 4 points: (i) two-thirds of it reflected inventories build-up and not final sales; (ii) consumer spending really hardly rose; (iii) the economy slid in April and May retail sales suffered its first drop in 11 months; (iv) each US dollar of stimulus spent in 2008 and 2009 added much less than a US dollar to GDP. Two other problems worried him: (a) lack of an explicit plan to deal with the budget deficit and rising national debt (60% of GDP), and (b) incoherent policy on the US dollar value. All these add to the lack of business confidence to make entrepreneurial investments and new expansions to generate employment. Marty makes a compelling case.

Global growth re-visited

It is already well known that the disaster in Japan, the violence in MENA, the euro-zone's fiscal strains and the “soft patch” in US Q2 of 2011 growth are bad for the global economy. But it's hard to tell how bad. This lack of clarity can be as harmful as the disruptions and war. One gauge of uncertainty is the increase in stock market gyrations. Japan's so called “fear gauge” (the VXJ-index of stock market volatility) rose 22.4% on the day following the quake and tsunami. On the other hand, the recent US stock volatility was, in hindsight, relatively mild. The Dow Jones Industrial Average had fallen for 6 consecutive weeks the largest losing streak since 2002 leaving the index below 12,000 for the first time since March. But the Dow was down only 6.7% from its April high, just over 1% a week. The Dow still remains up 3.2% for 2011. The US equivalent of the “fear index” (the Vix) remained quiet at below 20, well far from panic (30-40). Be that as it may, businesses don't like uncertainty managers defer decisions to invest and hire, missing opportunities to create employment.

The World Bank's revised June forecasts place world growth as moderating to 3.2% in 2011 and recovering to 3.6% in 2012. Latest Organisation for Economic Cooperation and Development lead indicators also show more or less the same trends a mild loss of momentum in most economies notably France and Italy as well as Brazil and India. High income nations are seen to grow at 2.2% this year and 2.7% in 2012, compared with nearly three times the pace (6.3% and 6.2% respectively in 2011 and 2012) in the emerging countries. Embedded in the World Bank forecasts, US growth was cut to 2.6% this year pointing to a growth pause in Q2 of 2011 but there is little prospect of a “double-dip.” Euro-zone will grow more slowly at 1.2%. But emerging nations, although also slackening, continue to maintain a strong pace accounting for about one-half of global demand for oil, while China alone absorbed 40% of world's metal supplies. Oil prices were up 37% in 2010; copper up to record high, with mining companies struggling to meet demand. Nevertheless, China's growth will slow-down to 9.3% this year (10.3% in 2010) and to 8.7% in 2012. Latest indications are that a soft-landing remains in sight for China. India will grow at 8% in 2011 and 8.4% next year.

The threat of inflation

While developed economies have to contend with high unemployment and Europe's debt crisis and fiscal austerity, many emerging nations with strong expansions, notably China, India and Brazil, have to deal with rising inflation brought about in part by rising food and commodity prices and strong capital inflows, and partly by the inability to remove fiscal stimulus enacted earlier. Real interest rates remain low (or negative) in many countries. For the developing countries, inflation was 7% in May from a year earlier. In India, official inflation in May is now 9.1%, Indonesia 6%, South Korea 4.2% and China 5.5% (above official target of 4%). Vietnam, Asia's worst inflation performer, suffered a surge to 20% in April. For many of them, consumer prices have eased somewhat in May due to better harvests (India), increased wheat exports (Ukraine), appreciating currencies, softening oil prices and the impact of tightening monetary policies (India). Credit Suisse's “surprise index,” which measures the difference between inflation announcements and consensus forecasts, turned downwards in May, indicating consumer price rises may be moving downwards. This reflected in the end, decelerating growth in Asia from last year's breakneck expansion. Western markets for Asian exports are also weakening.

Make no mistake, Asian inflation is not going away. The slowdown may have taken the sting off the problem for the time being. Look at “core” inflation indices, which strip out volatile elements of food and energy prices; they have continued to move up in many countries, even as headline inflation softened. Structurally, underlying price pressures remain a worry in Asia if nothing else, they are grossly under-estimated by price control measures in particular. In both China and India, loan growth may have slowed but they remain above nominal GDP growth. This over-supply of credit continues to fan inflation. Then, there are the ever present cost-push factors; input prices are getting more expansive and wages are rising across the region. So, inflation is a very much underrated longer-term threat that continues to require close monitoring and decisive action by central banks and finance ministries. It will most certainly flare up when you least expect, in particular once growth de-accelerates (or fails to definitely decelerate) or surprise “shocks” reappear.

Malaysia: back to pre-crisis trend

Expectation is for growth to return to the pre-crisis trend. In 2011, GDP growth was 4.6% (4.8% in Q4 of 2010) supported mainly by expansion in manufacturing and services. There are increasing signs that Q2 of 2011 is already hitting a soft patch; April's industrial production contracted 2.2% from a year ago (on a month-to-month basis, it fell 7.6%), orders in the electrical and electronics sector have since slowed-down and so has capital spending, activity in services appears to have slackened. This is not unique to Malaysia. Business sentiment at Asia's top businesses fell in Q2 of 2011, hitting its lowest since Q3 of 2010 according to Reuters' Asia Corporate Sentiment Index. The consensus is for a weak Q2 of 2011 stretching to Q3, but with rapid recovery in Q4 of 2011. Sentiment in South-east Asia has turned cautious, with China and India remaining the more optimistic. The World Bank's April forecast for Malaysia of 5.1% (range being 3.8%-5.7%) for 2011 appears now on the high side hitting the mid of the range is more likely, in the region of 4%-5% for the year as a whole.

Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting the public interest. Feedback is welcome; email: starbiz@thestar.com.my

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