2011: Annus horribilis


  • Business
  • Saturday, 31 Dec 2011

AS the world recovered in 2010 from the throes of the 2008/09 recession, it turned lacklustre in 2011, dragged down by the downturn as the debt crisis in peripheral Europe engulfed its neighbours, in the face of flattish growth in the United States and a mild contraction in Japan.

All these pulled down demand for exports and with it slower growth in the emerging and developing (E&D) world. A horrible and a hugely disappointing year.

For the second time in three years, global recovery stands at risk. That was the world that was in 2011.

Storm clouds gather

The world has become an increasingly dangerous place. Thousands of people have taken to the streets to protest, including on Wall Street, London and Warsaw. Global activity weakened in the course of 2011 and became even more uneven.

Since mid-year, confidence has fallen sharply and downside risks have grown and are still evolving.

Against the backdrop of a world immersed in imbalances, a barrage of shocks hit the global economy this year, such as the devastating Japanese earthquake and tsunami, and the Arab Spring unrest in many parts of oil producing Middle-East and North Africa.

The US economy slackened, reflecting political impotence; the eurozone debt crisis blew out of hand; and markets experienced major sell-off of risky sovereigns. These imposed unprecedented risks with adverse spillover to the real economy, already fragile with the jobless recovery.

As the crisis persisted, the impact on rich economies proved to be even more intractable than expected, and the process of reform even more complicated and difficult. Prospects for the E&D economies have become more uncertain although growth this year should remain reasonably robust.

Growth in emerging Asia remained strong but had since moderated. More recently, fiscal austerity in the United States and Europe, and the deepening sovereign debt crisis fanned financial volatility and adversely affected consumer and investor sentiment.

Also, domestic demand in Asia has begun to soften, driven by tightening policies to fight inflation, although it had remained sufficiently robust to continue to contribute to global growth. Looking forward, considerable downside risks remain.

Poor rich world

The global economy had been deteriorating by the month. Succeeding reviews had downgraded global performance, so that by September the International Monetary Fund (IMF) moderated world growth to 4% through 2012, from 5% in 2010. Rich nations would grow at an anaemic pace, while the E&D economies would slacken but still register a solid pace.

Since then, reviews in November by the Asian Development Bank and then the World Bank had further revised forecasts downwards, culminating in the most bearish outlook to-date by the Organisation for Economic Cooperation and Development (OECD) in late November, putting rich nations' growth in 2012 at 1.6% (1.9% in 2011), reflecting growth of 1.5% to 2% in the United States through 2012, no growth in the eurozone, and a flattish outcome in Japan.

But growth in China, India and Indonesia will remain robust in 2012. China will still expand at 8.5% (9.3% in 2011), India at 7.2% (7.7%), and Indonesia at 6.1% (6.3%).

Even so, the latest indicators show continued weakening in manufacturing and services activities in both rich and poor nations, reflecting (i) growing lack of confidence in Europe; (ii) poor sentiment on US leadership to unlock the Congressional gridlock; and (iii) as of now, the E&D markets feeling the intense pressure of weakening overseas demand for their exports.

As I write, the outlook is much darker today than it was in early December. Underlying it all is the deepening eurozone crisis, with contagion again threatening to engulf Italy and Spain, and lapping at the door of France, although of late, US retail and car sales seemed a bit more upbeat, maybe because they have been down for so long.

But, as forecasters fret, not all in the rich world is suffering. German employment hit another post-unification high in October, highlighting a disconnect between its prosperity and the pain in most of eurozone's periphery. True, forecasts are constantly being revised down, but by now most economists expect the rich OECD economies to grow by as low as 1% in 2012, with Europe going into recession in the fourth quarter of 2011 to the first quarter of 2012.

The great concern is for the downturn in Europe to exacerbate stresses in the debt and bank funding markets, creating a vicious downward spiral akin to 2008, with rising probability of a collapse of the euro. Most observers, including myself, expect the euro to just about survive, but not because the leadership is capable of solving the underlying problems.

US, eurozone and Japan

Most economists expect a modest US recovery in an election year. With unemployment still high and growth above Europe on the back of better consumer spending, latest survey data pointed to continuing low growth (2% against 1.7% in 2011, but no recession) with nothing to be excited about.

Given another disappointing year, the engine of global growth has moved decisively to the large E&D economies, notably China. It's a pretty dicey situation a few misturns here or there, especially in the eurozone, could raise domestic risks considerably, with the potential to derail US recovery and renew fears among financially fragile households and investors.

The US Federal Reserve singled out turmoil in Europe's volatile financial markets as the biggest risk to the outlook. With the eurozone already in recession, the United States is expected to struggle to maintain even its current modest growth pace.

In the eurozone, the OECD expects growth to collapse: minus 1% in the fourth quarter of 2011 and minus 0.4% in first quarter of 2012 (+0.2% in the third quarter of 2011). Then, there will be slow recovery to 1.8% by the fourth quarter of 2013. But nothing is cast in stone. There is still time for decisive action to shore up stricken credibility and avert a far worse outlook.

So far, its own crisis had scared off investments and had eaten into business and consumer confidence. Europe's factories are feeling the brunt of the stress, while government austerity and job losses are depriving corporates of demand and crunching exports. Markit's eurozone composite purchasing managers' index showed private business contracting for the third month in November. Italy is facing the worst (fourth quarter 2011 to contract by 1%), while growth in both France and Spain is likely to slacken by 0.5%.

Germany contracted as well in November, sinking for the first time in 2 years. All point to the eurozone facing a recession.

Forging a fiscal compact to save the euro risks making the whittling down of debt tougher than it needs to be. Pro-growth reforms are sidelined as deficit cutting takes hold. Worse, the eurozone periphery is made to bear the heaviest burden in correcting imbalances that lie at the heart of euro's existential crisis.

As I see it, Germany needs to stop tightening and adopt mildly expansionary policies to get growth going again to save the euro. There is already excessive austerity at a time when economies are contracting; it dampens the outlook. Austerity merely compounds economic weaknesses and does nothing to improve competitiveness and trade imbalances. Moreover, it wreaks havoc with public finances.

The gloom over Japan had been bad, reflecting “structural pessimism”. Its economy rebounded (+6% in the third quarter 2011) from the recession triggered by the devastating tsunami and nuclear disaster in March, and the subsequent supply chain disruption.

Since then, the effects of the high yen and slowdown in overseas demand are weighing on business sentiment. The December Tankan index dipped negative, indicating Japanese exports are getting hammered. But the index also suggested some good news the key auto sector showing a strong rise, and there's improvement in sentiment among non-manufacturers, supported by private consumption.

Things are beginning to look better, with OECD expecting gross domestic product (GDP) growth to pick up in 2012 to up to 2%, against minus 0.3% in 2011.

All across China, India and the rest of Asia, the eurozone crisis is being felt, especially in export-oriented manufacturing, prompting fears that falling overseas demand and financial disruptions could once again cause a steep drop in growth and a loss of wealth as it did during the 2008/09 recession.

East Asia remains robust

Still, emerging East Asia's economic momentum remains robust.

But the region now faces greater risks as eurozone's debt problems worsen and a fragile US economy could turn wary, unleashing devastating consequences. Already, business sentiment among Asian's top corporates fell in the fourth quarter 2011 to its lowest in two years, with fears over global slack and rising costs being the risks to the outlook.

More recently, financial volatility dampened investor confidence and consumer sentiment. Domestic demand has since softened, although it continued to remain a reliable contributor to growth. GDP in developing East Asia would expand 8.2% in 2011 and 7.8% in 2012 (9.7% in 2010).

Slackening growth reflected lower demand for exports, tightening monetary conditions and lower manufacturing, especially of electronics. Recent events have intensified investors' concerns over growth and stability, and have triggered capital outflows toward safer havens.

Within Asia, China and India expanded the fastest although evolving developments have not been encouraging. In South-East Asia, Indonesia's GDP expanded 6.4% in 2011 (against 6.1% in 2010) and is expected to grow steadily in 2012 (6.3%).

The World Bank estimated activity in Malaysia had also slackened: 4.3% in 2011 (7.2% in 2010), and 4.5%5% in 2012.

High reserves and current surpluses would protect most of East Asia from possible renewed financial stress. Looking forward, East Asia needs to balance between growth and fighting off the impact of uncertainty. The region is likely to hold off further policy tightening, ready to ward off negative effects. Their strong fiscal positions also leave space for stimulus when needed.

China

In China, overall growth remains heavily dependent on exports. Growth will slacken to 9.2% this year. But manufacturing activity contracted in December, while foreign direct investment fell for the first time in 28 months.

China faces severe foreign trade restrictions in the first quarter 2012 due to the “grim and complicated” global outlook. For 2012, “growth momentum remains weak with additional downside risks from exports and property market not yet fully filtering through”.

With Europe already in recession, the United States struggling with a fragile recovery and Japan battered, China's exports have flagged, with expectations of worse to come.

Domestically, there is no growth in property starts, electricity output is slackening, and exports in November and December are likely to be awful. These have since triggered a shift in policy focus to expand domestic demand, including a stronger yuan.

Fiscal policy in 2012 will be more proactive, and monetary policy more accommodative. Social spending will rise, reflecting the “inclusiveness” of development. Low-income housing construction will pick-up. “Targeted easing” will also help prop up small manufacturers. They signal preparedness to move aggressively to stoke consumption.

Both the OECD and the World Bank are optimistic China will grow at 8.5% in 2012, its slowest pace in a decade, and 9.5% in 2013. The World Bank and IMF consider China's banking system is able to withstand exchange rate and interest rate shocks, including significant spillover from the eurozone debt restructuring.

I would err with caution because China still needs to rebalance from exports bias to consumption-driven, as the transition can be disruptive.

What to do?

Next year is fraught with uncertainty. Things will become more unsettling before they get better. Unfortunately, uncertainty extends beyond nations and regions to worries about political stability and global economic order, eroding the quality of public goods.

It's no coincidence that all these are happening simultaneously, adding to anxiety that comes with the loss of once dependable anchors. We just don't know how things will pan out what is evolutionary and what will be sudden, even disruptive.

Experts have varying views on what to look for, what to expect, and where and how best to change and adapt.

The economic and financial or social and political dynamics are complex. What's going to happen in 2012? Even by the first quarter 2012?

Psychologist and Nobel laureate economist Daniel Kahneman believes that “there are domains in which expertise is not possible And in long-term political forecasting, it has been shown that experts are just not better than a dice-throwing monkey.” So take your pick!

Former banker Tan Sri Dr Lin See-Yan is a Harvard-educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting public interest.

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