By Stefan Wagstyl, Eastern Europe Editor
Crisis-hit European Union states in central and eastern Europe should consider scrapping their currencies in favour of the euro even without formally joining the eurozone, according to the International Monetary Fund.
The eurozone could relax its entry rules so countries could join as quasi-members, without European Central Bank board seats, says the fund.
“For countries in the EU, euroisation offers the largest benefits in terms of resolving the foreign currency debt overhang [accumulation], removing uncertainty and restoring confidence.
“Without euroisation, addressing the foreign debt currency overhang would require massive domestic retrenchment in some countries, against growing political resistance.”
Disclosure of the confidential report, prepared about a month ago, could reignite a fierce debate over strategies to assist central and east Europe.
Even though global leaders hailed last week’s G20 summit as a success, eastern Europe’s challenges remain. Amid deepening recession, Ukraine and Latvia, two states already in IMF programmes, have in recent days balked at approving IMF-mandated reforms. A third, Hungary, is struggling to create a government capable of implementing reforms.
The IMF report was compiled to support a campaign by the fund, the World Bank and the European Bank for Reconstruction and Development to persuade the EU and eastern European states to back a region-wide anti-crisis strategy, including a regional rescue fund. The campaign failed amid widespread opposition from both west and east European states.
Eurozone members also oppose easing the eurozone’s entry rules, as does the ECB.
The IMF, which forecasts a 2.5 per cent decline in regional gross domestic product in 2009, estimates that “emerging Europe” – including Turkey – must roll over $413bn in maturing external debt in 2009 and cover $84bn in projected current account deficits.
The report estimates that “the financing gap” – money needed from international financial institutions, the EU and governments – will be $123bn this year and $63bn next, or $186bn in total.
Much could come from the IMF. But the report says “up to $105bn” could be needed from other sources, including the EU.
Showing posts with label Economy. Show all posts
Showing posts with label Economy. Show all posts
Wednesday, April 8, 2009
Investors maintain faith in emerging markets
By Martin Arnold in London
The fall in private equity funding is spreading to emerging markets, but funds focused on some countries, such as China, India and Brazil, are still attracting investors in spite of the downturn, research will show on Monday.
Three-quarters of investors in private equity in emerging markets plan to commit more money to funds in these regions, according to a survey of 156 financial institutions, including funds-of-funds, pension funds, endowments and rich families.
“In past downturns you have seen investors pulling out of these markets en masse, particularly in 1990-91,” said Sarah Alexander, president of the Emerging Markets Private Equity Association, which produced the research with Coller Capital. “But now they look at these markets and see growth potential they don’t see in western markets.”
Brazil is growing in popularity, with more than a quarter of investors aiming to start investing in the country or increase their exposure. China and India were rated as the two other most attractive markets.
However, Russia is set to lose investors, with three-quarters saying it was unattractive this year. Central and eastern Europe and Turkey also lost ground.
“Of the Bric [Brazil, Russia, India and China] markets, the one that seems to have stalled is Russia, which has really fallen out of favour,” said Erwin Roex, partner at Coller Capital, which invests in second-hand private equity assets.
“Brazil is an investment grade country and that has made quite a difference,” he added. “It has huge natural resources and reserves, its pension funds are supporting private equity and it is stable politically.”
Almost three-quarters of investors said emerging markets had become more risky in the past year. However, 77 per cent said they expected annual returns above 16 per cent over three to five years from emerging markets private equity, against only 43 per cent who expected the same for their global private equity portfolio.
“If you are investing very carefully with general partners who understand these markets, then they should absolutely outperform groups investing in a traditional way in US and western European private equity,” said Steven Cowan, managing director of PCGI, a Washington-based group with $1bn invested in non-US private equity.
Ms Alexander said the financial crisis had hit both private equity fundraising and investment activity in emerging markets in the first quarter, which dropped by about half to $8bn-$10bn and $5bn-$8bn, respectively.
Richard Laing, chief executive of CDC, the $4bn state-owned UK investor in emerging market private equity, said: “Fundraising in our markets is really tough and while most investors are still there, they are coming in for smaller amounts.”
The fall in private equity funding is spreading to emerging markets, but funds focused on some countries, such as China, India and Brazil, are still attracting investors in spite of the downturn, research will show on Monday.
Three-quarters of investors in private equity in emerging markets plan to commit more money to funds in these regions, according to a survey of 156 financial institutions, including funds-of-funds, pension funds, endowments and rich families.
“In past downturns you have seen investors pulling out of these markets en masse, particularly in 1990-91,” said Sarah Alexander, president of the Emerging Markets Private Equity Association, which produced the research with Coller Capital. “But now they look at these markets and see growth potential they don’t see in western markets.”
Brazil is growing in popularity, with more than a quarter of investors aiming to start investing in the country or increase their exposure. China and India were rated as the two other most attractive markets.
However, Russia is set to lose investors, with three-quarters saying it was unattractive this year. Central and eastern Europe and Turkey also lost ground.
“Of the Bric [Brazil, Russia, India and China] markets, the one that seems to have stalled is Russia, which has really fallen out of favour,” said Erwin Roex, partner at Coller Capital, which invests in second-hand private equity assets.
“Brazil is an investment grade country and that has made quite a difference,” he added. “It has huge natural resources and reserves, its pension funds are supporting private equity and it is stable politically.”
Almost three-quarters of investors said emerging markets had become more risky in the past year. However, 77 per cent said they expected annual returns above 16 per cent over three to five years from emerging markets private equity, against only 43 per cent who expected the same for their global private equity portfolio.
“If you are investing very carefully with general partners who understand these markets, then they should absolutely outperform groups investing in a traditional way in US and western European private equity,” said Steven Cowan, managing director of PCGI, a Washington-based group with $1bn invested in non-US private equity.
Ms Alexander said the financial crisis had hit both private equity fundraising and investment activity in emerging markets in the first quarter, which dropped by about half to $8bn-$10bn and $5bn-$8bn, respectively.
Richard Laing, chief executive of CDC, the $4bn state-owned UK investor in emerging market private equity, said: “Fundraising in our markets is really tough and while most investors are still there, they are coming in for smaller amounts.”
Thursday, March 26, 2009
EU leader condemns US ‘road to hell’
European Union hopes for a new era in relations with the US were thrown into chaos on Wednesday when the holder of the EU presidency condemned American remedies for the global recession as “the road to hell”.
Barely a week before Barack Obama is due to arrive in Europe on his first official visit as US president, Mirek Topolanek, the Czech Republic’s prime minister, put the 27-nation EU on a collision course with Washington.
His attack compounded the confusion that has engulfed EU policy after the Czech leader lost a no-confidence vote in the country’s parliament on Tuesday, forcing him to offer his government’s resignation midway through its six-month EU presidency.
Mr Topolanek said EU leaders had been disturbed at a summit in Brussels last week to hear calls from Tim Geithner, the US Treasury secretary, for more aggressive policies to fight the global downturn.
“The US Treasury secretary talks about permanent action and we, at our spring council, were quite alarmed at that . . . The US is repeating mistakes from the 1930s, such as wide-ranging stimuluses, protectionist tendencies and appeals, the Buy American campaign, and so on,” he told a European parliament session in Strasbourg. “All these steps, their combination and their permanency, are the road to hell.”
US officials made no comment on the remarks. But the Obama administration says it took great pains to ensure that the Buy American provisions in the $787bn (€579bn) stimulus that the president signed into law last month were consistent with World Trade Organisation rules. It followed, therefore, that any attempt to make them permanent would continue to be consistent with WTO rules.
EU diplomats said it was the most extraordinary outburst from a political leader in charge of running the EU’s affairs since Silvio Berlusconi, Italy’s prime minister, caused uproar in 2003 when he likened a German socialist member of the European parliament to a Nazi concentration camp guard.
Other leaders of EU member states, including Angela Merkel, Germany’s chancellor, disagree with US calls for big fiscal stimuli to battle the recession. But they have couched their opposition in more diplomatic language than Mr Topolanek’s.
The Czech leader was speaking eight days before Mr Obama was due to arrive in London for a G20 summit of the world’s developed and emerging economies.
After the summit and a Nato meeting in France and Germany, the US president is due to fly to Prague for an EU-US summit, at which the Czech Republic will represent all 27 member states.
Relations between the Obama administration and Mr Topolanek’s government have been delicate in recent weeks because of signals from Washington that Mr Obama may reassess plans to deploy parts of a US anti-missile shield in the Czech Republic, a project to which the Topolanek government has been committed.
Mr Obama has vigorously opposed the view that the Great Depression was caused by too much spending, rather than too little, a view held by a small handful of rightwing economists.
Barely a week before Barack Obama is due to arrive in Europe on his first official visit as US president, Mirek Topolanek, the Czech Republic’s prime minister, put the 27-nation EU on a collision course with Washington.
His attack compounded the confusion that has engulfed EU policy after the Czech leader lost a no-confidence vote in the country’s parliament on Tuesday, forcing him to offer his government’s resignation midway through its six-month EU presidency.
Mr Topolanek said EU leaders had been disturbed at a summit in Brussels last week to hear calls from Tim Geithner, the US Treasury secretary, for more aggressive policies to fight the global downturn.
“The US Treasury secretary talks about permanent action and we, at our spring council, were quite alarmed at that . . . The US is repeating mistakes from the 1930s, such as wide-ranging stimuluses, protectionist tendencies and appeals, the Buy American campaign, and so on,” he told a European parliament session in Strasbourg. “All these steps, their combination and their permanency, are the road to hell.”
US officials made no comment on the remarks. But the Obama administration says it took great pains to ensure that the Buy American provisions in the $787bn (€579bn) stimulus that the president signed into law last month were consistent with World Trade Organisation rules. It followed, therefore, that any attempt to make them permanent would continue to be consistent with WTO rules.
EU diplomats said it was the most extraordinary outburst from a political leader in charge of running the EU’s affairs since Silvio Berlusconi, Italy’s prime minister, caused uproar in 2003 when he likened a German socialist member of the European parliament to a Nazi concentration camp guard.
Other leaders of EU member states, including Angela Merkel, Germany’s chancellor, disagree with US calls for big fiscal stimuli to battle the recession. But they have couched their opposition in more diplomatic language than Mr Topolanek’s.
The Czech leader was speaking eight days before Mr Obama was due to arrive in London for a G20 summit of the world’s developed and emerging economies.
After the summit and a Nato meeting in France and Germany, the US president is due to fly to Prague for an EU-US summit, at which the Czech Republic will represent all 27 member states.
Relations between the Obama administration and Mr Topolanek’s government have been delicate in recent weeks because of signals from Washington that Mr Obama may reassess plans to deploy parts of a US anti-missile shield in the Czech Republic, a project to which the Topolanek government has been committed.
Mr Obama has vigorously opposed the view that the Great Depression was caused by too much spending, rather than too little, a view held by a small handful of rightwing economists.
Wednesday, March 25, 2009
Gathering storm
For the past 20 years, foreign businesspeople working in central and eastern Europe have seen unremitting progress in local business conditions, particularly in the 10 states that joined the European Union in 2004.
The modernisation of laws, regulations and commercial practices, integration with western Europe, huge investments in infrastructure, and, above all, rapid economic growth have transformed the business environment.
But now the global economic crisis has added a new dimension of difficulties. The crisis is hitting the region principally through the financial sector. The west European banks that dominate the market are suffering unprecedented difficulties refinancing themselves, both for their day-to-day operations and for capital to boost their balance sheets to cope with increases in bad debts.
Credit growth has slowed dramatically, leaving companies, particularly smaller enterprises, desperately short of cash. As in western Europe, businesses are increasingly cautious about choosing clients and suppliers, and setting contract terms. Companies prefer to trust the counterparties they know best, making it even harder for newcomers to break into the market.
While all of these challenges have also emerged in western Europe, they are much more acute in some east European states, particularly those most dependent on foreign financing.
Katinka Barysch, deputy director of the Centre for European Reform, a think-tank, writes in a recent report: “The traditional central and east European growth model appears to be broken, at least for now.”
But it is important to keep in mind that the region is composed of states with increasingly different business environments. As the common communist starting point fades into history, economic conditions come under the influence of more recent policymaking. In Hungary, for example, successive years of high government borrowing helped drive the country into economic crisis and forced it to seek an emergency loan from the International Monetary Fund.
By contrast, its central European peers – Poland, the Czech Republic and Slovakia – ran tighter budgets and have weathered the storm better. Slovakia, like Slovenia, has the added advantage of being in the eurozone.
As Manfred Wimmer, chief financial officer of Erste Group, the Austrian bank which has extensive east European operations, says: “What’s been lost in this crisis, very often, has been the ability of people to differentiate.”
For foreign businesspeople new to the region, the challenges are particularly relevant. Government agencies and chambers of commerce are aware of the problems and are offering to help with information and contacts. Nevertheless, as in western Europe, the authorities are finding it difficult to counteract the caution in the market place, especially in the crucial banking sector.
Foreign investment is shrinking dramatically. The Institute of International Finance, a bankers’ umbrella group, estimates that private capital flows to emerging Europe (including Russia and Turkey) shrank from £283bn in 2007 to £183bn in 2008, and just £21bn so far this year. The turnround in banking finance makes a dramatic contribution to these totals: dropping from an inflow of £156bn in 2007 to one of £88bn last year to a forecast net outflow of £19bn this year.
And yet, there is business to be done in these conditions. The credit crunch is driving down asset prices, with debt-laden owners forced to do deals or sell out altogether at valuations they would have found laughable a year ago.
Those owners who can afford to wait for better times will do so, but others cannot. For cash-rich investors this creates a rare chance to invest in the region, at prices not seen for years. Industrial companies, private equity funds and rich individuals are all sniffing around in the hope of snapping up a bargain.
Among them is, for example, Zdenek Bakala, a Czech entrepreneur. His coal company, New World Resources, is buying a 25 per cent stake in Ferrexpo, the Ukrainian iron ore group, from Kostyantin Zhevago, Ferrexpo’s controlling shareholder, after Mr Zhevago came under financial pressure and had to sell the stock.
The same arguments apply in trade. Companies were raising prices for their products a year ago but are now under pressure to cut prices. In comparison with western European companies, they may find this easier to do because they are more flexible, having lived through a series of mini-crises in the past two decades.
Lower wage costs, for example, were one reason Dell, the US computer maker, decided to cut operations in Ireland and move them to an existing site in Poland. The sharp decline in eastern European currencies has also increased the competitiveness of the region’s exporters.
Meanwhile, the crisis has had little impact on the ease of doing business in the region – in terms of dealing with officialdom and red tape. But this may not last, if governments increase their role in the economy. As the European Bank for Reconstruction and Development noted in its annual review last autumn: “While there has been no serious backtracking on reform in any transition country during the past year, there have been worrying instances of the state taking a more intrusive role in key sectors of the economy, notably in Russia.”
After years of reform, conditions in the most advanced east European states are now approaching west European levels. The World Bank reported last summer that Slovakia, the top-rated east European state, came 36th on a global list of countries ranked by the ease of setting up companies and similar functions, only nine places behind Austria. Hungary was not far behind in 41st place. Admittedly the east European “tail” is rather long, with the Czech Republic ranked 75th, Poland 76th and Ukraine 145th. And the World Bank does not capture the whole picture. Bulgaria and Romania do well on its criteria, ranking 45th and 47th, but they have a poor reputation for fighting corruption.
Some observers fear that if the state’s economic role increases, it could make life more difficult for businesses, particularly newcomers with little knowledge of domestic bureaucratic practices. Pavol Demes, a former Slovak foreign minister and head of the central and east European office of the German Marshall Fund, a US think-tank, says that people are beginning “to question” liberal democracy, market economics and the loose regulatory frameworks of recent years.
Ivan Krastev, head of the Centre for Liberal Studies, a Bulgarian think-tank, warns that the crisis is undermining the people who were the strongest supporters of the globalisation drive and creating opportunities for inward-looking politically oriented rivals. “The worst hit are the best integrated, best managed and most westernised companies,” he says.
But, for the moment, these risks should not be exaggerated. Countries inside the EU will be obliged to continue operating within the single market’s rules. Candidate countries will have to stick to these regulations too, or jeopardise their accession hopes. While populist leaders may demand, for example, protectionist policies, east European governments will have to bear in mind that they are currently significant beneficiaries of EU aid programmes, financed by west European states.
For multinational businesses, the principal attraction of the region remains: low-cost, high-skilled labour inside the huge EU market. Even in the depths of the crisis, companies are intensely aware of this.
Sergio Marchionne, chief executive of Fiat, the Italian carmaker, recently pointed out that the group’s one Polish factory makes 400,000 cars a year, while the six Italian plants together produce 600,000. “This is offensive,” he told an Italian newspaper.
It may also become unsustainable.
Stefan Wagstyl is eastern Europe editor
The modernisation of laws, regulations and commercial practices, integration with western Europe, huge investments in infrastructure, and, above all, rapid economic growth have transformed the business environment.
But now the global economic crisis has added a new dimension of difficulties. The crisis is hitting the region principally through the financial sector. The west European banks that dominate the market are suffering unprecedented difficulties refinancing themselves, both for their day-to-day operations and for capital to boost their balance sheets to cope with increases in bad debts.
Credit growth has slowed dramatically, leaving companies, particularly smaller enterprises, desperately short of cash. As in western Europe, businesses are increasingly cautious about choosing clients and suppliers, and setting contract terms. Companies prefer to trust the counterparties they know best, making it even harder for newcomers to break into the market.
While all of these challenges have also emerged in western Europe, they are much more acute in some east European states, particularly those most dependent on foreign financing.
Katinka Barysch, deputy director of the Centre for European Reform, a think-tank, writes in a recent report: “The traditional central and east European growth model appears to be broken, at least for now.”
But it is important to keep in mind that the region is composed of states with increasingly different business environments. As the common communist starting point fades into history, economic conditions come under the influence of more recent policymaking. In Hungary, for example, successive years of high government borrowing helped drive the country into economic crisis and forced it to seek an emergency loan from the International Monetary Fund.
By contrast, its central European peers – Poland, the Czech Republic and Slovakia – ran tighter budgets and have weathered the storm better. Slovakia, like Slovenia, has the added advantage of being in the eurozone.
As Manfred Wimmer, chief financial officer of Erste Group, the Austrian bank which has extensive east European operations, says: “What’s been lost in this crisis, very often, has been the ability of people to differentiate.”
For foreign businesspeople new to the region, the challenges are particularly relevant. Government agencies and chambers of commerce are aware of the problems and are offering to help with information and contacts. Nevertheless, as in western Europe, the authorities are finding it difficult to counteract the caution in the market place, especially in the crucial banking sector.
Foreign investment is shrinking dramatically. The Institute of International Finance, a bankers’ umbrella group, estimates that private capital flows to emerging Europe (including Russia and Turkey) shrank from £283bn in 2007 to £183bn in 2008, and just £21bn so far this year. The turnround in banking finance makes a dramatic contribution to these totals: dropping from an inflow of £156bn in 2007 to one of £88bn last year to a forecast net outflow of £19bn this year.
And yet, there is business to be done in these conditions. The credit crunch is driving down asset prices, with debt-laden owners forced to do deals or sell out altogether at valuations they would have found laughable a year ago.
Those owners who can afford to wait for better times will do so, but others cannot. For cash-rich investors this creates a rare chance to invest in the region, at prices not seen for years. Industrial companies, private equity funds and rich individuals are all sniffing around in the hope of snapping up a bargain.
Among them is, for example, Zdenek Bakala, a Czech entrepreneur. His coal company, New World Resources, is buying a 25 per cent stake in Ferrexpo, the Ukrainian iron ore group, from Kostyantin Zhevago, Ferrexpo’s controlling shareholder, after Mr Zhevago came under financial pressure and had to sell the stock.
The same arguments apply in trade. Companies were raising prices for their products a year ago but are now under pressure to cut prices. In comparison with western European companies, they may find this easier to do because they are more flexible, having lived through a series of mini-crises in the past two decades.
Lower wage costs, for example, were one reason Dell, the US computer maker, decided to cut operations in Ireland and move them to an existing site in Poland. The sharp decline in eastern European currencies has also increased the competitiveness of the region’s exporters.
Meanwhile, the crisis has had little impact on the ease of doing business in the region – in terms of dealing with officialdom and red tape. But this may not last, if governments increase their role in the economy. As the European Bank for Reconstruction and Development noted in its annual review last autumn: “While there has been no serious backtracking on reform in any transition country during the past year, there have been worrying instances of the state taking a more intrusive role in key sectors of the economy, notably in Russia.”
After years of reform, conditions in the most advanced east European states are now approaching west European levels. The World Bank reported last summer that Slovakia, the top-rated east European state, came 36th on a global list of countries ranked by the ease of setting up companies and similar functions, only nine places behind Austria. Hungary was not far behind in 41st place. Admittedly the east European “tail” is rather long, with the Czech Republic ranked 75th, Poland 76th and Ukraine 145th. And the World Bank does not capture the whole picture. Bulgaria and Romania do well on its criteria, ranking 45th and 47th, but they have a poor reputation for fighting corruption.
Some observers fear that if the state’s economic role increases, it could make life more difficult for businesses, particularly newcomers with little knowledge of domestic bureaucratic practices. Pavol Demes, a former Slovak foreign minister and head of the central and east European office of the German Marshall Fund, a US think-tank, says that people are beginning “to question” liberal democracy, market economics and the loose regulatory frameworks of recent years.
Ivan Krastev, head of the Centre for Liberal Studies, a Bulgarian think-tank, warns that the crisis is undermining the people who were the strongest supporters of the globalisation drive and creating opportunities for inward-looking politically oriented rivals. “The worst hit are the best integrated, best managed and most westernised companies,” he says.
But, for the moment, these risks should not be exaggerated. Countries inside the EU will be obliged to continue operating within the single market’s rules. Candidate countries will have to stick to these regulations too, or jeopardise their accession hopes. While populist leaders may demand, for example, protectionist policies, east European governments will have to bear in mind that they are currently significant beneficiaries of EU aid programmes, financed by west European states.
For multinational businesses, the principal attraction of the region remains: low-cost, high-skilled labour inside the huge EU market. Even in the depths of the crisis, companies are intensely aware of this.
Sergio Marchionne, chief executive of Fiat, the Italian carmaker, recently pointed out that the group’s one Polish factory makes 400,000 cars a year, while the six Italian plants together produce 600,000. “This is offensive,” he told an Italian newspaper.
It may also become unsustainable.
Stefan Wagstyl is eastern Europe editor
The world needs an unbiased risk assessor
Policymakers are increasingly calling for the creation of an early warning system to prevent future breakdowns of the global economy. But so far no one has answered the key questions of who would operate such a system and how it could work. If crises are to be detected and dealt with promptly, those charged with the task must be able to speak clearly and with authority.
Any forthright, disinterested assessment of the global economic system’s stability requires two sorts of independence. First, the institution making the analysis and judgments must not have anything other than its own reputation riding on its assessment; in particular, its own policies or lending should not be shaped in any way by its judgment. That means it should not have any policy or lending facilities. Thus it cannot be part of the existing international financial institutions (IFIs), all of which are policymaking, governmental or lending institutions.
Second, the institution must be independent of the big countries or parts of the global economic system that might contribute to future instability. Therefore it cannot be subject to interference by the board of the institution. That means that its assessments cannot be part of the IFIs in their current form, or indeed any form that may emerge from reform proposals. The fact is, main shareholders, through their board membership, always interfere in any statement that they think might be interpreted as critical of their country.
Those who have served in the IFIs at a senior level (in my case for a decade in the European Bank for Reconstruction and Development and the World Bank) will know how hard it is to make judgments about important economies without the direct and indirect intervention of board members or their staff, often on explicit instructions from their home capitals. It would be impossible to have frank and clear assessments of economic risks if such politically motivated board interventions or editing were possible.
We must not delude ourselves that this task of fostering stability could be performed by the International Monetary Fund, the World Bank, the Financial Stability Forum, the Bank for International Settlements or any future form of such institutions. John Maynard Keynes foresaw the inevitability of such interference from the board clearly as he shaped those institutions at Bretton Woods in 1944. Experience has shown the wisdom of his prescience. Separation of the assessment from board interference is crucial.
What would be required? The structure of any new institution follows directly from the need for the two types of independence. Further, the impact of its assessment of sources of instability will depend on the quality of its analysis, so it must be staffed by first-rate officials. Its task would be to warn explicitly of the key sources of future instability and, in doing so, put pressure on decision-makers in government or key private institutions.
With 100 high-quality staff and outstanding leadership, such an institution could be very effective. A budget of $20m (€15m, £14m) per annum would be sufficient. An endowment of $500m would give it the independence it needs for 30 years or more. Its board would be advisory, non-resident and meet not more than twice a year. The board would have the power to appoint the head (for, say, a seven-year term) and ensure its finances are well managed. It would have no power to interfere with, or comment on, its assessments.
It should be led by someone with outstanding economic credentials, who has strong policy experience at a senior level and who will be respected for taking a position independent of his or her country of origin. Examples of possible leadership, focusing on countries that are not part of the Group of Eight industrialised nations (this need not be a requirement, provided the individual has a strong international perspective), include: Montek Singh Ahluwalia (India), Leszek Balcerowicz (Poland), Kemal Dervis (Turkey), Francisco Gil Díaz (Mexico), Stanley Fischer (Israel) and Trevor Manuel (South Africa).
Tinkering with existing institutions cannot provide the independence we need. The politically sensitive task of warning about growing systemic risks can be delivered only by a new institution. We can create one at a cost that is very modest in relation to the dangers we face. As we witness the extreme consequences of getting it wrong, now is the time for action.
The writer is IG Patel Professor of Economics & Government, LSE, and is formerly chief economist of the EBRD (1994-99) and World Bank (2000-03). His book A Blueprint for a Safer Planet will be published on April 2
Any forthright, disinterested assessment of the global economic system’s stability requires two sorts of independence. First, the institution making the analysis and judgments must not have anything other than its own reputation riding on its assessment; in particular, its own policies or lending should not be shaped in any way by its judgment. That means it should not have any policy or lending facilities. Thus it cannot be part of the existing international financial institutions (IFIs), all of which are policymaking, governmental or lending institutions.
Second, the institution must be independent of the big countries or parts of the global economic system that might contribute to future instability. Therefore it cannot be subject to interference by the board of the institution. That means that its assessments cannot be part of the IFIs in their current form, or indeed any form that may emerge from reform proposals. The fact is, main shareholders, through their board membership, always interfere in any statement that they think might be interpreted as critical of their country.
Those who have served in the IFIs at a senior level (in my case for a decade in the European Bank for Reconstruction and Development and the World Bank) will know how hard it is to make judgments about important economies without the direct and indirect intervention of board members or their staff, often on explicit instructions from their home capitals. It would be impossible to have frank and clear assessments of economic risks if such politically motivated board interventions or editing were possible.
We must not delude ourselves that this task of fostering stability could be performed by the International Monetary Fund, the World Bank, the Financial Stability Forum, the Bank for International Settlements or any future form of such institutions. John Maynard Keynes foresaw the inevitability of such interference from the board clearly as he shaped those institutions at Bretton Woods in 1944. Experience has shown the wisdom of his prescience. Separation of the assessment from board interference is crucial.
What would be required? The structure of any new institution follows directly from the need for the two types of independence. Further, the impact of its assessment of sources of instability will depend on the quality of its analysis, so it must be staffed by first-rate officials. Its task would be to warn explicitly of the key sources of future instability and, in doing so, put pressure on decision-makers in government or key private institutions.
With 100 high-quality staff and outstanding leadership, such an institution could be very effective. A budget of $20m (€15m, £14m) per annum would be sufficient. An endowment of $500m would give it the independence it needs for 30 years or more. Its board would be advisory, non-resident and meet not more than twice a year. The board would have the power to appoint the head (for, say, a seven-year term) and ensure its finances are well managed. It would have no power to interfere with, or comment on, its assessments.
It should be led by someone with outstanding economic credentials, who has strong policy experience at a senior level and who will be respected for taking a position independent of his or her country of origin. Examples of possible leadership, focusing on countries that are not part of the Group of Eight industrialised nations (this need not be a requirement, provided the individual has a strong international perspective), include: Montek Singh Ahluwalia (India), Leszek Balcerowicz (Poland), Kemal Dervis (Turkey), Francisco Gil Díaz (Mexico), Stanley Fischer (Israel) and Trevor Manuel (South Africa).
Tinkering with existing institutions cannot provide the independence we need. The politically sensitive task of warning about growing systemic risks can be delivered only by a new institution. We can create one at a cost that is very modest in relation to the dangers we face. As we witness the extreme consequences of getting it wrong, now is the time for action.
The writer is IG Patel Professor of Economics & Government, LSE, and is formerly chief economist of the EBRD (1994-99) and World Bank (2000-03). His book A Blueprint for a Safer Planet will be published on April 2
Monday, March 23, 2009
Power Up
Rana Foroohar
What's called a 'global' recession is in fact shrinking economies mainly in the West, not the East.
As Chinese Premier Wen Jiabao informed the world recently, he's a "little bit worried." Not about China, mind you, but about the United States. "We have loaned huge amounts of money to the U.S., so of course we have to be concerned," said Wen earlier this month, warning America to "honor its word" and "ensure the safety of Chinese assets." Translation: Those guys on Wall Street really screwed up. We think the dollar might tank and erase the value of our $2 trillion in T-bills. Get your act together.
It's a stunning turnabout from even a year ago, when such warnings were almost always issued by rich nations, like the U.S., to poorer ones. But a lot has changed in recent years and recent days. Emerging giants like China are stronger, more economically competent and vastly richer. Their confidence has only increased amid a calamity that is widely described as the worst "global" recession in 70 years, but is in fact not truly global. It is shrinking the richest economies, but only slowing the emerging giants. This year GDP is expected to contract by 3 percent in the U.S. and Europe, and by close to 6 percent in Japan, while continuing to expand in China and India by 7 and 5 percent, respectively.
That growth gap is destined to reshape the economic future of the world. Goldman Sachs chief economist Jim O'Neill now predicts that the major emerging markets—Brazil, Russia, India and China, a.k.a. the BRICs—could overtake the combined GDP of the G7 nations by 2027, nearly a decade sooner than the forecast in a landmark study a few years back. The ascent of the formerly poor giants is accelerating, and their confidence is evident not only in the utterances of Wen Jiabao. Manmohan Singh of India has blamed the "massive failure" on authorities in "developed societies," but his peers all name America by name. Vladimir Putin of Russia scorns "the irresponsibility of the system that claims leadership." Luiz Inácio Lula da Silva of Brazil, in an interview with NEWSWEEK (following story), says the U.S. bears the brunt of responsibility for the crisis, and for fixing it at the upcoming G20 summit in London.
Power is not only shifting toward the BRICs, but among them as well. For all their outspokenness, Brazil and Russia have been hit much harder by the crisis than India and China. Dependent on sales of commodities that are shrinking rapidly in price, Russia's economy has fallen off a cliff, and could shrink 3 percent this year. Brazil will likely stagnate. Their recoveries could be slow and painful, too. Goldman Sachs projections for the period from 2011 to 2050 show Russia growing at just 2.8 percent, Brazil at 4.3 percent, China at 5.2 and India at 6.3. If those figures turn out to be correct, three of the top four economies in the world—China, the U.S., India and Japan, in that order—would be Asian within the next two decades. The Asian Century is almost here.
The markets seem to know it. While the S&P 500, down about 45 percent last year, has plummeted another 15 percent since the start of 2009, the Shanghai Composite Index is up by 20 percent, continuing a rally that began in November.
The grim consumer outlook, unemployment paranoia and general siege mentality that's taken hold in the West is also largely absent in Asia. In China and India, sales of cars, white goods and many other types of consumer products are still rising, in large part because of the strong and swift stimulus measures taken by these nations, which have clearly learned a lot about macroeconomic policymaking since the 1990s. Capital goods and machinery are showing double-digit growth in India, and cement sales in China have suddenly risen, now that it's getting warm enough to build. Russia once again is the outlier: consumer spending there is still down sharply.
Americans are ceding the role of world's most resilient shoppers to the Chinese and Indians. Chinese bank lending this past December was up 1,000 percent over the same period last year, as the government lowered interest rates, reigniting the real-estate market. "That's opening up a whole new, broader base of local people in China who can now afford apartments—and believe me, the demand is there," says Michael Klibaner, head of China research for the real-estate marketresearch firm Jones Lang LaSalle.
The big question for China has been whether it can forge an economy that depends not on exports to the West, but on consumption. Klibaner says it's happening, because the strongest real-estate growth now is not in big cities that cater to exporters but in smaller ones geared toward the domestic market. That follows the trend in Brazil, where the middle class is the largest segment of the population, and also in India. "Consumer spending is 60 percent of GDP in India," says Global Insight chief economist Nariman Behravesh. "That's a key reason why the economy hasn't been hit harder in this downturn."
None of this means that BRIC consumers will save a world in financial crisis. Their purchasing power is still far too weak compared with rich nations like the U.S. and Japan. Yet as their economies grow, so will the power of their wallets. Sooner rather than later, consumers in the BRIC nations will dictate the R&D investments of major corporations, the travel routes of airlines and the marketing campaigns of multinationals.
The BRICs are better positioned to recover than their richer peers. Broadly speaking, better control of inflation, lower deficits, increasing productivity, richer social programs and greater political stability have given the emerging giants greater room for error at a time when the macro-economic environment in rich countries has been deteriorating. Even Brazil and hard-hit Russia have used raw-materials windfalls (oil and gas for Russia, soybeans and iron ore for Brazil) to build a buffer for the downturn—Russia has spent more than $300 billion defending the ruble, and still has that much in reserve. Brazil's $208 billion reserve remains almost untouched.
What's more, the BRICs have learned from our follies. Strong regulatory oversight allowed the Indian and Chinese financial sectors to emerge relatively unscathed from the credit crisis. Through the first half of 2008 (the most recent available data), Chinese banks were acquiring foreign rivals and increasing their share of global financial markets. If that continues, a Deutsche Bank report released last week predicts, China will become one of the dominant financial markets in the world by 2018, alongside the U.S. and the EU, with a 13 percent share in global bond markets, 40 percent of equity markets and 18 percent of global banking.
Sooner than that, the Chinese will likely see an uptick in exports. Purchasing-order surveys in China have been up for three months now, notes CLSA economist Andy Rothman, as factory owners in places like the Yangtze River Delta struggle to fill rush jobs for Western clothing chains that panicked and reduced orders too much. Rothman calls it the "Wal-Mart effect", and expects the interest of increasingly thrifty Western consumers in all things cheap to help Chinese exporters rebound. Many others say the "cheap is cool" phenomenon will ultimately buoy all kinds of emerging-market products and services, from Mexican cement makers to Indian telecom providers, that still tend to offer the best prices. When consumers around the world do start buying again, it seems they'll be doing it in the BRIC countries.
What's called a 'global' recession is in fact shrinking economies mainly in the West, not the East.
As Chinese Premier Wen Jiabao informed the world recently, he's a "little bit worried." Not about China, mind you, but about the United States. "We have loaned huge amounts of money to the U.S., so of course we have to be concerned," said Wen earlier this month, warning America to "honor its word" and "ensure the safety of Chinese assets." Translation: Those guys on Wall Street really screwed up. We think the dollar might tank and erase the value of our $2 trillion in T-bills. Get your act together.
It's a stunning turnabout from even a year ago, when such warnings were almost always issued by rich nations, like the U.S., to poorer ones. But a lot has changed in recent years and recent days. Emerging giants like China are stronger, more economically competent and vastly richer. Their confidence has only increased amid a calamity that is widely described as the worst "global" recession in 70 years, but is in fact not truly global. It is shrinking the richest economies, but only slowing the emerging giants. This year GDP is expected to contract by 3 percent in the U.S. and Europe, and by close to 6 percent in Japan, while continuing to expand in China and India by 7 and 5 percent, respectively.
That growth gap is destined to reshape the economic future of the world. Goldman Sachs chief economist Jim O'Neill now predicts that the major emerging markets—Brazil, Russia, India and China, a.k.a. the BRICs—could overtake the combined GDP of the G7 nations by 2027, nearly a decade sooner than the forecast in a landmark study a few years back. The ascent of the formerly poor giants is accelerating, and their confidence is evident not only in the utterances of Wen Jiabao. Manmohan Singh of India has blamed the "massive failure" on authorities in "developed societies," but his peers all name America by name. Vladimir Putin of Russia scorns "the irresponsibility of the system that claims leadership." Luiz Inácio Lula da Silva of Brazil, in an interview with NEWSWEEK (following story), says the U.S. bears the brunt of responsibility for the crisis, and for fixing it at the upcoming G20 summit in London.
Power is not only shifting toward the BRICs, but among them as well. For all their outspokenness, Brazil and Russia have been hit much harder by the crisis than India and China. Dependent on sales of commodities that are shrinking rapidly in price, Russia's economy has fallen off a cliff, and could shrink 3 percent this year. Brazil will likely stagnate. Their recoveries could be slow and painful, too. Goldman Sachs projections for the period from 2011 to 2050 show Russia growing at just 2.8 percent, Brazil at 4.3 percent, China at 5.2 and India at 6.3. If those figures turn out to be correct, three of the top four economies in the world—China, the U.S., India and Japan, in that order—would be Asian within the next two decades. The Asian Century is almost here.
The markets seem to know it. While the S&P 500, down about 45 percent last year, has plummeted another 15 percent since the start of 2009, the Shanghai Composite Index is up by 20 percent, continuing a rally that began in November.
The grim consumer outlook, unemployment paranoia and general siege mentality that's taken hold in the West is also largely absent in Asia. In China and India, sales of cars, white goods and many other types of consumer products are still rising, in large part because of the strong and swift stimulus measures taken by these nations, which have clearly learned a lot about macroeconomic policymaking since the 1990s. Capital goods and machinery are showing double-digit growth in India, and cement sales in China have suddenly risen, now that it's getting warm enough to build. Russia once again is the outlier: consumer spending there is still down sharply.
Americans are ceding the role of world's most resilient shoppers to the Chinese and Indians. Chinese bank lending this past December was up 1,000 percent over the same period last year, as the government lowered interest rates, reigniting the real-estate market. "That's opening up a whole new, broader base of local people in China who can now afford apartments—and believe me, the demand is there," says Michael Klibaner, head of China research for the real-estate marketresearch firm Jones Lang LaSalle.
The big question for China has been whether it can forge an economy that depends not on exports to the West, but on consumption. Klibaner says it's happening, because the strongest real-estate growth now is not in big cities that cater to exporters but in smaller ones geared toward the domestic market. That follows the trend in Brazil, where the middle class is the largest segment of the population, and also in India. "Consumer spending is 60 percent of GDP in India," says Global Insight chief economist Nariman Behravesh. "That's a key reason why the economy hasn't been hit harder in this downturn."
None of this means that BRIC consumers will save a world in financial crisis. Their purchasing power is still far too weak compared with rich nations like the U.S. and Japan. Yet as their economies grow, so will the power of their wallets. Sooner rather than later, consumers in the BRIC nations will dictate the R&D investments of major corporations, the travel routes of airlines and the marketing campaigns of multinationals.
The BRICs are better positioned to recover than their richer peers. Broadly speaking, better control of inflation, lower deficits, increasing productivity, richer social programs and greater political stability have given the emerging giants greater room for error at a time when the macro-economic environment in rich countries has been deteriorating. Even Brazil and hard-hit Russia have used raw-materials windfalls (oil and gas for Russia, soybeans and iron ore for Brazil) to build a buffer for the downturn—Russia has spent more than $300 billion defending the ruble, and still has that much in reserve. Brazil's $208 billion reserve remains almost untouched.
What's more, the BRICs have learned from our follies. Strong regulatory oversight allowed the Indian and Chinese financial sectors to emerge relatively unscathed from the credit crisis. Through the first half of 2008 (the most recent available data), Chinese banks were acquiring foreign rivals and increasing their share of global financial markets. If that continues, a Deutsche Bank report released last week predicts, China will become one of the dominant financial markets in the world by 2018, alongside the U.S. and the EU, with a 13 percent share in global bond markets, 40 percent of equity markets and 18 percent of global banking.
Sooner than that, the Chinese will likely see an uptick in exports. Purchasing-order surveys in China have been up for three months now, notes CLSA economist Andy Rothman, as factory owners in places like the Yangtze River Delta struggle to fill rush jobs for Western clothing chains that panicked and reduced orders too much. Rothman calls it the "Wal-Mart effect", and expects the interest of increasingly thrifty Western consumers in all things cheap to help Chinese exporters rebound. Many others say the "cheap is cool" phenomenon will ultimately buoy all kinds of emerging-market products and services, from Mexican cement makers to Indian telecom providers, that still tend to offer the best prices. When consumers around the world do start buying again, it seems they'll be doing it in the BRIC countries.
Hungary’s PM ready to quit
Hungary has been thrown into a new bout of political uncertainty following the the prime minister’s weekend announcement that he will quit.
Ferenc Gyurcsany said he was leaving because disputes about his personal political role was impeding progess on economic reforms vital to the crisis-hit country’s recovery.
His planned departure is likely to be followed by around two weeks of political manouvering as a successor - possibly a non-party technocrat - is found to lead a new govt.
With Hungary facing difficulties managing an IMF rescue programme as it slides deep into recession, investors will be watching closely whether Mr Gyurcsany’s successor can restore political and economic stability.
Mr Gyurcsany is set be eastern Europe’s second political victim of the economic crisis following the resignation last month of Ivars Godmanis, the prime minister of Latvia, which is also receiving IMF aid.
There are also serious concerns about stability in Ukraine, the third state with an IMF rescue.
Mr Gyurcsany, who has led a minority government since the collapse of a Socialist-Liberal coalition a year ago, said parties should find a prime minister who would enjoy broad party support to carry out reforms.
The new prime minister will have at most a year before elections due next spring. Opposition parties say they will not accept a Socialist politician in the role, meaning Mr Gyurcsany’s successor will have to rely on ad hoc dealmaking to pass legislation during a precarious 13-month term in office.
Gabor Ambrus, an economist at 4cast, the London consultancy, said markets were likely to adopt a wait-and-see stance when they open on Monday, but warned that any successor would need a credible economic programme to stop investor flight. He said the Hungarian forint, which has swung between 280 and 320 forints to the euro over the past month, was likely to remain stable while a successor was sought. ”If they choose somebody with a credible programme [...] it doesn’t mean the forint will immediately rise to 280, but at least it might not reach 350ft to the euro.”
Some 85 per cent of consumer loans in Hungary last year were denominated in foreign currencies, which means consumers, who already face declining real incomes, are heavily exposed to falls in the local currency, while banks could see a sharp rise in loan defaults.
Of the candidates who have emerged to succeed Mr Gyurcsany, the biggest hitter is Lajos Bokros, the former finance minister who in the mid-1990s earned plaudits by making deep cuts to state social spending, laying the ground for strong growth during the late 1990s and early 2000s. Though he became the least popular politician in Hungarian history in the aftermath of his ”Bokros package”, the economics professor’s stock has since risen to the extent that opinion polls show cautious enthusiasm for a man with a proven track record.
Fidesz, the largest opposition party, has called for early elections, which are a near certainty if the other parties fail to agree on a successor
Ferenc Gyurcsany said he was leaving because disputes about his personal political role was impeding progess on economic reforms vital to the crisis-hit country’s recovery.
His planned departure is likely to be followed by around two weeks of political manouvering as a successor - possibly a non-party technocrat - is found to lead a new govt.
With Hungary facing difficulties managing an IMF rescue programme as it slides deep into recession, investors will be watching closely whether Mr Gyurcsany’s successor can restore political and economic stability.
Mr Gyurcsany is set be eastern Europe’s second political victim of the economic crisis following the resignation last month of Ivars Godmanis, the prime minister of Latvia, which is also receiving IMF aid.
There are also serious concerns about stability in Ukraine, the third state with an IMF rescue.
Mr Gyurcsany, who has led a minority government since the collapse of a Socialist-Liberal coalition a year ago, said parties should find a prime minister who would enjoy broad party support to carry out reforms.
The new prime minister will have at most a year before elections due next spring. Opposition parties say they will not accept a Socialist politician in the role, meaning Mr Gyurcsany’s successor will have to rely on ad hoc dealmaking to pass legislation during a precarious 13-month term in office.
Gabor Ambrus, an economist at 4cast, the London consultancy, said markets were likely to adopt a wait-and-see stance when they open on Monday, but warned that any successor would need a credible economic programme to stop investor flight. He said the Hungarian forint, which has swung between 280 and 320 forints to the euro over the past month, was likely to remain stable while a successor was sought. ”If they choose somebody with a credible programme [...] it doesn’t mean the forint will immediately rise to 280, but at least it might not reach 350ft to the euro.”
Some 85 per cent of consumer loans in Hungary last year were denominated in foreign currencies, which means consumers, who already face declining real incomes, are heavily exposed to falls in the local currency, while banks could see a sharp rise in loan defaults.
Of the candidates who have emerged to succeed Mr Gyurcsany, the biggest hitter is Lajos Bokros, the former finance minister who in the mid-1990s earned plaudits by making deep cuts to state social spending, laying the ground for strong growth during the late 1990s and early 2000s. Though he became the least popular politician in Hungarian history in the aftermath of his ”Bokros package”, the economics professor’s stock has since risen to the extent that opinion polls show cautious enthusiasm for a man with a proven track record.
Fidesz, the largest opposition party, has called for early elections, which are a near certainty if the other parties fail to agree on a successor
EU chokes on cost of economic rescue
Calls to boost an EU-wide economic stimulus package seem likely to be in vain, as France and Germany focus instead on improving financial regulation when a two-day EU summit opens on Thursday.
The economic crisis - Europe's worst since the 1930s - will naturally dominate the Brussels agenda.
Labour unrest has already put governments under pressure in Greece, Latvia - where the government was forced to quit - France and the UK.
BusinessEurope, a European employers' organisation, expects 4.5 million more European jobs to disappear this year - nearly two million of them in Spain and the UK alone.
The Czech Republic - a novice at chairing EU summits - faces the tough task of rallying the 27 nations behind a joint EU position ahead of the crucial G20 summit in London on 2 April.
The argument about the desirability, or not, of more crisis spending by the wealthier "old" EU countries is proving especially divisive. Anxiety about growing budget deficits looms large.
So, a spokesman for the Czech EU presidency, Jan Sliva, told reporters "there is no talk of extra stimulus, because the recovery plans still have to kick in".
In December, EU leaders agreed on a 200bn-euro (£187bn; $262bn) recovery plan proposed by the European Commission. The fiscal stimulus will amount to 1.5% of EU gross domestic product (GDP).
But a Nobel Prize-winning economist, Paul Krugman, told the EU this week that it really should spend 500bn euros this year and up to a trillion euros in total over the next three years to revive recession-hit economies.
Rescue packages
France's President Nicolas Sarkozy and German Chancellor Angela Merkel have already signalled that they are prioritising better financial regulation. Last week they said they were united on the need for "concrete results" on regulation at the G20 summit.
The Czech presidency says there is a need for EU leaders to get rapid agreement on new laws to regulate credit rating agencies, insurance firms and banks' capital requirements. The pressure is on because the European Parliament goes into recess in a few weeks' time, ahead of European elections in June.
The EU is considering "topping up" a 25bn-euro emergency package for non-eurozone member states whose budgets are particularly unstable, Mr Sliva said. It has already used up about 10bn euros in emergency bail-outs for Hungary and Latvia.
EU leaders will also "fine-tune" a 5bn-euro package of unspent EU budget funds which will now be allocated to green technologies and expanding broadband internet access. Some funding for the controversial Nabucco gas pipeline project, which avoids Russia, is also included in the package.
The EU plans to beef up its contribution to IMF funds, though the leaders may not announce a figure.
Energy urgency
The winter gas crisis that left much of Eastern Europe shivering had a profound impact on the EU, so energy security will also figure prominently at this summit.
Russia's row with Ukraine over gas prices shut down the flow until an EU-brokered deal succeeded in restoring it.
EU leaders are expected to push for specific national actions to improve Europe's energy infrastructure. The gas crisis highlighted the need to develop the pipeline network with interconnectors and reverse-flow capacity, so that gas can be distributed more efficiently and rapidly.
A related topic is the development of closer ties with "periphery" countries in the former Soviet bloc. The Czech Republic is rallying the EU behind an "Eastern Partnership" with Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine.
The Georgia-Russia war last summer and the Ukraine-Russia gas crisis pushed this issue up the EU's agenda.
The economic crisis - Europe's worst since the 1930s - will naturally dominate the Brussels agenda.
Labour unrest has already put governments under pressure in Greece, Latvia - where the government was forced to quit - France and the UK.
BusinessEurope, a European employers' organisation, expects 4.5 million more European jobs to disappear this year - nearly two million of them in Spain and the UK alone.
The Czech Republic - a novice at chairing EU summits - faces the tough task of rallying the 27 nations behind a joint EU position ahead of the crucial G20 summit in London on 2 April.
The argument about the desirability, or not, of more crisis spending by the wealthier "old" EU countries is proving especially divisive. Anxiety about growing budget deficits looms large.
So, a spokesman for the Czech EU presidency, Jan Sliva, told reporters "there is no talk of extra stimulus, because the recovery plans still have to kick in".
In December, EU leaders agreed on a 200bn-euro (£187bn; $262bn) recovery plan proposed by the European Commission. The fiscal stimulus will amount to 1.5% of EU gross domestic product (GDP).
But a Nobel Prize-winning economist, Paul Krugman, told the EU this week that it really should spend 500bn euros this year and up to a trillion euros in total over the next three years to revive recession-hit economies.
Rescue packages
France's President Nicolas Sarkozy and German Chancellor Angela Merkel have already signalled that they are prioritising better financial regulation. Last week they said they were united on the need for "concrete results" on regulation at the G20 summit.
The Czech presidency says there is a need for EU leaders to get rapid agreement on new laws to regulate credit rating agencies, insurance firms and banks' capital requirements. The pressure is on because the European Parliament goes into recess in a few weeks' time, ahead of European elections in June.
The EU is considering "topping up" a 25bn-euro emergency package for non-eurozone member states whose budgets are particularly unstable, Mr Sliva said. It has already used up about 10bn euros in emergency bail-outs for Hungary and Latvia.
EU leaders will also "fine-tune" a 5bn-euro package of unspent EU budget funds which will now be allocated to green technologies and expanding broadband internet access. Some funding for the controversial Nabucco gas pipeline project, which avoids Russia, is also included in the package.
The EU plans to beef up its contribution to IMF funds, though the leaders may not announce a figure.
Energy urgency
The winter gas crisis that left much of Eastern Europe shivering had a profound impact on the EU, so energy security will also figure prominently at this summit.
Russia's row with Ukraine over gas prices shut down the flow until an EU-brokered deal succeeded in restoring it.
EU leaders are expected to push for specific national actions to improve Europe's energy infrastructure. The gas crisis highlighted the need to develop the pipeline network with interconnectors and reverse-flow capacity, so that gas can be distributed more efficiently and rapidly.
A related topic is the development of closer ties with "periphery" countries in the former Soviet bloc. The Czech Republic is rallying the EU behind an "Eastern Partnership" with Armenia, Azerbaijan, Belarus, Georgia, Moldova and Ukraine.
The Georgia-Russia war last summer and the Ukraine-Russia gas crisis pushed this issue up the EU's agenda.
Tuesday, March 10, 2009
Europe rejects extra stimulus appeal
By Alan Beattie in Washington and Tony Barber in Brussels
European ministers said on Monday they had no plans to add to recent fiscal stimulus packages despite calls from the US for radical expansions in government action to boost ailing economies.
Meeting in Brussels, finance ministers from the countries in the eurozone said they wanted first to see the effect of stimulus packages that had been passed. Peer Steinbrück, the German finance minister, said: “We are not debating any additional measures.”
He said that Germany had recently passed a second stimulus package worth €50bn ($63bn, £46bn) and was also counting on the automatic fiscal stabilisers that increase government spending in a downturn.
Jean-Claude Juncker, chair of the “eurogroup” of ministers, said: “The 16 finance ministers agreed that recent American appeals insisting Europeans make an added budgetary effort were not to our liking.”
Lawrence Summers, senior economic adviser to Barack Obama, US president, told the Financial Times recently that the Group of 20 countries should agree to boost government demand. On Monday Christina Romer, chair of the White House Council of Economic Advisers, said: “The more that countries throughout the world can move toward monetary and fiscal expansion, the better off we will all be.”
But European ministers are concerned that building up more government debt would threaten the stability of the eurozone and say that they want to assess the effects of spending boosts that have already been passed before considering more. The US Treasury declined to comment on their remarks on Monday.
The G20 finance ministers meet near London this weekend amid deepening gloom over the world economy. A new European Union policy paper, due to be approved by finance ministers today, calls the prospects of a return to economic growth next year “highly uncertain”.
The document, obtained by the FT, paints a darker picture of the EU’s outlook than forecasts published in January by the European Commission, which predicted a gradual economic recovery in the course of next year. “The outlook for 2010 is highly uncertain,” the paper says. “Feedback loops between the real economy and the financial markets are aggravating the situation.”
The paper says “financial markets remain volatile and credit channels are not yet functioning properly”, while “unemployment rates are expected to rise sharply in most member states in 2009 and 2010”.
A recent assessment by the International Monetary Fund said that the US had enacted new discretionary economic stimulus equal to 2 per cent of gross domestic product for 2009, compared with 1.5 per cent for Germany, 1.4 per cent for the UK and just 0.7 per cent for France. But the IMF said that automatic stabilisers were worth 2 per cent of GDP for the UK and France, which have relatively large welfare states, compared with 1.5 per cent for the US.
On Monday Warren Buffett, the investor, unsettled markets with a bleak assessment in which he said that the US economy had “fallen off a cliff” and was facing a pervasive loss of confidence and negative feedback loops that would make the recession worse.
“People are confused and scared,” Mr Buffett told CNBC television.
European ministers said on Monday they had no plans to add to recent fiscal stimulus packages despite calls from the US for radical expansions in government action to boost ailing economies.
Meeting in Brussels, finance ministers from the countries in the eurozone said they wanted first to see the effect of stimulus packages that had been passed. Peer Steinbrück, the German finance minister, said: “We are not debating any additional measures.”
He said that Germany had recently passed a second stimulus package worth €50bn ($63bn, £46bn) and was also counting on the automatic fiscal stabilisers that increase government spending in a downturn.
Jean-Claude Juncker, chair of the “eurogroup” of ministers, said: “The 16 finance ministers agreed that recent American appeals insisting Europeans make an added budgetary effort were not to our liking.”
Lawrence Summers, senior economic adviser to Barack Obama, US president, told the Financial Times recently that the Group of 20 countries should agree to boost government demand. On Monday Christina Romer, chair of the White House Council of Economic Advisers, said: “The more that countries throughout the world can move toward monetary and fiscal expansion, the better off we will all be.”
But European ministers are concerned that building up more government debt would threaten the stability of the eurozone and say that they want to assess the effects of spending boosts that have already been passed before considering more. The US Treasury declined to comment on their remarks on Monday.
The G20 finance ministers meet near London this weekend amid deepening gloom over the world economy. A new European Union policy paper, due to be approved by finance ministers today, calls the prospects of a return to economic growth next year “highly uncertain”.
The document, obtained by the FT, paints a darker picture of the EU’s outlook than forecasts published in January by the European Commission, which predicted a gradual economic recovery in the course of next year. “The outlook for 2010 is highly uncertain,” the paper says. “Feedback loops between the real economy and the financial markets are aggravating the situation.”
The paper says “financial markets remain volatile and credit channels are not yet functioning properly”, while “unemployment rates are expected to rise sharply in most member states in 2009 and 2010”.
A recent assessment by the International Monetary Fund said that the US had enacted new discretionary economic stimulus equal to 2 per cent of gross domestic product for 2009, compared with 1.5 per cent for Germany, 1.4 per cent for the UK and just 0.7 per cent for France. But the IMF said that automatic stabilisers were worth 2 per cent of GDP for the UK and France, which have relatively large welfare states, compared with 1.5 per cent for the US.
On Monday Warren Buffett, the investor, unsettled markets with a bleak assessment in which he said that the US economy had “fallen off a cliff” and was facing a pervasive loss of confidence and negative feedback loops that would make the recession worse.
“People are confused and scared,” Mr Buffett told CNBC television.
Friday, February 20, 2009
Push for EU aid to struggling economies
By Chris Giles in London
Published: February 17 2009 01:39 | Last updated: February 17 2009 01:39
Austria has stepped up its campaign for the EU to aid struggling eastern European economies, with Ewald Nowotny, the governor of the central bank, telling the Financial Times “I cannot imagine a policy of benign neglect will be the last word” for countries of strategic importance such as the Ukraine.
Keen to downplay the problem as one that will bring down Austrian banks, Mr Nowotny insisted that three-quarters of the loans of his country’s banks were to EU eastern European countries with the biggest share in the relatively stable Czech Republic.
Austrian banks, he said, accounted for only 20 per cent of the exposure of western EU banks to Eastern Europe, so “therefore what is important is to see the exposure to this region as a European problem ... and not only an Austrian problem”.
On Monday, S&P, the credit ratings agency, put Ukraine on negative credit watch, as it waits for clarification of the country’s willingness and ability to fulfil the conditions of its International Monetary Fund loan.
A problem in Ukraine could trigger a “domino effect” of economic difficulties in the European Union, Josef Pröll, Austria’s finance minister warned last week.
But Mr Nowotny tried to press home the positive case for engagement with eastern European EU members, saying this would be in the collective interest of western European economies, Germany in particular. “Old Europe,” he said, had a €60bn ($76bn) trade surplus with member states further east, which was vulnerable if these economies were allowed to falter.
While Mr Nowotny insisted that Austrian banks’ loans to customers in eastern Europe were sill healthy, there is little doubt that compared to the size of the economy, Austria is more exposed to the east than other EU states.
East European loans account for 75 per cent of gross domestic product, followed by Sweden (30 per cent) and Greece (19 per cent).
Austria’s difficulties with its eastern neighbours has raised the borrowing costs of the government with the yield on Austrian 10-year government debt over 1 percentage point higher than equivalent German debt, still far below the spread in Greece, for example.
Mr Nowotny said that while markets had not differentiated different risks sufficiently within eurozone countries in the past, now “I am afraid we are going from one extreme to another”. “Markets tend to overshoot,” he added.
But the market’s assessment of higher risks in funding the Austrian government has not diminished Mr Nowotny’s desire to promote Keynesian economics on the European Central Bank governing council, an area where most other members are much more cautious.
“What we are relearning – because it is an old Keynesian position – is that if there is a deep recession, monetary policy alone is not enough and has to be supplemented by expansionary fiscal policy”.
With almost all EU countries adopting expansionary policies, he added, “the chances to be effective ... are of course much better than if countries went alone and that is one of the reasons, for me, for cautious optimism”.
Copyright The Financial Times Limited 2009
Published: February 17 2009 01:39 | Last updated: February 17 2009 01:39
Austria has stepped up its campaign for the EU to aid struggling eastern European economies, with Ewald Nowotny, the governor of the central bank, telling the Financial Times “I cannot imagine a policy of benign neglect will be the last word” for countries of strategic importance such as the Ukraine.
Keen to downplay the problem as one that will bring down Austrian banks, Mr Nowotny insisted that three-quarters of the loans of his country’s banks were to EU eastern European countries with the biggest share in the relatively stable Czech Republic.
Austrian banks, he said, accounted for only 20 per cent of the exposure of western EU banks to Eastern Europe, so “therefore what is important is to see the exposure to this region as a European problem ... and not only an Austrian problem”.
On Monday, S&P, the credit ratings agency, put Ukraine on negative credit watch, as it waits for clarification of the country’s willingness and ability to fulfil the conditions of its International Monetary Fund loan.
A problem in Ukraine could trigger a “domino effect” of economic difficulties in the European Union, Josef Pröll, Austria’s finance minister warned last week.
But Mr Nowotny tried to press home the positive case for engagement with eastern European EU members, saying this would be in the collective interest of western European economies, Germany in particular. “Old Europe,” he said, had a €60bn ($76bn) trade surplus with member states further east, which was vulnerable if these economies were allowed to falter.
While Mr Nowotny insisted that Austrian banks’ loans to customers in eastern Europe were sill healthy, there is little doubt that compared to the size of the economy, Austria is more exposed to the east than other EU states.
East European loans account for 75 per cent of gross domestic product, followed by Sweden (30 per cent) and Greece (19 per cent).
Austria’s difficulties with its eastern neighbours has raised the borrowing costs of the government with the yield on Austrian 10-year government debt over 1 percentage point higher than equivalent German debt, still far below the spread in Greece, for example.
Mr Nowotny said that while markets had not differentiated different risks sufficiently within eurozone countries in the past, now “I am afraid we are going from one extreme to another”. “Markets tend to overshoot,” he added.
But the market’s assessment of higher risks in funding the Austrian government has not diminished Mr Nowotny’s desire to promote Keynesian economics on the European Central Bank governing council, an area where most other members are much more cautious.
“What we are relearning – because it is an old Keynesian position – is that if there is a deep recession, monetary policy alone is not enough and has to be supplemented by expansionary fiscal policy”.
With almost all EU countries adopting expansionary policies, he added, “the chances to be effective ... are of course much better than if countries went alone and that is one of the reasons, for me, for cautious optimism”.
Copyright The Financial Times Limited 2009
Monday, February 16, 2009
Narrow-minded leadership hurts Europe
By Wolfgang Münchau
Published: February 15 2009 19:27 | Last updated: February 15 2009 19:27
“It is justifiable if a factory of Renault is built in India so that Renault cars may be sold to the Indians. But it is not justifiable if a factory ... is built in the Czech Republic and its cars are sold in France” – Nicolas Sarkozy, president of France.
This is a troubling statement indeed. But instead of launching a tirade against Mr Sarkozy, I would like to make an observation that is perhaps not immediately evident: his statement is entirely consistent with the way the European Union has reacted to the financial crisis.
To see the link between crisis management and the rise in protectionism, look at the initial policy response to last September’s financial shockwaves. European leaders have woefully underestimated the crisis and possibly still do. The European economy is now heading towards a depression, with German gross domestic product falling at an annualised rate of almost 9 per cent. The early misjudgment of the crisis resulted in stimulus packages with two defects. They were initially too small but, more importantly, they were not co-ordinated. One important aspect of the economic meltdown is the presence of strong cross-country spillovers, both globally and inside the EU. The policy response failed to take account of these spillovers.
For the bank bail-out programmes, the EU managed to set a minimum level of competition rules, but these programmes, too, were national and not co-ordinated. So how does the combined effect of these two unco-ordinated responses lead to protectionism?
If stimulus money is dispersed at national level, governments naturally try to make sure that the money stays inside their countries. The prospect that consumers might spend the money on imported goods was one of the reasons why eurozone governments were reluctant to cut taxes. Because of EU competition rules, the same logic also applies to government purchases. Under those rules, governments had to open public projects to EU-wide tenders. If you play by the rules, keeping the cash in your country is not easy.
Governments have since relaxed those rules. In other words, if you want to make sure that these programmes function in their warped way, you have to dismantle the single market. The same logic applies to the bank rescue packages. If the European Commission tried to block each uncompetitive bank rescue, it would be blamed for causing a financial collapse. Governments have found a way to circumvent the EU, by breaking so many rules at once, that the Commission cannot even begin to react effectively.
Expect to see three effects with progressively destructive force. The first is that the stimulus is much less effective than it could otherwise have been. When everybody tries to gain a competitive advantage over each other, the effects usually cancel out.
Second, the stimulus and bank rescue packages harm the single European market directly. The French subsidies are more blatant, as is the protectionist rhetoric of its president. But everybody in Europe plays the same game. It is not as though the single market is the default position for European commerce. Much of the service sector is exempted. Europe lacks an effective pan-European retail infrastructure and retail banking system. Reversing this programme long before it is completed would be a mistake.
Third, and most destructive, the combined decision on stimulus and financial rescue packages poses an existential threat to monetary union. A blanket loan guarantee to every bank, as most governments have granted, in combination with indiscriminate capital injections and a reluctance to restructure, will mean the transformation of private into sovereign default risk – aggravated further by the economic downturn. Some insolvent banks are now owned by the state, while the bulk of damaged, not-yet-insolvent banks are lingering on, hoarding cash. This programme is a drain of resources with no resolution in sight.
I would now expect several eurozone countries with weak banking sectors to get into serious difficulties as the crisis continues. There is a risk of cascading sovereign defaults. If this was limited to countries of the size of Ireland or Greece, one could solve this problem through a bail-out. But solvency risk is not a problem confined to small countries. The banking sectors in Italy, Spain and Germany are increasingly vulnerable.
When European leaders meet for their anti-protectionism summit on March 1, they will produce warm words to reaffirm their commitment to the single market. I suspect they will continue to misdiagnose the crisis. Protectionism is not the root of the problem. The protectionism we are experiencing now is caused by co-ordination failure. It is neither sudden, nor surprising.
The right course would be to solve the underlying problem – to shift at least some of the stimulus spending to EU or eurozone level and, ideally, drop those toxic national schemes altogether and to adopt a joint strategy for the financial sector, at least for the 45 cross-border European banks. But this is not going to happen. It did not happen in October, and it is not going to happen now. As a result of the extraordinary narrow-mindedness of Europe’s political leadership, expect serious damage to the single market in general and the single market for financial services in particular. As for the eurozone, I always argued in the past that a break-up is in effect impossible. I am no longer so sure.
Published: February 15 2009 19:27 | Last updated: February 15 2009 19:27
“It is justifiable if a factory of Renault is built in India so that Renault cars may be sold to the Indians. But it is not justifiable if a factory ... is built in the Czech Republic and its cars are sold in France” – Nicolas Sarkozy, president of France.
This is a troubling statement indeed. But instead of launching a tirade against Mr Sarkozy, I would like to make an observation that is perhaps not immediately evident: his statement is entirely consistent with the way the European Union has reacted to the financial crisis.
To see the link between crisis management and the rise in protectionism, look at the initial policy response to last September’s financial shockwaves. European leaders have woefully underestimated the crisis and possibly still do. The European economy is now heading towards a depression, with German gross domestic product falling at an annualised rate of almost 9 per cent. The early misjudgment of the crisis resulted in stimulus packages with two defects. They were initially too small but, more importantly, they were not co-ordinated. One important aspect of the economic meltdown is the presence of strong cross-country spillovers, both globally and inside the EU. The policy response failed to take account of these spillovers.
For the bank bail-out programmes, the EU managed to set a minimum level of competition rules, but these programmes, too, were national and not co-ordinated. So how does the combined effect of these two unco-ordinated responses lead to protectionism?
If stimulus money is dispersed at national level, governments naturally try to make sure that the money stays inside their countries. The prospect that consumers might spend the money on imported goods was one of the reasons why eurozone governments were reluctant to cut taxes. Because of EU competition rules, the same logic also applies to government purchases. Under those rules, governments had to open public projects to EU-wide tenders. If you play by the rules, keeping the cash in your country is not easy.
Governments have since relaxed those rules. In other words, if you want to make sure that these programmes function in their warped way, you have to dismantle the single market. The same logic applies to the bank rescue packages. If the European Commission tried to block each uncompetitive bank rescue, it would be blamed for causing a financial collapse. Governments have found a way to circumvent the EU, by breaking so many rules at once, that the Commission cannot even begin to react effectively.
Expect to see three effects with progressively destructive force. The first is that the stimulus is much less effective than it could otherwise have been. When everybody tries to gain a competitive advantage over each other, the effects usually cancel out.
Second, the stimulus and bank rescue packages harm the single European market directly. The French subsidies are more blatant, as is the protectionist rhetoric of its president. But everybody in Europe plays the same game. It is not as though the single market is the default position for European commerce. Much of the service sector is exempted. Europe lacks an effective pan-European retail infrastructure and retail banking system. Reversing this programme long before it is completed would be a mistake.
Third, and most destructive, the combined decision on stimulus and financial rescue packages poses an existential threat to monetary union. A blanket loan guarantee to every bank, as most governments have granted, in combination with indiscriminate capital injections and a reluctance to restructure, will mean the transformation of private into sovereign default risk – aggravated further by the economic downturn. Some insolvent banks are now owned by the state, while the bulk of damaged, not-yet-insolvent banks are lingering on, hoarding cash. This programme is a drain of resources with no resolution in sight.
I would now expect several eurozone countries with weak banking sectors to get into serious difficulties as the crisis continues. There is a risk of cascading sovereign defaults. If this was limited to countries of the size of Ireland or Greece, one could solve this problem through a bail-out. But solvency risk is not a problem confined to small countries. The banking sectors in Italy, Spain and Germany are increasingly vulnerable.
When European leaders meet for their anti-protectionism summit on March 1, they will produce warm words to reaffirm their commitment to the single market. I suspect they will continue to misdiagnose the crisis. Protectionism is not the root of the problem. The protectionism we are experiencing now is caused by co-ordination failure. It is neither sudden, nor surprising.
The right course would be to solve the underlying problem – to shift at least some of the stimulus spending to EU or eurozone level and, ideally, drop those toxic national schemes altogether and to adopt a joint strategy for the financial sector, at least for the 45 cross-border European banks. But this is not going to happen. It did not happen in October, and it is not going to happen now. As a result of the extraordinary narrow-mindedness of Europe’s political leadership, expect serious damage to the single market in general and the single market for financial services in particular. As for the eurozone, I always argued in the past that a break-up is in effect impossible. I am no longer so sure.
Monday, February 2, 2009
EMU on the rocks and all exits closed
The euro was created to bring economic stability to Europe. However, the politicians who promoted European Monetary Union ignored inherent flaws in the project. The credit crisis has exposed these flaws. As a result, a number of the weaker eurozone members are facing severe deflation and a quite desperate economic outlook.
The leading European politicians behind the euro project, such as former French president Francois Mitterand, weren’t much interested in economics. In a new book, The Euro: The Politics of the New Global Currency (Yale) David Marsh shows how these politicians brushed aside the concerns of their advisers as they rushed eagerly towards monetary union. Mr Mitterand’s vision for the single currency, says Mr Marsh, was “based on emotion, psychology and wishful thinking” rather than rational economics.
It was hoped that the euro would bring faster and more stable economic growth, while exporting Germany’s record of price stability to other members of the single currency. But many potential economic problems with European Monetary Union were identified decades ago. In 1973 Derek Mitchell, a British Treasury official, observed that the loss of exchange rate flexibility would remove a simple method for rectifying imbalances between Europe’s economies. Without the option of exchange rate depreciation, once imbalances appeared “equilibrium could only then be restored”, declared Mr Mitchell, “by inflation in the ‘high performance’ countries and unemployment and stagnation in the ‘low performance’ countries, unless central provision is made for the imbalances to be offset by massive and speedy resource transfers”.
Economists at the Bundesbank wanted to delay monetary union until the performance of Europe’s various economies had converged around similar inflation and growth rates. They were defeated by French bureaucrats, who believed that the euro would bring about convergence. Former Bundesbank (and later chief European Central Bank) economist Otmar Issing questioned whether Europe could move to a single currency without parallel moves to political union. Eddie George, then governor of the Bank of England, warned that Europe needed to improve its labour market flexibility before entering into a monetary union. His counterpart at the Bank of Italy, governor Antonio Fazio, questioned whether Italy would make a suitable member of EMU given that the country had a history of periodically devaluing the lira in order to regain competitiveness.
Despite these reservations, the single currency was created without effective controls on the ability of member governments to issue debt and with no formal arrangements for fiscal transfers to aid stricken countries through hard times. A high level of cross-border labour mobility, which anyhow would have required a common language, was never achieved. There were no ground rules for dealing with divergent economic competitiveness among member countries produced by differing rates of inflation and productivity over time.
Europeans are paying the price for the oversights of their former political masters. Since the euro came into existence a decade ago, consumer prices in Portugal, Ireland, Italy, Greece and Spain have risen by an average of about 20 percentage points more than in Germany. They have also experienced lower productivity growth. In addition, they have run large current account deficits and, with the exception of Italy, have experienced tremendous housing bubbles and credit booms. The ECB inadvertently contributed to the credit booms by setting an excessively low interest rate for fast-growing economies, such as Ireland.
In the past, the weaker European economies faced with the current crisis would have simply devalued their currencies. With that option closed by monetary union, their economic outlook appears dire. Spain’s unit labour costs are currently about 20 per cent higher than Germany’s, according to Andrew Hunt Economics. Unemployment is rapidly approaching 15 per cent of the workforce. To regain competitiveness, Spain would have to cut costs sharply, including wages.
Ireland’s problems are even more acute. Irish exports amount to about 90 per cent of GDP and roughly a third of these exports go to the UK. Ireland also competes with Britain for foreign direct investment. Yet over the past year, the euro has appreciated by 20 per cent against sterling, rendering Ireland even less competitive at its moment of crisis.
As the credit ratings for the peripheral members of the eurozone are downgraded and their borrowing costs rise relative to Germany, there has been speculation that some countries may choose to ditch the euro. The trouble is that EMU is an economic roach motel – it’s easier to check in than it is to quit. Leaving the euro would be a painful and messy business. It would require breaking supposedly “irreversible” treaty commitments and disentangling a web of euro-denominated financial obligations. As former German Chancellor Helmut Schmidt says “the great strength of the euro [is] that nobody can leave it without damaging his own country and his own economy in a very severe way”.
However, the alternatives aren’t pleasant. Germany might be forced to make reluctantly huge fiscal transfers to eurozone countries with large current account deficits, such as Spain. But this wouldn’t make them more competitive. As former Bundesbank president Karl-Otto Poehl says: “The other European countries have no choice [but] to . . . embark on a course of cost-cutting.”
A decade after its birth, the euro is playing a similar deflationary role in the current credit crisis as the gold standard performed in the Great Depression. The Europeans of the 1930s had certain advantages. For a start, they were less leveraged and when the crisis arrived, they had no trouble casting off their golden fetters.
Edward Chancellor is a member of GMO’s asset allocation team
The leading European politicians behind the euro project, such as former French president Francois Mitterand, weren’t much interested in economics. In a new book, The Euro: The Politics of the New Global Currency (Yale) David Marsh shows how these politicians brushed aside the concerns of their advisers as they rushed eagerly towards monetary union. Mr Mitterand’s vision for the single currency, says Mr Marsh, was “based on emotion, psychology and wishful thinking” rather than rational economics.
It was hoped that the euro would bring faster and more stable economic growth, while exporting Germany’s record of price stability to other members of the single currency. But many potential economic problems with European Monetary Union were identified decades ago. In 1973 Derek Mitchell, a British Treasury official, observed that the loss of exchange rate flexibility would remove a simple method for rectifying imbalances between Europe’s economies. Without the option of exchange rate depreciation, once imbalances appeared “equilibrium could only then be restored”, declared Mr Mitchell, “by inflation in the ‘high performance’ countries and unemployment and stagnation in the ‘low performance’ countries, unless central provision is made for the imbalances to be offset by massive and speedy resource transfers”.
Economists at the Bundesbank wanted to delay monetary union until the performance of Europe’s various economies had converged around similar inflation and growth rates. They were defeated by French bureaucrats, who believed that the euro would bring about convergence. Former Bundesbank (and later chief European Central Bank) economist Otmar Issing questioned whether Europe could move to a single currency without parallel moves to political union. Eddie George, then governor of the Bank of England, warned that Europe needed to improve its labour market flexibility before entering into a monetary union. His counterpart at the Bank of Italy, governor Antonio Fazio, questioned whether Italy would make a suitable member of EMU given that the country had a history of periodically devaluing the lira in order to regain competitiveness.
Despite these reservations, the single currency was created without effective controls on the ability of member governments to issue debt and with no formal arrangements for fiscal transfers to aid stricken countries through hard times. A high level of cross-border labour mobility, which anyhow would have required a common language, was never achieved. There were no ground rules for dealing with divergent economic competitiveness among member countries produced by differing rates of inflation and productivity over time.
Europeans are paying the price for the oversights of their former political masters. Since the euro came into existence a decade ago, consumer prices in Portugal, Ireland, Italy, Greece and Spain have risen by an average of about 20 percentage points more than in Germany. They have also experienced lower productivity growth. In addition, they have run large current account deficits and, with the exception of Italy, have experienced tremendous housing bubbles and credit booms. The ECB inadvertently contributed to the credit booms by setting an excessively low interest rate for fast-growing economies, such as Ireland.
In the past, the weaker European economies faced with the current crisis would have simply devalued their currencies. With that option closed by monetary union, their economic outlook appears dire. Spain’s unit labour costs are currently about 20 per cent higher than Germany’s, according to Andrew Hunt Economics. Unemployment is rapidly approaching 15 per cent of the workforce. To regain competitiveness, Spain would have to cut costs sharply, including wages.
Ireland’s problems are even more acute. Irish exports amount to about 90 per cent of GDP and roughly a third of these exports go to the UK. Ireland also competes with Britain for foreign direct investment. Yet over the past year, the euro has appreciated by 20 per cent against sterling, rendering Ireland even less competitive at its moment of crisis.
As the credit ratings for the peripheral members of the eurozone are downgraded and their borrowing costs rise relative to Germany, there has been speculation that some countries may choose to ditch the euro. The trouble is that EMU is an economic roach motel – it’s easier to check in than it is to quit. Leaving the euro would be a painful and messy business. It would require breaking supposedly “irreversible” treaty commitments and disentangling a web of euro-denominated financial obligations. As former German Chancellor Helmut Schmidt says “the great strength of the euro [is] that nobody can leave it without damaging his own country and his own economy in a very severe way”.
However, the alternatives aren’t pleasant. Germany might be forced to make reluctantly huge fiscal transfers to eurozone countries with large current account deficits, such as Spain. But this wouldn’t make them more competitive. As former Bundesbank president Karl-Otto Poehl says: “The other European countries have no choice [but] to . . . embark on a course of cost-cutting.”
A decade after its birth, the euro is playing a similar deflationary role in the current credit crisis as the gold standard performed in the Great Depression. The Europeans of the 1930s had certain advantages. For a start, they were less leveraged and when the crisis arrived, they had no trouble casting off their golden fetters.
Edward Chancellor is a member of GMO’s asset allocation team
Sunday, February 1, 2009
Davos finds no answers to crisis
By Tim Weber
Business editor, BBC News website, in Davos
The World Economic Forum has ended with a call to rebuild the global economic system.
Founder Klaus Schwab announced a "global redesign initiative" to reform banking, regulation and corporate governance.
For five days, more than 2,000 business and political leaders discussed what some here called the "crisis of capitalism".
However, most discussions described the problems, not solutions.
The forum's official theme this year had been "shaping the post-crisis world", but that turned out to be premature.
Rather, the debates proved the widespread uncertainty amongst both politicians and corporate bosses, as they tried to gauge the depth of the economic crisis and explore ways how to get out of it.
Nobody in Davos tried to refute the prediction that the global economy is heading into a deep and long recession.
One top money market manager said: "If you believe that the world economy will turn the corner at the end of this year, or in [the first quarter] of 2010, I tell you we have not turned the corner, we can't see the corner, we don't even know where the corner is."
Another participant summed up the state of the discussion as "we don't know what to do, only that we need to do something and we need to do it fast".
With the old certainties of the free market gone, even free marketeers accepted the need for more regulation, quick.
Professor Schwab said the current situation was a perfect example of where banks could take the lead and devise a system of self-regulation, and not wait for governments to regulate it.
It may be too late for that, though, with politicians from Germany's Chancellor Angela Merkel to UK Prime Minister Gordon Brown calling for a global regulator to ensure a smoother running of the international financial system.
Capitalism revisited
South African Archbishop Desmond Tutu said "we worshipped in the temple of cutthroat competition, and so some cooked the books, because the treasure is so great".
"We spend billions on banks," Mr Tutu said, "when we know that a fraction of this money could save all the children in the world."
Not every intended recipient of this message was present, though. The top bosses of most Wall Street banks had cancelled their trips to the Swiss mountains and stayed in the office.
It might have been for the better, because even here, in this temple of arch-capitalism, there were calls for swift criminal punishment of the people who caused the crisis coming from fellow chief executives.
Nonetheless, nearly everybody agreed that while capitalism needed fixing, it wasn't irreparably broken.
Nouriel Roubini, one of the few economists that accurately predicted the credit crunch, was not the only one to use a variation of a Churchill quote: "Capitalism is the worst system except for all those others that have been tried."
Power balance
The annual Davos meeting is also a good place to take stock of the geopolitical landscape. It was here that one could track the rise of emerging economies like India and China.
Record numbers of heads of state and government had come to Davos, mostly cloistered away in face-to-face meetings with their counterparts and key business leaders.
It was no coincidence that the keynote speeches on the first day had been reserved for China's Premier Wen Jiabao and Russia's Prime Minister Vladimir Putin.
However, with even China's economy at a crawl, and the value of Russia's oil wealth plummeting, their speeches proved that the economic crisis is truly global, and hurting around the world.
In April, the spotlight will be on the G20 meeting in London, where leading politicians both from industrialised and emerging economies will debate ways out of the crisis.
Professor Schwab attempted some expectation management. "The G20 will not solve everything," he said, "it won't address the totality of the issue."
Poverty trap
Probably the biggest worry, apart from getting the world economy "out of intensive care" (Prof Schwab), was the threat of protectionism.
Raising trade barriers now, politicians, business leaders and campaigners agreed, would have a devastating impact, for starters on the economies of rich countries, but even more so on poorest people in the world.
The Davos organisers tried hard to ensure that the crisis of the financial system did not take away all the attention from the fight against poverty, but it was difficult.
After all, it was a long list of problems that the global elites had to discuss during their five days of soul-searching.
What had once been seen as a long schmoozefest, a show-off party of the rich and powerful, had bumped into reality.
The strikes in France and the UK had not gone unnoticed, and business leaders were acutely aware that millions of people hurt by the crisis were angry, very angry. And in case they forgot, there were plenty of social activists and trade unionists here to remind them.
Business editor, BBC News website, in Davos
The World Economic Forum has ended with a call to rebuild the global economic system.
Founder Klaus Schwab announced a "global redesign initiative" to reform banking, regulation and corporate governance.
For five days, more than 2,000 business and political leaders discussed what some here called the "crisis of capitalism".
However, most discussions described the problems, not solutions.
The forum's official theme this year had been "shaping the post-crisis world", but that turned out to be premature.
Rather, the debates proved the widespread uncertainty amongst both politicians and corporate bosses, as they tried to gauge the depth of the economic crisis and explore ways how to get out of it.
Nobody in Davos tried to refute the prediction that the global economy is heading into a deep and long recession.
One top money market manager said: "If you believe that the world economy will turn the corner at the end of this year, or in [the first quarter] of 2010, I tell you we have not turned the corner, we can't see the corner, we don't even know where the corner is."
Another participant summed up the state of the discussion as "we don't know what to do, only that we need to do something and we need to do it fast".
With the old certainties of the free market gone, even free marketeers accepted the need for more regulation, quick.
Professor Schwab said the current situation was a perfect example of where banks could take the lead and devise a system of self-regulation, and not wait for governments to regulate it.
It may be too late for that, though, with politicians from Germany's Chancellor Angela Merkel to UK Prime Minister Gordon Brown calling for a global regulator to ensure a smoother running of the international financial system.
Capitalism revisited
South African Archbishop Desmond Tutu said "we worshipped in the temple of cutthroat competition, and so some cooked the books, because the treasure is so great".
"We spend billions on banks," Mr Tutu said, "when we know that a fraction of this money could save all the children in the world."
Not every intended recipient of this message was present, though. The top bosses of most Wall Street banks had cancelled their trips to the Swiss mountains and stayed in the office.
It might have been for the better, because even here, in this temple of arch-capitalism, there were calls for swift criminal punishment of the people who caused the crisis coming from fellow chief executives.
Nonetheless, nearly everybody agreed that while capitalism needed fixing, it wasn't irreparably broken.
Nouriel Roubini, one of the few economists that accurately predicted the credit crunch, was not the only one to use a variation of a Churchill quote: "Capitalism is the worst system except for all those others that have been tried."
Power balance
The annual Davos meeting is also a good place to take stock of the geopolitical landscape. It was here that one could track the rise of emerging economies like India and China.
Record numbers of heads of state and government had come to Davos, mostly cloistered away in face-to-face meetings with their counterparts and key business leaders.
It was no coincidence that the keynote speeches on the first day had been reserved for China's Premier Wen Jiabao and Russia's Prime Minister Vladimir Putin.
However, with even China's economy at a crawl, and the value of Russia's oil wealth plummeting, their speeches proved that the economic crisis is truly global, and hurting around the world.
In April, the spotlight will be on the G20 meeting in London, where leading politicians both from industrialised and emerging economies will debate ways out of the crisis.
Professor Schwab attempted some expectation management. "The G20 will not solve everything," he said, "it won't address the totality of the issue."
Poverty trap
Probably the biggest worry, apart from getting the world economy "out of intensive care" (Prof Schwab), was the threat of protectionism.
Raising trade barriers now, politicians, business leaders and campaigners agreed, would have a devastating impact, for starters on the economies of rich countries, but even more so on poorest people in the world.
The Davos organisers tried hard to ensure that the crisis of the financial system did not take away all the attention from the fight against poverty, but it was difficult.
After all, it was a long list of problems that the global elites had to discuss during their five days of soul-searching.
What had once been seen as a long schmoozefest, a show-off party of the rich and powerful, had bumped into reality.
The strikes in France and the UK had not gone unnoticed, and business leaders were acutely aware that millions of people hurt by the crisis were angry, very angry. And in case they forgot, there were plenty of social activists and trade unionists here to remind them.
Thursday, January 29, 2009
Eastern Europe
It’s grim out east. Emerging Europe’s unravelling economic situation this week prompted the European Bank for Reconstruction and Development to downgrade its 2009 growth forecast for its 30 countries of operation from 2.5 per cent to 0.1 per cent. Five countries, it believes, will experience recessions; Ukraine and Latvia could contract by 5 per cent. Social unrest is surfacing in several capitals.
The risk is that better-off western Europeans abandon their eastern neighbours to their fate. Already Greece has cautioned its banks against transferring funds from a €28bn support package to Balkan subsidiaries because of fears of financial turmoil. Such disengagement would be a historic mistake. Certainly, many east European countries made errors, going on credit binges fuelled by foreign currency borrowing and running up yawning current account deficits. They are suffering now, however, in large part because of their integration with the international economy. Nowhere is integration greater than in financial services: large chunks of east Europe’s banks are owned by foreign groups.
That creates opportunities and risks. In spite of political rhetoric, funds from west European banking bail-outs are generally trickling through to eastern subsidiaries. But further moves such as Greece’s could threaten such flows. Providing support only via western banks’ subsidiaries is also insufficient and could lead to disparities, depending on what proportion of countries’ banking systems are foreign-owned, and whether the owners are, say, French, Italian or Austrian. Eastern Europe’s public authorities need access to more funding for systemic measures.
Several commercial banks operating in the region are calling for European institutions to extend the kind of financial initiatives undertaken in the west into eastern Europe, including countries outside the European Union. The European Commission and EBRD back that call. Unless rapid co-ordinated action follows, however, eastern Europe’s economic achievements of the past decade could be undermined. And that will only exacerbate the challenges faced farther west.
To e-mail
The risk is that better-off western Europeans abandon their eastern neighbours to their fate. Already Greece has cautioned its banks against transferring funds from a €28bn support package to Balkan subsidiaries because of fears of financial turmoil. Such disengagement would be a historic mistake. Certainly, many east European countries made errors, going on credit binges fuelled by foreign currency borrowing and running up yawning current account deficits. They are suffering now, however, in large part because of their integration with the international economy. Nowhere is integration greater than in financial services: large chunks of east Europe’s banks are owned by foreign groups.
That creates opportunities and risks. In spite of political rhetoric, funds from west European banking bail-outs are generally trickling through to eastern subsidiaries. But further moves such as Greece’s could threaten such flows. Providing support only via western banks’ subsidiaries is also insufficient and could lead to disparities, depending on what proportion of countries’ banking systems are foreign-owned, and whether the owners are, say, French, Italian or Austrian. Eastern Europe’s public authorities need access to more funding for systemic measures.
Several commercial banks operating in the region are calling for European institutions to extend the kind of financial initiatives undertaken in the west into eastern Europe, including countries outside the European Union. The European Commission and EBRD back that call. Unless rapid co-ordinated action follows, however, eastern Europe’s economic achievements of the past decade could be undermined. And that will only exacerbate the challenges faced farther west.
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Wednesday, January 28, 2009
Eastern Europe set for near-zero growth in 2009
By Stefan Wagstyl, east Europe Editor
Published: January 27 2009 17:21 | Last updated: January 27 2009 17:21
The economic clouds hanging over eastern Europe darkened today as the European Bank for Reconstruction and Development slashed its forecasts for the region and predicted near-zero growth for 2009.
The region’s 30 states, including the former communist bloc plus Turkey, will see gross domestic product growth of just 0.1 per cent, says the bank, making a dramatic cut in its previous forecast of 2.5 per cent, made just three months ago.
Six countries – Ukraine, Turkey, Hungary and the Baltic states – are plunging into recession, while another five, including Russia, are seeing growth rates slow to 1 per cent or lower.
Erik Berglof, the EBRD’s chief economist, said the sudden deterioration in outlook was caused by the continuing decline in the global economic environment, which was undermining demand for the region’s exports. The last quarter of 2008 had also come out much worse than expected, bringing down the estimated growth figure for the year for the region from 6.3 per cent to 4.8 per cent, with two countries – Hungary and Latvia – already in recession.
“The EBRD region is feeling the full impact of the global slowdown, mainly because of the region’s increased integration within the global economy,” said Mr Berglof.
“The ability of these countries to withstand such a major external shock over the longer term will depend largely on the speed of the recovery of the global economy, the combined efforts of individual governments and international financial institutions, including the EBRD, to safeguard financial systems in the region, and the support of foreign banks to their eastern subsidiaries.”
Mr Berglof noted that the international banks active in the region had so far fully supported their subsidiaries. But he expressed concern that west European governments putting together bank rescue packages for their own countries would discriminate against foreign subsidiaries. “This is a very big worry. We hear countries may be putting restraints on banks’ ability to finance activities abroad,” said Mr Berglof, naming the UK, Greece and Austria as states where such policies were under discussion. “At the moment, this issue is vague. We will have to see how it works out in practice.”
Published: January 27 2009 17:21 | Last updated: January 27 2009 17:21
The economic clouds hanging over eastern Europe darkened today as the European Bank for Reconstruction and Development slashed its forecasts for the region and predicted near-zero growth for 2009.
The region’s 30 states, including the former communist bloc plus Turkey, will see gross domestic product growth of just 0.1 per cent, says the bank, making a dramatic cut in its previous forecast of 2.5 per cent, made just three months ago.
Six countries – Ukraine, Turkey, Hungary and the Baltic states – are plunging into recession, while another five, including Russia, are seeing growth rates slow to 1 per cent or lower.
Erik Berglof, the EBRD’s chief economist, said the sudden deterioration in outlook was caused by the continuing decline in the global economic environment, which was undermining demand for the region’s exports. The last quarter of 2008 had also come out much worse than expected, bringing down the estimated growth figure for the year for the region from 6.3 per cent to 4.8 per cent, with two countries – Hungary and Latvia – already in recession.
“The EBRD region is feeling the full impact of the global slowdown, mainly because of the region’s increased integration within the global economy,” said Mr Berglof.
“The ability of these countries to withstand such a major external shock over the longer term will depend largely on the speed of the recovery of the global economy, the combined efforts of individual governments and international financial institutions, including the EBRD, to safeguard financial systems in the region, and the support of foreign banks to their eastern subsidiaries.”
Mr Berglof noted that the international banks active in the region had so far fully supported their subsidiaries. But he expressed concern that west European governments putting together bank rescue packages for their own countries would discriminate against foreign subsidiaries. “This is a very big worry. We hear countries may be putting restraints on banks’ ability to finance activities abroad,” said Mr Berglof, naming the UK, Greece and Austria as states where such policies were under discussion. “At the moment, this issue is vague. We will have to see how it works out in practice.”
Monday, January 19, 2009
Eurozone economy 'to shrink 1.9%'
The eurozone economy will shrink 1.9% in 2009 and grow by only 0.4% in 2010, the European Commission has forecast.
The Commission said in a statement that the whole European Union was facing a "deep and protracted recession".
Unemployment in the the 16 countries using the euro is expected to exceed 10% in 2010, up from 7.5% in 2008.
The commission hopes it will be possible "to create the conditions for a gradual recovery in the second part of 2009" in the eurozone economy.
Economy Commissioner Joaquin Almunia said in a statement it would be achieved through "measures to stabilise the financial markets, the easing of monetary policy and the economic recovery plans".
The commission said annual inflation in the 16 countries using the euro would be 1% in 2009 and 1.8% a year later.
'Continued fall'
According to official figures, the eurozone has been in recession since September of last year.
"As events unfolded late last autumn, it became increasingly clear that the EU would not be spared a deep and protracted recession," the commission said.
It added that "the outlook is for a continued fall in GDP throughout the first half of this year".
Different vews
Analysts gave different opinions on the commission's latest forecast.
Sunil Kapadia at UBS Bank said: "On the growth figures for 2009, it's a pretty fair assessment".
However, Gilles Moec at Bank of America said it was more pessimistic than the Commission, forecasting a contraction of 2.6% in 2009.
Last week, Germany became the latest country to unveil an economic stimulus package worth about 50bn euros ($67bn; £45bn) to kick-start Europe's largest economy.
Eurozone's key interest rate is now at 2%, its lowest level since December 2005.
The Commission said in a statement that the whole European Union was facing a "deep and protracted recession".
Unemployment in the the 16 countries using the euro is expected to exceed 10% in 2010, up from 7.5% in 2008.
The commission hopes it will be possible "to create the conditions for a gradual recovery in the second part of 2009" in the eurozone economy.
Economy Commissioner Joaquin Almunia said in a statement it would be achieved through "measures to stabilise the financial markets, the easing of monetary policy and the economic recovery plans".
The commission said annual inflation in the 16 countries using the euro would be 1% in 2009 and 1.8% a year later.
'Continued fall'
According to official figures, the eurozone has been in recession since September of last year.
"As events unfolded late last autumn, it became increasingly clear that the EU would not be spared a deep and protracted recession," the commission said.
It added that "the outlook is for a continued fall in GDP throughout the first half of this year".
Different vews
Analysts gave different opinions on the commission's latest forecast.
Sunil Kapadia at UBS Bank said: "On the growth figures for 2009, it's a pretty fair assessment".
However, Gilles Moec at Bank of America said it was more pessimistic than the Commission, forecasting a contraction of 2.6% in 2009.
Last week, Germany became the latest country to unveil an economic stimulus package worth about 50bn euros ($67bn; £45bn) to kick-start Europe's largest economy.
Eurozone's key interest rate is now at 2%, its lowest level since December 2005.
Friday, January 16, 2009
Citigroup reports big loss and a breakup plan
By Matthew Saltmarsh and Eric Dash
Friday, January 16, 2009
Citigroup capped a devastating 2008 by announcing Friday that it would split into two entities and that it had posted an $8.29 billion loss for the fourth quarter.
Citigroup confirmed that it would divide, for management purposes, into two separate businesses — Citicorp and Citi Holdings.
"We are setting out a clear road map to restore profitability and enable us to focus on maximizing the value of Citi," it said in a statement with the earnings.
Citigroup also issued a statement from its lead director, Richard D. Parsons, signaling that changes in its board were in the offing. Parsons, the former chairman of Time Warner, has been widely expected to become Citigroup's next chairman.
Citigroup's loss, which amounts to $1.72 a share, compares with a loss of $9.8 billion, or $1.99 a share, in the period a year earlier.
Peter Dixon, an economist at Commerzbank in London, said the decision to split the financial giant was "an indication that the era of big financials is at an end for now."
Reports emerged early this week that Citigroup was accelerating moves to dismantle parts of its troubled financial empire.
But some Wall Street analysts and investors questioned whether the plan, which included the announcement on Tuesday that it would split off its prized Smith Barney brokerage, goes far enough to address Citigroup's immediate troubles.
The bank has reported a loss for five consecutive quarters and announced a further $7.78 billion in write-downs in securities and banking for the fourth quarter. Revenue was $5.6 billion during the quarter, down 13 percent, lower across all regions.
The bank also said Friday that its head count had been reduced by approximately 29,000 since the third quarter and approximately 52,000 for all of 2008.
Analysts estimated on average that Citigroup would break even on a per-share basis, according to a survey by Bloomberg News.
Citigroup moved its earnings announcements forward from next week to address increasing anxieties among shareholders and pressure from the U.S. government government to deal with its growing difficulties.
Citigroup posted $5.6 billion in revenue, down 13 percent on a same quarter a year earlier, reflecting the "difficult economic environment and weak capital markets." All regions suffered.
For the full year 2008, Citigroup reported a net loss of $18.72 billion. With unemployment rising and evidence of a global slump, the bank is bracing for another dismal year.
The company's stock has dropped by almost half in the last week, closing Thursday at $3.83, down 70 cents, or 15 percent on the day.
With nearly every part of the company suffering a massive blow, Vikram Pandit, the chief executive, is rolling out a new strategy that will divide into a "New Citi" and "Legacy Citi" that aims to focus its executives' attention on its stronger remaining businesses while winding down its money-losing operations.
Even so, Pandit agreed to split off Smith Barney, its valuable retail brokerage arm, to raise capital so that it could offset the fourth quarter's massive losses.
"I have no doubt we will emerge from the current environment stronger, smarter, and better positioned to realize the full earnings power of this great franchise," Pandit said in a statement with the results.
Pandit is also hosting a noon town hall meeting at Citigroup's Park Avenue headquarters to address demoralized employees.
The bank's break-up plan comes after a stern regulatory warning it received in late November, when its rapidly deteriorating share price prompted the government to give it a second cash infusion, of $20 billion.
Citigroup's first cash infusion from the government came in October in a $25 billion capital injection from the Troubled Asset Relief Program, or TARP. Eight other banks also received capital infusions to stabilize them as the global financial crisis deepened.
With its receipt of a second lifeline from the government in November, Citigroup began operating under what is known as open-bank assistance, which involves a loss-sharing arrangement devised by the FDIC and an investment by the Treasury typically reserved for deeply troubled institutions.
Since then, U.S. government regulators have been leaning hard on Citigroup to shake up its board and shrink the sprawling company to address a credibility gap with its investors.
The changes draw a somber curtain over the one-stop shop created in 1998 when the company's architect and former chief, Sanford Weill, merged the insurance giant Travelers Group and Citicorp, then the nation's largest bank. The deal brought traditional banking, insurance and Wall Street businesses, like stock underwriting, under one roof.
But the company came under repeated fire from shareholders for lackluster results; its stock price has fallen more than 76 percent since it was formed. And the fourth quarter was no different.
Friday, January 16, 2009
Citigroup capped a devastating 2008 by announcing Friday that it would split into two entities and that it had posted an $8.29 billion loss for the fourth quarter.
Citigroup confirmed that it would divide, for management purposes, into two separate businesses — Citicorp and Citi Holdings.
"We are setting out a clear road map to restore profitability and enable us to focus on maximizing the value of Citi," it said in a statement with the earnings.
Citigroup also issued a statement from its lead director, Richard D. Parsons, signaling that changes in its board were in the offing. Parsons, the former chairman of Time Warner, has been widely expected to become Citigroup's next chairman.
Citigroup's loss, which amounts to $1.72 a share, compares with a loss of $9.8 billion, or $1.99 a share, in the period a year earlier.
Peter Dixon, an economist at Commerzbank in London, said the decision to split the financial giant was "an indication that the era of big financials is at an end for now."
Reports emerged early this week that Citigroup was accelerating moves to dismantle parts of its troubled financial empire.
But some Wall Street analysts and investors questioned whether the plan, which included the announcement on Tuesday that it would split off its prized Smith Barney brokerage, goes far enough to address Citigroup's immediate troubles.
The bank has reported a loss for five consecutive quarters and announced a further $7.78 billion in write-downs in securities and banking for the fourth quarter. Revenue was $5.6 billion during the quarter, down 13 percent, lower across all regions.
The bank also said Friday that its head count had been reduced by approximately 29,000 since the third quarter and approximately 52,000 for all of 2008.
Analysts estimated on average that Citigroup would break even on a per-share basis, according to a survey by Bloomberg News.
Citigroup moved its earnings announcements forward from next week to address increasing anxieties among shareholders and pressure from the U.S. government government to deal with its growing difficulties.
Citigroup posted $5.6 billion in revenue, down 13 percent on a same quarter a year earlier, reflecting the "difficult economic environment and weak capital markets." All regions suffered.
For the full year 2008, Citigroup reported a net loss of $18.72 billion. With unemployment rising and evidence of a global slump, the bank is bracing for another dismal year.
The company's stock has dropped by almost half in the last week, closing Thursday at $3.83, down 70 cents, or 15 percent on the day.
With nearly every part of the company suffering a massive blow, Vikram Pandit, the chief executive, is rolling out a new strategy that will divide into a "New Citi" and "Legacy Citi" that aims to focus its executives' attention on its stronger remaining businesses while winding down its money-losing operations.
Even so, Pandit agreed to split off Smith Barney, its valuable retail brokerage arm, to raise capital so that it could offset the fourth quarter's massive losses.
"I have no doubt we will emerge from the current environment stronger, smarter, and better positioned to realize the full earnings power of this great franchise," Pandit said in a statement with the results.
Pandit is also hosting a noon town hall meeting at Citigroup's Park Avenue headquarters to address demoralized employees.
The bank's break-up plan comes after a stern regulatory warning it received in late November, when its rapidly deteriorating share price prompted the government to give it a second cash infusion, of $20 billion.
Citigroup's first cash infusion from the government came in October in a $25 billion capital injection from the Troubled Asset Relief Program, or TARP. Eight other banks also received capital infusions to stabilize them as the global financial crisis deepened.
With its receipt of a second lifeline from the government in November, Citigroup began operating under what is known as open-bank assistance, which involves a loss-sharing arrangement devised by the FDIC and an investment by the Treasury typically reserved for deeply troubled institutions.
Since then, U.S. government regulators have been leaning hard on Citigroup to shake up its board and shrink the sprawling company to address a credibility gap with its investors.
The changes draw a somber curtain over the one-stop shop created in 1998 when the company's architect and former chief, Sanford Weill, merged the insurance giant Travelers Group and Citicorp, then the nation's largest bank. The deal brought traditional banking, insurance and Wall Street businesses, like stock underwriting, under one roof.
But the company came under repeated fire from shareholders for lackluster results; its stock price has fallen more than 76 percent since it was formed. And the fourth quarter was no different.
Thursday, January 15, 2009
S&P cuts Greece’s credit rating
By David Oakley in London and Kerin Hope in Athens
Published: January 14 2009 14:44 | Last updated: January 14 2009 19:16
Greece on Wednesday became the first big western European economy to have its credit ratings downgraded since the start of the financial crisis because of rising fears over its ballooning public sector debt.
Standard & Poor’s decision to cut its ratings sent Greek stocks plunging, saw the euro weaken, and heightened concerns across the eurozone over the public finances of the weaker economies as they take on record levels of debt.
Marko Mrsnik, S&P analyst, said: “The global financial and economic crisis has exacerbated an underlying loss of competitiveness in the Greek economy.”
Thomas Mayer, chief European economist at Deutsche Bank, added: “The downgrade of Greece is a wake-up call to everyone that there is a price to pay for taking on big levels of debt.”
The downgrade of Greece’s sovereign credit ratings from A, which is five notches below the top triple A rating, to A minus comes only five days after the country was put on credit watch by S&P.
It turns the spotlight on Portugal and Spain, which were put on credit watch by the agency this week, and Ireland, which was put on a negative outlook last Friday. These countries could face imminent downgrades.
On Wednesday night, the European Commission said that it never commented on ratings moves. Officials in Brussels are understood to be watching the situation with some concern, but take the view that the countries involved still appear to have their individual situations under relatively good control.
It also puts further strain on the eurozone as it celebrates its 10th birthday this month, with the bonds of Germany, the monetary union’s biggest economy, outperforming the so-called peripheral countries.
This is reflected in the widening gap in bond yields between Germany and Greece, Spain, Portugal, Ireland and Italy, which have risen to record highs since the start of the single currency in 1999.
Ken Wattret, economist at BNP Paribas, said it was “valid to say that there are question marks about the cohesion of the monetary union” with the region experiencing its worst downturn.
He said the collapse in housing prices and stock markets in some of these peripheral economies had exposed serious competitiveness problems as they no longer had the option of devaluing their way out of difficulties.
The vast amount of bonds due to be issued this year – more than €1,000bn is expected in Europe, nearly double that of last year – is also putting increasing pressure on governments as they try to issue debt.
On Wednesday, Italy was forced to pay much higher interest rates than it had bargained for to attract investors to sell five-year bonds. Last week, a German bond auction failed as it fell short of the amount of cash it had targeted to raise.
In Athens, the stock exchange plunged by more than 5 per cent on S&P’s move, with the banking sector, the bellwether of the market, hardest hit.
The sharp fall in the market also reflects concerns about political stability following last month’s street riots in Athens.
Athens has seen its current account deficit soar above 14 per cent, the highest in the eurozone, while its debt to gross domestic product ratio has risen to 94 per cent – only Italy has higher debt levels.
S&P said the country’s repeated failures to stick to budgetary plans had led to structural weaknesses in fiscal management.
The agency believed the sizeable share of social transfers, public wage bill and interest payments in public expenditure highlighted the need for reform.
Published: January 14 2009 14:44 | Last updated: January 14 2009 19:16
Greece on Wednesday became the first big western European economy to have its credit ratings downgraded since the start of the financial crisis because of rising fears over its ballooning public sector debt.
Standard & Poor’s decision to cut its ratings sent Greek stocks plunging, saw the euro weaken, and heightened concerns across the eurozone over the public finances of the weaker economies as they take on record levels of debt.
Marko Mrsnik, S&P analyst, said: “The global financial and economic crisis has exacerbated an underlying loss of competitiveness in the Greek economy.”
Thomas Mayer, chief European economist at Deutsche Bank, added: “The downgrade of Greece is a wake-up call to everyone that there is a price to pay for taking on big levels of debt.”
The downgrade of Greece’s sovereign credit ratings from A, which is five notches below the top triple A rating, to A minus comes only five days after the country was put on credit watch by S&P.
It turns the spotlight on Portugal and Spain, which were put on credit watch by the agency this week, and Ireland, which was put on a negative outlook last Friday. These countries could face imminent downgrades.
On Wednesday night, the European Commission said that it never commented on ratings moves. Officials in Brussels are understood to be watching the situation with some concern, but take the view that the countries involved still appear to have their individual situations under relatively good control.
It also puts further strain on the eurozone as it celebrates its 10th birthday this month, with the bonds of Germany, the monetary union’s biggest economy, outperforming the so-called peripheral countries.
This is reflected in the widening gap in bond yields between Germany and Greece, Spain, Portugal, Ireland and Italy, which have risen to record highs since the start of the single currency in 1999.
Ken Wattret, economist at BNP Paribas, said it was “valid to say that there are question marks about the cohesion of the monetary union” with the region experiencing its worst downturn.
He said the collapse in housing prices and stock markets in some of these peripheral economies had exposed serious competitiveness problems as they no longer had the option of devaluing their way out of difficulties.
The vast amount of bonds due to be issued this year – more than €1,000bn is expected in Europe, nearly double that of last year – is also putting increasing pressure on governments as they try to issue debt.
On Wednesday, Italy was forced to pay much higher interest rates than it had bargained for to attract investors to sell five-year bonds. Last week, a German bond auction failed as it fell short of the amount of cash it had targeted to raise.
In Athens, the stock exchange plunged by more than 5 per cent on S&P’s move, with the banking sector, the bellwether of the market, hardest hit.
The sharp fall in the market also reflects concerns about political stability following last month’s street riots in Athens.
Athens has seen its current account deficit soar above 14 per cent, the highest in the eurozone, while its debt to gross domestic product ratio has risen to 94 per cent – only Italy has higher debt levels.
S&P said the country’s repeated failures to stick to budgetary plans had led to structural weaknesses in fiscal management.
The agency believed the sizeable share of social transfers, public wage bill and interest payments in public expenditure highlighted the need for reform.
China becomes third largest economy
By Geoff Dyer in Beijing
Published: January 14 2009 14:20 | Last updated: January 14 2009 19:08
China overtook Germany to become the world’s third-largest economy in 2007 after the Chinese authorities revised upwards the figures for growth during that year.
China’s National Bureau of Statistics said on Wednesday that the economy expanded by 13 per cent in 2007, a sharp increase from the 11.9 per cent growth rate the authorities had previously stated.
With only the US and Japan larger than China, the new figures highlight the rapid transformation that the Chinese economy has undergone during the past 30 years since Mao-era controls were eased, although it is experiencing the toughest period in a decade as a result of the global financial crisis.
The fresh data will reinforce the case to give China and other large emerging economies a bigger role in global financial decision-making, even though China has been hesitant about taking on new responsibilities.
“It is symbolically significant that China is now bigger than Germany and it will not be too long before its economy overtakes [that of] Japan,” said Mark Williams at Capital Economics in London.
Many economists reckon that Chinese growth in 2009 will fall well short of the 8 per cent government officials are forecasting. It has slowed sharply in recent months. However, given the steep declines forecast for many developed economies, China will remain one of the main contributors to global growth.
In the medium-term, economists say that there is plenty of scope for China to maintain relatively high growth rates. Urbanisation and technology catch-up have decades to run. But the outlook is complicated by a rapidly ageing population and costs of damage to the environment.
Goldman Sachs forecasts that the Chinese economy will overtake that of the US by about 2040. The Economist Intelligence Unit forecasts in terms of purchasing power parity – which adjusts for price differences between countries to reflect actual buying power of local incomes – China will outstrip the US by 2017.
Despite rapid growth and hundreds of millions of people lifted out of poverty, China remains relatively poor. In the World Bank’s rankings of GDP per capita for 2007 using purchasing power parity, China took 122nd place at $5,370, behind Egypt, El Salvador and Armenia.
According to the IMF, Germany’s GDP was $3,321bn in 2007, using market exchange rates for that year. By the new estimate China’s GDP was $3,382bn. US GDP was $13,807bn and Japan $4,382bn. China is also close to surpassing Germany to be the world’s biggest exporter.
It was the second time China had revised upwards growth figures for 2007’s GDP, first calculated to be 11.4 per cent. Some suspect Chinese authorities of massaging figures to underplay economic volatility, exaggerating growth when conditions are tough, underestimating it when the economy is booming.
Germany’s economy has also slowed sharply, perhaps contracting by as much as 2 per cent in the fourth quarter, its statistical office said. First estimates, indicating that gross domestic product fell by between 1.5 per cent and 2 per cent compared with the previous three months, emphasise the downturn.
That is likely to intensify fears Germany’s recession will be the worst since the second world war, dragging down economies continent-wide. That would pressure policymakers to beef-up emergency rescue packages.
Published: January 14 2009 14:20 | Last updated: January 14 2009 19:08
China overtook Germany to become the world’s third-largest economy in 2007 after the Chinese authorities revised upwards the figures for growth during that year.
China’s National Bureau of Statistics said on Wednesday that the economy expanded by 13 per cent in 2007, a sharp increase from the 11.9 per cent growth rate the authorities had previously stated.
With only the US and Japan larger than China, the new figures highlight the rapid transformation that the Chinese economy has undergone during the past 30 years since Mao-era controls were eased, although it is experiencing the toughest period in a decade as a result of the global financial crisis.
The fresh data will reinforce the case to give China and other large emerging economies a bigger role in global financial decision-making, even though China has been hesitant about taking on new responsibilities.
“It is symbolically significant that China is now bigger than Germany and it will not be too long before its economy overtakes [that of] Japan,” said Mark Williams at Capital Economics in London.
Many economists reckon that Chinese growth in 2009 will fall well short of the 8 per cent government officials are forecasting. It has slowed sharply in recent months. However, given the steep declines forecast for many developed economies, China will remain one of the main contributors to global growth.
In the medium-term, economists say that there is plenty of scope for China to maintain relatively high growth rates. Urbanisation and technology catch-up have decades to run. But the outlook is complicated by a rapidly ageing population and costs of damage to the environment.
Goldman Sachs forecasts that the Chinese economy will overtake that of the US by about 2040. The Economist Intelligence Unit forecasts in terms of purchasing power parity – which adjusts for price differences between countries to reflect actual buying power of local incomes – China will outstrip the US by 2017.
Despite rapid growth and hundreds of millions of people lifted out of poverty, China remains relatively poor. In the World Bank’s rankings of GDP per capita for 2007 using purchasing power parity, China took 122nd place at $5,370, behind Egypt, El Salvador and Armenia.
According to the IMF, Germany’s GDP was $3,321bn in 2007, using market exchange rates for that year. By the new estimate China’s GDP was $3,382bn. US GDP was $13,807bn and Japan $4,382bn. China is also close to surpassing Germany to be the world’s biggest exporter.
It was the second time China had revised upwards growth figures for 2007’s GDP, first calculated to be 11.4 per cent. Some suspect Chinese authorities of massaging figures to underplay economic volatility, exaggerating growth when conditions are tough, underestimating it when the economy is booming.
Germany’s economy has also slowed sharply, perhaps contracting by as much as 2 per cent in the fourth quarter, its statistical office said. First estimates, indicating that gross domestic product fell by between 1.5 per cent and 2 per cent compared with the previous three months, emphasise the downturn.
That is likely to intensify fears Germany’s recession will be the worst since the second world war, dragging down economies continent-wide. That would pressure policymakers to beef-up emergency rescue packages.
JPMorgan chief says 2009 will be bleak
By Francesco Guerrera in New York
Published: January 14 2009 18:48 | Last updated: January 14 2009 21:30
The US financial and economic crisis will worsen this year as hard-hit consumers default on credit cards and other loans, Jamie Dimon, chief executive of JPMorgan Chase, has predicted in an interview with the Financial Times.
Mr Dimon, whose bank will report fourth-quarter results on Thursday, gave his bleak assessment as shares on both sides of the Atlantic tumbled on rising fears that banks would need more capital and a larger-than-expected fall in US retail sales.
“The worst of the economic situation is not yet behind us. It looks as if it will continue to deteriorate for most of 2009,” said Mr Dimon. “In terms of our sector, we expect consumer loans and credit cards to continue to get worse.”
Analysts predict that JPMorgan, which has navigated the financial turmoil better than most rivals, will just about break even in its fourth-quarter results.
Investor fears over the financial sector were stoked by Tuesday’s news that Citigroup is preparing to split off a third of the company into a “non-core” unit in a bid to ensure its survival.
Citi’s shares closed down 23 per cent to $4.53. Citi brought forward its earnings release by a week to Friday to end speculation about its losses – which analysts expect could total $6bn-$10bn in the fourth quarter.
The Standard & Poor’s 500 index closed down 3.4 per cent in New York, with retailers leading the way down following the news that US retail sales fell 2.7 per cent in December, more than forecast. Stocks in Europe were also down, with banks particularly hard hit after Deutsche Bank reported a large fourth-quarter loss.
Mr Dimon told the FT that JPMorgan was prepared for an expected deterioration in consumer-oriented businesses but added that if things were to get worse than expected it would have to cut costs again.
Mr Dimon said the bursting of the credit bubble would force the banking industry to refocus on its traditional businesses of advising on deals and lending to companies and individuals.
”When we look back at industry excesses in areas such as highly leveraged lending and securitisation, it is clear that some of these markets will never come back,” he said. “In the next few years, the industry will go back to basics: serving individual and corporate customers as best as we can.”
Analysts expect JPMorgan’s huge portfolio of consumer loans, credit cards and commercial mortgages to have been hit by rising defaults and higher provisions in the fourth quarter. The bank is in line to record a $5bn post-tax profit for the year – higher than most of its peers, but well below the $15bn in 2007.
Published: January 14 2009 18:48 | Last updated: January 14 2009 21:30
The US financial and economic crisis will worsen this year as hard-hit consumers default on credit cards and other loans, Jamie Dimon, chief executive of JPMorgan Chase, has predicted in an interview with the Financial Times.
Mr Dimon, whose bank will report fourth-quarter results on Thursday, gave his bleak assessment as shares on both sides of the Atlantic tumbled on rising fears that banks would need more capital and a larger-than-expected fall in US retail sales.
“The worst of the economic situation is not yet behind us. It looks as if it will continue to deteriorate for most of 2009,” said Mr Dimon. “In terms of our sector, we expect consumer loans and credit cards to continue to get worse.”
Analysts predict that JPMorgan, which has navigated the financial turmoil better than most rivals, will just about break even in its fourth-quarter results.
Investor fears over the financial sector were stoked by Tuesday’s news that Citigroup is preparing to split off a third of the company into a “non-core” unit in a bid to ensure its survival.
Citi’s shares closed down 23 per cent to $4.53. Citi brought forward its earnings release by a week to Friday to end speculation about its losses – which analysts expect could total $6bn-$10bn in the fourth quarter.
The Standard & Poor’s 500 index closed down 3.4 per cent in New York, with retailers leading the way down following the news that US retail sales fell 2.7 per cent in December, more than forecast. Stocks in Europe were also down, with banks particularly hard hit after Deutsche Bank reported a large fourth-quarter loss.
Mr Dimon told the FT that JPMorgan was prepared for an expected deterioration in consumer-oriented businesses but added that if things were to get worse than expected it would have to cut costs again.
Mr Dimon said the bursting of the credit bubble would force the banking industry to refocus on its traditional businesses of advising on deals and lending to companies and individuals.
”When we look back at industry excesses in areas such as highly leveraged lending and securitisation, it is clear that some of these markets will never come back,” he said. “In the next few years, the industry will go back to basics: serving individual and corporate customers as best as we can.”
Analysts expect JPMorgan’s huge portfolio of consumer loans, credit cards and commercial mortgages to have been hit by rising defaults and higher provisions in the fourth quarter. The bank is in line to record a $5bn post-tax profit for the year – higher than most of its peers, but well below the $15bn in 2007.
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