Florence Chong, Editor
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How Euro meltdown will impact on Asia
ANALYSIS, Florence Chong*
26-07-2010
ATI June/July 2010 issue
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WHEN the sovereign debt crisis hit the US$12 trillion European economy, the weakening euro immediately pushed up Asian currencies. This, in turn, hit Asian stock markets.
The euro has fallen to its lowest level in four years against the Greenback, to which a number of Asian currencies, especially the Hong Kong dollar and the Chinese yuan, are linked.
This will make Asian exports into Europe less competitive, compounding reduced demand as Europeans tighten their belts in what could be a summer of unrest and uncertainty.
Europe is Asia's largest market, in particular for China. With 380 million people, the continent has a GDP that is bigger than that of the US. EU countries have started to cut budgets and public services, with unemployment already hovering around 10 per cent in some countries — such as Spain, says leading regional economist. Andy Xie. As budget deficits are trimmed, so unemployment will worsen."As Asia is export-oriented, obviously there will be an impact," Xie told ATI.
Europe barely escaped negative growth in the second quarter of 2010, and some economists believe it could slip into recession later this year. But Europe's sovereign debt problem is not of the style of US sub-prime, and, hopefully, is unlikely to push the global economy into its second recession in as many years.
Europe will, however, likely face rolling crises as its debt contagion spreads. Ongoing problems could have a destabilising impact on the global economy because they will influence investment decisions elsewhere in the world.
The problems in Europe have not come as a surprise to some economists. Jim Walker for one, a highly-respected pundit on the Asian economy, has predicted for some time that the smaller European states would be swept up into the global crisis.
"The smaller European countries were in trouble," says Walker, but adds that these were sideshows compared to what is now unfolding in Southern Europe.
If the problem had been confined to Greece alone, it would be barely a blip on the health of the global economy. Greece is about one-tenth of the size of Germany. But if problems spread to Spain, which is already struggling to raise sovereign bonds, it would be a different story. Spain is half the size of Germany, Europe's largest economy, says Walker.
And if Britain also stumbles, there will be ramifications for the rest of the world. As the sixth-largest economy in the world, the UK impact goes beyond the size of its population, remarks Walker.
UBS equity analyst Carl Berrisford says, even though the South European states do not have a big share of overall European GDP, they have been high growth countries and are, to a degree, responsible for growth in Europe as a whole. In Asia, Berrisford says, some countries — Japan, Indonesia and India — have high levels of debt, but they are not likely to face problems like Greece, because of the region's rich foreign reserves. "Their concerns are on the growth front and the competitiveness of Asian exporters, given that the euro has fallen 10 per cent for the month (April) and by 14 per cent over four months," Berrisford told ATI.
More sobering to some economists is a possible slowdown in China, because this would have a far-reaching impact. (see page 10)
However, with the United States continuing to recover, and rising consumption in Asia, Frederic Neumann, who is HSBC Co-Head, Asian Economic Research, says there will be an offset to weaker demand from Europe.
"As long as one of these two areas is growing, the global economy can fly on one engine. (But) if both are out, then we are in trouble," says Neumann. He points out that the US created 270,000 new jobs in April, and, with the bulk of the Obama Administration’s economic stimulus due to be deployed this year, the US will continue to grow in 2010.
Other analysts warn that US state governments, especially California (the biggest) must reduce their deficits to balance their budgets. And some three million public service jobs are mooted to go when the axe starts to fall on spending. Neumann's colleague, Chris Lewis, HSBC’s Head of Trade and Supply Chain for Greater China, says that, generally, people are still confident on the economic and trade outlook in Asia. "There are two leading indicators for trade, the value of LCs which we issue for imports and exports; and from our constant dialogue with customers. Based on what I have seen, and in talking to industry peers, there was very strong double-digit growth of up 20-30 per cent in letters of credit at the beginning of the year."
Lewis says this rate of growth tapered down, but has since picked up again. "It still shows strong signs of double-digit growth,” he says.
"The US is slowly recovering. My biggest concern for the US — we've seen it happening in Europe already — is the debt issue. The US has not yet dealt with it. Their current deficit figures are astronomical. And the trade imbalance has picked up, as Americans are buying more." Lewis says feedback from the likes of large retailers show good sales. "I wouldn't call it a tremendous bounce-back. (But) the trend is positive for US sales," he says.
On the downside, the US unemployment rate is close to 10 per cent, and latest data on mortgage applications shows a 27 per cent drop month-on-month, says Lewis, adding that there are lots of mixed signals.
If the current European crisis has one silver lining, it may take the heat off Asian growth and, therefore, inflation fears. Coupled with stimulus and growing consumption, the region's economies are in danger of overheating. China, for one, recently acted to curb inflation. That said, while exports might escape the crunch from Europe, Asian currencies will bear some of the brunt. UBS’s Carl Berrisford told ATI that the RMB, for example, has gained 14 per cent against the euro over four months. So there is concern. On a trade-weighted basis, the RMB has appreciated 5.0 per cent.
“The house view of UBS was that there is every chance we might start to see a highly-anticipated appreciation of the RMB, with expectation of it going to 6.5 against the US$ — from a current level of 6.83,” he says. “But this might not happen now. Our main thesis is that the RMB will appreciate because the current account surplus in China at 11 per cent of GDP is too high and causing problems. There is too much liquidity, which is, in turn, leading to pressure on inflation.”
Berrisford says RMB appreciation has implications and repercussions for currencies across Asia. "RMB appreciation can be viewed positively because it can tackle the issue of consumer price inflation by raising purchasing power for commodities and imported goods. This will help stimulate domestic consumption growth, particularly in China, where consumption contributes just 37 per cent of GDP, the lowest level among Asian countries.
Lewis says European (particularly German) exporters now enjoy a competitive edge. German exporters had previously said their best exchange rate would be around 1.25 euros to 1.30 USD to the Euro to maintain their competitiveness. The exchange rate is where they want it to be. It is the suddenness of the euro depreciation, he says, that has put everybody into a panic mode.
While the major exporting European countries — Germany, France and Italy — will benefit from a weaker euro, it will not necessarily help Greece, Ireland, Spain or Portugal out of their particular problems.
These countries tend to trade more within the Euro zone rather than outside the region. They will, however, benefit from tourism, because international tourists may be attracted by cheaper holidays to Europe.
A cheaper euro also means that, for importers like China, there is another market from which to source products. Up to now, China has looked to the US for more value-added and high-technology goods, he says. Trade flows between China and Europe will increase. But imports into Europe will be more difficult because of the appreciation of Asian currencies.
Lewis says that how much this will impact on trade with the region, and particularly China, will depend on how long the crisis lasts.
A long-term slowdown in European demand will ultimately affect Asian exporters. And some view a resolution to Europe's debt problem with considerable pessimism.
Says one economist: "Greece's debt to GDP ratio is 14 per cent. The European Union and the IMF want it to get it down to less than 3.0 per cent within three years. That means cutting spending very sharply. They have to cut deficit spending by 5.0 per cent of GDP annually.
“The issue in Greece (or any other affected country) is the fall-out on the whole economy. The private sector depends on government contracts and public servant spending, and if private companies go bust because the government has cut back spending, the deficit will go higher. Unemployment will rise and the unemployed will turn to the government for welfare support. To stimulate the economy, the government will have to turn up its spending.
“This is not just a Greek problem. It is replicated across Europe, including Ireland. If these countries were not inside the Euro zone, they could devalue their currencies to get out of their problems. But they can't do that.” |
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