With the latest PMI reading in China back below the crucial 50 level, overnight markets have become more concerned at the increasingly synchronous nature of the global business cycle. During the period 2007-2010, G7 output contracted by 1% in real terms. Meanwhile, the BRICs (Brazil, Russia, India, China) saw output increase 24% over this period. In other words, the emerging world managed to successfully de-couple.
From one angle, given that we are in a sovereign and developed market crisis, the same should happen this time around, not least because the IMF sees developed market sovereign debt rising over the next five years (up to 106% of GDP) and developing market debt falling (to 29%). On the wider picture, these themes are likely to dominate, but nearer term the slowing in China has to be managed. It requires a more sustainable pace and better balanced mix of growth in the near-term, but without getting caught in the downdraft of the developed market slowdown. It’s a fine balance to achieve.
Guest post by FxPro
Indian rupee’s fall from grace. The INR has declined almost 20% since the end of August, by far the greatest fall amongst Asia’s major currencies. International investors, worried by contagion from Europe’s sovereign debt and banking crisis, have been abandoning Indian assets this year. For instance the Sensex has fallen by 22% in 2011 making it one of the worst-performing emerging equity markets. The collapse in the currency represents an enormous challenge for the Reserve Bank of India, at a time when the economy is clearly weakening and inflation remains high. Particularly troubling is the significant deterioration in the government’s fiscal position, reflecting a marked slowing of revenue collections. Also, higher oil prices are pressuring the trade deficit at a time when exports are slowing due to weaker foreign demand. October’s trade deficit of USD 19.6bn was the highest since 1994! For its part, the Reserve Bank of India’s ability to intervene is rendered somewhat limited because local banks have been borrowing aggressively from the central bank over recent weeks. That said there is a suggestion that the RBI will need to engage in some industrial-strength quantitative easing before too long. Interest rates right across the maturity spectrum in India are a crippling 9%. The RBI has already lifted key interest rates on seven separate occasions this year in order to grapple with rising inflation. Unfortunately, it remains the case that when advanced economies sneeze, many emerging economies still catch a cold.
Tough month for the Aussie. Against the backdrop of renewed global growth concerns, Europe’s sovereign debt crisis and the commencement of a potentially significant rate-cutting cycle by the RBA, it has been a very tough month for the Aussie. After almost reaching 1.08 late in October, the AUD has fallen by close to 10%, almost touching 0.98 yesterday. Part of the explanation for the recent weakness lies in trader re-positioning ahead of fiscal year-end, which for some is actually the end of November. Furthermore, there appears to have been something of a vacuum with respect to sovereign wealth fund-buying of late. The dollar-diversification push, which has been such a constant feature of activity over recent years, appears to have been put on hold temporarily. An additional source of selling pressure for the Aussie has been narrowing interest rate-differentials. Down under, now that the RBA has commenced a rate-cutting cycle, there is a growing expectation that this could be the start of something rather more substantial. Indeed, a couple of local banks have suggested recently that the cash rate could dip to 3% from the current 4.5% by the second half of 2012. Despite the darkening global growth outlook and the potential for domestic cash rates to fall appreciably, it is worth pointing out that international investors still hold the Aussie in high regard. With Europe continuing to trigger widespread trepidation, foreign investors have been encouraged by Treasurer Swan’s commitment to ensure the budget returns to surplus. Australia retains a AAA credit rating, and its banks are also highly regarded. Aussie bears have had a profitable November after a disastrous October, but they cannot afford to be complacent. While Europe craters, the AUD will probably continue to attract some buying interest from offshore.
UK’s painful fiscal journey. The UK Prime Minister yesterday paved the way for some downbeat economic forecasts when the Chancellor gives his autumn statement next week, with the downward revisions to the BoE’s growth profile of last week also adding to the more pessimistic outlook. But with seven months of the fiscal year gone, the budget numbers are not looking that bad. Indeed, excluding financial sector interventions, they are currently on course to just about meet the deficit target announced in the March budget for the current financial year. Receipts are running 5% higher vs. the same point a year ago and, whilst current spending is higher, net investment spending is some 40% lower. Still, lower GDP could well mean that the 5.8% forecast for the current FY deficit is exceeded, but not by a substantial margin. The UK is also benefitting from substantially lower funding costs than were factored in earlier this year. Of course, the benefit of this only trickles through in time as debt is re-financed, and the UK also has a longer average maturity than most other developed nations, so it is slow. But unlike the US, the UK is not using this low-yield environment as a reason to drag its feet on the required fiscal consolidation. It hurts, but Italy, Spain and others are learning just how painful the alternative can be.