GLOBAL GROWING PAINS POSE FISCAL RISK / THE WALL STREET JOURNAL ( A MUST READ )

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JUNE 8, 2011.

Global Growing Pains Pose Fiscal Risk
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By RICHARD BARLEY

Euro-zone investors may be looking for trouble in the wrong places.

Their assessment of whether indebted peripheral nations can rein in deficits largely has focused on domestic fiscal policies. But the slowing global economy may be a threat to debt dynamics in Greece, Ireland and Portugal, and will add to nerves about Spain, where activity is limp and hopes depend on exports. These countries aren't alone. Western governments generally have little scope to deal with renewed recession.


That outcome no longer looks like such a remote possibility. Global manufacturing activity has slowed to its lowest level since September 2010, driven by slower expansion in the U.S., euro zone, China, U.K. and India. Unemployment levels remain high in many countries, and high commodities prices, particularly for oil, have hurt the prospects for consumer spending in developed countries.


A cooler global economy isn't a pretty backdrop for fiscal tightening. For the euro-zone countries hardest hit by the crisis—Greece, Ireland and Portugal—it may make the fiscal journey longer and more painful, raising concerns about debt snowballing.


The fiscal cost already is high. Greece had to make spending cuts and tax increases equivalent to 8% of gross domestic product to deliver a five-percentage-point reduction in its 2010 deficit after the economy shrunk more than expected, the International Monetary Fund notes. Countries need to deliver nominal growth higher than the average interest rate on debt to prevent debt ratios from rising.


Other countries also are vulnerable to slower global growth. Spain's debt level is low, at 60% of GDP, but it still must reduce its budget deficit to 6% this year from 9.2% in 2010 to retain market confidence. The Spanish government forecasts growth of 1.3%, but this is driven entirely by net exports. France and Germany are doing well, but Spain's May manufacturing purchasing managers index signaled a renewed contraction. A slowdown also may reawaken concerns about asset quality at banks. Meanwhile, Standard & Poor's last month slapped a negative outlook on Italy, in part due to concerns over sluggish growth.


The slowdown may be a soft patch, and global growth may reaccelerate. Deficit plans would get back on track. But the vulnerability remains. Outside the euro zone, the U.S. and U.K. are wrestling with deficits of over 10% and struggling to expand. A renewed downturn would be a challenge for governments. The capacity for fiscal response may be close to exhaustion.


No wonder there already are calls for further loosening of monetary policy, including more quantitative easing.




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