January 11, 2012 8:39 pm
How the globe can grind to a halt
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If the world economy is to maintain any sort of momentum this year, it will be driven by fast-growing emerging markets led by China. But like the developed world, the emerging nations are living in the shadow of the globe’s greatest economic threat – the eurozone crisis.
From Galicia to Guangdong, business is more globalised than ever before. And the explosion of financial links, alongside traditional trade ties, means that economic news travels at unprecedented speed – especially, or so it often seems, bad news.
Click to enlarge
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While there are reports of progress in tackling the challenges faced by Greece, Italy and other vulnerable eurozone states, the eurozone’s traumas are far from over. “The crisis has damaged the European economy ... and this crisis is by no means behind us,” Olli Rehn, European Union economy commissioner, said this week. “It will take time. Structural reforms often take a long time ... Markets, however, tend to be impatient and this impatience can push sovereigns or banking institutions into a liquidity crisis.”
As things stand, the eurozone is expected to fall into recession in 2012, helping to drag global economic growth down to about 3-3.5 per cent. But the world could fare far worse if Mr Rehn’s fear of a possible liquidity crisis does materialise. Its effects would hit nations far beyond Europe, not least in the developing world.
As the charts show, the economic and financial links between the eurozone and developing countries run deep – and have grown hugely in the past decade. While these connections have contributed greatly to the development both of the EU and emerging markets, they are also transmission belts of economic danger. The dividing line between risk and reward can be very fine and the swing from boom to bust very rapid, as investors found in successive emerging market crises, including Asia in 1997-98, Russia in 1998, Brazil in 2002 and central and eastern Europe in 2009.
In 2011 tentative hopes of a solid global recovery were dispelled midyear by a slowdown in the US, concerns about a Chinese hard landing, and an upsurge in eurozone fears, triggered by panic over Greece. With US growth now healthier than was forecast, and China apparently heading for a soft landing, the focus on the eurozone is even stronger than it was last summer. As Mr Rehn says: “The sine qua non necessary to return to the path of economic growth is that we ... resolve the sovereign crisis and the banking sector problems.”
A glance at the data demonstrates the impact on emerging markets: a big sell-off in equities in 2011, higher bond yields reflecting bigger risk premiums, and forecasts of a growth slowdown in 2012 compared with 2011.
The effects spread through a range of channels, starting with the financial markets. Capital flows from the developed to the developing world have swung wildly since the onset of the 2008 global crisis and show few signs of settling. Meanwhile, bank credit from the developed to the developing world is falling after recovering from its previous slump in 2008-09. Leading this time are European banks as they cover losses and conserve capital to meet tough new rules.
The emerging region most exposed to the eurozone crisis is eastern Europe, especially those states that integrated their economies most with the west of the continent, such as the Czech Republic, Hungary and Poland. Not only do trade links run deep but these countries also depend on western European bank finance.
The risk of a general banking retreat from eastern Europe is limited. But banks are distinguishing between the economically strong, headed by Poland, and the weak, led by Hungary – as the populist government in Budapest has seen to its cost.
Further afield, eurozone-related risks are lower. While Asian exporters trade actively with the eurozone, they are increasingly looking for business in other emerging markets. But world financial markets are so interlinked that a shock for one financial centre quickly becomes a shock for all, including the emerging powerhouses.
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While there are reports of progress in tackling the challenges faced by Greece, Italy and other vulnerable eurozone states, the eurozone’s traumas are far from over. “The crisis has damaged the European economy ... and this crisis is by no means behind us,” Olli Rehn, European Union economy commissioner, said this week. “It will take time. Structural reforms often take a long time ... Markets, however, tend to be impatient and this impatience can push sovereigns or banking institutions into a liquidity crisis.”
As things stand, the eurozone is expected to fall into recession in 2012, helping to drag global economic growth down to about 3-3.5 per cent. But the world could fare far worse if Mr Rehn’s fear of a possible liquidity crisis does materialise. Its effects would hit nations far beyond Europe, not least in the developing world.
As the charts show, the economic and financial links between the eurozone and developing countries run deep – and have grown hugely in the past decade. While these connections have contributed greatly to the development both of the EU and emerging markets, they are also transmission belts of economic danger. The dividing line between risk and reward can be very fine and the swing from boom to bust very rapid, as investors found in successive emerging market crises, including Asia in 1997-98, Russia in 1998, Brazil in 2002 and central and eastern Europe in 2009.
In 2011 tentative hopes of a solid global recovery were dispelled midyear by a slowdown in the US, concerns about a Chinese hard landing, and an upsurge in eurozone fears, triggered by panic over Greece. With US growth now healthier than was forecast, and China apparently heading for a soft landing, the focus on the eurozone is even stronger than it was last summer. As Mr Rehn says: “The sine qua non necessary to return to the path of economic growth is that we ... resolve the sovereign crisis and the banking sector problems.”
A glance at the data demonstrates the impact on emerging markets: a big sell-off in equities in 2011, higher bond yields reflecting bigger risk premiums, and forecasts of a growth slowdown in 2012 compared with 2011.
The effects spread through a range of channels, starting with the financial markets. Capital flows from the developed to the developing world have swung wildly since the onset of the 2008 global crisis and show few signs of settling. Meanwhile, bank credit from the developed to the developing world is falling after recovering from its previous slump in 2008-09. Leading this time are European banks as they cover losses and conserve capital to meet tough new rules.
The emerging region most exposed to the eurozone crisis is eastern Europe, especially those states that integrated their economies most with the west of the continent, such as the Czech Republic, Hungary and Poland. Not only do trade links run deep but these countries also depend on western European bank finance.
The risk of a general banking retreat from eastern Europe is limited. But banks are distinguishing between the economically strong, headed by Poland, and the weak, led by Hungary – as the populist government in Budapest has seen to its cost.
Further afield, eurozone-related risks are lower. While Asian exporters trade actively with the eurozone, they are increasingly looking for business in other emerging markets. But world financial markets are so interlinked that a shock for one financial centre quickly becomes a shock for all, including the emerging powerhouses.
Copyright The Financial Times Limited 2012.
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