Sunday, 18 December 2011

Turbulent economic forecast for 2012


 Eurozone crisis has caused uncertainty in global economy

By CECILIA KOK cecilia_kok@thestar.com.my

WHILE not everybody believes that the much-hyped prediction of an impending apocalypse by the ancient Mayan society holds any absolute truth, one can be sure that the gloom and doom-like feeling will continue to permeate the world economy as it approaches the new year.

As some economists put it, we are entering an era of even greater uncertainty. With the considerable amount of unknowns presented to us, we can only expect to be in for another round of wild and tumultuous ride in 2012.

The situation in the European Union (EU) at present remains the biggest wildcard for the global economy, as its sovereign debt crisis continues to spread across the region, producing new signs of strains in the financial system each passing day.

Hopes were high when the top EU leaders converge for a make-or-break meeting last week in Brussels, Belgium, to find a resolution that could douse the spreading flame of the euro and sovereign debt crisis. But the crucial meeting went past without a credible solution that could offer a long-lasting impact that could pacify investors in general.

There is no just quick fix to the EU sovereign debt crisis, economists at the Royal Bank of Scotland (RBS) explain in their recent report.

“While the recent fiscal compact' deal might strengthen fiscal union of the EU members, it doesn't solve the immediate insolvency problems of some members,” they say.

RBS reckons that the European Central Bank (ECB) is still at risk of being drawn into an outright quantitative easing (QE), that is printing of money, which could ultimately undermine the euro's strength.

Although QE might help improve liquidity in the region, more of such a measure will also deepen the policy dilemma for non-QE countries such as those in Asia, RBS' economists say.

More QE in 2012? 

QE has become commonplace in developed economies from the United States to the UK and Japan in recent years since the onslaught of the global financial crisis in 2008, as governments resorted to pumping liquidity into their systems to jumpstart economic growth.

While such a measure may seem convenient to implement, it does bring with it some negative side effects such as the weakening of a country's currency and inflation.

But desperate situation calls for desperate measures. The severity of the global economic downturn three years ago necessitated policymakers to undertake such controversial measures.

The United States, for one, has already had two rounds of QE. QE1 launched in 2008-2009 was valued at US$1.3 trillion, while QE2 announced at the end of last year was worth US$600bil.

No fresh QE by the US Federal Reserve is in sight yet, as policymakers, coming out from its last Federal Open Market Committee (FOMC) meeting for 2011 over the week, have decided to save the QE bullet for another day.

Their decision was premised on a slightly more optimistic outlook for the US economy, as indicators had been pointing to some improvements, especially in the overall labour market conditions.

Still, most experts believe QE3 is on the cards, and will probably be unleashed within the first half of 2012.

As it stands, the US Fed remains very cautious on the prospects of the country's economy, citing significant downside risks posed by strains in global financial markets.

If and when QE3 comes - and depending on its size - one can expect to see asset prices (from stocks to commodities and properties) to be inflated once again, and some countries, especially developing markets in Asia, will likely have to contend with inflationary pressure once again. But until then, the prevailing uncertainties are already pointing to a waning global risk appetite going into 2012.



Depreciating Asian currencies

The trend of global funds reversing from emerging markets back to developed markets has started since September 2011, and it is likely to persist next year, according to analysts.

Save for China and Hong Kong, this trend will spell a further weakening of currencies for economies in Asia (excluding Japan).

(The renminbi, deemed significantly undervalued, has been under intense political pressure to appreciate faster, while the Hong Kong dollar is pegged to the US dollar.)

For reasons not related to their economic fundamentals, Asian currencies in general have already started trending lower against the US dollar since the second half of this year. This was due mainly to capital outflows arising from global risk aversion, as well as intensified deleveraging process foreign investors.

Several Asian central banks have reportedly been stepping into the foreign exchange market to smooth the volatility, even though those measures have not been sufficient to stem the decline of their currencies.

Year-to-date, Malaysia's ringgit has weakened by around 4% to 3.1869 against the US dollar.

Expecting capital outflows to accelerate in the first quarter of 2012, economists believe the ringgit could weaken further to as much as 3.25, before recovering in the second half of next year.

Depreciating currencies aside, there is also a growing concern among experts that the continuous outflow of capital could result in tighter domestic liquidity conditions, although countries with larger current account surpluses will be less affected.

In Asia, Malaysia has the second largest buffer in its current account balances at more than 10% of its gross domestic product (GDP), after Singapore, whose buffer in current account balances exceeds 20% of its GDP.

It is unmistakable that policymakers in Asia will be kept very, very busy next year, as they contend with the challenges that await them.

Besides having to manage the lingering effects of weakness in developed economies on their economies, policymakers in some countries will also deal with domestic economic challenges that could add salt to the wound.

According to Morgan Stanley Global Economics team, the risks for Asian economies in 2012 remain skewed to the downside, with China facing the potential of a sharper-than-expected correction in its property market, India facing a weaker investment sentiment, and South Korea facing the prospects of high household debt weighing down consumption growth.

The risk factors, if materialised, could result in a bear case scenario, in which the global financial institution expect economies in Asia (ex-Japan) to slow to 5.9% next year, compared with its base-case forecast of a 6.9% GDP growth.

For Malaysia, Morgan Stanley argues that the risk factors are mainly external, with a sharper-than-expected global slowdown increasing the country's downside growth risks via the trade and commodity channels.

This is because a severe global slowdown will not only result in the demand for Malaysia's exports of goods and services, but it will also cause further decline in commodity prices, in which case, Malaysia, being one of the largest net commodity exporter in the region, could see the terms of trade to deteriorate further.

“Malaysia's vulnerability to a global growth shock remains similar to that in 2008. Its open economic structure means that there is no escape from a global slowdown,” Morgan Stanley explains.

Although it notes that policymakers in the country have been making efforts to boost domestic demand, particularly in private investment, it remains concerned that such policies at this juncture have not gathered enough momentum to provide much growth catalyst in view of the country's high trade linkages and a global slowdown that could affect investor confidence.

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