The BRICS are coming

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WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN

THE term BRIC (Brazil, Russia, India, China) was first used in 2001 by economist Jim O'Neill (Goldman Sachs) to call attention to four rapidly rising large emerging economies considered able to play a significant role in global affairs, championing the interests of developing nations. Very much like what G-7 does for the developed world.

For years since, it was treated by investors and journalists as a shorthand for the big emerging markets. Adding South Africa to the group widens its focus to include more from outside fast-growing China and India.

The BRICs held its first summit in 2009 in Russia, discussing issues on international monetary reform, including the possibilities of a new dominant reserve regime to replace the US dollar-based system. This year, China played host and invited South Africa to join, formally naming the group BRICS. Together they exceeded three billion people, nearly 45% of the world, and about 25% of the world's 2011 gross domestic product (GDP) based on purchasing power parity.

China's total output is bigger than the other four put together. The economic clout of the BRICS is now growing as the developed world struggles to expand and pare debt. Indeed, they are starting to operate as a common bloc in the G-20, providing a counterpoint to the United States and Europe.

Building BRICS

But the group is vastly different. India, Brazil and South Africa are vibrant democracies in contrast to the more authoritarian Russia and China. They need to balance the interests of its members: three large commodity exporters and two huge commodity importers. For sure, they have to get used to obeying rules they played little part in shaping. China's economy, the world's second largest, is nearly three times the size of Brazil's, close on four times that of Russia and India, and 16 times that of South Africa.



They also differ on exchange rate policies. Brazil is vocal against China's tight management of the yuan's value, keeping its exports relatively cheap. China is becoming prominent in BRICS' trade already it is Brazil and South Africa's largest source of imports. Be that as it may, the group shares strong macroeconomic fundamentals going into 2012.

China and India will grow 8.5%-9% this year; Russia and Brazil, 4%-4.5%; and South Africa, 3.5%. Their structural budget deficits are well contained, with low debt/GDP ratios, highest being in India (68%) and South Africa (65%).

China continues to have a current balance of payments surplus (5.7% of GDP), while all the others' deficits are each less than 5%. But they share a common problem inflation: 6.5% in China, 9% in India, 9% in Russia, 7% in Brazil and 6% in South Africa. Containing inflation remains a top priority of public policy. Still, they continue to struggle to deal with this threat.

The 2nd BRICS Summit held in April 2011 reaffirmed the group's determination to transit from global pax americana to a new order in the “development of humanity.” The BRICS' emphasis on co-operation in their call for reform of the US-dollar dominated international monetary system and for tighter supervision of commodity derivatives and markets, and capital flows show the group is seeking to refrain from too much assertiveness. Still the desire to shake off the old hegemony is there; it calls for a larger role in international fora.

It condemns “the inadequacies and deficiencies” of global finance and the “excessive volatility in commodity prices.” The Sanya declaration underscored their concerns about underlying factors that fuel inflation and currency volatility in many emerging economies, as well as their strong desire to shift away from reliance on the US dollar.

“We call for more attention to the risks of massive cross-border capital flows now faced by the emerging economiesExcessive volatility in commodity prices, particularly for food and energy.”

The BRICS took a new step towards cementing their global influence by: (i) calling for a broad-based reserve currency system “providing stability and certainty”, one that is more reliable and stable; (ii) welcoming discussion about the global role of Special Drawing Rights (SDR), the International Monetary Fund (IMF)'s in-house accounting unit but a global reserve asset, and on the SDR's basket of currencies (now comprising the US dollar, the euro, yen and pound sterling); (iii) establishing mutual credit lines denominated in their home currencies among the state development banks of the group. To start the ball rolling, China Development Bank will issue loans worth 10 billion denominated in yuan this year to other BRICS nations, mostly to fund oil and gas projects; and (iv) forging a common emerging market negotiating stance on issues from climate change to world trade, and to act as a credible counterweight to the West in settings like the G-20.

BRICS & Asia

The Asian Development Bank (ADB) expects Asia to grow 7.5% this year (against 9.2% in 2010) and 7% in 2012. “If anything distinguished the region from the rest of the world, it is its strong macro fundamentals.”

However, a dark cloud in the horizon is the slowdown in exports to its traditional markets in the United States, Europe and Japan. Against this is the region's potential for rapid expansion in intra-regional trade, amid signs of rising domestic demand in Asia.

True, manufacturing and services-related activities stalled across much of the world in August, raising fears of another global downturn. True also, factory and services output throughout Asia, including China and India, slackened in August, pointing to growing evidence that weaker demand in the United States and Europe is weighing on Asia's export-driven economies.

Moreover, investor confidence dropped to the lowest in two years in September in the eurozone and the United States, and consumer confidence, already fragile, weakened further. Unfortunately, the United States' anaemic growth and Europe's worsening debt crisis have prompted governments to deepen budget cuts, undermining consumer demand and clouded growth prospects with uncertainty.

Barring a full-blown double-dip in the United States and Europe, Asia will still suffer significant bruising from deepened dashed expectations, with most of the pain centred on highly exposed nations Taiwan and South Korea. No doubt, the BRICS economies are bound to face clear challenges in responding to the angst over weakened global conditions.

Missing BRICS

O'Neill has since suggested his original four BRICs be expanded to include Turkey, Indonesia, Mexico and South Korea, to form the new “growth markets”. A fresh look is taken to measure exposure to equity markets beyond market capitalisation (GDP, corporate revenue growth and volatility of asset returns); any emerging market accounting for 1% or more of world GDP should be taken seriously. Mexico and South Korea each represented 1.6% of world GDP, Turkey, 1.2% and Indonesia, 1.1%.

Among them, I particularly favour Indonesia. Like Brazil, Indonesia's success is based on the commodities boom: gas and coal to China and India, and palm oil to the world. Investments are flowing in. With a population of 237 million (the world's largest Muslim nation), the country is in the midst of a consumer boom.

Indeed, it has the potential to become one of the world's biggest economies. But it has to get its act together. It will grow 6.2% this year (6.1% 2010) and hopefully 6.5% in 2012. South-East Asia's largest and fastest growing economy is firing on all cylinders. It is today rated a notch below investment grade and should be upgraded soon. It will become a credible 6th member of the BRICS.

What impresses is its growing middle class. World Bank puts private consumer spending at close to one-half of GDP. The middle class (disposable household income exceeding US$3,000 a year) numbered 1.6 million in 2004. Today, Japanese investment bank Nomura estimates it to be about 50 million, more than in India and larger than in any of its nine other Asean neighbours. By 2014-2015, Nomura thinks it could reach 150 million.

The country is growing so fast, especially in the urban areas, that inflation is a major political issue at 7.2% for 2011. But it's stable, bearing in mind the rupiah appreciated 5% this year. Affluent middle-class Indonesians are spending, mainly on motor cycles (eight million sold in 2010, dwarfing sales in the rest of South-East Asia), cars (750,000 in 2010) and smart phones.

Indonesia is reputed to be the world's No. 2 in Facebook members and world's No. 3 in Twitter users. But, Indonesia, to be frank, remains a difficult place to do business because of poor infrastructure (adding to production and distribution costs), and corruption (“non-transparent random regulations”). But there are signs things are changing for the better. It is still attractive to foreign investors: nowadays “if you are not here, you have to have a good reason.” Most new consumer desirables are still imported.

Wall of BRICS 

As a group, the BRICS are growing fast. China has surpassed Japan as the world's No. 2. India and Brazil are following fast behind. Catching-up is always much easier because the leader has already set the path and the pace. At some point, reliance on emerging nations as engines of growth begins to disappoint, as it becomes harder to sustain the pace. Growth will slow down (as did Europe, and Asian Tigers and Japan before them) or may even falter (as did Latin America in the 1990s).

There is a lesson from history. A recent study by three scholars Barry Eichengreen (University of California, Berkeley), Doughyun Park (ADB) and Kwanho Shin (Korea University) called the EPS study* attempted to draw potential warning signs by examining economies since 1957 whose GDP per capita (on a purchasing power parity or PPP basis) rose more than 3.5% a year for seven years, and then suffered a sharp slowdown when growth dipped precentage points or more.

The focus was on economies enjoying sustained catch-up growth. The common sense behind PPP is the same amount of money should purchase the same product in any two countries (hence, the term purchasing power parity). That is, the purchasing power of money, expressed in one currency, should change pari passu in different countries. If US$5 buys a cup of Starbucks coffee in New York and the actual cost of the same Starbucks coffee in KL is RM12, then the exchange rate should be US$1=RM2.40 according to PPP. But the actual exchange rate is close to RM3, or 20% cheaper. So, the use of PPP serves to neutralise any currency distortions.

What emerged was as follows: (i) growth slowdowns occurred when GDP per capita reached about US$16,740 per capita; and (ii) the average growth rate then falls from 5.6% per year to 2.3%. In the 1970s, growth rates in Western Europe and Japan cooled off at about the US$16,740 threshold, as did Singapore in early 1980s and South Korea and Taiwan in the late 1990s.

Thereafter, growth often continues and may even accelerate. Japan's boom lost momentum in early 1970s, then accelerated until it blew up in the 1990s. But, no one-size-fits-all depends on circumstances. When the United States passed its threshold, it kept on growing rapidly, consistent with its innovative prowess. Other risk factors matter, including openness to trade; lifting of consumption to beyond 60% of GDP; low and stable inflation; high ratio of workers to dependents. On the other hand, an under-valued exchange rate raises the risks of a slowdown.

* “When Fast Growing Economies Slow Down: International Evidence and Implications for China.” NBER, March 2011.

The EPS study does draw interesting parallels. China is destined to reach the US$16,740 GDP per capita threshold by 2015, well ahead of India and Brazil. Will it then slacken? The risk factors for China include: an ageing population, low consumption and an under-valued currency. On these alone, the study suggests high odds (over 70%) of a definite slowdown by then! But China is unique. These risks can be managed by shifting development inland, leaving the maturing urban centres room to innovate.

China is already reforming to become a more consumption-based economy, while its currency is being managed to reflect market considerations. Prompt structural reforms help cushion the effects of any slowdown. Even so, a percentage point drop in growth to 6%-7% does not sound so scary. For China, it should not really be such a big deal.

● Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time writing, teaching & promoting the public interest. Feedback is most welcome; email: starbizweek@thestar.com.my 

Putting finance to work

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 The financial sector must be transformed and serve the real economy

THINK ASIAN By ANDREW SHENG

FINANCE is a service industry, but in the past three decades it seems to have gone its own way.

The functions of the finance sector are to protect property rights for the real sector, improve resource allocation, reduce transaction costs, help manage risks and help discipline borrowers. Financial intermediaries are agents of the real sector. Bankers were traditionally among the most trusted members of the community because they looked after other peoples' money.

The divide between bankers and their customers (the real sector) is epitomised by a recent report which said that the mantra of a large British bank is about “increasing share of wallet of existing customers”. It recalls Woody Allen's joke that the job of his stockbroker was to manage his money until it was all gone. And despite what bankers say, a lot more would have gone between 2007 and 2009 without massive bailouts from the public purse.

The heart of the problem is the principal-agent relationship, where trust is everything. The real sector (the principal) trusts the finance sector to manage its savings, and the banks, as agents, have a fiduciary duty to their customers. Agency business is a big public utility because the intermediary does not take risks, which are those of his customers. All this changed when the drive for short-term profits pushed banks more and more into proprietary trading for their own profits. All this was in the name of capital efficiency, a misnomer for increasing leverage.

In the past 30 years, with growth in technology and financial innovation, finance morphed from a service agent to a self-serving principal that is larger than the real sector itself. The total size of financial assets (stock market capitalisation, debt market outstanding and bank assets, excluding derivatives) has grown dramatically from 108% of global GDP in 1980 to over 400% by 2009 . If the notional value of all derivative contracts were included, finance would be roughly 16 times the size of the global real sector, as measured by GDP. The agent now dwarfs the real sector in economic and, some say, political power.

Can finance be a perpetual profit machine that makes more money than the real sector? In the US, finance's share of total corporate profits grew from 10% in the early 1980s to 40% in 2006. Since wages and bonuses make up between 30% to 70% of financial sector costs, there are tremendous incentives to generate short-term profits at higher risks, particularly through leverage.



The key thrusts of the post-crisis reforms in the financial sector are - caps on leverage, strengthened capital and liquidity, more transparency in linking remuneration with risks, and a macro-prudential and counter-cyclical approach to systemic risks. What the current reforms have not addressed is the increasing concentration of the finance industry at the global level and increasing political power that may sow the seeds for another Too Big to Fail (TBTF) failure in the next crisis.

In 2008, the 25 largest banks in the world accounted for US$44.7 trillion in assets equivalent to 73% of global GDP and 42.7% of total global banking assets . In 1990, none of the top 25 banks had total assets larger than their “home” GDP. By 2008, there were seven , with more than half of the 25 banks having assets larger than 50% of their “home” GDP.

Post-crisis, the concentration level has increased as there were mergers with failed institutions. With this rate of growth and concentration, the largest global financial institutions simply outgrew the ability of their host nations and the global regulatory structure to underwrite and supervise them. Such concentration of wealth and power is a political issue, not a regulatory one.

Finance is not independent of the real sector, but interdependent upon the real sector. It is a pivotal amplifier of the underlying weaknesses in the real sector that led to the financial crisis over-consumption, over-leverage and bad governance. In the past 30 years, the finance sector has helped print money, encouraging its customers and itself (particularly through shadow banking) to take on more leverage in the search for yield. Instead of exercising discipline over borrowers and investors, it did not exercise discipline over its own leverage and risks.

Unfortunately, there was also supervisory failure. To bail out the financial sector from its own mistakes, advanced countries, already burdened by rising welfare expenses, have doubled their fiscal deficits to over 100% of GDP.

In spite of these trends, we should not demonise finance or blame the regulators, but examine the real structural and systemic issues facing the world and how finance should respond. The greatest opportunity for finance is the rise of the emerging markets.

An additional one billion in the working population and middle class over the next two to three decades will have more to spend and more to invest. At the same time, the world needs to address the massive stress on natural resources arising from new consumption, which is likely to be three times current levels. Ecologically, financially and politically, the present model of over-consumption funded by over-concentrated leverage is unsustainable.

Indeed, to replicate the existing unsustainable financial model in the emerging markets may invite a bigger global crisis.

Sustainable finance hinges on sustainable business and on a more inclusive, greener, sustainable environment.

Financial leaders need to address a world where consumption and investment will fundamentally change.

To arrive at a greener and more inclusive, sustainable world, there will be profound changes in lifestyles, with greener products, supply chains and distribution channels.

Social networking is changing consumer and investor feedback so that industry, including finance, will become more networked and more attuned to demographic and demand changes.

As community leaders, finance should lead that drive for a more inclusive, sustainable future.

The greatest transformation of the financial sector is less likely to be driven by regulation than by the enlightened self-interest of the financial community.

Only when trust is restored, when finance cannot thrive independently of the real sector, will we have sustainable finance.

The incentive issues are very clear. If financial engineers are paid far more than green engineers, will a green economy emerge first or asset bubbles?

■ Andrew Sheng is president of the Fung Global Institute.

Credit Suisse cuts M’sia GDP forecast

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By JEEVA ARULAMPALAM jeeva@thestar.com.my

It says Asian growth set to slow more sharply

PETALING JAYA: Credit Suisse AG has cut its real gross domestic product (GDP) 2011 growth forecast for Malaysia to 4.6% from 5.3%, as the Western world is teetering on the brink of recession and large parts of Asia remain highly susceptible to growth developments in the United States and Europe.

It also cut its 2011 GDP forecast for other Asian economies such as Thailand, Hong Kong and South Korea.

In an economics research yesterday, Credit Suisse said Asian growth was set to slow more sharply over the coming months.

 “With the fiscal support provided during the global financial crisis removed and the lagged effects of higher interest rates working their way through, we had expected the Asian economies to soften from second quarter of 2011.

“Now that the Western world is teetering on the brink of recession we believe the outlook has dimmed further,” it said.

In addition to cutting its GDP forecast for this year, Credit Suisse trimmed next year's forecast to 4.8% from 5.8% previously. The new 2011 and 2012 GDP forecasts imply annualised sequential growth rates of an average 3.5% in the second half of this year and 5.5% for next year.

“What has kept us from cutting our growth forecasts further is the likely support from domestic demand. We think more investments from the Economic Transformation Programme (ETP) should come onstream, especially in the oil and gas sector which benefited from high oil prices.

“Also, the Government has underspent its budget in the first half and we expect it to increase spending in the second half to meet its target,” it said.

It added that some factors that exacerbated the slowdown in the second quarter were likely to be temporary but Credit Suisse did not expect domestic demand to be shielded from a further weakening in external demand.

“Moreover, Malaysia's growth is vulnerable to a collapse in commodity prices if this were to happen,” it said.

In the report, Credit Suisse said it expected Bank Negara to keep the overnight policy rate unchanged at 3% until the end of next year (it previously expected one 25 basis points hike).

With the global growth outlook highly uncertain and inflation slowing, it suspects that the central bank will be in no hurry to raise the overnight policy rate further. However, a severe global recession could see rates being cut.

“In contrast, we think there is little scope for the Government to stimulate the economy through fiscal policies above and beyond the existing high deficits they projected (5.4% of GDP for 2011).

“Even as things stand now, Malaysia would probably need to undertake significant fiscal adjustments over the next decade if it wants to bring its relatively high debt to GDP ratio down.

“A prolonged weakness in growth would increase the risk that the Government would further delay its plan to cut subsidies and raise the consumption tax,” it said.

Bank Negara is maintaining its GDP forecast of 5% to 6% for the full year as it expects strong domestic demand and ETP projects to fuel economic growth in second half of the year. Malaysia's second-quarter GDP moderated to 4%, compared with 4.9% in first quarter, dampened by a slowdown in the manufacturing sector and weaker external environment.

AmResearch Sdn Bhd, in a report last week, said that while it expected a full-year 5% growth rate to be achieved given the current climate, possible trigger points for a downgrade included an adverse impact of a very large drop in crude oil prices and any further delay in the ETP projects.

“As a net exporter of oil, Malaysia still relies heavily on crude oil in terms of generating income for the country. As long as the full-year average lies between US$85 and US$90 per barrel, all is well and within budget.

“On a positive front, a sharp fall in crude oil may well mean a reduction in total subsidies spent by the Government. The net impact will, however, be detrimental to the Government's coffers and overall growth,” AmResearch director of economic research Manokaran Mottain said in his report.

For latest GDP reports from the Statistics Department click here  

Dark clouds over US and Europe !

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WHAT ARE WE TO DO By TAN SRI LIN SEE-YAN

Within the past couple of weeks, the world has changed. From a world so used to the United States playing a key leadership role in shaping global economic affairs to one going through a multi-speed recovery, with the emerging nations providing the source of growth and opportunity. This is a very rapid change indeed in historical time. What happened? First, the convergence of a series of events in Europe (contagion of the open ended debt crisis jolted France and spread to Italy and Spain, forcing the European Central Bank or ECB to buy their bonds) and in the US (last minute lifting of the debt ceiling exposed the dysfunctional US political system, and the Standard & Poor's downgrade of the US credit rating) have led to a loss of confidence by markets across the Atlantic in the effectiveness of the political leadership in resolving key problems confronting the developed world. Second, these events combined with the coming together of poor economic outcomes involving the fragilities of recovery have pushed the world into what the president of the World Bank called “a new danger zone,” with no fresh solutions in sight. Growth in leading world economies slowed for the fourth consecutive quarter, gaining just 0.2% in 2Q'11 (0.3% in 1Q'11) according to the Organisation for Economic Cooperation and Development. The slowdown was marked in the euro area. Germany slackened to 0.3% in 2Q'11 (1.3% in 1Q'1) and France stalled at zero after 0.9% in 1Q'11. The US picked up to 0.3% (0.1% in 1Q'11), while Japan contracted 0.3% in 2Q'11 (-0.9% in 1Q'11).

A construction worker guides a beam into place in Philadelphia. Picture: AFP Source: AFP

IT’S not always sunny in Philadelphia. The Federal Reserve Bank of Philadelphia has reported severe dark clouds over the area’s factory sector. 

The US slides

Recent data disclosures and revisions showed that the 2008 recession was deeper than first thought, and the subsequent recovery flatter. The outcome: Gross domestic product (GDP) has yet to regain its pre-recession peak. Worse, the feeble recovery appears to be petering out. Over the past year, output has grown a mere 1.6%, well below what most economists consider to be the US's underlying growth rate, a pace that has been in the past almost always followed by a recession. Over the past six-months, the US has managed to eke out an annualised growth of only 0.8%. This was completely unexpected. For months, the Federal Reserve had dismissed the economy's poor performance as a transitory reaction to Japan's natural disaster and oil price increases driven by turmoil in the Middle East. They now admit much stiffer headwinds are restraining the recovery, enough to keep growth painfully slow. Recent sentiment surveys and business activity indicators are consistent with expectations of a marked slowdown in US growth. Fiscal austerity will now prove to be a drag on growth for years. Housing isn't coming back quickly. Households are still trying to rid themselves of debt in the face of eroding wealth. Old relationships that used to drive recoveries seem unlikely to have the pull they used to have. Historically, consumers' confidence had tended to rebound after unemployment peaked. This time, it didn't happen. Unemployment peaked in Oct 2009 at 10.1% but confidence kept on sinking. The University of Michigan's index fell in early August to its lowest level since 1980. Thrown in is concern about the impact of the wild stock market on consumer spending. Indeed, equity volatility is having a negative impact on consumer psychology at a time of already weakening spending.

Traders in the oil options pit of the New York Mercantile Exchange – the oil price slipped as US growth was revised down in the second quarter. Photo: AP

Three main reasons underlie why the Fed made the recent commitment to keep short-term interest rates near zero through mid-2013: (i) cuts all round to US growth forecasts for 2H11 and 2012; (ii) drop in oil and commodity prices plus lower expectations on the pace of recovery led to growing confidence inflation will stabilise; and (iii) rise in downside risks to growth in the face of deep concern about Europe's ability to resolve its sovereign debt problems. The Fed's intention is at least to keep financial conditions easy for the next 18 months. Also, it helps to ensure the slowly growing economy would not lapse into recession, even though it's already too close to the line; any shock could knock it into negative territory.

The critical key

Productivity in the US has been weakening. In 2Q11, non-farm business labour productivity fell 0.3%, the second straight quarterly drop. It rose only 0.8% from 2Q10. Over the past year, hourly wages have risen faster than productivity. This keeps the labour market sluggish and threatens potential recovery. It also means an erosion of living standards over the long haul. But, these numbers overstate productivity growth because of four factors: (a) upward bias in the data - eg the US spends the most on health care per capita in the world, yet without superior outcomes; (b) government spending on military and domestic security have risen sharply, yet they don't deliver useful goods and services that raise living standards; (c) labour force participation has fallen for years. Taking lower-paying jobs out of the mix raises productivity but does not create higher value-added jobs; and (d) off-shoring by US companies to China for example, but they don't enhance American productivity. Overall, they just overstate productivity. So, the US, like Europe, needs to actually raise productivity at the ground level if they are to really grow and reduce debt over the long-term. The next wave of innovation will probably rely on the world's current pool of scientific leaders - most of whom is still US-based.



US deficit is too large

The US budget deficit is now 9.1% of GDP. That's high by any standard. According to the impartial US Congressional Budget Office (CBO), even after returning to full employment, the deficit will remain so large its debt to GDP will rise to 190% by 2035! What happened? This deficit was 3.2% in 2008; rose to 8.9% in 2010, pushing the debt/GDP ratio from 40% to 62% in 2010. This “5.7% of GDP” rise in the deficit came about because of (i) a fall of “2.6% of GDP” in revenue (from 17.5% to 14.9% of GDP), and (ii) a rise of “3.1% of GDP” in spending (from 20.7% to 23.8% of GDP). According to the CBO, less than one-half of the rise in deficit was caused by the downturn of 2008-2010. Because of this cyclical decline, revenue collections were lower and outlays, higher (due to higher unemployment benefits and transfers to help those adversely affected). They in turn raise total demand and thus, help to stabilise the economy. These are called “automatic stabilisers.” In addition, the budget deficit also worsened because, even at full-employment, revenues would still fall and spending rise. So, the great recession did its damage.

Looking ahead, the Obama administration's budget proposals would add (according to CBO) US$3.8 trillion to the national debt between 2010 and 2020. This would raise the debt/GDP ratio to 90% reflecting limited higher spending, weaker revenues from middle and lower income taxpayers, offset in part by higher taxes on the rich. Even so, these are based on conservative assumptions regarding military spending, no new programmes and lower discretionary spending in “real” terms. No doubt, actual fiscal consolidation would imply much more spending cuts and higher revenues. According to Harvard's Prof M. Feldstein, increased revenues can only come about, without raising marginal tax rates, through what he calls cuts in “tax expenditures,” that is, reforming tax deductions (eg cutting farm subsidies, eliminating deductions for ethanol production, etc). Such a “balanced approach” to resolve the growing fiscal deficit will be hard to come-by given the political paralysis in Washington. Worse, the poisonous politics of the past two months have created a new sort of uncertainty. The tea partiers' refusal to compromise can, at worse, kill off the recovery. The only institution with power to avert danger is the Fed. But printing money can be counter-productive. Fiscal measures are the preferred way to go at this time. Even so, the US fiscal problems will mount beyond 2020 because of the rising cost of social security and medicare benefits. No doubt, fundamental reform is still needed for the long-term health of the US economy.

Eurozone stumbles

Looming large as a risk factor is Europe's long running sovereign debt saga, which is pummelling US and European financial markets and business confidence. So far, Europe's woes and the market turmoil it stirred are worrisome. The S&P 500 fell close to 5% last week extending losses of 15.4% over the previous three weeks, its worse streak of that length in 2 years, and down 17.6% from its 2011 high. The situation in Europe has been dictating much of the global markets' recent movements. The eurozone's dominant service sector was effectively stagnant in August after two years of growth, while manufacturing activity, which drove much of the recovery in the bloc shrank for the first time since September 2009. Latest indicators add to signs the slowdown is spreading beyond the periphery and taking root in its core members, including Germany. The Flash Markit Eurozone Services Purchasing Managers' Index (PMI) fell to 51.5 in August (51.6 in July), its lowest level since September 2009. The PMI, which measures activity ranging from restaurants to banks, is still above “50”, the mark dividing growth from contraction. However, PMI for manufacturing slid to 49.7 the first sub-50 reading since September 2009. Both services and manufacturing are struggling.

Going forward, poor data show neither Germany nor France (together making- up one-half the bloc's GDP) is going to be the locomotive. Indeed, the risks of “pushing” the region over the edge are significant. Germany faces an obvious slowdown and a possible lengthy stagnation.

European financial markets just came off a turbulent two weeks, with investors fearing the debt crisis could spread further if Europe's policy makers fail to implement institutional change and new structural supports for the currency bloc's finances. In the interim, the ECB has been picking up Italian and Spanish bonds to keep borrowing costs from soaring. The action has worked so far, but the ECB is only buying time and can't support markets indefinitely. So far, the rescue bill included 365 billion euros in official loans to Greece, Portugal and Ireland; the creation of a 440 billion euros rescue fund; and 96 billion euros in bond buying by the ECB. Despite this, market volatility and uncertainty prevail. Europe is being forced into an end-game with three possible outcomes: (a) disorderly break-up - possible if the peripherals fail in their fiscal reform or can no longer withstand stagnation arising from austerity; (b) greater fiscal union in return for strict national fiscal discipline; and (c) creation of a more compact and more economically coherent eurozone against contagion; this implies some weaker members will take “sabbatical” from the euro. My own sense is that the end-game will be neither simple nor orderly. Politicians will likely opt for a weak variant of fiscal union. After more pain, a smaller and more robust euro could emerge and avoid the euro's demise. Nobel Laureate Paul Krugman gives a “50% chance Greece would leave and a 10% odds of Italy following.”

Leaderless world

The crisis we now face is one of confidence. Starting with the markets across both sides of the Atlantic and in Japan. This lack of confidence reflected an accumulation of discouraging news, including feeble economic data in the US and Europe, and signs European banks are not so stable. The global rout seems to have its roots in free-floating anxiety about US dysfunctional politics and about euroland's economic and financial stability. Confidence is indeed shaky, already spreading to businesses and consumers, raising risks any fresh shock could be enough to push the US and European economies into recession. Business optimism, at best, is “softish.” Consumers are still deleveraging. Unfortunately, this general lack of confidence in global economic prospects could become a self-fulfilling prophecy. In the end, it's all about politics. The French philosopher Blaise Pascal contends politics have incentives that economics cannot understand. To act, politicians need consensus, which often does not emerge until the costs of inaction become highly visible. By then, it is often too late to avoid a much worse outcome. So, the demand for global leadership has never been greater. But, none is forthcoming not for the US, not from Europe; certainly not from Germany and France, or Britain.

The world is adrift. Unfortunately, it will continue to drift in the coming months, even years. Voters on both sides of the Atlantic need to demand more from their leaders than “continued austerity on autopilot.” After all, in politics, leadership is the art of making the impossible possible.

Former banker, Dr Lin is a Harvard educated economist and a British Chartered Scientist who now spends time writing, teaching and promoting the public interest. Feedback is most welcome; email: starbizweek@thestar.com.my.

Malaysia's GDP Growth Falters to 4% in Q2 2011

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Q2 GDP moderates to 4%

By CECILIA KOK cecilia_kok@thestar.com.my

KUALA LUMPUR: Malaysia's economic growth moderated to 4% year-on-year (y-o-y) in the second quarter (Q2) of the year, after a revised growth of 4.9% y-o-y in the preceding quarter due to a weaker external environment.

The country's gross domestic product (GDP - goods and services produced within the country) growth rate for the three months to June, however, was higher than market expectations of 3.6% based on Bloomberg's poll of 16 economists.

Bank Negara governor Tan Sri Dr Zeti Akhtar Aziz said Malaysia's overall economy continued to be sustained by healthy domestic demand and strong exports of commodity and resource-based products amid slower global growth.

Domestic demand in Malaysia during the second quarter grew 5.2% y-o-y due to sustained growth in private spending.

Private consumption remained healthy amid robust labour market conditions, while private capital spending was sustained by expansion in production capacity and investment in new growth areas.

“Based on the growth we have achieved so far, it is likely that Malaysia's GDP for the full year would expand by at least 5%,” Zeti told a press conference here yesterday. She said it was still too early to revise the country's GDP growth forecast.

Malaysia's GDP for the first half of the year grew 4.4% y-o-y, compared with 9.5% y-o-y in the corresponding period last year. The official GDP growth target for the year was between 5% and 6%.

If there was a need for revision, it would be done during the Budget period in October, Zeti said, while emphasising that the central bank remained watchful and was closely monitoring the global economic developments.

“If we have a situation where the United States and Europe slipped into a recession or any other trigger factors that could result in the disruption in international financial markets, we will have to make a reassessment,” Zeti said.



Bank Negara highlighted the fact that global growth had moderated since the second quarter of the year due to a various factors, including fiscal issues and structural weaknesses in advanced economies and global supply chain disruptions stemming from the March 11 earthquake and tsunami in Japan.

These challenges, as the central bank revealed, were reflected in the slower growth in Malaysia's manufacturing sector at 2.1% y-o-y during the second quarter, compared with 5.5% in the preceding quarter.

Zeti conceded the downside risks to Malaysia's external demand had increased following heightened uncertainties in external demand. In the immediate term, she said, fiscal uncertainties and structural weaknesses in advanced economies would continue to challenge global growth and increase volatility in global financial markets.

“Categorically, we have to say we have a strong domestic economy... our fundamentals are strong enough to support our economy,” Zeti said, stressing that a contraction of Malaysia's economy was not to be expected despite the deepening euro debt crisis and sluggish growth in the United States.

CIMB Research, in its report yesterday, expressed optimism that Malaysia's economy would remain in the positive growth trajectory. The research house said the stepping up of government capital spending in the second half and the continued vigour of private capital spending would sustain the momentum of the country's economy.

“We maintain this year's GDP growth estimate at 5%, implying an average growth of between 5% and 5.5% in the second half, compared with 4.5% in 1H11,” CIMB Research said in its report.

Bank Negara also highlighted that the country's inflation, as measured by the consumer price index (CPI), had eased marginally last month. CPI for July gained 3.4% y-o-y, compared with 3.5% y-o-y.
Zeti said Malaysia's full-year CPI would remain within target of 2.5% to 3.5%.