John Greenwood, Invesco chief economist, says in his latest quartely outlook that the economies of emerging Asia and Latin America will provide the strongest growth.
Euro-area real GDP declined by 0.6% quarter-on-quarter in 2012 Q4, reflecting not only the on-going recessions in the periphery, but spreading weakness in the core. German real GDP contracted by 0.6% while France’s real GDP declined by 0.3%. Weak domestic demand has been accompanied by falling consumer and business confidence. The weakness has continued into the first quarter of 2013: the February composite manufacturing PMI for the eurozone fell from 48.6 to 47.9, and further to 46.5 in March, pointing to the prospect of a falling real GDP in Q1. New orders were just 45.2 suggesting further declines in the future. Even Germany’s manufacturing PMI declined below 50 in March to 48.9, while its services index slumped from 54.7 to 51.6. This was followed by Germany’s IFO declining to 106.7. Meanwhile France’s manufacturing PMI fell to 43.9 and services to a very weak 41.9, suggesting France will also remain in recession.
Although the eurozone economies have performed poorly, financial markets had until recently largely shrugged off the area’s economic weakness, buoyed by the upswing in America and by the strong assurances from ECB President Mario Draghi that the authorities would do “whatever it takes” to ensure the survival and integrity of the euro. However, the Cyprus crisis has rudely reminded financial market participants that the euro crisis is by no means over.
At least two aspects of the Cyprus crisis are worrying for the long term outlook. First, the initial problems of Cypriot banks were caused by having to take 80% write-downs on Greek government debt when the Troika demanded a bond
exchange to lower the value of Greek government debt outstanding. Cyprus has a smaller banking system relative to its GDP than Luxemburg, yet it is being compelled to ditch its successful international banking business in order to conform to a euro-area business-model for banking. If this restructuring is forced through, then Cyprus will follow Greece, Ireland and Spain into depression.
Second, the nature of the Cypriot settlement, a 10 billion euro loan from the Troika worth 55% of Cyprus’s GDP, is bad news for the eurozone banking sector in the short term. Under the “bail-in” scheme, shareholders, bondholders and uninsured depositors of Cyprus’s second largest bank, Laiki, will lose almost everything, while the remaining insured deposits and “good assets” will be folded into Bank of Cyprus, the largest bank, which itself will be recapitalised with funds from uninsured depositors, equity shareholders and bondholders. This marks the first time, following 503 billion euros of taxpayer-funded rescue schemes for other peripherals that the EU authorities have “bailed-in” other creditors.
The implications are clear: future eurozone banking problems will have to be solved by funding from creditors, not taxpayers. This implies euro-area banks will have to be much more conservative in their funding, leading to extended deleveraging.
In view of this outcome, it is clear that the euro-area orthodoxy implies further austerity and almost endless depression. To achieve the necessary structural adjustments in the euro-area economies the austerity programs enforced by the Troika are likely to need to continue much longer than had been planned. This means that the prospects for GDP recovery in the eurozone in 2013 or 2014 are diminishing by the month. My forecast is for real GDP growth of -0.2% (compared with an estimated -0.5% in 2012). In short, there will be no meaningful recovery in 2013, and there is a risk of the downturn extending into 2014. Inflation, too, should remain subdued at 1.7%, held down by low money and credit growth, high rates of unemployment and spare capacity, with some deflation in the periphery. The longer term danger is a “Japanization” of Europe as growth stalls and deflation takes hold.