The slowdown in the global economy is starting to bite from one end of Latin America to the other. The OECD forecasts that growth in the region in 2012 will slow to 3.2% from 4.4% last year. That would be the first deceleration in a decade. Just last week Argentina reported that its GDP growth in September was only one tenth of a percentage point higher than in the same month last year. Far to the north, Mexico said its third-quarter growth, at one half of a percentage point over the previous quarter had been its lowest since the first quarter of last year. Mexico, Latin America’s second largest economy, can at least comfort itself with the fact that its growth for the full year is likely to come in at 4%. Brazil, is looking at 2% growth for 2012, if it is lucky.
Mexico’s policy makers will have to wrestle with balancing cuts in interest rates to stimulate a sluggish economy with the risk of stoking inflation. That is a classic central banker’s dilemma, at least. Argentina, the region’s third largest economy after the other two, is facing problems as much of its own making as of the global slowdown’s. A poor grain harvest may have been outside the government’s control, but high inflation and import and currency controls on investment were not. The country’s long boom has come to an abrupt and ugly end this year.
The government’s newly lowered forecast of 3.4% growth for the year now looks optimistic. Private economists say 2% would be more realistic. If that is so, it would be a huge problem for Buenos Aires. Annual growth falling to 3.26% triggers $4 billion worth of payments next year to holders of Argentina’s GDP-growth-linked debt. Already embroiled in one international row over the accuracy of the country’s official inflation figures, another one on the GDP numbers now looks to be on the cards.
With politicians in the U.S. and Europe abrogating responsibility for getting their zones of the world economy growing again, the task falls by default to central bankers. Yet they are standing pat for fear of being left spent in the event the feared second dip of recession materializes.
Economists have been cutting their global and national economic growth forecasts in recent months, but leading central banks have taken only relatively modest steps to stimulate economies. To deploy a cliche, they may have been talking the talk. They are not walking the walk. This week:
- the ECB left its benchmark interest rate unchanged at 0.75%. Last week, its president, Mario Draghi, promised to do “whatever it takes” to preserve the euro;
- the Bank of England, which last month announced an increase of £50 billion ($78 billion) in its quantitative easing (QE) program, held its benchmark interest rate at 0.5%;
- The U.S. Federal Reserve confirmed that it would keep keep its extremely low interest rates (0.0-0.25%) until late 2014.
Meanwhile, in the world of factory floors and customers, the JP Morgan Global Manufacturing Purchasing Managers’ Index (PMI) fell to 48.4 in July from 49.1 in June–edging even further away from the dividing line of 50 that separates contraction from expansion. Like central bankers in China, those in Europe and the U.S. are holding out the hope that the policy actions they have already taken will kick-in in time. That they are now keeping the last of their policy powder dry suggests that they are hoping against all hope.
The LIBOR scandal will be a field day for our learned friends. An estimated $350 trillion worth of financial instruments is tied to the benchmark interest rates. The potential cost of litigation against the banks from those who own and trade those swaps and other securities that were priced using LIBOR could be substantial, as will be the legal fees involved. Contingent provisioning against that has yet to be fully priced into bank stocks.
Barclays’ settlement with U.K. and U.S. regulators over LIBOR rigging is just the start. Several other international banks are still being investigated by authorities. Heftier fines than even the £290 million ($450 million) one imposed on Barclays are quite possible, as will be taking away LIBOR-setting from the hands of the bankers themselves. No longer will it be the responsibility of their industry group, the British Banking Association. That latter step will be part of an urgent rebuffing of London’s reputation as a transparent internal financial centre that will need to be undertaken by the U.K. authorities.
One other consequence of the LIBOR scandal will be to make U.S. lawmakers even less inclined to embrace international financial regulation. It will be argued that benchmark interest rates that affect American consumers and investors should be regulated at home, even if many in the U.S. Congress had been blissfully unaware of LIBOR until very recently.
China looks set to give a big boost to its nascent muni-bond market this year. The Finance Ministry is to quintuple the quota for local government bond issuance to 250 billion yuan ($40 billion) this year, Caixin, a Beijing-based financial newspaper, reports.
In addition, more provinces will reportedly be added to the list of those able to issue bonds directly. Since 1994, the ministry has done that on behalf of local governments but started an experiment in direct issuance in October last year with Shanghai, Shenzhen, Guangdong and Zhejiang. That privilege will be extended to six more provinces and municipalities. The ministry is expected to maintain the close control over the bond issuance by the larger group that it has exercised over the trial quartet, including having a big say over what the funds raised can be used for.
Expanding the muni-bond market is both part of the broader reforms of the financial system and local government finances. The latter are teetering under the burden of 10.7 trillion yuan of debt, at least 3 trillion yuan of which falls due by the end of this year. Much of the debt piled up as a result of the stimulus spending in the wake of the 2008 global financial crisis. Much of it is infrastructure loans, for things like toll roads to nowhere, that are weighing heavily on the creditworthiness of China’s banks.
Earlier this month the China Banking Regulatory Commission ordered banks to clean up their balance sheets with regard to local government lending. It first told them to do that in June last year, but progress clearly hasn’t been rapid enough, or, as a result of the cooling of both the economy and the property market, problem loans are mounting. Good and bad loans alike were probably rolled over when banks tackled the 2 trillion yuan of local government loans that fell due last year. Another red flag raised by China’s audit office: irregularities it has found with 530 billion yuan worth of the lending. Taken together, an estimated 2 trillion-3 trillion yuan of local government lending has soured, which would be sufficient to raise the banks’ non-performing loan ratios to 5% from their current average of 1.1%.
The new quota of 250 billion yuan for bond issuance won’t wipe away the problem but every little bit helps–and places like Greece serve as a reminder that bond issuance is not an infallible inoculation against government profligacy. Yet while the immediate priority is to deflate China’s local-government debt bubble before it can go damagingly pop, an expanded muni-bond market also pushes provincial and municipal governments in three other desirable directions: less reliance of land sales to raise revenue, less need for the off-balance sheet financing via captive investment vehicles that local authorities have resorted to get round restrictions on official borrowings, and more transparency generally about their finances.
This is an edited version of a post first published by China Bystander.
Filed under Banking, China
One overlooked aspect of the agreement struck by the member nations of the European Union over fiscal and budgetary alignment is the matter of enforcement. The failure to incorporate the proposed agreement into the EU’s basic treaty, the Lisbon Treaty, means that neither the European Commission nor the European Court of Justice will have standing to deal with recalcitrants. Both institutions’ writ runs only to treaty matters, not those covered by intra-EU sub-agreements and those between national governments, as this latest deal will be structured in the face of opposition by non-euro-using countries, notably the UK.
That is one reason that the agreement envisions the new fiscal and budgetary constraints being baked into national constitutions, and the European Court of Justice being given new powers to adjudicate on whether countries are baking in the Brussels-approved manner. This is a conscious attempt to put the governance of national fiscal policy under greater judicial and less political sway, just as the EU has used the courts to enforce central directives in other areas.
One of the failures of the Maastricht agreement that launched the euro 10 years ago was that countries’ compliance with the economic conditions for membership – holding budget deficits to no more than 3% of GDP was one of them, remember – was entirely in the hands of national politicians. For all the goodwill being expressed towards greater fiscal integration in the heat of the euro debt crisis, national politicians are not going to give up their power of economic policy making willingly. Many will see this as the judicial Trojan Horse that will lead to a Federal EU with full economic and political integration. National politics is going to continue to shape Europe’s fiscal integration, and markets will have to learn to live with all the uncertainty that implies.
Italy doesn’t have an economic problem as much as a political one. While the country has underperformed economically over the past decade both relative to its eurozone peers and relative to its earlier self, as Daniel Gros, director of the Centre for European Policy Studies in Brussels, points out,
[Italy’s] three most important measurable growth factors actually improved in both absolute and relative terms:
- Investment in physical and human capital; the former is high and the latter is improving rapidly.
- Structural indicators in terms of product and labour market regulation (all improving absolutely and relative to Germany according to OECD indicators).
- Investment in R&D (improving).
The only factors that have deteriorated absolutely and relative to the core of the Eurozone are indicators of governance – such as corruption and rule of law.
Italy’s performance has deteriorated dramatically over the last decade – the years of Berlusconi governments – on the three governance indicators the World Bank considers most important for an economy: the rule of law; government effectiveness in general; and control of corruption. Italy now ranks lower than any other eurozone country, including Greece, on all three.
Changing a country’s political culture to support good governance of the body politic is the hardest thing to achieve, yet “progress on these fronts might in the end be more important for growth than the reforms now being imposed by the EU,” Gros says.
It’s not the bunga-bunga that gets them. It’s the bonds. Looks like Italy’s beleaguered prime minister, Silvio Berlusconi, is the latest to learn that. He squeezed his quickly cobbled together austerity package through parliament, but at the cost of his governing coalition holding together. What months, or is it years, of partying in questionable taste and the after scandals couldn’t do to him, the yield on his country’s sovereign debt could. Berlusconi has offered to resign, albeit at a time uncertain. Investors have spoken. Electors, it seems, weren’t consulted.