A tough 2012 in Europe to have mild impact on Asia-Pacific
Hong Kong, 19 March 2012 — Ernst & Young’s Eurozone Spring Forecast (EEF) predicts a slow return to growth in 2013 – but the intervening recession will only have a mild impact on prospects for the Asia-Pacific region.
With the main Asian economies, China and India, already slowing towards the end of 2011 - partly due to earlier tightening of monetary policy to counter fears about inflation - weaker demand in Europe will weigh further on export prospects in 2012. With 20% of their exports going to the EU, both China and India will be impacted, as will other leading exporters in the region including South Korea, Thailand and Taiwan.
Although the Eurozone faces a challenging year with large amounts of public and private sector debt yet to be refinanced, tight credit conditions, further fiscal austerity and more job losses, EEF forecasts a slow return to growth in 2013. But the European Central Bank (ECB) has to continue to play a central role by being prepared to cut interest rates further and purchasing government bonds in peripheral countries.
With a default on Greek sovereign debt negotiated and a second bailout agreed, and assuming that policy-makers continue to keep up the momentum by putting a credible firewall around Spain and Italy, EEF is forecasting a modest recessionary fall in Eurozone GDP of 0.5% this year, with nine of the seventeen Eurozone members’ economies set to contract. However EEF expects Eurozone GDP to grow by about 1% in 2013 before picking up to 2% a year in 2015-16.
Eurozone recession will have only mild impact on Asia-Pacific
The continued high level of financial market stress stemming from the sovereign debt crisis in the Eurozone will continue to deter global capital flows and Foreign Direct Investment (FDI) to the emerging markets in general, putting further pressure on their balance of payments.
Gerard Dalbosco, Managing Partner, Markets, Asia-Pacific at Ernst & Young comments, “Although banks in Asia and credit conditions generally may not be directly affected by Europe’s banking sector problems, there will be knock-on effects that will slow credit growth in some Asian markets. But many countries in the region are now relaxing monetary policy, which will help to offset the threat from the mild recession in Europe, and intra-Asian trade and capital flows remain solid. In addition, domestic demand in China and some other Asian countries remains robust.”
The expected slowdown in China and India (now seen growing by about 8.5% and 6% respectively in 2012, down from around 9% and 7% in 2011), will affect other countries in the region, dampening their exports and weighing on business and consumer confidence. But commodity prices are likely to remain relatively high in real terms, helping to support activity and state spending in many of the region’s economies despite the adverse effect on consumer demand.
However, the recent renewed strength of oil prices is a concern to oil importers in the region, especially India, and may trigger renewed inflation concerns. But unless oil prices spike significantly from current levels, the continued strength of domestic demand in many of the economies should shield Asia-Pacific from the recession in Europe, especially if demand continues to hold up reasonably well in the US and other parts of the world such as Latin America and Africa, both of which have increasing trade and investment links with Asia.
Outlook for Asia-Pacific
Marie Diron, senior economic adviser to the Ernst & Young Eurozone Forecast comments, “Although the recovery from recession is likely to be the slowest in Europe in the last 40 years the actions taken by the authorities over the last few months, particularly the introduction of the long-term refinancing operations by the ECB, have created conditions where it is possible to now see light at the end of the tunnel even if actual recovery is still some way off. These policy efforts have to be rigorously maintained and even reinforced at a Eurozone and national level to ensure we don’t lose momentum.”
Dalbosco comments, “The Eurozone needs to do more to improve the economic outlook beyond 2013. Tackling rigidities in the labor market, improving the quality of institutions in some countries, taking difficult decisions on the care of ageing populations, and encouraging a single market for services would all go a long way toward improving long-term growth prospects. By taking these steps now, Eurozone governments would also take a big step towards easing the current crisis and help prevent the next.”
Dalbosco concludes, “Despite the uncertain environment in Europe, GDP growth in emerging Asia overall is still forecast at 6.5% in 2012, only a little lower than the estimated 7% in 2011, and a rebound to about 7.5% is forecast for 2013 as the slow recovery expected in the Eurozone and stronger growth in the US help to bolster performance in China, India and other major economies in the region. This in turn will reinforce the overall trend for the Asia-Pacific region – and emerging markets overall – of decoupling from the developed economies.”
Further information from Ernst & Young’s Eurozone Spring Forecast (EEF)
Fiscal consolidation and lack of credit weigh on growth
The main constraints to Eurozone growth this year will stem from fiscal consolidation, which EEF estimates will amount to more than 1% of GDP, and tight credit. Despite the introduction of the long-term refinancing operations (LTRO), which has boosted financial markets and ensured that the prospect of a banking credit crisis has receded, latest data indicates that much of the liquidity provided has not yet been lent on into the wider economy.
Lack of consumer and businesses confidence results in rising unemployment
In response to tighter financing conditions, an increase in spare capacity and weaker domestic demand, businesses are likely to scale back investment spending. Spanish and Italian firms are forecast to cut capital spending by 5% or more in 2012, while in France and Benelux investment will remain flat or edge down slightly. Amongst the larger economies, only in Germany is investment spending likely to grow meaningfully but not until the second half of the year.
Despite a moderation in inflation this year (assuming no further rise in oil prices), consumer spending is also likely to be reduced reflecting an uncertain external outlook and deepening fiscal austerity although perhaps by less than might be expected. At the Eurozone level, EEF predicts that growth in consumer spending is likely to be negative at -0.7%. However, German consumers are likely to increase spending by around 1%, while French household spending will remain broadly flat.
This outlook for business investment and consumer spending means job creation is set to weaken in most Eurozone economies. With Germany again set to be one of the few exceptions, EEF forecasts unemployment rates to rise across the Eurozone in 2012 peaking at 18.2 million at the turn of the year, although given the relatively strong balance sheets of many European corporates this trend could be quickly reversed if confidence begins to return.
ECB must continue to play its part to ensure weak recovery
The ECB will continue to play a critical role in 2012 by providing extensive support to the Eurozone economy. Should the economic environment deteriorate, EEF believe this should include lowering interest rates further to 0.5% and stepping up purchases of government bonds to facilitate debt refinancing by peripheral countries at affordable interest rates. Without action, there is a risk of a series of disorderly defaults among weaker countries that could threaten the future of the Eurozone.
EEF is optimistic however that the Eurozone policy community will tackle these challenges successfully and avoid any permanent structural damage to the currency. Nevertheless, given the impact of the crisis on banks’ balance sheets, and the weakness of public finances in many countries, the recovery will be much slower than after previous downturns.
The scale of current crisis could also be the trigger for Eurozone-wide reforms that would have otherwise been considered too difficult to implement. Real structural change to encourage medium and long term growth to enable the region to compete with developing markets is in many cases long overdue.
About the Ernst & Young Eurozone Forecast
The forecasts and analyses presented in the EY Eurozone Forecast are based on the European Central Bank’s model of the Eurozone economy. This model embeds state-of-the-art economic theory and techniques and is used by the ECB to produce its quarterly forecasts of the euro area.
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