Sital Ruparelia

Guest article by Mitul Kotecha

Since we last discussed the economic outlook at the end of quarter 1, much has happened and unfortunately there has not been a great deal of positive news.  I retained a cautiously optimistic outlook for economic recovery for the Q1 Economic Review: elections, recovery and underemployment discussion article, but highlighted that recovery would be a long and drawn-out process, with western economies underperforming Asian economies.

The obstacles to recovery discussed then continue to apply now, including consumers paying down debt, high unemployment, tight credit conditions and weak confidence.

European Debt Issues

One of the biggest points of uncertainty and worry over the last quarter has been the ongoing sovereign debt crisis in Europe, which has resulted in higher borrowing costs for many European countries and pressure on the euro currency.

Some of this pressure on European markets has abated in the wake of a substantial EUR 750 billion rescue package, but nonetheless, market concerns have not receded fully.  Although there is less concern about a potential default and restructuring of sovereign debt, worries about banking sector exposures to bad debt and real estate have increased.

Austerity Measures

Governments across Europe and the world for that matter have embarked on fiscal tightening or austerity measures to try and reduce the size of burgeoning budget deficits.  This is crucial towards restoring market confidence but the economic cost will be severe as reduced government spending and higher taxes act to slow recovery.

It is also not clear that all major governments are taking a similar approach towards such fiscal retrenchment, with US President Obama’s administration taking a less severe stance on reducing the US fiscal deficit than European governments have done in reducing theirs.  The latest example was the tough emergency budget in the UK in which major spending cuts and tax hikes were announced.

Industrial Unrest

One of the consequences of austerity measures implemented by governments is that public opposition and unrest have been growing in the wake of painful spending cuts, public wage cuts, increased taxes and increasing retirement ages.

This is the unfortunate cost of profligate spending over the previous years and of course the massive fiscal injections needed to kick-start economic growth in the wake of the financial crisis.  Such opposition is likely to continue over coming months, but governments will have little choice but to carry out planned measures.

Unemployment

A spate of weaker than expected economic data, especially in the US, has also fuelled growing uncertainty about the economic outlook, with speculation of a double-dip recession intensifying. One of the biggest concerns is the slow pace of improvement in the labour market.  Unemployment in the developed economies is declining but only at a very slow pace.

In the US the unemployment remains high by historical standards and as the economy improves, it will draw in a lot of previously disaffected workers and result in an even slower reduction in the unemployment rate.

Growth In Asia

Even in Asia it appears that growth momentum is slowing as indicated by many manufacturing surveys.  Attention remains on China and India but it is unlikely that these economies will slow dramatically and more likely that they will remain important growth engines for the global economy even if economic conditions in western economies look less positive.

For example, China’s recent decision to allow its currency, the renminbi,to float came from a position of strength rather than fragility and even worries about a bursting of China’s real estate market look overdone.

Double-Dip?

The bottom line is that the prospects of a double-dip recession have increased but rather than a renewed downturn in economic activity, there is a more likely prospect of a slow recovery taking place.

The US economy is still set to outperform many other economies, especially those in Europe where not only will growth be slower than in the US, but there will also be a significant divergence between the faster-growing export-led countries in Northern Europe such as Germany compared to Southern European countries such as Spain and Portugal.

The Job Market

For the jobs market the picture has continued to improve even if the unemployment rates have been slow to decline whilst compensation packages have become increasingly competitive. Financial institutions that were quick to reduce staffing levels have been aggressive in hiring over recent months, suggesting that despite banking sector worries and relatively slow economic recovery, hiring is quickly picking up pace.

The risk is that actual business does not pick up as quickly as the hiring would suggest, but given how quickly jobs were slashed during the crisis, financial institutions and firms in other sectors still have plenty of scope to re-hire.

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Based in Hong Kong, Mitul Kotecha is Managing Director and Global Head of FX Strategy for a large European Investment Bank. You can follow Mitul’s views on the economy and financial markets at his personal blog, ‘The Econometer’
Mitul’s Previous Guest Articles

Q1 Review 2010: Elections, Recovery and Underemployment

Q4 Review 2009: Dubai, Economic Recovery and Predictions For 2010

Q2 Review 2009: Recovery On Track, But Look Out For The Roadblocks

Q1 Review 2009: Light At The End Of The Tunnel