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Friday, December 13, 2002

German Debt to Lose AAA Status?

It seems Germany's status as the benchmark in the eurozone debt market is under threat because of growing concerns about their ability to hold on to their triple A credit ratings. Arguably investors are already begining to price in the risk of a German downgrade as the fiscal position continues to worsen. Standard & Poor's this week affirmed Germany's triple A rating with a stable outlook, but pointed to growing debt and fiscal deterioration as an indication that Germany "has begun to fall behind its triple A rated peers in terms of fiscal and economic indicators". Because of its benchmark status - the result of Germany's historically strong finances - Berlin has been able to borrow more cheaply than other eurozone governments, this position could now be in the process of changing, making the debt more costly to maintain and thus in principle increasing the deficit.

David Riley, head of sovereign ratings at Fitch, said: "Germany's triple A rating can no longer be taken for granted." Fitch plans to review Germany's rating in the first quarter of next year. "We are going to Germany because we are concerned about the structural issues and I would not rule out a negative action," Mr Riley said. Moody's is also planning to visit the country next year but it said that its main concerns focused on long-term structural issues, such as the state pension system, rather than on the shorter-term fiscal position. A downgrade or even a change of outlook on Germany by any of the three large rating agencies could affect its benchmark status. While German 10-year yields are still the eurozone's lowest, some analysts now expect France, its closest rival since the euro came in, to achieve benchmark status next year in terms of the price of its debt.
Source: Financial Times

Meantime Italy, with a current debt GDP ration of around 109.8%, plans to use a piece of 'coupon-clipping' to reduce the outstanding stock of debt to around 108.5% by swapping €39 billion of 1% government bonds held by the Bank of Italy in its own portfolio with comparable issues carrying higher coupons (say in the 4-5% range). Since an increase in the coupon would reduce the nominal value of the debt this move would help the debt/GDP ratio, the stream of future budget deficits, in contrast, would go up by around one-tenth of a percentage point a year in paying the higher interest. The real problem, however, is that a country with a stock of debt larger than its GDP keeps living beyond its means and borrowing from the future, and no amount of financial jiggery-pockery is going to change that reality.

Thursday, December 12, 2002

World Bank Warns on Risk of Latin American Detachment

In a report published 11 December (Global Economic Prospects and the Developing Countries: 2003) the World Bank suggests something which most thinking people have already discerned: that economic growth 2003 will be a sluggish affair. They also the opportunity to highlight the growing risk that Latin American economies generally can become detached from the pack in an environment of hightened investment risk and stronger than par economic growth in Asia.

They argue that after exceptionally slow growth in 2001 and 2002, global GDP is now expected to rise by 2.5 percent in 2003, higher than the previous two years but still well below the 3.9 percent expansion recorded in 2000 and significantly below long-term potential growth rates. The report warns that the global rebound might quickly lose momentum and suggest there is a significant risk that the world could slip back into recession. According to their latest forecasts, high-income countries are expected to grow at about 2.1 percent in 2003. On average developing countries will grow considerably faster, at 3.9 percent. But the average masks wide regional differences, with East Asia leading the pack at 6.1 percent, followed by South Asia at 5.4 percent. Other regions are expected to grow less than 4 percent, with Latin America managing a mere 1.8 percent. Outside of Asia and Eastern Europe, growth rates in most developing countries are too low to generate a marked reduction in poverty.

The report argues that factors suppressing global growth in the near term include waning consumer confidence, high debt levels in the face of a weak equity market, and the fallout from corporate financial scandals in the U.S., continuing investor worries over imbalances in the Japanese banking system, and over-investment in telecommunications and other high technology in Europe, as well as concerns about debt problems in Latin America.

At the same time, the region remains more vulnerable than many other developing regions. First, a high debt overhang from the 1980s remains a problem to finance in many countries. In the 1990s, some countries continued to rely on significant debt financing, particularly in the public sector. Public debtto- GDP ratios rose in some countries and the maturity of that debt shortened in duration, increasing their vulnerability to shifts in investor sentiment as they question debt sustainability. LAC countries may have to learn to live with less debt in the future, adjusting public expenditures as required. Countries need to create fiscal space during good times (boom years) to be able to conduct countercyclical policies in future downswings in economic activity. Second, many countries, especially the low-income coffee producers, also need to further diversify their export base to reduce vulnerability to large swings in commodityprices. Finally, the region still lags in financial deepening (which could help raise national saving rates), infrastructure, and quality of institutions—areas that need to be improved before the region can attain high sustainable growth rates.
Source: World Bank

Wednesday, December 11, 2002

Portuguese Workers Are Not Happy

Portugal was brought to a virtual standstill by a general strike yesterday as unions challenged reforms introduced by the centre-right government in its effort to cope with the eurozone's spending and borrowing rules and the impact of European Union enlargement. The 24-hour stoppage, Portugal's first general strike in a decade, mainly involved public sector workers who say they are bearing the brunt of the austerity measures which are designed to bring the budget deficit back within the limit set under the eurozone's growth and stability pact. Whatever the complexity of the problems lying behind Japan's deflation problem, it is not too hard to look into the proverbial crystal ball and see how the future is likely to pan-out for some Euro-zone members. Faced with an inflation dynamic which makes them increasingly less competitive they are finding growth hard. At the same time an ageing population and escalating future pension liabilities mean they have a debt trap - they cannot try to stimulate growth by getting into debt because the future growth expectations, which would enable them to pay-off the debt, just are not there. Hence deflation is an ever present danger.

"Portugal is in danger of losing an important dimension of social solidarity and stability if the government goes ahead with these reforms," said Manuel Carvalho da Silva, general-secretary of the CGTP-Intersindical trade union federation, which called the strike. But António Bagao Félix, labour and social security minister, said the reforms were vital if Portugal was to compete successfully for export contracts and inward investment with the east European countries due to join the EU in 2004. The strike, which disrupted hospitals, schools and courts and brought public transport to a standstill, was mainly targeted at government proposals to replace about 80 labour laws with a single new code designed to increase efficiency.
Source: Financial Times

EU Expansion Agreement Proving Difficult

With a summit aimed at admitting 10 more countries to the European Union only two days away, the candidate governments are still bargaining hard for better financial terms of membership, and the member governments are still trying to decide how much to offer. According to the experts, with so much unresolved, the summit that opens Thursday in Copenhagen could well extend beyond its scheduled two days. In fact European officials are saying that the most difficult issues will not be resolved until government leaders sit down behind closed doors for last-minute deal-making. Of course, the main sticking point in the negotiations between the 15 EU countries and the candidates is money. The countries joining the union will get direct cash payments in the form of development aid and support for farmers, far beyond the amounts they will have to pay into the EU. But they are joining at a time of economic constraints in Europe generally. In return for the aid the new countries would have to accept a series of strict agricultural production quotas. Poland, which has more farmers than Germany and France combined, has been particularly vocal in crticising the proposed terms, pressing for more farm aid and higher production quotas in areas such as milk. The nub of this problem is that all this comes at a time when the leading EU countries are experiencing far more economic difficulties than were expected at the time of proposing entry. Germany in particular is having to propose a very difficult package to its own citizens this winter to maintain its commitment to the stability pact, while having higher than desireable interest rates due to Euro membership. This means that it is in no position to be especially generous. Hence we have an 'expectations gap', the new, poorer, countries being in a worse position that the existing members imagine, while the existing members are unable to meet the generosity expectations of the newcomers. All-in-all it is difficult to see how this can work well long-term.

"This has to be in the hands of the heads of state and government," said Romano Prodi, president of the European Commission, the EU's appointed executive body. "The decision is too important a decision to be taken beforehand." He added, "Miracles are always possible." Prodi said he did not expect the haggling to derail plans to formally issue membership invitations to the 10 countries -- Poland, Hungary, the Czech Republic, Slovakia, Slovenia, Malta, Cyprus, Latvia, Lithuania and Estonia. "The deep sentiment of all the heads of state and government -- I repeat, all -- is in favor of enlargement," Prodi said. "The enlargement is seen as an historic goal. It is not a decision of 'if,' it is a decision of 'how.' "
Source: Washington Post

Tuesday, December 10, 2002


The U.S. unemployment rate shot up to 6 percent in November as employers reduced their payrolls by the largest amount since February, the US government said on Friday in a weak jobs report that offered little short term optimism for the economy. The jobless rate hit its highest level since April, jumping three-tenths of a percentage point from October's 5.7 percent, according to the Labor Department. Many US labour market watchers had been expecting a more modest rise to about 5.8 percent. At the same time, the number of workers on U.S. payrolls outside the farm sector fell by 40,000 last month, a worrisome showing compared to a consensus expected gain of 38,000. The hard-hit manufacturing sector shed 45,000 jobs last month. Furthermore, in a worrying indication that businesses are remaining cautious in the run up to the Christmas holiday shopping season, retail jobs sank 39,000. All this, when placed alongside the rapidly rising US productivity number gives some cause for concern that a deflationary environment may be slowly but surely arriving.

The monthly decline in the nation's job market was the biggest in nine months. Highlighting the slide was a further reduction in manufacturing payrolls, which contracted by 45,000 jobs in November. It was the 28th consecutive drop in monthly employment at the nation's factories.

While manufacturing only represents about 20 percent of the nation's output, analysts said the economy would be hard-pressed to return to a sustained growth path until factory output and employment start to rebound.

The manufacturing numbers, which included a third successive decline in aggregate hours worked, strongly suggest that industrial production fell again in November. The Federal Reserve is scheduled to release industrial production statistics on Dec. 17. In advance of the jobs report, economists had been forecasting a modest 35,000 to 40,000 increase in nonfarm payrolls. Part of the optimism was based on a string of declines in new weekly claims for unemployment benefits. But the hopeful feeling was inaccurately based, some analysts said."This will cause people to remember that claims tell you how many people are getting laid off," said David Resler, chief economist at Nomura Securities International. "They tell you nothing about how many people are being hired."

On a brighter note, employment in the service sector rose. Health-related companies made up more than half the November increase, with notable gains in hospitals and nursing homes. But employment at temporary-help agencies fell for the second month, after several months of steady gains. Such employment is closely watched by economists because companies often seek temporary help as their businesses start growing again, instead of taking on full-time workers. Other big industries showed little change in November, including construction and government, which had a large gain in October. Economists said the rise in the unemployment rate would undoubtedly be a topic of discussion when Federal Reserve policy-makers meet on Tuesday. But the Fed, which last month announced a sharp cut of half a percentage point in short-term interest rates, is very unlikely to approve another rate cut anytime soon, the economists said. "They made a strong statement last month, and will sit back and watch for a while," said Ward McCarthy, a managing director at Stone & McCarthy, an economic research firm in Princeton, N.J. "But they have to be disappointed with these numbers." The rise in the unemployment rate is almost certain to stoke talk about the need for further stimulus, probably in the form of tax cuts, analysts said. "There is a very high chance of some sort of new fiscal package," Mr. Harris at Lehman Brothers said.
Source: New York Times