26 May 2010, Beijing The recently announced unprecedented package to avert the destabilization of the Euro financial system by the European Commission (EC), the International Monetary Fund (IMF) and the European Central Bank (ECB) are important steps towards ensuring that the Euro area will survive and prosper, said Citi’s Chief Global Economist, Mr. Willem Buiter at a press briefing hosted by Citi economists today.
“The creation of the European Stabilization Mechanism (ESM) and the accompanying announcements have, for the time being, eliminated the prospect of sovereign liquidity crisis turning into a sovereign solvency crisis and failures of EU banks due to its sovereign exposure,said Mr. Buiter.
However, he cautioned that much work remain to be done.
“The ESM needs to be expanded and be made permanent. Tough and credible conditions need to be attached to any support provided through the ESM and are rigorously enforced,said Mr. Buiter.
The unprecedented package announced included up to 00 billion European Stabilization Mechanism from Euro-area governments with additional contribution from the IMF of up to 50 billion.
Given the importance of “neighbourhood risk,David Lubin, Citi Global Emerging Markets Chief Economist, believes that Western Europe’s turmoil has affected financial markets in Central and Eastern Europe (CEE) worse than anywhere else. Mr. Lubin highlights three channels of contagion, as well as several positive factors.
The contagion mechanisms include a “financialchannel via European banksexposure to CEE; a “realmechanism that threatens CEE export growth if Eurozone woes deepen; and a “thematicmechanism in which investors might target CEE economies with large debt burdens.
On the positive side, the region’s credit-dependence has fallen, partly as a result of the post-Lehman adjustment process they’ve gone through; and with the exception of Hungary, public debt burdens remain low in spite of the crisis.
On balance, though, any deepening of the Eurozone crisis will keep CEE more vulnerable than other emerging economies. As a rule we think the strongest CEE countries are likely to be those where competitiveness is relatively high; where economies are relatively closed; where Western European banks have shown little desire to exit, and where their exposure is relatively small; and where public debt burdens generate few concerns. Poland, Romania and Ukraine seem to be a lot better-protected on these measures than, say, Hungary.
“While the fiscal austerity and potential strains in the banking system will probably be a drag for Eurozone growth, we see no impact on Asia yet,said Ms. Johanna Chua, Asia Pacific Chief Economist for Citigroup.
She added that “While momentum has peaked on both external demand risks and China’s more aggressive move to slow property investment, we find that growth in Singapore, Taiwan, Hong Kong, Malaysia, Korea and Thailand are more sensitive to a Euro area growth downturn, while domestic-demand driven economies of India, Indonesia, China and the Philippines are relatively more insulated.
“However we see greater headwinds in the coming quarters. While the US and emerging markets recovery may have legs, the more serious effort of China to slow down property investment is likely to have a more meaningful impact on growth in the second half of the year,she said.
In the first two quarters of this year, economies across the Asia region have registered positive growth as a result of several factors including re-stocking in the US and Europe, accommodative policies in China to keep investment strong, and a meaningful upturn in domestic demand across the region.
In the past two months, Citi has upgraded 2010 GDP forecasts across most markets in Asia including China (10.5%), Singapore (9.5%), Korea (5.2%), Taiwan (5%), Hong Kong (4.2%) and Malaysia (7%) on broad-based recovery.
Citi economists also expect delays in monetary tightening by Asian central banks on the back of delayed US Federal Reserve’s rate hike to second quarter of 2011, from fourth quarter of 2010.
According to Ms. Chua, the Fed is likely to refocus the need for prolonged accommodation to address asset price volatility in Europe that could provide headwinds to financial conditions.
“While hiking earlier than the Fed in most of Asia looks inevitable given the region’s growth/inflation momentum, we sense it would be difficult for Asian central banks to be too far ahead of the Fed as widening interest rate differentials could exacerbate capital inflows and complicate FX and liquidity management,she said.
The economists also noted that while the RMB appreciation in the coming month is imminent, global growth concerns and sharp appreciation in the USD has made the move on RMB less desirable for Chinese policymakers.
“The sovereign crisis in Europe has helped soften external pressures on China to revalue the RMB,said Mr. Buiter, expecting the authorities will opt for a smaller pace of appreciation of 1.9-percent by end-2010 as compared to 3-percent in their previous forecasts.
Given the strong external liquidity position in Asia as compared with other emerging market regions, Asian asset classes (FX, equities and CDS) have relatively ‘low-beta,and over the medium term, Asia is seen as ‘safe haven.
“Moves by global policymakers to keep monetary policy looser for longer will inevitably provide avenues for liquidity to increasingly shift to the region,the economists added.
