Jan 25 2012
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Risk alert - again
The year 2012 may not appear to be any better than 2011 as many businesses had hoped. A new update of the International Monetary Fund's (IMF) World Economic Outlook, says global economy will rise 3.3% in 2012, a downward revision from 4% in its previous forecast.
Excluding Libya, MENA growth projections for 2012 and 2013 are set to be lower by -1.6 and -1.2 percentage points, respectively, than in the September 2011 WEO.
Even stalwarts like Saudi Arabia will not escape the heat. Samba Financial Group estimates that the Kingdom's economy will grow by 3.8% in 2012, a far cry from th blistering 6.8% growth in 2011. Other economies including the UAE, Qatar and Kuwait will also see their economies unable to scale last year's growth rates.
The Institute of International Finance (IIF) echoes the IMF's growth forecasts. The Institute expects the UAE to post 3.1% growth this year (2011: 4.4%), Qatar 5.3% (2011: 18%) and Kuwait 3.1% (2011: 4.4%). Overall the Arab World is expected to grow 3.6% in 2012 compared to 4.9% in 2011.
Why the gloom in the global economy?
Among other major factors is the threat of an escalation with Iran.
"Concerns about geopolitical oil supply risks are increasing again. The oil market impact of intensified concerns about an Iran-related oil supply shock (or an actual disruption) would be large, given limited inventory and spare capacity buffers, as well as the still-tight physical market conditions expected throughout 2012," noted the IMF analysts in the report.
The crisis, which has been orchestrated by Western nations, could well be a self-inflicted for the global economy at a time when it could ill-afford a spike in energy prices.
While oil prices remained flat, although high, the IMF expects prices to remain elevated despite lower demand.
"These risks are expected to remain elevated for some time, and oil prices will ease only marginally in 2012 despite less favorable prospects for global activity," said the Fund.
Due to the contradictory risks (supply disruptions versus cooling demand), the IMF's crude price projection for 2012 remains largely unchanged to $99 for a barrel of WTI compared with $100 in the previous estimate.
Other analysts agree.
CIBC's Katherine Spector notes that global oil fundamentals look to be at something of an inflection point. Oil inventories are still on the low side of normal, but appear to have bottomed and should have an opportunity to rebuild in the coming months.
"Saudi production is always a key swing variable in the supply/demand balance but looks to be even more so this year, as Libyan output recovers. In fact, Saudi production exceeded the market's call on Saudi crude in December for the first time in two years," said Spector.In a sense, Saudi has more optionality than it has had in some time. On the one hand, there is plenty of scope to single-handedly cut production to maintain the now oft-cited $100 price level. With inventories on the low side, small tweaks to production could effectively keep the market on the edge of balance, and keep prices broadly rangebound, said Spector.
On the other hand, maintaining current, high production could easily allow inventories to rebuild, or -- going one step further -- challenge other, more price-sensitive producers for market share.
That's where geopolitics could come into play.
"Although our gut feeling is that a collection of smaller challenges in places like Nigeria and Sudan will ultimately mean more to the market this year than Iran, it's hard not to at least give the erstwhile Gulf producer a mention," said Spector. "Ironically, there's a good chance that oil sanctions will hurt consumers more than Iran, and an even stronger chance that bombastic talk about closing Hormuz will hurt Iran more than anyone else."
Oil is just one major variable. The IMF is also concerned about financial risks escalating not just in Euroland but fragilities elsewhere.
"Specifically, concerns about banking sector losses and fiscal sustainability widened sovereign spreads for many euro area countries, which reached highs not seen since the launch of the Economic and Monetary Union. Bank funding all but dried up in the euro area, prompting the European Central Bank (ECB) to offer a three-year Long-Term Refinancing Operation (LTRO)," said the IMF.
The Fund expects the developed economies to expand by 1½ percent on average during 2012-13. Given the depth of the 2009 recession, these growth rates are too sluggish to make a major dent in very high unemployment. Moreover, the 2012 growth projection is a downward revision of ¾ percentage points relative to the September 2011 WEO.
"The euro area economy is now expected to go into a mild recession in 2012," warns the Fund.
"With only limited policy room, growth in most other advanced economies is also lower, mainly due to adverse spillovers from the euro area via trade and financial channels that exacerbate the effects of existing weaknesses."
Risks in the EU are skewed to the upside, particularly in the short term, investment bank BarCap agrees. A significant source of upward risk is the implementation of higher indirect taxes.
Although, they are not yet officially on the cards, we calculate that 3pp and 2pp hikes in the general VAT rates of France and Spain - which are currently at 19.6% and 18% respectively. Should these be decided or not in the very near term, it remains that having an inflation rate stickier than initially expected and probably above 2.0% during the bulk of 2012 could be a hurdle towards further traditional easing by the ECB.
"The severe fall in economic activity that peripheral countries are likely to experience this year, led by Portugal and Greece at -3.7% and -3.5%, as well as Italy and Spain -0.7% and -0.6% (with clear downside risks), coupled with subdued activity in core countries (Germany (0.5%), France (0.0%), the Netherlands and Belgium (-0.3% and -0.2%) should put downside pressure on core prices," says BarCap.
EMERGING MARKETS' HARD LANDINGS
Emerging markets will be called upon once again to carry the burden of creating growth, jobs and investment opportunities. But they will disappoint.
The Fund expects developing economies to 5.75%, a major slowdown from its previous forecast of 6.75%.
"This reflects the deterioration in the external environment, as well as the slowdown in domestic demand in key emerging economies. Despite a substantial downward revision of ¾ percentage point, developing Asia is still projected to grow most rapidly at 7½ percent on average during 2012-13," the Fund notes.
There is a great possibility of hard landing in emerging economies, as they face the consequences of high credit and asset price growth.
In the Middle East while oil exporters should continue to benefit from high oil prices, the oil-importing nations will struggle.
"Most oil-importing countries in the region face muted growth prospects due to longer-than-expected political transitions and an adverse external environment," said the Fund.
But while the IMF paints a grim picture of the global economy, it proposes a set of remedial measures that can be taken.
Some of these include:
Quantitative easing: If downside risks to growth materialize, further monetary stimulus -- including through quantitative easing -- may well be necessary.
Capital injection: To break the adverse loops between weak growth and deteriorating bank balance sheets, more capital needs to be injected into the euro area banks.
Credit growth: Easy funding in the short-term must be coupled with continued progress to repair and reform financial systems.
Euro credibility: Restoring confidence in the viability of the euro area hinges on deepening financial and fiscal integration over time and on implementing structural reforms to help resolve internal imbalances.
Emerging market: In emerging and developing economies, the near-term focus should be on responding to moderating domestic demand and slowing external demand from advanced economies, while dealing with volatile capital flows.
For all practical purposes, it appears that the global economy faces yet another tough year.
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