PSI, Budget Commissioner for Greece: Implications for the Sovereign Debt Crisis and the future of the Eurozone

So a PSI is almost a done deal for Greece. Is the beginning of the end for the Greek-cum-Eurozone crisis? Not On Your Nellie…

In my last blog I signed off with some fundamental concerns about both the impact and sustainability of the process in Greece set against a clear lack of consensus and domestic ownership for the austerity forced in Greece – either among the rulling classes or across society more generally (and to date putting the Greek situation at odds with Italy).

What is clear from both the last IMF report in December and the data so far is that the economic compression in Greece is worse than baseline forecasts from even mid-2011. Whilst the Fund is focussing on a medium-term path to sustainability of debt to 120% of GDP and a return to growth fostered by fiscal and structural reform, the facts are that an economy heading south does not bode well for any projections   – leaving alone the intention of widening the tax base or ramping up the efficiency of tax collection.

There are no signs of productivity growth but instead, as to be expected, indications of internal devaluation Latvian-style through a decline in domestic wages....and unlike Latvia growing signs of ever-increasing domestic opposition as the pain of austerity bites deeper.

How long can this continue?

Economist's Answer: …until marginal gain = marginal cost!...

Or put another way, there is a argument to be made that it is in the interests of (at least the elite) Greeks to secure the maximum in terms of transfers, aid, soft financing and reduction in Net Present Value of external liabilities….until it becomes too painful and the marginal cost/pain outweighs the marginal gain.

Have we reached the point of equality of the marginal changes?

The leaked terms of the new EU-IMF deal has some pre-conditions which both crank up the requirement for further cuts in civil servants by a reported 100-150k and …here are the interesting parts:

i.                     A legal commitment to prioritise future debt service  and an implicit requirement to meet future budget constraints due to non-disbursement of traches through cuts in primary expenditure.

ii.          A formal “Transfer of National Budgetary Sovereignty….see the full text below:

Budget consolidation has to be put under a strict steering and control system. Given the disappointing compliance so far, Greece has to accept shifting budgetary sovereignty to the European level for a certain period of time. A budget commissioner has to be appointed by the Eurogroup with the task of ensuring budgetary control. He must have the power a) to implement a centralized reporting and surveillance system covering all major blocks of expenditure in the Greek budget, b) to veto decisions not in line with the budgetary targets set by the Troika and c) will be tasked to ensure compliance with the above mentioned rule to prioritize debt service.

The new surveillance and institutional approach should be formulated in the MoU as follows: “In the case of non-compliance, confirmed by the ECB, IMF and EU COM, a new budget commissioner appointed by the Eurogroup would help implementing reforms. The commissioner will have broad surveillance competences over public expenditure and a veto right against budget decisions not in line with the set budgetary targets and the rule giving priority to debt service.” Greece has to ensure that the new surveillance mechanism is fully enshrined in national law, preferably through constitutional amendment.

As someone who has worked with over 20 governments and Ministries of Finance – and therefore a certain amount of operational knowledge on fiscal positions - I cannot recall even developing and aid-dependent countries being asked to, in effect, delegate its fiscal sovereignty to this extent – although policy conditionality can be tough – and where it is, it is in effect requested and signed-off  by the country.

And needless to say the initial reaction from Athens has been vociferously negative.

Moving on from basic economics to slightly more advanced stuff, lets take a leaf out of Game Theory…..

i.                     Is  Germany, which is clearly behind this initiative – given the blueprint in action of the Fiscal Compact – willing to take this to the limit? Does it expect Greece to comply, get the funds and thereby help placate German public opinion (which is against handouts to Greece) and then in future take charge through the implementing arrangements being put in place, or

ii.                   Are the Greeks being pushed to exit the Eurozone…if yes game over

iii.               Lets go to time period 2: Assume the Greeks bite the Bratwurst…sorry the bullet…and agree to the deal and then renege…what happens………yup, back in the Twilight Zone!

iv.            Introduce dynamics…Portugal sees what’s happening (Miguel look forward to  your views!), then the Cypriots, Irish,…Spain…and why not those peddlesome new Member States that never really sorted out basic corruption issues…say the Bulgarians or the Romanians….hmm how about the French while we’re at it. Will the other sovereigns in the firing line or those reliant on EU aid transfers within the expanded EU start to put up a coalition of resistence towards greater fiscal co-ordination or sign-up?

As far as Greece is concerned, there have to be grave doubts about the democratic legitimacy of the proposal but I can see a watered down version waived through in the EU-language of solidarity and partnership that allows  both Germany and Greece to get their desire. However, we’ll not be much further down the road from answering whether the entire process is credible – where I started or if we’re anywhere nearer a resolution of the Euro-Crisis.

From the donor side – and this is an apt term as Greece in effect aid dependent – there is a real (and understandable) concern about how to introduce a clear incentive-based approach that binds Athens to structural adjustment – however painful, and that if sustained lead to a sense of “revelation” for Greeks sometime in the next few years.

What is clear is that the fiscal measures agreed are not working so far. 

Sales of assets to raise €50bn? The original timeline of 2015 was stretched to 2017 but aside from the risk of achieving firesale prices or low value as far as the Greek tax-payer is concerned, there is a paradox in play – the Greeks need to sell but the fear of “Drachma-sation” and de facto devaluation in Greece (with a likely dose of high inflation) is putting off potential buyers. By corollary, the more the markets feel that Greece can stick the course  the more likely that the risk of drachma-sation will recede and appetite pick up.

So what we’re left with is …further budget cuts in the offing…including a further to-be programmed cut of 1% in the budget outlay in 2012.

Conclusions:

i.                     A bit like the end of the transfer-deadline today for football in England, gamesmanship means leaving things till the 11^th if not 12^th hour.

ii.                   A Greek default is not in anyone’s interests in the Eurozone or in the wider EU. The PSI settlement will be followed by some fudged-compromise agreement to the new conditionality and subsequent disbursement of a new €130bn tranche. And (back to Game Theory) the Greeks know this, the Germans know this, the Greeks know the Germans know this...the Germans know that the Greeks know that the Germans know this...hmm do the Scottish Nationalists know this ? :)

iii.                  Greece will meet the March 20^th deadline for meeting the next debt payment of €14.4bn

iv.                 Expect increased vigilance at the Eurozone level of Greek budget programming and implementation….no bad thing in terms of broader governance for the Greek taxpayer…

v.                   …expanding over to the other sovereigns who, like Oliver Twist,  come round asking for more.

vi.                 Does it solve the economic collapse in Greece…No…so back to Oliver Twist we all need more...and more means a co-ordinated response for "more growth please!"

vii.                Will the risk on Greece meeting future debt repayments decline? Difficult to say at this stage: possibly, but push-come-shove  and Greece could still default in the future although the starting conditions will be significantly improved….

viii.              What it may do is to increase a typically iterative EU advance towards a fiscal Union through pooling of resources – cross-country collateralisation of debt issuance or Eurowide bonds. It may also as a consequence lead to a clear segmentation of countries within the Eurozone towards comparable zones…hmm wasn’t that the DM-zone before?

Greek Debt Crisis - Key Issues and Likely Outcomes

After the festive break, we’re back in action…and deja-vue… its Greece again.

The issues are now a little clearer but the political economy issues remain stark.

• Greece is due to make a €14.4bn debt repayment by March 20^th. It is unable to make this payment without external support.

• The latter involves “burden sharing” to help solve Greece’s financing gap: (i) further debt restructuring of Greece’s external liabilities through an effective write-off of approximately €100bn of its €350bn public debt and (ii) external support from the IMF and the EU.

Will a deal with the private holders of the debt – under the aegis of the Institute for International Finance – be reached in time to avoid another D-Day calamity? Short answer, yes!

A co-operative arrangement for a debt restructuring is the preferred option for all parties - the creditors, the EU (and IMF) and Greece. For the creditors, precedents are being set for possible replication later in Cyprus and Portugal at the very least for the debt write-offs. The EU wants to avoid a spillover from a disorderly default onto the other peripheral economies as well as further impact on already dicey banking sectors and a fragile real economy. Greece doesn’t want to be the relegated from Europe, be shunned by the markets (although there’s plenty of evidence in the last 50 years that markets have short memories…), face a real bank run or lose access to EU-transfers and the current soft aid it’s receiving……and the likely ex-post likelihood this could in effect lead very quickly to an all out socio-economic collapse, hyperinflation, even a possible military coup and probable need for emergency outside support and finance.

The basic parameters of the deal have been agreed in terms of the write-off and the sticking point is now the interest rate on the swapped bonds: 3.5%, 4% or something in the middle. Brinkmanship may delay the decision but not the outcome. A lower interest rate will of course mean a higher reduction in terms of Net Present Value of the existing debt load for existing bond-holders.

Will all bond-holders agree to the outcome? Probably not and this may well lead to a technical default as far as rating agencies are concerned but – particularly if some holders refuse to accept the offer and which in turn leads to de facto non-payment to those who continue to hold existing paper. But then again those who didn’t settle still hold Argentine paper from its sovereign default in 2002 so this is not a killer point.

Will a “credit event” occur that triggers CDS payments? Again unlikely given the importance given in the EU to avoid contagion. Such an event would typically occur if there was a disorderly default (very low probability) or if there were holdouts by some bond-holders that in turn leads to a change in Greek legislation that effectively legitimises – at least in Greece – the switch to the new bonds (low probability).

The Greek Tragedy is alas exactly that…the economy is in a tailspin and shrank 6% in 2011 and isn’t expected to return to growth until 2020. Debt sustainability (120% of GDP is the magic target ratio under discussion) is only feasible over the medium-term if the country is able to at least grow in nominal terms as fast as the debt service….else.. as being currently grasped in the UK, austerity alone can actually lead to higher debt ratios if the economy contracts or grows at a rate lower than the debt interest rate due. i.e. the focus has to be on growth-enhancing policies.

Will this Private Sector Initiative or PSI in Greece coupled with another likely €130bn aid package from the official sector be it and deliver this path to nirvana? Probably not....

And this takes us back to the real questions and policy issues that require address….does Greece have genuine “ownership” for the structural adjustment it is being asked to implement and if not what incentive measures are feasible, if any...what will it REALLY cost - over and above the current and pending financial packages and debt reduction under discussion …..and what does it therefore say about the current and putative EU architecture for economic convergence and fiscal co-ordination….(next blog/s!)

Hungary: Political Economy, the Calculus of EU-IMF support and Prognosis

Would Hungary make the cut for EU entry today? This question in many ways encapsulates the political-economy questions facing both the recent CEE entrant into the EU and the fate of the Union itself amidst the on-going Euro crisis that has yet to be played out.

The blueprint for EU Accession was/is the so-called Copenhagen criteria set out at the European Council there in 1993 that set out the joint pre-conditions of a State being a market economy able to survive the rigours of the Single Market and a democracy with institutions that guarantee rule of law, human rights and protection of minorities.

And the country met the conditions and duly joined the EU Club in the Big Bang of May 2004.

Fast forward to 2010/11 …and…Hungary finds itself subject to infringement procedures by the Commission, the EU’s Executive for constitutional measures, freedom of the press, judiciary and the central bank; and a dressing down of its PM, Victor Orban, by the European Parliament that has threatened today, Jan 19^th, to escalate punitive measures last taken against Austria in 2000 when it dallied with the far-right party of Jorg Haider.

Victor Orban, Hungary's prime minister, has come in for a lot of flak. Here is a man who started off on the left-of-centre at the beginning of transition and is now occupying a nationalistic banner firmly on the right wing of domestic and European politics amid an overwhelming mandate from the electorate in 2010. His nationalistic go-alone model has been compared to the Putin-model followed in Russia of centralisation of power and politics.

Alas Mr Putin has had economic independence through Russia’s hydrocarbon endowment…as well as a black belt in Judo to boot …

The economic crisis globally and within the EU partly propelled Mr Orban back into power. History is rife with examples of economic collapse and rise of nationalism and there are signs of this across the EU from the rise of the Finnish People’s Movement, through Holland, France and - with the extension of the EU eastwards - into geographies last understood in the West in the pre-communist area of the collapsing Austian-Hungarian territories.

Yes, the Euro crisis has seen a domino effect of collapsing right-of-centre governments affected by the sovereign debt crisis from Ireland, Iberia via Italy through Greece by left-of-centre ones but with the exception of Spain, the jury is still out if these technocratic governments have sufficient traction and political experience to sustain the argument to austerity-fed electorates.

Prognosis:

• Hungary is a small open-ish economy and has neither the political or economic clout to be an outlier – within or outside the EU.
• Forget the shenanigans of the Euro crisis, Hungary is dependent on the EU for internal transfers (yes they exist ..look up Cohesion Fund) and for pending EU-IMF financial support. The diplomatic upsurge in Hungary’s efforts to mollify Brussels and the visit to the IMF to seek external support will have brought home to Mr Orban that he will have to play by the EU rule-book. Expect a rapid vole-face and repeal of the conditions outlined by the EC last week regarding the new Central Bank Act passed at the end of 2011 and the explicit and implicit erosion of the central bank’s independence.
• The European Parliament’s tough stance will not be followed up by the European Council but expect the EC to keep up the pressure to ensure that the  4^th pillar of an open civic society and plurality of views is kept up...this can only be good for both Hungary's democracy but also for those waiting in the wings to join like the Croats in 2013.
• The economic crisis is also having the effect of galvanising the EC’s approach to enforcement EU law - and frankly this too can only be a good thing if the Copenhagen criteria are to survive -  be it the preservation and deepening cross-country economic and commercial links with the EU through freedoms of capital, labour and goods moving about (ie the UK position in the last 2 decades) …or thorough guarantees of civil liberty, freedom of thought and voice.
• In the economic space, the EC’s leverage is likely to expand in two ways in the EU:

i)              Greater focus generally on fiscal co-ordination and surveillance (already under way through Excess Deficit  Procedures) even if the Fiscal Compact will be a watered-down version

ii)           For the new EU CEE economies who are net recipients of EU transfers far greater impact of implicit or explicit conditionality – through existing aid and soft loans but…also through the EC’s effective control of any IMF assistance in the offing.

• This is not the place to discuss the possible modalities of EU-IMF assistance that the joint mission is currently reviewing in Budapest. From a sovereign perspective, the key points are that Hungary is an EU member state and it will get assistance in the same way that Latvia and Romania did– a localised financial collapse in Hungary will not be allowed to happen and that could have unintended spillovers into the region or the Eurozone, not mentioning the highly vulnerable banking sectors in the region (as rightly picked up by both the World Bank's recent report and by Eric Berglof at the EBRD...a blog for another time).
• Any budget or Balance of Payments support will require of Hungary conditionality - both pre-conditionality and programme compliance ie. interim benchmarks/policy conditions. With the IMF on board, this means that Hungary will sign-up to roll-back of some heterodox economic policies such as the flat tax although it’ll be interesting to see what the outcome is as regards the Hungarian version of financial repression of its banking system - used by the government to try and put a ceiling on FX exposures on a large swathe of the household mortgage sector that had taken a punt on the "carry trade" on the then cheaper CHF but which is now a curse on private sector balance sheets.
• In the medium-term the increased monitoring of Hungarian economic policy will be + for both FDI and porfolio flows. 
• In the short-term - and for the reasons outlined above - I am bullish on Hungary. I expect CDS spreads to narrow and the forint to strengthen. 

·         

Rating Downgrades for the Eurozone Sovereigns and the EFSF: Implications

S&P downgraded the EFSF today – Jan 16^th -  from triple A to AA+. This followed on the coat-tail of the rater’s downward adjustment on Friday of nine Eurozoners. France and Austria lost the triple-A status as it was adjusted down a notch, as were Malta, Slovakia and Slovenia.

What does this mean in terms of the Euro-crisis thus far and looking ahead?

• The S&P downgrade was flagged in early December so it was expected and priced in. The French government in particular had had time to prepare its public, and in time-honoured fashion, have a dig at the English. And neither was there was much of an effect on sovereign bond yields during trading in Europe during Monday.

• That said the US was on holiday today and the announcement on Friday was also late in the day, so expect a delayed reaction – and possible second round effects in other geographies thereafter. And expect the other raters to join ranks in the coming weeks, with more “noise” and market volatility around these events. This may will lead to further compression of yield in northern bond markets - following the negative yield posted in Germany recently. 

• In the medium-term, the loss of a single notch will not effect France or Austria’s financing capacity at the margin. There is clearly a risk that both countries could get sucked away from the Division 1 or Euro-zone Core that is de facto emerging…or being re-acknowledged as the convergence plays of the last decade reverse back to the old DM-zone…(plus Estonia…”Tere” to my friends there)….

• I expect French polity to kick-in further fiscal structural adjustment post presidential elections, whoever’s elected – be it VAT reform or further, and politically difficult, cuts in the welfare state. Baseline: if anything expect the S&P rating and possible follow-ups  by Moody’s and Fitch, to increase the probability of French regaining its drive to re-join the Eurozone core….rather than the reverse.

• More interesting is the fate of the EFSF, which at the end of the day is simply a derivative, relying as a pooled-fund for guarantees provided by the EU 27 Member States. The French and Austrian downgrades will have a significant effect of reducing by 41% the AAA rated guarantees the facility can tap to €260bn.

• In turn this means two choices: a lower kitty or higher subscriptions. With Germany’s Finance minister already scoffing the idea (…which normally means the country will change its mind at some late stage) of a top up, this means the fire-power for the EFSF is lower. Does this matter? Its successor – the more muscular European Stability Mechanism (ESM) comes into effect in July 2012. Given the programme of debt management in the EU in H1, the loss of the EFSF rating will likely inspire the Eurozone group to raise the benchmark from the touted €0.5trn facility to a higher “shock-and-awe” €0.7-0.9 trn – the higher range the more likely the greater the likelihood of a “disorderly default” in Greece.

• It does however leave a shortfall should another need emerge in the coming weeks beyond the pencilled in support to the Irish, Portugal and the €100bn odd to Greece. 

• The one big concern about the ESM is the same as for the EFSF  - its leverage to around a factor of 6 and use of financial engineering that the same policy-makers continuously referred to as “toxic” till the onset of the sovereign debt crisis….ahh the irony of it all.

• Do the ratings effect the likely calculus of outcomes for Greece? Directly no, but in practice it will act to further strengthen European political will to not give in to “Anglo-Saxon” market forces. In one sense Greece is in default already and the question now is how the debt-resolution is played out…whether the settlement is voluntary, involuntary and the extent of possible contagion in the southern Euro periphery.

• Impact on the Fiscal Compact? The ratings will give fillip to the tough-love fiscal northern countries. Ironically the S&P assessment – whatever the critique of its pro-cyclical assessments– was clear in lambasting the policy focus in the EU on fiscal retrenchment rather than the external weaknesses and competitive problems. Any attempt to revert back to the original early-December draft of the Compact that effectively implies an external sanction on domestic budget choices will simply not work. The ECB's already had a dig at the watering-down of the original blueprint and in effect it means an unlikely shift from the current status-quo. 

• Austria’s rating downgrade is an interesting case given the potential contingent liabilities that could emerge given banking exposures to Central and Eastern Europe.

• Which will leave continued role for the ECB…following its increasing involvement since the inauguration of Mr Draghi…and in particular the successful 3-year liquidity facility for banks….although it won’t solve the solvency problem for banks in the Eurozone (last point)

• The IMF as an additional “backstopper”? The idea of the EU sending payments to DC to then have it returned seems ludicrous…but in reality is a ruse to get around the Bundesbank-inspired restrictions placed on central bank financing that exists for the Eurozone. With the emerging world and also the US politely turning the other cheek, this won’t happen – although it’s to be hoped that the Fund can continue knock sense in the EU-mindset for the current on-going negotiations in Greece ----at least on the Maths.

• So more fun and games….lots of summits, agreements, downgrades, economic revisions…volatility to continue into 2012....

• But...to end on a brighter note...upside risks also...the consensus-forecasts are likely over-shooting the negative sentiment about global growth prospects. The Euro will continue to slide both against the dollar and in effective terms, helping to boost EU growth and complementing some positive economic data in the last few weeks, and there's a real chance of above-forecast growth for the US and continuing - if slightly less hot - growth in emerging Asia. 

Forecasts for 2012: Russia and the FSU

When I was a kid growing up in north-west London, there was a popular rhyme I recall at primary school …Hungary was hungry, ate Turkey, slipped on Greece and broke…China. 

Needless to say with such a aposite upbringing, it was perhaps no surprise to folk, that I became a big fan of developing-cum-transition economics and economies!

There is something prescient however about such a cross-country linkage for these emerging economies because in many ways it describes lucidly the increasing connectivity that exists between economies and across regions – a trend that has accelerated in the post WWII era. The collapse of communism ushered a wave of wannabee free marketers from Tallinn to Beijing and an outcome what others such as Thomas Friedman have have ascribed as a 'flattening of the world'.

These transition economies have tried to “converge” with developed economies – be it in terms per capita incomes, human development indices or simply put to aspire to similar quality of life. Those that entered EU have had to jump hoops to comply with the EU’s entry requirements…and those on the periphery …from the Western Balkans that are formally in queue with Croatia now granted an entry ticket in 2013…to a ring of countries that form the “External Neighbourhood” from Morocco around the Med to Egypt, taking in Jordan and Syria and then into the Caucuses and up through Ukraine and Belarus….

Apples and oranges? Yes maybe..

It also leaves out Russia and the ‘stans in the former Soviet Union which I'lll have a stab at here.

That said, the above-stated interlinkages are still playing out – be it the asset bubbles that have mushroomed within the EU that allowed free movements of capital but without genuine prior structural convergence OR macro imbalances regionally as China followed a mercantilist route to growth, exporting to the West and then parking the receipts to finance the balance of payments deficits back in the West that had bought its exports…ostensibly the US. 

…Or the impact of the entry of the transition economies’ entry into the global economy in terms an initial deflationary force that kept down global inflation and which is now reversing as the growing masses in these emerging economies raise their demand for resources, toys and gadgets..

So 2012?

1.       Lets start with mother Russia: a country, language and people I know a wee bit… forget about the is it 3 or 4% growth this year and the central bank's would-be new inflation targets in the offing....expect status quo with the hydrocarbon sector continuing to drive growth and revenue flows on the budget…even if global demand for oil declines in the short term due to an unexpected confluence of slowdown across different geographies, volatility in the Arab theatre will keep prices fizzling over the medium term….anything over US80/barrel and the Russian elite is happy… and as already clear in the last couple of days uncertainty in the oil markets will help the rouble and help the regime to raise current expenditure.

2.       Will we see a Russian-Spring or Perestroika II? Insufficient time for a sustained impact on presidential elections slated March 2012 and no change from the scheduled Putin 2.0. That said, I expect increased pressure for improved governance as an increasingly informed middle class and youth with access to Internet-based information from outside state-control continue gaining traction although it’ll be interesting to see if the rag-tag umbrella coalition of ‘anybody but the P n M’ with nationalists and communists thrown in can hold it together or whether the pros in the Kremlin play the age-old divide-and-rule strategy. Russia won’t go down the route of Belarus and jail anyone opposing the regime....unless you're a billionaire who didn't follow the piper's tune..

3.       As in almost any economy the key demand of citizens/electorates is job security and general economic prospects. There is sufficient ‘fiscal space’ for the govt to spend its way out of the political problems – although there are 2 major risks here in the medium term:

a)      the Russian economy will continue to suffer from the Dutch-Disease facing any oil/commodity producer. Put another way, the hydrocarbon sector is a curse on the non-hydrocarbon sector through rising real exchange rates unless it is able to adjust through faster improvement in productivity. The fate of the non-hydrocarbon sector – the size in the relative share of economy, the size of the its fiscal deficit – are continuing medium term risks.

b)      the problem of policy advice inc. the IMF’s prescriptions is that the very structural adjustment required: be it a re-adjustment of the non-oil fiscal target, facing up to the future growth trjectory of the non-hydrocarbon sector, or reforms in healthcare and pensions, are policy choices that that are simply not politically feasible for a Russian polity that needs oil funds to finance its way through the political headwinds in 2012. More worryingly it is not clear if the former spooks in power have any real notion or political will to initiate genuine structural reforms that could incentive the non-hydrocarbon sector to improve productivity and create jobs. The wannabees that joined the EU had an anchor for reform through the very basis of membership's requirements (..ahum ahum... except Romania and Bulgaria that is).

Elsewhere?

• Status quo for the ‘stans… although a ratcheting up of cross-border trade and flows of energy from  Turkmenistan will continue…
  

•  No change in Ukraine…a lost hope

• Or Belarus…where Russia will continue to “Russify” remaining prime assets – the country is awash with Russian capital …and ever more tied to Russian largesse for balancing its books….which will continue at least till late 2012 and post-Russian elections…whilst the Lukashenko regime without any checks-and-balances will be able to continue imposing “inflation tax” domestically through massive devaluations as happened in 2011 without real fear.

•   .. and Moldova where nothing will change...except braindrain, Romanianisation of citizens before they head off to the Latin countries in the EU and rampant corruption... but it will continue to blindly sign-up to the EU Association Agreement hoping for EU freebies and Romanian good-will.

Alas, we haven't got to Hungary...

Forecasts for the US, Middle East and SE Asia

Continued…

The US

1. Never write off the US economy (and as I keep telling friends and foes…never write of the Manchester United…despite tonight's 3-0 thumping at Newcastle). I expect growth to pick-up, the genie of the fiscal imbalances resolved through a mix of higher taxes and lower expenditures….although not until after the presidential election in November – ie not before 2013.
2.  And the US$ to continue strengthening….particularly against the € (and which in turn should help the Euro economy to export its way to growth)
3.  The polarisation of US politics to right and left and away from the consensual politics since the New Deal to continue although I expect a presidential race-off between a moderate Romney v the incumbent Democratic president – and I expect Mr Obama to be re-elected.

 Middle East
 

1. Continuing political risk...with Syria continuing to internally combust (a real pity, a lovely place and people), Egyptian polity unresolved as the economically powerful military resists losing its role and privileges, Yemen and possible further spillover into the rest of the Arab-speaking Gulf, Maghreb (next parliamentary elections in May 2012) and sub-Sahara.
2. The buyout of possible social discontent …”social contract” of a sort…will continue to limit the spread of the Arab Spring into Saudi Arabia as it and others in the GCC hand out oil-fuelled freebies to electorates fussy about political rights and accountability.
3. Unknown unknown in Iran as internal squabbles there play out...even possible (hot air) threats of oil disruptions in the Strait of Hormuz will lead to nervousness and gyrate oil prices….as will the possibility of an Israeli strike in Iran (which is unlikely until the situtaionSyria is resolved).
4. Turkey: muscular foreign policy in recent years has been -  a bit like Russia – propelled  by a booming economy. A rapid slow-down and reversal on the Turkish Lira will, in turn dampen - at least for a bit - a return to quasi-Ottoman role in the Levant.
5. Iraq…sadly the internecine domestic violence no longer shocks and the departure of US troops will not materially change risks to oil outflows…but if the situation in Iran spins into a high-risk tail event,  then …
6. Economically the risks for 2012 must be on the downside. Tourism receipts will continue to be hit – important from Jordan, Egypt to the GCC (eager to be global hubs between Europe and emerging Asia) but also in the Maghreb. The political risk coupled with a global slowdown will be a credit negative for inflows of foreign non-debt monies. This will not matter for the uber-rich oil-rich economies but will hit the rest – and in turn further raise potential political unrest if it leads to higher (and in particular youth) unemployment.

South East Asia

1. I had the pleasure of reviewing many of the sovereigns this year…and the economic challenges there were of how to slow down over-heating economies. The global slowdown and repatriation of bank capital from EU banks in 2011 has already had the de-celerator effect…
2. With growing middle classes and high savings rates, a glide path to a steady Goldylocks economic growth rates will ensue despite the effects of natural disasters in Japan and the floods in Thailand.
3. China: a lot of quasi-fiscal debt floating about, a lot of NPLs, but at the end of the day its all sovereign and can therefore be absorbed (ok it won't solve the flow problem of it re-emerging without some serious structural reform)….with a change-over in leadership in 2012-13, a mix of fiscal and monetary loosening, and some dodgy numbers, will mean no hard landing….just a easing down of growth
4. …helping the region to chug along nicely..
5. Japan:  lest we forget this remains, despite a moribund decade, the world’s largest creditor and the world’s third largest economy. Following an awful 2011 with the devastating effects of the Earthquake in March and the nuclear accident, the rebound in reconstruction-fuelled growth will continue to drive domestic demand into 2012. I expect intra-Asian supply chains to steadily rise with a rise in recent years’ trend of off-shoring production of lower-value into emerging Asia. 
6. Delicious timing of the Dec 25^th announcement of the China-Japan Currency Pact…most of us were busy tucking into Christmas pudd at the time. This will help yuan-yen trade without having to go via dollars but the bigger story is the continuing – and healthy – internationalisation of the yuaan with a transition through trade financing, international investment and ultimately reserve holding…
7. India: the region’s 3^rd largest economy will continue to motor along at almost the same growth rate as last year although the tightening monetary policy will have a lagged effect into 2012. Currency weakening will push up import costs but any balance of payment problems will be avoided. Despite the volte-face on opening the retail sector to the likes of Walmart, the Jan 1^st announcement of allowing foreign nationals to invest directly in listed companies marks a general strategy of financial liberalisation Indian style – and a means to increase capital inflows that in turn should help to cover the financing for any current account wobblies. Is this a reaction to the currency outflow and weakening rupee? Sure, but these are important steps in broader financial and capital account liberalisation.

to be continued...Russia deserves at least a paragraph...

Forecasts for 2012 in the Eurozone and EU

1. Recession in the EU through German-inspired austerity but no break-up of the Euro.
2. Worth a repetition: no break-up of the Euro. The problem of course is that in today’s 24-7 news-media, once it’s been mentioned as a possibility – initially made for Greece – then it has become necessary for folk to comment about it and for geeks to run scenarios…giving the possibility some potential credibility. It won’t happen…so long as Germany along with other net-payers in the north continue to de facto support the south through a mix of aid flows (EU Structural Flows) and related lending from the EIB for infrastructure AND indirectly from the sequenced adjustments in the Net Present Value (NPV) of outstanding debt stocks….
3. …and yes, I expect the Portuguese and the Irish to ask for more dosh…sorry I mean “solidarity”.
4. Easing overall monetary conditions in the Eurozone through a combination of de facto QE by the ECB (direct policy action) and a depreciating exchange rate (indirect factor) as a result of the weakening Euro-economy
5. Silver Lining: Structural adjustment in peripheral economies in the Eurozone economies, consequent improvement in supply side economics and productivity – particularly into 2013-14. The key will be if these technocratic governments can survive into 2013….which I expect due to argument 2.
6. Weak domestic demand as consumers faced with rising risk of unemployment and uncertainty, further rein in household expenditure. Ditto with corporates who will sit on cash rather than ramp up Capital Expenditure.
7. The increasing role of Expectations and a new form of pro-cyclicity in fiscal adjustment viz bond spreads:  Sovereigns in the Eurozone will continue to fear the dark-side-of-the force from the Bond markets …as well as Madam Merkel – this risks a “self-fulfilling prophecy” whereby governments retrench faster in response to rises in risk-premia on the bond markets i.e. faster than justified.
8. Relatedly, expect a continuation of the theme since mid-2010 of a Jekyll-and-Hyde market gyrations: (a) widening spread on sovereigns seen to by fiscally imprudent (b) narrowing of spreads as target Sovereign/s bows to the market pressure and promises an emergency supplementary budget ie cuts (c) an “oh gosh” 2^nd reaction by the markets as realisation dawns that these very cuts will actually further compress growth and be worse off than the outset...and widening of spreads again
9. Political risk: expect more dominos to fall after the detrothing of leaders in Iberia, Greece, Italy and Ireland….. what price Monsieur Sorkozy to be the next to face the guillotine of voters’ wrath?...for the interested Ladbrokes has an in-play market (http://sports.ladbrokes.com/en-gb/politics/french-politics/2012-french-presidential-election-e215023201) which shows that he is in 2^nd place at 11-8. Not the place here, but worth considering what would happen to the mooted Franco-German axis and the proposed changes to the EU Treaty if Monsieur Hollande was elected.
10. …further de-ratings of EU Sovereigns  although a generic across-the-board drop in grades for may not have the disastrous effect on putative investments – to where else will the supply of funds revert?
11. Changes to the EU Treaty will take place as the de facto D-Mark Zone coalesces around the vision and funding from Germany.  A multi-speed Europe will become formal as the Fiscal Compact becomes binding on the first 9 signatories from the Eurozone as a form of Maginot Line for the defence of the Euro.

The Rest of the EU

1. A mild depression in the UK due to a continuing loose Monetary Policy and a fiscal stance that will ease slightly into 2012 (plus the uplift from the Olympics and Diamond Jubilee for the Queen i.e. 60^th year on the throne)
2. Scandanavia and Baltics: the high tech service economy will continue to help ride out, but not totally, the slowdown in the EU – with much depending on the impact in Asia and the US. The Baltics have already undergone “internal devaluation” and will lecture the others on how its done…but still want sizeable EU transfers/aid from Brussels.
3. Poland is an interesting one…with a sizeable internal market it will again avoid full-blown recession; both the Polish government and the OECD project 2.5% which may actually be a tad on the low side Rest of the New EU:  those with strong economic ties to Germany (Czech, Sloavika..) will trend-along with a whisper of growth…and perhaps increasing disenchantment from electorates.