Deleveraging of European banks still has a way to go
Never mind the US jobs data looking better than expected, or Spanish bond yields falling 18 bps to 6.98%, the global crisis is getting worse. US GDP numbers are lower for two quarters running and Spanish 10-year yields were 7.75% last week. The saving grace for India, however, has been the impact hasn’t been as bad as was feared. In the past, the IMF estimated the financial sector impact, especially in times of crisis, is several times the real sector impact—a 1% fall in US GDP, for instance, would lower India’s GDP by 0.05% through normal trade and finance channels for India, but this could rise to 0.8% because of the dramatically increased financial sector impact today. The consequence of the euro crisis, similarly, is best seen in terms of the possible deleveraging of European banks. From $159.1 bn in June 2011, direct claims of European bank on India fell to $146.1 bn in December 2011 as banks started liquidating Indian assets, but these claims then rose to $150.6 in March 2012—while the exposure on non-UK and non-Swiss banks in Europe fell from $ 61.4 bn in June 2011 to $54.3 bn in March 2012, this was more than made up by a rise in Swiss and UK bank exposure.
The problem, however, the just-released IMF 2012 Spillover Report forecasts, is the Euro Area could well see a 5 percentage point fall in GDP over the next two years if Europe’s politicians don’t act in time—contrast this with the IMF’s baseline WEO forecasting, just two weeks ago, that Europe would bounce back from a 0.3% contraction in 2012 to a 0.7% growth in 2013. And in the US, after the Article IV consultations a few weeks ago, the IMF said not tackling the fiscal cliff could take 2013 growth to even a possible 1%. Indeed, given that over 40% of US growth since Q1 2009 has come from exports, this puts another barrier to a faster US recovery, regardless of whether there is a QE3 or not. Also, the larger danger is that the US may have shifted down to a natural rate of growth that’s 0.25-0.5% below what it was in the pre-crisis period—that has large consequences for the future of global growth especially since China is also slowing at the same time.
In this context, the IMF’s Spillover Report asks if the Euro shock has played itself out. Partly yes, but mostly no, is the answer. And the reason why the full impact hasn’t been felt, it argues, is the feeling that Europe’s political bosses will still save the day. If that doesn’t happen, IMF says, and the deleveraging increases, European banks are likely to start selling assets held outside of Europe as well—right now, most of the deleveraging is taking place inside Europe. That India should be in the middle of a fight between the government and the central bank on cutting interest rates when the world’s future is looking so bleak is quite unfortunate.