Brian Fallow 's Opinion

The Economics Editor of the NZ Herald

Brian Fallow: Heading for a slowdown

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The risk that the economy gets sideswiped by another global recession tops the list of international concerns in the survey of business leaders.

After all, it has not fully recovered from the last one.

In per capita terms, economic output is still nearly 4 per cent below its December 2007 peak.

Consensus forecasts of growth among New Zealand's main trading partners have been falling for months, and with these things it is the trend, rather than the most recent reading, that carries the information.

The Treasury, in its pre-election economic and fiscal update (Prefu) is relatively sanguine about the international outlook. Its forecasts have trading partner growth stronger next year than it has been this year.

That assumes an orderly resolution to the euro area debt crisis - which is survey respondents' second gravest concern.

But even if Europe's leaders manage to avert a second global financial crisis on the scale of the one three years ago, it is already too late to avoid a serious slowdown. The European Commission is forecasting growth of just 0.5 per cent for the European Union next year, as near to recession as makes no difference.

The European Union's single market is the largest in the world and was overtaken only this year by China as New Zealand's second largest trading partner after Australia.

If Europe becomes the epicentre of another global financial crisis, the last one showed that, as well as the real economy channels of trade and commodity prices, New Zealand is vulnerable to offshore credit markets freezing.

The Prefu acknowledges that the risks to its forecast are "skewed to the downside".

"A failure on the part of governments to contain the crisis in the euro area could, in particular, cause a severe disruption to global funding markets."

The same risk dominated last week's financial stability report from the Reserve Bank, and is front-of-mind for the business leaders surveyed, who ranked instability in global capital markets No. 4 among their international concerns.

The Prefu sketches a downside scenario in which European leaders fail to manage their sovereign debt issues, leading to carnage in the markets.

Compared with 2008, there would be little scope for monetary and fiscal policy to limit the fallout and a protracted global recession would ensue, severe enough to slow China's growth to 6 per cent, against an average of more than 10 per cent over the past decade.

The implications for New Zealand's growth, employment, external accounts and public finances are grim, but mitigated by a weaker dollar and the need to rebuild Christchurch.

Survey respondents recognise that the fiscal crisis offshore is something of a tag team affair.

Right now Europe is in the ring, but only a few months ago political brinkmanship in Washington took the United States to the edge of defaulting on its debt.

The level of US government debt ranks as the third highest international concern in the survey. The International Monetary Fund puts US gross general government debt (including the states) at 100 per cent of GDP and its deficit this year at 9.5 per cent.

Among developed countries only Japan, Greece, Italy, Ireland and Portugal have more public debt, relative to the size of their economies.

The US Government is borrowing around 40c in every dollar it spends.

Next week the Congressional "super committee" made up of six Republicans and six Democrats is due to report back on how to cut US$1.2 trillion from the Budget over the next 10 years. Otherwise automatic across-the-board cuts are triggered.

"The Republicans are reluctant to raise taxes and the Democrats are protective of domestic social programmes," AMP chief economist Bevan Graham says.

"$1.2 trillion is a mere drop in the bucket in terms of what needs to be achieved over the next few years in budget consolidation, but failure now would not bode well for the bigger job ahead."

Survey respondents ranked the strength of the US recovery as their fifth biggest offshore concern.

The Federal Reserve has revised down its growth forecasts for next year, though at 2.5 to 3 per cent it is a lot better than Europe's near-term outlook.

But four years after the sub-prime crisis blew up, the US housing market remains weak with foreclosures continuing apace and one mortgage in four under water.

That, combined with 9 per cent unemployment, is not good for consumer confidence, and puts a question mark over the durability of a recent pick-up in consumption - crucial for an economy where private consumption represents 70 per cent of aggregate demand.

And overshadowing it all is the entirely unresolved question of what Washington is going to do about its chasm of a deficit - larger, relative to GDP, than ours was in the past year when we had to book the costs of the Christchurch earthquakes.

With a year to go before the next US general election, that concern is unlikely to dissipate anytime soon.

Exchange rate concerns also feature prominently among business leaders' concerns - volatility even more than levels.

Fear and relief, risk off and risk on, alternate in the markets on almost a daily basis.

In the past year the kiwi dollar has averaged a historically elevated 79c against the US dollar and has swung around in a peak-to-trough range of nearly 15c or 20 per cent.

- NZ Herald

Brian Fallow

The Economics Editor of the NZ Herald

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