Euro Area May Suffer as Emerging Markets Tank

We discussed that EU financial institutions may be at risk if capital flight from emerging economies continues. Europe will also suffer along with developing markets for another reason: they also have strong trade links.

From Bloomberg:

The European economy’s close ties to emerging markets are turning from a blessing to a curse.

Already skirting recession, the 15 euro nations face greater pain as economies which gave them an edge over the U.S. and Japan falter. Trade partners to the east, that buy about a third of the region’s exports, are faltering as their banks weaken and currencies slide. Meanwhile, the halving of oil prices is slowing demand from the Middle East.

European companies such as France’s Schneider Electric SA and Finland’s Kone Oyj are saying orders will weaken as emerging- market countries from China to Argentina succumb to the credit crunch. Citigroup Inc.’s economists now expect deeper interest- rate cuts and recession in the euro region.

“It’s a huge threat to the euro area,” said Nick Kounis, chief European economist at Fortis in Amsterdam. “It had been hoped these markets would hold up better and drive European growth.”…

Ukraine, Hungary and Pakistan are seeking aid from the International Monetary Fund and Argentina’s markets are in turmoil after its government tried to take over private pension funds. Russia has pledged more than $200 billion to stem its worst banking crisis since 1998 and China is slowing after expanding more than 10 percent for five years.

Europe’s vulnerability to a downturn in emerging markets is reflected by how it benefited from their upswing. Exports to them were equivalent to about 6 percent of the continent’s gross domestic product in 2006, compared with about 4.5 percent in 2000 and less than 4 percent in the U.S., says Juergen Michels, an economist at Citigroup Inc. in London.

The dozen, mostly Eastern European, nations which joined the broader European Union since 2004 account for 15.3 percent of the euro-area’s foreign demand, up a third since the start of the decade, according to the ECB. The contributions of China and Russia have almost doubled. By contrast, the U.S. and U.K. portions have each dropped about 4 percentage points to 11.9 percent and 14.5 percent respectively.

“With a higher share of exports to emerging markets, the European countries benefited much more than the U.S. from booming emerging-market economies in recent years,” said Michels. Now they’re “more exposed” to their downturn.

The euro-area economy will contract for the first time since 1993 next year, forcing the ECB to cut its benchmark rate to at least 2 percent from 3.75 percent, he predicts.

Schneider, the world’s biggest maker of circuit breakers, now expects emerging markets to slow after four years. Even China “isn’t immune to external forces,” Chief Executive Officer Jean- Pascal Tricoire said on Oct. 22. Kone, a manufacturer of elevators, said the previous day that investment is slowing from Mexico to India to Qatar and that Russia is a “question mark.”

Gareth Williams, an equity strategist at ING Bank NV in London, says more companies will downgrade earnings forecasts. Firms in Austria, Portugal and Spain have the most revenues from emerging markets, while Ireland, Greece and Italy have the least, he said in a report to clients yesterday.

Eastern Europe is “rapidly becoming a key risk” to the euro area, said Stephane Deo, chief European economist at UBS AG in London. He estimates Germany and the Netherlands are most at risk of losing out with 3.5 percent of their GDP accounted for by shipments to the former communist bloc.

Buoyant demand from Russia and the Middle East is ebbing as falling oil prices curb their purchasing power. Crude rose 625 percent from 2001 to a record $147.27 per barrel in July, enabling oil producers to buy equipment such as MAN AG’s trucks and “Made in Europe” luxury goods including handbags from Gucci Group NV.

The demand was strong enough for Europe to recoup two-thirds of its higher oil bill in the past five years, calculates Klaus Baader, chief European economist at Merrill Lynch & Co. While the drop in energy costs will “be good in the short-term for domestic demand, over the medium term, reductions in demand for exports are going to weigh on the European economy,” he said.

Already retrenching as they try to cover $221.8 billion in losses and writedowns, European banks also stand to be hurt more than most if emerging markets goes sour, said Stephen Jen, chief currency strategist at Morgan Stanley in London.

European banks lent $3.5 trillion to these economies, compared with $500 billion from the U.S. and $200 billion from Japan, according to his estimates. Those in Austria and Spain were particularly exposed, he said. Three quarters of loans to China and India originate in Europe.

“Pressures on emerging-market economies could have a particularly negative boomerang effect on European banks,” Jen said.

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  1. doc holiday


    This is somewhat entertaining:

    Goldman, Hungary and Regulators

    … So the US authorities should have known – and presumably did know – that by allowing Morgan Stanley and Goldman to become banks they were in effect forcing a serious contraction in the hedge-fund industry, which in turn would lead to sales of all manner of assets held by hedge funds and precipitate turmoil throughout the financial economy.

  2. baychev

    in a world where some produce to subsidize the consumption of others to suggest that the hit will be unequally distributed is just delusional.
    the bigger question is who is going to emerge stronger: the debtor or the creditor? and i am not talking here in banking sense, but who holds the production capacity and resources to turn the wheels first again.

    look at the chart. who is the odd man out?

  3. Anonymous

    Sorry if this is off topic but it might be of consequence…

    ‘The Treasury TIPS auction today was a disaster. The market is sending Treasury and Congress a very strong warning that you both better cut this crap out or the Treasury market may dislocate, ending the party for America entirely.

    If you want to know where that nasty selloff came from in the market late this afternoon, you just found the reason.’

  4. Allan Baraza

    ditto that, @ baychev. This rhetoric of the Euro area will be hit more than North America, emerging markets will suffer more than developed markets, etc, etc completely misses the point. We’re living in a severly interconnected and global world..we have UBS operating in NY, we have Barclays in Kenya, we have Goldman in London, we have Morgan Stanley in Asia…there is way TOO much interconnection today for some delusional person to start making assessments about who gets hit more. Let’s think more objectively, please.

  5. Anonymous

    I do not understand the logic with which analists continue to predict that economic downturn will force the ECB to cut rates. When I watch cnbc, I only need to wait for like 10 minutes before someone starts to talk about rate cuts, same with newspapers; journalists seem obsessed with rate cuts. Rate cuts are the modern medicine for the economy, but I never hear these journalists talk about more structural changes to strengthen the economy. The mandate of the ECB is price stability and I am not convinced rate cuts are needed or will lead to economic growth. The US has shown it results in speculation with cheap money, not real economic growth. And it punishes savers while for example the US needs people saving money. I think the real reason all these financial analysts want rate cuts is because they want at all costs stock markets to rise, as this is their daily bread and butter.

  6. Anonymous

    Sure, it’s going to hit very hard here in Germany – business leaders are just beginning to realize. Yesterday there was a little note in Handelsblatt (business daily) about Heidelberg Cement (midcap firm) buying up its own debt. Isn’t that what firms do in a depression?

    Unfortunately, your average Joe (or Michel here) doesn’t know what’s coming. The main trade union (IG Metall) is still threatening to strike for a nationwide 8% claim, while the car plants are already shuttering. The trade union leaders seem to imagine the finance crisis is just a trick to fool them. Ach weh!

    But there is another thing which makes me sick. Too many British and American commentators are evidently hoping its going to hit everybody else EVEN WORSE! How bloody stupid can you GET!!! We are all in this boat together, and, as Dubbya said, this sucker might go down – with all of us.

    OK what do we need? Two things:

    1) A global agreement that NO currency will be allowed to fall victim to a speculative attack, whether it’s the Pakistani Rupee or the Chinese Renminbi. Yes, the Renminbi too – the Chinese know their enormous reserves could be gone in the twinkle of an eye if what we suspect about the Chinese economy is true. And they will only expand domestic demand if they are secure on the currency side.

    2) A global investment plan for eliminating poverty (in China too) and conversion to CO2-free energy production. Finance it by issuing bonds that are so AAAA that everyone will buy them. Precondition – stable currency conditions (see (1) above).

  7. dlr

    A quick and easy way to take care of the currency problems is to restrict or freeze cross-border money flows that were used to purchase stocks or bonds. Watch for it. Either ‘indefinitely’ (for the ‘duration of the crisis’), or for a specified time (say a couple of years).

    I’m not even sure it wouldn’t be a good idea. One of the reasons that China has done so well, this time around AND last time around, is because of the limited convertibility of the yuan. Most of the foreign investment in China has been via ‘direct investment’ – a company comes in and builds a plant. Other countries might want to take a long hard look at doing something similar to limit hot money INFLOWS. Which of course would certainly decrease the destablizing effects of hot money OUTFLOWS next time around.

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