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Risks multiply for world economy

by Michael Holstein, DZ Bank

Risks multiply for world economy

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The Japanese disaster and the Libyan escalation have greatly increased the risks facing the international economy. In Japan, a recession in 2011 has become probable. It is still too early to gauge the economic impact on the Asian region and key trading partners. In the short term, concerns over the global economy are being fanned by the Libya crisis and fears this will spill over into other countries. The focus is less the direct effect on international trade, more the latent dangers in a rising oil price.

An enduring rise in the oil price will damage both industrialised countries and emerging markets. In the industrialised countries it threatens the still fragile recovery. The loss of purchasing power by private households could considerably dampen consumer demand. Many emerging markets are already having to contend with high inflation rates. This could be exacerbated by further energy price rises, forcing central banks to opt for a more restrictive course.

In the euro area debt crisis, crucial decisions were taken at the end of March on the future of economic and monetary union. EU leaders agreed the European Stability Mechanism (ESM) that will replace the provisional European crisis fund in 2013 and is set to have a total volume of €700bn. Moreover, the Stability and Growth Pact established in 1997 is being tightened and European monitoring of national economic policies introduced under the terms of a so-called Euro-Plus pact.

All this is necessary because the debt crisis showed that alongside overly high budget deficits, other macroeconomic imbalances can become a danger. A current example is Portugal, whose government has largely forfeited any confidence on either the domestic front or in the international financial markets. Yet its key financial policy indicators had not, prior to the financial crisis, triggered a reaction by the EU stability watchdogs. In Portugal, the public sector budget deficit in 2007 was 2.8% of GDP and therefore within the tolerance zone of under 3%, while debt levels of 62.7% only mildly infringed the regulations.

Yet Portugal has now admitted that it cannot handle its problems without outside assistance, and has lodged a request for funding under the ‘temporary’ EMU rescue facility set up in May 2010. Given the resignation of the Portuguese prime minister, economic uncertainties are compounded by deep-seated political worries.

The Brussels agreement on a European crisis mechanism can be treated as positive news, even if some issues remain open. Independent of this, as regards the economic outlook, the consolidation programmes necessary in the individual countries in the current year and next year are a major factor dampening economic performance and are included in the forecasts. By contrast, an expansion of the Japanese and Libyan crises has not been factored into the figures.