Sunday, October 2, 2011

Be prepared for Europe crisis fallout.


THERE were no surprises when US Treasury Secretary Timothy Geithner appeared unexpectedly during the recent Eurozone Finance Minister's meeting in Poland.

The surprise, however, came when Geithner warned the European Finance Ministers that they should stop the internal bickering with their central banks and quickly trim their budget deficits even if they have to "engage in drastic steps".

Although Geithner's attendance is unprecedented, his remarks are not unpremeditated. At the risk of annoying its economic allies, the US warning came amid deep concern on the financial calamity that is besieging the Eurozone countries.

To aggravate the situation, the US economy itself is facing one of its biggest challenges since the depression of 1930s with an unemployment rate of 9.1 per cent and a spiralling deficit of US$3 trillion (RM9.57 trillion). No economy can survive such liability - not even the US - and the last thing they need is a teetering European economy.

Undeniably, there is a perfect storm brewing across Europe and the possibility that the once formidable European economy might be on the fringe of financial collapse is raising concern across the globe.

Indeed, the entire region is now wreaked with low consumer spending, unemployment, falling incomes and continuous fiscal crisis. The once feared prophecy of an economic doomsday spreading across Europe is now becoming a reality and this has prompted the head of the World Bank to declare the financial market as entering into a "new danger zone".

Indeed, the imminent European financial meltdown was prophesised years ago. Since 2009, the European economy has shrunk by almost 4 per cent annually - an unprecedented contraction since its establishment.

The entire financial system became extremely vulnerable since the first Greece bailout in May 2010 and this is now exacerbated by fears that Spain and Italy could join other infamous troubled Eurozone nations. Such fears have prompted market sentiment across Europe to remain weak and will remain so unless drastic policies are imposed.

Although GDP for 2010 may have increased in some countries across the Eurozone, there appear to be marked differences in economic performances, with Germany taking the lead by a 5 per cent expansion, but Greece seemed to collapse under its austerity measures.

Following its second bailout package in July, virtually everyone expects Greece to go into default.

Spain's economy is barely growing while Ireland appears to contract sharply. There is more bad news for Spain. Youth unemployment is especially high and this is exacerbated by a collapse in the construction industry that left many unemployed.

The root cause of public discontent is unemployment. Weak economic growth combined with high levels of public debt makes it difficult for governments to create jobs. This is the reason why Greece could not promote its austere economic agenda because of its high debt to GDP ratio of 127 per cent and a budget deficit of 15.4 per cent.

Consequently, the ordinary Greeks are suffering. Over the last 12 months unemployment has shot up by 40 per cent and the economy has contracted by more than 5 per cent and is expected to shrink further by 3 per cent over the next six months.

Recently, there was a consensus by the European Central Bank to tighten its monetary policy while simultaneously raising its benchmark but raising the benchmark is not a solution in fixing the structural problems facing the Eurozone without debt restructuring.

Tightening monetary policy on the other hand would make matters worse. It will only force a stale income, soaring prices and market distortion within the already dampened economies.

The US prescription to tackle budget deficits through public spending cuts and tax increases have offered little reassurance to investors, who are well aware that austerity measures will usually take their toll on growth.

While there is still uncertainty surrounding the possibility of default and subsequent collapse, it is essential for developing economies like Malaysia to take heed of the situation and prepare for the worst.

Eurozone countries have always been Malaysia's loyal trading partners, being the country's third largest partner after the US and China. Bilateral trades stood at RM136.5 billion in 2010 with exports contributing to RM68.7 billion, or 10.7 per cent of Malaysia's total exports. There were trade surpluses of RM40.7 billion in Malaysia's favour.

Since the Asian financial crisis, there has been a steady flow of investment from the EU to Malaysia with RM3.8 billion invested last year. In the event of a total financial meltdown, a reduction in exports of 30 per cent to 40 per cent from the Eurozone will result in a contraction of 2.5 per cent of Malaysia's GDP, in addition to a loss of RM1.8 billion worth of investments.

It is therefore vital for Malaysia to develop strategies to curtail whatever economic damage that will likely occur in the event of a full-blown financial meltdown. These strategies should include strengthening the country's macroeconomic policies, both monetary and fiscal, as well as its structural policies.

The role of Bank Negara Malaysia now is more critical than ever and one of its biggest challenges is to continue to provide support to the economy and the financial sector while remaining vigilant to any external distortions that are harmful to the economy.

Structural policies include market reforms and boosting productivity to ease the country's fiscal burden.

In summary, the resulting effect of Eurozone nations failing to provide rescue package of loans to other fragile member countries are real and the consequence of a default will be disastrous to everyone.

There is an urgent need for Malaysia to develop drastic measures to cushion a looming global financial catastrophe before the world economy turns into a tailspin.

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