Risk Of A Hard Landing

Global Recession Watch: A Dozen Significant Economies Are At Risk Of A Hard Landing

By Nouriel Roubini | 25 June 2008

Which countries around the world are at risk of a hard landing, i.e. a sharp growth slowdown and an outright recession? Following the U.S. the list is now growing. Countries now at risk of a hard landing now include: the U.S., the U.K., Spain, Ireland, Italy, Portugal, Japan, Canada, New Zealand, Latvia, Estonia and a few other central-south European countries.

Let us start the countdown and see the details of the recession risks in each one of these countries

The United States is already in a recession; while headline GDP figures still show positive growth in Q1 many other indicators show that the US economy entered a recession in Q1: monthly GDP (as measured by MacroAdvisers) is down since February through April (so far available data); employment has been falling for five months in a row; most components of aggregate demand (durable and non durable consumption, residential investment, capex spending by the corporate sector) are already in negative growth territory; industrial production and manufacturing production are falling. So both on the demand and supply side it is clear we are in a recession. The only open issue is whether this will be a short and shallow V-shaped recession lasting six months (as the consensus forecasts) or a longer and deeper U-shaped recession lasting 12 to 18 months (as being argued in this forum).

The worst housing bust since the Great Depression, the US consumer being shopped out, saving-less, debt-burdened and with plunging confidence, a worsening credit crunch and financial crisis that is spreading well outside of the subprime mortgage market, oil now above $140 a barrel, inflation rising leading to stagflationary risks and constraining the Fed’s behavior are all reasons why this will be a severe and protracted recession.

What about the rest of the world?

A hard landing recession is now highly likely in the UK, Spain and Ireland where housing bubbles even larger than the one in the U.S. are now going bust. In these three economies the credit bubble was not limited to housing; you also had— as in the U.S.— a surge in unsecured consumer debt (credit cards, etc.) that became excessive. Add to this bust the effect of overvalued currencies and real appreciation leading to large current account deficits and you get a dynamics very similar to that of the US [[except that, in the US, the dollar is probably about 15% undervalued.: normxxx]].

In the rest of the Eurozone Italy and Portugal also look close to a recession. There the deflation of smaller housing bubbles is one factor. More importantly the strong Euro is really hurting the competitiveness of all of the Club Med Eurozone members (Italy, Portugal, Spain and Greece). These countries— whose exports tend to be more labor intensive and lower value added— were already losing export market shares to China and Asia even before the euro strengthened so much. But a euro close to 1.60 relative to the US dollar and the sharp appreciation of the euro relative to Asian currencies is really a massive problem for the Club Med.

Add to these woes of these countries— and more generally of the Eurozone economies— the following additional bearish factor: oil close to $140 (that even converted into a stronger euro is much more expensive in euro terms than a year ago). The effects of the liquidity and credit crunch affects European corporations' ability to borrow even more than their US counterparts as they rely more on bank financing rather than capital markets; the fact that real domestic demand— especially consumption has been anemic in the Eurozone as real income/wages have been anemic; the fact that a lot of the growth of the Eurozone— especially Germany— was driven by net exports that will now slow because of the US recession and global slowdown; and finally the fact that the ECB— worrying about inflation— is on hold and likely to hike rates [[and they did, by 0.25%: normxxx]] while at least the Fed has confronted downside risks to growth via a 325bps easing in the Fed Funds rate. So no wonder that— after a good Q1— growth is sharply slowing down in Europe and the Eurozone, including Germany (as a euro close to $1.60 hurts even an export super-power such as Germany) where the forward looking Ifo survey now suggests seriously weakening business confidence. And the latest figures for industrial production in the Eurozone show an outright contraction.

So, in summary in the European/Eurozone area UK, Spain, Ireland, Italy and Portugal are headed to a hard landing recession while growth is slowing down dramatically in the rest of the Eurozone.

Another major economy at risk of a recession is Japan. In the last couple of years Japan was growing at an anemic but ok rate for two main reasons: a weak yen and the strong growth of exports to the U.S. driven by strong U.S. growth. But now the yen is much stronger than in the past and the U.S. recession is already taking a toll both on Japanese exports to the U.S. and the U.S. sales of Japanese subsidiaries (such as the auto transplants of Japanese car-makers in the U.S.).

In addition to the double whammy noted above, there are two additional negative shocks to the Japanese economy: first, with oil well above $140 a barrel a country like Japan that imports every single drop of oil is hit by a nasty stagflationary shock; second, a variety of measures of the Japanese corporate sector signal weakening of performance, profitability and confidence. Put these four negative shocks together and Japan— after a good Q1— is slowing down sharply and headed towards a likely recession.

Canada may also be headed towards a recession. Its GDP actually fell by 0.3% y/y in Q1 because of falling inventory and residential investment. 75% of Canada’s exports go to the U.S; thus a U.S. recession has significant effects on Canada, even if rising commodity prices have benefited the commodity exporting provinces of the country. In addition to the U.S. contraction there are other negative factors slowing down Canada: high credit costs and a strong Canadian dollar crowding out non-commodity exports; are offsetting strong commodity exports and buoyant domestic demand. Also with inflation rising, the Bank of Canada is now constrained in its willingness to cut policy rates further.

New Zealand is now most likely already in the middle of a mild recession. Consumption is declining as urban households are hit by a bursting housing bubble, high debt servicing burdens, high interest rates, and high fuel and food prices. The service sector (accounting for 67% of GDP) has slowed down sharply and experienced a sharp drop in employment. Even rural households are in trouble in spite of high commodity prices: a severe drought has reduced farm production.

Thus, falling exports, plus the increasing profits paid to the foreign owners of New Zealand's oil fields are widening the current account deficit, already one of the largest among advanced economies. The central bank has hiked interest rates because of its inflation concerns. And the consensus forecasts Q1:08 GDP growth is at -0.3% q/q followed by another contraction in Q2.

Finally, even some emerging market economies are at risk of financial stress and hard landing, especially the Baltic states and some central-south European economies. All the three Baltic countries are experiencing a sharp growth slowdown, with some analysts calling for outright recessions. Both Latvia’s and Estonia’s GDP contracted in Q1 (-1.9% and -0.5%, respectively), while Lithuanian growth was close to zero. Weak domestic demand is the main driver of the slowdown, propelled by tighter credit conditions and a real estate market bust after the bubble of the last few years. Adding to Baltic troubles is double-digit inflation, which is eroding consumers’ spending power and leading to concerns of stagflation.

In Central-South Europe Bulgaria, Romania and Hungary have twin fiscal and current account deficits, balance sheet vulnerabilities (currency and maturity mismatches), overvalued currencies (especially Bulgaria and Romania). While their growth is still positive, they are most at risk that a sudden stop of capital inflows and worsening global credit conditions may lead to financial pressures (reduced availability and rising cost of foreign capital to finance their external imbalances and thus pressures on their currencies and other asset markets).

Given that the housing boom in some of these countries was financed mostly in foreign currency mortgages there is a risk that a sharp downward movement in their currencies would lead to a severe balance sheet effect that would create financial stress for the household sector. Thus, conditional on a serious U.S. recession and a global economic slowdown these countries are vulnerable to financial stresses and risk a hard landing.

For more details on the countries at risk of a hard landing see also the RGE Monitor coverage of Global Recession Monitor: Which Countries Are on the Brink of Recession?

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Normxxx    
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