EcoTV by BNP Paribas – n°27 – november 2009
Sibylle Dehesdin:
Hi and welcome everyone to this new edition of EcoTV, the monthly program of BNP Paribas economists.
On today's edition, Government budget deficits are expanding in the greatest number of countries. Philippe d'Arvisenet analyses this phenomenon.
Why is Russia so much more affected than Brazil by the world crisis ? Valerie Perracino and Anna Dorbec will give us some clue on this issue.
And lastly, an overview of the situation in the euro zone and the United States with Eric Vergnaud…
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Sibylle Dehesdin: But first, let's welcome as usual, Philippe d'Arvisenet, global chief economist.
Hello Philippe,.
Philippe d'Arvisenet: Hello
Sibylle Dehesdin: Everywhere the recession resulted in a deterioration in public finances but opinions seem to diverge regarding how fast a consolidation is necessary. So what do you think about this ?
Philippe d'Arvisenet: Well I don't think it is necessary just now because when you look at the recovery which seems to have happen over the last one or two quarters depending on countries, it was largely due to the support coming from the government to change cars for instance. They explain 100% of the growth that was exhibited by the national account in France in the second quarter, half of what happened in the US in the third quarter. So it's a bit soon to withdraw that, and my guess is it's there to stay for a few more quarters.
It's not that painful today because the increasing debt did not resulted in an increase in the burden of that debt because interest rates remain low, but then will come a time when governments will have to announce something serious in terms of fiscal consolidation.
Sibylle Dehesdin: So what kind of measures would you advise?
Philippe d'Arvisenet: Well, an announcement, first, in order to avoid the build-up in inflation expectations which would increase interest rates and then make the thing even more difficult. Second, to avoid the expectations of a large increase in taxation otherwise people would save more and it would slow down the economy. I think most of the burden should fell on the expenditure side. We have seen in the past experiences nearly twenty years ago now, in countries like Sweden or Canada. They did it, one shot measures on expenditures, and the result was quite impressive. But, these countries have been helped by devaluations and by a fall in saving ratios. It's more difficult today because every country is in the same basket and you cannot be helped by a devaluation against the others. And in a country like the US, you cannot be helped by a decrease in the household savings ratios. So fiscal consolidation is difficult, but it is unavoidable.
Sibylle Dehesdin: Thank you Philippe.
And you editorials are on line on BNP Paribas website.
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Sibylle Dehesdin: We are now on line with Valerie Perracino and Anna Dorbec.
Anna, Valerie, hello…
Sibylle Dehesdin: Russia has suffered much more than Brazil from the global crisis since September 2008 and has been slower to recover. Russian real GDP fell by nearly 10% year on year at Q2 2009, while Brazil real GDP contracted by only 1,3% for the same period... How can we explain such differences? (graphe PIB)
Anna: First, we have to remember that Russia's specialization is much more biased toward commodities than Brazil's. With oil and gas representing about 70 % of its exports, Russia has suffered an adverse terms of trade shock much more pronounced than Brazil.
Valérie: Yes, and the reaction of the labour market also proved much more favourable in Brazil than in Russia. In Brazil, generous wage increase at the beginning of the year kept real labour income on a rising trend, with a positive effect on consumption. In Russia, workers were de facto forced to accept unpaid administrative leaves, delays in wage payments or wage cuts.
Sibylle Dehesdin: And what about balance sheets' vulnerabilities? We know that high indebtedness rates, exposure to exchange rate risks or high external financing needs often are key factor in emerging markets' crisis. Was Russia in a more difficult situation than Brazil from this point of view?
Anna: At an aggregate level, not really, especially if you consider that Russia was posting a huge current account surplus and held about USD 600 billion in forex reserves at mid 2008. However, two factors made external accounts adjustment much more contractionary in Russia than in Brazil: first, the violence of the terms of trade shock we already talked about, and second, confidence issues that resulted in record capital outflows.
Sibylle Dehesdin: And at a less aggregated level, if we look more closely at private and public balance sheets?
Valérie: You're right. Russia enjoyed undoubtedly higher fiscal room of manoeuvre than Brazil, which had to maintain a substantial primary surplus to avoid explosive public debt dynamics. But if we consider private sector's balance sheets, the advantage was for Brazil. Brazilian banks and corporates were notably less dependent from external financing flows and less exposed to exchange rate fluctuations than their Russian peers.
Anna: And there is all what is not captured in balance sheets numbers, namely the behaviours and habits created by the memory of past crisis. In Russia local economic agents still keep a part of their savings in foreign currencies and tend to overreact to any rumour of devaluation, thus amplifying the evolutions in the forex market.
Sibylle Dehesdin: Such behaviours of “flight to the dollar” do not exist in Brazil ?
Valérie: No, not really. In fact, currency substitution has always been limited in Brazil due to legal restrictions but also to the existence of domestic currency instruments that preserve the real value of private sector assets in face of adverse shocks through appropriate indexation mechanisms.
Sibylle Dehesdin: And how have these differences in private and public sector's balance sheets influenced policy reaction?
Anna: Dollarization has undoubtedly limited the efficiency of Russian monetary policy. Currency mismatches in private sector balance sheets and, above all, the sensitivity of private sector expectations to exchange rate fluctuations prevent Russian monetary authorities reluctant from letting the rouble depreciate, forcing them to raise their policy rates at the worst of the crisis and to accommodate passively the demand for dollars. As a result, measures to ease domestic liquidity tensions proved rather inefficient in Russia: the roubles injected in the domestic economy were quasi immediately converted into dollars on the spot market, as reflected by the sharp contraction of monetary aggregates.
Sibylle Dehesdin: And what about fiscal policy? Russia had higher fiscal room of manoeuvre than Brazil.
Valérie: You're right. Brazil's fiscal room of manoeuvre was lower but it was used in the fullest. The government even resorted massively to off budget expenditures to mask the deterioration of public accounts and avoid a worsening of market expectations.
Anna: …while in Russia, the situation was exactly the opposite: Russia had high fiscal room of manoeuvre but didn't use it. Spending execution was delayed till mid 2009, because of administrative inefficiencies and probably also because of past default experience that made Russian authorities reluctant to spent their savings at times of uncertain oil prices outlook.
Sibylle Dehesdin: If you had to conclude in two words, what could Russia learn from Brazil's experience ?
Valérie: Diversify, to be less dependent from oil prices fluctuations
Anna: and De-dollarize to improve monetary policy efficiency and pave the way for inflation targeting
Sibylle Dehesdin: Thank you
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Sibylle Dehesdin: And now let's welcome Eric Vergnaud…
Hello Eric,
Eric Vergnaud: Hello Sibylle.
Sibylle Dehesdin: The United States and the euro zone seem to be emerging from recession. What is the situation?
Eric Vergnaud: The US and the eurozone economies emerged from recession in the third quarter However, while all of the economic indicators are signalling that growth will continue. It is highly likely that this will be at a slower rate. The rebound in output due to the end of the destocking process will not last. Budgetary support measures will disappear gradually, as a result of higher oil prices inflation will return to positive territory in the very near future. And lastly worsening job market is continuing to dent consumer confidence, So, a recovery, but a gradual recovery.
Sibylle Dehesdin: In such conditions, what will be the monetary policy like?
Eric Vergnaud: Both the Fed and the ECB are likely to maintain very accommodative policies in the coming quarters in order to underpin the recovery. Moreover, inflation will remain moderate in the coming quarters. Thus there is no hurry for exit strategy
Sibylle Dehesdin: And what are the prospects on the bond markets?
Eric Vergnaud: A gradual recovery, moderate inflation , ample liquidity and short term rates at low levels. All of this let us foresee a strong performance by the bond market over the next few months.
Sibylle Dehesdin: Thank you Eric.
Eric Vergnaud: Thank you Sibylle.
Sibylle Dehesdin: Thank you all for your attention. We'll see you next month for a new edition of EcoTV, the monthly program of BNP Paribas' economists.
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