By Dieter Wermuth, Chief Economist, Wermuth Asset Management.
Other than I had expected, the June 29 agreements about the euro area banking union had impressed markets for only a short while. I think, though, that we have been witness to an irreversible quantum leap towards a stable institutional set-up for the common currency. The dangerous link between bank solvency problems and government finances has been cut: banks will be supervised by the ECB or an agency close to it, and the coming area-wide bank resolution authority, most likely the ESM, the European Stability Mechanism, supported by the ECB, will take over from national governments the task to close, shrink and re-capitalize systemically important banks, or even any bank. The banking sector will no longer have the capability to ruin governments.
By itself, this is good news for the global economy, for commodities and for Russia. Although the structural banking sector problems will most likely be out of the way by year-end, euro area sovereign debt remains a Damocles sword. There is so far no progress with regard to the mutualization of debt or indeed a fiscal union. Progress in this direction is inevitable, though, as even German policy makers are beginning to admit, because both business and most normal people want to keep the euro. Opponents of the euro have been unable to develop an alternative model. But I have to admit that the road ahead will be rocky. After the heavy betting against the euro it will take a while before markets come round to the view that there will be a happy end.
Economic statistics continue to be bad, especially in the euro area where the ECB was forced last week to cut rates, by 25 bp to 0.75% for the main refinancing facility, and to zero for the deposit facility. The Spanish government is pursuing an increasingly ambitious austerity program, in spite of a deep recession and a 25% unemployment rate. This is self-defeating and not the way out of the crisis. The government’s 10-year borrowing costs have shot up to almost 7% again. Italy is travelling down the same road. Since even solid Germany expands at a sub-par rate, real GDP of the euro area as a whole is presently shrinking, at an annualized rate of about 1%. Other disappointments are the sluggish growth of the Chinese economy and the poor performance of the US labor market.
So for Russia the external environment keeps deteriorating. But at home things still look good. This is because the level of commodity and therefore export prices is still quite elevated. The balance of trade surplus is running at an annual rate of no less than US$220bn. Russia is a large-scale capital exporter. The WTO membership that will be achieved this month after 19 years of negotiations, is likely to stimulate foreign direct investment inflows, competition and structural changes. Corruption will become a less acceptable component of the cost of doing business. It will be harder to pass on that cost to consumers.
The rouble is well supported by these developments, but the main force determining its exchange rate is the slow-down of global growth and the likely fall of commodity prices. A first sign that Russia will do less well in coming months have been the June manufacturing PMIs which declined to 51.0 from May’s 53.2. Industrial output could be on the brink of stagnation. While stock market valuations are extremely low, investors are not yet convinced that the time is right for betting on Russia in a big way.
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