A Global Overview

Concerns of sovereign debt defaults ease

Concerns about the fallout from the sovereign debt problems involving several countries in Europe, have eased recently. Greece, which has the worst fiscal health in the region, has moved ahead with its plans to curb government spending and rein in future deficits. It is now believed that even if a country defaults, it will not pull in other countries and damage the economic recovery. The improved sentiment was further helped by the sustained gains in most global economic indicators. The commitment of major central banks to keep interest rates low, despite improved economic conditions, continues to support market optimism.

With the exception of Europe, these trends helped global equity prices hold steady last month. Most other leading economic indicators in major economies made further advances. Factory output across the world expanded again in February, though at a slower rate in select economies. In Europe, helped by the weaker euro, which has made exports more competitive, increased manufacturing activity exceeded expectations. However, surveys for countries which are facing fiscal difficulties, like Greece and Spain, continue to show declining factory output. Global trade volumes improved during the last quarter of 2009, with the most gains coming in December.

Fiscal and monetary stimulus exits remain the key

The global economic recovery is still not sufficiently broad and hence remains fragile. Private consumption and investments in the developed economies have not revived sufficiently. Growth is still disproportionately dependent on government spending, which cannot be continued indefinitely. That makes the timing of the fiscal and monetary stimulus measures in the large economies the key to the global economic outlook. An early exit, before private spending is robust enough, will stunt the recovery, while a delayed withdrawal will leave undesirable inflationary pressures and asset price bubbles.

Increased cash holdings may encourage investments

Corporate earnings have recovered across most sectors, helped mostly by the cost savings forced by the downturn, but also by the modest recovery in demand. Cash surpluses held by large firms are at their highest level in recent years. Without taking on additional debt, these firms will be able to invest readily in expansion, when demand improves further and outstrips existing capacity. Firms may also be more ready to close deals with financing less of a constraint, as indicated by some of the recent transactions.

Just as demand is recovering in major developed markets, the outlook for the automobile industry is clouded by the spate of product recalls, which has spread to most leading manufacturers. The immediate financial costs and the long-term impact of lower brand reliability vary for different manufacturers, with some also facing difficulties because of currency fluctuations. At the same time, firms unaffected by the recalls will find the environment favorable to boost their market shares.

Though some of the enthusiasm among policy makers for comprehensive financial reform has cooled in recent weeks, it remains one of the policy priorities for several governments. In the U.S., a proposal has been sent to the Congress for consideration, which will disallow deposit-taking institutions from trading and investment activities using their own capital. Broader proposals including the creation of a Consumer Financial Protection Agency are still being debated.

Demand for materials and industrial goods are still dependent on government stimulus measures, especially in emerging markets. While several of these economies are soon expected to match the growth rates seen before the global crisis, they have also started winding down their stimulus programs. This may lead to slower demand growth for materials and industrial products.

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