Market Outlook - BNP PARIBAS - Investment Services India

Political question of whether people in Germanyand France want to bail out their neighboursThat said, the budget deficit as a share of GDP forthe eurozone as a whole is not that great. It is lowerthan that of the US and Japan, so the scale ismanageable. Because of this, it could be argued thatthe eurozone’s financial/fiscal troubles boil down tothe political question of whether the citizens inGermany and France will agree to bail out theirsouthern neighbours. In other words, will integrationon the fiscal front proceed or not? A fundamentaldefect of the eurozone is that there has never been amechanism for ensuring that member states maintainfiscal discipline. There are no established rules forhow the entire eurozone should share the fiscal costof a shock that any member cannot handle on itsown, so the authorities first put off taking anyresolute action and then only started adoptingpolicies piecemeal once a crisis began to take shape.While it could be argued that there has been no needfor such a rule, as fiscal support between states wasprohibited in the Lisbon Treaty, such excuses nolonger hold when problems trigger financial turmoilthat engulfs the global economy.Will Japan end up like ailing eurozone states?While Japan was the frontrunner with respect to sucheconomic problems as NPL woes (balance-sheettroubles), banking crises, long-term economicstagnation, surging public debt and deflation, wehave been surpassed by the eurozone with respectto sovereign debt issues destabilising the financialsystem. But if Japan continues to put off fiscalreforms, it will eventually end up like the nations ofsouthern Europe today. Japan could, in fact, be inworse shape because it won’t have a Germany or aFrance to bail it out. (The IMF, of course, could stepin, but that would entail severe conditions like thoseimposed on emerging economies). The US, with itshuge budget deficit and soaring public debt, mayavoid succumbing to such a fate thanks to thegreenback being the global standard. But then again,it may not, as difficulty in financing budget deficitsand the external account could cause the dollarstandard to collapse. At the very least, if thegreenback is no longer the only global standard,easy adjustments via dollar depreciation shouldbecome difficult owing to the loss of seigniorage asthe sole key currency.Needed structural policies are put off out ofconcern over near-term painWhy have the US and Europe failed to heed Japan’slesson and put off needed structural reforms untilcrises emerge in the financial market? The reason isthat politicians, and the people that elect them, tendto be myopic with regard to policymaking, focusingonly on the immediate level of consumption. But, as2520151050Oct-09Nov-09Dec-09Jan-10Chart 5: EU Bond Spreads(%pp, 10-y spread to German bund)GreecePortugalSpainItalyFeb-10Mar-10Apr-10May-10Jun-10Jul-10Source: Bloomberg, BNP Paribas30025020015010050Aug-10Sep-10Oct-10Nov-10Dec-10Jan-11Feb-11Mar-11Apr-11May-11Jun-11Jul-11Chart 6: Japan’s Public Debt(central & local, % of GDP, FY)Aug-11Sep-11Oct-11080 82 84 86 88 90 92 94 96 98 00 02 04 06 08 10 12 14 16 18 20 22Source: MOF, Cabinet office, BNP ParibasForecastpointed out in earlier reports, the ultimate aim ofeconomic policy should be to raise the level of percapita real consumption sustainably, bolstering percapita trend growth being an interim objective. Thecrucial point is that the improvement in theconsumption level (trend growth) must continue intothe future and not be just a momentary short-term jolt.For the US and Europe to raise the level ofconsumption sustainably, they must first resolve theirstructural problems (balance-sheet troubles,sovereign debt issues), something that requirespainful burdens over the near term. But becausepeople are loathe to see any reduction in immediateconsumption, needed structural policies are put offuntil problems reach crisis stage.Macro stabilisation does not serve its primaryroleWhile the authorities put off needed structuralpolicies out of concern for near-term pain, theyaggressively resort to discretionary macrostabilisation. Macro stabilisation, however, cannotresolve structural problems like balance-sheettroubles and sovereign debt woes; it can only easeRyutaro Kono 20 October 2011Market Mover18www.GlobalMarkets.bnpparibas.com