The last two days have created history. Two of the half a dozen and more “bulge bracket” houses have ceased to exist, US economy is witnessing events that had been considered unconceivable[1] and well the pain is only beginning. The financial world or shall we say the world will never be the same again.
This calamity started as the now infamous sub prime crisis, was fuelled by the increasing oil prices and the increasing inflation sent the world into a credit crunch. While oil is now trading at around USD 92 a barrel, inflation and the credit crunch have shown no signs of abating. Global economy is in a state of shock and there is a wide spread belief that it is only a matter of time that the fire will cross the Atlantic to hit Europe.
How bad will be the impact in Europe? To answer that question one needs a closer look at the macro economic factors, the exposure of individual economies to the housing market and the strength of the local financial system.
Table 1: Macroeconomic and Financial Soundness Data[2]
With the highest forecasted GDP growth rate, the healthiest current account and a relatively low CPI, Germany seems to be the most resilient economy in Europe. The positive net lending[3] and the low mortgage debt to GDP ratio bring comfort that (i) in case of an economic turmoil the economy has some cushion to weather the storm and (ii) the country will not suffer excessively due to a downturn in the housing market.
The situation, however, is completely different for the UK. Not only does the country have an alarmingly high mortgage debt to GDP ratio, it also has a current account deficit and a negative net lending ratio. Further more the UK economy is heavily dependent on the financial services sector and any further impact on the industry will skew the unemployment rate away from the current forecast. Any further increase in unemployment along with the high inflation will cause significant economic turmoil in the country. According to an IMF research, almost 50% of the loans[4] made by UK banks are external loans. This means, that an impact on the UK financial sector will also have presumably far reaching consequences outside the country.
While similar to the UK in terms of high a mortgage to GDP ratio and high current account deficit, Spain probably will not have as much of an impact on the world (given that only c.10% of its loans are external). Moreover, the Spanish banking industry is quite fragmented and supported by solid deposit bases. This in itself could contain some of the impact. However, given the strong emphasis on the construction boom in the recent years, Spain is definitely vulnerable in the current global economic situation.
It is interesting to note that while the 5-year senior USD CDS levels indicate that Germany is indeed believed to be a safer bet currently, the market has not priced in sufficient risk for the UK. On the flip side, the equity markets have penalized Germany relatively more than the UK, despite a Northern Rock and a Bradford & Bingley in the UK.
Table 2: Credit and Equity Market Data[5]
In conclusion, I believe that the doom and gloom might not be as bad as being portrayed. After the US though, it is now UK’s turn to see a changing landscape of the finance industry. With the weaker dominance of these two majors maybe finally the scales have shifted in favour of those who are located eastwards. But does eastwards mean the Continent or does it mean the Far East is yet to be seen.
This calamity started as the now infamous sub prime crisis, was fuelled by the increasing oil prices and the increasing inflation sent the world into a credit crunch. While oil is now trading at around USD 92 a barrel, inflation and the credit crunch have shown no signs of abating. Global economy is in a state of shock and there is a wide spread belief that it is only a matter of time that the fire will cross the Atlantic to hit Europe.
How bad will be the impact in Europe? To answer that question one needs a closer look at the macro economic factors, the exposure of individual economies to the housing market and the strength of the local financial system.
Table 1: Macroeconomic and Financial Soundness Data[2]With the highest forecasted GDP growth rate, the healthiest current account and a relatively low CPI, Germany seems to be the most resilient economy in Europe. The positive net lending[3] and the low mortgage debt to GDP ratio bring comfort that (i) in case of an economic turmoil the economy has some cushion to weather the storm and (ii) the country will not suffer excessively due to a downturn in the housing market.
The situation, however, is completely different for the UK. Not only does the country have an alarmingly high mortgage debt to GDP ratio, it also has a current account deficit and a negative net lending ratio. Further more the UK economy is heavily dependent on the financial services sector and any further impact on the industry will skew the unemployment rate away from the current forecast. Any further increase in unemployment along with the high inflation will cause significant economic turmoil in the country. According to an IMF research, almost 50% of the loans[4] made by UK banks are external loans. This means, that an impact on the UK financial sector will also have presumably far reaching consequences outside the country.
While similar to the UK in terms of high a mortgage to GDP ratio and high current account deficit, Spain probably will not have as much of an impact on the world (given that only c.10% of its loans are external). Moreover, the Spanish banking industry is quite fragmented and supported by solid deposit bases. This in itself could contain some of the impact. However, given the strong emphasis on the construction boom in the recent years, Spain is definitely vulnerable in the current global economic situation.
It is interesting to note that while the 5-year senior USD CDS levels indicate that Germany is indeed believed to be a safer bet currently, the market has not priced in sufficient risk for the UK. On the flip side, the equity markets have penalized Germany relatively more than the UK, despite a Northern Rock and a Bradford & Bingley in the UK.
Table 2: Credit and Equity Market Data[5]In conclusion, I believe that the doom and gloom might not be as bad as being portrayed. After the US though, it is now UK’s turn to see a changing landscape of the finance industry. With the weaker dominance of these two majors maybe finally the scales have shifted in favour of those who are located eastwards. But does eastwards mean the Continent or does it mean the Far East is yet to be seen.
No comments:
Post a Comment