Is global recession imminent?

In the midst of market uncertainty coupled with sluggish economic growth, few had expected robust beginning to this New Year. But few had actually anticipated or openly admitted that attempts to bring global economy back on track could be numbered. That Eurozone has approached ‘a perilous new phase,’ acknowledged by none other than the International Monetary Fund (IMF) on Tuesday has certainly given it credibility. But hasn’t the threat of global recession been on the cards for some time now?

The bleak prediction by International Monetary Fund is based on two prevailing situations – high financing cost borne by euro zone nations and European banks facing severe credit crunch. Experts are of the opinion that each of the two conditions could have triggering effect on the other and may lead to further economic contractions.

Factors outside Eurozone could also have a large impact on global economy. Important among them are hike in global oil price due to sanctions on Iran, investor fear in the prevailing market scenario or possibility of spill-over effect of European debt crisis on other big economies like the United States as well as emerging economies like Japan.

On its quarterly updates, IMF has scaled down its previous global growth estimates of the year 2012 from 4 percent to 3.25 percent. In her latest speech, Managing Director of IMF, Christine Lagarde, has called on all the nations of the world to help bolster the bail-out fund and combat the threat of global recession. Currently, the fund is seeking $500 billion in addition to its present reserve.

EFSF rescue fund loses its highest rating

In a major move, global credit rating agency Standard and Poor has stripped the EFSF (European Financial Stability Facility) bail-out fund off its AAA status to a grade lower to AA+ status. Not that it is surprising considering that last week S&P has already lowered the ratings of nine eurozone nations, including that of France and Austria (two main EFSF’s guarantors). S&P has cited insufficient policy initiatives by European leaders as the cause of ratings downgrade.

The existing lending capacity of European bail-out fund is up to €440 billion, depending on contributions from its guarantor nations which are eurozone countries with triple-A ratings. After ratings downgrade of nine nations, only four nations remain with highest creditworthiness. These are Germany, Finland, Netherlands and Luxembourg.

Klaus Regling, the chief executive of EFSF fund has downplayed S&P’s latest move. Despite this, the reduced rating of EU rescue fund is seen as a big blow to those nations which are already reeling under European debt crisis. With six months still to go for ESM (European Stability Mechanism) fund to be effective, there is tremendous pressure on the existing top credit-worthy eurozone nations to step up cash flow to the EFSF rescue fund and also find a convincing solution to European debt crisis.

European debt crisis threat as Italian Bonds touches new high

The fear of European debt crisis became more pronouned on Wednesday as Italian government bond spiked to a new high of 7 percent plus. Italian market tumbled in the afternoon as bonds breached the important threshold of 7 percent, triggered by the fear that EU has no rescue plan for Italy. This had a spiraling effect on other world markets, including Asian markets on early Thursday.

Italy, a core Euro zone member and the 8th largest world economy, is the world’s third largest bond market. Its debt amounts to a huge 2.6 trillion Euros – considered too much to be absorbed by EU.

German chancellor, Angela Merkel, warned that unless concrete and quick structural reforms take place to cut cost, it could result in collapse of the Euro currency. Angela Merkel has also demanded changes in the EU treaties.

The European Central Bank has bought, until recently, large chunks of Italian bonds to cut back its borrowing cost. But it is unlikely that the bank will be willing to buy any more after the new high.

As the resignation of Italian Prime Minister, Silvio Berlusconi, is still a month away, investors confidence has gone southward. Experts feel that Wednesday’s market reaction is not because of its poor fundamentals but because of fear of instability triggered by lack of decisive action on the part of Italian Premier.

A new accord to address Eurozone debt crisis

After some hard bargaining, European leaders have finally succeeded in striking an agreement that could tackle the much-awaited Euro crisis or Eurozone financial crisis. Under the agreement reached on Thursday early morning, European banks would absorb 50 percent losses on Greek debt and would also step up the rescue package from 440 billion Euros to 1.4 trillion Euros. This is expected to address three important issues on hand – Greece debt crisis, unstable banking sector and, finally, global economy.

The agreement calls for Greek private bondholders to voluntarily write off the bond value by 50 percent, which roughly amounts to 100 billion Euros. This is believed to bring down their spiralling debt burden from 150 percent to 120 percent of its economic output (GDP) by 2020.

As a first step, banks are required to raise new ‘safe’ capital – at least 150 billion Euros by June end. This is needed to shield themselves from the losses incurred on loans to capital-starve countries including Greece. That, in turn, should increase their risk-free asset holdings to 9 percent of the total capital.

Though definitely a positive step, it remains to be seen how this enormous amount would be funded. Question is, can they arrange for such a massive bail-out fund? Only time will tell.