Report Cites Eurozone Crisis as Greatest Risk to Global Recovery

Downside risks to the global recovery in 2012-13 have risen and growth in emerging market economies will slow more than previously expected, according to the latest macro-risk report from Moody’s Investors Service, which forecasts that growth in 2012 will be materially lower than in 2011 and 2010.

The Moody’s report, entitled ‘Update to the Global Macro-Risk Outlook 2012-2013: Euro Area Debt Crisis Continues to Pose the Greatest Risk’, updates the credit rating agency’s (CRA) April global macro risk scenarios report. It revises previous baseline forecasts for 2012-13 and discusses the downside risks to the forecasts, focusing on euro area recession risks and the risk of a hard landing in major emerging markets.

Moody’s says that risks to the global forecast remain to the downside and have risen relative to the risks perceived earlier in the year. The main risks to the global macro outlook stem from:

  • A deeper than currently expected recession in the euro area, for example caused by deeper credit
  • The risk of a hard landing in major emerging market economies, including China, India and Brazil.
  • An oil price supply-side shock resulting from resurfacing geopolitical risks.
  • The risk of sudden and sharp fiscal tightening in the US in 2013, given recent political gridlock.

“We are revising downwards our forecast for these large emerging market economies, where the weaker external environment and decelerating domestic demand are causing a slowdown in growth momentum,” says Elena Duggar, Moody’s group credit officer for sovereign risk. “We continue to expect that the slowdown in advanced economies and volatile capital flows will suppress growth in emerging markets.”

Moody’s says that only a modest recovery is likely in the G20 advanced economies. The CRA maintains its forecasts for relatively robust growth in the US, whilst the euro area as a whole will very likely experience a mild recession in 2012. For the G20 economies overall, Moody’s expects real growth of around 2.8% in 2012 and 3.4% in 2013, compared with 3.2% growth in 2011 and 4.6% in 2010.

“In our view, fiscal consolidation efforts, weak consumer and business confidence, banking and household sector deleveraging, persistently high unemployment levels, and real-estate market weakness will continue to constrain growth in advanced economies,” says Duggar.

In a separate report, Moody’s says that some economies in Central and Eastern Europe (CEE) and, to a lesser extent, in the Commonwealth of Independent States (CIS) could potentially be negatively affected by further economic stress emanating from the euro area. Its conclusions are based on an econometric assessment of the numerous linkages and transmission channels between CEE and CIS countries and the euro area.

The report, entitled ‘CEE and CIS Economies Could be Affected by Possible Euro Area Economic Shocks, Albeit to Varying Degrees,’ assesses the potential short- to medium-term effects of any further negative economic shocks from the euro area on some economies in the CEE and CIS. It uses the econometric technique of vector auto regression (VAR) to examine three possible channels of transmission: trade, foreign direct investment and bank flows. The report does not speculate on the likelihood of further economic shocks occurring or on how these might materialise.

As part of its analysis, Moody’s has grouped CEE and CIS economies into three categories to take account of the different levels of institutional integration with the euro area:

  • The EU member states in the CEE that are not members of the euro area.
  • EU accession countries in the CEE.
  • Economies in the CIS that are often referred to as the EU’s ‘Eastern neighbourhood’.

By applying the lesser-known (i.e. not value at risk) VAR technique, Moody’s arrived at the following estimates of the likely extent to which the three categories of CEE and CIS economies might be affected by any further economic stress emanating from the euro area:

  • The CEE region’s EU economies that are not members of the euro area have a high average sensitivity and would be significantly affected by further euro area developments.
  • EU accession countries in the CEE would, to varying degrees, also be affected by further euro area shocks.
  • While the economies in the EU’s Eastern neighbourhood are the least exposed compared with the other two groups, they would nevertheless be affected by euro area shocks, despite the absence of the comprehensive integration frameworks that are available to EU and accession countries.

The CRA adds that debt ratings currently assigned to sovereign governments covered by the report reflect its current economic forecast for the euro area, which calls for a slight contraction in 2012 and weak recovery next year. Although not Moody’s central scenario, this report suggests that a deep and prolonged contraction in the euro area following an intensification of the current crisis would likely have negative rating implications for some countries in the CEE region and possibly in the CIS.

Rating implications arising from such a situation would ultimately be a function of each country’s shock absorption capacity, fiscal position and debt profile, as well as the effectiveness of the country’s policy response to manage the economic and financial pressures that would arise from a severe economic disruption in the euro area.


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