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Europe has been the epicenter of a financial crisis for the past few months, but we see the fiscal crisis as a serious bump on the road to recovery, not as presaging its end.
In Europe, fiscal austerity packages have been announced in addition to the initial fiscal tightening. Markets worry fiscal tightening can choke off the economy. But one shall notice, the overall change in the fiscal stance for Eurozone is modest, a mere 0.2% of GDP this year. We think this is manageable, especially given that the recent Euro depreciation has provided us with a comfortable offsetting buffer. According to the estimation of Organization for Economic Cooperation and Development (OECD), 10% Euro depreciation yields an increase of 0.7% in Europe's GDP for the first year. Currency depreciation will continue to be an important escape valve for Western Europe to overcome the dampening impact of substantial fiscal tightening. In our view, Western Europe should not follow the periphery in a prolonged period of economic difficulties is underrated in the market's perception at the moment.
Source: Bloomberg, BOCHK
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The threat of contagion from the sovereign credit crisis does pose a clear downside risk to US economy. Yet, emboldened movements of European policymakers are expected to ring-fence the effects of the crisis. The recent batch of economic indicators shows the recovery in US is gaining traction, in spite of Europe's debt woes. Barring the tail risk of an intense freezing up of global liquidity, the further impact of deterioration in Europe's economy on the US will be muted.
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In China, exports to the European Union account for a non-negligible 20% of total exports. However, the concerns may be overblown as the four countries experiencing the most fiscal stress in Southern Europe accounted for only around 3% of total export. Moreover, the effect of cyclical upswing in external economies will likely dominate the growth-dampening effect of ongoing sovereign debt crisis. Given raised concerns on the deteriorating economy in Europe, Chinese policy makers may also consider postponing the liquidity exit pace. We reiterated the macro picture in China remains benign; growth stays at a robust level while inflationary pressures in the pipeline have been moderating.
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Hong Kong's stock market retreated on strong carry trade unwinding. The interbank aggregate balance trimmed to around HK$145 billion, signalling reversal of capital flow. Still, stock of ample liquidity could offer a sizeable buffer for outflows, before interest rates would come under significant upward pressure. In addition, Asia generally has little common features with fiscally troubled EUR countries, stronger fundamentals in Asia are expected to attract liquidity inflow on the back of "flight to quality". In sum, we do not see the fluctuations in capital flows represent a significant threat to Hong Kong's financial market in medium-to-long term, albeit the near-term trading environment will be dominated by macro concerns.
Source: Economic Research Division, BOCHK
Information provided on 19 July 2010
Risk disclosure:
The above information is for reference only and is not intended to provide investment advice and should not be relied upon as such. The above information is prepared on the basis of materials obtained from sources believed to be reliable but Bank of China (Hong Kong) Limited ("BOCHK") accepts no liability in relation to the use of the above information for any purposes. BOCHK does not make any representation or warranty and accepts no responsibility or liability as to the accuracy, completeness or correctness of the above information. The above information does not constitute an offer or solicitation to enter into any investment arrangement. Investment involves risk. Although investment may bring about profit opportunities, each type of investment product or service comes with its own risks. Due to the fluctuating nature of the markets, the prices of products may rise or fall beyond customers' expectations dramatically and may become valueless and customers' investment funds may increase or decrease in value as a result of selling or purchasing investment products. It is likely that losses will be incurred rather than profits made as a result of buying and selling investment products. Loss may equal or exceed the amount of the initial investment. Income yields may also fluctuate. Due to market conditions, some investments may not be readily realizable. Before making any investment decision, customers should assess their own financial position, investment objectives and experience, willingness and ability to bear risks and understand the nature and risk of the relevant product. For details of the nature of a particular product and the risk involved, please refer to the relevant offering documents. Customers should seek advice from an independent financial adviser.
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