China decelerating, EU banking union, and financial disintegration in Europe
China: decelerating trend in Q2 GDP
China’s Q2 real GDP growth slowed to 7.6% yoy (1.8% qoq, sa) after 8.1% yoy in Q1 – the slowest rate since Q1 09 – putting H1 12 growth at 7.8%.
Q2 growth was in line with market expectations. Details show that while the slowdown occurred across all sectors, deceleration in the real estate segment was more pronounced. This suggests that the government’s resolve not to unwind curbs on property markets had an impact. Deceleration in growth so far has been orderly, with macro-stability intact. However, micro-level data has been worrying i.e. poor corporate revenues and a rise in account receivables. This will no doubt lead to mounting pressure for more accommodating policies.
The most likely scenario is marginal easing of property market curbs, further easing in monetary policy to support liquidity and targeted stimulus measures to bring forward some infrastructure projects, with a view to preserving jobs and supporting consumption. This should help to contain systemic risk arising from bankruptcies and defaults. The rebound in H2 is not yet assured, as suggested by leading indicators such as PMI. But we expect public investment, as shown by the recent pick-up in fixed asset investment, to limit the downside.
EU banking union: The dangerous rush to make quick fixes
Different messages are emerging as to how quickly the proposed banking union can be established, with Germany rightly emphasising that this is a complex and hence medium-term project. There are, however, suggestions that the urge to be seen to be doing something will result in quick fixes being sought. They would include (i) selling slightly modified versions of the long-winded legislative proposals on reform of deposit guarantee schemes and resolution regimes as new, breakthrough initiatives and (ii) using Art. 127(6) TFEU to transfer limited supervisory powers to the ECB, e.g. by mandating it to monitor capital cushions of the largest institutions.
It appears that the EU will, in the end, indeed succumb to the temptation of quick fixes rather than devising well-thought-out designs. This is deplorable: banking union is needed, but only if there is a consistent institutional framework that preserves the single financial market, financial stability and the euro. The EU has wasted decades trying to get financial supervision right; there is no need to rush now. Specifically, member states should think twice before plumping for the option of endowing the ECB with even more powers, simply because the Treaty offers that option and every other avenue is more complicated. Not only would the ECB run the risk of potentially competing mandates and reputational damage, but as central bank, supervisor, and de facto macro prudential supervisor, the ECB would be dealer, policeman and judge all in one. This is undesirable, particularly with an eye on the challenge of establishing sufficient democratic accountability for an independent central bank exercising supervisory powers.
Financial disintegration in Europe
The combined effect of the sovereign debt and financial crises is that cross-border linkages in the EU are now significantly weaker than a few years ago, reversing a lot of the progress made pre-crisis. 1) European banks’ claims on other western European countries have slumped by 28% since peaking in early 2008. 2) Bonds issued by foreign non-banks in other EU countries declined from 45% of euro-area banks’ total bond portfolio in 2007 to just 27% at the end of 2011. Holdings of foreign sovereign bonds fell from 22% to 11%. 3) Funding from foreign banks fell from 12.7% of EU-15 banks’ total assets in 2007 to 7.5% in 2011. 4) Domestic securities now account for two-thirds of the collateral used in ECB refinancing operations, compared with 49% in 2007. 5) Within Germany, foreign banks’ market share in lending to the manufacturing industry has declined steadily from 16.3% at end-2008 to 11.7% now.
Financial disintegration in the EU is the result of market forces as much as regulatory and political influences and, ironically, is unfolding as policymakers discuss the creation of a European banking union. Whether the latter will be able to halt or even reverse the former will be crucial for the survival of the single market in financial services.
* * *
Published with kind permission of Deutsche Bank Research.