SUOMEN PANKKI
Puhe
1.12.2011

Deputy Governor Pentti Hakkarainen: Economic Outlook – Flee from Risks

Deputy Governor Pentti Hakkarainen
Speech at Fibox 20 Gala Dinner in Helsinki on 1st December 2011
 
The main content of the speech.

Ladies and Gentlemen,
 
We celebrate FIBOX's 20 years anniversary during difficult economic time.
 
Economy is stumbling and struggling to its feet, and we bankers have been blamed for complicated financial innovations, subprime crisis, too risky business and so on. Now we have problems of excessive debts. We have not found a big bazooka which would be effective to shoot all troubles away.
 

The World Economy

 
The world economy and its outlook have deteriorated this year. This is the case in all major economies (slide 2).
 
Weak developments in the spring were partly related to one-off factors. The natural disaster in Japan in March had not only domestic implications but also caused breakages in world-wide production chains. The car and electronics industries, having a lot of subcontracting, were suffering from supply shortages. In addition, turmoil in North Africa raised the price of oil. Higher energy prices slowed growth in consumers’ real incomes and spending in advanced economies.
 
It has become evident that the growth slowdown was not only due to temporary events but there are more broad-based factors affecting the world economy. World trade did not recover as expected and firms’ output expectations continued to fade. Downward revisions to data on recent economic performance of major economies bring more uncertainty about growth prospects. The difficult debt ceiling negotiations in the United States and the euro area debt crisis further undermined confidence. In particular, trust in political decision-making suffered a serious blow in the markets.
 
Gloomy forecasts have also begun to erode household and business confidence. Other indicators of expectations have been declining as well in many countries. Purchase managers’ indices foresee very sluggish industrial output. And as you know, purchase managers' indices (PMIs) have been very good in predicting what kind of economic development takes place afterwords i.e. the correlation with the actual GDP growth has been almost 1:1.
  
We have seen increased uncertainty also in the financial markets. This has hit stock markets world-wide. Price of risk has raised in both government and corporate bond markets. At the same time, demand has shifted towards ‘safe haven’ investments. Investors are buying German and US government debt securities and gold, which have lifted their prices to record high levels.
 
The uncertainty will eventually result in weak economic activity. Based on experience from economic history, faltering confidence may lead to a decline in household consumption and corporate investment. It is likely that this time having a serious financial crisis as a part of current economic slump, a correction will take time. 
 
(Slide 3) Research shows that rebounding from recessions, which are accompanied by financial crisis, is slow. It takes a long time to solve problems of high unemployment, reduce leveraging and downsize overheated sectors.
 

Sovereign debt crisis

 
We see excessive debt levels in various parts of the world, however mostly in advanced economies. Before the financial crisis the countries' debt-to-GDP -ration was close to 60 %, but now the level exceeds 100 %. We have incurred debt amounts of war time without a war. And Europe is the epicenter of the sovereign debt crisis. This hampers the functioning of euro area financial markets.
 
In the European financial sector, there are signs of a weakening of mutual confidence among financial institutions. In interbank markets the risk spreads have widened and the prices of credit default swaps have risen. The write-downs relating to sovereign debt holdings and equity exposures weaken banks' balance sheets. This worsens banks' lending capacity. From companies' point of view this will raise financing costs and may even hinder their access to financing. 
 
The longer uncertainty in financial markets prevails, the stronger its implications are for the real economy. In addition to financing channels, adverse effects the crisis spread through trade channels, to the entire world economy.
 
We can compare the current situation with what we had in 2008. We have now less means at our disposal to stimulate our economies. The economic outlook is weak and contains more downside risks. 
 
However, there are some positive things. The current situation has not come as a total surprise like in 2008. Another positive thing is also that the corporate-sector balance sheets are still quite sound in both Europe and the United States. In addition, many companies have increased their cash reserves to be able to meet unforeseen needs. Also banks have been able to prepare themselves for the situation and strengthen their balance sheets and liquidity positions. Moreover, with lessons learned from financial market problems in 2008, central banks have the readiness to provide liquidity to financial institutions.
 

Political decisions

 
Restoring confidence in politicians’ ability to make decisions is a key to stabilising the situation.
One of the difficulties is the fact that the debt problems are broadly based in several European countries. Greece, Portugal and Ireland have already fallen into a government debt trap. Although, the root cause of the problems were different the outcome is an excessive debt-to-GDP ratio in all cases. An obvious threat is that other countries will follow.
 
Market confidence in the debt-servicing ability of Italy and Spain has already weakened. Italy is suffering from its very high public debt level creating questions of the sustainability of its economic standing. One country that has been in the headlines recently is France. However, discussions on the country’s economy have been very different in nature as those on Italy and Spain: whether the credit rating of French government bonds remains in the top AAA category or whether it will be downgraded.
 
The debt problem is the Achilles’ heel of some European countries. There is no way to solve the problem quickly and easily. Resolution requires long-term policy changes, not only in regard to public-sector debt but also private-sector indebtedness.
 
Measures taken by a troubled country no longer necessarily suffice to remedy the situation; a broad-based common commitment is required. An important step in this direction would be a swift implementation of the crisis-management decisions already agreed upon.
 

Conclusions

(slide 4)
 
Ladies and Gentlemen
 
Let me now summarise what I have told you tonight by highlighting some key characteristic of the current economic situation.
 
  • Global economy is growing – but at a slower pace
  • Growth disappointments in advanced economies in 2011
  • Deteriorating public finances in the euro area and elsewhere
  • Uncertainty on political decision making in the US and Europe
  • Growing anxiety over sovereign states and financial institutions in the euro area and elsewhere
  • Run away from risky assets.
Salutations
 
Let me come back to the years when FIBOX was established, in the other words year 1991. That time the future outlook for companies in international business was not at all bright. However FIBOX went through all difficulties, it grew and prospered. The company was able to do so during economically very uncertain period.
 
Today we do have uncertainties in front of us again I am convinced that FIBOX will carry on its activities withstanding all challenges and storms there may arise, as it has done during preceding two decades