European and global financial risks grow but experts say threat to business overhyped

In early October stock markets around the world tumbled over fears of a triple dip recession and the spectre of deflation in Europe. Volatility was also fuelled by a slowdown of the Chinese economy and Japan's battle against deflation. Ebola, Russian trade sanctions and political unrest in the Middle East also added to financial market jitters. According to the OECD, the world economy remains stuck in a low gear. Global GDP growth is projected to reach 3.3% in 2014, 3.7% in 2015 and 3.9% in 2016. This pace is slightly lower than the last OECD forecast in September. It is modest compared with the pre financial crisis period and below the long-term average. While recovery remains robust in the US, growth in the eurozone is a major concern for the OECD and financial markets. The OECD expects growth in Europe to pick up slowly from 0.8% in 2014 to 1.1% in 2015 and 1.7% in 2016. In Japan, the OECD expects growth to be 0.9% in 2014, 1.1% in 2015 and 0.8% in 2016.hideAccording to the OECD there is a growing risk of stagnation in the eurozone and financial risks remain high. It highlights some significant downside risks, most notably weak demand in the eurozone that points to a rising threat of a prolonged period of stagnation and low inflation. It also warned that the expected tightening of US monetary policy could lead to further financial market volatility for emerging market economies. Sentiment in financial markets has certainly changed since the start of the year, according to Roman Lechner, Senior Economist at Swiss Re. At the start of 2014, the US and UK economies were growing and Europe had recently emerged from a double dip recession. However, European economists may have been too optimistic, he said. While peripheral states like Ireland, Spain, Greece and Portugal have made some progress, the Italian economy remains a concern, explained Mr Lechner. Optimism about the German economy has also fallen, while the French economy appears to be stagnating, he said. However, the economic recovery may only have been temporarily postponed, said Mr Lechner. "We don't see a re-emergence of the eurozone debt crisis, although this is something that is in the background. However, there is now more deflation risk in Europe than before, which is a symptom of the lack of demand in several European countries," he said. The consequences of deflation in Europe would be severe, according to Mr Lechner. If debt increases compared to asset values and economic activity, company and household insolvency would increase, he said. "We are now in a stagnation phase but I am still optimistic for a eurozone recovery and would not expect to see prolonged deflation, although the recovery may take longer than expected. The base-line risk is that the recovery has been postponed and with less speed," he said. Economic recovery from the financial crisis has been long and protracted, characterised by below trend growth and low inflation, according to Guy Miller, Chief Market Strategist and Head of Macro Economics at Zurich Group in Switzerland. "We have always believed that the recovery would be unconventional due to the large amount of outstanding debt. Many countries have in fact seen debt levels rise and not fall since the financial crisis," he said. Despite the risks, Mr Miller is also optimistic that the eurozone can avoid a further recession and deflation. "There are a number of positive indicators that the risk of recession in the eurozone is not as high as many believe," said Mr Miller. "In recent weeks there has been renewed talk of a eurozone breakup, but this is fundamentally misplaced," according to Mr Miller. "There will be hard data released in the coming weeks that should indicate that the risk of recession in the eurozone is less than many believe," he said. Mr Miller noted the positive outcome of the European Central Bank's (ECB) comprehensive assessment of 130 banks in October. He also believes that the ECB's plan to buy asset-backed securities should reduce pressure on bank balance sheets and help stimulate consumer demand. "The stress tests were a significant event that appears to have been under-appreciated," said Mr Miller. "It has removed a cloud that was hanging over Europe's banks, which had been reluctant to lend ahead of the assessment," he said. Recent lending figures have shown increasing demand for credit in the eurozone as companies in countries like Spain begin to expand, according to Mr Miller. There has also been an increased willingness to lend and banks have begun to ease their lending criteria, he said. "There is good reason to have an optimistic outlook. Policy makers in Europe and Japan are determined to make sure that growth comes through and concerns around deflation should then dissipate. But it is an uncomfortable optimism, based on policymakers doing the right thing," said Mr Miller. He believes the primary risk for European businesses in the next 3-5 years is policy error. "So much of the outlook depends on policy decisions, and there is always the risk that someone will slip up," he said. Policymakers will have to balance the risk of creating asset price inflation through too much stimulus with the risk of falling back into a recession if they end stimulus too early, explained Mr Miller. "We think that the asymmetry of risks mean that policymakers will side on providing liquidity. Given the risk of getting it wrong, the likelihood is that policy makers will err on the side of caution," he said. In addition to concerns over Europe's economy, fears have also been growing for emerging markets. The OECD expects economic growth in China to slow from 7.4% in 2014 to 7% for 2015-16. Growth in Brazil has slumped to 0.3% in 2014, although it is expected to recover to 1.5% in 2015 and 2% in 2016. Russia has been hit by lower oil prices and weakening trade and its economy is not expected to grow at all in 2015. Mr Lechner advises companies to be more careful when it comes to emerging market growth. "Expansion in emerging markets may have been a no-brainer when they were growing. It's not to say they are not growing, but in general they will be riskier and will require companies to take a closer look at individual markets," he said. Concerns for emerging markets stem largely from China, where growth is slowing and people fear a hard landing for the Chinese economy. However, China has changed its approach since the financial crisis and is looking for controlled growth through targeted stimulus. China has been deliberately slowing its economy as it transforms into a consumer demand-led economy, explained Mr Miller. While some emerging markets, like Brazil, are in the doldrums, others have been improving, noted Mr Miller. For example, the rebound in the US economy and domestic reforms have begun to help Mexico, while the new government of Narendra Modi in India is a mandate for change in that country, he said. "Emerging markets are a diverse group, but many are linked to demand in China and the US. If these two economies are doing well, then this implies emerging markets will be okay," he said.

European and global financial risks grow but experts say threat to business overhyped

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