World Risk Developments July 2010: Spotlight on eurozone and renminbi

This month’s issue of EFIC’s newsletter, World Risk Developments, looks at two issues of international importance – sovereign debt concerns in the eurozone and China's new exchange rate arrangement.

Markets have been repricing eurozone sovereign risk for over a year now, and not just at the periphery.  There have been periodic spikes in the spreads of Austrian and Belgian bonds over German bunds and a large wedge – 150 basis points – has opened up between the Italian bond spread and the bund. This is quite different from mid-2008 when the market was essentially saying that all eurozone sovereign risk was more or less equal.

Are the recent movements cause for alarm?  According to EFIC senior economist Ben Ford, ‘None of the core eurozone members is likely to default, but markets are putting them under pressure to tighten their fiscal policies while their private sectors are still stagnant, which increases the risk of so-called double-dip recessions ’.

The People's Bank of China announced on 19 June that it was moving to enhance exchange rate flexibility.  This was greeted with widespread applause as it is commonly acknowledged that a stronger renminbi, which greater exchange rate flexibility would allow, would help the world economy in a couple of important ways: by putting the current global economic recovery on a firmer footing; and by promoting more balanced long-term growth.  But two things quickly happened to quell the excitement.  First, the People's Bank in the following days hardly allowed the exchange rate to appreciate.  Second, attention turned to the fine print in the Bank’s statement.  This noted that no grounds existed for a large currency adjustment and that therefore the exchange rate would remain 'basically stable'.  The applause quickly turned to scepticism. 

On 14 July, the forward currency market was pricing in only a 1.7% appreciation of the renminbi against the greenback over the next year.  EFIC chief economist Roger Donnelly believes that ‘such a modest appreciation if it comes to pass will do little to alleviate trade tensions with Washington or help the process of ‘global rebalancing’’.

In other stories, the newsletter looks at

• Emerging and advanced economies – how they measure up against one another for FDI receptiveness
• Thailand – how manufacturing is cushioning the tourism downturn
• Philippines – how the financial markets are looking upon the new president with equanimity
• Venezuela – how President Chavez is shifting up a gear in his drive to nationalise the economy, ‘preparing funeral candles for capitalism’ as he puts it
• Kazakhstan, Guinea, Mozambique, DR Congo – how political risk is tracking in four markets at the frontier of the current international resource boom.