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Broadgate: Weekly Briefing

16 December 2011

Europe – The downturn in the 17 economies that share the euro eased slightly in December, according to a closely watched survey.

The composite survey of thousands of firms by Markit (a highly regarded independent research company) showed a continued contraction, but at a slower rate than in November.

Manufacturing in Germany, the eurozone’s strongest economy, shrank for the third month in a row. However, the figures were not as bad as many economists had expected. “It’s an encouraging sign that the index didn’t fall any further. Quite what will happen henceforth remains highly uncertain,” said Markit’s chief economist, Chris Williamson.

The composite Markit Purchasing Managers’ Index (PMI) rose to 47.9 for December from 47 in November. A number below 50 indicates a contraction.

Europe – Funds across Europe experienced EUR30bn of outflows in October as investors continued to lose faith in the markets.

This is according to data from the European Fund and Asset Management Association (EFAMA), which also suggested that outflows are slowing. The EUR30bn figure is far lower than September’s, when EUR49bn poured out of funds.

Net outflows from equity funds more than halved to EUR8bn from EUR17bn the previous month and EUR27bn in August. Net outflows from bond funds went down from EUR12bn in September to EUR5bn in October and Balanced funds saw net outflows halve to EUR5bn from EUR10bn in September.

Money Market fund outflows fell from EUR12bn in September to EUR10bn in October, as banks continued to tempt investors into deposits.

France – French leaders are preparing for the loss of the nation’s top credit grade, with the central bank governor suggesting that debt-rating companies are “incomprehensible and irrational.”

Standard & Poor’s (S&P) said last week it may lower France by two levels in a euro-region downgrade, stemming from political leaders’ failure to arrest the financial crisis that began in Greece in 2009.

“A downgrade doesn’t strike me as justified based on economic fundamentals,” Bank of France Governor Christian Noyer said. “Or if it is, they should start by downgrading the U.K., which has a bigger deficit, has much more debt, more inflation, weaker growth and where bank lending is collapsing.”

A cut by S&P or Moody’s Investors Service, which said this week it will review European ratings, may complicate Europe’s efforts to stem the crisis by threatening the rating of the bailout fund.

China – China’s economic policymakers have pledged to guarantee growth in 2012, despite an “extremely grim” global outlook for the year ahead.

After their annual closed-door economic meeting in Beijing, the country’s leaders declared that monetary policy would remain “prudent”.

They said the currency, the yuan, would remain “basically stable”.

The meeting avoided big policy changes before China’s top two leaders retire next year, analysts said. “The trend in the global economy on the whole is grim and complicated.

Uncertainties are rising around a recovery in the world economy,” said the statement, published by the official Xinhua news agency.

But it added: “China will ensure that macroeconomic regulation policies and overall consumer prices will remain basically stable and will guarantee the steady growth of the economy and maintain social stability.”

Global – Emerging market equities was the worst performing asset class in 2011, according to research performed by HSBC.

In tracking the sterling total returns on major asset classes from the end of December 2010 to the end of November 2011, the report has revealed that equity classes made up the majority of negative performers.

Emerging market equities achieved a negative return of around 18percent over the course of the year. Private equity, Asia Pacific ex-Japan equities and Japanese equities also all delivered negative returns, of 17percent, 16percent and 14percent, respectively.

Europe equities lost approximately 10percent while Global equities offered a negative return of 6percent. The best of the worst were U.K. equities, which lost 4percent and U.S. equities which lost approximately 0.5percent.

Gold was the strongest performing major asset class as it achieved a return of 23percent over 2011. Comparatively, the second-best performer was index linked gilts which returned 17percent.

Commodities – Commodities posted their biggest drop in almost 11 weeks on Thursday, led by gold and crude oil, as concerns mounted that European leaders are failing to stem the region’s debt crisis, eroding demand for energy, metal and crops.

The S&P GSCI index of 24 raw materials declined 4.1percent, swinging to a loss in 2011. Gold closed at the lowest price in five months, with silver at the cheapest since February. Oil slid more than 5percent.

German Chancellor Angela Merkel said there is no easy solution to the European crisis after rejecting an increase in the upper limit of funding for the region’s permanent bailout mechanism. Additionally, the Federal Reserve refrained from taking new measures to spur growth on Thursday.

Spotlight on: Russia’s imminent membership of the World Trade Organisation (WTO)

Russia is on the brink of becoming a member of the WTO (confirmation is expected on Friday, 18 years since negotiations first started). There are still some worries about how state-run industries will fare in a new, open market, but most observers think the step is long overdue.

This represents a huge opportunity to fund managers and investors alike, enabling better access to (potentially, long term at least), bigger and truly globally competitive companies.

For Russia, accession to the WTO is not just a question of political prestige, it carries with it a host of economic advantages, according to Susan Stewart, researcher at the German Institute for International and Security Affairs (SWP).

“Membership is another step toward integration with the world economy, and away from marginalization,” Stewart told Deutsche Welle. “Since Russia is not modernising enough at the moment, marginalisation is a real threat.”

Accession to the WTO will also spur innovation in Russia. Stewart thinks that many companies and even whole industries like manufacturing could become more competitive. However, the extra pressure to compete in a more open market also worries some Russian critics. Many parts of the Russian economy are, they point out, still state-controlled. They predict that old companies dating from the Soviet era will have problems facing international competition.

Others, like Rolf Langhammer of the Kiel Institute for the World Economy (IfW), view accession as an opportunity for Russia, because the WTO will open the door to foreign investment, the key to Russia’s modernization.

“WTO membership is a signal that foreign investors can rely on the rule of law and the protection of intellectual property rights,” Langhammer said.

There are other benefits to joining the WTO as well, argues Langhammer. “It’s not as if Russia has to open itself up completely,” he said. “The WTO is not a free trade agreement. The WTO is, after all, just an instrument to promote non-discrimination, non-discrimination between members and between domestic and foreign manufacturers.”

The economist believes the WTO even protects Russia from one-sided pressures from other members. “It’s also about getting away from bilateral agreements and onto a larger level of legal stability, provided by multilateral agreements,” he said.

Stewart believes access to the WTO’s mediation mechanism will be a bonus for Russia and also expects fewer anti-dumping actions (‘dumping’ being the practice of manufacturers exporting a product to another country at a price either below the price charged in its home market. Dumping can force established domestic producers out of a market and lead to monopolistic positions by the exporting nation. For example, a glut of Chinese garlic exports in the mid 2000s forced many North American producers to switch crops and leave the market.)

“Another advantage is that Russia will also be at the negotiating table when other rules are being discussed,” she added. “If you’re a member, you get to take part in the discussion and be part of alliances to support certain positions. You can influence how the framework of rules develops.”

Stewart also believes that accession to the WTO will promote a closer partnership with the European Union (E.U.). “This is important for the E.U., because for years now it has been negotiating a new agreement to define its relationship with Russia. The E.U. has been negotiating on the assumption that Russia will be a WTO member,” she said.

Russia, which has been negotiating for WTO membership since 1993, needs the approval of all of its 153 members. Once that approval has been sealed this Friday, the dream could be fulfilled by the middle of 2012.

Kirill Dmitriev, Chief Executive Officer of the Russian Direct Investment Fund commented on the news, saying “We expect a rise in mutual cross-border investments given that WTO membership will remove trade barriers and barriers to investment. In many industries Europe is fully saturated, and companies on the continent need to seek out new sources of growth. The challenge is further complicated by huge sovereign debt burdens in many European states. Russia, by contrast, has massive growth potential and some of the strongest macroeconomic fundamentals of any country globally. It is natural then that we are seeing more European companies coming to Russia for growth they cannot get at home.”

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