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Broadgate: Weekly Briefing

25 November 2011

Europe – European Commission (E.C.) president Jose Manuel Barroso has unveiled plans for eurobonds, in the face of German opposition. The E.C. is launching a consultation to assess if the 17 eurozone countries can use the so-called ‘stability bonds’ to raise cash.

Mr Barroso said: “Stability bonds will not solve our immediate problems and cannot replace the reforms that are needed in countries currently under pressure.

“But it is also important to show to public opinion and to international investors that we are serious about stronger governance in the euro area, both in discipline and in convergence, and stability bonds are exactly an example of that.”

German Chancellor Angel Merkel has said that E.U. treaty changes rather than eurobonds will help solve the eurozone debt crisis.

Spain – Spain’s cost of borrowing rose sharply on Tuesday, when the government sold short-term debt on financial markets.

Spain raised EUR2.98 billion in an auction of three and six month bonds, but at higher yields.

On the three-month bills, the annualised interest rate Spain had to pay more than doubled to 5.11percent, from 2.29percent at the last auction in October. On the six-month bills they surged to 5.22percent from 3.30percent.

Demand in the financial markets for the debt was strong, out-stripping supply by more than three-to-one, and allowing Spain to meet its target of raising up to 3bn euros.

But the rise in yields suggests that investors do not feel more optimistic that the new government will be able to fix the economy and meet budget-cut targets.

U.S. – The U.S. congressional committee tasked with reducing the deficit by USD1.2tn has failed to come to an agreement (U.S. national debt has recently risen above USD15 trillion).

The outcome means automatic cuts outlined in the bill that created the committee should take effect from 2013.

The panel was set up in August, the result of a last-minute deal between the two sides in Congress to raise the debt ceiling and avert a default on U.S. debt payments.

“After months of hard work and intense deliberations, we have come to the conclusion today that it will not be possible to make any bipartisan agreement available to the public before the committee’s deadline,” Democratic Senator Patty Murray and Republican Representative Jeb Hensarling said in Monday’s joint statement.

U.S. – The U.S. Federal Reserve sought to bolster confidence in the U.S. banking system this week, as concerns over the European sovereign-debt crisis disturb financial markets and pose risks to the economic expansion.

The Fed has instructed the 31 largest U.S. banks to test their loan portfolios against a deep recession to ensure they have enough capital to withstand losses. Banks with large trading operations will also test against a European market shock. The most severe scenarios outlined by the Fed include an unemployment rate of as much as 13percent, an 8percent drop in GDP and a 52percent plunge in stocks from the third quarter of 2011 to the fourth quarter of 2012.

The tests, which the Fed said don’t represent its outlook for the economy, aim at making banks’ capital adequacy more transparent by demonstrating whether they can handle a deeper downturn and financial market shock. The Fed helped clear away uncertainty surrounding banks in May 2009, when it published stress tests showing that 10 U.S. firms needed to raise a total of USD75bn, giving investors more clarity.

India – Templeton Asset Management will add to its holdings of Indian equities, Mark Mobius said, as the nation’s benchmark stock index sank to a two-year low this week.

“Indian markets look more and more interesting as prices come down,” Mobius, who oversees USD40bn as executive chairman of Franklin Templeton Investments’ Emerging Markets Group, said. “As prices come down we would pick up more of what we have and may be pick up something we don’t have.”

“When you have a sudden downturn the recovery can come very fast,” Mobius said. “Make sure you are fully invested. The recovery can come fast and the upside can be remarkable.”

Japan – Standard & Poor’s (S&P) said Japanese Prime Minister Yoshihiko Noda’s administration hasn’t made progress in tackling the public debt burden, an indication it may be preparing to lower the nation’s sovereign grade.

“Japan’s finances are getting worse and worse every day, every second,” Takahira Ogawa, director of sovereign ratings at S&P in Singapore, said. Asked if that means he’s closer to cutting Japan, he said it “may be right in saying that we’re closer to a downgrade. But the deterioration has been gradual so far, and it’s not like we’re going to move today.”

A reduction in S&P’s AA- rating would be a setback for Noda, who took office in September and has pledged to both steady Japan’s finances and implement reconstruction from the nation’s record earthquake in March.

Brazil – Brazil’s economy expanded at the slowest pace in 10 quarters in the three months through to September, after policy makers curbed bank lending and raised interest rates to rein in inflation.

GDP grew 0.3percent from the previous three months, according to an estimate given to Congress by the Finance Ministry in Brazil. That’s equivalent to annualized growth of 1.2percent. GDP expanded 0.8percent in the second quarter.

Brazil, after expanding faster than most emerging markets last year, will underperform its peers this year, according to IMF estimates. GDP will grow 3.8percent, while emerging markets and China will expand 6.4percent and 9.5percent respectively, the IMF said in its September World Economic Outlook.

Commodities – Gold added 0.25percent to USD1,697.03 an ounce on Thursday morning, having slipped on Wednesday on falling equities, weak Chinese factory data and a contracting euro zone economy.

Prices have eased more than 10percent since hitting a record of around USD1,920 in September.

“In the near term, gold needs to sustain or close above USD1,726 an ounce for the reversal of the bullish tint,” said Pradeep Unni, senior analyst at Richcomm Global Services.

Spotlight on: BRIC, ten years on…

Just over a decade after he first talked about the global economy being driven by the growth of the BRICs of Brazil, Russia, India and China, Goldman Sach’s Jim O’Neill is even more convinced that these four, along with other rising stars, are the “growth engine of the world economy, today and in the future”.

He is incredibly bullish about their future, remarking that his “only regret” on his first BRIC analysis of 2001 is that “we weren’t bolder”.

The scale of their growth surprised him and he is now as supportive of their future potential, even in the face of those who say it was the product of an unrepeatable set of circumstances; rapid export growth, the commodity boom and unsustainable U.S. demand.

So convinced is O’Neil of the economic standing of the BRIC countries, that he feels their rise to prominence merits a greater role in the shaping of global economics, through involvement in the various global organisations and committees that exist. His view of the world is the traditional power-brokers are not necessarily the best placed to carry on leading global economic discussions.

The statistics add weight to his argument…

For example, since 2001, Brazil has overtaken Italy as the world’s seventh largest economy; China has overtaken Japan to become the second largest and will surpass the U.S. within another two decades. Yet Italy and Japan are founding and existing members of the G7, Brazil and China are not.

He also looks at those with greatest market influence and comes to the conclusion that, for example, Zurich and Singapore are more important financial centres than those of Toronto, Milan and Rome that are part of two G7 member countries.

O’Neill also revisited the question of the viability of the G7, G8 and IMF that he had originally argued were no longer suitable entities to deal with the challenges of the new world.

His conclusion now is: “Today it is even more obvious”, adding: “Unless the BRICs are embraced more fully by the powers that now dominate the world’s economic policy councils, we cannot enjoy the full benefits of their growth”.

O’Neill is acutely aware that there is more than national or political pride here, and that those countries that make up the G7 (the U.K., U.S., Canada and Japan along with three eurozone members, Germany, France and Italy) “cannot afford to be judgemental about countries which now rival them economically, just because of their different social and political systems.”

A G7 being formed today, he argues, would have to include China and he suggests a new G8 (with the G standing for ‘Growth’) that includes the BRIC countries, plus Mexico, Indonesia, South Korea and Turkey.

He argues the case for the IMF to re-evaluate membership of these groups, with eligibility criteria and clear objectives for their entry or ejection, so they are truly representative of the global economy.

“It would be a tough diplomatic challenge for the IMF or anyone to manage the national egos and force implementation of such an approach but, if successful, it would make the G groups consistently relevant and manageable.”

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