The annual World Economic Summit, fondly known as Davos, has come to an end. Stories again arose from it and in a new Morgan Stanley (NYSE:MS) research report by Huw Van Steenis, “What I Learned at Davos.” he gives his take on this year’s meeting.
Here are some highlights from the report.
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Van Steenis noted that after meeting with CEOs, many were more constructive than 2012 while delegates seem relieved that the existential crisis in the Eurozone has been put out. One CEO of a consumer group noted material improvement in sales, but it has really just come from emerging markets. This belief was echoed by many and it comes on a more stable backdrop and an increasing confidence in a U.S. recovery and growth in China while it is not being met by the incremental Europe moves.
There was good news at Davos and that included the reduction in tail risks and and more confident business leaders.
The bad news included a lack of agreement on the right tool box to catalyze growth. As noted by Christine Lagarde in a public debate, “the global recovery is fragile and timid. Policy makers must not relax.” She added, the euro zone in particular, “is fragile because it is prone to political crisis.”
How to build on that foundation is a challenge and according to Van Steenis, one central banker said, “central bankers feel more confident they know how to fight crises now, but policy makers are very poor at fixing the underlying problems.”
Van Steenis posed the question that without European growth, can we really say debt problems are extinguished. He then cited five areas likely to affect growth in the medium term and the financial system.
The recalibration of financial regulation
He writes: “Central bankers and Chancelleries are becoming much more conscious of the need for a re-evaluation; even if some regulators are hoping to cling to the rules to avoid everything being thrown up in the air again. In the words of one central banker, some of the rules were “misspecified” using “primitive academic assumptions”, which need to be refined with experience and seen in the round with the totality of financial regulations.”
Three rules will be re-assessed as prime candidates for recalibration grow: the net stable funding ratio, rules on collateralization of derivatives and rules on repos.
The Balkanisation of banking markets
He writes: “I think more likely that a series of protectionist measures will ensue, as policy makers in both the US and Europe look to protect their own systems. I outlined our framework for this in ‘The State of Disunion: Balkanisation and Banking Union,’ June 2012, and continue to be concerned that a desire to reduce interconnectedness is likely to have lasting implications for cross border flows of credit, for instance to CEE and Southern Europe.”
Infrastructure investment to pump prime economies
He writes: “Given the new rules and funding realities, few banks wish to write loans at 10-years or beyond: so funding for infrastructure, social housing and the like is hugely constrained. The lack of wiggle room in the public purses means that governments are equally wary. Add to this the hindrances of Solvency 2, which my colleague Jon Hocking and we have written about, and there is a major problem in the provision of long-term assets that needs addressing. My conversations in Davos convinced me that more policy makers are beginning to understand this at a national level, but there is there no consensus yet at international level.”
To print or not to print?
He writes: “The consensus of much of the official sector and investors at Davos was that central banks have maxed out and should be soon start focusing on exit, given the unprecedented size of this experiment and its impact on asset prices. Every single long-term asset owner I met, and numerous longer-term investors, voiced concern about asset prices and the risks from a huge knock from rates backing up (a super-sized version of 1994).”
“While so far one can argue that the monetary injection was vital to offset massive deleveraging, it is clear that the risks for debasement of currencies remain high. One of the most debated topics in the corridors of Davos was the dramatic changes in Japan, with the new government keen to jumpstart the economy with a new 2% inflation target which has led to a material depreciation in the Yen.”
Cyprus and navigating political and economic risks
He writes: “It was striking how much more bearish policy makers were than the private sector. This was not just due to the harsh realities of tough choices and politics, but immanent issues to address. Take one example: Cyprus. While the market is now assuming this is a tiny restructuring with little systemic consequences, it was interesting quite how much debate European policy makers and investors focused on this issue. It is not just because the EU had said Greek debt restructuring is a one off, but how could private sector be “bailed in” when there is only a modest amount of senior bank debt and that the uninsured.”
“As Charles Dallara, managing director of the Institute of International Finance, said to the Wall Street Journal on January 24, “Cyprus had the potential to spark another phase of the euro-zone crisis”. He said the “bailing in of uninsured depositors would set a precedent that would have an effect elsewhere, for example in Spain.” The lack of growth means that tough choices on debt will persist for years to come.”