Nearly two years ago, France lost its triple A credit-rating and the news has only got worse. Unemployment has risen and economic growth in France has remained low and this is one of the reasons why France’s credit rating has been downgraded further from AA+ to AA. A high credit rating doesn’t guarantee market confidence, but it does help to keep the cost of borrowing for the government low. Thus, this downgrading could spell trouble for French borrowing costs.
Standard and Poor’s (S&P), who downgraded the French credit rating, is expecting government debt to rise to 86% of gross domestic product and believes that unemployment will remain above 10% until 2016. While the French government has put various reforms in place to boost the struggling economy, S&P don’t believe they are sufficient and have been very public in criticising the government’s effort. They were quoted as saying:
We believe the French government’s reforms to taxation, as well as to product, services and labour markets, will not substantially raise France’s medium-term growth prospects and that on-going high unemployment is weakening support for further significant fiscal and structural policy measures.
Following the downgrading, the return for those investors purchasing French debt did begin to rise, echoing the theory that the cost of borrowing would rise. 
The yield on French government 10-year bonds increased from 2.158% to 2.389%. The outlook given to France by S&P was ‘stable’, implying that there is a relatively low chance that S&P would change France’s credit-rating again in the next two years.
Many were surprised at the downgrading of France’s credit rating, but this may be the nudge that President Hollande needs to push through extensive labour market reforms with the aim of reducing unemployment and generating growth in the economy. Despite this latest move by S&P, the other credit rating agencies have yet to take similar action. Perhaps they are more convinced by the Finance Minister, Pierre Moscovici who claims that France’s debt is ‘one of the safest and most liquid in the world.’ He commented that:
They are underestimating France’s ability to reform, to pull itself up … During the last 18 months the government has implemented major reforms aimed at improving the French economic situation, restoring its public finances and its competitiveness.
It will take some time for the full impact of this development in France’s economy to become apparent. The cost of borrowing has already risen only time will tell what will happen to market confidence over the coming weeks. However, what is certain is that pressure is already mounting on Francois Hollande. The following articles consider the French economy.
France told to reform labour market after second credit rating downgrade The Guardian, Phillip Inman (8/13/13)
France’s credit rating cut by S&P to AA BBC News (8/11/13)
S&P lowers France rating on reform doubts, markets unfazed Reuters, Nicholas Vinocur (8/11/13)
Hollande approval rating slumps as France downgraded The Telegraph, James Titcomb (8/11/13)
S&P cuts France’s credit rating by one notch to double-A Wall Street Journal, William Horobin (8/11/13)
Five charts that show the state of the French economy The Telegraph (8/11/13)
France rating downgrade heaps pressure on Francois Hollande Financial Times, Michael Stothard (8/11/13)
Questions
- What does a double A rating mean for the French economy?
- Which factors will be considered when a ratings agency decides to change a country’s credit rating?
- France’s unemployment rate is one of the key factors that S&P has considered. Why is France’s unemployment rate so high? Which type(s) of unemployment are increasing?
- Use a diagram to illustrate the unemployment that France is facing.
- If a country does see its credit rating downgraded, what might this mean for government borrowing costs? Explain why this might cause further problems for a country?
- Markets have been ‘unfazed’ by the downgrade. How do you think markets will react to over the coming weeks? Explain your answer.
- What action could the French government take to ensure that S&P is the only ratings agency that downgrades their credit rating?
Turkey has experienced rapid economic growth in recent years and has attracted large inflows of foreign capital. The chart below illustrates how growth in real GDP in Turkey in most years since 2000 has considerably exceeded that in the OECD as a whole (click here for a PowerPoint). As you can see from the chart, growth in Turkey over the period has averaged 4.5%, while that in the OECD has averaged just 1.8%.
Indeed, Turkish growth has been compared with that of the BRICs (Brazil, Russia, India and China). However, like the BRICs, Turkey has been experiencing slowing growth in the past few months. Indeed, the slowdown has been especially marked in Turkey.
In recent years Turkey has benefited from large inflows of foreign capital. Partly these were direct investment flows, encouraged by a large and rapidly growing internal market, boosted by a rapid expansion of consumer credit, and also by a growing export sector. But to a large extent, especially in recent years, there has been a large rise in portfolio and other investment inflows. This has been encouraged by a large increase in global money supply resulting from policies of quantitative easing in the USA and other developed countries.
But the economic climate has changed. First investors have become worried about the conflict in Syria escalating and this impacting on Turkey. Second Turkey’s large financial account surpluses have allowed it to run large current account deficits and have maintained a high exchange rate. Third the tapering off and possible reversal of quantitative easing have led to recent outflows of finance from various countries perceived as being vulnerable, including Turkey.
The effect of this has been a depreciation of the Turkish lira and upward pressure on inflation. The lira has fallen by 14% since the beginning of 2013 and by nearly 7% since the beginning of August alone.
The question is whether the supply side of the Turkish economy has become robust enough to allow the country to ride out its current difficulties. Will foreign investors have sufficient faith in the long-term potential of the Turkish economy to continue with direct investment, even if short-term financial inflows diminish?
Articles
Turkey’s economy faces uncertainties amid possible military intervention in Syria Xinhua, Fu Peng (29/8/13)
Turkey may cut 2014 growth target to 4% Turkish Daily News (8/9/13)
Turkish lira at record low, threatening growth Daily News Egypt (7/9/13)
Turkish lira may need higher interest rates to escape emerging markets rout Reuters, Sujata Rao and Seda Sezer (20/8/13)
Turkey Economic Crisis: Crises from Both Sides Wealth Daily, Joseph Cafariello (9/8/13)
Western financial prescription has made Turkey ill The Observer, Heather Stewart (1/9/13)
Turkish Deputy PM Babacan calm amid economic fluctuations Turkish Daily News (8/9/13)
The Fragile Five BBC News, Linda Yueh (26/9/13)
Data
Economic growth rates (annual) for Turkey, Brazil, Russia, India and China: 2000–13 IMF Economic Outlook Database (April 2013)
Quarterly growth rates of real GDP for OECD countries and selected other countries and groups of countries OECD StatExtracts
Turkey and the IMF IMF
Turkey: data World Bank
Links to Turkish Official Statistics Offstats
Country statistical profile: Turkey OECD Country Statistical Profiles
Spot exchange rate, Turkish Lira into Dollar Bank of England
Questions
- Why has the Turkish economy experienced such rapid growth in recent years and especially from 2010 to 2012?
- Why has Turkish growth slowed over the past year?
- Why has “Western financial prescription made Turkey ill”
- Why has the Turkish lira depreciated? What has determined the size of this depreciation?
- What are the beneficial and adverse effects of this depreciation?
- Why must any surplus on the combined financial and capital accounts of the balance of payments be matched by a corresponding deficit on the current account?
- How is a tapering off of quantitative easing likely to impact on developing countries? What will determine the size of this impact?
- Istanbul has lost its bid to host the 2020 Olympic Games? How is this likely to affect the Turkish economy?
The rate of growth in India has fallen to its lowest level since the first three months of 2009 – the period when many countries were plunging into recession. Although the annual rate was still 4.4% in Q2 2013 (a rate most Western governments would love to achieve!), it had averaged 8.2% from 2003 to 2007 and 9.5% from 2010 to 2011 (see).
And the rupee has been falling in value (see chart below). The exchange rate of the rupee to the dollar has depreciated by 21% since the start of the year and by 14% since the beginning of August (click here for a PowerPoint of the chart). This has pushed up the price of imports and raised fears that inflation, already approaching 10%, will rise.
There have also been concerns about the health of India’s banking sector, with worries over the possible rise in bad loans.
One result of all these factors is that the confidence of investors has been shaken. Bond prices have fallen and so too have share prices. The Mumbai Sensex index fell by 11.5% from 22 July to 27 August. Worried about possible capital flight, the Indian government imposed capital controls on Indian residents on 14 August. It has, however, since ruled out limiting the outflow of funds by foreign investors.
The following articles and videos look at the causes of the current economic problems and what can be done about them.
Webcasts
India’s sliding economy Aljazeera (24/8/13)
Economic woes grow for Indians as rupee continues to slide BBC News, Sanjoy Majumder (30/8/13)
What is behind the Indian economy’s fall from grace? BBC News, Yogita Limaye (30/8/13)
Indian rupee: How onions reflect health of economy BBC News, Nitin Srivastava (30/8/13)
The rise and fall of India’s economy NDTV (20/8/13)
Is the Indian economy heading for a doom? NDTV, Dr Arvind Virmani, Adi Godrej, P N Vijay, Sanjay Nirupam and Prakash Javadekar (20/7/13)
Can Rajan stabilise India’s economy? FT Video, Stuart Kirk and Julia Grindell (7/8/13)
Articles
India in trouble: The reckoning The Economist (24/8/13)
PM warns of short term shocks, attacks BJP for stalling Parliament The Economic Times of India (31/8/13)
External global factors led to rupee slide: Manmohan in Lok Sabha Hindustan Times (30/8/13)
India seeks allies to defend rupee as growth skids to four-year low Reuters, Manoj Kumar and Frank Jack Daniel (30/8/13)
Rupee charts in uncharted territory Reuters, Saikat Chatterjee and Subhadip Sircar (30/8/13)
Indian Prime Minister Says Rupee Crisis Will Only Make Country Stronger Time World, ilanjana Bhowmick (30/8/13)
Is India in danger of another crisis? BBC News, Linda Yueh (8/8/13)
India’s GDP shows continuing slowdown BBC News (30/8/13)
Slowest India Growth Since 2009 Pressures Singh to Support Rupee Bloomberg, Unni Krishnan (30/8/13)
Questions
- Why has the rupee fallen in value so dramatically? Is there likely to have been overshooting?
- What are the economic consequences of this large-scale depreciation? Who gain and who lose?
- What factors are likely to affect the rate of growth in India over the coming months?
- Why is the Indian economy more vulnerable than many other Asian economies?
- What economic policies are being pursued by the Indian government? How successful are they likely to be?
The Preliminary Estimate of the UK Q2 GDP figures by the Office for National Statistics show that the UK economy grew by 0.6% in the second quarter of 2013: double the growth rate of the first quarter and almost back to the long-run average growth rate prior to 2008.
At first sight, this would seem to be good news – certainly from the government’s point of view. What is more, unlike the previous quarter, growth is spread relatively evenly across the three main sectors: the production (manufacturing, mining, water supply, etc.) and services sectors both grew by 0.6% and the construction sector by 0.9% (this sector fell by 1.8% in the previous quarter). (Click here for a PowerPoint of the chart below.)
But while growth in the latest quarter may be balanced between the broad sectors, the rise in aggregate demand is not balanced between its components. As an earlier news item (A balancing act) showed, the rise in aggregate demand has been driven largely by a rise in consumption, and a corresponding fall in saving. Exports are rising only slowly and investment is some 25% lower than in the boom years prior to 2008.
So will the latest growth be sustainable? Will investment now begin to pick up and what constraints are there on investment? The following articles consider some of the issues.
Articles
Economy firing on all cylinders as growth hits 0.6pc The Telegraph, Philip Aldrick (25/7/13)
The good, the bad or the ugly? How the UK economy stands up. The Telegraph, Philip Aldrick (25/7/13)
George Osborne’s 0.6% growth is good but unspectacular The Guardian, Larry Elliott (25/7/13)
The (not-so) green shoots of recovery The Economist, John Van Reenen (23/7/13)
Economic recovery slow to take root for some in UK Reuters, William Schomberg and Max De Haldevang (25/7/13)
GDP figures offer hard evidence for political narrative BBC News, Paul Mason (25/7/13)
Ignore the hype: Britain’s ‘recovery’ is a fantasy that hides our weakness The Observer, Will Hutton (21/7/13)
UK economy: Half-speed ahead BBC News, Stephanie Flanders (25/7/13)
BoE guidance can help sustain the UK recovery The Economist, Kevin Daly (22/7/13)
George Osborne’s description of the economy is near-Orwellian The Guardian, Ha-Joon Chang (26/7/13)
Economic growth: more must be done to encourage investment The Guardian, Phillip Inman (1/8/13)
Data
Gross Domestic Product: Preliminary Estimate, Q2 2013 ONS (25/7/13)
Questions
- Compare the macroeconomic situation today with that prior to the financial crisis of 2007/8 and subsequent recession.
- What factors will determine the sustainability of the UK economic recovery?
- What is meant by the ‘accelerator’ and what will determine the size of any accelerator effect from the latest rise in UK GDP?
- What supply-side constraints are likely to limit the rate and extent of recovery?
- Why do economies that are in recession ‘naturally bounce back’ without any government intervention? Have the macroeconomic policies of the UK government helped or hindered this bounce back? Explain.
- What monetary measures by the Bank of England are most appropriate in the current circumstances?
There’s some good news and some bad news about the UK economy. The good news is that there are signs that the recovery is gathering momentum; the ‘green shoots’ are growing bigger. The bad news is that it’s the ‘wrong type of growth’!
One of the main underlying problems of the 2008 financial crisis was that household debt had been increasing to unsustainable levels, egged on by banks only too willing to lend, whether as personal loans, on credit cards or through mortgages. When the recession hit, many people sought to reduce their debts by cutting back on spending. This further fuelled the recession.
What the government and most economists hoped was that there would be some rebalancing of the economy, with less reliance on consumer spending to drive economic growth. Instead it was hoped that growth would be driven by a rise in investment and exports. Indeed, the 25% depreciation of sterling exchange between 2007 and 2009 was seen as a major advantage as this would boost the demand for exports and encourage firms to invest in the export sector.
But things haven’t turned out the way people hoped. The recession (or lack of growth) has been much deeper and more prolonged than previous downturns in the economy. Today, real GDP per head is more than 7% below the level in 2007 and many people have seen much bigger declines in their living standards.
But also, despite the austerity policies, the economy has not been ‘rebalanced’ towards exports and investment. Exports are 3% lower than in 2006 (although they did grow between 2009 Q2 and 2011 Q1, but have since stagnated). And investment is 27% lower than in 2006. Household consumption, however, has grown by about 2% and general government consumption by around 9% since 2006. The chart shows the figures, based on 2006 Q1 = 100.
(Click here for a PowerPoint of the chart.)
And recent evidence is that consumption is beginning to grow faster – not because of rising household incomes, but because of falling saving rates. In 2008, the household saving ratio had fallen to nearly 0% (i.e. households were on average saving about the same as they were borrowing). Then the saving ratio rose dramatically as people reined in their spending. Between 2009 and 2012, the ratio hovered around 7%. But in the first quarter of 2013, it had fallen to 4.2%
So the good news is that aggregate demand is rising, boosting economic growth. But the bad news is that, at least for the time being, this growth is being driven by a rise in household borrowing and a fall in household saving. The videos and articles consider whether this is, however, still good news on balance.
Webcasts
Britain’s imbalanced economy The Economist, Zanny Minton Beddoes and Richard Davies (4/7/13)
Britain’s Export Drought: an enduring disappointment The Economist, Andrew Palmer and Richard Davies (9/2/13)
‘Green shoots’ of economic recovery in Rugby BBC News, Paul Mason (12/6/13)
Articles
Is the UK economy seeing the ‘wrong kind’ of green shoots? BBC News, Stephanie Flanders (3/7/13)
The export drought: Better out than in The Economist (9/2/13)
Exports and the economy: Made in Britain The Economist (21/1/12)
The economy: On a wing and a credit card The Economist (6/7/13)
Unbalanced and unsustainable – this is the wrong kind of growth The Telegraph, Jeremy Warner (8/7/13)
The UK economy’s looking up – but no one’s told manufacturers The Guardian, Heather Stewart (10/7/13)
Data
Quarterly National Accounts, Q1 2013 (27/6/13)
Forecasts for the UK economy: a comparison of independent forecasts HM Treasury (June 2013)
ISM Manufacturing Report on Business® PMI History Institute for Supply Management
Questions
- What are forecasters expecting to happen to economic growth in the coming months? Why?
- What factors determine investment? Why has it fallen so substantially in the UK?
- Explain what is meant by the ‘accelerator’. Is the rise in consumption likely to lead to an accelerator effect and, if so, what will determine the size of this effect?
- Why have exports not grown more rapidly despite the depreciation of sterling after 2007?
- What will determine the rate of potential economic growth in the UK economy? How will a rise in real GDP driven by a rise in consumption impact on potential GDP and potential economic growth?
- What supply-side policies would you recommend, and why, in order to increase potential economic growth?
Nearly two years ago, France lost its triple A credit-rating and the news has only got worse. Unemployment has risen and economic growth in France has remained low and this is one of the reasons why France’s credit rating has been downgraded further from AA+ to AA. A high credit rating doesn’t guarantee market confidence, but it does help to keep the cost of borrowing for the government low. Thus, this downgrading could spell trouble for French borrowing costs.
The yield on French government 10-year bonds increased from 2.158% to 2.389%. The outlook given to France by S&P was ‘stable’, implying that there is a relatively low chance that S&P would change France’s credit-rating again in the next two years.
