'Brump' heightens uncertainty in global economy

The global economy has not fully recovered from the 2008 financial crisis and the failure to implement the necessary reforms has left it vulnerable to new shocks. The new political risks and uncertainty emanating from the Brexit vote in the United Kingdom and the unexpected victory of Donald Trump in the US may prove to be the catalyst for a new bout of economic instability. Kavaljit Singh elaborates.

THE two big political events of 2016 - the Brexit referendum on 23 June and Donald Trump's victory in the US presidential election on 8 November - have added significant uncertainty to an already fragile global economy. Due to economic and political uncertainty caused by the Brexit vote, the International Monetary Fund (IMF) has lowered the global economic growth forecast for 2017 to 3.4%.

Eight years after the onset of the global financial crisis in 2008, the economic recovery remains uneven in most advanced economies, with persistently weak private demand and limited job growth. The financial crisis is far from over, only its intensity and geography have changed. The crisis led to a severe global economic recession followed by sovereign debt crises that are ongoing in the eurozone.

In terms of macroeconomic parameters (e.g., growth, employment, inflation, trade), one finds major weaknesses in one region or another. Some analysts view the drop in the unemployment rate to 4.6% (the lowest since 2007) in November 2016 as a sign of stronger recovery in the US. However, most of the new jobs created in the US belong to low-wage sectors such as bars and restaurants. According to the US Bureau of Labor Statistics, out of the 178,000 new jobs added in November 2016, only 9,000 are full-time jobs while part-time jobs increased by 118,000. Hence, the quality of jobs is a major concern as good jobs are being replaced by bad ones.

The world economy will face multiple challenges in 2017, largely due to political factors. There was a time when the political risk was largely seen in the context of the developing world (for instance, military coups taking place in Pakistan, Nigeria or Burundi). But now political risks and uncertainty are building up in the developed countries, particularly in the European Union.

The 'Brump' factor

The Brexit vote was the biggest shock to the political establishment in the UK and across Europe. More than seven months have passed since the Brexit vote, but there is still uncertainty as to how the whole process will play out.

Firstly, there has been a battle over procedure in invoking Article 50 of the Lisbon Treaty, the legal process to exit the EU. Initially, British Prime Minister Theresa May insisted that her government was 'getting on with Brexit', but the High Court ruled that the UK cannot leave the EU without parliamentary approval. An appeal by the government failed when the Supreme Court affirmed that such consent was necessary.

Secondly, the real battle is over the nature of the exit and the country's economic relations with the EU, i.e., whether it will be a 'hard' Brexit or a 'soft' one. After initially refusing to divulge her Brexit strategy, claiming that to do so would weaken her government's negotiating position, May finally revealed her plans for Britain's clean break from the EU in a much-anticipated speech to European diplomats at Lancaster House (London) on 17 January.

In her speech May outlined her government's strategy for Brexit by confirming that Britain wants a complete break from the EU's single market, which allows free movement of goods, services, capital and people within the 28-nation bloc. The government, she said, would pursue a 'new, comprehensive, bold and ambitious' free trade agreement with the EU. This choice of a 'hard' Brexit was subsequently confirmed in a White Paper published by the government.

The decision to opt for a 'hard' Brexit has created consternation across the political divide. Hence, when the Brexit bill (a short 137-word document) was introduced in the British House of Commons on 26 January, there were more than 100 pages of amendments to try to either change course or introduce some social safeguards. But all were voted down, although the government did agree to allow parliament to vote - on a yes-or-no basis - on the final Brexit deal that is eventually reached with the EU.

From the House of Commons, the bill now goes to the House of Lords for approval. Initially there was seen to be little likelihood of any major revolt in this chamber of parliament to scuttle the bill, and it appeared as if the government would be able to invoke Article 50 by the end of March as originally envisaged. However, there are now moves to push for amendments in the House of Lords; while this is unlikely to defeat the bill, it could delay approval and further add to the uncertainties surrounding the Brexit process.

The British pound sterling has already fallen by about 18% against the US dollar since the Brexit vote. It is likely to drop further by some 5% to $1.15 against the dollar after May triggers Article 50, according to a Reuters poll of over 60 foreign exchange strategists. In an interview with Bloomberg, George Saravelos, global co-head of foreign exchange at Deutsche Bank, predicted that the pound could even decline to as low as $1.05 against the dollar, as the 'incredibly complicated' nature of Brexit becomes clearer.

As the City of London is the leading international financial centre, ongoing uncertainties related to the timing and nature of the Brexit process could pose additional risks to the global financial system.

The victory of Donald Trump in the US presidential election was another major political upheaval. President-elect Trump has already announced that he would dilute or dismantle financial regulatory measures undertaken to implement the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. A deregulation push under his presidency could free big US banks from new regulatory rules introduced in the aftermath of the 2008 crisis. In other words, the big banks may become even bigger if the already tepid Dodd-Frank Act is dismantled.

Trump's policy agenda in other areas such as international trade, climate change and immigration will also be closely watched as most of his cabinet colleagues are business elites with hardly any public office experience.

Needless to say, people around the world are anxiously waiting to see how the 'Brump' phenomenon (Brexit plus Trump) unfolds in the coming months.

The rise of the far-right in Europe

Almost every European country has witnessed a surge in support for far-right political parties in recent years. Such parties have been able to garner substantial popular support based on their anti-immigration policies and nationalistic outlook.

In 2017, elections are due in the Netherlands, Germany, France and possibly Italy. Most political analysts expect far-right parties to achieve big electoral successes on the back of an anti-establishment sentiment fuelled by the Brexit vote and the Trump victory. The possibilities of such parties coming into power are far greater now than ever.

Instead of targeting austerity programmes and neoliberal economic policies which contribute to economic instability and unemployment, far-right political parties use nationalist, anti-immigrant and xenophobic rhetoric to draw public support.

The growing popularity of such parties across Europe indicates the possibility of other countries leaving the EU, including France (Frexit), the Netherlands (Nexit), Italy (Italeave) and Austria (Auxit). In all likelihood, the EU may survive Brexit but a Frexit would completely jeopardise the entire European integration project.

Global banking fragility

The global banking system is still in a fragile state. The big banks, particularly in crisis-hit countries, are facing numerous challenges despite the huge efforts that have been made by central banks and governments to clean up their balance sheets. According to the IMF's Global Financial Stability Report (October 2016), over 25% of banks in developed countries (controlling $11 trillion in assets) remain weak.

In the US, very little progress has been made to prevent taxpayers from having to bail out 'too-big-to-fail' banks. Under the Dodd-Frank Act, banks are required to create 'living wills' outlining how they would shut down their business if they fail, at no cost to taxpayers. In April 2016, the US regulators issued a failing grade to five big banks (including Bank of America, Wells Fargo and JPMorgan Chase) on their emergency wind-down plans in a crisis-like situation. Put simply, if another financial crisis were to hit the US today, these banks would need a bailout from the US government to prevent a major financial shock from happening again.

In Europe, high levels of non-performing loans may spark new crises in the banking sector in the coming months. According to KPMG, the European banking sector has about 1.1 trillion in non-performing loans and an average NPL ratio of 5.7% (three times as much compared with the US or Japan). Policy-makers are currently focusing on eight of Italy's troubled banks.

In particular, the financial position of Italy's Banca Monte dei Paschi di Siena, the oldest surviving bank in the world, is extremely weak as it was the worst performer in the annual stress tests carried out on 51 lenders across the EU in late 2016. The bank has nearly 50 billion in non-performing loans, accounting for 38% of its total loans. It recently failed to raise 5 billion in fresh capital as part of its recapitalisation plan. Hence, a state bailout of this ailing bank cannot be ruled out even though such a move may not comply with EU state aid rules.

In the UK, Royal Bank of Scotland (RBS) failed the annual stress test carried out recently by the British central bank. The UK government had bailed out RBS in the aftermath of the 2008 crisis. It is important to emphasise here that any further weakening of RBS' financial strength will directly impact the UK's public finances because the government currently owns 73% of the bank. Similar will be the fate of many other European banks which were bailed out by their national governments following the 2008 crisis.

Deutsche Bank in trouble

The weak financial position of Deutsche Bank should be a matter of grave concern. Since 2008, Deutsche Bank has faced numerous lawsuits and investigations over its alleged role in rigging of interest-rate benchmarks and commodity prices, violations of US sanctions and mis-selling of mortgage-backed securities. Even after paying more than $16 billion in fines and settlements worldwide since 2008 for serious misconduct, Deutsche Bank's troubles are not yet over as it has lost more than half of its value in 2016.

With Deutsche Bank having a leverage of 40 times, some analysts forecast that its failure may trigger a far bigger financial crisis than the 2008 crisis. As Deutsche Bank is highly interconnected with other big banks and insurance companies in Germany, there is a valid concern that it could pose a systemic threat to Germany's entire financial sector.

In June 2016, an IMF Financial System Stability Assessment report on Germany stated that 'among the G-SIBs [globally systemically important banks], Deutsche Bank appears to be the most important net contributor to systemic risks, followed by HSBC and Credit Suisse'. The report further noted that 'Germany, France, the UK and the US have the highest degree of outward spillovers as measured by the average percentage of capital loss of other banking systems due to banking sector shock in the source country'.

Further, Deutsche Bank is the biggest European bank in London, with a staff strength of 8,000. The bank generates nearly 20% of its revenue from the UK and therefore is exposed to greater Brexit risk than other European banks.

What about bright spots?

In 2016, India and China were seen by many as the two bright spots on the world economy map but both economies are facing their own challenges.

Post-demonetisation, India's growth projections have slipped. The stated objective of the demonetisation initiative, launched on 8 November, was to crack down on the black (shadow) economy. At the time of writing, news reports point out that this policy objective has not been realised as 94% of demonetised notes have been deposited back in the banks, thereby putting a big question mark on the efficacy of this entire initiative which wrought mass hardship on the majority of India's 1.2 billion people.

There is growing evidence to show that the demonetisation initiative has badly affected the informal sector (which constitutes roughly half of India's economy), where legitimate cash transactions are common. In the rural and semi-urban areas where banking infrastructure is sorely lacking, this move has negatively impacted the jobs and livelihoods of working people who earn and spend money in cash. Numerous media reports have highlighted how cash shortages led to the closure of many micro and small enterprises throughout the country, with adverse impact on the incomes and jobs of the people associated with these enterprises. In particular, the agriculture, textile, jewellery, retail trade, automobile, real estate and construction sectors have been adversely hit by the demonetisation initiative. In such a scenario, an immediate revival of economic activity is unlikely to happen.

In the case of China, the shadow banking system (non-bank financial intermediaries) poses a potential systemic risk given its large size and opaque nature. Since shadow banking institutions are interconnected with China's commercial banks, risks in the shadow institutions can easily be transmitted to the Chinese banking system.

Brazil and Russia suffered heavily due to the crash in commodity prices in the past two years. Now as commodity prices have stabilised, it is expected that both these economies may come out of recession in 2017.

To sum up, the world economy is not out of the woods yet. A more robust, sustained and balanced global recovery is still elusive.

The global financial reforms implemented so far are inadequate to prevent another crisis from happening. The political will to implement deep-seated global financial reforms is currently missing at the G20, the premier forum for international economic cooperation, where progress in regulatory cooperation has been patchy and spasmodic. The member countries of the grouping have yet to implement several past commitments on financial reforms. As a result, the policy agenda to create a more transparent, inclusive and resilient global financial system has lost momentum. At the opening session of the G20 summit in Hangzhou, China, in September, Chinese President Xi Jinping urged the G20 to be a 'group of action, instead of a talk shop'. It appears that G20 leaders have forgotten about the root causes of the global financial crisis.

Kavaljit Singh works with Madhyam, a non-profit organisation based in New Delhi devoted to research and public education on economic and developmental issues. The above is an updated version of an article which first appeared on the Madhyam website (

*Third World Resurgence No. 316, Dec 2016, pp 2-4