By Zhao Jinping, Research Team on Economic Trend Analysis, Research Department of Foreign Economic Relations, the DRC

I. International Financial Crisis Approaches Bottom But 2~3 Years Are Required to Eliminate the Impact of Credit Squeeze

Currently, the international financial crisis has shown visible signs of easing. One, the pressure test result of financial institutions indicates that the leading financial institutions in the United States have not become insolvent. The size of required capital injection is smaller than market expectation and is within the scope acceptable to financial institutions and government bailout funds. Two, the confidence of financial markets has somewhat picked up, with the leading stock markets beginning to bounce back, the oil prices rising and the housing price reduction becoming blunt. Three, the possibility that the recession of the real economies would further tie down the financial systems has become smaller. In the first quarter, the economies in Europe, the United States and Japan continued the momentum of the sharp downturn in the fourth quarter of 2008. But after March, the declines in economic indicators became narrower. The Federal Reserve believed that the free fall of the American economy has come to an end. The economic report of the Japanese government for May adjusted the economic expectation from "continued drastic deterioration" to "deterioration beginning to ease", for the first time in three years.

Whether the financial market in the United States can stabilize depends mainly on two factors. One is whether the capital injection required by the pressure test of financial institutions can be materialized smoothly. The other is whether the plans for acquiring nonperforming assets can be implemented smoothly. As to the first factor, the 74.6-billion-dollar capital injection is not a target difficult to achieve. Only one of the 10 banks needs government capital injection. The nine others have worked out plans for increasing capital on their own. With 70% having been materialized, it is highly likely that their goals can be achieved. As to the stripping of their nonperforming assets, many private funds are willing to participate because an acquisition framework has been formed for government and the private sector to jointly contribute 1 trillion dollars. Concrete execution is expected to begin in July. This will help eliminate market panic. The above two points indicate that the financial situation in the United States is turning for the better and is likely to impact the whole world gradually. In addition, there have been concerns earlier that the debt and economic crisis hitting some countries in East and Central Europe might burden the financial system in West Europe and trigger a new wave of global financial shocks. But as the International Monetary Fund has greatly boosted its financing strength after the 20-nation London conference, the funding assistance from international organizations has visibly reduced this risk. The fact that some leading emerging economies have also begun to gradually stabilize has also produced positive impacts on stabilizing the confidence of the financial markets. For example, South Korea's economic growth in the first quarter was better than in the fourth quarter of last year and its financial situation has also improved since March.

Although the international financial crisis has somewhat eased, it is unlikely to end soon. Credit squeeze and financial risk will continue to exist before the nonperforming assets are effectively disposed. This might require at least 2~3 years. This judgment is based on the following points. One, the nonperforming asset loss of the financial institutions in the United States is estimated at 2.8 trillion dollars and it is still uncertain whether the 1-trillion-dollar acquisition program can meet the requirement. Japan's experience indicates that after the burst of its bubble economy, it took about two and half a years to reduce the 1-trillion-dollar nonperforming assets by half. Compared with the then external condition featuring robust world economic growth, the world economic situation confronting the United States is much worse and the bad accounts are more difficult to treat. Two, the number of local bank bankruptcies in the United States has risen to 36 since the beginning of this year, more than the total number of 25 registered in the whole year of 2008. "Problem banks" are 20% more than at the end of last year. This indicates that there still exists a great risk that the financial system is attacked. Three, the major financial institutions have yet to fundamentally overcome their difficulties. The major financial institutions in the United States are still under a tremendous bad-account pressure. The banking systems in Europe as a whole are extremely fragile. In particular, three banks in Germany and Switzerland still have the high-risk securitized assets which are twice as much as their equity assets. Six largest commercial banks in Japan reported they posted deficit in their total profit for the first time in the financial year ending in March, and all the first three banks incurred huge losses. Four, the financial institutions still have the problem of credit squeeze. The statistics of the Federal Reserve indicate that in March, 21 commercial banks in the United States which had received government capital injection saw their total credit dropping by 0.9% year-on-year.

II. World Economy Has Experienced Worst Recession since World War II and Leading Economies Are More Likely to Bottom out This Year

In the first quarter of 2009, the economy of the United States contracted 5.7%, and the economies of the Euro Zone and Japan respectively dropped 9.8% and 15.2%, at the monthly annualized rates. In the fourth quarter of 2008, the economies in the United States, Europe and Japan had already fell 6.3%, 6.2% and 14.3% respectively. In the past two quarters, the leading developed economies already experienced the worst recession since World War II.

The economic trend after March indicates that the downturn of these economies has begun to ease. First, although industrial production has yet to overcome its year-on-year decline, the decline in April became narrower than in March. Japan's industrial output 5.2% in April over the previous month posted the largest monthly growth since 1953. Next, the composite index of leading indicators of the World Major Enterprises Association in the United States rose 1% in April. It was the first rise in the past seven months and the highest in nearly four years. In the previous recessions, this index usually presented a similar rise two month before the end of these recessions. Third, the financial markets in the United States, Europe and Japan all saw their long-term interest rates rising since April, indicating that market expectation had begun to improve. In May, the consumer confidence index in the United States posted a sharp rise over the previous month, which was a record high since October last year. The index reflecting future confidence was also visibly higher. Finally, the economic stimulus packages of the leading developed economies will produce positive effects on economic pickup. The 787-billion-dollar stimulus package of the U.S. government is expected to gradually produce economic effects as from the second quarter. On top of its 120-billion-dollar additional fiscal spending last year, Japan adopted a new 154-billion-dollar additional budget in April this year. The economic stimulus programs of the leading economies in the Euro Zone have also produced some effects. The International Monetary Fund projected in April that the economies of the United States, Euro Zone and Japan would respectively shrink 2.8%, 4.2% and 6.2% in 2009. In particular, the projection for Japan was made without taking the new additional budget into account. According to Japanese analysis, the new additional budget was about to boost GDP growth by 4.3%, of which one-third would be achieved this year. As a result, Japan's economic decline in 2009 may shrink from the earlier projected 5% to about 3%. Therefore, we can determine that the economic downturn in the leading developed countries will ease visibly in the second and third quarters and these economies are likely to bottom out within this year. However, credit squeeze is unlikely to be fundamentally eliminated in a fairly long time due to the burden of nonperforming assets. Therefore, even if the developed economies move out of recession, their growth rates are likely to remain fairly low. With the gradual ease of the effects of this round of economic stimulus packages, we cannot rule out the possibility that these economies will fall again into recession after a brief recovery if no follow-up actions are taken. Overall, the world economy will experience a process featuring a low growth rate and a tortuous recovery in the 2~3 years from 2010.

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