Is it Really a ‘Job-Rich' Recession?
May 22, 2009
By Deyi Tan & Chetan Ahya | Singapore, Shweta Singh | Mumbai
Jobless Recoveries and ‘Job-Rich' Recessions
In the early 1990s and early 2000s in the US, we saw what were called ‘jobless recoveries'. The labour market then was unusually slow to pick up in the aftermath of the recession. In this global recession, the labour market in Singapore seems to be showing a contrary trend. To be sure, the labour market is a lagging indicator. Employment growth in Singapore lags GDP growth by around two quarters. On the way up, corporates are usually slow to add to headcount, preferring to increase overtime hours for existing workers until the macro recovery firms. On the way down, human resource management simply cannot be as precise as just-in-time inventory management. The demand shock tends to be absorbed first by the profit cushion before the wage cost containment exercise starts.
The lag effect not withstanding, at first blush, the quarterly net employment decline in 1Q09 (-1,000 preliminary) looks a tad resilient amid what is likely the worst recession in Singapore's recorded macro history. In 1Q09, the overall unemployment rate reached 3.2% (versus the high of 4.8% during SARS in 2003) and the resident unemployment rate stood at 4.8% (versus the high of 6.3% during SARS). Analyzing net employment trends against output growth trends for the eight quarters before and after the start of the recessions in the 1997, 2001 and 2008 cycles lead to the same findings:
1) In the four quarters since the recession started in 2Q08, GDP growth has averaged -3.3%Y. This is about 1-4pp lower than in the 1997 (+1.0%Y) and 2001 (-2.2%Y) cycles. However, quarterly net employment has seen an average increase of +36,850 versus +4,675 in 1997 and -25 in 2001.
2) In the four quarters since the recession started in 2Q08, quarterly manufacturing growth has averaged -14.1%Y, 3-16pp lower than in 1997 (+2.4%Y) and 2001 (-11.0%Y). However, the average quarterly net employment decline of -3,050 was marginally better compared to -4,050 in 1997 and -3,800 in 2001. Specifically, net employment in the petroleum and chemical industry (quarterly average of +2,633 in the three quarters since the start of the 2008 recession) appears to have been better than expected compared to historical trends (+67 and 0, respectively, in the three quarters since the start of the recession in the 1997 and 2001 cycles), although average growth momentum has been slower (-5.3%Y versus +11.6%Y in 1997 and +2.4%Y in 2001).
3) In the four quarters since the recession started in 2Q08, quarterly services growth has averaged +1.4%Y. This is higher than the average of -0.2%Y in the 1997 cycle but lower than the +1.6%Y average in 2001. However, the average quarterly net employment increase in this cycle was much higher at +25,050 compared to +6,075 in 1997 and +9,350 in 2001. Specifically, community, social and personal services (which include education, public administration, health and other social services), business and real estate services, transport, storage and communications, hotels and restaurants, and wholesale and retail saw more resilient job loss elasticity compared to past recessions.
Making Sense of the Labour Market ‘Paradox'
Prima facie evidence points to a more resilient labour market and what looks like a phenomenon in a few other Asian economies as well. The factors driving the resilience will have implications for what pans out later.
In our view, the lagged nature of capex expansion explains what looks like a relatively resilient net employment trend for now. Although the demand shock post Lehman was swift and sharp, putting a drag on headline growth, aggressive capacity expansion plans commissioned during the bull years in the not-too-distant past are being completed even now. Historically, hiring has been strongly tied to capacity additions/capex trends rather than GDP growth per se. Indeed, through our channel checks, we note that hiring in pockets of the economy has not been driven by stronger end demand (demand growth has been poor, as data suggest). Rather, we are seeing hiring in areas where previously commissioned capex plans have now come onstream. Tying in with our findings in 2) and 3) above, recruitment in pharmaceuticals/healthcare/chemicals was on the back of new plants having been completed. Recent new retail malls have also supported retail hiring, and the same story applies for the hotel segment with new supply additions. Strong construction activity due to these capex plans has also supported employment in the construction sector, lending strength to the headline jobs data.
Interestingly, while capex momentum has supported recruitment in the interim, it has not stopped labour market adjustments from being borne out in terms of compensation. Despite what looks like relatively slower job losses, real monthly earnings have still seen worse declines compared to the 2001 cycle. This is supportive of the fact that hiring is driven by previously committed capacity expansion plans rather than end demand, which tends to be inflationary.
Macro Implications
Slower job losses should support confidence and backstop the final phase of the macro slowdown, where a rise in unemployment spills over to domestic demand. The problem is that the consumers themselves seem to have low conviction, either because they expect more job losses in the pipeline or because income growth is a more important factor in spending patterns. Indeed, retail sales momentum has reached the lows seen in the 1998 crisis, when domestic confidence took a hit.
Policy measures such as Skills Programme for Upgrading and Resilience (SPUR) and the Job-Credit Scheme were rolled out late last year and earlier this year, respectively, and with only 1Q09 jobs data available, the jury is still out on how effective these measures have been. However, if the seeming resilience of the labour market is being supported merely by the lagged nature of capex, and not by other structural factors such as stronger corporate balance sheets supporting stronger employment ability, we suspect that the labour market disconnect would be temporary and job losses could soon catch up when the capex recession invariably intensifies.
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Rates to Test New Lows, Fiscal Deterioration Main Medium-Term Risk
May 22, 2009
By Pasquale Diana | London
On May 15 we attended the CNB presentation of the May Inflation Report to analysts. We also had separate meetings with members of the research department. Our views from our trip are below.
GDP outlook bleaker, compounded by bad 1Q results: The Czech National Bank revised down its expectations for both GDP and inflation, and now sees an overall GDP contraction of 2.4%Y (previously -0.3%), followed by a more pronounced upturn in 2010 (+1.4%Y, up from +0.9% previously). Note that the weaker-than-expected 1Q GDP release, published after the cut-off date, introduces significant risks to the forecast: assuming an unchanged quarter-on-quarter profile, GDP growth in 2009 would be almost a full percentage point below the recently published forecast. Note also that the CNB assumes (correctly, in our view) that the car scrappage incentives are simply borrowing from future growth rather than adding to the overall level of GDP.
On the inflation side, the bank maintains that the overall macro environment remains pro-inflationary (due to lagged effects of previous FX depreciation), but the economy has clearly turned anti-inflationary, with abundant slack and weak labor markets pushing down domestic inflationary pressures. Overall, a weaker FX, a higher inflation starting point but a weaker economy imply higher inflation in 2009, but lower inflation in 2010. Also, regulated prices are expected to exert a major anti-inflationary effect in 2010, with regulated price growth turning negative for most of 2010.
Fiscal deterioration is main medium-term risk: During our conversations, it transpired that the fiscal risk is the one most currently underestimated by the markets. True, the Czech Republic continues to have low government debt (33% of GDP this year) and has run very small fiscal deficits over the recent period. However, the expected change in the deficit is dramatic, with the gap likely to widen by nearly three percentage points, to 4.3% of GDP in 2009 (and further to 5.4% in 2010), according to the central bank. We note that the European Commission has similar projections. True, the CNB assumes that some anti-cyclical fiscal easing will be put in place this year that has not been approved yet, but this assumption seems very reasonable to us. And it is unlikely that any fiscal tightening gets approved before the parliamentary elections later this year. In short, it seems as though the Czech Republic will have the most expansionary fiscal stance in 2009 in Central Europe (indeed, the only one, albeit marginally). This is good for growth, but less so for budgetary dynamics. The Czech authorities we met also appear concerned regarding fiscal deterioration elsewhere (Western Europe) and believe that the wall of government bond supply set to hit markets in the coming quarters may both crowd out private investment and make it difficult for the Czech Republic to finance its own deficit. This should continue to pressure long-term yields, we think.
More rate cuts possible, rates to test 1%; no QE in sight: Rates are already at an all-time low, and our view prior to the trip was that rates had reached a bottom. We now see risks tilted towards more near-term cuts. The 1Q GDP data were a clear downside surprise, and several on the CNB will revise down their growth outlook, we believe. Senior board members like Singer and Hampl have also signaled over recent days that the door remains open for further rate cuts. We warn that any further easing will be limited and rates are unlikely to be cut by more than a further 50bp at most (1% trough). Note that the current inflation forecast is consistent with 3M PRIBOR at 1.7% by year-end (currently 2.1%), so the bank expects further falls in interbank rates. These can come via either a drop in the liquidity premium, or a fall in base rates, or both. The central bank does seem to assume some fall in the liquidity premium, but it has already made it clear that it does not see the gap between 3M interbank rates and official rates as a sign that monetary policy is ineffective. On the contrary, it sees it as a reason to ease rates more. And given the macro backdrop, we believe that the CNB will err on the side of more rather than less easing. Importantly, we saw significant resistance to any suggestion of quantitative easing, which the CNB views suspiciously due to its potential monetary and inflationary consequences, and officials seem very skeptical as to its merits.
While further near-term easing is our new base case, we continue to think that the CNB will be the first central bank in Central Europe to start reversing the rate cuts, tightening rates in early 2010. While this is in part predicated on our ECB view (75bp of hikes next year), we also note that the CNB is the most proactive central bank in the region, and we think that it will not hesitate to start taking rates to a more neutral level if our forecast of a recovery later this year and in 2010 materializes. We therefore forecast Czech rates up to 2.25% by end-2010.
Risks to our view: CZK, wages on the upside; growth on the downside: The CNB has been highly sensitive to the exchange rate. Two months ago, senior board members were talking about rate increases to stem CZK weakness. Thus, no forecast of Czech rates is immune from risks from the FX side. We think it is unlikely that CEE currencies undergo the same sort of stress that we saw in the first quarter: we are past the worst point for growth, risk appetite has improved and investors better understand the true funding needs of the region and the degree of official support which is available. Even if an episode of risk-aversion were to take place, we think there is now a much greater understanding that the Czech Republic is in a structurally superior position to any of its CEE peers (in terms of stability of banking system, vulnerability of borrowers to FX swings, external debt profile). As a result, the koruna should remain relatively more insulated, we believe. We see CZK moving broadly sideways (with a bias to strengthen) until year-end and resuming its appreciating trend versus EUR in 2010 (24.50 by year-end).
Perhaps a more serious upside risk is wage growth. Conditions in the labor market are changing dramatically, with the unemployment rate up 2.8pp since last summer, more than in the rest of Central Europe, due to the Czech Republic's extremely high relative exposure to industry and construction. Wage growth was rather sticky up to 4Q08, at 8.3%Y, which had kept ULC growth quite high, in the region of 6.2%Y. For this year, the CNB expects a significant slowdown, with wage growth down to 1.1%Y by the end of 2009 (and ULC growth at 0.8%Y). The first months of data for 2009 do provide some indication that wage growth is easing sharply: for example, industrial sector wages were up just 1.3%Y in 1Q09, down from 6.0%Y in 4Q08. The degree of labor market adjustment assumed in the CNB forecast seems very high indeed. However, Czech firms can dramatically lower labor costs by shortening the workweek: for instance, moving the workweek from five days to four would cut wages by 8% (only 60% of the fifth day is paid). There is sufficient flexibility in labor contracts to implement measures like these fairly easily.
The main downside risk to our view that rates go up relatively quickly in 2010 is of course the economy. A prolonged period of stagnation could leave rates on hold for longer than we currently expect. Being one of the most open economies in the CEE, the Czech Republic is very geared towards global trade, so the external outlook is absolutely key. Elga Bartsch, our euro area economist, notes that the improvement in the surveys is consistent with gradual economic recovery, but stresses that growth is likely to remain sub-par next year. Note also that IMF studies show that the ongoing recession is likely to be a long and severe one, due to its roots in a financial crisis and its globalized nature.
Bottom line: A weaker-than-expected growth outturn in 2009, the unconvincing nature of the recovery and falling inflation, together with receding chances of CZK weakness, will keep the CNB biased to ease in the next few months, we think. While the scope for further rate cuts is not large, we now see the bottom at 1% (previously: 1.50%). We also think that fiscal risks are currently being underestimated and long-term yields are likely to remain under pressure due to fiscal easing, widening budgets and increased government bond supply. While the yield curve has steepened substantially already, we think it has scope to steepen more.
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