An Economic Update: Troubling Times in the Global Economy

The global economy continues to rank among the leading concerns of managing partners, and going by press reports over the last two weeks or so, it is of no wonder. A tour of the globe illustrates how many competing economic concerns are playing on the minds of law firm leaders.

Eurozone Concerns Continue

June saw the release of economic data for the first quarter of 2012 for a number of jurisdictions, as well as the latest unemployment figures in the U.S. In most cases, they were not pleasant reading, with a blend of uncertain growth across many key economies and a rising risk of financial meltdown in the Eurozone. The U.S. and Europe continue to be affected by stalling recoveries*, economic bail-outs and double-dip recessions† (registration required).

Europe’s sovereign debt crisis persists and is a main cause for concern. This week began with Spain seeking assistance in the form of €100bn in EU rescue funds to recapitalize troubled domestic banks. This has brought the prospect of a further EU economic bail-out, this time for Europe’s fourth largest economy, one step closer. Concerns regarding the stability of Italy remain, while Greece also goes to the polls this Sunday. Could a Greek exit from the Euro be a real possibility if an anti-bailout/austerity coalition is elected?

Impacts on Emerging Markets

This continued economic unrest is beginning to reverberate elsewhere, with economies weakening around the world. China, India and Brazil, although not immune to the global financial meltdown, were able to weather the initial crisis far better than the West. This relative economic prosperity provided many international law firms active in these regions a safety valve for growth. However, the latest figures published for the first quarter of 2012 by The Economist indicate that these emerging markets are cooling.

Brazil’s output grew by only 0.2% quarter on quarter and has led the government to announce a series of stimulus measures. Even assuming an up-tick in the second half of 2012, Brazil’s GDP is now forecast to grow at a slower rate than first thought (2.7% down from an estimated 3%).

India’s growth rate has also fallen to its lowest level in seven years, down from a near double-digit rate experienced pre-global recession, to 5.3%. High government borrowing, high inflation and dearth of private investment have been having an impact, as well as a lack of much needed political reforms.

That brings us to China – to date the success story of the global economy. As recently as 2007, the Chinese economy was growing at 14.2% a year. GDP growth was down to 9.2% in 2011, and dropped further in the first quarter of 2012 to a surprisingly weak 8.1%. Officials at China’s National Development and Reform Commission have indicated that the second quarter is expected to be weak also with GDP growth likely to fall below 8%. Lower external demand for China’s exports has been cited as a key reason for the drop. In March the government announced a target of 7.5% GDP growth for this year and an average of 7% until 2015. This fairly sudden softening of economic growth has prompted some to question China’s ability to continue providing the growth engine for the global economy that it has managed thus far.

Silver Linings?

A global recovery faltering so soon after the previous recession is worrisome to say the least and suggests the global economy will remain idle in the near term. It will mean that law firms will need to continue to focus on winning market share from competitors to achieve top-line growth, rather than hoping for any up-tick in demand levels.

However, it’s not all doom and gloom. Although economic growth has slowed in China, this is not necessarily viewed by all as a negative. Fear of an overheating economy had led some to speculate that lower GDP growth levels in China may allow for more stable, consistent long-term growth, rather than a ‘bubble’ forming. Furthermore, China relies very little on foreign borrowing, continues to have strong investment rates and a high saving rate (51% of GDP). China’s banks are highly liquid and its state-dominated financial system means it is well placed to deal with repayment delays or defaults, so the economic softening is unlikely to lead to anything near as calamitous as the current sovereign debt crisis in Europe.

Chinese industry has also been focused on expanding internationally and a recent report indicated that this trend has continued in the first quarter of 2012 with the value of out-bound deals increasing over 100% compared with the same period in 2011. Acquiring strategic assets overseas and hedging against reduced domestic growth has driven Chinese companies to used their relatively cash-rich position to make acquisitions in South America and Europe, predominantly in the energy and resources sector.

This continued increase in out-bound work presents opportunities for law firms in markets targeted by Chinese companies and has led to a refocusing of China strategy for a number of firms. Strategies have switched from servicing predominantly in-bound investments into China by foreign companies, to also include advising China-based companies on their international acquisitions and investments. It has also been driving a greater international focus of domestic law firms, a previous topic of our blog.