Year: 2010

Champagne makers signal return to growth

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Remy Cointreau, which makes Piper-Heidsieck champagne, said sales of champagne rose 23 percent to 16.7 million euros ($21.3m) in its fiscal first quarter to June 30. Vranken-Pommery said sales rose 52 percent to 66 million in the quarter.

“Because of the crisis, consumers temporarily switched to cheaper brands. This phenomenon is now receding. We’re seeing a move back to the major brands and cuvees de prestige,” Vranken-Pommery Chairman Paul-Francois Vranken said.

Vranken-Pommery said it was optimistic about all of its champagne brands for the rest of the year, adding that the first half had seen “an end to the crisis for champagne”.

Remy Cointreau said it was seeing renewed growth in champagne, particularly in its domestic French market and Europe, against the backdrop of an ongoing uncertain economic environment.

Rival champagne maker Laurent-Perrier posted a 17 percent rise in sales to 36.8 million euros for the quarter to June 30 on Tuesday, boosted by exports to the UK, the US, Germany and Asia.

The performance showed demand was picking up, and customers would continue to turn towards more expensive bottles over the coming quarters, the company said.

Remy Cointreau, which has a market value of around 2.2 billion euros, makes about one-tenth of sales from champagne, whilst the majority of revenue comes from cognac.

The company said overall group sales rose 24 percent to 171 million euros in the fiscal first quarter, including a 43 percent rise in cognac sales to 91 million euros, driven in particular by growing demand in China.

“The good growth by Remy Martin (cognac) continued to benefit from the highly positive dynamics in China and in travel retail, as these two markets recorded the strongest growth. The US and Europe also increased,” the company said.

Overall, there was growth in all regions apart from Japan, Remy Cointreau said. The US had modest growth, while Russia and the UK underpinned growth in Europe.

China visible in eurozone bond buys – EU trade chief

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“China’s presence in Europe is visible across the board whether in China’s recent purchase of several hundreds of millions of euros of government bonds in the eurozone, particularly Spain or Greece, or in other large-scale investments too, such as the acquisition of Volvo by the car maker Geely,” European Trade Commissioner Karel De Gucht said.

Speaking at the Shanghai World Expo, he said he was confident Europe’s salvage package for 860 billion euros ($1,097bn), has been very effective in easing the sovereign debt crisis.

“I am quite confident that the euro is in good shape again.”

The trade chief added that the eurozone bonds China had been buying from Spain and Greece were a good investment and would keep their value.

He estimated that China had spent around 420 million euros buying Spanish and Greek bonds, but could not confirm it.

“There is no risk at all to the Chinese treasury.”

Global concerns over China’s protection of intellectual property has flared up in recent months and De Gucht said European companies were becoming increasingly worried.

Indigenous innovation policies, where China encourages government departments to buy locally made products from Chinese companies, would force European firms to register as a Chinese company in order to get access to the public procurement market.

However, De Gucht said China had already started to respond.

“Some changes were made to the indigenous innovation legislation that is certainly accommodating to a certain extent some European worries,”

China has revised its offer to join the World Trade Organisation’s government procurement agreement. De Gucht said the opening up of the public procurement market would help resolve the ongoing Doha saga if a substantial package was reached.

“The proposal that China has been putting on the table is largely insufficient, so we think additional offers should come on the table,” he said, without specifying what they should be.

Rare earths
Access to China’s raw materials is a hot topic in Europe and De Gucht said the current case the EU had against China was a case they would win at the WTO.

“We have a lot of understanding that a fast-growing economy needs a lot of raw materials but it is not the right way because it creates monopolies which distort the market.”

China holds about 90 percent of the world’s reserves of rare earth materials, which are used in a number of electronic devices, digital displays and military applications.

Foreign traders, manufacturers and military strategists have grown increasingly vocal about Chinese moves to reduce the volume of exports of rare earths.

However, China says export controls prevent wasteful exploitation, support volatile international prices and encourage high-tech manufacturers to shift operations to China, where rare earth prices are cheaper.

China will not block exports of rare earth metals, premier Wen Jiabao told a German trade delegation earlier in July.

IMF: Low oil price a risk to Gulf region growth

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In an updated report on GCC member states the IMF urged countries to prepare exit strategies from the current high spending levels but not to implement them until economic conditions were right.

The IMF revised up its growth forecast for non-oil growth for GCC states to 4.3 percent, higher than the 4.0 percent it forecast in May.

GCC states include Saudi Arabia, UAE, Kuwait, Oman, Qatar and Bahrain.

The IMF said challenges in the financial sector in GCC states may restrain growth in the short-term but those problems remain manageable and should not undermine long-term prospects.

It said banks’ capital adequacy ratios “remain strong and there are strong indications on profitability”.

IMF staff analysis of listed non-financial corporates shows that at the end of 2009 GCC corporates had adequate capacity to service their debt obligations, the report said.

The report said regional spillovers from the Dubai debt crisis were minimal although noted there was persistent uncertainty about Dubai.

Still, the IMF urged the Dubai authorities to complete the planned debt restructuring of debt-laden conglomerate Dubai World and to determine the full breath of potential problems in other government-related entities.

“The impact from financial developments in Dubai and Greece should continue to have limited effect on the GCC countries, and substantial foreign assets are available to mitigate the impact of new shocks,” the IMF added.

It said Greece’s debt crisis had heightened uncertainty over the strength of the global economic recovery, which had caused oil prices to fall and increased volatility on equity markets.

South Africa faces hard choices to solve jobs crisis

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But reforming labour markets, one obvious way to help narrow the gap with other emerging economies, will not be easy given the political clout of a union movement that was instrumental in bringing an end to white-minority rule in the 1990s.

“You need a much more flexible labour force but the unions are still very powerful,” Mthuli Ncube, chief economist at the African Development Bank, said.

“How do you tell the unions, ‘Don’t ask for more wages, don’t unionise?’ They’re such a big political and social force. I don’t know how you deal with that.”

Similarly, boosting the export sector by weakening the rand, a proposal endorsed by the OECD, risks stoking inflation and scaring off the foreign capital needed to pay for much-needed infrastructure.

It is a hard choice, but there is a growing realisation in the upper echelons of the African National Congress (ANC) that something has to be done.

Since a spike in employment in the six years that followed the end of apartheid in 1994, the number of jobs in Africa’s biggest economy has plateaued, despite annual growth of around five percent from 2002-2007.

Now, after the first recession in 17 years, the official and narrowly defined rate of unemployment stands at 25 percent, a source of much newspaper comment and ANC hand-wringing.

It is, however, the least worrying set of jobs data.

As a simple percentage of its 17 million-strong workforce, South Africa’s unemployment is actually around 45 percent, and has never been below 40 percent since 2000.

Such stagnation points to its workforce being one of the world’s least productive, and a principle reason the economy struggles to grow faster than between four to five percent a year – speedy when compared to Europe but anaemic alongside Asia or more dynamic African ‘frontier’ markets such as Nigeria, Ghana or Uganda.

Of rich and emerging economies in 2008, only Turkey fared worse in terms of labour usage, with one in two of its workforce idle, according to the OECD.

Brazil and Russia, two ‘BRIC’ economies that South Africa likes to regard as its emerging market peers, have broad unemployment of only 25 percent, the Paris think-tank says.

More exports
So what can be done to drag the millions of jobless South Africans, most of them young, poorly educated and black, into work and, ultimately, tackle crime and yawning inequality?

The ANC is already pumping a whopping 20 percent of its budget into education, and large amounts into job training, to address a shortage of skills, but it also knows the economy must provide jobs for people once they do leave school.

One solution is to refocus the economy on exports, especially in labour intensive sectors like clothes and electronics, rather than the coal and gold shipments that have been South Africa’s staples for decades.

The ANC has also seen the sense of selling to the faster growing economies of Asia, South America and Africa, rather than the traditional markets of Europe and the US that will see only weak growth in the next few years.

“South Africa needs to look for alternative export markets, such as Africa, and other fast-growing emerging economies, where our comparative advantage is good,” Finance Minister Pravin Gordhan told reporters.

To this end, Gordhan wrote of the need to reform “network industries”, basically the underinvested and overstaffed state firms running South Africa’s ports and railways.

But more trade with the likes of, say, China and India, the other two members of the BRIC quartet, means more competition, and in terms of labour costs South Africa fares poorly.

The average monthly salary, including overtime and benefits, is 6,400 rand ($830), according to Statistics SA.

By contrast, this year the official average monthly wage for a city worker in China has been 1,783 yuan ($263) and a menial entry-level factory worker could be on a third of that, albeit with food and dormitory accommodation thrown in.

Weaker rand or lower wages?
Such comparisons throw the spotlight on arguments from South Africa’s unions to boost exports by weakening the rand, whose value has been underpinned in the last year by foreigners buying up local stocks and bonds.

COSATU, the union federation that forms part of an official ANC-led government alliance, wants an end to the rand’s free float in favour of a fixed rate of 10 to the dollar, compared to its current 7.6.

Yet even at this level the improvement in raw labour costs against China would be marginal, and the central bank is wary of the inflation that would inevitably result.

All of which points to the labour market as one of the few avenues left open to reform, essentially by making it easier for employers to hire and fire workers.

Yet it is a brave president who takes on unions who still wield huge social and political clout due to their prominence in the struggle against apartheid, and during his first year in office Jacob Zuma has tended to favour consensus over conflict.

Gordhan avoided the issue of labour reform, but in a major report the OECD made clear its belief that the ANC and unions’ perfectly laudable desire for “decent work” was at the expense of wider job creation.

Such comments, alongside an avalanche of research on South Africa during and after its successful hosting of the World Cup, may yet provide the impetus for long-term and radical change.

The alternative is a South Africa stuck on a “spluttering trajectory” well below emerging market rivals, political analyst Alec Russell wrote recently.

“South Africa’s economy has been utterly outstripped by the ‘southern’ giants of China, India and Brazil,” he said.

IMF should be realistic about Hungary deficit-Kosa

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The IMF should be realistic when considering a deficit target for Hungary for 2011, ruling Fidesz party vice chairman Lajos Kosa has told public television m1.

When asked in an interview whether lenders’ expectations for Hungary to cut its deficit to 2.8 percent of GDP next year from a target of 3.8 percent in 2010 was too strict, Kosa said:

“It is obvious that Hungary’s situation is one of the most difficult of all member states in European Union. In such a situation, expecting us to run the lowest deficit …. they can say that, but this will not work.

“The IMF must be mindful to remain grounded in realities.”

A review of Hungary’s Ä20bn IMF/EU funding agreement signed in October 2008 was suspended on July 17 after lenders failed to get sufficient clarity of the new centre-right Fidesz government’s future economic policies.

Prime Minister Kosa told public television that Hungary, which has been under the EU’s excessive deficit procedure since joining the bloc in 2004, would at some point cut its deficit below three percent of GDP but declined to say when it would do so.

“We will achieve this and this is our intention,” Kosa said. “As to what numbers next year’s budget will contain, that will be revealed only when we submit it (to parliament in October).”

Argentina’s import curbs threaten to bite back

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The South American nation, which saw exports rise 25 percent year-on-year in May, responded to the global financial crisis by limiting imports of shoes, fresh fruit and other goods that it also produces.

The curbs, designed to protect jobs and boost local production, range from administrative delays at borders and in customs to anti-dumping penalties on goods such as steel products and textiles.

China has stopped buying Argentine soy oil in response to the restrictions.

Separate complaints from the EU at the World Trade Organisation and from Brazil, the top destination for Argentine exports, have raised concerns that Argentina’s protectionist stance could backfire.

“Argentina is creating a certain amount of tension with its informal and formal commercial policies,” said Dante Sica, a trade expert with the Buenos Aires consultancy Abeceb.com. “There are always risks of retaliation.”

Frustrations about the Argentine measures have also soured negotiations to open up new markets for Argentina’s producers, including talks on an EU-Mercosur accord that would create the world’s largest free trade zone.

For the time being, Argentine exports are faring well.

Its soy oil producers have found new customers in India, Bangladesh and Peru and are enjoying a bumper harvest. Argentine exporters of grains, cars and consumer goods also are finding plenty of customers, especially in Brazil.

Enrique Mantilla of the Argentine Chamber of Exporters told reporters that Argentina’s exports were set to increase 17 percent this year from a year ago.

He said it would take a long time for Europe’s complaints to work through WTO mediation, and described the chance that other countries would retaliate, as China did, as slight.

“(Exporters) are mostly preoccupied with the facts. Today it is a problem of imports not exports,” he said of the Argentine border measures.

Protectionist
Argentine Economy Minister Amado Boudou has defended his government’s trade measures as helping “to preserve the quality of life among Argentines” and said: “Europe has farm subsidies, and the countries that champion free trade also have restrictions.”

But with Argentina’s economy recovering well, in part due to the strong sales to Brazil, economists said it was unlikely other countries would continue to accept what they see as unfair treatment of their goods.

“It is difficult to justify, today, with Argentina’s current volume of trade,” Abeceb.com’s Sica said. “Maybe last year there was less criticism from other countries, but today there is less tolerance with protectionist measures.”

Last month, European farm ministers said Argentina’s curbs on imported foods threatened the drive for a EU-Mercosur deal that would link the European bloc with Brazil, Argentina, Paraguay and Uruguay, covering trade valued at 65 billion euros ($82bn) a year.

Roberto Bouzas, an economics professor at Argentina’s San Andres University, said the country’s defensive trade stance would be just one thorn in the side of those negotiations, which restarted in May after a six-year hiatus.

“Without a doubt it complicates things. But the obstacles to an agreement go far beyond that individual problem.”

The long-sought deal has faced strong opposition from environmentalists, lawmakers and farmers in Europe who fear an influx of food imports from South America.

Boris Segura, senior economist for Latin America at RBS Securities, said Argentina needed to “play ball” and be clear about the restrictions it is imposing to avoid losing access to the markets that were key to its exporters.

“The main complaint from these trade partners is the arbitrariness of the (Argentine) barriers,” Segura said.

Companies working to bring goods into Argentina would also prefer clear trade policies to the current makeshift mix, said Miguel Ponce of Argentina’s Chamber of Importers.

“Obviously we support the return as soon as possible to an open trade policy,” Ponce said. “We would like to see everything normalise.”

Africa equity funds end 44-week inflow streak

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A 44-week streak of inflows to funds investing in emerging and frontier equities in Africa has ended while inflows to South Africa have risen, fund tracker EPFR Global said.

EPFR Global had recorded net inflows of over $480m to African regional funds in the first half of the year, an indication of investor appetite for the fast-growing continent.

But the fund tracker said that the long stretch of inflows ended in the week ending July 14.

“Flows into (Europe, Middle East and Africa) Equity Funds were, for once, not driven by investor interest in the commodities story of Russia and Africa, with Africa Regional Equity Funds seeing their 44-week inflow streak come to an end,” it said.

“The focus shifted to South Africa and Turkey. South Africa Equity Funds had their best week since early April while Turkey Equity Funds attracted $26m, a 13-week high.”

It gave no figures for net flows to Africa or South Africa.

Philippines may raise taxes

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Asia’s largest sovereign issuer of offshore bonds may post its second successive record budget deficit this year, and the key factor that will determine how markets react to the election result will be whether the winning candidate tackles the fiscal situation with sufficient urgency and resolve.

Most analysts say markets should not be too ruffled in the meantime if candidates pledge not to raise taxes or impose new revenue measures. Such promises are highly unlikely to be kept.

“Any candidate who … promises no new taxes is going to eat his words,” said an economist at a large local bank. “It’s going to happen, otherwise we could lose the confidence of investors.”

The four leading presidential candidates in the May polls have all promised measures to boost the tax to GDP ratio, estimated at a five-year low of 12.8 percent last year, but most of them have given scant details on how they will do it.

Of the four, frontrunner Benigno Simeon Aquino III and former President Joseph “Erap” Estrada, ranked third in opinion polls, are the only ones who have declared they would not impose new taxes or raise tax rates and would instead focus on plugging tax leakages that have kept state revenues low.

But Aquino softened his stance in February when he told reporters he would consider raising taxes if the budget gap was not quickly cut by a crackdown on tax evasion.

Aquino was aiming to soothe market worries that he did not grasp the urgency of raising state revenues. Analysts and traders say they largely ignored his first statement on taxes in January because they did not expect him to stick to it if he won power.

But if the next president does try to avoid new taxes, this will be punished with a sell-off of Philippine assets by markets worried about the precarious fiscal position.

Intensive care
“The government is like a patient in an intensive care unit and it needs to raise taxes as the prescribed medicine to recover fast,” Jonathan Ravelas, chief market strategist at Banco de Oro Unibank, told reporters.

Traders say offshore investors would sell out wholesale from the Philippines if there was any sign the next president will introduce drastic changes to economic policy that quickly show positive results via higher state revenues.

“Remember, especially the offshore investors, they don’t care what happens to the country. They only want to make sure that they get paid,” said a treasury official at a foreign bank. “The moment you inject some scepticism on the ability of this country to pay, they will dump you while they can.”

The Philippines’ five year credit default swap spreads are trading at 162 basis points compared to a weighted average of 120 for the Thomson Reuters Emerging Asia Index. Spreads have come down from a peak of 217.5 basis points this year after the official campaign period kicked off on February 9, but traders say they will quickly widen again if the likely election winner does not set out a clear economic plan.

Yields on Philippine sovereign bonds due in 2020 are hovering at three-month lows, suggesting that investors do not expect a fiscal blowout in the near term after the country completed its planned 2010 foreign debt issues of $2.5bn pesos ($54.79m) just two months into the year.

But ratings agencies may downgrade the country’s sovereign credit from the current two notches below investment grade if Manila doesn’t raise revenue collection soon.

The government is likely to incur more foreign and local debt to fund its budget deficit, thus reversing gains made since its 2005 tax reform programme.

But there is minimal risk for now of a Greece-style panic that that Manila would default on its debts. It has reduced its debt-to-GDP ratio to around 57 percent from a peak of 78 percent in 2004.

More tax reforms
All the top candidates also espouse stamping out a deeply entrenched culture of corruption at revenue agencies to improve tax collection, but analysts say such a lofty ambition would take years to implement and major results are unlikely to be seen in the first six months of the new administration.

Finance Secretary Margarito Teves said the low revenue base would make it difficult for the new government to fund higher spending on badly needed infrastructure upgrades and better social services, suggesting more tax reforms might be necessary, especially after the government passed several new laws, with others still pending, seeking to give tax exemptions.

Teves partly blames lost revenues of 49 billion pesos from tax exemptions imposed last year for the record 2009 budget deficit of 298.5 billion pesos, or 3.9 percent of GDP. Manila was hoping to limit its shortfall last year to 250 billion pesos.

Some analysts expect Manila’s budget gap to exceed 300 billion pesos this year, another record high.

Economists say the next government could raise revenues by tweaking excise taxes on alcohol and tobacco. VAT of 12 percent could also be raised to 15 percent, a proposal administration candidate Gilberto Teodoro wants to adopt in exchange for lowering individual income and corporate taxes.

Former Philippine economic ministers have said there is room for substantial cuts in the funding allocation for pet projects of legislators, more widely known as pork barrel, and in the spending subsidies given to local government units.

The Philippines avoided a possible financial crisis in 2005 when President Gloria Macapagal Arroyo raised the VAT rate to 12 percent from 10 percent and expanded its coverage to include electricity and petrol sales.

That helped cut the budget deficit to 68 billion pesos, or 0.9 percent of GDP, in 2008 from a 2002 peak of nearly 211 billion pesos, or 5.3 percent of GDP. But the shortfall ballooned again last year when corporate incomes dropped due to the global economic crisis and as Manila spent more on infrastructure upgrades and social services to pump prime the economy.

Moody’s downgrades Ireland, outlook stable

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Moody’s has downgraded Ireland’s sovereign bond rating by one notch to Aa2, citing weaker growth prospects and the high costs of rebuilding the country’s crisis-hit banking system.

The rating agency, which cut Ireland from Aa1, said the outlook was stable.

The move, which put Moody’s on par with rival agency Standard and Poor’s AA rating and still one notch above Fitch, comes a day before Ireland plans to sell bonds worth between Ä1bn and Ä1.5bn at its regular monthly auction.

“Today’s downgrade is primarily driven by the Irish government’s gradual but significant loss of financial strength, as reflected by its deteriorating debt affordability,” Dietmar Hornung, a Moody’s vice president and lead analyst for Ireland, said in a statement.

Moody’s said it expects Irish economic growth to be below historical trend over the next three to five years. It said banking and real estate – engines of growth in the years preceding the country’s crisis – would not contribute meaningfully to overall growth in the coming years.

The IMF recently said Dublin would not meet a European Union-agreed deadline to reduce its budget deficit to three percent of GDP by 2014, a day after a think tank forecast that bank bailouts could expand this year’s budget deficit to almost 20 percent.

“The timing isn’t great, given the bond auction tomorrow and certainly this will add to the premium that will need to be paid to raise money,” Alan McQuaid, chief economist at Bloxham, said.

“While some it may be justified I think some of it is over the top.”

The spread of Irish 10-year bonds against their German equivalent widened on Monday to 300 basis points, their highest since July 2.

AgBank closes mega IPO with tepid HK debut

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Agricultural Bank of China’s $19.3bn IPO crossed the finish line on July 16 after a hectic three-month sprint, notching up modest gains in its Hong Kong debut amid concerns about valuations and glut of bank share sales.

Industrial & Commercial Bank of China and Bank of China both soared 15 percent on their Hong Kong openings after listing in 2006. Founded in 1951 by Mao Zedong as the rural unit of the central bank, AgBank is the last of China’s “Big Four” state-owned lenders to list its shares.

“Even though the response from the retail side was a bit disappointing, it was well received by institutions, so this was expected,” said Ben Kwong, the chief operating officer of securities firm KGI Asia Limited. “The chances of further upside will be relatively small.”

Kwong’s view on lack of upside was shared by several analysts and traders, aware that AgBank, historically the weakest of China’s top four banks, is going public during a sliding stock market.

Still, the lender pushed ahead in a down market, published figures that forecast a profit and a pared down bad loan book.

Hong Kong’s Hang Seng is down about eight percent in the three months since the AgBank IPO kicked off, while the Shanghai Composite has shed almost a quarter.

AgBank’s IPO could still rise to a world record $22.1bn if additional shares set aside in an over-allotment option are sold in the coming weeks. Should the stock come under pressure in Shanghai and Hong Kong, underwriters are expected to purchase shares to help stabilise the price.

Its soft debut bodes ill for upcoming fundraisings by peers including ICBC and BoC, who are returning to capital markets to raise tens of billions of dollars to supplement their capital.

Who’s who
Top executives at the Beijing-based bank gave a crystal model of the company’s headquarters to the Hong Kong Stock Exchange.

Hong Kong’s top legislators, including CEO Donald Tsang, were on hand to watch, along with CICC investment banking head honcho Levin Zhu, Deutsche Bank CEO Josef Ackermann and other top executives at the companies involved.

Also present were the top investment bankers involved in the three-month process of selling the offering to mutual funds and arranging the cornerstone investors which accounted for $5.45bn of the Hong Kong IPO.

According to the bankers involved, the deal was remarkably quick but gruelling.

AgBank’s Vice President Pan Gongsheng is the man credited with leading the IPO process, having led ICBC in its record $21.9bn float in 2006.

Pan is known for running a rigorous deal, and he didn’t disappoint this time around. His team kept attendance records and daily reports on the performance of the 10 banks handling the IPO.

Valuation concerns
AgBank’s Chairman Xiang Junbo, a war hero and award winning script writer, was relaxed in the morning, eating breakfast alone at Hong Kong’s Shangri-La hotel before the listing.

Wearing a red tie, he only took three questions from the reporters at the listing ceremony, which disappointed the local media gathered there.

“After this listing, the bank will enhance its competitiveness in the market and its risk management,” he said.

 The timid start to AgBank’s life as a public company is attributed to several factors.

One is that AgBank’s IPO price was set at a slight premium to Bank of China in terms of price to book value. That may allow AgBank to raise the most money ever through the IPO, but some fund managers viewed the stock expensive, given that the bank was historically the weakest of China’s top four lenders.

With almost 24,000 branches and some 441,000 employees, AgBank has almost double the staff and twice as many outlets as BoC, but a similar asset base.

The offering price represents 1.65 times AgBank’s forward book value, just above BoC, but below that of ICBC and China Construction Bank.

China International Capital Corp (CICC), Deutsche Bank, Goldman Sachs, JPMorgan, Macquarie and Morgan Stanley are the banks handling the Hong Kong offering, along with AgBank’s own securities unit. CICC, Goldman and Morgan Stanley held the top role.

CICC, Citic Securities, Galaxy and Guotai Junan Securities handled the Shanghai portion.

Russia and Germany pledge closer economic ties

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Russia and Germany have pledged to strengthen economic ties as Russian President Dmitry Medvedev called Europe’s largest economy Moscow’s “key partner” for the future.

German Chancellor Angela Merkel said relations between the two states had taken a stride forward as she led a delegation of business leaders on a tour of Russia, China and Kazakhstan.

“Germany is our key strategic partner,” Medvedev said after meeting Merkel in the Urals city of Yekaterinburg, urging Germany to invest in Russia and help modernise its economy.

The Russian leader has called for warmer relations with the West as he seeks to diversify the Russian economy after the global economic crisis underlined its dependence on exports of energy and commodities.

Business deals signed during Merkel’s visit included an agreement worth Ä2.2bn ($2.8bn) for German engineering conglomerate Siemens to supply trains to Russian Railways.

According to Russia’s Customs Service, Germany was Russia’s biggest trading partner in 2009, just ahead of the Netherlands, with China in third place. The EU accounted for over half of Russian trade last year, and the US just 3.9 percent.

However, Germany’s exports to Russia have fallen sharply in the economic crisis, prompting German business lobbies to criticise the pace of Russian economic reform.

Merkel, who initially adopted a more reserved attitude to Russia than her predecessor Gerhard Schroeder when she took office in 2005, has increasingly warmed to Moscow, meeting Medvedev for the second time in just a few weeks.

“Relations between both countries are more intensive than they have been for a long time,” Merkel said, adding that it was vital the pair stepped up economic cooperation.

“We talked about how it would be good to have a few shining beacons out there to demonstrate that (economic) relations are not a one way street,” the chancellor said.

Lucrative deals
Merkel’s trip gave her an escape from a run of negative political developments at home, and a chance to trumpet the German economy’s recovery from a record slump in 2009.

Among the industry leaders travelling on her delegation were the bosses of Siemens, carmaker Volkswagen, planemaker Airbus, chemicals group BASF, retailer Metro and lender Commerzbank.

On top of its contract to supply trains, Siemens also secured a Ä1bn renewable energy joint venture with Russian wind power companies Rosteknologii and Rusgrido.

EADS unit Airbus won an order worth more than Ä2bn to deliver A330 planes to Russia’s Aeroflot, a source familiar with the deal said.

And Gazprom Bank will take a 30 percent stake in Russian-German energy agency Rudea. The bank, which has stakes in some 500 Russian firms, will fund energy efficiency projects, such as plans to update street lighting across the country.

Siemens has partnered with RZhD (Russian Railways), Russian power generators and medical groups for years, earning billions of dollars from RZhD alone.

It supplied RZhD with eight trains for its fledgling high speed link between Moscow and St Petersburg last year, and signed a 30-year maintenance contract for Ä630m.

The group will also build a research centre at Skolkovo – a technology hub set up by Medvedev to mimic Silicon Valley.

Economists

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 The tarnished Alan Greenspan
Architect of the now much-derided “Greenspan put”, he protected the US economy from the collapse of the dotcom stock market bubble by dropping official interest rates. However that action is also seen as fuelling the risk-taking that preceded the most severe financial meltdown in 75 years.

The global Jeffrey Williamson
An authority on globalisation this Harvard economics professor argues that the upheavals were much bigger in the 50 years between 1820-1870 than they are today. Back then, globalisation was triggered by migration, colonial expansion, and rapid industrialisation. In short, not that much different from now.

The long-serving Jacques Polak
As well as a 40-year career at the IMF, Polak was one of the last survivors of the 1944 Bretton Woods conference that created the post-World War II monetary system. As Dominique Strauss-Kahn observed in a tribute, he was “a leader of critical thought during the post-war evolution of the global economy”.

The much-misunderstood John Maynard Keynes
The widespread view that Keynes’s theories are behind “quantitative easing” policies adopted by most western nations in the wake of the financial crisis could hardly be more wrong. The champagne-loving Keynes did ground-breaking work on trade cycles and growth, but he always believed that printing money was highly dangerous and should be temporary.

The rigorous Friedrich A. Hayek
Winner of the Nobel Prize, the late Austrian-born Hayek has made a big comeback in the financial crisis because of the great debate over the role of public spending. Hayek argued that private borrowing was a far more effective stimulus than public borrowing. As he put it back in 1932, an economic recession was no time for “new municipal swimming baths”.

Allan H. Meltzer, scourge of Obamanomics
A long-term adviser to the Reagan and Bush administrations, 82 year-old Meltzer says “Obamanomics has failed”. A world authority on the monetary policy which lies at the heart of anti-crisis measures, the professor compares the sluggish results of the Obama stimulus package unfavourably with the quick turnarounds achieved by the corporate tax cuts of Ronald Reagan.

Arch-globaliser Deepak Lal..
Indian-born and Oxford-educated, professor Lal blames the current crisis on “financiers taking ever more risky gambles with the complicity of the government.” Much-admired for his bold, often contrarian views, he is also an apostle of globalisation who believes that its opponents can be loosely divided into Asians who mistakenly fear creeping westernisation or westerners who want the status quo.

Chris Edwards, enemy of public debt
A member of the Cato Institute’s influential think tank, Edwards predicts that today’s youth will pay an exorbitant price tomorrow for fast-rising public debt in the US and elsewhere. In a just-published study called Rising federal debt is fiscal child abuse, he warns that “federal policymakers are leaving a terrible fiscal legacy to the next generation, and a stimulus package would only make matters worse”.

Fearsome BIS economists Stephen Cecchetti, M.S. Mohanty and Fabrizio Zampolli
Ageing populations is the next big threat, say these economists in a March paper from the increasingly influential BIS. They warn that “drastic measures” are essential to reverse the future cost of age-related liabilities piled on top of sky-high official debt incurred in the wake of the crisis.

Fact-mongerers Carmen Reinhart and Kenneth Rogoff
The terrible twins of US economics, Reinhart and Rogoff, have concluded after spending the best part of a decade digging into the entrails of financial crises past and present that we’ve never had enough of the right kind of information to know exactly what’s going on. The former IMF economists are amazed at “how little [facts] the authorities have at their finger-tips”. Fortunately, they will make available to other scholars the voluminous data they’ve assembled for their big-selling 2010 book, This Time is Different: Eight Centuries of Financial Crisis.

Ukraine bows to IMF demands, raises gas prices

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Ukraine, bowing to pressure from the IMF ahead of a new loan deal, will take the painful step of raising gas prices for households from August, the government has announced.

Prime Minister Mykola Azarov said the 50 percent price hike, an unpopular move aimed at cutting the budget deficit, was necessary to secure a new $14.9bn stand-by facility from the fund.

“We have to tell people the truth. In these circumstances, we had no other choice than to agree with the IMF on financial support,” Azarov said at a televised government meeting.

“In talks with the IMF, the government defended its own vision of ways to combat the crisis and protect the people. But the creditor’s position is always stronger than that of a weakened country in need of support.”

Utilities such as gas supplies have benefited from Soviet- era subsidies in Ukraine which have kept prices at an artificially low level. Raising prices would reduce government spending on these subsidies but was likely to cause some discontent against the new administration of President Viktor Yanukovich.

The price hike will affect about 18 billion cubic metres of gas a year gas used for cooking in apartment blocks and heating in small houses. This represents a significant part of the 47-50 billion cubic metres the ex-Soviet republic consumes every year.

Tariffs for central heating, which accounts for another big slice of annual gas consumption, have not been changed yet.

Azarov said the government, which is committed to fighting poverty in the country, would widen the list of poorer households eligible for social security payments to partly offset higher gas bills.

Ukraine reached a preliminary agreement with the IMF on a new $14.9bn stand-by facility needed to plug holes in its budget.

Under the deal, it needs to reduce the consolidated budget deficit to 5.5 percent of GDP this year from the earlier projected 6.3 percent.

The Ukrainian government has to present a letter of intent to the IMF which should lead to approval of the deal by the IMF board and the unlocking of a first tranche of credit, possibly in August.

Total recall

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It is every manufacturer’s worst nightmare – the product that the company has spent millions developing, producing, marketing and shipping all around the world may have a fault. There is a risk that some of the products – maybe a few, perhaps many – could be harmful. The company faces a stark choice: voluntarily pull the stock off the shelves or the forecourt and ask customers to return items for an immediate refund, or wait until the authorities compel them to do so, while also making potentially sensitive product information public.

Either way, the costs can easily escalate into tens of millions of pounds and leave the company reeling. One has only to look at the current recalls in the motor industry to see how cripplingly expensive and damaging the whole process can be. Three separate but related recalls of automobiles by Toyota Motor Corporation occurred at the end of 2009 and start of 2010. Toyota initiated the recalls, the first two with the assistance of the US National Highway Traffic Safety Administration (NHTSA), after several vehicles experienced unintended acceleration. The first recall, on November 2, 2009, was to correct a possible incursion of an incorrect or out-of-place front driver’s side floor mat into the foot pedal well, which can cause pedal entrapment. The second recall, on January 21, this year was begun after some crashes were shown not to have been caused by floor mat incursion. This latter defect was identified as a possible mechanical sticking of the accelerator. Toyota also issued a separate recall for hybrid anti-lock brake software in February.

As of January 28, 2010, Toyota had announced recalls of approximately 5.2 million vehicles for the pedal entrapment/floor mat problem, and an additional 2.3 million vehicles for the accelerator pedal problem. Around 1.7 million vehicles are subject to both. Certain related Lexus and Pontiac models were also affected. The next day, Toyota widened the recall to include 1.8 million vehicles in Europe and 75,000 in China. By then, the worldwide total number of cars recalled by Toyota stood at nine million. As of January, 21 deaths were alleged due the pedal problem since 2000, but following the January recall, additional NHTSA complaints brought the alleged total to 37.

At the beginning of March General Motors announced that it is recalling 1.3 million small cars in North America because of a power steering problem that has been linked to 14 crashes. The firm said four models were affected – the Chevrolet Cobalt, Pontiac G5, Pontiac Pursuit and Pontiac 4. It said the fault meant that at low speeds “greater steering effort may be required”, but that the cars could still be “safely controlled”. GM blamed the fault on a supplier partially owned by Toyota.

On March 4 Japanese car group Nissan said that it will recall 540,000 vehicles, including some Titan full-size pickup trucks, to check and repair potentially faulty brakes or fuel gauges. The recall is focused on brake-pedal pins in 2008-10 model-year Titan pickup trucks, Quest minivans and Armada and Infiniti QX56 sport-utility vehicles. Nissan is also looking into fuel gauges in 2005-08 model year Titans, Armadas and QX56s and some 2006-08 model-year Frontier pickups and Pathfinder and Xterra SUVs.

Daihatsu, meanwhile, has told the Japanese Ministry of Transport that it will recall four models, including the Atrai and the Hijet, due to airbag problems. That recall covers 60,774 vehicles, while Suzuki will recall 432,366 vehicles focusing on two models, the Every and the Scrum, sold under the Mazda brand. The ministry said it normally gets about 300 auto recall filings a year from automakers and the recalls.

This is not the first time the US car industry has been hit with a major product recall. In the summer of 2001 former Ford chief executive Jacques Nasser had to testify before Congress about the safety of its 4×4 sports utility vehicle, the Ford Explorer. The hearings took place soon after the US NHTSA announced that 203 people had been killed in accidents involving Explorers with Firestone tyres. Ford replaced around 13 million tyres at a cost rumoured to be around $3bn. Soon after, Ford’s CEO was also replaced. Even as long ago as 1959 Cadillacs had to be recalled after the steering linkage (pitman arm) failed on many cars while making a 90 degree turn at 10 to 15 mph.

To some, the furore surrounding recalls is not always consumer motivated, although they might begin that way. According to Dennis Desrosiers, president of DesRosiers Automotive Consultants, product liability cases are often stoked by class action lawyers. “The US is a legal-driven society and the lawyers see very deep pockets in these original equipment manufacturers,” says Desrosiers. “In the case of Toyota, there are more than 40 class-action lawsuits and dozens of individual actions. And most of the talking heads in the media blasting Toyota have been lawyers involved in litigation. Since Toyota still has billions in the bank, these lawyers are extremely motivated – and have deep pockets to keep this going a long time,” he adds.

“What the public needs to understand is that vehicles have become so complex that it’s inevitable that every original equipment manufacturer will eventually be hit with a serious recall – with no exceptions,” says Desrosiers. “Most people don’t realise it but there are literally thousands of vehicle complaints filed with regulators each year. The vast percentage can’t be replicated, leaving open the question of whether there was a problem with car or driver. Many motorists can’t admit or don’t know they were at fault. Pedal misapplication – frantically pressing the accelerator, thinking it’s the brake – is a recurring issue on most brands. Poor emergency response by motorists is an even bigger problem, but elections aren’t won by telling voters that they are bad drivers.”

Of course, cars are not the only products that have been the subject of costly recalls. The Yo Yo Ball, a once-popular kids’ toy, had to be recalled in 2003 following at least 410 reports of near-strangulation of young children. The toy’s stretchy cord proved excessively dangerous to younger children who unknowingly wrapped it around their throats. Countries like Canada and the UK instituted outright bans of the product in 2003: Canada’s health department even recalled over 2,000 of the toys before its ban went into effect.

Food scares are among the most common product recalls. The Nestle Toll House cookie recall of 2009 arose from scares of an E. coli contamination that made several consumers ill after eating the dough in its raw, uncooked state. Fears of a more widespread contamination prompted Nestle to recall 300,000 packages of the cookies after the Wall Street Journal revealed a total of 65 reported illnesses (with at least 25 people being hospitalised in connection with eating the poisoned cookies, including seven with severe complications that could cause kidney failure). Some food scares have been particularly grim. A design flaw with boutique chocolates made for sweet-toothed South Korean and Chinese consumers was uncovered in August 2007 – the chocolates were laced with “little white worms”. What’s worse, the chocolates were actually counterfeits of a popular brand, and the worms were larvae of a common moth. Chinese businesses feared that the worm scandal would lead to a weakening of the already questionable “made in China” brand.

In the past five years Europe has become much more stringent in recalling or withdrawing products from the market, as well as making consumers aware of their associated dangers. In 2005 the General Product Safety Directive came into effect to improve the safety of consumer products. The directive can force European companies from all 27 EU member states to carry out a total recall of products deemed to put consumers at risk. The rules also allow the European Commission to make commercially sensitive information public if it believes that there is an unnecessary health risk relating to a company’s product.

The directive requires member states to ensure that producers place only “safe” products on the market and applies to all products intended for consumer use. While this definition includes products used in the context of service provision, such as hairdryers used in hair salons, gym equipment used in health centres and lifts in shops and offices, it could also include aeroplanes, trains and cars used for public transport.

The directive applies to both manufacturers and distributors. Both have a duty to “immediately” inform the authorities if they conclude that a product that they have placed on the market is dangerous, and must provide details of their response plans. Producers must also take “appropriate action” in the event of a product crisis, including withdrawing products from the market, adequately and effectively warning consumers and – as a “last resort” – recalling products from consumer hands. If they fail to do so voluntarily, national authorities can order them to take action. This means that producers must take steps to ensure that they are kept aware of any product risk and that their goods are sufficiently traceable. Relevant measures include compulsory product reference/batch marking and, if appropriate, sample testing, investigations and the maintenance of complaints registers.

From January 1, 2004, when the directive came into force in most other EU member states, up until October 1, 2005, when the UK enacted the rules, there were over 900 recall notifications on the European Commission’s website. These ranged from the usual faulty electrical goods to carcinogenic underwear from Slovakia and trumping figurines from Poland that contain cyclohexanone, a substance indicated on the EU’s list of dangerous substances.

Given the spate of product recalls – voluntary as well as forced – IT firms have realised that there is a growing market to provide products that will give greater assurance. Hewlett Packard, along with the Canadian arm of GS1, a non-profit organisation dedicated to improving supply chain efficiencies, launched a new cloud-based recall service late last year that can trace and remove potentially harmful food products from the supply chain.

According to HP, the GS1 Canada Product Recall service will run on its cloud computing platform for manufacturing, which allows companies to see and share information across the supply chain. Food and consumer products organisations can use the service to reduce errors, decrease the amount of time it takes to respond to a recall, and mitigate the costs associated with managing the recall process.

But relying on software may not be enough. Lawyers warn that companies should be under no illusion that the directive can be strictly enforced at the highest level. The European Commission, for example, has considerable powers to ensure compliance and enforcement.  National authorities must notify details of product crises and response measures to the Commission, which in turn disseminates that information to other member states. Where problems arise in a number of member states, the Commission may take steps at a Community level itself, including ordering that public warnings be given about risks posed by a product, requiring an EU-wide withdrawal or product recall, and imposing a temporary or permanent sales ban.

Furthermore, all information that is available to national authorities or to the Commission relating to risks to consumer health and safety will generally be made available to the public. In fact, the directive expressly provides that trade secret information may be disclosed, if necessary, to protect consumer health and safety.

As of March 5, 2010, there were a number of new additions to the EU’s RAPEX website, the rapid alert system for all dangerous consumer products. A number of baby clothes made in Bulgaria were ordered to be withdrawn from the market because there was a risk of strangulation as the hoods of the tops had functional cords included. A bicycle tyre repair kit from the Netherlands has been banned and the product withdrawn after the product was found to pose a chemical risk because it contains 14 percent by weight of benzene and 1.1 percent by weight of toluene, which do not comply with the EU’s safe chemicals rules. Fairy lights produced in China but marketed from Hungary have also been withdrawn from the market with a consumer recall ordered by the Commission as there is a danger of electric shock.

So far, most recalls (in Europe especially) have been made voluntarily by producers. But the costs can be phenomenal. In 2001 a shipment of Sony Playstation games consoles fell foul of Dutch law relating to the Restriction of Hazardous Substances directive in electrical and electronic equipment. Acting on a tip-off, customs officials seized 1.3 million Playstations worth $160m because their cabling contained too much cadmium. The company spent $110m replacing the parts. In the UK, Coca-Cola’s recall of its bottled water product Dasani in 2004 is estimated to have cost £50m. The overall costs of the Sudan 1 red food dye recall earlier this year are reported to be in the region of £100m.

The Association of Manufacturers of Domestic Appliances (AMDEA) says that product recalls can be massively expensive. This is because a recall – as opposed to a product withdrawal, which means clearing shelves and stopping sales – can mean manufacturers and suppliers having to personally visit individual consumers and retrieve the faulty goods. UK business lobby group the Confederation of British Industry says that affordable insurance coverage to deal with product recall is “hard to find”. Insurers agree that recall policies are not popular among most manufacturers and suppliers, although the market is growing.

A difficulty facing EU companies is that even though each member state will have implemented the directive into their own legal system, it is likely to lead to 27 different versions of the same legislation, with punitive measures varying from one country to the next.

Companies need to be aware that while their products may comply with safety standards in Germany, they might infringe Italian, Spanish, Dutch, Swedish, or Polish regulators even though the local law is based on the same directive. Because member states will have some latitude on how to implement the directive, there may be significant differences between different national safety regimes.

Experts say that companies should err on the side of caution. One lawyer says that companies need to wise up. “Many businesses will need to overhaul their product monitoring and crisis management capabilities to ensure they comply with international rules on product recalls as it is increasingly likely that regulators will become involved at an early stage and seek assurances about the company’s controls and the traceability of the products. There are going to be large penalties if companies fail to comply.”

The 10 worst product recalls of all time
1: Simplicity and crib deaths
More than 400,000 drop-side cribs made by Simplicity were recalled in July 2009 after an 8-month-old child in Houston suffocated. The Chinese-made cribs had a detachable side that easily broke, creating a gap between the side of the crib and the mattress where a child could potentially become trapped and suffocate. It wasn’t Simplicity’s first problem with the cribs. In September 2008, the company recalled 600,000 cribs of the same type; in 2007 a million older-model cribs were recalled after two children became trapped and suffocated.

2: Chinese milk powder
In 2008, China’s largest provider of milk powder recalled 700 tons of baby formula after one child died and more than 50 others developed kidney problems. Melamine, a chemical used in the making of plastic, was found in the baby formula; it later emerged that unscrupulous manufacturers had been adding it to food products to cheaply boost protein values. Two men were eventually sentenced to death for their role in the scam. The revelations only further damaged China’s reputation in production. Melamine had been a problem a year earlier, in March 2007, when the FDA recalled more than 60 million cans of cat and dog food after the death of 14 pets.

3: Merck’s Vioxx
On September 30, 2004 pharmaceutical giant Merck announced it would voluntarily recall its worldwide stock of Vioxx, an arthritis drug that had brought in $2.5bn in sales the previous year. Merck executives said the recall was a precautionary measure spurred by a study that found patients who took the drug for at least 18 months incurred more heart attacks and strokes. However, in 2007, Merck paid $4.85bn to settle 27,000 lawsuits from people affected by injuries or death associated with the drug.

4: Peanut scare
After a 2008 salmonella outbreak that sickened hundreds of people and may have killed eight, federal investigators traced the strain to peanuts processed at Peanut Corp.’s Blakely, Georgia, plant. Once there, the investigators found nightmarish conditions – mould lining the walls and ceilings, rodents and cockroaches running amok, and food supplies contaminated with waste. Worse still, the FDA found evidence that the company allowed products to ship even after internal testing discovered salmonella contamination. The result was a massive recall of the processed peanuts contained in everything from peanut butter to ice cream. The company, which denies the allegations, declared bankruptcy in the wake of the investigation. Federal criminal charges against the company are pending. Barely two months later, California-based Setton Pistachio opted to recall its entire 2008 crop of pistachios due to Salmonella fears. The company is widely credited with getting out in front of the issue before it became a major problem, acting as soon as it discovered “several types of salmonella during routine analysis of the product”. While the infection was said to be unrelated to the peanut butter scare, Setton’s executives no doubt realised that consumers were in no mood to take risks and likely opted to initiate the recall as a proactive buffer against lawsuits and criticism.

5: Tylenol
Arguably the biggest and most publicised product recall in business history involved Tylenol, whose over the counter pain relief pills killed seven people in 1982. The deaths came as a result of the pills being laced with potassium cyanide and led Johnson & Johnson to issue a nationwide recall of some 31 million bottles with a retail value of about $100m. When the FBI investigated the incident, it was found that the poisoned bottles came from different factories, but the deaths all occurred in and around Chicago, suggesting that the tampering took place at the store level. The perpetrator was never charged, but a man named James W. Lewis was caught trying to extort money out of Johnson & Johnson to “stop the cyanide-induced murders”. Lewis served 13 years in prison on the extortion charges, but was released in 1995 on parole and now lives in Massachusetts.

6: Dell notebook batteries
When a Dell laptop burst into flames at a technical conference in Japan in June 2006, no one paid much attention. But what must have seemed at the time like a freak occurrence turned out to be a systemic flaw with over four million Dell notebook batteries produced by Sony. The lithium ion batteries were prone to excessive overheating, posing a fire hazard that at least six people reported before Sony mandated a worldwide recall of the defective batteries, which were used in Dell’s Latitude, Inspiron, Precision and XPS models. To its credit, Dell exchanged the hazardous batteries with new ones, often supplying consumers with brand new machines in its place.

7: Worcestershire Sauce
A two year investigation from 2005 to 2007 in the UK found that a Worcestershire sauce manufactured by Premier Foods had been contaminated with a carcinogenic dye known as Sudan 1. The contamination was linked back to adulterated chilli powder, and the resulting products were used in everything from pizzas to ready-made meals sold on supermarket shelves. Fear of the contamination and its risks prompted the removal of over 400 suspected products from shelves, at an estimated cost of over £100m.

8: Westland/Hallmark beef
Food processor Westland/Hallmark was forced in 2008 to recall over 143 million pounds of beef after the USDA deemed it unfit for human consumption. While there were no reported illnesses (and it was later concluded that no illnesses were likely), the beef was nevertheless recalled because cattle had failed to be inspected before the resulting beef was shipped to school cafeterias and supermarkets. The recall was a major blow to the company, with as many as 150 school districts ceasing to purchase any beef from Hallmark in what is now acknowledged as the largest beef recall in US history.

9: Cadbury-Schweppes chocolate
UK based Cadbury-Schweppes, now owned by Kraft, was forced to recall over a million chocolate bars in 2006 after a widespread food scare involving Salmonella poisoning in the UK and Ireland. The company was roundly criticised for recalling the chocolate after it had taken a decision to delay informing authorities about the Salmonella problem for five months. The biggest scare at the time involved Easter eggs, which may or may not have been contaminated before children got a chance to eat them.

10: Mattel toys
About nine million toys – including Barbie dolls and items from the digitally animated movie Cars – were recalled by Mattel in 2007 amid dangers from lead paint and magnets. Mainly produced in China, the toys were recalled after it was found that deadly and illegal lead paint had been used. The magnets also created controversy because of their small size and the ease with which they could be swallowed. This recall came just two weeks after an earlier one of about 1.5 million Fisher-Price infant toys, also because of lead paint scares. At least one child died from problems with the toys and 19 others required surgery after swallowing magnets.

Japan signals tax reform, seeks to avoid deadlock

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Japan’s government has announced it will press on with tax reforms to cut a huge public debt despite a stunning election setback, and was looking to two opposition parties to help drive policy change.

Prime Minister Naoto Kan’s ruling coalition lost its upper house majority in a weekend election, putting his policies to deal with debt and generate growth at risk and prompting warnings by credit rating agencies S&P and Fitch on Japan’s sovereign ratings.

His Democratic Party of Japan (DPJ) still controls the more powerful lower house. But it needs help from other parties to push bills through the upper chamber in the struggle to end decades of stagnation in the world’s number two economy.

“If we don’t see a credible plan come through by the end of the year, it will send a negative signal for its rating, adding pressure to the credit rating,” Andrew Colquhoun, Fitch Rating’s sovereign analyst for Japan told reporters.

Trying to soothe worries the election drubbing would sap political momentum for fiscal reform, National Strategy Minister Satoshi Arai said debate was still needed on a possible hike in the five percent sales tax, one of the lowest among major economies.

Kan had floated the possibility of doubling the tax as a way to bring down public debt about twice the size of the $5trn economy and to stave off a Greek-style debt crisis as social security costs soar to care for an ageing population.

Finance Minister Yoshihiko Noda conceded that Kan’s proposal may have turned off voters in the election campaign.

“But we must carry out an overhaul of the tax system including the consumption tax,” he told a news conference.

Unlike Greece, Japan’s public debt has long been financed from its massive pool of domestic savings that mostly sits in the banking system and is recycled into Japanese government bonds.

But fears are growing that the ageing population will start drawing on those savings, forcing Japan to rely on foreign investors to fund its debt and potentially creating market instability.

The change has already started and Japan’s savings rate has fallen to about three percent from over 10 percent a decade ago.

The Fitch warning of the higher risk of a ratings downgrade helped send September Japanese government bond futures to the day’s low at 141.33.

Tough challenge
In attempt to break the political deadlock, Kan told close aides he would ask the third and fourth-biggest parties in the upper house – the New Komeito and pro-reform Your Party – for policy-based cooperation, the Yomiuri newspaper reported, adding he was probably eyeing a formal coalition in the future.

But Kan, in office just since June, faces a tough challenge as the two parties have ruled out joining the government, pointing to a period of political manoeuvring and policy paralysis.

Your Party, which has 11 seats in the upper house after Sunday’s poll, could cooperate with the DPJ on getting the Bank of Japan to do more to fight deflation and on overhauling the country’s bureaucratic system.

But the party has said it would not join the debate on a possible sales tax increase, arguing that the government should first focus on cutting wasteful spending.

The Buddhist-backed New Komeito, which backs policies to fix the pensions system and social safety net, could agree to the debate on the sales tax but only if the government first tackles social security reform.

Bills at immediate risk in an extra parliament session expected in the coming months include one to scale back postal privatisation, sought by Kan’s current small coalition partner, the People’s New Party, but opposed by the Your Party.

Kan has a more pressing threat – a possible challenge from opponents in his own party including powerbroker and critic of the sales tax hike proposal, Ichiro Ozawa, ahead of a party leadership vote in September.

He could reshuffle his cabinet after the vote, Jiji news agency reported. He is already under pressure to replace his justice minister who lost her seat in the election.