Downside surprises replace upside ones
Bullish sentiment about the world economy since the start of the year has begun to ebb over the past month as downside data surprises replace upside ones. The news has been disappointing out of the US, the eurozone and China alike. In the eurozone, there has been a renewed widening of peripheral bond yields (Chart 1); in the US, a weak March payroll report; and in China, a soft-ish March quarter GDP number. The most worrying of the three is the spike in eurozone sovereign bond yields. This serves to emphasise that the eurozone debt crisis is far from over – as we have repeatedly argued in previous bulletins. Most immediately, it signals a growing danger that Spain may be forced to seek a bailout from the EU-ECB-IMF troika, joining Greece, Ireland and Portugal.
Taking the earlier promising signs with the more recent disappointing ones, how is the world economic recovery tracking? In its latest world economic outlook, the IMF actually upgrades its forecasts a touch from January. However, it also emphasises that downside risks still predominate. According to Prof Eswar Prasad of the Brookings Institution, the global recovery is ‘sputtering’. His widely-watched TIGER index shows that economic weakness extends across the Group of 20 leading economies, though advanced economies have deteriorated more than developing ones. The Reserve Bank of Australia says that ‘recent information is consistent with the expectation that the world economy will grow at a below-trend pace this year’.
China slows: Australia worries
Below-trend growth in the North Atlantic mightn’t signify much for Australia, since 70% of its exports now go to Asia. But the Chinese slowdown is rattling many observers. They worry about the knock-on effect to three things: commodity export prices, commodity export volumes, and Australian resource investment.
There will certainly be effects at the margin, but it is premature to call an end to the boom. It is true that the RBA’s A$ commodity price index has retreated 10% from its August 2011 peak. But this takes it back to only January 2011 levels and it remains well above long run averages. Besides, Australian exporters have been selling more volume even as they have been receiving lower prices (Chart 2). Finally, this situation of falling prices, but rising volumes and values, is expected to continue according to the Bureau of Resources & Energy Economics (Chart 2, RHS).
The final concern about the Chinese slowdown is that it could undermine the resource investment boom now underway. But for this to occur, the slowdown would have to be far sharper than currently foreseen. Current and forecast prices are well above operating costs for most existing coal and iron ore mines and gas fields, and above operating and capital costs for most planned projects.
Reverberations from ChongQing
Not only is the Chinese economy confronting setbacks from the eurozone and the need to ‘rebalance’ away from an overdependence on exports and investment; it will also have to negotiate a leadership changeover complicated by the astonishing downfall of Chongqing Communist Party secretary Bo Xilai and his wife Bogu Kailai. Until his fall, Bo had been considered a prime candidate for promotion to the Politburo Standing Commission this year. Yet the official Xinhua news service announced on April 10 that he had been removed from his party positions. Then on April 18, it was announced that Bogu had been arrested on suspicion of ordering the murder of British businessman Neil Heywood.
It is often forgotten that contested leadership changes are par for the course in China. Deng Xiaoping outmanoeuvred Mao Zedong’s chosen successor Hua Guofeng to become paramount leader in the late 1970s. Zhao Ziyang was replaced by Jiang Zemin after the Tiananmen protests in 1989. And in 2008, Politburo member Chen Liangyu was removed as party head of Shanghai and sentenced to 18 years gaol for bribery and abuse of power.
What distinguishes the current incident is its public airing; previous party intrigues might have been unsettling, but they were conducted out of the public eye. The highly publicised nature of Bo’s removal will be seen as unwanted exposure of the workings of the inner circle, and something to be avoided in future.
Though the incident is open to several interpretations, most pundits are inclined to put a positive gloss on it, downplaying the risks to foreign business executives that the case seems to highlight, and instead stressing how it strengthens the hand of market reformers against the ‘New Left’ and ‘Maoist revivalists’ whom Bo represented.
For its part, the Communist Party has claimed that the case shows that ‘no one is above the law’, even so-called ‘princelings’ like Bo and Bogu.
Never a dull moment in PNG
Esso Highlands, a subsidiary of ExxonMobil, announced on 30 March that a dispute with landowners over the US$16 billion PNG LNG project had ended. For approximately two weeks the dispute had disrupted work at the Hides gas field in the Southern Highlands Province, which is being developed to supply a planned liquefaction plant near Port Moresby.
Clan leaders in the Hides area reportedly agreed to lift their blockade of Hides after learning that the government was planning to announce a state of emergency to restore law and order. In the event, PNG’s National Executive Council decided on 28 March not to declare the emergency, but to deploy troops to the area instead.
Meanwhile, the political instability that has dogged PNG since last April when Prime Minister Sir Michael Somare left for medical treatment in Singapore continues (see box for background). The new government has got into a running battle with the judiciary and parliament has tried to postpone forthcoming elections, to the fury of civil society groups.
Despite this instability, some stabilising factors are in play as well. First, the public has remained largely calm and no one has been killed. Second, O’Neill has continued to govern the country with the support of parliament and the public service. Third, the Supreme Court could yet amend an earlier ‘advisory’ decision that O’Neill’s assumption of power was unconstitutional.
As for the election, it is likely to dispel some of the political uncertainty and instability and see a new post-independence generation of politicians take power. But it could also spawn some violence, especially in the Highlands where gun ownership is rife. It is also possible that the new government will include MPs who campaigned to amend the Mining Act to give more power to landowners in project negotiations.
Egypt's bumpy political transition
Investors are withdrawing capital from Egypt in response to political turmoil, weak growth, and an uncertain investment climate. This has resulted in a sharp drop in foreign reserves as the central bank tries to defend the exchange rate. At end-March, total reserves were US$15 billion, down from US$36 billion at end-2010; liquid reserves had fallen to US$11 billion – only two months’ import cover (Chart 3).
To make matters worse, long-promised IMF financing is also being delayed. The IMF has stated that a loan ‘must enjoy broad political support’, but the leading political party, the Muslim Brotherhood’s Freedom & Justice Party is unwilling to support it while the army remains in charge.
A balance of payments crisis looks possible: the 12-month nondeliverable forward market is predicting a 20% drop in the pound.
President Cristina Fernández sent a bill to Congress on 16 April to nationalise energy company YPF – Argentina’s largest private company. The plan is to take 51% of the company from the 57% share that Spanish energy company Repsol owns. The seizure of YPF would be the biggest nationalisation in the natural resources industry since the Russian government took control of Yukos in the early 2000s.
Authorities have reportedly already seized control of the company. The European Union has called for a ‘negotiated solution’, but a local court will reportedly determine how much the government pays Repsol in compensation. The company, previously stateowned, was privatised in 1999, when Repsol bought 98% for US$15 billion. At current market prices a 51% stake is worth around US$3.9 billion. At the start of the year 51% was worth US$7 billion.
The government says it is taking over YPF because it has underinvested in oil and gas production and thereby left the country with a rising oil import bill. The president has also accused Repsol of ‘emptying’ YPF. YPF had already been stripped of a number of operating concessions for not meeting investment targets.
Analysts point to Argentina’s high taxes, domestic price caps and the unpredictable regulatory environment as the real reasons for the fall in energy production.
The nationalisation of YPF highlights the political risks of investing in Argentina and may encourage further capital flight, worsening the fragile balance of payments.
Indonesia's uneven risk profile
In April, the OECD upgraded Indonesia’s country risk rating to a 3 from a 4 (on a 1/best – 7/worst scale). Since the borderline between 3 and 4 broadly corresponds to what ratings agencies call investment versus junk grade, one can say that this upgrade represents another promotion to investment grade. Private agencies Fitch and Moody’s have already upgraded Indonesia to investment grade – Fitch to BBB- and Moody’s to Baa3 – while S&P has indicated it could soon follow suit. Capital markets are similarly confident: in April, the government issued 10 and 30-year US$ bonds at yields of 3.85% and 4.95%, respectively. Driving the upgrades is Indonesia’s balanced growth, rising external buffers and low public debt (Chart 4).
But investment grade does not mean riskless conditions for direct investors — on some measures Indonesia’s business climate is one of the worst in Asia. A survey by the Fraser Institute, a Canadian think tank, says Indonesia is an unattractive destination for mining companies —ranking in the bottom 10 jurisdictions (out of 93) on the Institute’s ‘policy potential’ index (a measure of how attractive the jurisdiction’s policies are to a mining exploration manager). Most recently, a new law has been passed stipulating foreign ownership in new mines should be no more than 49% by the tenth year of production – the previous cap was 80%.
Vietnam's charm dwindles
Vietnam’s GDP growth fell to 4% (y/y), during the March quarter – its lowest level in three years and well below the 8%-plus pace of much of the 2000s. High interest rates introduced to curb double-digit inflation have been the main brake on the economy. The sharp slowdown is at odds with performance in the rest of the region, which seems to be weathering the eurozone crisis well – Indonesia, for example, is growing at 6½%, its fastest pace since the Asian financial crisis.
Though once a darling of portfolio investors, Vietnam has now post much of its charm, owing to lower growth, higher inflation, a weaker banking system, and hence bigger economic policy dilemmas, than many of its ASEAN neighbours and other emerging markets.
Burma edges in from the cold
The by-elections in early April, which saw Aung San Suu Kyi’s National League for Democracy win 43 parliamentary seats, represent a step towards political liberalisation. And in response, a number of countries have moved to lift diplomatic and economic sanctions on the military junta.
The US lifted some financial and travel restrictions on Burma’s leaders a few days after the election. Australia, meanwhile, has said it will do two things: reduce the number of Burmese subject to financial sanctions and travel restrictions and discontinue its policy of ‘neither encouraging nor discouraging’ trade and investment.
Removing sanctions could create new opportunities for Australian companies, particularly in the energy sector: Burma has substantial reserves of natural gas in 19 onshore and three major offshore fields that will require foreign expertise to develop. Mining, tourism and education are other areas reportedly under investigation.
Roger Donnelly, Chief Economist
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