World Risk Developments August 2013


International – The past month

The world economy appears to be accelerating out of the soft patch it fell into last year, though forecasters are generally marking down their outlooks for the rest of 2013 and 2014. Speculation about QE taper has prompted an emerging market selloff, though some capital has returned after the initial knee-jerk reaction.

Growth in the world economy appears to have picked up in the June quarter from the soft patch it experienced in the preceding year due to growth disappointments in the US, euro area and emerging economies. From the June quarter it appears to have accelerated to 3½% pa – around the historical average – from 2½% pa over the preceding year.

Though growth may be accelerating, the outlook has weakened recently because of dwindling hope that the Chinese economy will pick up in coming quarters and disappointment about the stubbornness of the euro area recession (despite positive growth in the June quarter – see next story).

Both the IMF and RBA now foresee the world economy growing at around 3% in 2013 before picking up to a slightly above average 3¾% in 2014.

Most commodity prices have continued to fall, and the consensus foresees further gradual decline into the medium term as new supply capacity starts up.

Financial markets have been dominated by the US Federal Reserve’s indication that it may begin to ‘taper’ its asset purchases later this year. This initially prompted some rise in emerging market bond yields, though more recently the yields have been retracing on a belief that the taper may not happen as soon or as fast as previously thought.

Downside risks to the outlook still predominate, although sharemarkets seem upbeat about a string of pleasant growth surprises in Japan, the US and the euro area. The risk of an escalating euro area crisis continues. An emerging risk is withdrawal of capital from emerging economies that had been experiencing large inflows of capital into their local currency sovereign bond markets during the ‘reach for yield’ phase. Thanks to hefty shock absorbers in the form of large foreign exchange reserves, low foreign debt and flexible exchange rates, such a reversal is unlikely to throw most of these economies into crisis. But it could present them with a nasty dilemma – either hold or raise interest rates to stem the outflow, or lower them to support weak activity. This is a dilemma India (story below), Turkey, Indonesia, Brazil and South Africa are finding especially vexing.

Another tail risk is that the deeply divided US Congress once again fails to agree to lift the federal government’s debt ceiling, thereby threatening another ‘shutdown’ of services.

In Australia, the focus has been on rebalancing growth away from resource investment. The 15% depreciation of the Aussie dollar in trade weighted terms since its peak in April should help this process. Strong growth in resource exports is expected in coming quarters as the export phase of the resource boom kicks in. The Treasury and RBA are also banking on a broader lift in exports thanks to a lower dollar and strengthening world growth.

Euro area – June quarter growth spurt likely to flag

The euro area finally recorded positive growth in the June quarter, but will struggle to post growth for the whole of 2013.

GDP growth turned positive in the June quarter for the first time since September 2011, expanding by 0.3% after contracting by 0.3% in the March quarter, Eurostat said recently.

Among the countries to record quarter-on-quarter growth were: Germany (0.7%), Finland (0.7%), France (0.5%), Slovakia (0.3%), Austria (0.2%), Estonia (0.1%) and Belgium (0.1%).

GDP shrank in Italy (-0.2%) and Holland (-0.2%), which recorded its fourth consecutive quarter of contraction.

Among bailout recipients, Portugal grew for the first time in ten consecutive quarters – by 1.1%. But GDP shrank in both Cyprus (-1.4%) and Spain (-0.1%). Data are not yet available for two other recipients, Greece and Ireland.

As promising as the June quarter performance might seem, the area will be lucky to record growth for the whole of 2013, because German growth looks likely to moderate and investment is stagnant throughout the area.

India – Emerging market selloff hits India hard

India has become one of the main targets of portfolio investors withdrawing capital from emerging markets in anticipation of a QE taper.

The rupee recently sank to its lowest level ever against the US$, intensifying pressures on the government and the central bank to introduce further measures to arrest its decline (Chart 1, right hand panel). But so far there appears to be little official appetite for tighter capital and exchange controls.


The pressure on the rupee reflects three factors. First, the economy has slowed dramatically in the last few quarters – it grew by only 5% in the year to March, the slowest year-on-year pace since 2009 (Chart 1). Though fast by developed country standards, this is a marked deceleration for India, which had been growing in the 8-10% range for the past couple of years. It is also below the pace required to soak up new entrants to the rapidly expanding labour force.

Second, inflation has remained stubbornly high.

Third, the country runs a large current account, largely financed by volatile portfolio inflows. This makes the rupee susceptible to shifts in investor sentiment, which was already moving against emerging markets, because of the looming ‘taper’ of the Federal Reserve’s quantitative easing program.

The weak growth-weak currency combination has reportedly led to rifts between the Reserve Bank of India and the Finance Ministry, with the Reserve wanting to hold interest rates to combat inflation and depreciation and Finance seeking lower rates to stimulate growth.

Philippines – Investment-led growth is welcome sign

Some tentative signs of investment-led growth look promising, but the country still presents a difficult legal and regulatory climate for investors.

The economy expanded strongly in the first quarter of 2013, growing at an annualised 7.8%, up from 7.1% in the December quarter of 2012. Much of the momentum reflects a strong rise in government outlays, particularly outlays for infrastructure projects, and a surge in construction. Impressively, the rise in government outlays did not weaken the public finances – stronger tax revenues and lower public debt interest have contained.

The private sector seems to be increasingly confident about the economy’s prospects – the central bank’s business confidence index reached a record high in the second quarter (Chart 2).


Higher levels of business confidence should provide a boost to investment, which is sorely needed because of a large infrastructure that has grown over the years – according to HSBC, the Philippine investment/GDP ratio has been among the lowest in the region, with a feeble contribution from foreign and private investors. As a result, the country’s infrastructure is one of the most lowly ranked among the Asian countries assessed by the World Economic Forum (Chart 3).


Improving the quality of infrastructure won’t be easy, particularly since the private sector will need to be involved and it has in the past been deterred from taking part in PPP arrangements because of the country’s difficult operating environment and weak governance.

The hope is that the Aquino administration’s broad reform agenda, including overhauling the country’s archaic tax code, making growth more inclusive and reducing red tape, will entice the private sector to play a larger role.

A real risk exists, however, that the reform program stalls in the face of resistance from vested interests, which in turn thwarts the infrastructure program.

Australia’s Macquarie Group is already active in the Philippines. Macquarie has teamed up with with the Government Service Insurance System, the largest pension fund in the Philippines, Dutch pension fund APG, and the Asian Development Bank to form the Philippine Investment Alliance for Infrastructure (PINAI). The fund raised US$625m in 2012 and is the first and largest infrastructure fund dedicated to the Philippines.

Egypt – Political violence deepens economic crisis

The recent political violence will only deepen the crisis that the economy fell into after Hosni Mubarak was swept from power in 2011. In particular, it may jeopardise the government’s ability to service its extensive domestic debt.

Mubarak’s removal in February 2011 was a severe blow to the economy and public finances. It knocked tourism, investment and GDP growth; raised interest rates (Chart 4) and shortened bond tenors; enlarged the fiscal and public debt; and caused currency depreciation (Chart 5) and drained foreign currency reserves (Chart 6).


In response, the government tightened capital controls, and reportedly ran up payment arrears of US$5b-9b with international oil companies. The strains on the balance of payments and the currency market would have been even more severe if friendly neighbouring countries had not provided stopgap funding. Qatar, Libya and Turkey did so during the Morsi presidency. More recently, Saudi Arabia, the UAE and Kuwait have pledged US$12b. The UAE and Saudi Arabia have reportedly already transferred US$5b to the central bank, probably explaining why reserves took a step up in July (Chart 6).

The recent removal of Mohammed Morsi and the crackdown against his followers will only worsen these negative developments. The government’s credit standing looks under threat, particularly its ability to service its extensive domestic debt.

This is because Cairo’s domestic debt dwarfs its foreign debt. Egypt’s foreign liabilities total US$39b, of which US$6b reportedly fall due in 2013. In contrast, US$60b worth of Egyptian pound-denominated public debt falls due this year alone, the bulk held by Egyptian banks. Essentially, the government has been financing itself by selling its debt to captive buyers – the local banks. This makes a domestic debt restructure look more likely than a foreign one.

These banks are unlikely to refuse to roll over the debt they already hold, but they are reportedly having difficulty absorbing the additional debt needed to fund the fiscal because of a lack of liquidity. They have been demanding higher interest rates, and this has prompted the government to cancel at least one debt auction.

A foreign debt restructure looks less likely not just because the foreign debt burden and financing task is less than the domestic one. To win the agreement of official creditors to a Paris Club debt rescheduling the government would need to first reach agreement with the IMF. But talks with the IMF over a US$4.8b standby loan stalled during the Morsi presidency, and are unlikely to resume any time soon because the government will find it impossible in the current disorder to carry out the cuts to food and fuel subsidies that the Fund is demanding. Besides, the recent pledge of Gulf money has made the need for such a deal less urgent.

Cairo could unilaterally restructure its foreign debts, but that would probably be self-defeating, leading to greater withdrawal of foreign credit than to debt relief. If it behaves rationally, it won’t choose this option.

Regardless of whether the government can avoid a foreign debt restructure, the risks of doing business in Egypt have gone up considerably – including the risk of currency inconvertibility and currency gyrations, and of payment default by public and private sector buyers alike.

Myanmar – Ageing population will be growth drag

Amid the enthusiasm about political and economic liberalisation, the OECD has noted one snag about Myanmar – population ageing.

It concludes that Myanmar may start ageing earlier than its neighbours. The Southeast Asian nation of 59 million people has a population structure similar to China’s in the 2000s, suggesting that it could soon approach the point where the share of working-age citizens starts declining. In contrast, other countries in the region at a similar stage of development, such as Cambodia and Laos, are seeing their proportion of workers continuing to rise.

Myanmar’s growth potential, sizable untapped resources and labour costs that the Japan External Trade Organisation says are the lowest in the region have attracted multinational companies such as Coca-Cola and Visa, as well as Australian oil and gas companies.

Although its demography may prevent Myanmar growing at near-10% annual rates as China did over 1978-2013, its outlook is hardly stagnation. The OECD estimates that even with an ageing population and without structural change the economy can grow at an average 6.3% over 2013-17.

Mexico – Energy reform still has hurdles to surmount

A plan by the president the oil industry to foreign investment could arrest Mexico’s declining production and exports and fund a boost to infrastructure spending. Though it has received criticism from both the left and right of Mexican politics, he hopes to garner enough support from the right to pass it.

President Enrique Peña Nieto announced plans on August 12 to allow foreign investors into Mexico’s oil industry for the first time in 75 years. The industry has been out of bounds to foreign investors ever since 1938 when the government expropriated the country’s oilfields from American and British companies, and handed them to the newly created national oil company, Pemex.

The president proposes to change Mexico’s constitution to allow both Pemex and the state power company, Comision Federal de Electricidad (CFE), to enter private sector partnerships with foreign investors involving profit-sharing contracts for the foreigners. International oil companies generally dislike such contracts, arguing they aren’t sufficiently attractive and bankable. But some have said that Mexico’s petroleum potential is promising enough to overcome these concerns.

The president may have more difficulty overcoming the concerns of the political left and right within Mexico. On the left, the Party of the Democratic Revolution (PRD) insists that the constitution’s prohibition of private investment should remain absolute – the PRD’s former leader Lopez Obrador has urged Mexicans to take to the streets to protest what he calls ‘the theft of the century’. On the right, the National Action Party (PAN) has called the government’s plan ‘timid’. It wants Pemex to partly privatise and expel union members from its board of directors.

Both these parties have the power to veto the president’s plan in the national and state legislatures through which it will have to pass. So it is not a foregone conclusion that it will receive approval. Still, the president is hoping that his moderate, yet still far-reaching proposal receives PAN support in the end. In that event, he will gain the two-thirds legislative majority he needs to make the necessary constitutional changes.

The benefits could be considerable. Under Pemex and the CFE, oil and gas production and exports have languished (Chart 7), the country’s shale and deepwater oil potential has run to waste, and electricity prices are the highest in the OECD. The private sector partnerships promise to arrest the decline by boosting investment on and offshore and bringing the American shale gas revolution south of the border.

Better still, the revenue that would flow into government coffers would help the president fund a proposed US$400b National Infrastructure Plan aimed at making critical upgrades to ports and roads.

As our May newsletter noted, there is considerable Australian interest in Mexican infrastructure, particularly by Macquarie Capital, which plans to invest US$10b in the sector over the next five years.


Mali – Peaceful election offers hope of greater stability

After an eventful 18 months that saw first a military coup, then an Islamist occupation of the northern part of the country, and a French intervention this year to oust the Islamists, Mali could now be settling down to a more peaceful future.

In a presidential run-off election on August 11, Ibrahim Boubacar Keita (‘IBK’) defeated Soumaila Cisse in a clear and uncontested result. IBK enjoys good relations with Paris and can look forward to billions of dollars in pledged aid and security assistance. Risks remain, however, from jihadist terrorist attacks from the north, a still-to-be-contested legislative election, tensions between social and ethnic groups exacerbated by the displacement of about 200,000 Malians from the north during the fighting, and a push for autonomy by some northern provinces.

Australian mining and engineering companies have done and are doing considerable business and investment in Mali. Resolute Mining owns and operates the Syama gold mine in the south-east; Papillon Resources is seeking to develop another gold mine in the south-west; and Birmian Gold has several gold tenements. Oklo Resources has several gold, uranium and phosphate tenements. Among mining service companies, there is African Mining Services and African Underground Mining Services.

Roger Donnelly, Chief Economist

Ben Ford, Senior Economist

The views expressed in World Risk Developments are Export Finance Australia’s. They do not represent the views of the Australian Government. The information in this report is published for general information only and does not comprise advice or a recommendation of any kind.  While Export Finance Australia endeavours to ensure this information is accurate and current at the time of publication, Export Finance Australia makes no representation or warranty as to its reliability, accuracy or completeness.  To the maximum extent permitted by law, Export Finance Australia will not be liable to you or any other person for any loss or damage suffered or incurred by any person arising from any act, or failure to act, on the basis of any information or opinions contained in this report.