World Risk Developments October 2013

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International – Emerging economies drag down world economic growth

Weak performance in emerging economies is causing a world economic slowdown this year. A gradual pickup in advanced economies next year should see world growth accelerate.

In its October World Economic Outlook released earlier this month, the IMF lowered its forecast for growth in the world economy in 2013 to 2.9%. This is 0.3% points less than its previous forecast in July, and the fourth time this year it has lowered its projections. The downward revisions come almost entirely from emerging markets, notably India, where the Fund now expects an expansion of just 3.8%, 1.8% points less than its previous forecast. China's expansion has also slowed, with growth expected to be 7.6% this year. A third notable downgrade is Mexico, whose forecast has been cut by 1.7% points.

Although the Fund notes that advanced economies are gradually strengthening, it actually forecasts them slowing in 2013 compared to 2012, before picking up in 2014. The reasons for the forecast recovery have to do with private sector recovery in the US, Abenomics in Japan, and some strengthening of core eurozone economies.

Obviously, a risk to this recovery that has come to the fore recently is the partisan fighting over fiscal policy in the United States. The recent Congressional agreement to end the partial government shutdown and lift the debt ceiling into early 2014 takes away the immediate risk of a fiscal crunch and sovereign debt default, but more budget crises are possible next year after the government’s funding and borrowing authority run out.

All up, the Fund foresees a second successive year of slowdown for the world economy in 2013, before an acceleration next year to 3.6%. Emerging economies continue to outgrow advanced ones and to contribute more to world growth. But the growth gap is narrowing.

Australia – Deloitte believes future growth will be export-led

Accounting firm Deloitte has pinpointed five export industries that may drive future economic growth – gas, tourism, agribusiness, international education and wealth management. Helping them to expand will be brisk demand from a rising Asian middle class tilted in an Australian direction by an Aussie dollar settling at US80c.

All five industries are at what it calls 'the intersection of global growth and Australian advantage'. In other words, ones where Australia has an edge, and can therefore supply – profitably to itself and at an attractive price to customers – what the world is increasingly demanding. These will be the industries 'powering ahead', providing a ‘tailwind’ to macroeconomic growth, eventually rivalling the mining industry, and in the process potentially adding $250b to GDP over the next two decades.

In its report, Positioning for Prosperity, the firm notes that the resource boom isn’t ending, but phase-shifting – with the investment phase peaking, and the production/export phase picking up. Investment remains high, but is no longer buoying growth. Meanwhile, mineral and gas exports from new investments will take over as the next growth buoy. For instance, the $200b of LNG investment that has been undertaken looks set to expand LNG output by 250% over 2013-18. This is likely to see Australia surpass Qatar as the world's No 1 gas exporter.

It is noticeable that all five of Deloitte's chosen industries are heavily export-oriented. This shouldn’t be surprising. The internal Australian market is a drop in the ocean of the world one, and therefore international demands will – in the absence of trade and investment barriers – dominate the sales of many Australian industries, the ‘trade-exposed’ ones. Moreover, international demand will increasingly mean Asian demand, given Asia’s outsized growth, the enormous middle class this is spawning, and Australia’s physical and cultural proximity to Asia.

How does the exchange rate figure in this story? Like many others, Deloitte believes that the Aussie dollar needs to depreciate further to enable Australia to keep paying its way in the world. Under the influence of further falls in commodity prices and eventual increases in world interest rates, the Aussie is likely to settle at around US80c, it believes. This is well off its above-parity peak, but higher than the US75c it has averaged in the three decades of a floating currency.

Papua New Guinea – Managing the LNG boom will take finesse

Like Australia, PNG is facing economic uncertainty as its resource investment boom winds down.

An IMF mission visiting Port Moresby last month for the 2013 Article IV consultation forecast GDP to grow by about 5½% in 2013 and 5¾% in 2014. Though these numbers are virtually the same, the Fund noted that the composition of the growth will change significantly. Whereas in 2013 it will be investment-led, in 2014 exports will be the driver, as construction of the PNG LNG project winds down and exports from the project ramp up. In line with this switch, the external current account dExport Finance Australiait is projected to narrow rapidly and turn into a surplus by 2015 as LNG exports reach full capacity.

Though this looks like a smooth rebalancing, the Fund did warn of risks. In the short term, a weak world economy could damp external demand and commodity prices. Over the longer term, shale gas development around the world could reduce LNG prices. The Fund also forecasts that non-resource GDP growth will slow to only 1% in 2014 as the construction boom ends; in other words the part of the economy that creates the most jobs will be stagnant.

To build economic resilience, the Fund urged the government to run a prudent fiscal policy and safeguard the integrity of its sovereign wealth fund (in which it will place resource revenue for 'rainy days' and infrastructure development).

Mongolia – Economy booms despite slowdown in coal exports and mining investment

Expansionary macroeconomic policies are buoying growth in the face of a slowdown in coal exports and FDI flows, but at the expense of balance of payments strains.

The economy expanded by 12½% in 2012 and 11½% in the first half of 2013 said an IMF mission visiting Mongolia for its 2013 Article IV consultation. Dragging growth down was a marked slowdown in coal exports and FDI-financed mining investment, but buoying it was strong farm output after a mild winter and expansionary fiscal and monetary policies.

The Fund noted that the expansionary policies were placing strains on the balance of payments and creating inflation risks. It warned that if the government didn't tighten fiscal and monetary policies, the country would become more vulnerable to external shocks, particularly from China as it underwent a structural slowdown and attempted to rebalance its growth from investment to consumption.

Turning to industry policy, the Fund said it welcomed the adoption of a new investment law that would improve the business climate for investors.

Though two-way trade between Mongolia and Australia is modest, Australia has significant and growing commercial interests in Mongolia. 

Bangladesh – Garment industry responds to local and international concerns

Fears that strikes and accidents would undermine the ready-made garment (RMG) industry have so far proven baseless.

RMG exports rose by 24% to US$6.2b in the September quarter, the Export Promotion Bureau said recently. This is despite a rising trend over the last decade of strikes and accidents – notably the Rana Plaza tragedy in April – and the emergence of other low-cost manufacturing destinations such as Cambodia, Vietnam and Myanmar. Many analysts thought these developments would prompt consumer boycotts and disinvestment, causing the industry to shrink.

But factory owners and the government have been responding in two ways. More than that, they have agreed to raise the minimum wage to US$38 a month from US$25. They have also agreed to go up to US$45 in response to union demands for more than US$100. Second, they have been cooperating with foreign governments, industry associations and NGOs to improve safety standards and working conditions. In July, for instance, the government signed a pact with the EU and ILO. It has also accepted a soft loan package from Japan to improve buildings and working conditions.

The jury is out on whether this will prove enough, but for the time being, the industry remains the country's top producer, employer and exporter – and on-track to overtake China as the No 1 RMG exporter.

Kenya – Australian-owned sand mine will be internationally significant

The about-to-start Kwale mineral sands project in Kenya, owned by the ASX/AIM-listed Base Resources, promises to eventually produce 14% of the world's rutile production, as well as ilmenite and zircon. It joins a growing list of projects that Australian companies have brought to the development stage in Africa, often in the face of considerable political risk.

The recent discovery of significant titanium, gold, coal, iron ore and rare earth elements in Kenya has seen some 300 foreign and local mining companies flock to the mining industry to do both prospecting and producing. The Kwale mine is currently the flagship, promising to add 0.6% to GDP

The previous Kwale owner, Tiomin, had to deal with considerable political and social risk, including environmental protests, disputes with local farmers over land compensation, and protracted talks with the government.

The current government of President Uhuru Kenyatta, which took office in April, has been sending the mining industry mixed signals. On the positive side, it has reversed a decision by the previous government to force foreign mining companies to cede 35% ownership of their operations to local partners. On the negative, it has revoked 43 mining licences granted in the first five months of 2013 because of alleged irregularities, and raised royalty rates and drilling levies.

Australian mining companies started to move into Africa in the early 2000s as commodity prices began to boom. More than 200 Australian mining companies controlling 700 projects now operate on the continent. Though many have had to wrestle with political risk, they have been able to bring more than a dozen projects to the development stage, across a broad span of countries including Cote d'Ivoire, Senegal, Mali and Ghana in the west; the DRC in the centre; Tanzania and Kenya in the east; and Mozambique in the south.

Roger Donnelly, Chief Economist
rdonnelly@exportfinance.gov.au

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