World Risk Developments October 2014 (II)

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World economy — Growth is mediocre, but could accelerate

View a summary of this month's edition.

Markets and forecasters have both suddenly turned pessimisticon concerns about faltering economic growth. Even so, it lookslike the world economy will accelerate out of the slow patch it fell into in the first half of 2014.

The mood of both markets and forecasters has darkened appreciably since our last bulletin. In asset markets, prices have declined, and risk premiums and volatility have increased. Meanwhile, forecasts have been marked down, in a continuation of a process that has been underway since 2011.

The selloff in asset markets actually started in September, but accelerated in early October. Virtually all asset classes have suffered negative returns since, and increased volatility. The greatest sell-offs

have been among the riskier assets – tech, small cap, corporate high yield – with US energy stocks leading the pack. Less risky assets, such as corporate investment grade bonds, have lost less value, though their prices have also been whipsawing around. The markets have shown little discrimination between developed and emerging market stocks: both have been hit hard.

What has been behind the mood swing? Concerns about the US, Germany, emerging markets, Greece, and Ebola have all been mentioned. Sometimes the selloff has been in response to a palpable deterioration in the real economy, such as falling exports and industrial production in Germany. But at other times the perception seems to have led the reality, with for instance declining US Treasury yields and a falling S&P 500 feeding a sense that all might not be right on Main Street.

Also damping the optimism has been the IMF’s latest world economic outlook (WEO). This downgrades the Fund’s world growth forecasts for the fourth successive year. It also predicts a four-in-10 chance of the euro area sliding into its third recession since the financial crisis over the next year, and a three-in-10 chance of deflation. In remarks on the outlook, the Fund chief added that the world was in danger of settling into a ‘new mediocre’ growth trend.

For all this gloom, the Fund has seen fit to forecast world growth of 3.3% in 2014, the same as this year, and 3.8% in 2015. The recent drop in oil prices from US$115/b for Brent in June to US$90 now is also good news. The Fund worries about supply disruptions from ‘geopolitical risk’ in the Middle East, saying that a 20% price spike could shave ½% pt off world growth. Yet the salient fact about recent oil prices is: they have been declining despite ISIS. And if a price spike can damp growth, a price fall can spur it.

Finally, as the IMF chief has noted, the ‘new mediocre’ doesn’t have to be accepted fatalistically – she calls for ‘bolder policies’ to impart a ‘new momentum’ to growth. The WEO backs this up with a call for increased infrastructure spending in economies with clearly identified infrastructure needs and economic slack.

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This in turn chimes with the G20’s Brisbane Action Plan, which aims to ‘address the global growth challenge’ through ‘concrete actions across the G20 to increase investment, lift employment and participation, enhance trade and promote competition’, all with a view to ‘raising the level of G20 output by at least 2% in the next five years’.

China – Soft landing in sight

Though the economy slowed again in the September quarter, it is showing signs of stabilising.

September quarter GDP growth slowed to 7.3% year-on-year from 7.5% previously, the National Bureau of Statistics reported recently — the slowest rate since the first quarter of 2009. On a quarterly basis, GDP grew 1.9%, slightly lower than the 2.0% expansion in the June quarter.

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What will the economy do next? The monthly industrial production (IP) numbers suggest it could speed up. These show September IP accelerating to 8.0% year-on-year from only 6.9% in August. Since IP is a good leading indicator of GDP, this acceleration bodes well for the broader economy.

A likely upcoming liquidity injection by the People’s Bank of China will also support growth and help the economy rebalance away from investment and property development towards consumption.

Indonesia — No honeymoon for Widodo

The new Indonesian president faces a strong opposition determined to thwart his reform agenda.

Joko Widodo was sworn in as the new Indonesian president on October 20, and Jusuf Kalla took over as vice president.

Hopes are high that ‘Jokowi’, as the new president is known, will bring the same decisive style to national government that won him praise in local government. Also under scrutiny will be how he seeks to carry out his promise to balance ‘pro-poor’ and ‘pro-growth’ policies.

An important clue to his approach will be his actions on fuel subsidies. Phasing them out is probably the clearest way he can promote growth and help the poor at the same time (box). He understands this, but has said he will proceed with a phase-out only ‘gradually’.

But even this gradual approach will face a hostile reception in parliament, where the opposition ‘Red & White’ Coalition controls 353 of 560 seats and has vowed to ‘obstruct’ his agenda. It has already scrapped direct elections for governors, district heads and mayors. This will make it harder for the central government to cut red tape and promote infrastructure investment. It may also hinder the president’s efforts to combat corruption, because local legislators no longer dependent upon mass support will become more susceptible to bribery by rent-seeking businesses.

Fiji — Airbus purchase no immediate financial threat

Recent borrowing by Fiji Airways to buy three Airbus A330-200s won’t cause immediate debt stress. Small Pacific island states have a chequered history with ‘think big’ ventures. Nevertheless, the government – also the majority shareholder in Fiji Airways – would probably bail out the airline if it got into difficulties.

Fiji Airways, formerly known as Air Pacific, has recently undergone a major rebranding exercise, including the purchase of the three Airbus planes valued at US$600m. To fund the expansion, it has secured US$90m from the national pension fund, with the balance sourced from European banks with guarantees from UK Export Finance. The borrowing is equivalent to 12% of GDP.

Pacific Island states have experienced severe financial indigestion from think big ventures in the past. Nauru’s national airline had to sell most of its fleet to service its debts. The Cook Islands and Tonga also both borrowed heavily to finance large projects, but the Cooks entered a severe debt crisis in 1996, while Tonga more recently had to restructure its debts.

Quite apart from whether Fiji Airways will put the new loans to profitable use is the issue of whether the national economy can cope if the investment doesn’t pay off. There is probably no cause for

immediate alarm. After all, public debt is equivalent to 50% of GDP, much higher than the regional average. But the majority of this is funded by the large pool of domestic savings in the nation’s pension fund. External public debt remains low at 16% of GDP, as does overall external debt at 25% of GDP.

Better still, Fiji’s return to democracy – following the recent conclusion of the first democratic elections in eight years – should broaden its access to international capital markets, and consequently lower borrowing costs. A US$250m sovereign bond issuance in 2011 came at an interest rate of 9%; the latest developments could reduce the country risk premium and push borrowing costs toward 7%. 

Iran - Nuclear talks hold out some commercial promise

A lowering of sanctions on Iran could present an opportunity for Australian investors and exporters 

Foreign companies looking to do business in Iran have been meeting for the first time since the country’s 1979 revolution – in London over October 15-16, at the 1st Europe-Iran Forum. Hundreds of people reportedly gathered at forum to meet some of Iran’s largest companies.

Relations between Iran and international powers have been undergoing a slow thaw since the election of a new president, Hassan Rouhani, 18 months ago. Under Rouhani talks have been taking place about placing curbs on Iran’s nuclear program in return for a lifting of sanctions. The sanctions have already been eased. However, they could be tightened again, unless a full deal is reached by November 24, something that can’t be taken for granted.

Even so, many companies are obviously wanting to position themselves for a lifting of sanctions. Iran’s 80m people, many young and well educated, present an opportunity for Australian firms selling consumer goods, pharmaceuticals and medical equipment. The government also plans to carry out US$100b of oil and gas investment over the next four years, which could benefit Australian companies that have experience in energy exploration and infrastructure development.

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

Fred Gibson, Economist
fgibson@exportfinance.gov.au

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.  

Photo credit: RTR4AS75 - President Widodo:  © Darren Whiteside / REUTERS / PICTURE MEDIA.