World Risk Developments September 2014

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China — Dwelling oversupply threatens downturn

Dwelling prices continued to fall in July. A housing correction is the biggest risk to China’s economic growth.

Prices for new residential flats fell in 64 out of 70 surveyed cities (in month-on-month terms) in July, according to data from the National Bureau of Statistics. This was up from the number of cities registering price declines in June - 55. Prices fell 1% in Beijing in July, their first monthly decline since April 2012. Only two cities experienced rising property prices in July, down from eight in June, and prices were unchanged in four cities in July versus seven in June.

Tighter mortgage lending standards have been deterring buyers, though 36 cities recently loosened lending measures to encourage demand again. Construction companies have been cutting prices since March to attract buyers and clear a glut of unsold dwellings.

Indonesia — Jokowi confirmed as president, but challenges remain

The president-elect has overcome his first obstacle – the challenge to his electoral win. There will be many more.

Indonesia’s constitutional court dismissed on August 21 a challenge to the presidential election result by former General Prabowo Subianto, clearing the way for Jakarta governor Joko ‘Jokowi’ Widodo to become the country’s next leader in October.

Mr Widodo will take over a country facing significant challenges, including economic growth at a five-year low, subsidies that have ballooned to a fifth of the budget, and resource exports handicapped by a ban on raw ore exports.

The president-elect has indicated he wants to direct funds from fuel subsidies to greater infrastructure and welfare spending, court private investment, and combat corruption. But he will face several obstacles, including a weak political mandate and resistance from governors, district heads and mayors. 

Thailand — June quarter recovery masks underlying risks

The economy is showing some signs of recovery, but political uncertainty clouds the longer term outlook.

The six months of unrest before the military coup in May did considerable economic damage. Real GDP shrunk at a more than 7% annual rate in the March quarter, as domestic demand and tourism both took a hammering.

But the economy managed to avoid a technical recession, after it grew at a 3½% annual rate in the June quarter. The stabilisation thus appears to have happened before the army staged its coup on May 20.

Many forecasters are tipping that the economy will continue to expand in the second half of 2014, now that the junta has established order, and starts to ramp up infrastructure spending. It reportedly wants to spend up to US$75b over the next eight years on rail and airport schemes, including two high-speed railways that will link to China worth US$23b.

As for the long term, the junta claims that ‘Thailand is back’. At a conference with that name in July, it promised an ‘inclusive’ reform process to prevent another political crisis. Some investors present reportedly accepted this, though others remained sceptical that a lasting political settlement will be reached.

There is a risk that the junta’s political reform ‘roadmap’ will sharpen rather than heal the social divisions that spawned the crisis. And beyond this political risk, there are also concerns that Thailand, because of population ageing and neglect of its manufacturing competitiveness, has fallen into a ‘middle-income trap’.

In any case, it will probably be the slowest growing economy in Asia outside Japan this year. What is less clear is whether it can regain its mojo. Will it return to long term growth of 4-5% a year, well above its population growth rate of 0.3% — under the firm guidance of the junta who steer the country back to stable democracy? Or will political risk, population ageing and the failure of manufacturing to reinvent itself retard growth to well below this rate?

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Australia – Farmers will withstand Russian import ban

Canberra is confident that Australian agriculture will be able to withstand the Russian import ban well, because Russia is not a large farm export destination, and restricted product can be switched to alternative markets.

The Australian Government has said it is ‘disappointed’ by Moscow’s decision to ban imports of agricultural products, raw materials and foodstuffs from countries that have imposed sanctions on Russia in response to the events in Ukraine.

Russian President Vladimir Putin signed a presidential decree on August 6 that imposes an immediate one-year ban on imports of specified agricultural products from Australia, and also the EU, US, Norway and Canada. Among the products targeted are: fresh and chilled meat, fish, vegetables, milk and milk products, cheese, sausages, vegetables, fruits and nuts (excluding any that could be used as infant food). The ban also does not cover livestock.

The Australian Government has said that its ‘immediate focus’ is to manage those exports currently at sea or in transit to Russian markets, and to help exporters switch to alternative markets. Some Australian exporters have already reported that Russian Customs is refusing entry of their cargoes.

The Government says that ‘the loss of any market is always of concern’, but ‘Australian agriculture will remain strong’, because Russia is not a large trading partner, and there is strong capacity to switch supplies to alternative markets where demand is brisk. 

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Read about Australian sanctions on Russia here.

Russia — Sanctions start to bite

The US and EU sanctions imposed on Russia over its intervention in Ukraine are already exerting a drag on the economy and a strain on external financing.

Even before Russia purportedly annexed Crimea at the end of February, the economy was slowing, as construction of the Nord Stream pipeline and the Sochi Winter Olympics facilities ended. But as initial sanctions were imposed on ‘individuals and entities responsible for violating the sovereignty and territorial integrity of Ukraine’ in the March quarter, it started to slump. Investors sold down heavily the share (Chart 1), bond (Chart 2) and currency (Chart 3) markets. The central bank was forced to respond by raising its policy rates a total of 250 bp and also defending the exchange rate. Meanwhile, the government felt obliged to cancel some domestic bond auctions. And in international markets, the cost of financing went up sharply, and issuance down — even before the US and EU imposed further financial sanctions in July. 

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And now the crisis has escalated and sanctions has moved to a tighter sectoral phase. In particular, financial sanctions announced on July 29 will severely restrict Russia’s access to US dollar and euro capital markets.

Even with the lower capital inflow and capital flight now in prospect, we still believe that the economy will be able to meet its gross external financing needs (meaning its maturing medium/long term debt plus outstanding short term debt less the current account surplus). These needs are estimated by the IMF to be US$159b in 2014 and US$178b in 2015, around 8-9% of GDP. The financial sanctions will obviously hinder the economy’s ability to meet this need. Yet many companies will turn to Russian banks for refinancing, drawing upon their foreign assets. The Kremlin may also turn to Chinese financing — the recent gas deal with China included US$25b of prepayments. Finally, consumption and investment spending, and associated imports, will be squeezed, further lowering the financing strain.

Still, if the crisis escalates further, Russia’s access to international capital markets will become even more restricted and capital flight could accelerate. The US Treasury could, for instance, do what it has done to Iran – restrict access to the US dollar-based international payment network. This would bite hard into Russia’s ability to export and import, and severely increase financing strains. It is easy to picture a situation in which net capital outflows come to swamp the current account surplus of 3% of GDP, and foreign assets consequently deplete. At some point, the authorities would either need to allow a steep ruble depreciation, or impose capital controls and ration available foreign exchange, maybe even reschedule foreign debt.

This is a scenario that both the IMF entertains in its June Article IV report, and the World Bank in its March Russia Economic Report. The Fund says that ‘a significant escalation of tensions’ could ‘in the extreme jeopardise external sustainability’. The Bank talks about the economy just scraping by, as the central bank finances with its reserves (final chart) the growing gap between the current account surplus and capital account dExport Finance Australiait.

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Roger Donnelly, Chief Economist
rdonnelly@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.