World Risk Developments November 2015


China —  Fifth Plenum delivers predicable outcomes

Policymakers  renewed their commitment at the Fifth Plenum to rebalance the economy away from investment and to support cleaner environmental practices over the next five years. It  also scrapped the one-child policy to address China’s ageing population over the coming decades.

View a summary of this month's edition.

Key outcomes from the recent meeting of the 5th plenary session of China’s senior policymakers—which determines policy over the next five years—include

  • promoting clean and green environmental practices
  • improving and social security continuing to rebalance the economy toward consumption and services
  • maintaining the goal of doubling incomes from 2010 to 2020
  • promoting innovation and greater market-based reforms to lift productivity, and
  • further loosening the one-child policy.

Beijing is planning to introduce a basic pension for all employees nationally and is committed to lifting innovation and productivity growth to foster greater production of higher-value added industries. The growing focus on cleaner environmental practices will reduce the use of coal in energy production

Services have reached 50% of GDP, while the industrial sector’s contribution has fallen toward 40%. Highlighting the growing consumer sector was the recent success of ‘Singles day’— a 24-hour online sale organised by e‑commerce giant Alibaba. The event raked in A$20b — 60% more than last year. Reports suggest the 24-hour sale caused an increase in demand for Australian infant formula. The event highlights the increasing preference for Australian agricultural goods and services.

But the rebalancing toward services and consumption will not be painless and the aim of doubling incomes between 2010 and 2020 will require a growth rate of around 6.5% over the next five years. To deliver this Beijing will probably need to administer further fiscal and monetary stimulus. 

The growing  middle class will be a key driver of Chinese growth over the next two decades. China's working age population started to shrink from 2012 partly as a result of its 35 year old one child policy and ageing population The removal of the 35 year-old one-child policy is an acknowledgement of this. Indeed the share of elderly citizens (those aged 65+) is forecast to treble between 2010 and 2050. This raises the tax burden on the working age population—especially since Beijing has committed to lifting social welfare. Furthermore, the elderly tend to consume less, reducing household spending and growth.

China — Yuan moves closer to  reserve status

The yuan is set to join the world’s reserve currencies. But tight capital controls and a heavily regulated foreign exchange market mean it still has a long way to go before it challenges the US dollar as the globe’s premier reserve currency.

The IMF recently supported the yuan’s inclusion in its basket of reserve currencies — which consists of the US dollar, yen, pound and euro. But the IMF Board will still need to ratify the yuan’s inclusion — widely expected to occur by the end of November.

The yuan’s presence in international trade and financing has grown significantly in recent years—SWIFT data on international payments suggest the yuan is now the 5th most used currency to settle payments (accounting for 2.5% of total payments), up from 35th (less than 0.5%) in 2010. But this is still well behind the US dollar (Chart 1).

The IMF’s recent assessment found the yuan was ‘freely usable’ and ‘widely used’ prompting the recommendation. Chinese policymakers, particularly those pushing for pro-market reforms, will view this as reward for China’s progress on liberalising the economy. Bringing the yuan into the SDR would strengthen the authority of China's central bank, one of the chief proponents of financial reform. Indeed admission to ‘reserve currency’ status could be the catalyst needed to allow greater investment into and out of China, and eventually the full liberalisation of the capital account.

From an Australian perspective the increasing acceptance of the yuan globally should make it easier to settle trade and investment transactions in yuan. Currently most trade transactions are converted into US dollars and then converted into either yuan or AUD. This can be costly for SME exporters and importers.

In the longer term, the liberalisation of China's capital account will set the scene for China to take a larger role in global finance. Capital account liberalisation is part of a closely managed transition to a new more market-oriented growth model for China.  These developments will have significant impacts for Australia's two-way trade and investment with China and the region.

Myanmar — Tough challenges follow election

The opposition National League for Democracy (NDL), led by Aung San Suu Kyi, triumphed in Myanmar’s first openly contested election in a quarter century. But while economic and democratic reforms may spur growth, the challenges are daunting.

The November poll attracted global attention as the bellwether of the country’s transition to democracy after 50 years of repressive military rule. In 1990, the NLD won 80% of parliamentary seats yet the army annulled the results and arrested opposition members, including Aung San Suu Kyi. But the NDL’s strong recent election result will not deliver it absolute administrative power — 25% of parliamentary seats are reserved for the army, so the NDL will need to form a coalition to achieve its key aim of constitutional amendment. The army’s political power will only be ended if the critical 25% waver. Contentious negotiations to form a new government and appoint a president will extend to March 2016, before which investors and donors will remain cautious. While President Thein Sein has vowed a smooth transition of power, anxieties remain about the longevity of the democratisation process.

The challenges created by decades of isolationist policies and economic mismanagement are daunting. And Ms Suu Kyi’s political program is sketchy. Myanmar is one of the poorest countries in Asia — more than 25% of its 60 million people live in poverty. It also suffers pitiable infrastructure, endemic corruption and antiquated banking. The World Bank’s 2016 Doing Business gauge ranked it 167 out of 189 countries. Performance was particularly poor for enforcing contracts — only Bangladesh and Timor-Leste are ranked worse. Further, Myanmar comprises a patchwork of ethnically-based regional parties stitched together with force (as a proportion of GDP, Myanmar outspent the US on defence last year). An agreement on the first nationwide ceasefire between the government and ethnic militias was reached with only eight of 15 rebel groups last month. Ethnic conflicts pervade large swathes of the country.

But Myanmar possesses large growth potential. Sandwiched between China and India and with an extensive seaboard and abundant natural resources, it has an important geostrategic location with compelling trade prospects. An economic overhaul to reintegrate into the global economy began in 2011. The subsequent easing of most Western sanctions has begun to bear fruit. The IMF expects growth of 8.5% this year (Chart 2). FDI reached a record US$8b during FY2015 — more than double the previous year — directed into the energy and garment industries.

Although currently still a small export destination, Australia’s exports to Myanmar — heavily dominated by food — doubled over the five years to FY2015 (Chart 2). Despite considerable challenges, democratic and economic reform in Asia’s last frontier could further boost the trade relationship.

PNG — Spending cuts target health and education

Papua New Guinea’s recently announced budget has outlined spending cuts to reduce the bulging fiscal deficit. But policymakers have maintained their spending on big ticket items at the expense of core outlays (health and education). This could have negative effects on long run growth. To shore up its finances, Port Moresby is set to tap foreign bond markets.

Slumping global energy prices have weighed heavily on export receipts and government revenues. To keep the budget deficit manageable and avoid a balance of payments crisis, policymakers have finally decided to cut spending. The majority of the cuts to expenditure are bundled up in the 2015 Supplementary Budget, cutting around 6.6 % of expenditure from the 2015 Budget. The 2016 Budget revises expenditure down a further 2.4 per cent. Outlays on education, transport and administration will fall more than 15% in 2016, with further reductions to core services beyond 2016 as the government aims to balance the budget by 2020 (Chart 3). While a return to a more fiscally sustainable path was required, the cuts will further reduce the Government’s ability to deliver services, ultimately impacting on its long term growth potential. 

Port Moresby is also hoping to raise A$1.3b in foreign bond markets to refinance its short term debt with longer dated bonds. We expect some of these funds will be used to finance the budget deficit and replenish PNG’s low stock of foreign reserves.

Aside from whether there is sufficient risk appetite amongst global investors, how much interest will PNG have to pay on this new debt? PNG sovereign debt is currently rated ‘junk’ (B) by the major ratings agencies. By looking at similar rated countries, it appears the PNG government would have to pay investors between 7% to 10% p.a. This is broadly consistent with the interest rate the PNG government currently pays on its external debt.

Turkey — Risk of autocratic rule rises

The risk of autocratic rule has risen following recent Turkish elections. The Justice and Development Party (AKP) has regained a parliamentary majority, but it didn’t secure the numbers to alter the constitution and expand presidential powers.

The AKP failed to win a parliamentary majority in June elections and to form a working coalition with minor parties, so a hung parliament resulted. The snap November 1 poll filled the political vacuum created by the impasse. President Erdogan has capitalised on ongoing security concerns and political uncertainty to push for a majority single-party government.

The presidency is currently a figurehead, but Erdogan has been trying over the last year to amend the constitution to expand presidential powers—effectively moving Turkey into autocratic rule. The recent election gives his party 317 seats in the 550-member parliament, but this is still short of the 330 needed to amend the constitution.

Markets initially welcomed the result —the Turkish benchmark equity index rallied 7%, and the lira 4% immediately afterwards. But the growing threat of authoritarian rule has weighed heavily on investor sentiment since, with the equity benchmark and lira both down 2% since early November. Indeed Turkey’s deep sectarian divide is creating social tensions, while slowing growth and the growing risk of a balance of payments crisis from external vulnerabilities are weighing on the economic outlook.

European leaders have been critical of Erdogan’s power-grab. But Turkey’s strategic location — in particular its border with Syria, the epicentre of the current refugee crisis and the war with ISIS, means political stability in Turkey may supersede concerns about growing autocratic rule.

Emerging markets – E-commerce opportunities multiply

Technological advances and the growing push of online payment systems and e-commerce are increasing integration of emerging markets into global trade. This opens up new market segments for Australian exports.

Access to the internet in emerging markets has grown strongly in recent years, with the number of new users rising in excess of 7% p.a. in 2014. Growth has been particularly robust in Africa and the Middle East (Chart 1). Concurrently the strong rise in mobile phone usage is paving the way for greater electronic transfers of money. This is reducing the reliance on traditional brick-and-mortar banking facilities, which are often lacking in emerging markets, particularly in rural areas.

Peer-to-peer lending systems have increased financial inclusion, while the growing push of electronic payment systems and e-commerce in emerging economies will make it easier for customers to buy goods and services as well as transfer money overseas.

Alibaba in China, Flipkart in India, and global giant Paypal are just some of the e-commerce providers investing heavily in emerging markets. Paypal has just acquired Xoom, a remittance provider operating in 33 economies including China, India, Pakistan, Mexico and the Philippines.

The growing presence of electronic payments and e-commerce means Australian exporters have an additional platform to market their goods and receive payments electronically. Linking companies directly with consumers reduces the need for both middlemen and physical foreign outlets to serve clients, a point particularly relevant for cash-strapped SME exporters. Policymakers are aware of the growing importance of e-commerce with the recent Trans-Pacific Partnership outlining provisions to promote greater trade electronically. For the first time in a trade agreement, TPP countries will guarantee the free flow of data across borders for service suppliers and investors as part of their business activity. Keeping information moving freely, with appropriate safeguards for privacy and public policy concerns, is essential to doing business in the digital economy.

Cassandra Winzenried, Senior Economist

Fred Gibson, 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.  

Photo credit: © Carlos Barria / REUTERS / PICTURE MEDIA