World Risk Developments April 2016

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Jokowi’s reform drive buoys Indonesia’s investment climate

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A recent reform package is buoying investor sentiment and offering hope that Jakarta and Canberra will reach an FTA.

President Jokowi’s administration has issued 11 wide-ranging reform packages since last September to improve Indonesia’s investment climate. Reforms focus on deregulation, domestic industry revitalisation, eased trade restrictions, improved logistics and attracting foreign investment. Practically this has translated into measures like a shortened approval process for building and land permits and reduced processing times at ports. The “Negative Investment List” has been reduced to allow foreign ownership in growth sectors like communications, health, manufacturing and tourism.

Renewed reformist zeal has boosted market sentiment. The stock market is up 18% from the 52- week low at end-September 2015. In comparison, the MSCI ex-Japan rose 7% over the same period (Chart 1). Progress on reforms has also helped encourage the re-activation of FTA negotiations with Australia. This will attempt to boost bilateral trade and investment, which is currently underdeveloped relative to the complementary nature of the Australian and Indonesian economies and their geographic proximity.

China’s ailing corporate profits are a bad omen

Falling Chinese corporate profits could drag on growth.

Profits fell 1.4% in 2015 for the first annual decline since at least 2000. Profit data in the opening two months of 2016 showed some improvement, but the overall trend remains gloomy. Falling mining profits were behind the disappointing profit numbers as overcapacity in the resource sector and lacklustre real estate investment has crimped the demand for commodities. Furthermore, the mining sector accounts for 20% of China’s total external debt and with profits falling more than 25%, and in some sub-sectors close to 70%, some companies may face increased difficulty repaying debt. 

Experiences in the US and Japan suggests a sustained downturn in corporate profits often foreshadows an economic downturn as business responds by cutting hiring and investment.

The mining profit slide could undermine China’s demand for commodities and the recent rally in commodity markets, particularly for iron ore and coal. The commitment to rebalance the economy away from investment towards consumption suggests mining profits will remain stagnant through 2016.

The 2015 profit numbers did have some positives. Consumer-oriented industries, including processed foods and drinks, medicines and clothing all outperformed relative to the other sectors ─ consistent with the rebalancing narrative

Resurfacing Greek debt problems threaten EU outlook

Resurfacing debt problems are increasing political risks in Greece and threaten to cause market instability in the Eurozone.

The Tsipras government’s popularity is eroding and the risk of a new political impasse is rising for three reasons. First, a review of the reforms Greece committed to implement in exchange for bailout funds last year has been stalled since Christmas. But a successful review by creditors is needed to unlock additional rescue loans and trigger discussions on how to reduce the country’s crippling debt load. Second, border closures and difficulties in implementing the EU-Turkey deal have stranded 50,000 refugees in Greece. Third, the economy continues to stagnate.

A solution to the debt deadlock is needed before July, when fresh bailout funds are required to repay Greece’s debts. The IMF insists its participation in another bailout is conditional on a credible plan to achieve long term fiscal sustainability — requiring both politically tough pension reform and/or sizable debt relief. But while core European creditors, led by Germany, demand the IMF on-board, these same creditors have also taken debt reduction off the table. And Greece has dragged its feet on the reforms required. The IMF is therefore at loggerheads with both Greece and European institutions. Grexit anxiety-related market turbulence is therefore likely to resurface in the months and years ahead, perhaps threatening Greece’s position in the Eurozone.  

Macri’s economic liberalisation to revive Argentinean economy

Economic reforms by the newly elected Macri administration are likely to boost the Argentinean economy and Australia’s modest exports to this market.

Argentina’s recently elected President Macri inherited one of Latin America’s most dysfunctional political systems. He used the failing economy to argue that the populist controls of his Peronist predecessors must be ditched in favour of economic liberalisation.

His administration has acted fast. Since December, the currency has depreciated around 50% (Chart 2), foreign exchange and trade restrictions have been relaxed and export taxes on mining eliminated. A deal with holdout creditors has been approved ending Argentina’s pariah status in international credit markets. And measures to reduce the fiscal dExport Finance Australiait to 1% of GDP by 2019 (down from 5.8% last year) are being implemented. 

But curbing flagrant public spending and switching to a market-determined economy will be painful and Macri’s political support is patchy. The commodity price slump will also frustrate attempts to lure mining investment. Yet if Macri can successfully navigate the enormous economic adjustment required, Australia’s modest exports to Argentina (consisting chiefly of coal) will likely grow.

Dairy exporters doing it tougher

A global supply glut will keep 2016 dairy prices at multi-year lows. 

Dairy prices have more than halved from the highs of 2013 and early 2014 (Chart 3) as robust European supply and weaker demand from China and oil-producing countries have pushed prices back to GFC levels.

The Australian Bureau of Agricultural and Resource Economics and Sciences (ABARES) expects that a nascent recovery in global demand will gradually absorb the supply glut and facilitate a recovery in global prices over the next 18 months.

Australia’s dairy exports fell 7% in 2015 led by weaker sales to China, South East Asia and the Middle East. Sales to Japan, our largest buyer of cheese, rose 10%. ABARES is forecasting a recovery in Australian dairy exports over the next 18 months. But risks from good weather boosting global supply or further weakness in emerging market demand could weigh heavily on export receipts.

Shipments to Japan are set to expand, albeit at a softer pace, driven by higher demand for cheese. Chinese imports will be subdued in the first half of 2016 as importers continue to run down stockpiles. But demand should pick up in the second half of the year. The Middle East is an important growth market for exporters but lower oil prices have severely crimped incomes and thereby that region’s demand for dairy. Export receipts from Kuwait, Saudi Arabia and the UAE fell 43% in 2015 and with oil prices forecast to remain subdued, Australian dairy exporters to this region will face tougher challenges.                                                                                                                                                                      

Remittances to developing Asia at risk

Lower oil prices will weigh on remittances to Asia.

Energy exporters, Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates are the largest employers of migrant workers in the Middle East and account for 58% of remittances to South Asia.

Government budgets across the Persian Gulf have been hit hard by falling oil prices over much of the last two years. In response public spending has been pared back, including cuts to infrastructure projects. This will weigh on the demand for migrant workers, who are often employed as labourers. To make the spending cuts more palatable, policymakers could also start to limit the number of migrant workers in an attempt to boost local employment. 

Emerging and frontier economies, particularly Nepal, Sri Lanka, Bangladesh and Pakistan rely heavily on remittances from the Gulf ─ equivalent to more than 3% of GDP. A fall in remittances could restrain household spending in these economies. Furthermore, a large influx of returning workers would cause a significant rise in unemployment. given the now softer growth trajectory in Asia.

Cassandra Winzenried, Senior Economist
cwinzenried@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.