Emerging - 13 July 2018
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    In emerging countries, the risks to economic growth are crystallising. Exports are slowing and portfolio investment flows have dried up, reflecting worries about the extent of the upturn in US long-term rates, the strength of the US dollar and trade war threats. Several central banks have raised their benchmark rates to counter the US dollar’s appreciation. Tariffs levied by the United States and the retaliatory measures that have followed in their wake can only accentuate the slowdown in exports. They will not only have adverse effects on world trade, but also threaten the recovery of private investment in emerging countries.
    Beijing is worried about the economic slowdown and its effects on the financial health of Chinese corporates. Domestic demand growth is weakening and the external environment is worsening, notably because of protectionist measures taken by the US. The authorities are adjusting their economic policy accordingly. They have slightly loosened monetary conditions, without changing their objective of cleaning up the financial sector and state-owned enterprises. They have also let the yuan lose 5% against the dollar in the last three months. It is now essential for the yuan’s depreciation to remain under control, in order to avoid any dangerous capital outflows and further pressure on the currency, as seen in 2015-2016.
    India has not been spared from the mistrust of international investors since April, even though growth has accelerated strongly. At a time of rising inflationary pressures, the central bank raised its key rates in June for the first time since 2014. This monetary tightening combined with the troubles reported by state-owned banks could strain the recovery of corporate investment, even though companies are in a better financial situation. Banks, in contrast, have accumulated financial losses of more than USD 9 bn following rule changes for the classification of credit risk. These losses account for nearly 75% of the amount of government injections into the banking sector in fiscal year 2017/2018.
    The recession is over, although there are signs that the recovery is flagging. Brazil has avoided a financial crisis. However, the fiscal situation remains very worrying and there is still a crisis of a political, social and even moral nature, with a general election also coming up in October. Against a background of emerging-market tension since March, international investors are worried that the next Brazilian administration might move away from the reform agenda. On the positive side, Brazil has addressed its macroeconomic imbalances – other than its fiscal ones – while its banks are solid and private-sector agents have deleveraged.
    Economic activity rebounded in Q1 2018 and the outlook for growth is still upbeat. Household consumption is expected to boost activity in the second half of 2018, bolstered by higher real revenues. Yet inflationary pressures could intensify with the rouble’s depreciation and the prospects of a 2-point VAT hike in January 2019. A gradual increase in the official retirement age starting in 2019 should help offset some of the structural constraints hampering growth potential, by increasing the share of the active population and reducing spending allocated to financing the pension fund deficit.
    After the re-election of President Erdogan and the AKP-MHP alliance’s victory in the 24 June parliamentary election, the markets welcomed the end of political uncertainty for the time being. Still, against a background of tensions in emerging markets and increasing geopolitical risk, investors are worried about Turkey’s economic and political trajectory. The authorities must respond to macroeconomic imbalances (inflation and current account deficit) and send a clear signal regarding the central bank’s independence. However, recent news concerning the new government do not suggest any change in its policy of supporting GDP growth, despite the macroeconomic risks.
    Economic activity rebounded significantly in 2017, notably buoyed by productive investment and dynamic export growth. In the short term, private consumption is also expected to be a major growth engine. Thanks to this favourable environment and moderate spending, the government managed to balance the budget, and public debt is declining. This trend should continue at least in the short term, notably thanks to the reduction in the debt service. The situation in the banking sector is improving, even though lending remains fairly lacklustre. Slovenia’s main sources of vulnerability are linked to the eurozone’s economic prospects and the political uncertainty that has emerged following the June elections.
    The newly elected government of Mahatir Mohamed inherited a country with solid macroeconomic fundamentals, even though it is highly vulnerable to the external environment. Real GDP growth was still robust in Q1 2018 and prospects are looking upbeat. Yet certain risks are on the rise. Uncertainty over fiscal policy could strain public and private investment. Moreover, the elimination of the goods & services tax and the freeze on diesel prices could trigger an upturn in the fiscal deficit as of 2018. However, the new government might be able to reverse the downturn of the business climate, which has been deteriorating for the past five years.
    In the Philippines, real GDP growth should reach 6.7% again in 2018, which is close to its long-term potential. The economy is showing signs of overheating: inflation is rising and will exceed the central bank’s target range in 2018, and the current account deficit has widened slightly. However, in the short term, the risks of overheating should remain limited, and the country benefits from solid macroeconomic fundamentals. Even so, economic policy will have to be managed very rigorously to minimise the risk of slippage.
    Since taking office in May 2017, Lenin Moreno has launched a radical transformation of Ecuador’s economy. The aim is to increase the private sector’s weight, clean up public finances and boost the country’s attractiveness in the eyes of foreign investors. In the very short term, however, the economy faces the effects of the growth slowdown and the sharp increase in public debt, which have been registered since commodity prices dropped off in 2014. Although the proposed measures are welcome, they might not suffice to strengthen the government’s solvency.
    By using alternative trade channels and through massive government support of the banking sector, the Qatari economy has stabilised since the end of 2017. Despite the constraints of the embargo, Qatar’s economic growth remains robust, thanks notably to the government’s ongoing investment programme. Yet external debt is huge, notably for banks, and represents a significant source of vulnerability. In the medium term, although there is room to question Qatar’s capacity to diversify the economy, the coming on stream and exporting of new natural gas resources should bolster the emirate’s financial solidity.
    Nigeria is slowly exiting recession thanks to the rebound in oil production and the upturn in crude oil prices. Forex reserves have virtually doubled since end-2016, the spread between the new benchmark exchange rate and the official rate has narrowed, and the risks of further pressure on the local currency seem limited in the short term. Even so, the situation is still fragile. Public finances are constrained by the very low revenue base and the high cost of domestic debt. The monetary environment is still restrictive, the financial system is becoming increasingly vulnerable and the non-oil economy has not yet recovered. It is hard to be completely reassured with the approach of general elections in 2019.   
    The political tensions that flared up after Kenyatta’s re-election in the re-run of the presidential election have begun to ease recently. The appeasement of the political climate has been accompanied by improvements in several key economic indicators: growth has been showing signs of recovering, inflation has slowed down and external liquidity has strengthened. But the country’s financial stability is still fragile, notably due to the high level of government debt. Despite fiscal consolidation efforts, the budget deficit is expected to remain high given the social programme planned for the president’s next mandate. Lastly, despite the rationing of private-sector lending, non-performing loans continue to swell in the banking sector.
    Emerging - 25 April 2018
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    The IMF reports published in mid-April insist once again on the external financial vulnerability and indebtedness of the emerging and developing countries (EMDCs). The potential risks are highly focused on the low-income countries (LICs), especially the commodity exporters. These countries benefited from a financial windfall, but did not improve their macroeconomic fundamentals. Of the large emerging economies, Argentina, Egypt and South Africa show similar weaknesses to those of the LICs. The reforms launched in the first two countries are encouraging, but further efforts are still needed. In certain respects, South Africa has made the most progress, but the hardest part is yet to come.
    Despite the current economic recovery and a persistently favourable international environment, it is still premature to hope for sustainable fiscal consolidation. The errors of fiscal policy in past years have left their mark in the form of deteriorated public finances. The new administration that will take power in January 2019 will face the formidable task of meeting high social expectations while laying down fiscal targets that reassure investors. Structural reforms will have to be reintroduced, such as the pension reform that was swept under the carpet by the Termer administration. Without structural reforms, Brazil’s public finance trajectory could become unsustainable in the medium to long term.
    Russia consolidated its macroeconomic fundamentals in 2017. The economy swung into growth of 1.5% after contracting 0.2% in 2016. The fiscal deficit narrowed sharply to 1.4% of GDP thanks not only to higher oil and gas revenues but also to spending cutbacks. The central bank has demonstrated its capacity to face up to rising credit risks and troubled banks. The creation of a “bad bank” should help clean up the banking sector even further. Despite persistently strong headwinds that are preventing growth from accelerating, the rating agency Standard & Poor’s has upgraded Russia’s sovereign rating to BBB-. However, new US sanctions against oligarchs should weigh on economic growth.
    On the positive side, growth is accelerating rapidly and should return to levels close to the potential growth rate as of fiscal year 2018/19. Private investment finally seems to be entering a sustainable recovery. As part of a bank recapitalisation plan, public banks, whose asset quality has deteriorated further, received an injection of nearly USD 14 bn in March, which should help ease the pressures on the most fragile banks and bolster the rebound in investment. On the negative side, the government has taken a pause from the consolidation of public finances. The current account deficit has widened slightly, reflecting a deterioration in the terms of trade and a decline in export market shares.
    Trade tensions between China and the US are growing. China continues to enjoy a very strong external financial position, and exports to the US account for only 4% of its GDP. Therefore, any implementation of tariff hikes by the US should have a moderate direct impact on China’s macroeconomic performance. However, protectionist measures could dampen its export growth and constrain the industry’s efforts to climb the value chain, whereas China is starting to see a slight loss of its world market share. Moreover, weaker-than-expected growth in exports and GDP could shake the determination of the authorities to slow the rise in domestic debt.
    The situation improved in 2017: the election of President Moon Jae-In marked the end of the political crisis, diplomatic relations have calmed down and GDP growth has bounced back. The outlook is good in the short term but there are still a number of weaknesses. First, the lack of parliamentary majority could make it hard for the government to implement its proposed reforms. Secondly, maintaining a normal relationship with the United States and China while fending off the North Korean threat will be a major challenge. Lastly, although South Korea’s external financial position is robust, the economy still relies substantially on its export sector, which is exposed to the ups and downs of world trade and the rising tide of protectionism.
    Poland’s economic indicators are excellent. Economic growth is the strongest since 2011. Consumption is bolstered by real wage increases and new social transfer programmes. Investment is accelerating thanks to the inflow of EU structural funds and an upturn in credit. The fiscal deficit is the lowest since 1995. Although the economy is operating at full employment, inflation is still mild and below the central bank’s target. Lastly, a compromise could be taking shape on the thorny issue of judicial reform, which has escalated tensions between Poland’s leaders and Brussels since 2016.
    Argentina continued to report robust economic growth in H2 2017, and it clearly maintained this pace in Q1 2018. From the demand standpoint, economic growth should be somewhat better balanced than it was last year thanks to an upturn in exports. However, we can already see signs of overheating and tensions: domestic lending has increased sharply in real terms, the trade deficit has widened, and above all, inflationary pressures have picked up. For the time being, there is nothing alarming about the underlying savings-investment imbalance, notably because fiscal consolidation targets have been met. Yet the authorities are faced with a monetary policy dilemma that is typical of an emerging economy.
    After the Egyptian pound’s floatation in November 2016, the Central Bank of Egypt (CBE) drastically tightened its monetary policy. Inflation has fallen regularly since Q3 2017, and should meet the central bank’s target. Money supply is growing at a relatively fast pace, bolstered by capital inflows. Maintaining interest rates at a high level is placing a major strain on lending growth, and the monetary easing that began in 2018 will continue gradually. The ongoing decline in inflation is still vulnerable to higher energy prices, and external financing constraints are still high.
    In a less buoyant regional environment and at a time of fiscal consolidation, economic growth has remained positive even though it slowed in 2017. Thanks to a mild upturn in oil prices and fiscal stimulus in 2018, the economy should gradually return to more robust growth, despite some persistent geopolitical and economic uncertainties. The country’s fiscal position is still precarious, but the government’s solvency is solid. In the medium term, the public sector’s external debt should continue to swell. The Emirates benefit from favourable financing conditions, which will facilitate ongoing efforts to diversify the economy.
    The year 2017 ended with record high twin deficits, which brought the exchange rate and inflation under fierce pressure. Strengthening macroeconomic stability will be hard to achieve. The authorities have very little manoeuvring room. Foreign exchange reserves have fallen below the threshold of three months of imports. The central bank has tightened monetary policy at the risk of increasing the squeeze on bank liquidity, but the impact on inflation will remain small as long as the dinar continues to depreciate. Fiscal consolidation also promises to be a difficult process. Between social pressures, conditions imposed by the IMF and a high public debt, the government has no other option but to reduce the fiscal deficit.
    Cyril Ramaphosa became South Africa’s new President in February 2018, which created a positive confidence shock. The formation of a new government, the presentation of the 2018-2019 budget and the announcement of structural reforms ended a long period of political uncertainty, restored investor confidence, strengthened the rand and paved the way for improvements in public finances. In the short term, renewed confidence should boost economic growth. If the recovery is to extend into the medium term, however, the country must successfully introduce major structural reforms that are essential for raising the potential growth rate.  The new administration, and the ones to follow, face a daunting challenge.
    In the midst of an economic transformation, Ethiopia is the fastest growing country in Sub-Saharan Africa, thanks to major public infrastructure investments. But this robust activity hides major macroeconomic imbalances and the vulnerability of the country to fluctuating weather conditions and commodity prices. Low foreign exchange reserves and high current account deficits remain a major source of concern despite the birr’s recent devaluation against the dollar. Above all, an increasingly tense political climate could slow the country’s economic development.

On the Same Theme

Between comfort and unease 4/16/2018
High confidence levels, a global economic upswing, cautious central banks, sustained job creation and companies’ stepped up investments: enough reasons to feel comfortable when assessing the outlook for world economic growth. Yet a feeling of unease has been on the rise in recent weeks. The softening of sentiment indicators confronts us with the question of what happens after the peak. Is the flattening of the yield curve in the US a harbinger of bad weather to come? Should the share price decline of certain tech companies be read with the experience of TMT stocks in 2000 in mind? Will US inflation end up overshooting the Fed’s objective? And last but not least, to what level will the trade disputes escalate?
Tensions flare up 1/25/2018
It looks like 2018 will be a year of strong growth across the globe, with very few countries left behind. In the United States and the eurozone, business climate indicators are close to the peaks last seen in the mid-2000s. Although pressure on production capacity has been rather mild so far, business leaders are beginning to feel it more acutely. Asset prices – both financial and real estate – continue to rise, and some now fear the emergence of bubbles. The time is ripe for the normalisation of monetary policies. The central banks are cautiously pulling out of the government bond market, which is likely to spark an upturn in interest rates. This risks placing a damper on activity as of 2019.
The recovery continues, but… 7/11/2017
A wave of optimism is sweeping the economy, especially in the eurozone, where growth is accelerating and spreading to all member countries. As we enter summer 2017, all economic indicators are looking upbeat, job creations are picking up, and unemployment is declining at a faster pace. The horizon looks bright, with just one exception, China, where a few clouds are forming. Beijing is taking action to curb credit growth again, which is bound to strain activity, notably in the real estate sector. Heavy industry is already showing a few signs of relapsing, and global commodity prices are easing.
Stronger momentum 4/25/2017
Economic indicators are picking up in most of the developed countries. Eurozone growth is more robust, at an annualised rate of nearly 2% in first-quarter 2017. The rebound is also better distributed, as the economic cycles of the 19 eurozone member countries are tending to move more in sync. The United States reported an upturn in oil and shale gas- related activities, and corporate investment in this sector probably rebounded at the beginning of the year. Inflation rebounds, approaching or overshooting the official 2% target. The central banks keep calm, however.

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