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World Risk Developments - April 2011 (Size 3.4Mb)
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Last month, we were preoccupied with the MENA turmoil, the Japanese earthquake and tsunami, and the eurozone sovereign debt-cum-banking crisis. This month we still are. The impacts from all three dislocations continue to reverberate.
MENA. The so-called Arab Spring entered a new phase. While most regimes have been prepared to listen to the socio-economic grievances of protesters, they have been less willing to share political power. Regimes across the region, but most notably in Libya, Syria, Yemen and Bahrain, have mounted crackdowns. In the process, Libya has entered a civil war, and Yemen looks on the brink.
It is too early to tell who will gain the upper hand, but what is more certain is that there will be no return to the status quo prior to these protests. Any attempts by autocrats to achieve such a return will only undermine their legitimacy further and set the scene for renewed conflict. A key question is: Will they be able to manage discontent through economic and social concessions while keeping their grip on power? Or will the protesters go for broke, demanding regime change as well?
In the two countries where the old regimes have already been overthrown – Egypt and Tunisia – recent developments are promising. Constitutional change and elections are being planned. But the situation remains unstable and uncertain, with the position of security forces and Islamic opposition groups in particular unclear.
What does all this imply for businesses trading with and investing in the region? A lot of upside potential, but also much downside risk. In short, more uncertainty.
There is some – weak – evidence that more government accountability leads to improved governance (Chart 1). But there are also examples where governance and economic performance do not improve following the overthrow of an autocrat – the Philippines being one, at least on face value (Chart 2). However, it is possible that the effects of democratic transition may take many years to flow through – in the Philippines, for example, economic performance has staged a turnaround in the last few quarters, almost 25 years since Marcos was ousted.
Japan. There is some good news to report about the Japanese quake impact. Despite a spate of stories about businesses round the world being disrupted by a lack of parts, components and equipment from Japan, world manufacturing production in aggregate doesn't seem to have suffered a severe knock. That at any rate is the message from purchasing manager indices (PMIs) for March. The JP Morgan global manufacturing PMI fell to 55.8 in March from 57.4 in February, but remained well above the borderline 50 mark, below which contraction is indicated. The disaster has indeed caused supply chain disruptions, but apparently firms outside the disaster area in Japan, and in other countries, have rushed to supply the shortfall.
While world manufacturing production might be managing well, Japanese GDP has certainly been impacted, with imports going down correspondingly, including from Australia. The Australian Treasury’s latest estimates suggest that Australian export earnings could receive a $2 billion setback in 2010-11. This comes on top of a $9 billion hit from the Queensland floods and cyclone. As we argued in our newsletter last month, however, Australian exports could receive a subsequent boost as reconstruction gets underway and as the Japanese power industry strives to close the energy gap created by the disaster at the Fukushima nuclear power plant.
Eurozone. Highly indebted peripheral eurozone governments continue to struggle with their public finances.
Portugal’s caretaker government sought on 6 April a bailout from the EU – the third country to do so after Greece and Ireland. Portugal had been experiencing increasing difficulty tapping capital markets since January, and its predicament only got worse after opposition parties voted in March against an austerity package of the then-minority government, forcing its resignation. Markets are currently pricing in around a 40% chance that Portugal will default within five years. The failure of the EU to hold the line at Greece and Ireland won't affect just Portugal: it could also make life difficult for governments in Spain, Belgium and Italy.
Meanwhile, bank stress tests in Ireland showed that banks were in worse shape than thought, requiring the government to tip in a further €24 billion to boost their capital ratios.
And in Greece, the government is having difficulty meeting fiscal targets in its 2010 bailout package.
Three other big stories over the past month have been
Interest rate rises. Both China and the European Central Bank have hiked policy rates.
The ECB rise follows increases in emerging markets and commodity exporting countries, such as Australia, Canada and Norway. But it is the first increase since the financial crisis and comes ahead of the US Federal Reserve, the Bank of Japan and the Bank of England, all of which continue to sit tight. The increase is appropriate for the expanding German economy but won't be welcome on the struggling eurozone periphery.
China's increase was the fourth in five months. In an effort to damp the overheating economy, the People's Bank of China has also increased bank reserve ratios several times and clamped down on various financing schemes, such as one using copper stockpiles as collateral. Reining in inflation will be hard; even with the rate rise, lending rates are still no match for China’s nominal GDP growth rate of around 14%. Moreover, there is little that monetary policy can do to restrain the chief inflation culprit: food prices that are rising much faster than general prices (7.2% versus 4.9%). Rising Chinese nominal wages have also contributed to the inflation breakout.
Oil price rises. A strike in Gabon, which produces only 240,000 b/d of oil, helped push the oil price (Brent) above US$120/b for the first time since 2008. That such as small producer could have such an outsized effect points to intensifying supply concerns in a market already fretting about the virtual collapse of Libya’s oil production of 1.6m b/d. The increase will be particularly unwelcome in many emerging economies, such as India and China, which import a lot of oil and have inflation problems. India, for example, is already grappling with 'food and fuel' inflation and has raised interest rates eight times since March last year in response.
US budget agreement. A US federal government shutdown was averted after congressional factions reached an agreement on a framework budget for the current fiscal year, which ends in September. The agreement, which is set to deliver discretionary spending cuts in the order of US$39 billion, also includes stopgap financing which should keep the federal government going while the agreement works its way through the legislative process. But other fiscal issues loom large. In particular, the need to reach an agreement on the legal debt ceiling so that the federal government can keep borrowing to meet its obligations. The country also faces more difficult medium-term fiscal challenges, notably achieving a larger fiscal consolidation and making inroads into entitlement reform.
Roger Donnelly, Chief Economist
rdonnelly@efic.gov.au
Dougal Crawford, Senior Economist
dcrawford@efic.gov.au
Ben Ford, Senior Economist
bford@efic.gov.au
The views expressed in World Risk Developments are EFIC's. They do not represent the views of the Australian Government.