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Roger Donnelly, Chief Economist
rdonnelly@efic.gov.au
Benjamin Ford, Senior Economist
bford@efic.gov.au
Dougal Crawford, Senior Economist
dcrawford@efic.gov.au
The views expressed in World Risk Developments are EFIC's. They do not represent the views of the Australian Government.
International: QE2 launch proves controversial
As expected, the US Federal Reserve announced on 3 November a second round of quantitative monetary easing – QE2 – to boost the flagging US economy. Criticism of the initiative has been loud and varied, and support muted.
As well as holding its benchmark interest rate at 0-0.25%, the Fed announced it would buy another US$600 billion in Treasury securities by June 2011. The US$600 billion equates to purchases of US$75 billion a month, and will come on top of reinvestment of principal payments from debt and mortgage-backed securities bought in the first QE round, around US$35 billion a month. Of the Treasuries to be bought, 46% will mature in 5½-10 years and another 40% in 2½-5½ years. Although the initiative was well broadcast beforehand, a wide variety of financial and commodity markets worldwide rallied immediately afterwards.
The Fed hopes that QE2 will push down yields on Treasuries, encouraging investors to switch to riskier assets, thereby lowering borrowing costs for businesses and households. This in turn should cut mortgage costs and boost share prices and confidence – ultimately increasing investment and demand. It noted that the US unemployment rate of 9.6% remains high and underlying inflation is low.
The program is proving controversial both at home and abroad. Some alarmists say it represents a slippery slope to hyperinflation. In fact, the policy comes with quite a different risk: it could fail to stop the slide of the economy into deflation.
For one thing, the size of the program is modest in a US$15 trillion economy. Moreover, with the economy now stuck in a 'liquidity trap' where businesses and households are hesitant to spend even at nominal interest rates approaching zero, the policy faces uphill work to induce them to spend more. Still, with a new round of fiscal stimulus out of the question politically, it is the only macroeconomic policy lever available.
Overseas, the policy is also ruffling feathers, especially in countries such as China, Korea and Germany wedded to an economic growth model that relies on a weak exchange rate to boost exports. Chinese Vice Finance Minister Zhu Guangyao has said that it will increase ‘hot money’ inflows into emerging markets. According to German Finance Minister Wolfgang Schäuble, the policy (sic) is ‘clueless’. Washington should not attack the undervalued renminbi when it is also weakening the dollar through monetary easing, he said.
But countries in this camp don't speak with one voice. Chinese Finance Vice Minister Wang Jun has said that QE2 could help the world economy ‘tremendously’. Thailand has also welcomed the Fed’s initiative.
In defence of QE2, Fed chairman Ben Bernanke has said it will help the world economy by lifting growth in the US. Other QE2 supporters dismiss the charge that America is guilty of a double standard in criticising the currency manipulation of other countries, when QE2 is just currency manipulation by another name. They note that the US is acting in the international public interest by seeking to expand American and global demand; US dollar weakness is simply a by-product of its monetary stimulus. In contrast, countries like China are directly manipulating their currencies and damping domestic, and by extension global, demand by tightening monetary policy.
Eurozone: Sovereign debt and bank concerns resurface
Concerns about sovereign debt default and bank insolvency in peripheral eurozone countries have flared up again after subsiding through September and early October.
Irish, Portuguese and Greek bond spreads have surged since mid-October to reach all-time highs (Chart 1). The trigger for the increase was a move by the bond market clearing house LCH.Clearnet to twice increase the deposit it demands of traders dealing in Irish debt securities.
Traders are also reportedly fretting about the implausibility of fiscal adjustment plans and assumptions in the three countries, political opposition to those plans, and moves by the EU to establish a ‘permanent crisis resolution regime’ that would give haircuts to bondholders of governments seeking a bailout.
In related developments, the Irish government entered talks on 17 November with the EU, European Central Bank (ECB) and IMF on whether the Irish banking system needed a rescue package. The Department of Finance (DOF) insists that the government itself needs no bailout because it is 'fully funded until well into 2011’. But many Irish banks are struggling to raise funds in capital markets and some are also suffering deposit withdrawals. As a result, they have been obliged to go to the ECB for liquidity support. The ECB, however, dislikes such increasing and open-ended support, because it prevents the bank from unwinding its liquidity support program. Moreover, there is a concern that the problem at Irish banks is festering and could cause contagion to other peripheral eurozone countries. The Portuguese finance minister, for instance, has warned that his country might need to seek financial support due to the Irish problems.
Against this backdrop, other EU governments are reportedly pressing Dublin to take more responsibility for the banking system's plight by seeking a pre-emptive IMF/EU rescue package. From such a package the government could then lend to the banks to alleviate their liquidity problems and make further capital injections if need be to shore up their solvency.
International: ‘Dark clouds' of protectionism gather
The WTO, OECD and UNCTAD have warned that ‘dark clouds’ of protectionism are gathering.
In a report prepared for the G20 summit meeting held in Seoul last week, the three bodies noted that ‘by and large’ G20 governments had continued to resist protectionist pressures over the previous year. But they warned that those pressures were intensifying because of high unemployment, macroeconomic imbalances and tensions over exchange rates.
The report advised governments to resist the temptation to hold down exchange rates so as to encourage exports and discourage imports. It also warned that the stability of the trading system could be put at considerable risk by such exchange rate manipulation. It is drawing attention here to the temptation of countries hit by ‘exchange rate dumping’ to retaliate with either their own currency market intervention or trade restrictions.
The report didn't make explicit mention of ‘QE2’ – the new round of quantitative monetary easing that the US Federal Reserve announced on 3 November (see story above). Still, QE2 is an important backdrop: many people worry that the liquidity it will make available could spur already strong capital inflow to emerging markets, prompting governments in these countries to make extra efforts to hold down their exchange rates with foreign exchange purchases and capital controls, and to curtail imports directly through trade restrictions.
International: Doing business becomes easier despite GFC
Business climates around the world are on the whole improving, says the World Bank.
The Doing Business 2011 survey examines business climates in 183 countries. It is the eighth in an annual series. It finds, unsurprisingly, that doing business remains easiest in high-income OECD economies and hardest in Sub-Saharan Africa and South Asia. But 66% of developing economies have reformed business regulation over the past year. In the past five years, about 85% of economies have made it easier for local entrepreneurs to operate, through 1,511 improvements to business regulation.
Kazakhstan improved business regulation the most in the past year. Two other post-communist economies, Tajikistan and Hungary, were also among the 10 most-improved economies, climbing 10 places and six places respectively. China and India are among the top 40 most-improved economies over the past five years. Among the top 30 most-improved economies, a third are from Sub-Saharan Africa.
This year's list of the 10 most-improved economies includes three in Sub-Saharan Africa – Rwanda (a consistent reformer of business regulation), Cape Verde, and Zambia – as well as Peru, Vietnam, Grenada, and Brunei.
For the fifth year running, Singapore leads the world for ease of doing business, followed by Hong Kong, New Zealand, the UK and US. Among the top 25 economies, 18 made things even easier over the past year.
The survey finds that the GFC has been no impediment to business deregulation. Quite the contrary: ‘The economies most affected by the financial crisis – especially in Eastern Europe – have been targeting regulatory reforms over the past year to make it easier for small and medium-size enterprises to recover and to create jobs.’
The survey provides valuable guideposts for foreign investors, but its results should be interpreted carefully and it shouldn't be viewed in isolation. Many of the Doing Business improvers start from a low base. Others, while they may score well for their ‘ease of doing business’, have other drawbacks. For instance, Vietnam is currently suffering from overheating and balance of payments strains. Private businesses in Kazakhstan's oil and gas sector face increasing difficulties. Georgia (12) outranks Germany (22), but would that remain the case if infrastructure quality and rule of law were put into the balance?
Transition economies: Central Asia and CIS outgun Europe
The European Bank for Reconstruction and Development (EBRD) is forecasting entral Asian states and the CIS to outgrow the richer countries of Central and Eastern Europe.
The Bank released updated macroeconomic forecasts last month, estimating that GDP growth among its client countries will reach 4.2% in 2010 and 2011. It forecasts that Turkey, Georgia, the CIS and Mongolia will outgrow the more developed economies of Central Europe, the Balkans and the Baltic states. Countries lucky enough to benefit from higher oil prices and production and workers’ remittances are among the fastest growers – Kazakhstan, Uzbekistan and Turkmenistan. Russia is also benefiting from higher petrodollar earnings. Russian GDP is forecast to expand by 4.4% this year and 4.6% next. Russia is in turn expected to boost Central Asia, driving regional GDP growth up to 6.7% in 2010 and 6.6% in 2011.
India: Profit-sharing proposal draws miners’ and landowners’ ire
Mining companies and landowners alike are criticising a provision in a proposed new mining law directing miners to give a 26% profit share to local communities. The miners say it goes too far; the landowners say not far enough.
The mining bill has good intentions: to give just compensation to local communities on whose lands mines have been established. That hasn't always been the case. Rapid growth over the past two decades has lifted demand for minerals, which has spawned a mining rush. In the process, land has often been compulsorily acquired against the wishes of local communities, often tribal groups in remote areas, with people being dispossessed and becoming destitute. In frustration, some have pushed back. In many cases, they have resorted to violence, often in alliance with the Maoist ‘Naxalite’ insurgency. Such attacks have taken place mainly in the resource-rich provinces of Orissa, Andhra Pradesh and Jharkand (see map below). More broadly, public opposition to mining has obstructed several mining investments, including ones proposed by Tata, Coal India, Hindalco, Vedanta, and Korea's POSCO.
The bill aims to overcome this opposition by making mine development fairer and more inclusive. But it has drawn criticism from mining companies and landowners alike. The miners say the profit-sharing provisions are too ambitious. Indigenous groups and environmental and human rights activists, by contact, are complaining that the bill does not go far enough.
The new law is intended to replace the current 1950s law, but is some way from being enacted. It has been approved by a group of key ministers, but needs to go to cabinet for final approval before being put to parliament.
Naxalite affected districts in India
Profit sharing aside, the passage of the bill should give the mining sector a boost. Although community resistance has constrained the sector’s expansion, it has also been crimped by the current law’s outdated ownership provisions and cumbersome processes that have deterred all but the bravest and best connected foreign miners.
Indonesia: Market darling status brings hot money headaches
Surging capital inflow is placing unwanted pressure on the rupiah and increasing vulnerability to a reversal. In response, the government is loosening its FDI policy in an attempt to attract less flighty capital. It may also decide to tighten capital controls.
Over the past year, foreign investment inflows have surged to a record US$30 billion (Chart 2). Investors are attracted by a robust growth outlook, high domestic interest rates, and rising terms of trade thanks to the country's commodity exports. Most of the inflow has been portfolio investment.
The inflow has caused three headaches. First, rupiah appreciation of 24% in real effective terms since late 2008, which has undermined the competitiveness of Indonesia's export and import-competing industries. Second, strong asset price inflation, raising fears of a bubble. Third, rising foreign ownership of Indonesia's capital markets, which increases the risk of a dislocation if sentiment reverses. Foreign investors now hold 30% of all government bonds and central bank certificates on issue.
To slow the rupiah’s rise and insure against a reversal in sentiment, the central bank has been intervening in the FX market and accumulating foreign currency. Since end-2008, it has lifted its reserves from US$40b to US$90b. However, rising interest rate differentials have meant sterilising these purchases is becoming very costly. As a result, continued large inflows may force the central bank to tighten capital controls instead. A small step in this direction occurred in July, when a one month minimum holding period on central bank paper was imposed.
The authorities are also focusing on making Indonesia more attractive to direct investors. FDI is favoured because it is more stable than portfolio investment, directly increases the economy’s productive capacity, and visibly results in skill and technology transfer. In September, local governments were directed to create one-stop investment portals. The aim is to cut regulatory duplication between levels of government and lower the influence of vested interests. The list of industries partly or fully closed to foreign investors has also been shortened. Agriculture is now open to investors for the first time. Investment caps in construction and healthcare have also been raised.
For background, see our country profile.
Venezuela: Business faces further hostility
Gunmen abducted a group of business leaders last month and there have been more nationalisations.
The head of the business chamber Fedecámaras and several colleagues were kidnapped at gunpoint, robbed and beaten; one of the victims suffered bullet wounds. The chamber has said it doubts that the abduction was conducted by criminals.
Meanwhile, the Venezuelan government has nationalised another three companies over the past month: locally-owned farm supplies and credit firm Agroisleña and steel company Sidetur, plus American-owned bottle maker Owens Illinois. These bring the total number of nationalisations in 2010 to 200.
The takeovers of Agroisleña and Sidetur are less surprising than that of Owens Illinois since the first two are in ‘strategic’ industries that the government is explicitly targeting. However, other companies in ‘non-strategic’ industries have also been targeted where they have been in dispute with trade unions.
Venezuela is the only Latin American country expected to remain in recession this year, despite being a large oil and gas exporter that has benefited from high international petroleum prices.
See previous Venezuela stories: ‘Further nationalisations won't be the last’, World Risk Developments, October 2010; ‘Chavez prepares funeral candles for capitalism’, World Risk Developments, July 2010.
Ghana: Economy recovers from S&P downgrade
A $13 billion loan from China plus a 75% upward revision to the GDP estimate is giving Ghana a much-needed boost after a recent surprise ratings downgrade from Standard & Poor's.
Although Ghana has been growing strongly and is set to begin oil production in late 2010, it was caught offguard by a decision of S&P in August to cut its sovereign credit rating to B from B+. The agency had a range of fiscal concerns, including over a large deficit, substantial arrears to suppliers, loss-making state enterprises and problems among banks.
More recent news, however, has been more positive. China recently announced that it would lend the government US$13 billion – US$3 billion from China Development Bank for oil and gas development and almost $10 billion from China Eximbank for roads, railways and dams. This was followed by an announcement from the IMF that it endorsed the loan. Finally, the national statistical agency earlier this month announced that it had been signifcantly underestimating the size of the economy, and needed to revise up its estimate of GDP by three quarters. This correspondingly raised the estimate of per capita GDP to US$1300, making Ghana one of few middle-income countries in Sub-Saharan Africa and the sixth largest economy in the region, just below Kenya (Chart 3). It also lowered public debt from more than 60% of GDP to less than 40%.
Where previously there was considerable concern that the government would overspend in anticipation of petrodollars that hadn't arrived yet, there is now growing optimism that the country will use the impending revenue to restructure the economy and diversify away from an overdependence on cocoa and gold exports.