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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, currency wars and the slowing world economy
A slowing world economy is straining international economic cooperation and threatening an increase in ‘exchange rate protectionism’ as well as trade protectionism.
The upswing that began mid-last year continued to strengthen in the first half of 2010; world GDP in that period grew at a 5%-plus annual rate. Surging inventory and a revival of investment were behind the strong result (see next story). Even the G3 economies – America, the eurozone and Japan – managed to post 3 ½ % annualised growth.
But many economies have now begun to lose steam as the temporary spurs from inventory accumulation and fiscal stimulus inevitably fade. Meanwhile, core inflation in the G3 continues to fall towards zero.
To revive growth, the Bank of Japan lowered its policy rate to zero earlier this month. Along with the Federal Reserve and Bank of England, it has also recently begun to talk about the possible need for a second round of 'quantitative easing’, or ‘QE2’. QE was undertaken following the bankruptcy of Lehman Bros in 2008. It entailed central banks buying long-term public and private financial assets with newly printed money. This ‘liquefied’ private sector balance sheets and put downward pressure on long-term asset yields and exchange rates.
The possibility of a QE2-led flood of liquidity into world financial and currency markets has spurred capital inflows into a range of emerging markets, as well as Japan and Switzerland. The central banks of these countries have responded by intervening heavily in currency markets to stem the resultant appreciation pressures – pressures that could damage export growth. China is the biggest intervener, having bought a daily average of US$1 billion for the past five years and accumulating in the process foreign reserves equivalent to about 50% of GDP. In Korea, Brazil and Thailand, governments have also been either imposing or increasing taxes on capital inflows with the same aim of weakening their currencies.
Recriminations have accompanied these policy responses and counter-responses. In America, Treasury Secretary Tim Geithner has called the renminbi 'significantly undervalued' and Congress has threatened to legislate for countervailing duties to be placed on Chinese goods if China persists with an ‘undervalued’ currency. Tokyo has added its voice recently, urging Beijing and Seoul to 'act responsibly' on exchange rates. China's central bank governor Zhou Xiaochuan has retorted that an exclusive focus on exchange rates is wrong, and that ultra-loose American monetary policy is the destabilising factor: encouraging large capital inflows and forcing it to intervene in the currency market where otherwise it wouldn't need to. Premier Wen Jiabao has added that forcing China to revalue its currency would lead to ‘disaster for the world’. ‘Many of our exporting companies would have to close down. Migrant workers would have to return to their villages.’ Brazil’s finance minister, Guido Mantega recently called these interventions in currency markets to keep exchange rates competitive and stem capital inflow an ‘international currency war’.
The attempts by China and other countries to keep their currencies down against the US dollar threaten to obstruct the rebalancing the world economy needs to undergo to achieve sustained growth. That rebalancing entails 'shopping nations' such as the US, UK, Spain and Greece 'shopping less and shipping more', and ‘shipping nations’ ‘shipping less and shopping more'. This adjustment in turn requires a real exchange rate adjustment between the two groups of countries, with shopping nations going down against shipping ones. However, shopping and shipping nations alike now want to ship more; in other words, spur export-led growth through competitive currency interventions. This increases the risk that struggling economies like the US will take protectionist steps to shield their industries from foreign competition.
International: IMF forecasts slowndown and fragility
The IMF is forecasting world GDP to ease through the rest of 2010 and into 2011. It notes that recovery will remain fragile without ‘global rebalancing’.
In October, the IMF updated its forecasts for world GDP in 2010 and 2011. Its world growth forecasts are 4.8% for 2010 and 4.2% for 2011. Growth appears to have peaked in the first half of 2010 and is expected to slow noticeably in the second half of 2010 and into early 2011 (Chart 1).
Growth in advanced economies is expected to be soft: 2.7% in 2010 and just 2.2% in 2011. The reasons for the slowdown are two-fold. Fiscal stimulus and inventory rebuilding are fading and private demand is struggling to take over due to high unemployment, weak confidence and consumer deleveraging.
In contrast, growth in emerging economies is forecast to be relatively robust at 7.1% in 2010 and 6.4% in 2011. Activity in Asia is expected to be particularly strong: China and India are forecast to grow by more than 8% a year in 2010 and 2011. The only weak spots are a few emerging European countries struggling with large debts (Bulgaria, Hungary and Romania).
The Fund sees the risks to its growth forecasts as tilted to the downside. It notes that the recovery will remain fragile without two economic ‘rebalancing acts’:
- Internal rebalancing: stronger private activity in advanced countries taking up slack created by fiscal consolidation.
- External rebalancing: rising net exports from the US (and other deficit countries) spurred by growing domestic demand in surplus countries, notably Asia.
The IMF finds that so far such rebalancing has been limited (Chart 2).
International: Emerging market companies look abroad
Emerging market multinational companies (MNCs) are becoming an increasing source of cross-border direct investment.
The Institute of International Finance forecasts that foreign direct investment (FDI) from emerging market MNCs will top US$200 billion this year, and approach US$250 billion in 2011 (Chart 3).
Outward FDI from emerging markets has quadrupled over the past five years. UNCTAD – the UN Conference on Trade & Development – estimates that emerging markets now account for 20-25% of all FDI outflows compared to just 5% 20 years ago. Similarly, 28% of MNCs are from emerging markets, up from 8% in the early 1990s. Many are now widely recognised, and some even household names: Tata (India); Petrobras and Vale (Brazil); Lenovo, CITIC and Sinopec (China); Lukoil and Gazprom (Russia); Samsung, LG and Hyundai (Korea); and Petronas (Malaysia).
MNCs from ‘BRIC’ countries are leading the rise in outward direct investment. Chinese MNCs on their own accounted for US$50 billion of outward FDI in 2009. This trend reflects several factors. First, BRICs’ large, 50% share of emerging market GDP. Second, large dynamic economies allowing firms to reach the domestic scale needed to fund offshore expansion. Third, large national savings surpluses to fund offshore takeovers and investment. Finally, government policies supporting MNCs’ offshore quests, including extension of ‘national champion' status, soft loans, and capital control exemptions.
The state ownership and backing of many emerging market MNCs can create obstacles to their foreign investment. This is especially the case for China where state-owned enterprises account for 80-90% of total outward direct investment. Some countries targeted for investment have expressed concern that the investment, coming as it does from the Chinese state, may be based on strategic criteria that aren't in their national interests. Tensions are particularly strong in the resource and technology areas. A well-publicised instance is Chinese state oil company CNOOC's failed bid to buy Unocal, a US exploration and production company, in 2005 in the face of strong opposition from US politicians concerned about selling oil reserves to entities owned by a foreign government.
Still, this issue appears to be less of a problem in other emerging markets, particularly those with significant investment needs. Partly as a result, large amounts of outward FDI from emerging market MNCs are following a 'South-South' investment path. UNCTAD estimates that inter-regional investment in non-Japan Asia accounts for 40% of the total FDI stock in the region. Meanwhile, one-fifth of the FDI inflow into Africa comes from developing Asia, increasingly China. Recent example are Chinalco's purchase of a 50% stake in part of the Simandou iron ore deposit in Guinea for US$1.35 billion and Indian telecom Bhatt Airtel's purchase of Kuwaiti telecom Zain’s African operations for US$10.7 billion.
Brazil: New president will inherit booming economy
The winner of the presidential run-off election on 31 October will inherit an economy that is booming, BRIC, investment grade and on the verge of big oil developments; but also overheating.
Against expectations, the presidential election on 3 October did not deliver victory for Dilma Rosseff of the governing Workers’ Party. She now faces a run-off on 31 October against runner-up Jose Serra of the opposition Social Democrats. Though opinion polls suggest that Serra is closing in on Rousseff, she still looks likely to win, thanks to the popularity of the Workers’ Party government and her mentor, current President Luiz Inácio ‘Lula’ da Silva.
If so, she will lead a coalition likely to have more than three fifths of the seats in both houses of parliament. This is enough to change the constitution, a power denied to both Lula governments.
The new president will inherit an economy that is now much less volatile than before, is rapidly becoming more international in outlook, and is on the verge of becoming a major oil and gas producer.
Though once a byword for boom-bust and hyperinflation, Brazil has over the past decade experienced a much less exciting business cycle thanks to good policy and favourable external factors. The policies have included inflation targeting, a flexible exchange rate policy and prudent fiscal policy. The notable external factors are brisk demand for Brazil's farm and mine exports and FDI inflow. Together these have delivered sustained and broad-based economic growth, an impressive reduction in inflation and external public debt, rising foreign exchange reserves, and a 20 million reduction in the poverty headcount since 2003. In recognition of the country's much-improved financial strength, all three major rating agencies now give Brazil an investment grade credit rating.
The economy has also become more international. Previously state-directed companies such as Vale (the iron ore miner), CSN (the steelmaker) and Petrobras (the oil company) are behind the country’s emergence as one of the developing world’s largest outward foreign direct investors. According to the Institute of International Finance, investment overseas by Brazilian companies tripled to US$18.3 billion in the year to August from US$6.3 billion in the same period a year earlier. Subsidised financing by BNDES, the national development bank, has supported the overseas investment drive.
The discovery of large reserves of 'pre-salt' oil off the coast is ‘likely to catapult Brazil from 24th to 8th or 9th in global reserves and turn the country into a major oil and gas producer’, says consultancy firm Oxford Analytica. Petrobras has a five-year, US$224 billion investment plan centred on developing these reserves. To raise the capital to develop them, it recently made a US$70 billion share sale. This is the largest share offering ever and will make Petrobras the second largest oil company by market capitalisation after ExxonMobil.
The story isn't, however, all boom and no gloom. Mounting inflation pressures and a soaring current account deficit are the immediate problems that the new president will need to tackle. They result from policy stimulus applied during the global financial crisis, but not withdrawn as the economy has recovered.
On fiscal policy, both candidates support prudence, though Serra is regarded as the more austere. On monetary policy, only Rousseff has endorsed the current monetary policy and backed the central bank’s operational independence. Serra has criticised the central bank’s actions during the crisis and is pressing for a more interventionist exchange rate policy. Markets have reportedly looked favourably on leaks that Rousseff is preparing to appoint ‘steady hands’ to the ranks of her cabinet and advisers.
Nigeria: Oil industry outlook improves
The outlook for the oil industry is improving, but a lot hinges on the passage of a new petroleum industry law.
The improved outlook rests on two factors: an amnesty with insurgents in the Niger Delta and the impending start of offshore production. International oil companies have been reporting steady increases in production as a result of the Delta amnesty, and most see exports continuing to rise. In addition, the Nigerian National Petroleum Corporation (NNPC) is forecasting its production to reach 2.6 million barrels a day (bpd) in the short term, up from 2.1 million bpd now. A series of new deepwater offshore projects due to come onstream over 2011-14 are likely to increase production even further and confirm Nigeria's status as Africa's top oil exporter. This No 1 spot was briefly usurped by Angola at the height of the Delta insurgency in 2009, when Nigerian production was dwindling and Angola's was increasing. But Nigeria has regained the lead as its production has revived and Angola's has declined due to planned maintenance and production setbacks.
The passage of a long-delayed delayed Petroleum Industry Bill will be crucial for the development of offshore oil production. This bill will reportedly give the oil and gas industry its biggest shake-up since the 1950s and is expected to pass into law within weeks. However, a failure to pass the bill could reportedly deal a severe setback to plans for the development of the offshore fields.
Venezuela: Further nationalisations won't be the last
President Hugo Chávez is pressing on with his radical nationalisation agenda in spite of, and perhaps because of, recent electoral losses.
Chávez announced on 10 October the expropriation of two further companies – Venoco, a petrochemical producer, and Fertinitro, a fertiliser maker. In Fertinitro’s case, the state will add to its current 35% stake by forcibly acquiring the 55% of the firm owned by US company Koch and Italy’s Snamprogetti; the remaining 10% is owned by Venezuelan brewer and food firm Polar.
The expropriations form part of Chávez’s plan to take over strategic industries and ‘prepare funeral candles' for capitalism.
The poor showing of the government in last month's legislative elections, in which it lost its two-thirds majority in the National Assembly, is reportedly encouraging the president to soup up his nationalisation plans. He has said the government will continue to expropriate large rural estates in the coming months ‘at a gallop’. Pursuant to this policy, he announced earlier this month plans to take complete control of the British agribusiness Vestey Group after previously nationalising bits of the group.
Far from lowering prices and alleviating shortages, as the president reportedly hopes, the nationalisations are likely to intensify shortages, depress productivity, and impose a significant burden on the already stretched state budget for compensation of the expropriated. The nationalisations are already prompting disinvestment, especially from the oil industry.