April 2008 

 April 2008 

In this issue ...

  • News in brief
  • International/Asia - Multilateral forecasts show guarded optimism
  • International - Food shortages spawn host of problems
  • Nigeria - US$50b credit pledge ratchets up Chinese resource push
  • Turkey - Moves to unseat government disturb investors
  • Iceland - Speculators short 'Atlantic tiger'
  • Sri Lanka - Credit rating downgraded as going gets tough

News in brief

Developments since mid-March ...

  • Indonesia's finance minister told an emergency press conference on 4 April that the 'economic situation is largely healthy' despite a fall in the Jakarta stock exchange of almost 4½%. Investors were reportedly concerned about the rising fiscal cost of food and fuel subsidies as commodity prices soar.
  • Ratings agency Fitch awarded Peru an investment grade credit rating of BBB- - two decades after the country defaulted on its foreign debt. Peru now joins Chile and Mexico in the Latin American investment grade club. Brazil is expected to follow shortly.
  • World sharemarkets finished their worst quarter in five years on 31 March, with some markets down more than 20%. Mark-to-market losses on sub-prime assets have so far reached US$200b, with many pundits tipping another US$200b of writedowns still to go. Then again, some writebacks are also likely as securities that are held to maturity turn out not to default.
  • US and European central banks reportedly held discussions about directly buying mortgage-backed securities (MBSs) to ease the global credit squeeze. So far, they have been playing their traditional role of 'lender of last resort' - lending to cash-strapped banks against the collateral of MBSs so the banks don't have to engage in fire sales of assets. But this hasn't stopped panicky markets from pushing down MBS prices, forcing banks to write down their assets and capital, and restrict lending to stay within statutory capital adequacy ratios. The idea now is that central banks become 'buyers of last resort' - buying MBSs at prices below their face value but above current prices to set a price floor in the MBS market. This would enable banks to make writebacks to their P||Ls and balance sheets and start lending again.
  • Police clashed with hundreds of artisanal miners outside the town of Kolwezi in the Katangan copper belt of the Congo (Dem Rep) . The miners were protesting at plans to evict them from private mining concessions, some of which are held by Australia's Anvil Mining.
  • North Korea expelled South Korean officials from its Kaesong industrial zone in retaliation for the harder line against North Korea being pursued by the new conservative South Korean president, Lee Myung-bak. Kaesong hosts 70 South Korean manufacturing firms employing 24,000 North Koreans.
  • The Philippine government asked fast food chains to halve their rice servings in an effort to curb demand and preserve dwindling national rice stocks.
  • The OECD projected that sustained growth by China would see it become the world's largest economy by 2015 and catch up to Russia's per capita GDP by 2030.
  • Assets of sovereign wealth funds grew 18% in 2007 to US$3,300b, according to International Financial Services London, a British association representing the financial services industry.
  • The Congo (Dem Rep) released the results of a review of 61 mining contracts negotiated during the second Congo war and subsequent transition to democracy over 1998-2003. It said 'none' of the contracts met international standards and 'many' would have to be cancelled or renegotiated.

International/Asia - Multilateral forecasts show guarded optimism

Multilateral bodies have been hard at work revising down their world and Asian economic forecasts in the light of what the IMF calls 'the largest financial crisis in the US since the Great Depression'. Despite the magnitude of the shock, each body foresees only a moderate slowdown in world growth as emerging markets show resilience in the face of an OECD downturn. All, however, warn of downside risks, with the IMF calling a 25% chance of world recession (world growth of 3% or less).

IMF. In their latest World Economic Outlook, the IMF forecasts world economic growth of only 3.7% in 2008 and 3.8% in 2009. This represents a 0.5 percentage point shaving of the global growth forecast for 2008 that it issued in January. To put these numbers in perspective: the world economy grew at 4.9% in 2007 and at an annual average of around 4% pa since 1970. For the US, the Fund forecasts growth of only ½% in each of 2008 and 2009.

World Bank. In its East Asia and Pacific Update, the World Bank says that credit turmoil plus global slowdown will subtract 1-2 percentage points from growth in Developing East Asia in 2008, taking it to around 8½%. It forecasts growth to be around 8½% again in 2009.

ADB. In its Asian Development Outlook, the Asian Development Bank forecasts that growth in Developing Asia in 2008 will 'taper off' to 7.6% from its multiyear high in 2007 of 8.7%. This performance will still be only slightly below the past five years' average.

ESCAP. The UN's Asian offshoot, ESCAP, in its Economic & Social Survey of Asia & the Pacific, judges that robust Asia/Pacific growth will continue in 2008. It expects the developing countries in the region to grow at 7.7% in 2008.

Decoupling. The overall picture of Asia painted by the World Bank, ADB and ESCAP is of 'strong growth momentum under clouded skies' (World Bank), 'solid performance in an unsteady global economy' (ADB) and 'healthy fundamentals shielding the region from global financial turbulence' (ESCAP). In a word: resilience.

Reasons advanced for this resilience include

  • Gradual US downturn. Unlike the last major US downturn - the dot.com bust in 2001 - the current downturn is more gradual. More importantly, it isn't marked by a crash of US high tech imports, as happened during the dot.com bust. The dot.com bust hit Asia's tech-intensive export sectors particularly hard.
  • Brisk non-US export growth. While US import growth is moderating gradually and has yet to turn negative, import growth has held up well in other industrial countries and in developing countries. Taking advantage of this healthy non-US import growth, Asian countries have been able to sustain in many cases double-digit US$ export growth rates.
  • Brisk domestic demand. Accelerating growth of domestic demand in countries like Indonesia, the Philippines and Vietnam has also been a cushion to declining export growth to the US. Many Asian economies ended up growing faster at the end of 2007 than they were growing at the start of the year.
  • Healthy credit fundamentals. Enabling countries to expand domestic demand have been large external current account surpluses and foreign exchange reserves. Whereas in previous international downturns countries had to compress imports in response to an export setback in order to head off balance of payments crisis, this time they have the surpluses and reserves to expand domestic demand and imports. If anything, the falling tide of international credit is doing them a favour by checking capital inflows and hence pressures on their currencies and money supplies.

Downside risks. Asia will be vulnerable if the global credit squeeze intensifies and worsens the OECD downturn. But it arguably faces two equally important home-grown risks - rising headline inflation and fuel and food subsidies. Headline inflation is now 11% in Vietnam and 9% in China, while according to government estimates fuel subsidies in Indonesia could reach Rp 130 trillion (US$14.3b) in 2008 if oil prices average US$95/bbl. Inflation and subsidies will hinder the scope of Asian governments to cushion the blow of any export shocks. More flexible exchange rate regimes and better targeting of subsidies are needed to counter these problems.

International - Food shortages spawn host of problems

Soaring food prices are having far-reaching implications for the international trading system and for poor countries - food exporters and importers alike.

Rice prices on world markets have risen 37% over the past fortnight, and 90% since the start of February . On 27 March alone they rose 30% after Egypt announced an export ban. These increases are part of a broader rise in food prices which began in 2006.

In response, food-exporting countries are now rushing to restrict exports to safeguard supplies for their own consumers. Before Egypt announced its ban, Vietnam said it would cut its rice exports, while India announced a ban on all non-basmati rice and pulses. In Argentina the government has moved to raise agricultural export taxes, but faces protests by farmers.

Food importers, meanwhile, are lowering import restrictions to offset the burden on their consumers of rising world prices. The world's largest rice importer, the Philippines, has also doubled the rice import quota of private traders in a bid to boost imports.

Many governments are also beginning to dust off the idea of price controls again, after largely phasing these out in the 1990s with World Bank and IMF support.

According to the UN Food & Agriculture Organisation, poor countries will have to pay 35% more this year for cereal imports and 36 will face food shortages. Governments face a difficult choice of whether and to what extent to pass increases in world prices through to the consumer. Price controls will shield the poor, but come at considerable fiscal cost. Then again, a complete pass-through will protect public finances, but risk social unrest.

Nigeria - US$50b credit pledge ratchets up Chinese resource push

An offer by Beijing of up to US$50b in export credit guarantees is China's boldest step yet to tap Africa's resource wealth - and an order of magnitude up from previous pledges.

The Nigerian finance minister told the Financial Times on 2 April that China's official export credit agency, Sinosure, had offered Lagos US$40b-50b in export credit guarantees over the next three years to help fund projects.

As with previous offers of credit and guarantees to Africa, Beijing seems again to be seeking repayment at least partly in resources, and to be making strategic investments in sectors such as transport, power and ports that open up the African interior and connect its resource deposits to Chinese markets.

The Nigerian petroleum minister has reportedly started talks with China about investment in refineries and petrochemical plants in return for access to oil blocks. The Chinese say they are also interested in railways and power.

China's previous biggest pledge of credit assistance to Africa was last September to the Congo (Dem Rep). Beijing initially offered US$5b to rehabilitate mines and build roads and railways connecting Congolese mines to existing transport networks and ports. But in January, it expanded the offer to US$9b. The deal will reportedly give China access to two large copper and cobalt concessions. In return, the Chinese will build high-voltage power lines and power plants, repair and expand water supplies, and build 31 hospitals, 145 health care centres, four universities, a parliament, and some 20,000 government housing units. China has also been actively extending resource-backed credits to Angola and Sudan.

The ability of Chinese companies to invest in Africa with massive state credit backing has raised concerns among mining and engineering companies from countries that don't provide such backing that they could be in put at a severe disadvantage when competing for resource concessions and infrastructure contracts.

Turkey - Moves to unseat government disturb investors

Domestic politics is damaging investor confidence and increasing Turkey's already considerable external vulnerability.

A decision by the Constitutional Court to begin proceedings to shut the ruling Justice & Development Party (AKP) for undermining the secular state has taken investors aback. Especially concerning is that the move coincides with increasing risk aversion in world capital markets - markets on which Turkey depends to meet large external funding needs. The 'increasingly fraught political and global environment' has prompted ratings agency Standard & Poor's to revise its outlook on Turkey's credit ratings (BB- long-term foreign currency) to negative from stable.

A showdown between Turkey's secularist establishment and the AKP has been building for some time now, and the possibility of a move to shut the AKP has been widely discussed. Yet the decision to press for the party's closing - and the banning from politics of its leaders - did still come as a surprise. At issue is legislation from the AKP and approved by the legislature to allow women to wear headscarves in universities. Secularists see this law as the first item on an otherwise 'hidden AKP agenda' to Islamise the state. Somewhat contradictorily, many also believe that behind its Islamist veneer, the AKP is a puppet of the Bush administration, doing its bidding in Middle Eastern politics. The move to shut the AKP has deeply divided public opinion, and threatens to undo the stabilising effect of the AKP's victory at July 2007 elections, in which it won 47% of the vote.

Leading Turkish civil society organisations representing business, unions and the professions have asked the two sides to reach a compromise, but that would appear to require the AKP to shelve its headscarves law, something it has said it isn't prepared to do. Given this stand-off, no resolution seems in prospect for several months. An additional complicating factor is the lapse of an IMF standby agreement in May. Many investors worry that the political crisis plus the removal of IMF oversight could cause economic policy-making to deteriorate.

Even before the legal move against the AKP party was announced, Turkish financial and currency markets had been falling. Since January yields on domestic government bonds have risen by more than 200 bp, the sharemarket has fallen 28%, and the lira has depreciated by 25% against the euro.

Iceland - Speculators short 'Atlantic tiger'

Aggressive foreign borrowing by Icelandic banks during the credit boom is now coming home to roost during the squeeze.

Highly-geared companies and financial institutions aren't the only ones suffering now that global credit boom has turned to squeeze. Whole economies and economic sectors are also coming under scrutiny. The Kazakh banking system is one sector that has been hit hard, because of its reliance on overseas borrowing to fund a rapid expansion of lending. Unable to roll over maturing debt, it is calling in domestic loans to raise funds to meet foreign debt repayments.

Market attention has now turned Iceland (population 300,000) - 'the giant hedge fund off the west coast of Norway', according to the Financial Times.

As in Kazakhstan, banks in Iceland have been funding a rapid expansion of their domestic and overseas assets through overseas borrowing, specifically through issuance of 'glacier bonds' - eurobonds denominated in Icelandic krona. Over the period 2000 to the second quarter of 2007, banking assets grew from less than 100% of GDP to 900%, a mammoth number. The rapid growth of domestic credit that this has allowed has stoked up a share and housing boom, rising inflation and a yawning current account deficit. In 2006, the current account deficit was 25% of GDP, though last year it came down to 16%.

As credit conditions tightened last year, investors started to worry about the banks' liquidity and even solvency. As a result, they have been selling Icelandic assets aggressively. In the process, spreads on bank credit default swaps have risen to 1000 bp from less than 50 bp in August 2007, and the central bank has been forced to lift its official interest rate 125 bp to 15% to stem a rapid fall in the krona.

According to the central bank governor, 'unscrupulous dealers' have been short-selling the economy to engineer a financial collapse from which they would profit. As a miniscule, highly-geared, open economy, Iceland is more exposed than most to such destabilising self-fulfilling speculation.

Sri Lanka - Credit rating downgraded as going gets tough

Sri Lanka is currently facing not only tougher international economic and financial conditions, but the 2002 ceasefire agreement between the government and the LTTE has broken down.

These setbacks prompted ratings agency Fitch on 4 April to downgrade its sovereign credit rating of Sri Lanka to B+ from BB-. It cited concerns about inflation, which reached 28% pa in February. Also of concern to Fitch: worsening terms of trade and fiscal deficits brought on by rising international commodity prices and increased defence spending in a context of greater commercial and market-based borrowing by the government.



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