World Risk Developments October 2015

Trans-Pacific Partnership — achievements and challenges

As the largest trade pact struck in two decades, the TPP will support the diversification of Australia’s export base — by improving market access for farm and service exporters and providing new opportunities for SMEs to integrate into global value chains. But it first needs to be ratified by each member.

View a summary of this month's edition.

These are the US, Japan and 10 other Pacific Rim economies (1), including Australia (Chart 1). Together these economies constitute 36% of global GDP (Chart 2) and buy a third of Australia’s exports.

The fine print has yet to be made public. But in broad terms, the TPP will eliminate 98% of tariffs on Australia’s exports to TPP countries within 10 years — eliminating an estimated US$9b in customs duties.

The deal will support the diversification of Australia’s export base which will be helpful in the aftermath of the mining boom.

  • Agriculture — the benefits for agriculture are particularly positive. Market access improvements were brokered for beef (to Japan, Mexico, Canada and the US), sugar (doubling Australia’s entitlement to the US market), rice (to Japan and Mexico), dairy (to Japan, US, Mexico and Canada), cereals, wine and others.
  • Services — will also receive a significant boost, including for providers of higher education, professional services, transport, financial services and government procurement.
  • SMEs — new e-commerce provisions will promote cross border flows of data, allowing SMEs to increasingly participate in global value chains.

Globally, the TPP will be a long term positive for growth and trade. It aims to establish new standards and rules for 21st century global commerce, including regulatory provisions on cross-border data flows, customs procedures, labour standards, environmental law, intellectual property, competition policy and treatment of state owned enterprises. The TPP does represent a shift away from the high ground of worldwide agreements and does not yet include China. But with the 14-year old Doha round of world trade talks long stalled, the TPP may help shake the current global trade recession. Once in place, the TPP’s open architecture will allow other members to join in the future — amplifying its benefits. Potential accession economies include Korea, Taiwan and the Philippines.

The TPP is not a done deal. It must still be ratified by the national legislatures of member countries. Free trade is hard to champion — suggesting a long slow grind to fruition. The beneficiaries of TPP — exporters and consumers — are numerous, but their potential gains diffuse. By contrast, inefficient firms facing intensified international competition are vocal. Washington provides the TPP’s largest hurdle. While President Obama eventually won trade promotion authority enhancing his power to negotiate, Congress could still prove obstructionist. Democratic front-runner Hillary Clinton has denounced the TPP as it now stands, and Republican frontrunner Donald Trump has also been critical. Ratification is also unlikely to be straightforward in Canada and Malaysia.

China — soft landing so far; but risks remain

Policymakers continue to engineer a soft landing for the economy. But the weakness in manufacturing and real estate, particularly if it intensifies, poses risks to the outlook and more importantly a rebalancing toward a more consumer-oriented economy.

Strong consumer spending is driving a robust services sector, partly offsetting the weakness in the broader economy. Growth printed at 6.9% from a year ago in the third quarter, slower than the 7% recorded a quarter earlier. Weak global growth is crimping the demand for China’s manufacturing exports, while ongoing weakness in real estate investment is weighing on heavy industry. The IMF in its latest World Economic Outlook expects growth to slow to 6.8% in 2015, before slowing further to 6.3% in 2016 driven by soft industrial activity and the rebalancing toward consumption.

The underperforming industrial sector is weighing heavily on Australian mining revenues, but low cost iron ore and coal miners remain profitable as they ramp up export volumes and secure greater market share in China. The growing importance of the consumer sector and rising middle class meanwhile bodes well for Australian non-resource exporters particularly those in agriculture.

But there are considerable risks. The industrial sector remains an important cog as it employs 30% of the Chinese population. This leaves a sizable cohort at risk from an intensifying deterioration in the manufacturing and real estate sectors, particularly if this was to lead to mass layoffs. The government is aware of these risks and continues to roll out monetary and fiscal stimulus, including infrastructure fast-tracking. The 5th Plenary session of the Communist party’s main planning committee—Central Politburo of the Communist Party—scheduled for late October, will give us further insight into Beijing’s plans to combat the slowdown and promote restructuring over the next 5 years.

India — energy shortage could favour Australian coal

China’s slowing economy and the growing preference for cleaner fuels have weighed heavily on coal prices. But India’s thirst for energy to satisfy both its large population and ongoing development present opportunities for Australian coal miners.

India has a chronic energy shortage and the picture looks even scarier when compared to China. More than one in five Indians did not have access to electricity in 2012, well behind the 100% coverage in China or even the 94% China recorded in 1990. The efficiency of India’s current power infrastructure is also poor with 17% of its generated electricity going to waste; China has a loss rate of 6%.

The energy shortfall will only intensify (Chart 3) because India’s strong growth trajectory, forecast at 7.5% p.a. over the next five years by the IMF, is driven by robust investment in energy-intensive industry and elevated consumer spending. Renewable energy is being touted as the way forward, but it remains unclear whether this can meet all of India’s energy requirements, particularly in densely populated urban areas. History offers some perspective with periods of rapid growth — the Industrial Revolution, and more recently China — fuelled by coal.

Coal remains the cheapest source of power in India and in the low price environment, coal power stations are a viable option — a point not lost on policymakers as they have already commissioned several such stations. But India’s domestic coal supply remains well short of current demand and with the plethora of new power stations expected over the next five years, the coal shortage will only worsen and require higher imports. The potential opportunity for Australian coal exporters is immense, because India’s projected import demand by 2035 is estimated to be three times Australia’s thermal coal exports in 2014 (Chart 4).

Major trading partners — weaker growth; but better business climate

GDP growth in Australia’s ten largest export markets is expected to slow this year compared to last, amid a weaker global economic outlook and increasing downside risks. But this coincides with improved measures of competitiveness and productivity in our largest export destinations that will be supportive of the business climate.

The IMF’s latest World Economic Outlook foresees lower global growth of 3.1% in 2015 — the worst outcome since 2009. While a modest recovery is expected in advanced economies, emerging markets are projected to slow for the fifth consecutive year. The IMF warns that downside risks to the outlook have risen — reflecting declining commodity prices, reduced capital flows to emerging markets, and increasing financial market volatility. It estimates up to US$3t in over-borrowing in emerging markets and a worst case entailing a ‘vicious cycle of fire sales and volatility’.

In a context of weaker global growth and escalating risk, how do Australia’s major trading partners fare? Unfortunately, not well. China is Australia’s largest export destination, buying 30% of exports last year. But Chinese growth is projected to slow further, if gradually, to 6.8% in 2015. Only Japan and the US are expected to record improved GDP growth this year and feature on our top 10 list of export destinations. Overall, when weighted by the scale of exports in 2014, aggregate GDP growth in Australia’s 10 largest export markets is expected to slow to 4.1% in 2015 (from 4.4% in 2014).

But this coincides with improved ‘competitiveness performance’ in Australia’s largest export markets — as measured by the World Economic Forum’s 2015-16 Global Competitiveness Index (GCI). The GCI defines competitiveness as the set of institutions, policies, and factors that determine the level of productivity of an economy. (2) Three of Australia’s 10 largest export markets — New Zealand, India and Malaysia — improved their rankings a collective 19 positions. Another five retained their 2014 ranking, while the UK and Taiwan fell a collective two spots. Overall, when weighted by the scale of exports in 2014, the average position of Australia’s 10 largest export markets improved to 20th. Although the most improved, India provided Australia’s least competitive major export market, ranked 55 out of 140 countries. It is also our fastest growing export market, with the IMF predicting an economic expansion of 7.3% in 2015 (Chart 5).

Philippines — reform-minded ’presidentiables’ bode well for economy

All three likely candidates in next May’s presidential election are laying stress on improving governance and infrastructure.

The IMF expects the economy to grow by over 6% next year (Chart 6) despite a gloomier world economic outlook and China’s slowdown. Lower oil prices and strong worker remittances will lift household consumption while improved budget execution will boost public spending.

Last month Fitch improved its outlook to positive on the country’s investment-grade credit rating, citing better governance and enhanced competitiveness. Indeed, between 2010 and 2014 the Philippines climbed almost 50 places in Transparency International’s Corruption Perceptions Index (now 85 out of 175 countries). Since 2007 it has leapfrogged 17 places to 47 out of 140 countries in the World Economic Forum’s Global Competitiveness Index.

But with national elections due in May 2016 anxieties have risen over the possible approach of the next administration. The three main presidential candidates — or ‘presidentiables’ as Filipinos like to call them — are Vice President Jejomar Binay, Liberal Party candidate Manuel Roxas and independent Senator Grace Poe. Latest polls suggest a close race — Poe has 26% support, Roxas 20% and Binay 19%.

Policy positions are still evolving, but all candidates lay stress on improving governance, national infrastructure and business conditions. Front-runner Poe’s agenda includes pushing ‘inclusive growth, global competitiveness and transparent government’, reducing taxation and devoting 7% of GDP to developing national infrastructure (currently 5% of GDP). Binay promises to replicate the success of Makati — the country's wealthiest municipality by virtue of its business and financial sectors — which his family has long controlled. Binay nominates a pro-business environment, effective tax collection, infrastructure development and budgetary prudence as the characteristics of Makati’s success. Roxas has pledged to continue current President Aquino's key economic initiatives, notably a public-private partnership (PPP) scheme to boost infrastructure and a ‘straight path’ graft-free government agenda.

Australia sold more than A$2.3b of goods and services exports to the Philippines last year. And more than 200 Australian companies already have a local presence. But regardless of the electoral outcome, increased consumer spending and demand for new hard and soft infrastructure is expected to underpin new business opportunities. In particular, the civil and infrastructure construction sector will be fuelled by a buoyant real estate market and a significant pipeline of PPP-supported infrastructure projects. Ten out of 50 proposed PPP projects have been awarded to date with a number more likely to be put out to tender next year. Among these is a contract to modernise regional airports and the south line of the North-South Railway Project (the largest project in the PPP pipeline).

The strong pro-infrastructure agenda of all presidential hopefuls and strong economic fundamentals both bode well for these opportunities continuing.

Southeast Asia — El Niño could obstruct growth

El Nino could crimp agricultural production over the next six months. That could in turn be a drag on growth and a spur to inflation across Southeast Asia.

Meteorologists expect the El Niño weather phenomenon to cause extensive droughts across Southeast Asia over the coming months. The World Meteorological Organisation is expecting the worst El Niño since 1950. Agricultural production in Southeast Asia over the next 12 months is at risk with reports of farmers already having to abandon their fields due to drought.

Agriculture is a major driver of growth. The region produces significant quantities of rice, coffee, soybeans, rubber and palm oil. An IMF study looked at the impact of El Niño on major Asian and Pacific economies and found that it was likely to reduce Indonesian GDP by 1% point over 12 months. Cambodia, Laos and Vietnam suffered larger declines due to their higher dependence on agriculture (Chart 7). There are reports of rice farmers in Laos, Cambodia, Thailand and Vietnam already experiencing drought.

Lower agricultural production would also lift food prices, stoking higher inflation across most of Southeast Asia. Because most economies are already softening, policymakers would struggle to contain inflation without depressing growth further. 

Cassandra Winzenried, Senior Economist
cwinzenried@efic.gov.au

Fred Gibson, Economist
fgibson@efic.gov.au

The views expressed in World Risk Developments are Efic’s. They do not represent the views of the Australian Government. The information in this report is published for general information only and does not comprise advice or a recommendation of any kind.  While Efic endeavours to ensure this information is accurate and current at the time of publication, Efic makes no representation or warranty as to its reliability, accuracy or completeness.  To the maximum extent permitted by law, Efic will not be liable to you or any other person for any loss or damage suffered or incurred by any person arising from any act, or failure to act, on the basis of any information or opinions contained in this report.  

Photo credit: © Marco Garcia / REUTERS / PICTURE MEDIA

(1) The GCI includes 114 indicators of productivity drivers — revolving around institutions, infrastructure, the macroeconomic environment, health and education, goods market efficiency, labour market efficiency, financial market development, technological readiness, market size, business sophistication and innovation.

(2) TPP negotiations have been concluded by Australia, the United States, Canada, Japan, New Zealand, Mexico, Peru, Chile, Vietnam, Singapore, Brunei and Malaysia.