World Risk Developments May 2015

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‘Brexit’ could hurt Australian investments in the UK

A British exit from the EU would cost Australian businesses based in the UK preferential market access to the rest of the continent.

View a summary of this month's edition.

David Cameron’s Conservative Party remains in power following a convincing win in the recent British elections. Pollsters had predicted a tight race between the Conservatives and Labour leading to a hung parliament. Instead, the Tories won outright with 331 of 650 seats. Financial markets reacted positively — the pound rose 1% against the dollar to US$1.54, yields on 10-year government bonds fell to just below 1.9%, and the FTSE gained 2.1% on the announcement of the result.

The government will remain focused on reducing the budget deficit by trimming public spending by £30b over the next five years. But achieving this will be difficult as the Prime Minister has pledged to deliver £8bn of tax cuts, reduce inheritance tax, increase spending on health, and not cut pensions, schools or aid. This implies large cuts to other programs. The accompanying fiscal drag is likely to weigh on inflation and growth, keeping interest rates lower for longer.

A larger concern for Australian businesses based in the UK is ‘Brexit’. The Tories have promised to hold an ‘in/out’ referendum by the end of 2017 on whether Britain should remain a member of the EU. In the interim, the Prime Minister will lobby his EU counterparts to support a range of reforms. Priorities include extending the single market to cover digital, services and energy; reducing migration into Britain, such as by restricting EU workers’ access to welfare; allowing Britain to opt-out from the EU ambition to forge an ‘ever closer union’; and giving greater powers to national parliaments to block EU legislation.

A Brexit could impede market access into the rest of the EU and make the UK less attractive  to foreign investors. Australian companies that use the UK as a base to export to the rest of Europe would also be at risk. That said, the economics of a Brexit are unfavourable and polling indicates that more Britons want the UK to remain in the EU than  leave it.

Chinese rate cut should stabilise growth

Beijing is finding itself in a similar dilemma to many other governments trying to combat a slowdown through official interest rate cuts while being reluctant to prime its fiscal pumps for fear of excessive debt accumulation. Yet monetary stimulus alone is unlikely to restore growth to the 10% p.a. it averaged over the decade to 2014.

The economy is at risk of missing its 7% growth target for 2015. Disappointing trade, production, investment and retail data suggest growth could slow further in the second quarter. The authorities have responded by cutting rates 25 basis points—the third cut in six months. They have also reduced bank reserve requirements in five of the last six months.

The slowing economy has also raised the odds of increased government spending. Indeed, such spending has accelerated over the last six months with spending on social housing, transport and environmental protection the main growth areas (Chart 1). But large scale fiscal stimuli akin to 2009 aren’t likely as this episode saddled local governments with large debts, invested in unproductive assets that are currently undermining financial stability.

     

    

Further monetary easing is more likely. Yet whilst this will probably keep growth from deteriorating, it is unlikely to lift the rate above 7%. Restrictions on the property market and lacklustre trading partner growth are creating excess capacity in the economy, while labour scarcity is growing as China reaches the ‘Lewis turning point’, or in other words, deploys its surplus rural labour into factories, offices and shops in the cities. The government has released plans to swap unproductive short term local government debt for longer tenor bonds to restore confidence and stimulate lending. Recent reports also suggest policymakers have reverted to their unconventional playbook, forcing banks to lend to local government projects even if the borrowers are unable to make payments on existing loans. The central government is hoping that such ‘extend and pretend’ will help these projects to repay their debts eventually. But this poses risks to financial stability and contradicts the policy push toward financial deregulation.

South Africa’s ailing economy fuels nationalism and violence

A languishing economy, pervasive corruption, and entrenched inequality are fuelling political uncertainty, xenophobic violence and nationalistic reforms. All of which are likely to curtail export opportunities in Australia’s largest African market.

South Africa’s economy is stagnating — GDP growth of 1.4% last year was the lowest since the 2009 recession (Chart 2). The economy is plagued by a power crisis, protracted strikes, falling commodity prices, policy uncertainty and chronic unemployment. Moody’s  warned  this month that the country’s credit rating could be downgraded if fiscal consolidation falters. A downgrade would align Moody’s with S&P, which lowered South Africa's credit status to just one notch above ‘junk’ last June.

   

   

As the economy has faltered, corruption has flourished. South Africa ranked 67  out of 175 countries in Transparency International’s 2014 Corruption Perceptions Index, well behind neighbours Botswana (31), Namibia and Lesotho (both 55). The Auditor General’s report for the 2013 financial year cleared just 9% of 319 audited entities, while US$1.7b was found to be spent in a manner deemed to be unauthorised, irregular and wasteful.

Public anger over economic underperformance and corruption is fanning xenophobia in South Africa’s townships. Last month the army was deployed to quell violent attacks against immigrants from poor neighbouring countries that left at least seven dead.

It has also responded with increasingly nationalistic policies. Land reforms outlined in February will prevent foreigners from buying farmland and restrict the size of farms that local farmers may own. The government is also considering compelling farmers to relinquish 50% of their farms to employees. More populist parties are calling for ‘equitable redistribution’ — or the expropriation of all land without compensation.

Such proposals are likely to undermine the commercial farming sector — existing farmers argue that smaller plots are not economically viable. While only minimal land has changed hands since apartheid ended in 1994, the government itself asserts that 90% of redistributed farms are not productive. Increasingly nationalistic policies are also likely to curb foreign investment. Zimbabwe’s brutal land seizures of the early 2000s devastated its economy.

South Africa is Australia's largest export market in Africa — the country bought goods and services worth A$1.7b last financial year. But economic woes are taking their toll — Australia’s merchandise exports, concentrated in commodities and specialised machinery, fell over 7% last year. Economic stagnation, political uncertainly, the drift toward nationalism and rising violence are likely to damp export opportunities further.

Commodity slump leads to FX shortages in PNG

Foreign exchange shortages have arisen in PNG in response to falling commodity prices.

Falling commodity prices have buffeted PNG’s economy. The deterioration has prompted various expressions of concern. Last December, the IMF warned that ‘risks to the outlook are increasingly tilted toward the downside’. And last week Moody’s downgraded PNG’s credit outlook to negative citing deteriorating finances and rising vulnerability to external shocks.

The central bank’s attempts to resist currency depreciation have led it to intervene in the foreign exchange market. This has included imposing a trading band around the official rate, depleting hard currency reserves, and tightening exchange controls.

But the economy built up strong buffers during the commodity boom that will ward off crisis — running budget surpluses and retiring debt, and accumulating foreign reserves. Those reserves while declining (Chart 3) remain adequate, and the IMF concluded last December that the economy was at ‘low risk of debt distress’ despite ‘sharp fiscal expansions’. Increasing exports from the PNG LNG and other resource projects will also provide support to the economy. Even so, some further adjustment will be required to achieve balanced and sustainable growth.

   

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ASEAN e-commerce boom fuels export opportunities

With an estimated market potential of US$90b once it matures, ASEAN’s fast growing e-commerce market will improve regional trade interconnectivity and offer new opportunities for Australian exporters.

E-commerce remains relatively underdeveloped in ASEAN’s six largest economies — accounting for less than 1% of worldwide online retail sales. This is despite the ASEAN 6 accounting for 4% of global GDP and 8% of total population. Still, online retailing in these markets is forecast to grow by up to 25% annually to 2017 — driven by rising prosperity, growing internet penetration and better online offerings. This implies ASEAN's e-commerce market will grow at double the expected pace of online markets in Europe, Japan and the US over 2013-17.

Researchers estimate the ASEAN 6 e-commerce market will be worth up to US$90b once it matures (that is, consumers exhibit similar online usage compared to mature markets like the US and Europe); compared to US$7b in 2013. Indonesia, Thailand and Malaysia are forecast to experience the fastest growth and form ASEAN’s largest e-commerce markets (Chart 5).

  

  

Expanding e-commerce will strengthen regional trade linkages and business mobility consistent with the aims of the ASEAN Economic Community (a blueprint that aims to transform ASEAN into a single market and production base) to be enacted later this year. Growth in online retailing will also offer increasing opportunities for exporters. While some local providers have emerged, ASEAN consumers are attracted by foreign players — in Singapore almost half of the e-commerce market is made up of firms from outside ASEAN. Gaps in online coverage exist in retailing, jobs, music, networking, gaming, payments, real estate, travel and education. Current deficiencies in e‑commerce infrastructure will also offer opportunities for exporters — to deliver on demand for improved internet capacity, payments systems, logistics, online security and consumer services.

Australia’s budget — the export angle

The recently announced federal government budget has set aside funds to increase business awareness of Australia’s free trade agreements, expand the diplomatic network, increase Australia’s profile as an investment destination, and promote infrastructure development.

Studies have found Australian businesses are under-using the Free Trade Agreements and therefore failing to capture all their benefits. To remedy this, the government has given Austrade A$25m over two years from 2015-16 to promote business understanding of the agreements.

The government also proposes to push Australia’s global presence and profile. It has allocated A$98m over four years to establish five new diplomatic posts in Doha in Qatar; Buka in Papua New Guinea; Makassar in Indonesia; Ulaanbaatar in Mongolia; and Phuket in Thailand. This is the largest expansion of the diplomatic network in 40 years. The budget also allocated Austrade a further A$53m to promote Australia as an investment destination.

High transport costs and inadequate infrastructure have weighed on Australia’s export competiveness. On a global scale Australia’s infrastructure is inadequate relative to its level of development (Chart 6). The UK, US and Hong Kong are just some of the countries with lower levels of GDP per capita, but better infrastructure. The government is planning to establish a concessional loan facility of up to A$5b, with the objective of increasing private sector investment in infrastructure in Northern Australia. It has also set aside A$100m to 2018-19 to improve northern cattle supply chains.

  

  

Last, the budget provides A$5b in tax cuts and accelerated depreciation measures for small business. Given that around 60% of exporters have revenue less than A$2m, these incentives will likely stimulate investment and growth in Australia’s export sector.

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: © Andrew Winning / REUTERS / PICTURE MEDIA