Brazil, China, Commodities, Corporate Finance, Economics, Emerging Markets, Emerging markets, global economy, International Trade, Latin America, Long term finance, Uncategorized

Global Imbalances on the Rise

Capital Finance International, winter 2016-2017 

Discussions around large current account imbalances among systemically relevant economies as a direct threat to the stability of the global economy vanished in the aftermath of the global financial crisis. As the crisis originated in the U.S. financial system – followed by a second dip in the Eurozone – and global imbalances diminished in following years the issue has faded into the background.

More recently, some signs of a possible resurgence of rising imbalances have returned attention to the issue. We argue here that, while not a threat to global financial stability, the resurgence of these imbalances reveals a sub-par performance of the global economy in terms of foregone product and employment, i.e. a post-crisis global economic recovery below its potential. In addition, we approach how the re-orientation of the U.S. economic policy already announced by president-elect Trump suggests risks of new bouts of tension around global current account imbalances.

Are global imbalances rising again?

For five years now, the International Monetary Fund (IMF) has produced an annual report on the evolution of global external imbalances – current account surpluses and deficits – and the external positions – stocks of foreign assets minus liabilities – of 29 systemically significant economies. Results for 2015 have pointed out a moderate increase of global imbalances, after they had narrowed in the aftermath of the global financial crisis (GFC) and stabilized later (IMF, 2016a) – see Chart 1.

The evolution of imbalances in 2015 depicted in Chart 1 as explained by the IMF is reflective of three major drivers:

First, the recovery among advanced economies proceeded in an asymmetric fashion. Stronger recoveries in the U.S. and the U.K. relative to the euro area and Japan led to divergence in expected paths for monetary policies and appreciation of the dollar and sterling (pre-Brexit). The deficits of the U.S. and U.K. widened, together with increased surpluses in Japan and both debtor and creditor countries of the euro area (Chart 2).

Second, the fall of commodity prices – especially oil – transferred income from commodity exporters to importers. Overall however, it made only a moderate contribution to the narrowing of imbalances.

Third, prospects of monetary policy normalization in the U.S., as well as bouts of fears about the softness of China’s rebalancing, contributed to a slowdown of capital inflows and depreciation pressures in emerging markets (Canuto, 2016a).

All in all, larger U.S. deficits and augmented surpluses in Japan, the Euro area and China more than compensated for smaller surpluses in oil exporters and smaller deficits in deficit emerging markets and Euro area debtor countries. Hence, global current account imbalances widened last year, even if “moderately”.

However, a picture of higher global imbalances emerges if one focuses on the rising surpluses of two systemically relevant groups of economies. Chart 2 exhibits how in the euro area deficits in debtor countries have shrunk in tandem with the maintenance of surpluses in creditor countries (slightly increasing in the case of Germany). While the net foreign asset position (liabilities) of debtors has not diminished as much, their current account adjustment has added to the soaring surpluses the euro area as a whole runs with the rest of the world. Setser (2016) in turn has called attention to how the six major East Asian surplus economies – China, Japan, South Korea, Taiwan (China), Hong Kong (China), and Singapore – have reverted their post-GFC decline of surpluses and are currently topping even the euro area (Chart 3).

Such double trajectory of rising surpluses gives credence to those who have expressed concerns about a revival of rising current account imbalances as a source of risks to the global economy. While Eichengreen (2014) had declared “the era of global imbalances” to be over, more recently others believe they are “back” and claim that “rising global imbalances should be ringing alarm bells” (HSBC, according to Verma and Kawa (2016). To address this issue, however, it is worth first reviewing how the profile of current imbalances differs from the one prior to the GFC.

Global imbalances have evolved

The “era of global imbalances” up to the GFC (Chart 1) had two distinctive-yet-combined processes at its core:

On the one hand, credit-driven, asset bubble-led growth in the U.S., along with wealth effects, intensified the existing trend of domestic absorption (particularly consumption) growing faster than GDP. This resulted in falling personal saving rates and increasing current account deficits (Chart 4) (Canuto, 2009; 2010).

On the other hand, the accelerated structural transformation and rapid growth in China, led to high and rising savings and investments and producing ever larger current account surpluses (Chart 5) (Canuto, 2013a).

Two caveats about these distinctive-yet-combined processes are needed. First, the bilateral U.S. deficit with China in the period decreases by a third when measured in terms of value added,  as China became a “hub or a stroke” of value chains with intermediate stages supplied from abroad  (Canuto, 2013b). The U.S.-China bilateral imbalance therefore constituted outlets for production beyond China.

Second, while often linked as mirror images of each other – as in the hypothesis of an Asian “savings glut” causing low interest rates and asset price hikes in the U.S. (Bernanke, 2005) – the U.S. asset bubbles were more strongly associated to the “excess elasticity of the international monetary and financial system”, rather than to Asian current account surpluses (Borio and Disyatat,2011) (Borio, James, and Chin, 2014). Global current account imbalances cannot be blamed for the U.S.-originated GFC. As stressed by Eichengreen (2014):

“…the flows that mattered were not the net flows of capital from the rest of the world that financed America’s current-account deficit. Rather, they were the gross flows of finance from the US to Europe that allowed European banks to leverage their balance sheets, and the large, matching flows of money from European banks into toxic US subprime-linked securities.”

Asset bubbles in the U.S. to a large extent were blown by European banks through their balance sheets, by channeling U.S. money market funds into toxic assets. From the U.S.-Europe balance of payments standpoint, short-term outflows from the latter to the former were netted out by simultaneous long-term flows in the opposite direction. Close-to-zero net capital flows hid a lot of financial intermediation and asset-bubble blowing via banks’ balance sheets.

A parallel to that China-U.S. relationship can be traced within the euro area, including its later experience with a second dip of the GFC. The entry of the euro as a common currency was followed by a risk premium convergence toward German levels and to cross-border banking flows at extremely easy conditions. Consequent asset bubbles originated wealth effects and excess domestic absorption – besides inflated financial intermediation – in southern Europe and Ireland, leading to the subsequent debt crisis. The pattern of intra-euro area current account imbalances exhibited in Chart 2 was primarily a consequence of the euphoria taking place under conditions of “excess elasticity” of the euro area’s financial system.

The commodity super-cycle also helped shape global imbalances in this period seen in Chart 1. However, it was to a large extent a consequence of extraordinary global growth prior to the crisis, one in which commodity-intensive emerging market economies maintained growth trends above those of advanced economies (Canuto, 2010).

While such a pattern of global imbalances was unfolding prior to the GFC, much discussion took place about its potential to spark a crisis on its own when faced with a sudden stop. China’s current account surpluses were boosted by depreciated levels of the exchange rate sustained mainly by a piling up of foreign reserves. The same evolution was interpreted by some as an expression of a savings glut unmatched by enough domestic availability of safe-and-liquid assets like U.S. Treasuries.

Regardless of the emphasis of causality one might establish between export-led strategies and saving-glut-cum-safe-asset-scarcity, analysts were split into two camps, as described by Eichengreen (2014). Some analysts feared a possible crisis of confidence in the dollar bringing capital flows to a sudden halt, while others saw imbalances as an exchange of cheap Asian goods for safe and liquid U.S. assets. In the latter case, imbalances might gradually unwind as export-led strategies reached exhaustion and/or the desire for asset accumulation approached satiation.

In any case, the GFC happened before that dispute was settled and global imbalances started to unwind in its aftermath. U.S. personal saving rates began to climb, borrowers reduced leverage, the dollar devalued and the U.S. current account deficit shrank from almost 6% of GDP in 2006 to much lower levels from 2009 onwards. At the same time, as shown in Chart 5, China initiated its rebalancing from an exports and investment-led growth model towards higher domestic consumption and services, including an appreciation of the RMB and lower growth rate targets. This has not meant a straightforward change of trajectory, as caution against a post-GFC hard landing favored continued high investment in domestic housing and infrastructure as a component of the transition (Canuto, 2013a).

As we have already seen, deficits also diminished in the euro area in the aftermath of its debt crisis. The decline in commodity prices also helped global imbalances to shrink.

So, global imbalances did not spark a crisis and have returned in different configuration. Since current account balances are neither expected nor desired to be zero, how to make an assessment of whether the recent “moderate” uptick detected by the IMF might be a bad omen? Do those who have voiced concern over rising surpluses in East Asia and the euro area have a point? To answer these questions, it will be useful to look at the IMF exercise of judgement on whether global imbalances have been “in excess”, i.e. inconsistent with “fundamentals and desirable policies” (IMF, 2016a, Box 1).

How misaligned with fundamentals have current account imbalances been?

National economies are not expected to exhibit zero current-account balances and stocks of net foreign assets. At any period of time, domestic absorption – consumption and investment – can be larger or smaller than the local GDP, triggering inflows or outflows of capital, due to “fundamental” factors:

  • Differences in intertemporal preferences and age structures of their populations mean different ratios of domestic consumption to GDP;
  • Differences in opportunities for investment also tend to lead to capital flows;
  • Differences in institutional development levels, reserve currency statuses and other idiosyncratic features also generate capital flows and imbalances;
  • Cyclical factors – including fluctuations in commodity prices – may also cause transitory increases and declines in balances; and
  • Countries’ outstanding stocks of net foreign assets also have a counterpart in terms of service payments in their current accounts.

When global imbalances – and corresponding real effective exchange rates (REERs) – reflect such fundamentals, economies are in a better place than they would be in autarky (isolated with zero balances). There are situations, however, in which such imbalances may be gauged as in excess and countries should reduce them – as approached in Blanchard and Milesi-Ferretti (2010; 2011).

There is the straightforward case of imbalances being magnified by domestic distortions, the removal of which would directly benefit the economy. For instance, this is the case when deficits are higher because of lax financial regulation fueling unsustainable credit booms or excessively loose fiscal policies. It is also the case of surpluses that reflect extremely high private savings due to lack of social insurance or investments being curbed because of a lack of efficient financial intermediation. It is worth noticing that, while excessive deficits eventually face a shortage of external finance, surpluses suffer less automatic pressures to dissipate and can therefore persist for longer.

Furthermore, as pointed out by Blanchard and Milesi-Ferretti, there are also situations in which the multilateral interdependence of economies calls for restricting current-account deficits or surpluses. Unsustainable deficits of large, financially integrated economies are such a case, as a crisis associated to them may trigger cross-border effects.

Blanchard and Milesi-Ferretti additionally point out two conceivable situations in which surpluses can be deemed as in excess:

  • When current-account surpluses are the result of deliberate strategies of curbing domestic demand and deliberate exchange rate undervaluation, crowding out foreign competitors. On the other hand, given the simultaneous determination of savings and current account balances, it is always hard to disentangle such a strategy from other determinants of the current-account balance.
  • When an increase of one economy’s surplus takes place while others face difficulties to absorb it without suffering adverse, durable effects on their demand and output. This is the case when part of the world is caught in a “liquidity trap”, unable to resort to lowering domestic interest rates as an adjustment policy, or face obstacles to use countervailing fiscal policies.

The IMF “External Sector Report” aims to gauge to what extent current account balances and corresponding REERs are out of line with “fundamentals and desirable policies”, as well as whether stocks of net foreign assets are evolving within sustainable boundaries. What did the latest issue show?

Chart 6 displays its assessment of how intensively individual economies have exhibited current accounts – and REERs – that are out of line with their “fundamentals”, i.e. those features that would normally lead them to feature current account imbalances within certain estimated country-specific ranges. Stronger (weaker) corresponds to REER “undervaluation” (“overvaluation”). Stronger (weaker) also means that a current account balance is actually larger (smaller) than that “consistent with fundamentals and desirable policies” (IMF, 2016a, Box 1).

The report notices that the evolution toward less excess imbalances after the GFC has stopped and recent movements have given cause for concern (IMF, 2016a, p. 23):

First, those economies with external positions considered “substantially stronger” (Germany, Korea, Singapore) or “stronger” (Malaysia, Netherlands) have remained as such for the last 4 years. Also noticeable has been the shift toward stronger positions in the cases of Thailand and Japan.

Second, at the bottom of the distribution, while some countries reduced – or suppressed – degrees of “weakness” (Russia, Brazil, Indonesia, South Africa, and France), others remained (Spain, Turkey, United Kingdom) – with the addition of Saudi Arabia to this group after the oil price decline.

Third, on-going trends of current account imbalances are bound to lead to a further widening of some external stock imbalances accumulated since the GFC. While China’s external stock position is expected to stabilize, other large economies are projected to exacerbate their debtor (U.S., UK) and creditor (Japan, Germany, Netherlands) positions. Furthermore, the net foreign asset position of some euro-crisis countries remain highly negative despite years of flow adjustment with high unemployment and low growth.

In our view, although not giving ground to fears of a collapse in major financial flows, global imbalances have not gone away as an issue, as they reveal that the global economic recovery may have been sub-par because of asymmetric excess surpluses in some countries and output below potential in many others. The end of the “era of global imbalances” may have been called too early. Lord Keynes’ argument about the asymmetry of adjustments between deficit and surplus economies remains stronger than ever.

The IMF report has a point in calling for a “recalibration” of macroeconomic policies from demand-diverting to demand-supportive measures. This would be particularly the case for countries – or the Eurozone as a whole – currently able to resort to expansionary fiscal policies that have instead relied mainly on unconventional monetary policy – which has become increasingly ineffective at the margin. On the other hand, one must acknowledge that there are limits to which national fiscal policies can deliver cross-border demand-pull effects. Huge savings flows – like German or U.S. corporate profits – may also not be easy to redeploy.

Hence specific priority should be given to country-specific structural reforms addressing obstacles to growth and rebalancing. Which could be aided by cross-border dislocation of pools of savings currently parked in low-return assets. Paradoxically, global imbalances demand more globalization in a moment when the latter faces hurdles (Canuto, 2016b).

Implications of U.S. future trade and macroeconomic policies for global imbalances

Given the weight of the U.S. economy, global imbalances may undergo new shocks in the coming years as a result of the policy reorientation already announced by president-elect Donald Trump. Although at a preliminary stage, it is possible to devise two possible scenarios, the choice of which will depend on the options assumed by trade policies accompanying the macroeconomic reorientation.

President-elect Trump and his team have announced a macroeconomic platform with a likely strong potential impact: a major fiscal boost via infrastructure spending, corporate tax cuts, and a (financial and environmental) deregulation agenda (Canuto & Cavallari, 2016). Such platform underlies the announced goal of raising the U.S. economic growth to 4% a year, well above the potential 2% estimated by the IMF (IMF, 2016b).

Important details are yet to be filled out. For example, how much of the US$ 1 trillion of infrastructure investment pledged will be borne by the public sector or by public-private partnerships, and therefore how much of it will contribute to public sector deficits and debt. As suggested by different experiences around the world, including the United States, sudden increases in public investment are not easily implemented. The increase in investments in infrastructure will take some time to implement and there will be a lag in their effects, on both the demand and supply side.

Similarly, given that U.S. corporations currently display already high liquidity reserve buffers and low levels of acquisition of new fixed assets, the results of corporate tax reduction on their expenditures will depend significantly on the terms of conditions of local investment that may be attached. Such type of conditionality has already been alluded to in the case of profit repatriation.

There are also doubts as to the extent of the impacts of deregulation. In the case of finance, given the favorable climate in Congress and beyond to reforming the Dodd-Frank regulation, one can expect a relief from the regulatory burden that has been inhibiting bank credit in recent years. Environmental deregulation may also facilitate investment in the energy sector, particularly on shale oil and gas.

Assuming that, in fact, aggregate demand is stimulated, there remain doubts as to the current capacity of the response of domestic supply. After all, low rates of involuntary unemployment and upbeat levels of economic activity at the end of the Obama administration will be part of the latter’s legacy. In the event of binding supply limits, the macroeconomic effect will be largely directed to higher inflation and import growth. The frenetic appreciation of the dollar in the weeks following the initial announcements of Mr. Trump’s program reinforces the possibility of greater demand leaks via foreign purchases of goods and services.

In any case, a drastic change in the current regime of fiscal and monetary policies is likely to occur. The normalization of monetary policy by the Federal Reserve toward higher interest rates and smaller balance sheets tends to accelerate, while fiscal policy will definitely leave the consolidation path forced by Congress to the Obama administration in recent years. In effect, the U.S. is one of those cases in which the IMF – and others (Canuto, 2014) – have long advised a shift from monetary easing to expansionary fiscal policies. The appetite in the markets for Treasury bonds has been far from satiated and larger public deficits would be easily absorbed, for which it would suffice to issue signs of future reforms toward some smoothing of the public debt path.

It is in trade policy and in dealing with current account imbalances that two scenarios emerge: a “soft” scenario is the one in which the Trump government limits its campaign promises to occasional “arm twists” with corporations, like moral suasion and tax concessions in exchange for local investments or import substitution within value chains. The “hard” scenario would be to establish extraordinary tariffs and other restrictions on imports – China and Mexico were frequent targets of such threats during the election campaign.

In the “soft” scenario, there will be a demand stimulus for the rest of the world, albeit at the cost of greater current US imbalances which would not likely face financing difficulties. The “hard” scenario, in turn, contains high risks of substantial price increases in the domestic basket of goods and services, as well as of having a negative impact on the profitability of U.S. corporations. In addition, if followed by “trade wars” with countries directly affected, a “lose-lose” result in the global economy – as in the 1930s – could materialize (Canuto, 2016b). After all, the US economy nowadays has levels of trade and financial integration with the rest of the world sufficient to generate significant feedback loops.

Bottom line

Current account imbalances in the global economy have returned to the spotlight, albeit with a different configuration from the one that marked the trajectory prior to the global financial crisis. Not as a particular threat to global financial stability, but mainly because they reveal asymmetries in adjustment and post-crisis recovery between surplus and deficit economies and, in the coming years, for the risk of sparking waves of trade protectionism.

Otaviano Canuto is an Executive Director at the World Bank (WB). All opinions expressed here are his own and do not represent those of the institution or of those governments he represents at the WB Board.

Standard
Brazil, China, Commodities, Corporate Finance, Economics, Emerging Markets, Emerging markets, global economy, International Trade, Latin America, Long term finance, Shadow Banking, Uncategorized

2016 Retrospect – with links

 

2016

Global Macro-Economy

Financial markets seem to believe that president-elect Trump can deliver higher growth and inflation, as manifested in the rotation from bonds to equities. At the same time, the shock waves already felt by assets abroad may be a harbinger of the bumpy and treacherous journey ahead. No wonder Mr. Trump’s softening of statements — and campaign promises — after the election has been taken with sighs of relief.

Discussions around large current account imbalances among systemically relevant economies as a threat to the stability of the global economy faded out in the aftermath of the global financial crisis. More recently, some signs of a possible resurgence of rising imbalances have brought back attention to the issue. We argue here that, while not a threat to global financial stability, the resurgence of these imbalances reveals a sub-par performance of the global economy in terms of foregone product and employment.

Huffington Post, Roubini EconoMonitor (with Aleksandr V. Gevorkyan)

Capital outflows from emerging market economies have substantially accelerated since last year. The cycle of intense debt leveraging that took place in those economies after the 2008 global financial crisis has also started to reverse. Furthermore, 2015 was also a fifth consecutive year of growth deceleration in emerging markets. Some analysts have taken those features as pointing to a high likelihood of a “third wave” of the global financial crisis, this time centered on emerging markets. While arguably their combination may acquire a disorderly nature and materialize systemic risks to those economies as a group – and therefore to the global economy going forward – there are also reasons to expect the significant portfolio rebalancing at play not to lead to a disruptive break.

After a exponential rise in foreign exchange reserves accumulation by emerging markets from 2000 onwards, the tide seems to have turned south since mid-2014. Changes in capital flows and commodity prices have been major factors behind the inflection, with the new direction expected to remain, given the context of the global economy going forward. Although it is too early to gauge whether the on-going relative unwinding of such reserves defenses will lead to vulnerability in specific emerging markets, the payoff from strengthening domestic policies has broadly increased.

 

Global Trade

Prospects for growth in global trade in 2016 and 2017 have been downgraded again. The World Trade Organization (WTO) now expects that trade this year will increase at its slowest pace since the post-2008 global recession. What is going on?

World trade suffered another disappointing year in 2015, experiencing a contraction in merchandise trade volumes during the first half and only a low recovery during the second half (Figure 1). While last year’s trade performance can be associated to the ongoing growth transition in China and its reflections on other non-advanced economies, the fact is that last year’s performance came after a period since the 2000s in which world trade volumes have lagged behind GDP growth, a trend accentuated since the onset of the global financial crisis and in sharp contrast to global trade increases at a higher pace than world GDP prior to the new millennium.

For better or worse, TPP and TTIP could redefine global trade in the 21st century. At the moment, a Latin America perspective is largely lacking in the negotiation process; in TTIP, it is excluded by definition. But Latin American countries can move unilaterally to ensure that tariffs and regulations match what could become the new global standard. Of course, alternatively, they could rebuild protective economic walls. But if they do, later on down the road, they just might have to pay for it.

Trade has been a key driver of global growth, income convergence, and poverty reduction. Both developing countries and emerging market economies have benefited from opportunities to transfer technology from abroad and to undergo domestic structural transformation via trade integration in the last decades. Yet, more recently, concerns have been raised over whether the current pace and direction of world trade lead towards a lesser development-boosting potential.

Brazil

In recent years Brazil has experienced significant depreciation of its nominal exchange rate. Compared with its average in 2013, the Brazilian real lost 38 per cent of its value against the US dollar in 2016. At its weakest, in January 2016, it lost as much as 47 per cent. A year ago, we saw that depreciation as a silver liningfor Brazil amid its deep recession, as a source of support for exports. But Brazil’s recent GDP data (particularly for the second quarter of 2016) show a negative contribution of net exports to growth.

Brazil’s GDP is poised to decline by close to 7% in 2015-2016. Per capita GDP in 2016 is likely to shrink by more than 10% as compared to three years ago. We argue here that a double malaise has been ailing the Brazilian economy: given an anaemia of productivity increases, an appetite for public spending without prioritisation has led to a condition of fiscal obesity. We further approach why market reactions to the Brazilian government’s proposal of crisis response have been positive.

Now that impeached Brazilian President Dilma Rousseff is out of office, it is up to the newly empowered administration of President Michel Temer to clean up Brazil’s macroeconomic mess. Can Temer’s government save Brazil’s crumbling economy?

Brazil has been suffering from anemic productivity growth. This is a major challenge because in the long run, sustained productivity increases are necessary to underpin inclusive economic growth. Without them, increases in real labor earnings tend to conflict with global competitiveness; collecting taxes in order to fund government expenditures on infrastructure and social policies becomes a heavy burden; returns to private investment becomes harder to achieve; and ultimately citizens will have less access to high-quality goods and services at affordable prices. The focus on urgent fiscal reforms adopted by the new government- public spending cap, social security reform – must be accompanied by action on the productivity front.

Brazil’s GDP contraction since mid-2014 has multiple non-fiscal roots – Canuto (2016a; 2014) – but it has morphed into an unsustainable fiscal trajectory (Canuto, 2016b). Dealing with the latter has become a precondition for full economic recovery and the Brazilian government has submitted to Congress a constitutional amendment bill mandating a public spending cap for the next 20 years. This piece considers how the Brazilian landscape evolved toward such a precipice and why additional reforms – particularly on pensions – will have to be implemented to make the spending cap feasible.

With the impeachment of President Dilma Roussseff being sent to the Senate on April 17, Brazil continues a period of turmoil that has lasted for more than a year now. With images of protests, counter-protests and the minutia of the country’s legal proceedings blasted by media outlets around the world, it seems important to take a step back and remember that a lot more lies beyond the headlines.

Emerging Markets

This collection empirically and conceptually advances our understanding of the intricacies of emerging markets’ financial and macroeconomic development in the post-2008 crisis context. Covering a vast geography and a broad range of economic viewpoints, this study serves as an informed guide in the unchartered waters of fundamental uncertainty as it has been redefined in the post-crisis period. Contributors to the collection go beyond risks-opportunities analyses, looking deeper into the nuanced interpretations of data and economic categories as interplay of developing world characteristics in the context of redefined fundamental uncertainty. Those concerns relate to the issues of small country finance, the industrialization of the developing world, the role of commodity cycles in the global economy, sovereign debt, speculative financial flows and currency pressures, and connections between financial markets and real markets. Compact and comprehensive, this collection offers unique perspectives into contemporary issues of financial deepening and real macroeconomic development in small developing economies that rarely surface in the larger policy and development debates.

The Chinese economy is rebalancing while softening its growth pace. China’s spillovers on the global economy have operated through trade, commodity prices, and financial channels. The global reach of the effects from China’s transition have recently been illustrated in risk scenarios simulated for Latin American and the Caribbean economies.

A propensity to undergo periodic episodes of instability and volatility of emerging markets in global finance will persist. Get ready for a continuous dispute between the two financial tales about emerging markets, as well as to increasing efforts of differentiation among their assets.

Turkey’s economy is at a crossroads, and how the country emerges from the current period of political crisis could dictate its ability to meet its challenges. Will power consolidation and purges render a compromised central bank? Will truculence with major partners such as the EU and Russia lead to deceleration in real-sector growth? Will human rights abuses and risk aversion lead investors to steer clear of Istanbul? And how will a population on edge react to what many expect to be a miserable summer in tourism receipts?

Suriname is facing twin – external and fiscal – deficits that originated in the commodity price slump of recent years. In response, the Surinamese government started a four-pronged adjustment program in August 2015 to adapt to new circumstances.

 

 

Standard
Brazil, Corporate Finance, Emerging Markets, Emerging markets, Latin America, Long term finance

Latin American Corporate Finance: Is There a Dark Corner?

 

Since last year there has been much talk of possible financial stress stemming from increased debt leverage in non-financial corporates of emerging markets economies. A recent study has brought to light some key evidence on the Latin American case (Bastos et al, 2015).

Read here:

http://www.huffingtonpost.com/otaviano-canuto/latin-american-corporate_b_6627016.html

or here:

http://www.economonitor.com/blog/2015/02/latin-american-corporate-finance-is-there-a-dark-corner/

Best regards

OC

Standard
Uncategorized

My Articles in 2014 (with links)

Bear and bull dancing

Global Economy – Crisis Recovery and Secular stagnation Hypotheses

1. Macroeconomics and Stagnation – Keynesian-Schumpeterian Wars
Policy makers in the advanced economies at the core of the global financial crisis can make the claim that they prevented a new “Great Depression”. However, recovery since the outbreak of the crisis more than five years ago has been sluggish and feeble. Since these macroeconomic outcomes have to some extent been shaped by policy […]
May 6, 2014 | By Capital Finance International

2. Sluggish Postcrisis Growth: Policies, Secular Stagnation, and Outlook

(with Raj Nallari, and Breda Griffith)
Economic Premise n.139, April 2014.

3. Calibrating 2014
 Huffington Post – Posted January 2, 2014 | 12:35 PM
The global economy looks poised to display better growth performance in 2014. Leading indicators are pointing upward — or at least to stability — in major growth poles. However, for this to translate into reality policymakers will need to be nimble enough to calibrate responses to idiosyncratic challenges.

Emerging Markets

4. Liquidity Glut, Infrastructure Finance Drought and Development Banks
The world economy faces huge infrastructure financing needs that are not being matched on the supply side. Emerging market economies, in particular, have had to deal with international long-term private debt financing options that are less supportive of infrastructure finance. While unconventional monetary policies in advanced countries in the aftermath of the global financial crisis […]
September 19, 2014 | By Capital Finance International

5. Long-Term Finance in EMEs: Navigating between Risks and Policy Choices
(with Anderson Caputo Silva, and Catiana García-Kilroy)
Economic Premise n. 152, June 2014
(Also as: Forward – THE EUROMONEY – EMERGING MARKETS HANDBOOK 2015)

6. China and Emerging Markets: Riding Wild Horses
Huffington Post Posted February 3, 2014 | 8:08 PM
One month ago, I discussed some major risks to a slight upturn in the global economic scenario for 2014. Among those risks, concerns with the growth slowdown and challenges with shadow banking in China have already come to the fore as the Chinese Year of the Horse approached…
Read Post

7. Sovereign Wealth Funds Are Coming Home
Huffington Post Posted January 15, 2014 | 5:30 PM
Followers of this blog have read several recent pieces on the changing landscape of investment finance in developing countries, particularly in natural resource-rich countries. We have approached the rise of development banks partially filling the void left by the retrenchment of international banking. We have also highlighted how…
Read Post

8. Commodity Super Cycle to Stick Around a Bit Longer
Some analysts have predicted that the commodity price boom has played itself out. However, natural resource-based commodity prices (with the exception of shale gas and its downward pressure on US natural gas prices) have remained relatively high over the last few years, despite the feeble global economic recovery (Canuto, 2014). The commodity price spike that […]
August 22, 2014 | By Capital Finance International

Brazil

9. The High Density of Brazilian Production Chains
Huffington Post Posted November 13, 2014 | 12:50 PM
International trade has undergone a radical transformation in the past decades as production processes have fragmented along cross-border value chains. The Brazilian economy has remained on the fringes of this production revolution, maintaining a very high density of local supply chains. This article calls attention to the rising opportunity costs…
Read Post

10. Navigating Brazil’s Path to Growth
Huffington Post Posted November 9, 2014 | 10:01 PM
Brazil’s macroeconomic management will face four major immediate challenges in the near future. The response to them will be strengthened if we could have some indication of how to steer the Brazilian economy back to a growth route.
A first major challenge will be the upward realignment of domestic regulated…
Read Post

11. Three Perspectives on Brazilian Growth Pessimism
(with Philip Schellekens)
Economic Premise n.148, June 2014
It has become increasingly evident over the last two years that the growth engine of the Brazilian economy has run out of steam. Despite relative resilience during the global financial crisis and following a quick recovery, economic growth registered just 1 percent in 2012 and…

12. What’s Holding Back Brazil?

Project Syndicate,February 21, 2014

One often hears that Brazil’s economy is stuck in the “middle-income trap,” having failed to revive the structural transformation and per capita income growth that it enjoyed before the debt crisis…

13. Clogged Metropolitan Arteries
Huffington Post Posted February 10, 2014 | 3:45 PM
Bad conditions of mobility and accessibility to jobs and services in most metropolitan regions in developing countries are a key development issue. Besides the negative effects on the wellbeing of their populations associated with traffic congestion and time spent on transportation, the latter mean economic losses in terms of waste…

Middle-Income Trap

14. Access to Finance, Product Innovation and Middle-Income Traps
(with Pierre-Richard Agenor)
World Bank Policy Research Working Paper Series 6767, February 2014

15.  Access to Finance, Product Innovation, and Middle-Income Growth Traps

(with Pierre-Richard Agenor and Michael Jelenic)

Economic Premise n.137, March 2014.)

Debt Restructuring

16. Orderly Sovereign Debt Restructuring: Missing in Action! (And Likely To Remain So)
(with Brian Pinto and Mona Prasad)
The World Bank Research Observer 01/2014; 29:109-135.
(Accessible in Academia.edu and ResearchGate.net)

Standard
Brazil, Emerging Markets, Uncategorized

Navigating Brazil’s Path to Growth

Brazil’s macroeconomic management will face four major immediate challenges in the near future. The response to them will be strengthened if we could have some indication of how to steer the Brazilian economy back to a growth route.

Read here:

Navigating Brazil’s Path to Growth

Standard
Brazil, Economics

3 Perspectives on Brazilian Growth Pessimism – full version

Over the last few years, Brazil’s growth has significantly decelerated. Accompanying this slowdown, a change in commentary on Brazil’s economic future has emerged, and is reflected in a recent ratings downgrade of Brazilian sovereign paper and an overall much-bleaker growth outlook both for the near and medium term. This note examines three contributing factors to this change in sentiment: macroeconomic management, the external environment, and microeconomic fundamentals. Among these, this note argues that the relative lack of progress on the microeconomic reform agenda has been far more detrimental to the growth outlook than either the credibility cost of recent macroeconomic management or the negative influence of a less supportive external environment. Against this backdrop, the recent ratings downgrade is not inherently negative: while Brazil is not about to slide down a slippery slope of macroeconomic mismanagement or on the verge of an externally-powered economic meltdown, the downgrade can serve as a call to action for government to enact the necessary structural reforms to energize and sustain productivity growth.
Click here: Economic Premise 148

 

Standard
Economics

Three Perspectives on Brazilian Growth Pessimism

Otaviano Canuto and Philip Schellekens*

It has become increasingly evident over the last two years that the growth engine of the Brazilian economy has run out of steam. Despite relative resilience during the global financial crisis and following a quick recovery, economic growth registered just 1 percent in 2012 and a meager 2.5 percent in 2013. More recently, the economy grew at the annual equivalent of only 0.6 percent in the first quarter of 2014. Little improvement is expected in the near term. To the contrary, as of early June, the median forecaster expects growth of 1.4 for 2014 and 1.8 percent for 2015. Further out the horizon, a muted recovery is anticipated that would bring growth to 2.5-3 percent between 2016 and 2018.

Brazil’s recent slow growth performance is disappointing in at least two respects. While not atypical for an advanced economy that has exhausted the benefits of catch-up growth, the slow growth observed in Brazil would be neither typical nor desirable for an emerging market in need of further per-capita income growth and shared prosperity. Recent growth rates also disappoint relative to recent economic history as the 2004-2008 period saw growth in the region of 5 percent; instead, they evoke the memory of the 1981-2003 period when the economy grew on average 2 percent annually.

The Figure illustrates well the degree of current-day growth pessimism. Market forecasts about Brazilian economic growth two years out have dropped considerably. They have done so not only relative to the zenith of 4.5 percent reached in 2010-11 but also relative to estimates earlier in the last decade of 3.5 percent. While this deterioration reflects structural developments that are a cause for concern, we believe that the perceived decline in the growth capacity of the economy reflects excessive pessimism – not unlike the earlier period of exuberance when expectations were equally distorted, though then on the upside.

Figure: How Growth Optimism Turned into Pessimism
Growth forecasts two years later (daily median GDP forecast averaged over the year, percent)
Figure blog OC+Philip
Source: Central Bank of Brazil; World Bank staff calculations
What explains growth pessimism in Brazil?

The answers may be found in what underpinned the growth acceleration of the mid-to-late 2000s. The growth spurt back then resulted from the delayed effects of the reform efforts in the 1990s and the first half of the 2000s, when Brazil got its macroeconomic house in order and implemented reforms in the financial, trade and social sectors (Ter-Minassian, 2012; Canuto et al, 2013). Risk premiums on all Brazilian types of assets fell systematically after it became clear that the commitment with fiscal discipline, inflation targeting and flexible exchange rates would be preserved regardless of the political parties in government. In addition, favorable external conditions prior to the global financial crisis relaxed financial constraints and financed growth.

These same three factors once responsible for Brazil’s growth acceleration – the credibility of the macroeconomic policy framework, the support of the external environment and the reform efforts on the microeconomic front – have underpinned three strands of growth pessimism that have become prevalent in recent economic commentary on the future direction of Brazil.

The first strand of growth pessimism espouses the view that recent macroeconomic management has eroded the hard-won credibility of the macroeconomic policy framework built on fiscal prudence, exchange rate flexibility and inflation targeting. In response to slow growth coupled with high inflation, policymakers have relaxed fiscal policies, accommodated sticky inflation at the upper end of the target range, and introduced large currency market interventions to dampen exchange rate volatility. Critics point to these developments – alongside interventions to control inflation with administered prices and to support growth through less than fully transparent para-fiscal operations – as the beginning of a slide down a growth-reducing slippery slope (Wheatly, 2014). They also consider the recent downgrade of Brazilian sovereign paper to one notch above junk as validating their concerns.

These factors do not justify in our view the modest growth forecasts observed in recent months. While the return to macro instability of the sort seen in Brazil’s pre-stabilization period can be discounted as a remote possibility, the policy framework did suffer a credibility loss as the authorities struggled to respond to the evolving macroeconomic environment of slow growth and high inflation. But these interventions took place at a time when the flexibility implied by such actions would be considered as warranted in order to counter economic conditions and stabilize asset prices. Brazil also continues to enjoy large external buffers and the pillars of the macroeconomic framework have remained broadly intact. While care will need to be given to ensuring that fiscal buffers are restored and inflation returns to the mid-point of the target range, we do not consider that any credibility losses incurred so far have been an overarching factor in stalling growth or depressing expectations.

The second strand of growth pessimism laments the lack of a supportive external environment. This view is intricately related to the hypothesis that the growth acceleration before the global financial crisis was to a large extent thanks to external rather than domestic factors. Rapid capital inflows, better terms of trade, and lower global interest rates all played to Brazil’s favor when times were good. By analogy, as conditions changed for the worse, so did Brazil’s economic fortunes. Looking ahead, this view paints a depressing outlook for Brazil to the extent that its premier trading partner, China, continues to slow, major advanced economies remain stuck in the doldrums, and global capital becomes more expensive and less readily available as the Fed tapers off its purchases of long-term securities. All of the above are thought to present a clear and present danger for Brazil (BNP Paribas, 2013).
While external factors continue to play a role in Brazil – both by affecting the real and financial side of the economy – they are all too often overplayed. Growth in Brazil is still largely made in Brazil given the overwhelming share of its domestic market in GDP. Brazil’s external trade accounts also remain well diversified in terms of products, export destinations and import sources (Canuto et al, 2013). The role of the external environment in raising growth during 2004 and 2008 must also not be overstated as an important component of the growth acceleration back then was due to the delayed effects of earlier macro- and micro-economic enhancing reforms that produced stabilization gains and enhanced productivity (Canuto, 2013).

This then brings us to the third strand of growth pessimism, which relates to the lack of progress in improving the microeconomic fundamentals for growth. This strand is in our view of far greater concern than the credibility cost of recent macroeconomic management or the economic impact of the deterioration in the external environment. Indeed, the microeconomic environment is critical for growth even more so today than before. This is because demographic dynamics have reduced the growth of Brazil’s labor force. Higher growth will therefore require first and foremost higher output per worker or productivity. But productivity growth remains constrained by slow capital accumulation (both human and physical) as well as a cumbersome business environment. For Brazil to energize and sustain productivity growth, it will need to enable the enabling environment and disable the disabling environment.

Yet, during the recent period of slower growth, little progress has been made in tackling long-standing structural bottlenecks and therefore the structural reform agenda remains long and unfinished (Canuto, 2014). Unsurprisingly, slow growth has of late become primarily a supply-side phenomenon of a structural nature. This is indicated by the fact that, despite slower growth, the output gap is as good as closed, inflationary pressures are pronounced and the labor market is buoyant with unemployment at record lows.

The key challenge going forward will be to energize the momentum of progress. In this respect, the recent ratings downgrade is not to be un-welcomed. It is not a wake-up call in the sense that Brazil is about to slide down the slippery slope of macroeconomic mismanagement or on the verge of an externally powered economic meltdown; rather it should be seen as a call for action on the structural reform front. For the main risk facing Brazil and its economy is the specter of mediocre growth over a protracted period of time against a counterfactual potential of opportunity. Such scenario would not only exacerbate any current concerns about macroeconomic vulnerability but also – and more importantly – imply that Brazil would be ineffective in seizing its development potential.

* Respectively, Senior Adviser and former Vice President of the World Bank, and Senior Country Economist for Brazil, World Bank. The opinions expressed here are our own and do not necessarily reflect the views of the World Bank.

Standard