Tuesday, 18 September 2018

Contagion? Possible Second Round Effects for Emerging Markets

A decade on from the last financial crisis, the conventional wisdom is that that broad macro fundamentals are strong and that potential shocks from a hit on banks is a low probability event given the regulatory changes that have since beefed up capitalisation ratios for banks, coupled with new national or supranational instruments - especially in the EU - to provide backstop liquidity in case of any run on banks or general illiquidity due to shocks.
As I outlined in my last piece, the risk of EM wobblies is underway and affecting countries across all geographies, although there is a general bullishness that the scale will be limited and the impact contained.
Is this baseline valid?
Aside from basket case economies, Venezuela or Zimbabwe come to mind first, and those where credibility of policy is clearly the issue - Turkey being a case in point - it is indeed the case that the internal-external imbalances are less alarming as a genre for main EMs. Current Account deficits are not necessarily in nose-bleed territory and ditto with fiscal balances. Add to that FX reserves or months of import cover which the IMF focuses on for LDCs in particular. And a key lesson from the decade earlier and the SE Asian crisis in 1998 has been to have more flexible exchange regimes to take the brunt of adjustment. Russia's relatively successful stabilisation in recent years is a case in point.
That said, the risks of second-order impacts are under-valued.
One of the fascinating features of looking at biological equilibria models using game theory for viruses was how a seemingly salient long-lasting equilibria could be immediately and very quickly mutate into a contagion. Students of bank runs in the pre-Gold Standard era will be aware of how sentiment and confidence can turn into a riot - the herd instinct in short.
What are the potential sources of 2nd order or feedback loops?
  1. Mr Trump. Irrespective of one's view of him personally and the fascinating never-ending soap-opera around his administration, he remains an "unknown unknown" in terms of policy predictability. Given that his tweets can move shares and markets, his spat with Turkey could, if continued, not only lead to a recession in Turkey but spillover onto neigbours and into the EU via the Western Balkans. This could also affect Turkey's position on opening refugee routes back into the EU.
  2. China. The one emerging consistency of the Trump presidency's economic policy seems to be "correct" the modus-operandi of economic relations with China and to equalise the basis of bilateral trade and of investment policy in China that discriminates against Western investment vis-a-vis Chinese investment in the West. Mr Trump's escalation of additional tariffs on near 50% of bilateral trade with China and pressure on the likes of Apple to shift supply chains from China are examples that the pressure may not abate yet. China's tit-for-tat responses are programmed but have a limit - because ultimately its economic machine is reliant on trade surpluses, and with the US. A slowdown in external trade in China could set of a chain reaction.
  • China's growth rate, even accounting for a little official massaging of figures, needs to be north of 5-6% to prevent social discontent in China.
  • The elephant, sorry Panda, in the room is the potential spillover to the (in)stability of the Chinese financial system. The political-economy model in China means a mix of SOEs and a genuine private sector in tandem and with a legacy of bank lending to SOEs and to local authorities that could prove to be that catalyst that suddenly turns from illiquidity to mass insolvency. Whilst the Chinese could have perhaps played the US off against the other key western trading partners who also have increasing concerns about Mr Trump and his broader support for the existing post-War system of trans Atlantic system of economic and military relations, what they now find is a common position of the US+Japan+EU on this one issue.
  • Regional impact in Asia: any financial and/real impact on the Chinese economy would quickly ripple across onto other Asian economies through trade and financial channels. So the baseline models that project Goldilocks scenarios of sustained growth and resultant strength of equity markets in Asia may be at risk in such an eventuality.
Source: FRED using BIS data
3. Competitive Devaluations: as shown in the Figure above, the CNY:USD has devalued by around 8% since February and devaluation is an obvious policy choice although it would create further monetary headaches to deal with issues of subsequent sterilisation requirements. However, a bit like the Death Star in Star Wars, once you're in the gravitational pull, it don't matter how strong the force is with you! Asian currencies in SE Asia will do the same - as was the case in previous episodes. Moreover, it may lead to further angst from the "devil's workshop" and further Trumpian action.
4. The risk of currency mismatches on liabilities: this is where there could be some serious pain where the capital account is heavily reliant on dollar-denominated portfolio flows and domestic debtors have domestic currency assets and cashflows but possibly dollar-denominated loans.
5. I am still not fully convinced about the sustainability for the EU. OK we all now know that the pre-financial crisis baseline that Greek risk equated to EU risk and akin to Germany's turned out to be a load of moussaka! As crises from Latvia to Romania to Greece have shown in the last decade, a common monetary regime and fixed exchange rate for the entire Euro-zone means that external devaluation is not a possibility. Hence the impact of any external shock to weaker economies from any sustained EM contagion in the EU would be that much greater.
6. Political impact: a rising anti-EU tide is afoot with Sweden the latest example. With Poland and now Hungary facing Article 7 sanctions for being increasingly authoritarian and threatening the basis of fundamental EU values (Freedom of Expression, opposition and freedom of press and judiciary) and the bond market spooking in Italy when yields doubled in a few hours last week, a further move away from the centre ground of European politics of the last 30 years could yet lead to major de-stabilisation of southern and eastern EU economies.

Thursday, 13 September 2018

EM wobblies: deja vu Contagion?

Students of a certain vintage may recall the Junior School favourite (or not!) in the prehistoric days before the advent of mobile screens:
"Hungary was hungry, ate Turkey, slipped on Greece and broke China"
This basic kiddy whatchamacallit is one that comes to mind every so often when we experience Contagion across economies, most notably affecting EM economies in the transition, developing or LIC/frontier space. Are we again in the midst of something like 1998 when writing about the wave from South East Asia that spread to Russia and central Europe?
The world is even more inter-connected and the share of global wealth increasingly shifting towards the newly developed world and emerging economies. The transmission channels for possible vulnerability, economic shocks and volatility are therefore more synchronised than in the good old days of pre-Internet, Facebook and so-called Fake News. The pattern of increased synchronicity of business cycles across the globe means that economic policy can often be pro-cyclical in tandem across regional economies and ditto with short term external flows and a mis-match of currency exposures on national and private balance sheets, leaving economies and both private and public sectors to the mercy of a change of sentiment that can start with an isolated idiosyncratic issue and spread from one country to another.
Its clear that bad economic management has been the curse of many emerging economies although as we saw with Greece and possibly soon Italy, that this is not unique to developed economies but they at least tend have more sound governance and institutional structures - and importantly backstops from the EU and the IMF to plug finance gaps on the balance of payments and help plug gaping short-term holes on public finances.
The pains in Argentina, Venezuela and possibly South Africa obvious examples of the current geographical spread of woe. The pains of Turkey were, yes, affected by the macho stand off between Erdogan and Trump, but the increasingly authoritarian rule in Turkey with perhaps a Pretorian policy guard is in stark contrast to the more nimble approach taken by Putin in Russia where the central bank has been more orthodox and nimble in managing monetary policy.
Country specificities will always exist but common exogenous shock is the reversal of QE across the developed world. The tightening monetary stance in the US has had the most attention but the ECB and the Bank of England too are starting the unwinding of easy money that has found its way across asset classes - and to high yield investments in emerging and frontier markets.
If the taper tantrum that led to a surge in the yield of US Treasuries was the starter, we are now moving to the main course! The out-flow of funds is affecting not only the policy-wonky countries but other EM countries as confidence in the EM asset class abates and the age-old issue of the herd instinct kicks in.
As in 1998 the sudden outflow of hot money can leave countries gasping as exchange rates plummet, exposing currency mis-matches of FX borrowing and putting countries with Current Account imbalances on watch - witness the impact on India - and one that is likely to get worse before getting better.
The big unknown is the impact on commodity prices that affected developing and Low-Income countries (LICs) in the Africa-Caribbean-Pacific region (or ACP as the EU calls it in the aid jargon). Many of the poorer LICs were pounded during the 2008-09 financial crisis and needed sizeable budget support from the EU and development banks. One has to be vigilant for them.
China is a big guzzler of commodities so watch China. The considerable deceleration in broad money expansion is a positive sign to reign in dodgy lending policies, especially at a sub-national level but will put a brake on domestic demand. Add the risk of a sustained and accelerating trade tensions with the US and voila...
Transition Economies? Russia may take a further hit although it has taken plenty due to the sanctions it has faced and recent post-Soviet history shows that when Russia sneezes the CIS catches a cold. A rebound in oil prices may help to cushion the impact and neighbouring economies are not so heavily exposed to flight of international capital.
And yet and yet. There will undoubtedly yet be a few unforeseen surprises out there in terms of international bank lending. The likes of Serbia faced the music in 2009 but Venice Agreements under the EBRD helped to maintain credit lines to domestic banks reliant on external capital lines. This may be the transmission channel to watch and which oddly may well affect developed Europe and banks there.
Banks in Greece may be exposed to the Western Balkans, those in Spain to South America and those in Germany and France to Turkey. Have the ECB and other EU financial reforms in the last decade made banks sufficiently secure against the potential shocks in the offing? Time will tell.
The big elephant in the room in the EU may be Italy. In the aftermath of the horrific collapse of the bridge in Genoa, Italy wants to spend big on infrastructure and this means breaking the noose of the Stability pact and expanding its fiscal deficit. The new government is hostile to the EU, an increasing common phenomena amongst the EU electorate, and already talking of withholding payments to Brussels. With yields on government debt on the up and a debt burden over 130%, it doesn't take too much effort to figure out significantly alarming tail risks.
The potential second order effects and likely impact on mature debt and global equity markets are for another day but if previous contagious episodes are to go by, this is more likely than not.

Wednesday, 29 June 2016

BREXIT TO Dis-United Kingdom?

So here we are, the bleary-eyed evening after the long night of Referendum results. And politics, financial markets and potentially about the whole EU project going forward.
The UK electorate has voted 52% to 48% to Leave the UK. What next? 
I knew something was mightily afoot some weeks back when my 9-year old put down his Minecraft to ask about migrants, the then upcoming referendum - excellently presented by the BBC's Newsound for children - and then proceeded to tell me it was worse in Germany.
And some of us had outlined risk assessments on what might happen should Brexit become fact, even though the weight of opinion and expert recommendations were very much in the Remain camp. I thought it apt to review these 12 hours on from the momentous decision that sent genuine political shockwaves across the EU and economic spillovers across the world and various asset markets.
1. Political Risk
As expected PM Cameron has tendered his resignation. It was he who had engineered both the Referendum and the timing of it. Alas, for all his good work he'll go down as the PM that took the UK out of the EU. Ex London Mayor Boris Johnson was assessed to be the likely successor pending the formalities and his lodestar remains bright although other candidates could emerge, likely from the Brexit side of government.
The risk of a fresh election is now a real possibility only a year on from the last.
2. Exit Date from EU...uncertainties
Despite the shockwaves the fact remains that the UK will remain an EU Member State until Article 50 of the Treaty is exercised. This requires the UK government to submit a letter to the European Council  when a 2-year period ensues to sort out the dissolution.
In practice there is a chance that a 2nd referendum may ensue and over 2 million have signed an online petition that parliament will review.
Even without any 2nd referendum, the UK Parliament must ratify the referendum and there is a chance this will not happen, again leaving it to a fresh election to confirm the mandate.
Either way, uncertainty will result. PM Cameron will leave it to his successor to do the jolly work of actioning Article 50, which in reality will not happen until after new PM is anointed by the Conservatives at their conference in October 2016, so unlikely until early 2017 most likely.
1b. Impact on Political parties
There are many factors that led to the outcome of the Brexit win. One  was the Blue-on-Blue attacks within the ruling Conservative party that in effect means two groups with a differing world-view of the UK and Europe/EU and which could yet see some form of split.
Another has been the failure of the Labour leadership to explain to working class voters its position. Its leader, Jeremy Corbyn, also an outlier of a selection last year, will face pressure to resign. At the time of writing most of his shadow Cabinet has resigned.
With the pro-EU Lib-Dems essentially marginal in its impact on the Referendum, the main parties are anything but stable internally whilst essentially without any real representation in Scotland where the SNP has most of the seats.
2. Disintegration of the UK?
As expected the SNP, whose political DNA is to seek full Scottish independence, has set in motion a second referendum. The fact that Scotland overwhelmingly voted for Remain will give the SNP the springboard of legitimacy to seek a second plebiscite so soon after the first one in 2014. The risk of both a 2nd Scottish Referendum and the probability of a successful dissolution from the UK is now significantly higher. 
Not expected was calls from Sinn Fein in Northern Ireland for a poll-cum-referendum on Irish unification. The risk is low but Scottish Independence would accelerate demands and support, particularly if there is a significant economic hit from the loss of EU funds coupled with an economic contraction.
And Wales. The Welsh First Minister, Calwyn Jones has already flagged concerns for the Welsh economy and jobs particularly if EU funding for farming and poorer areas ends. There is a real risk now that there will be demands for greater transfers from London.
Spain has already asked for shared management of Gibraltar which is sited on the Iberian Spain but part of the UK and that unsurprisingly voted almost 96% for Remain. Things could get prickly with Spain that in turn could be a risk to the thousands of Brits living in southern Spain. 
Taken together, this raises the risk of disintegration of the UK and increasing incoherence within what then remains were Scotland to seek independence in order to remain in the EU.
3. Economic Impact
One for another time to review separately but the short term shock was partially predictable in terms of direction if not in magnitude.
Sterling has taken a hit which of itself may not be too detrimental as it improves UK competitiveness but will also mean a rise in imported inflation.
Country risk for the UK will rise and in turn the costs of borrowing and financing national debt. 
The stock market has taken a massive hit although markets in the EU have not been immune.
The UK's imbalances on the Balance of Payments and the fiscal accounts remains a concern and which leaves little fiscal space that will be required for the government to weather the expected acceleration in the economic slowdown already underway prior to the Referendum.
The uncertainty will affect business decisions both in the UK and foreign investors who delay or cancel investment into the UK. The pre-referendum doomsday predictions by the Minister of Finance/Chancellor et al. may not have affected the voting but may actually come to fruition through a marked reduction in household expenditure and housing transactions. 
Fiscal and monetary stances may require softening and UK interest rates may fall, although there is a tail-risk that they could in fact rise also if the pound plummets too far.
There remain a lot of ifs and buts on a range of issues such as the impact on current and future EU migrants in the UK that on balance remain a resource that has had a positive impact on the UK economy and net taxes collected. 
Many of the poorer areas from Cornwall to the former mining communities in Wales and England that voted for Brexit are the ones that have benefited from EU Structural Funds and many of these regions are suddenly waking up to the potential loss of these and asking if the UK government....itself in a fiscal bind...will do so. In the short term there will be no change in flow of EU funds but it raises the spectre of further economic disparities in England and Wales in the medium term.
Of course there will be ripple effects in the EU that could lead to another wave of financial market contagion - particularly in Eurozone countries in southern Europe.
Thanks Mr Cameron.

Thursday, 3 March 2016

BREXIT – Article 50 - The long goodbye?

So here we go. Six months of waffle, argument, zillions of articles and oodles of persuasion ahead to the Referendum on June 23rd 2016.
A lot has already been written about the emerging taxonomy of the two sides of the argument. Whilst the elite – most of the ruling Conservatives, the opposition and those who run UK Corp and unions are on the side of the “ins”, this may turn out to be a gross oversimplification of the Island mentality that lurks a scratch below many here in the UK, particularly England.
And insurgency against the elites is very much in fashion - both in Britain with the election of Corbyn as leader of the Labour party, in the US presidential race and across the EU where the middle ground of politics is under vociferous attack from both Left and Right.
Brexit risk has already had an effect on the FX markets through a devaluation of the pound against the dollar and the Euro - which the tradeable sector will gladly take and which in effect further loosens monetary conditions in the UK - and where the likes of UBS are forecasting parity with the Euro in case of Brexit (presumably assuming the Eurozone sticks it out...)
But what if the UK votes to leave? What then?
Leaving aside the possible political, economic and military ramifications for the rest of the EU shorn of the 2nd largest donor to the EU budget and a lodestar for many of the smaller more liberally minded economies in Europe, what would it mean in practice for the UK, hmm leaving on one side the further risk of the break-up of the UK should Scotland and/or Northern Ireland decide to stick with the rump EU27?
Unlike in Greece where the Syriza government had made no plans for issuance of Drachmas had Greece been booted out of the Eurozone in the last – or the one-before-last EU crisis – there is a position paper outlined by the UK Government, at least by its laudable Civil Service.
And it all boils down to Article 50 of the Treaty of the European Union. This lays the framework for an orderly exit of a Member State but one that has not been tested as no country has exited the EU (Greenland’s exit was partial as it remains an overseas Danish territory).
The short answer is that there is a 2-year sunset period but in reality this can mutate up to a decade for trade related agreements or re-agreements. It would also require the full EU institutional structures to be in motion – the European Commission, approval of the European Parliament, of all the remaining EU Member States (particularly for an extension to the 2 years) and of the European Council. Good luck...given the European electoral cycle from 2017.
The implications for a more drawn-out exit phase means that a clinical and immediate divorce sought - and assumed - by many of the Little Englanders will be less likely than envisaged. Likely, though not impossible - anyone schooled in history will recognise that disintegrations can happen very quickly, as those old enough to recall the domino effect of the fall of the Berlin Wall in the fall of Communism in Europe from 1989.
It also lends credence to the Conservatives who have argued that a Brexit vote can be a means to a better negotiated end for the UK - through a better bargain with the EU. This view was echoed initially by the current London Mayor, Boris Johnson, and by Michael Howard - who has argued that the EU has "form" with the Danish and Irish rejections of previous referenda...although these were for boring Treaty changes rather than remaining in the EU.
For more analysis and risk perspective please send an email. 

Tuesday, 16 February 2016

Is the Honeymoon on Ukraine over?

Is Ukraine lost? Again? Is the social contract between state and citizens fundamentally flawed?
We are now well past the "honeymoon period" of the post-Maidan street protests that ultimately led to the rather fast departure of the then president Yanikovich, who fled to Russia in 2014. Has the halcyon beacon of the EU helped to reshape the rampant political and economic corruption?
A spate of ministerial resignations at the start of 2016, an economy in dire straits and with a huge external debt overhang, having lost up to a third of its economic base from the loss of territories and ongoing conflict with Russia and being supported by western-supported IFI packages including dollops of soft EU macro-financial assistance, having witnessed a false dawn with the so-called Orange revolution in 2004 and the Maidan of 2014, which way reform?
Before I answer these questions, I invite you to view this video of a recent Cabinet meeting - it is fairly X rated... and unlike anything many who have attended any Cabinet meeting anywhere will have experienced. And it gives a flavour of the difficulties of copy-pasting a reform agenda without genuine political will and huge conflicts of interest without a fundamental reform of the current political system.
Many will have recognised a certain Georgian, Mikheil Saakashvili,who was former president of Georgia and now part of an "A Team" of former Georgian bureaucrats, fluent in Russian, brought in to help support the reform effort and given Ukrainian citizenships jousting (with glasses of water) with the Minister of Interior responsible for the police and security services,  himself an "oligarch". Oh yes, the Minister of Finance is originally American and the Minister of Economy - one of the key "reformers" Lithuanian-Ukrainian.
Now back to the questions. 
My starting point is to look at the data. And the picture is mixed. The odd-but-thus-far working relationship between the Prime Minister and the president has led to macroeconomic stabilisation - supported by strong western support - and important steps to liberalise the economy and reduce red tape. Global Governance indicators (that basically hoover up all available country risk indicators published) do show that Government Effectiveness has risen as shown in the figure below.
But Rule of Law?
Not so good - in fact its even worse. And the picture is the same when looking at Regulatory quality or perceptions of corruption. 
Ukraine’s minister for economic development and trade, Aivaras Abromavicius, announced his resignation in early February, citing corruption levels in the state.
Neither me, nor my team have any desire to serve as a cover-up for the covert corruption, or become puppets for those who, very much like the ‘old’ government, are trying to exercise control over the flow of public funds,” effectively saying what many have been complaining about, that there are too many bent officials trying to continue their corrupt ways - and of more significance, that things aren't really getting any better.
There is now a real political risk that the government will fall, possibly through a vote of no confidence. Polls have given it approval ratings of less than 10%. And there is scant evidence, despite a flurry of ad-hoc measures, that there is a clear roadmap of reform  - which is worryingly familiar territory given previous false dawns and stabilisation plans effectively written at the IMF.
Despite a huge groundswell of popular support in what remains of Ukraine for a pro-EU direction of travel, it is not an EU candidate country forced to go through hoops and checklists to comply with the EU body of law, the acquis.  
And the EU's efforts beyond financial help has led to little material effect thus far. The European Commission is great if there is a natural disaster that requires fast response or when there are longer-term structural adjustments through sector plans and the like as witnessed in the enlargements of 2004 onward for the former central and eastern European economies. Less so in dealing a country that is in need of a mix of quick-win reforms and deep reform, often painful for vested interests.
It is perhaps too early to assess if the social contract is broken. But walk past the parliament in Kiev, the Rada, and the side street and its car park are full of Bentleys, Rolls Royces and Porsches when the average salary is a few hundred dollars. 
The disconnect between the elite and the rest is the effect, but the fusion of political and economic control in the hands of this narrow elite that is an unfortunate legacy in most of the ex-Soviet space is THE core root cause. 
What then are the choices for the West? One for another day, but ultimately, the sad truth is that ultimately, political ownership for reform cannot be imposed. On the other hand, if there is a serious set of governance concerns and dysfunctional system that effectively limits democratic voice and accountability then a further Maidan cannot be ruled out. For the West, the EU and the US, we have to be more sanguine and realistic of expectations, but to have more targeted conditionality - political and economic. 

Friday, 5 February 2016

QE2, Pyrrhic Monetary Policy and a Rise in Inequality

Are Central Banks running out of firepower?
And is the second bout of QE or QE2 leading to both an arms race in competitive devaluations and more worryingly, actually accelerating inequalities?
With policy rates close to zero and years of money printing under the snake-oil terminology of "Quantitative Easing", moribund fiscal stances and private sector balance sheets in rehab zone, what more can central banks do to kick start inflation, if not growth trajectories?
No sooner had I suggested that I was against-trend in forecasting a baseline of no change in UK interest rates this year than we're faced with a change in mood music across the developed world and forecasts of more monetary easing or QE and even negative interest rates set by central banks.
Whilst the aim is to get cash to shift to production, investment and consumption by effectively taxing cash balances held by banks, in reality we are seeing plenty of unintended consequences:
  1. a greater incidence of financial and asset bubbles as cheap dosh chases higher yields - from property to stocks and financial assets (the short term excluded). This most will go with.
  2. this in turn is I would argue actually widening the gap between the haves and the have-nots, be it within countries and globally.
  3. for another day...a rise in competitive devaluations: a falling Yen, a falling Chinese currency and others will follow - from SE Asia to commodity producers. 
We hear plenty of research analyses that highlights a global phenomena - from the US through to the emerging economies - of an increasing inequality of wealth creation and ownership to a narrow group of economic players. Be they the kings of Silicon Valley, robber barons in Eastern Europe or the industrial titans of Asia, the pattern is uniform.
Oxfam's recent report came out with stark figures by countries but a headline one that is numbing to review - 1% of the global population have a wealth greater than that of the rest of the 99% in the world. The same conclusion came out broadly in the OECD's recent 2015 paper and notes "Income gaps are even more striking when it comes to the highest earners. In the 1980s, the top 1% of earners commanded less than 10% of total pre-tax income in every OECD country bar one. Thirty years later, their share was above 10% in at least nine OECD countries and above 20% in the United States."
 There are fundamental reasons in terms of basic governance, fundamental democracy and rule of law that explain many of the fissures in developing and emerging economies that prevent citizens from having rights to education, restricted access to financial capital and in some cases, as we see in north Africa and middle East,  access to education but limited opportunities to find employment. But we also see great strides by countries such as China and SE Asia on the back of growth and growth-based economic models.
Rising inequality is somewhat counter-intuitive when we think of the global reforms since the nineteenth century and following the two world wars, the rise and fall of communism and the rise of the welfare model in the post-war period. And whilst it may be less of a relative issue in the EU, rising inequality is a factor that may explain the political counter reactions from the anti-capitalist Occupy Movements in Wall St and the City as well as the drama that is the US election cycle. 
What are the policy lessons?
  • The OECD's focus on structural issues - gender, health, education et al - is the classical development tool kit. They are longer term.
  • A clear lesson in today's 24-7 world is that interconnectivity is here and exponentially increasing- be it in ideas, news or alas, contagion - financial fear and medical as we witness for the Zica virus. The corollary of this that international co-ordination cannot be ignored - be it in terms of global efforts to tame disease or economies. It also means sector and country risks are subject to a wider set of risks.
  • Loose Monetary Policy is ultimately pyrrhic without a looser fiscal stance in an environment, as a century before, to take up slack. 
  • Openness to innovation and growth and allied reward for risk takers cannot be compromised - but it needs to be complemented by efforts to ensure equity and fairness so that "everyone eats a bigger slice of a bigger cake"  - moves in the EU to tackle the Googles, Amazons and Cafe Neros of this world on dodgy tax affairs is part of this.

Thursday, 28 January 2016

Divergence in Monetary Policy and Macro-Risks for Emerging Markets

Are we entering a great divergence between the developed world and Emerging Markets, particularly for oil-fuelled economies and currencies?
In the UK the pound has taken has fallen off its perch by 6% against the dollar in the last few weeks alone - is it the spillover from the travails of the markets or in part a response to increasing country risk amidst a rise in chatter of Brexit?I was contra-market in my projections for UK base rates for 2016 and with the continued - possibly sustained - low oil prices, the arithmetic for inflation has changed and in turn the likelihood of tighter monetary stances.
Whilst the Fed's rate rise of 25 basis points was expected and arguably sound given its inflation target of 2% the landscape in the Euroland remains positively soporific. Again, more recent data shows that a lower inflationary perspective whilst Super Mario has in recent days sought to allay fears of an end to QE.
There is a deeper question for another day whether central banks role of de facto lenders-of-last-resort is now the norm and whether markets are addicted. Or what further can policy-makers more generally do in terms of firepower and tools, at least in the developed world, given near zero (or in some instances negative) interest rates and at least in the EU self-imposed strait jacket of fiscal restraint.
And the risk that the debt overhang that began in 2007 and mutated into various forms, has yet to play out.
And the Divergence?
In part this great Divergence is - like many of the economic-cum-financial narratives of the last decade - being affected and driven by developments in the middle Kingdom. China.
Anyone with experience in transition countries and a grounding in National Accounts will tell you how data can be massaged. I suspect that real activity is probably 40%-60% of what is being officially reported. And this in turn is affecting demand for commodities and hydrocarbons despite official orders to maintain production (and more importantly politically - employment) targets although the Chinese are making fantastic efforts at Energy Efficiency and switching away from hydrocarbons.
Three Major Implications I see:
  1. In the last couple of weeks we have seen a queue of oil producers, from the big cheese of them all Saudi Arabia, through to Russia, Azerbaijan, Nigeria through to Equador and even Venezuela facing huge macro-instability on the back of falling oil revenues that fuel both external and internal accounts. Saudi is talking of fiscal reforms to cut subsidies and even privatising part of ARAMCO, its oil genie. Azerbaijan is talking to the IMF for a possible support. Whilst most of these countries have followed sweet-talking consultants and set up whizzy wealth funds, these and the FX reserves will quickly deplete if authorities try to beat the markets (Soros or no). So expect tighter monetary policy, falling currencies and higher imported inflation in EM space - particularly for commodity-based economies, but with spillovers to neighbouring satellite economies (Russia and CIS par example).
  2. Debt Overhangs in EM. Deja vu 1990s? EM FX loans, particularly dollar-based will mean currency mismatches, although Russia's corporate sector is largely immune following the financial sanctions (although it's still in a macro-mess that will impede Mr Putin's foreign policy aims).
  3. Low Income countries haven't really had a mention but those of us who have worked across investment and risk analysis and development will be aware of the potential risk to vulnerable economies and the potential counter-cyclical hit it will have on public finances for economies most exposed. The EU successfully pushed through a package to aid 30 odd countries in 2008 in Africa and the Pacific by helping to ringfence critical public expenditure in health, education and public services - more of the same may well be required.