Archive for October, 2009

Back from the Brink? US-China trade relations

October 30, 2009
Presidents Hu and Obama  Source:  Google Images
Presidents Hu and Obama Source: Google Images

Looks like Mr. Hu and Mr. Obama and company may have stepped back from the brink of a trade war.  See CSFB report below on the recent G-2 meeting on trade and commerce.  Not that it’s all about individuals, but sometimes international relations can be driven by the tastes of individual leaders, as argued in a seminal paper from 2001 by Daniel Byman and Kenneth Pollack, which has the gender-insensitive title, “Let Us Now Praise  Great Men: Bringing the Statesmen Back In.”  Thus is the case with trade policy today between the G-2, especially given President Obama’s sympathy for protectionism.  Pledges made this week by both countries to avoid protectionism are encouraging, though on the U.S. side it came from the U.S. Trade Representative and the Secretary of Commerce.  While these fellows are no slouches, I for one would feel a lot more comfortable about the commitment of this administration to free trade if such anti-protectionist pledges were made by someone a little higher up the food chain, such as the Secretary of the Treasury, the Secretary of State, or even better, the President himself.

From CSFB:

Dong Tao
+852 2101 7469
Christiaan Tuntono
+852 2101 7409

China and the US concluded the 20th Joint Commission on Commerce and Trade on 29 October, and pledged no new trade protectionist measures. The two sides reiterated their opposition to trade and investment protectionism and pledged to observe the related consensus reached at the G20 summit. We think the meeting has helped both sides to develop a better understanding in view of the recent trade tensions, and has helped to lay the foundation for President Obama’s visit to China in November. No comment was made on the RMB exchange rate, which is an important pivot for bi-lateral trade relations. Despite rising pressure from the US and other major trading partners on the Chinese currency, we do not think China will allow major appreciation in view of its struggling export sector.
Some progress was made on agriculture, clean energy, intellectual property rights, and tourism. The meeting was chaired by China’s Vice Premier Wang Qishan and US Secretary of Commerce Gary Locke and US Trade Representative Ron Kirk. Delegates held discussions on a broad range of topics, including agriculture, clean energy, government procurement, intellectual property rights, medical devices/pharmaceuticals, and travel and tourism. Highlights of the agreements reached include China agreeing to reopen its markets to US pork products and live swine imports, to remove the local content requirement on wind turbines, to grant domestic product status to products produced by foreign invested enterprises, and the US agreed to relax its restriction on Chinese poultry imports and to further open the leisure travel market to Chinese citizens. The two sides also agreed on 13 cooperative activities covering agriculture, energy, anti-monopoly issues, healthcare, intellectual property rights, etc.

In other news, ChiNext, China’s second board, commenced trading today in Shenzhen, with its first 28 newly listed stocks recording a very strong performance. Of the 28 new stocks, five have seen their prices rise over 200%, with others have doubled. These came despite the 40-70 times forward PE multiples of these companies during the IPO process. According to the China Securities Commission, the companies listed on ChiNext are usually relatively small, making their prices subject to higher volatility. We think this initial strong performance reflects China’s excess liquidity conditions and the robust investment sentiment currently in the marketplace.

Emerging Europe has fiscal problems, says Fitch

October 29, 2009
Emerging Europe: Fiscal woes  Source:
Emerging Europe: Fiscal woes Source:

Fitch Ratings published a report this week analyzing the fiscal deterioration taking place in 21 countries in what it calls “Emerging Europe,” which includes three sizable economies — “rising” power Russia’s nearly $1.7 trillion economy, struggling Turkey’s $745 billion economy, and Poland’s nothing-to-sneeze-at $525 billion economy. Like much of the rest of the world, Emerging Europe juiced its economies with fiscal stimulus packages due to the Great Recession, and therefore, needs an exit strategy over the medium term to this fiscal deterioration. 

Fitch rates Russian sovereign debt at BBB with a Negative Outlook (likely to be downgraded within two years); Turkey’s BB- with a Rating Watch Positive (likely to be upgraded, albeit from a low level, within the next three months); and, Poland’s debt A- with a Stable Outlook.

Fitch expects Polish GDP growth to languish before rebounding to about 3% in 2011; Russian growth to creep back above 3%; and, Turkey’s to move back to around 4% per year.  Government deficits in all three will remain sizable at between 3-6% of GDP per year, though quite small next to America’s 10% this year.  Poland’s government debt will rise to nearly 60% of GDP by 2011; Russia’s government debt remains very, very small (at below 15% of GDP); and Turkey’s will rise to nearly 50% of GDP before plateauing.  These levels are still modest relative again to U.S. levels approaching 90% in the coming years.  Poland’s and Turkey’s current account balances (a measure of trade) are in deficit, though forecast by Fitch to be below U.S. levels, which should exceed 3% of GDP in the coming years.  Russia, of course, as an energy exporting powerhouse, remains in surplus on its current account.

Central European economies, including Poland’s, are expected to move out of recession nicely, driven by links to the euro area, especially to the reviving German economy.  Baltic and Balkan states are rebounding less nimbly, according to the Fitch report.

A number of countries have been assisted by sizable IMF financing, including Turkey, Hungary, Armenia, Georgia, Latvia, Romania, Serbia and the Ukraine, not to mention that Poland obtained a $20.5 billion Flexible Credit Line with the IMF.    

Have a look at the Fitch Press release on the report below. 

Fitch: Public Finance Concerns Move to the Fore in Emerging Europe
29 Oct 2009 4:00 AM (EDT)

Fitch Ratings-London-29 October 2009: Fitch Ratings says in a new report that although external financing risks have eased somewhat for many countries in emerging Europe (EE) during recent months, rising government deficits and debt ratios mean that sovereign rating dynamics remain negative.

“Worst fears of a systemic economic and financial meltdown in emerging Europe have receded as global output has started to recover and financial conditions have eased, driven by the massive global fiscal and monetary policy stimulus, rescue packages led by international financial institutions and, in many countries, impressive economic resilience,” says Edward Parker, Head of Emerging Europe Sovereigns at Fitch.

“However, major challenges remain due to the scale of the negative shocks to hit the region; the costly legacy of the crisis, notably rising public debt ratios; and the uncertain “exit” from the crisis, recession and accommodative policy settings; while a relapse in one of the more vulnerable countries could trigger ripples across the region,” says Mr Parker.

Concerns over public finances have moved to centre stage. Fitch forecasts the impact of the recession – in some cases augmented by fiscal stimulus measures, lower oil prices and bank bail-outs – to widen the average budget deficit to 5.9% of GDP in 2009 from 1.1% in 2008, before narrowing to 4.6% in 2010. It expects the average government debt/GDP ratio to rise to 36% at end-2010 from 23% at end-2007. Failure to implement credible medium-term fiscal consolidation could lead to rating downgrades. In many countries, social pressures and elections will make it harder to implement austerity measures. This is fertile territory for political shocks. For countries reliant on IMF-led programmes for fiscal and external financing and for underpinning economic confidence, failure to stick to programme conditions poses additional risks to macroeconomic stability.

Fitch has revised its forecast for 2009 EE GDP to -6.1% from -4.6% in its June forecast round, owing to an even steeper drop than anticipated in output in H109. This contrasts with just -0.1% forecast for emerging markets as a whole. It forecasts only Azerbaijan and Poland will avoid recession, while Armenia, Estonia, Latvia, Lithuania and Ukraine will suffer double-digit declines in GDP. However, it has revised up its 2010 growth forecast to 2.6% (from 1.5%), owing to the unwinding of the deeper 2009 contraction and more supportive global conditions. Indeed, it estimates EE GDP rose by about 1% q-o-q in Q209, after plummeting 7% in Q109, led by a rebound in Turkey. But weak investment, rising unemployment, moderate capital inflows and credit growth, fiscal consolidation and a rebuilding of balance sheets point to a subdued recovery.

External financing and currency risks, which were the primary vulnerability of many countries in EE in the initial phase of the crisis, have eased somewhat, though remain material. This reflects a rapid reduction in current account deficits (CADs), substantial multilateral assistance, a boom in sovereign external issuance (USD19bn year to date) and relatively resilient private-sector roll-over rates. Fitch estimates the region’s gross external financing requirement (CAD plus medium- and long-term (MLT) amortisation) at USD304bn in 2009 and 2010, down from USD363bn in 2008.

In contrast to the rally in EE government bond prices, sovereign ratings dynamics remain negative, albeit at an easing pace. Following 11 notches of downgrades of foreign-currency Issuer Default Ratings in Q408, there were two downgrades in Q109, three in Q209 and only one in Q309. The balance of Outlooks and Watches has improved slightly since August 2009, but 12 countries are on Negative and only one on Positive. Fitch expects future rating actions to be driven more by country-specific developments than general trends.

The full report, entitled “Emerging Europe Sovereign Review: 2009”, is available on the agency’s website at

Contacts: Edward Parker, London, Tel: +44 (0) 20 7417 6340, David Heslam, +44 (0)20 7417 4384; Eral Yilmaz, +44 (0)20 7682 7554.

Argentina rejoins the world economy?

October 23, 2009
Argentina's populist leaders, Juan and Eva Peron in 1951.  Source: Wikimedia Argentina’s populist leaders, Juan and Eva Peron in 1951. Source: Wikimedia
Argentina's current first couple, former President Nestor Kirchner, and current President Cristina de Kirchner  Source: Google Images Argentina’s current first couple, former President Nestor Kirchner, and current President Cristina de Kirchner Source: AFP

In 2001, Argentina defaulted on billions of dollars of sovereign bond debt, closing itself off from access to the international capital markets.  For years thumbing its nose at global capital, the Argentine government left the country’s borrowers severely underfunded, and infrastructure and other important investment spending suffered.  Once thought of as a rich country and a middle power (say, around 1900), Argentina’s long slide has been the result of economic mismanagement stretching back a century, including by Argentina’s most famous first couple, Juan and Evita Peron (pictured above).

Argentina’s current first couple, who managed to pull off a “Hillary” in 2007 by transferring power from husband to wife, which even the actual Hillary couldn’t pull off thanks to Barack Obama, has launched a second bond restructuring this week that Carola Sandy of CreditSuisse (see below) believes will include 90% of the defaulted bonds.  If Cristina and Nestor pull this off, Argentina can once again re-enter the global capital markets, and with its riches and economic potential, may have a shot at becoming a regional power again.  With good economic management, Argentina could once again represent a counterweight to rival Brazil, our textbook rising power.  This rivalry under the stars of the southern hemisphere is fought not only on the soccer field.  Have a look at the thorough CreditSuisse note below. 

Carola Sandy
+1 212 325 2471
Yesterday evening (22 October), Economy Minister Boudou announced that the government had accepted a proposal submitted by a group of investment banks to restructure the untendered bond debt. Boudou said that the proposal received was a “good base” to define the final terms of the new restructuring. Thursday’s announcement did not have as many details as the market might have been hoping for, but, in our view, it was still a positive development for two reasons. First, the government outlined concrete steps that it plans to take in the near term – it will seek approval for the transaction from the Argentine congress and from securities regulators. Second, according to Boudou, the proposal is backed by holders of about $10bn worth of defaulted bonds (50% of the outstanding amount of defaulted bonds). The fact that holders of such large amounts of defaulted bonds are on board suggests, in our view, that the terms of the upcoming transaction (albeit still unknown) cannot be much worse than those offered in the 2005 swap.
The government will send to congress, on Monday 26 October, a bill to seek congressional approval for this transaction. In 2005, congress approved a law – the so-called Bolt Law or Ley Cerrojo – that precludes the government from carrying out a new debt swap without congressional approval. The Kirchner coalition and its allies have majorities in both houses of congress and, thus, we expect the bill to be approved relatively quickly (in recent weeks, the government has obtained congressional approval for more controversial legislation, such as the media reform bill).
Boudou said that the financial terms of the new restructuring will be more favorable for the country than those of the 2005 bond swap. The prospectus filed with the 2005 debt swap included a so-called “most favored creditor” clause that said that if the government were to come to a more favorable agreement with creditors in the future, all creditors who had accepted the 2005 offer would have the opportunity to trade up to the better deal. Thus, it was broadly expected that the terms of any new restructuring would likely be worse, from the bondholders’ perspective, than those offered in 2005. We think that, by offering worse terms in the new restructuring, the government also seeks to build domestic political support for the transaction. In fact, Minister Boudou said the bill that will be sent to congress will expressly note that the new transaction will be “more beneficial for Argentina” than the one carried out in 2005. Boudou also noted that the government will not pay the fees of the investment banks (and, thus, we assume that these will be picked up by the bondholders).
Boudou also said that the government will seek a haircut to the principal in default of “at least 65%”. The haircut in the 2005 restructuring was 66.3%. Our base-case scenario is that if the government does seek a larger haircut to the principal in default than it did in 2005, it will be a token increase from the previous 66.3%, i.e., the size of the haircut will be increased a couple of percentage points. If the government were to seek a significantly larger haircut, we believe this would not be consistent with its objectives of having high participation in the transaction and of re-entering the international capital markets in the future.
The new restructuring will have a “new cash” component. Bondholders who tender defaulted bonds in the swap will have to buy new bond. Boudou said that the government will seek to raise about $0.10 for each $1 worth of defaulted bonds that investors tender in the swap (this is in line with our expectations). Boudou noted that the government has not defined yet the characteristics of the new bond (its currency or maturity), but he observed that the government “aims to pay a single-digit interest rate” on the new bonds. Boudou said that retail investors would not be asked to put in new money to participate in the swap (the government will probably exempt small orders from the “new cash” component).
We expect the government to announce additional details of the transaction in coming days. Boudou said that the government hopes to close the transaction “as soon as possible”. Thus, we expect more details to emerge in the very near term. At Thursday’s press conference, Boudou made no reference to how the government will compensate bondholders for the interest accrued since 2005, and did not explicitly say whether the new offer would include the GDP warrants. However, Boudou did say that the GDP warrants “were a good instrument for both the government and the bondholders,” thus implying that these would be again part of the deal. Our expectation is that the government will issue a bond in the middle part of the curve to compensate bondholders for the interest accrued and for the past payments on the GDP warrants. Given that we still have no official details about the exchange proposal, we refer our readers to our Debt Trading Monthly published on 16 October 2009 for estimates of the fair value of the exchange under different scenarios (these values are in the 40-50 range as a percent of the claim amount).
Boudou said that the government expects that at least 60% of the defaulted bonds will be tendered in the swap. The improvement in credit market conditions bodes well for a successful bond restructuring – i.e., 60% and possibly more of the defaulted bonds could be tendered – if the terms of the new swap are reasonably aligned with those acceptable to bondholders. We think that this is likely to be case. As we noted above, we view the fact that holders of $10bn worth of defaulted bonds have expressed their intention to participate in the swap as an indication that the proposal being considered by the government is not much worse than the one offered in 2005. If participation in the new swap is at least 60%, this would imply that 90% of the bond debt that was defaulted in 2001 has been restructured (and this would help the government deal with remaining lawsuits by holdout bondholders and would increase the chance of an upgrade of the country’s sovereign credit rating).
The government will start filing today (Friday 23 October) the required paperwork with the SEC in the US, and with securities regulators in Germany and Italy. It is unclear how long it will take the SEC (and the other regulators) to complete the review of the documentation submitted by the government. In our view, the timetable of the transaction will be largely driven by how quickly the security regulators approve the documentation (a process that could take a few weeks). However, even if the process of obtaining SEC approval goes smoothly, we would not rule out delays due to legal challenges. Boudou was quoted by Reuters as saying that the government expects to close the transaction in 45 days. We think that it will be very difficult to close the transaction so quickly; instead, we expect the bond swap to settle sometime in Q1 2010.
Boudou noted that the restructuring of the untendered debt is one of the steps the government is taking to enable Argentina to re-enter international capital markets. We think that the restructuring will lead to a further tightening of Argentina’s sovereign credit spreads and, thus, it will be a significant step towards accessing international capital markets again. Other steps that would help with this objective (which the government said it plans to follow) are re-establishing a relationship with the IMF, curing arrears with the Paris Club and restoring credibility to the official statistics.

New Normal: Is the World Economy back?

October 14, 2009
PIMCO CEO Mohamed El-Erian  Source: Google Images
PIMCO CEO Mohamed El-Erian Source: Google Images

An excellent Economist Special Report on the World Economy last week led with a quote from Pimco CEO, Mohamed El-Erian, that the economy has reached a “new normal,” or recovery on a reduced (less prosperous) path.  The Special Report rightly focused on US imbalances with China, the fiscal mess we’re in worldwide (especially in the United States), and worries of persistent unemployment and banking system weakness.  The only point I would stress more emphatically than either El-Erian or the Economist did is the dire need for medium-term fiscal consolidation to avoid a worsening of sovereign creditworthiness (and therefore higher interest rates and lower economic growth).

The El-Erian/Economist argument is that: 1) the weak banking sector will limit the mediation of savings to investment in the economy for some time, dampening growth; 2) households, buffeted by falling housing prices and lost jobs and income, will increase their savings and reduce consumption, also restraining growth; and 3) China, with its huge trade surpluses and low levels of domestic consumption, will not bail out such deficit countries as the U.S.  Therefore, a premature withdrawal of the fiscal stimulus any time soon could derail the incipient recovery before the private sector is back on its feet.   A fair point, but timing is everything.  If we wait too long to tighten fiscal policy, the goverment debt burden could skyrocket, interest rates will rise, the economy will tank, and the dollar will plummet.  Better to keep monetary policy loose instead — notwithstanding a call by some hawkish regional Fed presidents for rate hikes sooner rather than later. 

Before he was CEO of Pimco (the largest bond manager in the world), El-Erian managed the firm’s emerging markets book.  It was in this capacity that I met him a number of times as an emerging markets analyst.  He sports a quiet, brainy manner, holding his cards close and peering over onto yours — an image he cultivates, which convinces people to seek out his reluctant pearls of wisdom, like the “new normal.”   El-Erian was what we call a “country risk” analyst before taking the helm of Pimco.  Country risk analysts have seen this type of crisis many times before — in Mexico, Brazil, Thailand and Korea, among other places.  True, it is today more serious for the planet, given that the U.S., a $14 trillion economy, is at ground zero.  Nevertheless, the issues are much the same.   

Country risk analysts talk about a concept known as “debt dynamics.”  It is an equation in which you consider the variables that could drive government debt higher.  Interest rates, the non-interest budget balance (known as the “primary” balance), and GDP growth.  In order for government debt to be on a downward path, the government’s primary budget surplus (non-interest revenues minus non-interest spending) and GDP growth must be large enough to offset interest payments on the debt.  In the U.S. case, the primary balance has gone into deficit of nearly 10% of GDP this year, the real interest rate on the government debt is nearly 3%, the debt-to-GDP ratio is expected to rise to nearly 90% next year, and GDP growth is expected to languish at 1-2% per year.  Without a sharp reduction of the primary budget deficit, America’s debt-to-GDP ratio will explode.  What’s more, this will mean that America’s “country risk premium” will rise, moving the interest rate the government pays even higher, which in turn will further dampen economic growth.

This is why health care reform with its $900 billion price tag, however warranted over the longer time, is simply fiscally irresponsible right now.  Yet the Democrats insist on using their Congressional majorities, which won’t last forever, to expand entitlements in the middle of the most serious fiscal crisis this government has ever seen.  Americans, spoiled by prosperity, have not experienced the chill of a sovereign credit crisis like we have seen time and time again in emerging markets.  It can happen here.

In business school, they teach us that the U.S. government bond rate is the “risk-free” rate, and that “country risk premiums” on less-creditworthy governments represent the spread above America’s cost of capital that such governments must pay to borrow.  Will America’s government bond rate remain the risk-free rate after all is said and done in this crisis?  Or will America pay a spread above another government’s “risk-free” rate.  Washington will write that ending.

In emerging markets over the last 20 years, financial crises often began with a credit boom, which led to a bubble in equity and home prices, imbalances with the rest of the world (e.g. trade deficits), and a government bailout of the private sector, launching government debt to the stars.  In America, it is clearly deja vu all over again.  This is why country risk analysts almost unanimously supported the bank bailout last year, because by shoring up sick banks, you avoid even greater losses of output.  Yet many Americans (including leaders in both the Republican and Democratic parties) resented the government bailout of Wall Street.  

Great powers and great economies throughout history have declined under the weight of deteriorating finances.  I hope the “new normal” is for humankind to learn from history.

Focus: Brazilian elections 2010

October 12, 2009

In a year, essential Rising Power Brazil goes to the polls.  The election is currently heating up. On October 3, 2010 (and if need be, in a second round on October 24), Brazilians will vote for president, all 26 of their governors, all 513 members of the lower house of Congress, and two-thirds of their 81 senators.  This is a pivotal election, coming after eight years of President Lula’s rule, which has been emblematic of Latin America’s ongoing transformation away from political and economic polarization and toward a more equitable, though still market-based, society.  See an excerpt of a JPM report on Brazilian politics below.

Lula, whose personal approval remains at a colossal 80% (though approval of his government rests at around 67%), is seeking to hand the reins to comrade-in-arms Dilma Rousseff, a less-than-exciting minister in his government, whose predilection for state intervention in the economy is well-known.  Sadly for the left, she remains around 20 points behind Jose Serra in opinion polls.  Serra, also unglamorous, is the Social Democratic Governor of Sao Paulo, Brazil’s largest state by any measure, and the man Lula trounced in 2002 (albeit in two rounds).

Lula’s historic accomplishment has been to marry his impeccable leftist credentials and penchant for addressing Brazil’s woeful income inequality to market-based economics.  In effect, he has neutralized the arguments of his opponents, pushing Serra’s normally socially-conscious Social Democrats (PSDB party) to the right of Brazilian politics. 

Yet, with Brazil’s financial condition improving while he has been in office, not least because of the hard work of Serra’s predecessor and brother-in-arms former President Cardoso, Lula has allowed fiscal policy to slip of late.  This, in a country where the government debt to GDP ratio is a rather high 70%, a tough burden for an emerging economy.  

Lula’s first milestone toward establishing his market-friendly credentials took place in early 2003 with his appointment of BankBoston executive Henrique Meirelles to the Central Bank.  The Central Bank subsequently raised interest rates in order to break inflation expectations that had been aggravated by the collapse of the currency, triggered by worries over the election of firebrand former union leader Lula to Brazil’s highest office.  Meirelles, with whom I interacted many times as a Brazil analyst, while no Arminio Fraga in terms of economic orthodoxy and financial acumen, maintained the credibility of the Central Bank, wrought by Fraga and his team during the Cardoso administration.  He now wants a political career, probably aspiring to the presidency.  He is likely to sit this one out, perhaps running for VP as Dilma Rousseff’s running mate, putting his PMDB party (a non-ideological centrist party) in alliance with Lula’s PT (the Workers Party), counterpoised against the likely center-right coalition of Serra’s PSDB with the renamed Democrats, who are affiliated globally with Christian Democracy.  It is encouraging to see Brazil’s parties coalescing more or less into two ideological options, though we shall see if this sticks in Brazil’s notoriously fragmented multi-party system.

As of now, Governor Serra is way ahead in the polls.  However, a combination of Meirelles’s economic credentials with Dilma’s clout as a champion of the poor (and a former guerrilla), could pose some difficulties for Serra, especially if Meirelles and Dilma get a grip of Lula’s coattails.  Moreover, the injection into the mix of the mercurial, but exciting Ciro Gomes, a leftist former minister in Lula’s government, as the candidate of the small Brazilian Socialist Party, will be interesting at a minimum.  At stake, Brazil’s direction:  further right to achieve higher GDP growth and fiscal consolidation or along Lula’s path of gradually increasing state direction of the economy.  

From a J.P. Morgan article of October 6, 2009:

Brazil: Election countdown


On September 30, BCB Governor Henrique Meirelles joined ranks with the

PMDB party. There is rising speculation that he could run for the Senate, or even

get the vice presidential nomination on Dilma Rousseff’s ticket. Meirelles has

already said that he will stay at the central bank until March 2010, and will only

then decide his political future. One way or another, we think that he will be

orchestrating interest rate hikes before leaving. Our call for a tightening cycle of

200bp starting in January fits well with the electoral cycle since an earlier hike

would tame inflation expectations, opening room for a smooth tightening and

preserving decent growth rates at the time of elections.


Our central view that the elections will be competitive remains solid. The

current opposition is represented by São Paulo Governor José Serra. While Dilma

Rousseff is the government’s official candidate of the, two other contenders (Ciro

Gomes and Marina Silva) were part of President Lula’s cabinet and could very well

share the governing group’s advantages. Therefore, it is difficult to forecast the

outcome of the election, at least until the official electoral program starts on national

TV in August 2010. This is going to be a source of uncertainty and should

contribute to market volatility, especially as little is known about the candidates’



We feel that the October 2010 elections are important and could have market

implications. In the next decade, important foundations of a fast-growing

emerging market will likely consolidate, and many choices will need to be made

in terms of institutions, governability, the role of the state, infrastructure, etc.

Although Brazil is likely to join other countries in adopting a more hands-on

government approach in different sectors of the economy and society, the degree

and manner of how this is done varies widely across the political spectrum.


The plot thickens for the official candidate, but it is too soon to worry. The

latest polls indicate that official presidential candidate Dilma Rousseff’s (PT)

voting intention is falling. She appears tied or behind Ciro Gomes in most polls,

and her ratings have not really improved in six months. The Lula Administration’s

theory is that the president’s high popularity (about 80%) will spill over onto his

chosen presidential candidate. While we still believe that this will be the case,

Rousseff’s ratings need to improve in the next few months, when party coalitions

will start to consolidate. The PT national television program, to be aired in

December, should help considerably.

Emy Shayo

(55-11) 3048-6684

Banco J.P. Morgan S.A., São Paulo

China: Anchoring the dragon

October 12, 2009

Last week’s Economist had a couple of nice articles on China’s National Day on October 1st, when the Chinese showcased their military, including the DF-31 nuclear-tipped ICBM, which can hit any city in America.  Most of these armaments have “Made in China” tags, not unlike all of our clothes and toys.

The Economist leader on the subject lamented this show of militarism, even comparing modern-day China to Prussia/Germany and Japan in the late 19th century.  I recall attending Bastille Day celebrations along the Champs Elysee in Paris in years past, when the glory-obsessed French showcased their military hardware; yet nobody got bent out of shape about French militarism.

Yet the rise of China should rightfully be compared to the rise of powers-past, such as Germany, Japan, Russia and the U.S.  We should consider how status-quo powers such as Britain might have mismanaged some of these rises in the 19th century and how we might avoid such mismanagement with regard to China today.  The blame for German militarism rests largely on the shoulders of Germans, this is true, especially on the fragile shoulders of Kaiser Wilhelm II and his cabal (though even Bismarck shares some of the blame).  Even so, the Western Powers could have better managed Germany’s rise.  They lacked an agenda for providing Wilhelmine Germany with enhanced international privileges to match its rising power.  Matching privileges with power is key to peacefully managing a power’s rise.  And, anchoring a rising power in the institutions of the status quo is likewise critical.

With the Concert of Europe and the Congress system of Metternich dead by the late 19th century, there were no international institutions to anchor Germany.  China, by contrast, is a card-carrying member of the U.N. Security Council, the WTO, the IMF and World Bank, the G-20, G-2, and other institutions.  Furthermore, although China may still feel somewhat dissatisfied because Taiwan and other East Asian assets (such as oil reserves in the South China Sea) are not being handed to it on a silver platter, Chinese privileges in the world are being equated step-by-step with Chinese power.  The “peaceful rise” of the dragon is taking place, at least in part thanks to Western statecraft.

The parallel with Wilhelmine Germany is a nice one, but on one key parameter, China falls short of authoritarian Germany.  Germany of that era was a pluralist, if not a liberal, society.  There was the Reichstag, in which the Social Democratic opposition was well represented.  Sure, the Kaiser and his ministers were not beholden to the German parliament.  Yet the nascent democratic institutions were there, whereas Chinese communism has not provided such vehicles for democratic development.  Likewise, Bismarck had provided Germany of those days with the most progressive social security safety net in Europe, neutralizing in part the appeal of the left.  In China’s Workers’ Paradise, the social safety net is woefully inadequate.

A few months ago, observers worried that the global financial crisis could weaken the Chinese Communist Party’s hold on power.  As long as the CCP delivered economic growth north of 8% a year, few questions were asked by the populace.  But this social contract was seen as at risk.  These days, observers are applauding the resilience of the Chinese economy at weathering the storm.  However, China’s recovery has been driven by a huge fiscal stimulus and a massive state-directed lending boom, which could lead to banking sector weakness in the future.  True, China is much less-leveraged than the US or almost any Western nation, so it has room to be a little profligate.  Nevertheless, an economic shock in China, followed by political turmoil, cannot be ruled out.  Note that China’s leaders told Beijingers earlier this month to stay home in their crowded apartments to watch the National Day Parade on television, instead of thronging over to the Forbidden City, which couldn’t have a more suggestive name.  Since 1989, popular protests are the nightmare of China’s leaders.

Turkey: the harder they come…

October 7, 2009
Turkish Prime Minister Recep Tayyip Erdogan  Source: Google Images
Turkish Prime Minister Recep Tayyip Erdogan Source: Google Images

Sovereign risk in Turkey was once talked about in the same breath as Brazil’s.  Not so anymore.  One is going hat in hand to the IMF, likely to get $45 billion in the coming weeks; the other is largely self-financing.  What went wrong in Turkey?  Always keep your eye on the current account deficit, folks, even when Wall St. analysts tell you its nothing to worry about because it’s financed by FDI, or some such Bernanke-esque bunk.  Current account deficits mean borrowing from abroad.  And that means vulnerability.  Turkey went into the global crisis with a 5-6% current account deficit, while Brazil went in with small surpluses.  Keep your eye on America as well and its sovereign credit risk — current account deficits there have been nearly halved to 2-3% from 5-7% a couple of years ago, largely due to the US recession.  But the U.S. still can’t kick its foreign borrowing habit, Obama’s protectionism notwithstanding.  Likewise, watch out for “twin deficits.”  That’s when government deficits move in tandem with current account deficits (the former often driving the latter).  The US has these, as does Turkey (where government deficits are in the range of 5-7% of GDP, versus Brazil’s 3-4%).  Turkey’s overall government debt burden remains modest at under 50%, versus Brazil’s near-70%; however, Brazil’s government debt burden is headed down, while Turkey’s is rising.  Hence, Fitch moved Brazil up to investment grade not long ago, while Turkey languishes at BB-.  They both were BB- only a few years ago.  Sometimes the rating agencies get it right, even though it often takes them some time to do so.

So, the Turkish prime minister shows up hat in hand at the IMF’s doorstep, while President Lula’s Brazil is considered a rising power.  Have a look below at the CreditSuisse report from today on Turkey’s negotiations with the IMF.  Deputy Prime Minister Babacan, whom I met with in the past and perceive as smart and wily, is thankfully in charge of these negotations.

From CreditSuisse:

Berna Bayazitoglu
+44 20 7883 3431
Prime Minister Erdogan denounced yesterday the claims in the local media that the IMF has offered a sizable financing package to the Turkish government which it cannot turn down. As we reported in the Emerging Markets Economics Daily yesterday, Erdogan told the Wall Street Journal on Monday (5 October) that the Turkish government has resolved one of the sticking points with the IMF, namely the IMF’s request for an independent tax revenue administration, and added that “he would like to see a new IMF program for Turkey agreed soon.” This was the most upbeat assessment that Erdogan has offered on the subject in a long while. Looking for an explanation for the change in Erdogan’s tone about an IMF agreement, the Turkish media claimed yesterday morning that the IMF might have offered a large financing package to Turkey (amounting to $45bn) which Erdogan cannot turn down. However, at a reception later in the day, Erdogan denounced local media stories that the IMF has made a new offer to Turkey.

Nevertheless, Erdogan’s statements in the Wall Street Journal add strength to the possibility that the government might invite an IMF mission to Turkey soon. As we noted in the Emerging Markets Economics Daily yesterday, speaking at various conferences in the last few days at the IMF/World Bank annual meetings in Istanbul and somewhat in contradiction to Erdogan’s statements in the Wall Street Journal, Deputy Prime Minister Babacan (who is the senior policymaker in charge of policy discussions with the IMF) had said that the discussions on the tax revenue administration and local governments’ spending were still continuing and that the IMF was studying the government’s medium-term economic plan and fiscal program.

The Statistics Office will release the industrial production data for August tomorrow. We forecast that industrial production was down 4.7% yoy in August, slowing from a contraction of 9.1% yoy in July. Our forecast is more optimistic than the consensus forecast (according to Bloomberg) of a 5.2% yoy contraction.