Archive for the ‘IMF’ Category

Japanese debt: Bad, but not that bad!

April 27, 2010
How big is the Samurai debt?  Source:
How big is the Samurai debt? Source:

Government debt is mounting all across the developed world.  While Emerging Market countries such as China have low debt levels, and Brazil and India are beginning to grow out of their debts, the next crisis (or even the second half of this one) could be a fiscal shock — perhaps even a government bond default — in the industrialized world.  I’m talking about advanced countries with high credit ratings, which will experience sluggish growth and may fail to slash fiscal deficits over the medium term.  Greece may be a foretaste of what’s to come, unless reforms of public finances and efforts to increase growth potential are undertaken in earnest.

Japan’s fiscal woes predate the current crisis, going back to its lost decade of the 1990s.  No matter how you slice it, Japan’s government debt is unsustainably high.  Government debt is 200% of GDP, and GDP growth averages a sluggish 2% or worse in normal times.  Further, Japan seems to be under constant threat of price deflation, which is bad for debtors. 

Fitch Ratings prepared a nice report analyzing Japanese government debt (see press release below).  According to Fitch, Japan’s bond rating remains AA-, even though Japan’s headline government debt figure compares unfavorably with such highly-indebted advanced economies as Italy (AA-) and Belgium (AA+), whose debt/GDP figures are 115% and 98% respectively.  Yet Fitch does an exemplary job parsing the debt numbers to show that…it ain’t that bad.  The headline gross general government debt/GDP figure of 200% overstates Japan’s problem. 

First, Japan’s debt is held domestically.  Domestic savings have been higher in Japan than in most advanced countries. If you net out the amount of debt held by different levels of government, Japan’s debt drops to about 160% of GDP. A further 53% of government debt is held by  public institutions — the biggest one, Japan Post — yes that’s right, the Post Office.  Idiosyncratically, Japanese households deposit a good chunk of their savings at the government post office and these funds are invested in government debt.  A sizable portion of these funds go back to the private sector in the form of government loans to business.  Thus, Japan’s debt problem is a family affair.  It is between Japanese savers (households) and Japanese spenders (the government and business).  They have to work out who bears the burden of adjustment.

Likewise, Fitch points out that if you net out public sector assets, Japan is not such an outlier.  The OECD provides figures for what it calls governments’ net financial liabilities.  This figure subtracts from debt assets such as government deposits and loans to the private sector.  Japan compares more favorably here, with net government financial liabilities at 97% of GDP, the same as Italy and versus 81% in Belgium.  However, whether these loans to the private sector will be paid back in full is an uncertainty. 

Finally, the OECD figure does not include one major asset held by the Japanese public sector, over $1 trillion in foreign exchange reserves, derived from Japan’s persistent trade surpluses (automobile recalls notwithstanding).  This amounts to another 20% of GDP you can deduct from Japan’s debt burden.

In terms of the burden of the debt, the interest rate on Japan’s debt is low, making debt service less onerous than one would expect from the debt/GDP ratio.  Furthermore, with a relatively low tax burden — taxes in Japan were 32% of GDP versus the AA median of 41% — Japan has room to raise taxes to support debt payments in the future. 

The worry, however, is that any early tax hike would shut down GDP growth, which has been so sluggish for years.  Furthermore, Japan’s aging population suggests that the country’s high savings rate will decline.  Ergo, interest rates could rise in the future. 

Fitch suggests that the key to reducing the government debt burden in Japan is achieving higher GDP growth.  Under a scenario of 4% per year GDP growth, Japan’s debt/GDP would decline.  This will require structural reforms to improve growth potential and stave off price deflation.  Have a read…     

Fitch: Japan’s Sovereign Creditworthiness at Risk from Rising Government Debt   
22 Apr 2010 4:51 AM (EDT)

Fitch Ratings-Hong Kong/London/Singapore-22 April 2010: The Japanese government is one of the most indebted in the world. In the absence of sustained economic recovery and fiscal consolidation, government debt will continue to rise, placing downwards pressure on sovereign credit and ratings over the medium term, Fitch says today in a Special Report, “Just How Indebted Is The Japanese Government?”.

Japan’s headline gross government debt reached 201% of GDP by end-2009, the highest ratio for any sovereign rated by Fitch. Public debt sustainability is the central sovereign credit issue facing Japan, whose Long-term local currency Issuer Default Rating (IDR) of ‘AA-‘ is one notch below the Long-term foreign currency IDR of ‘AA’, uniquely among high-grade sovereigns. The lower local currency rating reflects the fact that all government debt is denominated in Yen and Japan’s net external creditor status. The ratings remain supported by low government debt yields, reflected in a budgetary debt service burden that is not especially high as a share of GDP, and by financing flexibility afforded by access to a large pool of domestic savings. The sovereign was a net external creditor to the tune of 15% of GDP at end-2009; but under Fitch’s forecast of rising government debt ratios, sovereign creditworthiness is set to deteriorate.

In the near term, the Japanese government’s funding prospects are further supported by ample banking-sector liquidity and by weak private-sector demand for credit. However, the slow but steady drop in the savings rate could eventually undercut the sovereign’s ability to fund itself domestically at low nominal yields, leaving it more exposed to interest-rate and refinancing risks. Fitch explored some scenarios for Japan’s public debt path using a simple debt dynamics model, and one possible development is that Japan’s government debt ratios could decline if positive nominal GDP growth were restored. However, upwards pressure on Japan’s ratings is unlikely without a sustained drop in government debt ratios consistent with a return to nominal GDP growth and meaningful fiscal consolidation.

The extent of Japan’s government indebtedness is often a source of confusion and conflicting statistics. On a broader measure, net general government financial liabilities reached 97% of GDP by end-2009; while still high, is not significantly more than other similarly rated sovereigns. However, the value and liquidity of the government’s financial assets is uncertain and on Fitch’s measure that only nets off currency and deposits; net government debt is estimated to be equivalent to 184% of GDP, still the highest of any rated sovereign. Fitch estimates the share of Japanese government debt owed to other public sector creditors at around 53% on the latest available numbers, including the postal savings and insurance systems, which partly mitigates concerns over the high level of the debt and reduces Japan’s exposure to ‘confidence shocks’. Nonetheless, on whichever measure is adopted, Japan’s government is amongst the most indebted and the key feature of previous rating downgrades – the adverse debt dynamics and steady rise in the debt ratio – remains the case, Japanese government debt will continue to rise bringing downwards pressure on Japan’s sovereign creditworthiness and ratings over the medium-term.

Applicable criteria ‘Sovereign Rating Methodology’, dated 16 October 2009, are available on

Contacts: Andrew Colquhoun, Hong Kong, Tel: +852 2263 9938; David Riley: +44 (0) 207 417 6338.

China can’t have monetary policy flexibility

April 26, 2010
China's currency:  Can't have it all... Source: Google Images
China’s currency: Can’t have it all… Source: Google Images

In today’s CSFB column on China (see below), Dong Tao and Christiaan Tuntono report that PBoC Governor Zhou Xiaochuan commented that China would like greater monetary policy flexibility in order to combat inflation.  Not that inflation is so high in China, but the Asian giant’s return to breakneck rates of growth (11.9% growth year-on-year in 1Q10) may push prices higher.  But, the Chinese are surely aware that in the world of economics, you cannot have your cake and eat it too. 

Remember the so-called “Mundell Trilemma,” named after ground-breaking economist Robert Mundell, who with Marcus Fleming at the IMF in the 1960s critiqued, or better, refined Keynesianism.  They analyzed the effects of monetary and fiscal policies under different exchange rate regimes (fixed or flexible) and under capital mobility (or not).  The Mundell Trilemma  posits that you cannot have all three of: fixed exchange rates (which China has held to tenaciously, much to the chagrin of balance of payments deficit countries like the US); monetary policy flexibility (which Mr. Zhou announced today he would like); and, capital mobility (on which the Chinese export juggernaut depends — i.e. FDI and other capital inflows).  So, the Chinese have given up monetary policy flexibility in exchange for $2.4 trillion in fx reserves and rising.  Excessively easy US monetary policy for many years (thank you, Sir Alan) has led to easy money in China, sometimes resulting in an inflation problem, though not of late.  Effectively, the Federal Reserve determines the money supply in China.

Do Mr. Zhou’s comments presage a more flexible exchange rate in China (aka a revaluation of the woefully undervalued RMB)?  Do we have one more set of tea leaves to read on China’s policy intentions — in addition to the U.S. government’s agreement to postpone calling China a currency manipulator in exchange for China’s cooperation on sanctions against Iran and a commitment to at least slowly revalue the RMB?  In any case, Mr. Zhou can’t have his desired monetary policy flexiblity without floating his currency. 

From CSFB 4/26/10:

Dong Tao
+852 2101 7469
Christiaan Tuntono
+852 2101 7409
PBoC Governor Zhou Xiaochuan highlighted the importance of inflation management and policy flexibility for China’s monetary policy. Zhou made his latest comments on China’s monetary policy during his attendance at the G20 meeting in Washington DC. Although the importance of policy continuity and consistency remains intact, greater weight appears to have been attributed to the focus and flexibility of policy measures in view of the potential rise of new economic conditions. At the same time, Zhou also stressed the importance of monitoring price movements and managing inflation expectations in his comments. We think Zhou’s comments reflect the PBoC’s concern about the rise of inflationary pressure in China, and its readiness to adjust the existing policy stance to cope with any new situation. The same message was also conveyed in the PBoC’s 1Q10 macro economic analysis published on 23 April, in our view. The report acknowledged the further strengthening of economic momentum, and identified the management of liquidity, credit growth, and price stability as the PBoC’s main tasks. The central bank also said that it will continue to maintain the balance between growth, structural adjustments, and inflation expectations going forward. The PBoC’s heightened focus on inflationary pressures is in line with our expectation for price levels to rise in 2010 on higher food prices and housing rents. Higher inflation is likely to drag real deposit rates into negative territory, prompting the central bank to raise rates in 2H10, in our view.
Meantime, the Chinese government has reportedly been studying the launch of a new round of stimulus measures, despite the fact that the economy grew by 11.9% yoy in 1Q10. This time, we understand the focus will be on helping economic transformation and establishing competitiveness in selected industries instead of boosting GDP per se. The plan is still at an early stage, but it could be as big as the RMB4trn package launched in late 2008 that prevented the Chinese economy from falling into recession. There is clearly a policy desire to upgrade and transform the economy, as China’s export engine may enter into a structural moderation amidst reduced US consumption and RMB appreciation. Unlike the emphasis on infrastructure investment in the previous stimulus package, we think the government intends to let private capital play a much bigger role this time.

USA could lose its AAA this decade

January 12, 2010
Obama OMB Director Orszag: oversees US budget.  Source:  Google Images
Obama OMB Director Peter Orszag. Source: Google Images

Planet Earth’s critical issue this decade will be whether American power will erode — and if so, what the implications will be for the liberal world order we erected after WWII.  The Obama administration’s fiscal stimulus package cum bank bailout, building on the Paulson-Bush-Geithner-Bernanke efforts of 2008 and the unprecedented coordination of economic policy globally, constituted a brilliant, stage-managed rescue of our planet, nothing less.  However, such a Herculean effort has created its own problems — huge debts, gaping goverment deficits, and a government intrusion in the economy that will be hard to reverse.  As yet, no plans to solve these problems have been offered.

Students of power and prosperity from Paul Kennedy on down know that imperial overextension accelerates the decline of great powers.  From this dynamic, the US is not immune.  While the relative decline of the US has been in place since the 1950s, its rapidity and consequences are far from inevitable.  A too precipitous, disorderly, angry decline that would occur if America does not right its fiscal ship soon would not only injure American prosperity, but would also put at risk our global institutions — the UN, the IMF and World Bank, NATO, the WTO, the G-20, etc.  These institutions have fostered cooperation and peaceful solutions to the world’s problems. 

The symbolic end to this Pax Americana, which has raised billions out of poverty and offered countless millions broader political participation, could be the loss of the AAA rating on US government bonds.  According to Brian Coulton, head of Global Economics at Fitch Ratings, this could occur later this decade if an aggressive fiscal consolidation program is not implemented by the Obama administration (see note below).  A narrow tax base, low discretionary spending (the kind of spending that is easiest to cut) and huge entitlements — including the $900 billion health “reform” up on Capitol Hill, the continued current account deficits in spite of sluggish GDP growth, and our dependence on foreigners for financing together spell a potentially rapid decline of America’s place in the world. 

So, who will fix this?  President Obama has chosen the nerd pictured above.  He is reportedly a bright, driven man.  I am not sure how hard it is to preside over the most massive expansion of entitlement spending in history and to oversee the distribution of hundreds of billions of dollars of stimulus spending to groveling constituencies.  But that was just his first year.  The president’s chief of staff Rahm Emanuel was reported in the New York Times to have said that Office of Management and Budget Director Orszag has “made nerdy sexy,” perhaps with some jealousy.  The Times article this Sunday highlighted Orszag’s loose love life and questions about his commitment to his families.  I am all for keeping a public servant’s private life out of politics in principle, but one wonders how so extravagant a player can be entrusted with the most difficult fiscal consolidation in human history.  I don’t think rating agencies take into account the social life of a sovereign’s budget director in making their rating decisions, but one wonders sometimes if they should.    This seems to be part of the hubris we have seen sometimes in this White House.  I hope he knows what he’s doing, because the stakes couldn’t be higher.

Fitch Affirms United States at ‘AAA’; Outlook Stable   

11 Jan 2010 8:31 AM (EST)

Fitch Ratings-London/New York-11 January 2010: Fitch Ratings has today affirmed the United States’ (US) Long-term foreign and local currency Issuer Default Ratings (IDRs) at ‘AAA’, respectively. The rating Outlook on the Long-term ratings is Stable. Fitch has simultaneously affirmed the US’ Country Ceiling at ‘AAA’ and the Short-term foreign currency rating at ‘F1+’.

“The near-term risk to the United States’ ‘AAA’ status is minimal given its exceptional financing and economic flexibility and the US dollar’s role as the world’s predominant reserve currency. However, difficult decisions will have to be made regarding spending and tax to underpin market confidence in the long-run sustainability of public finances and the commitment to low inflation,” said Brian Coulton, Head of Global Economics and the Primary Analyst for the US at Fitch.

“In the absence of measures to reduce the budget deficit over the next three-to-five years, government indebtedness will approach levels by the latter half of the decade that will bring pressure to bear on the US’ ‘AAA’ status,” added Coulton.

The US government remains exceptionally creditworthy – supported by its pivotal role in the global financial system and a flexible, diversified and wealthy economy that provides its revenue base – despite an unprecedented deterioration in fiscal performance. The government’s unparalleled financing flexibility enhances debt tolerance even relative to other large ‘AAA’-rated sovereigns, and has allowed the government to take aggressive counter-crisis and counter-cyclical policy measures, which now appear to be working in terms of restoring stability to the US financial sector and the economy.

However, the government faces significant medium term fiscal challenges with a sizeable structural deficit, a narrow tax base, limited expenditure flexibility and exposure to potential interest rate shocks due to the short duration and maturity of US government debt and a heavy reliance on foreign investors. Public debt on a general government (i.e. consolidated federal, state and local) basis is expected to rise to 89% of GDP in 2010 and 94% in 2011 from 79% of GDP in 2009, which would mark the highest level among ‘AAA’-rated sovereigns. Public debt was just 57% at end 2007.

The general government deficit – estimated by Fitch at 11.4% of GDP in 2009 and forecast at 11% in 2010 and 8.5% in 2011 – contains, in Fitch’s opinion, a sizeable structural component that will not be eliminated by the economic recovery and the unwinding of stimulus measures. Corporate taxes, in particular, collapsed in 2009 having been boosted by artificially strong financial sector profits and asset price gains in the years before the recession began and are unlikely to show a strong recovery. Fitch anticipates the economic recovery will be weak by the standards of previous recoveries and less dynamic than assumed in the latest official medium term fiscal forecasts. Deleveraging will continue to weigh on private sector demand, while rising long-term unemployment and the fall in investment through the recession could adversely affect supply side performance. In addition, while TARP related fiscal outlays have been lower than anticipated, fiscal risks relating to the financial sector remain, particularly with regard to Fannie Mae (‘AAA’/’F1+’/Outlook Stable) and Freddie Mac (‘AAA’/’F1+’/Outlook Stable).

Public debt levels compare particularly poorly with ‘AAA’-rated peers when expressed relative to fiscal revenue. General government debt was equivalent to 330% of revenues at end 2009 (even higher at 437% on a narrower central government basis), the highest among ‘AAA’-rated sovereigns and compared to a long-run ‘AAA’ average of 118%. Amongst high grade sovereigns, only Japan (‘AA’/’F1+’/Outlook Stable) and Ireland (‘AA-‘/’F1+’/Outlook Stable) have higher debt-to-revenue ratios. Debt interest payments are expected to rise to nearly 11% of revenue by 2011 and nearly 13% on a central government basis. Fiscal flexibility is also reduced by the limited scope for sizeable structural reductions in public expenditure, given low discretionary outlays and pressures on entitlement spending.

Both the dollar’s role as the predominant global reserve currency and the benchmark status of US Treasuries significantly reduce the scope for destabilising interest rate shocks. But the economy’s high external debt burden, the ongoing current account deficit and the high share of non-resident holdings of government debt (close to 50%) increase the potential for volatility in US asset prices if foreign investors were to become concerned about public debt sustainability or risks to the credibility of the monetary policy framework. With the average maturity of federal debt having shortened sharply over 2008 and 2009, rising interest rates would feed through to the budget relatively quickly.

Applicable criteria available on Fitch’s website at ‘Sovereign Rating Methodology’, dated October 16, 2009.

Contact: Brian Coulton, London, Tel: +44 (0) 20 7682 7497; David Riley, + 44 (0) 20 7417 6338; Shelly Shetty, New York + 1 212 980 0234.

Obamanomics: Reaganomics in reverse?

November 23, 2009
Source: Google Images Source: Google Images

A central challenge of our times:  America, Europe, and countries the world over will have to figure out a way to staunch the hemorraging red ink we are currently sustaining.   As a result of fiscal stimulus packages and bank bailouts, in addition to the standard generous provision of guns and butter, we will be talking a lot more about fiscal policy in the years to come.  The Economist produced three nice, analytically meaty articles on the subject in its Nov. 21-27 edition — not yet emailed to me electronically, but I will post them in this blog when available.

In the 1980s, in a moment of candor, Reagan’s Director of the Office of Management and Budget, David Stockman, said that the intent of the Reagan administration was to cut taxes so that deficits got so big that the government would be forced to cut spending so dear to liberals.  That was Reaganomics, smash liberalism not directly through spending cuts, but through tax cuts.  Publicly, however, we were sold some snake oil called Supply-side economics that purported to yield a higher tax intake because tax cuts would spur growth.  We would grow our way out of Reagain’s gaping deficits.  Not so.  George H.W. Bush had to raise taxes during his term, which arguably cost him re-election, the two-term Gipper safely back on his ranch in California.

Is Obamanomics the reverse?  We’re told that health care reform will yield cost containment, which will ensure that government spending on health care will not grow dramatically.  Many doubt the current packages in Congress will do that.  So, in effect, Obamanomics argues that by raising spending, we will reduce deficits through cost containment.  Reaganomics in reverse?  H.W. called this Voodoo Economics before he became the Gipper’s VP.

In any event, have a read of the Economists articles.  The Economist briefing on America’s fiscal deficit argues that in addition to spending restraint — including later retirement ages for baby-boomers and winding down soon our two wars in Iraq and Afghanistan —  tax hikes will be needed.  The article recommends tax reform, which will either close income tax loopholes favoring the rich and impose carbon taxes, or launch a Federal value-added tax, such as all other OECD countries have.  These decisions will be politically agonizing because they affect both economic efficiency and fairness.  The VAT discourages consumption, which we need to do, but is regressive, affecting the poor more than the rich.  Our current reliance on an income tax that has more holes in it than Swiss cheese — for wealthy mice to scamper through — provides disincentives to growth.  More importantly, if we don’t take these decisions — to raise taxes and cut spending, the Economist argues, the bond markets will punish us with higher interest rates and the rating agencies with a loss of our AAA credit rating.

Get used to it:  fiscal policy will become a critical kitchen-table issue in the years to come…

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.

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.

OECD Economic Outlook: Should we trust the economists?

June 24, 2009

May of OECD Members.   Source: Google Images

Why should we trust them?  Economists in think tanks the world over got it wrong before this crisis.  Now, many of them point to the “Black Swan” event, the large-impact, hard-to-predict rare event, to explain away their flawed work and keep their jobs.  Yet the data were there – reversion of U.S. households to negative savings, prolonged run-up in real estate prices, irresponsible monetary policy based on outmoded, ideological ideas (yes, that means you, Sir Alan). 

The OECD semi-annual economic outlook was released today, and they revised up their projections for the first time in two years.  The OECD is forecasting a bottoming of the global economy this year, but a weak and fragile recovery.  The report is useful in explaining the past, forecasting the near-future (i.e. 2009), and in detailing the challenges ahead.  However, as in the past, these economists base their forecasts on a continuation of current trends, instead of using intuitive thinking to discover future drivers of economic growth.

I’m reminded of a discussion I had with an economist at a rating agency in January 2008, when I suggested his forecasts for U.S. growth be revised way down due to the unknown impact of the painful adjustment of the abysmal household savings rate.  Equipped with his fancy charts and always a prisoner of his numbers (which economists usually are), he affirmed that there was no evidence in the figures to suggest things would be worse than he forecast.  They turned out to be much worse and exactly for the reason that should have been clear – the painful adjustment from the run-up in household debt we saw this decade.  What’s more, institutions with economists on staff, including the OECD but especially for-profit firms with money to lose, cannot be seen as putting a drag on market confidence with pessimistic forecasts.  It is only the odd gadfly analyst at a no-name institution that is willing to take such a risk (I’m reminded of a small analytical firm called CreditSights).    

Don’t get me wrong.  We can’t base our forecasts on fancy.  We have to look to the numbers.  But, the really good analysts, as opposed to the legions of well-educated ones whose salaries waste too much of our GDP, make intuitive leaps and see the problems and opportunities ahead. 

The OECD report forecasts growth in OECD countries of negative 4.1% this year, with inflation of 0.6%.  Growth in 2010 is forecast to be a sluggish 0.7% with inflation still under 1%.  These inflation rates suggest that the bond market today, with U.S. long rates at 3.7%, is wrong.  The real long rate (after subtracting inflation) thus stands at about 3%, while real short rates are zero or negative.  The bond market is worried about all the borrowing governments are doing and that fiscal deficits will not be trimmed in the medium term.  This pushes up long rates.

Unemployment will remain high through next year, according to the OECD, at above 10% in most major economies.  Disturbingly, world trade should contract this year by 16%, still below the nearly one-third contraction in the thirties, which was in part caused by protectionism.  The OECD rightly warns against the latter.  I hope Democrats in Congress are listening. 

The U.S. current account deficit, an indicator of U.S. borrowing from the rest of the world, will be more than halved in 2009, a positive development.  But it is still negative, and as such, does not reduce the enormous stock of debt U.S. residents (government and the private sector) have to non-residents.  At over 250% of broad exports, America’s net debt to foreigners is astronomical, only exceeded among sizable economies by Spain’s.  This suggests that the economic adjustment in the U.S. could be prolonged.  Economists underestimated this drag on the U.S. economy, with such guiding lights as Ben Bernanke arguing current account deficits were due to a global savings glut and superior U.S. investment returns, not to profligacy at home.

The OECD warns against governments failing to balance the fiscal books in the medium term, but also against consolidating too soon, which could derail the recovery.  The OECD advocates ensuring that spending plans put in place by the stimulus package are implemented in order to support recovery.  The flawed reasoning here is as follows:  the most powerful impulse to the economy provided by fiscal and monetary stimulus is the jolt to market confidence it provides.  The government cannot hold up a sagging economy on its own forever, without becoming insolvent.  If they tried to, they’d be the Soviet Union.  The best a government can do is to announce programs to stimulate the economy and clean up the banks, and hope confidence within the private sector is thus restored.  This confidence boost causes firms and consumers to spend, and that is the only sustainable way to grow.  By spending an additional 10% of GDP in one year, the government can add a couple of points to one year’s GDP growth rate.  But in so doing, the government’s debt-to-GDP ratio rises  — in the U.S. to a worrisome 85% of GDP this year.  The ideal situation is: the government announces a plan; consumers and businesses become so happy as a result that they spend and invest, driving the economy higher; this way the government avoids much of its announced stimulus outlays during later years (or even months), safeguarding its creditworthiness.  Remember, S&P recently put the U.K.’s AAA rating on a Negative Outlook (see previous post).

Agreed — the fiscal stimulus should not be withdrawn too soon.  Further, an announcement soon of a medium-term deficit reduction strategy would calm markets – thereby allowing long rates to fall.  However, the OECD in its report does not sound the alarm bells loud enough about the lack of indications that governments will consolidate over the medium term.  With Democrats tucking all their pet ideological projects, such as health care reform, into the current legislative calendar and not yet announcing a medium-term strategy, long bond rates remain high, making it difficult for private borrowers to raise and invest funds.

The OECD may underestimate the prospects for a double-dip recession as well.  The degree of balance sheet repair needed at banks may be more extensive than markets and analysts expect right now.  And, once the fiscal stimulus wears off, if private agents don’t step in, we’re back where we were in late 2008, except with a staggering government debt. 

If this latter scenario obtains, then the OECD’s dismissal of deflation as a risk could prove wrong.  Deflation is a worse enemy than inflation.  With price deflation, borrowers default en masse.  So, lenders refuse to lend and the economy spins downward.  Fixing the banks, whose balance sheet impairment hinders the transmission of monetary stimulus, is paramount here.  The Fed and other central banks should withdraw liquidity at some point, but not soon.  Better to withdraw the fiscal stimulus earlier, in order to prevent a deterioration in sovereign creditworthiness, allowing long rates to fall, which in turn reinforces the monetary stimulus.

In terms of reforming the regulatory framework, the OECD applauds; however, the Obama administration has not seized the opportunity to cut the U.S.’s overlapping and inefficient regulatory system, in which competing agencies – the Fed, the OCC, the FDIC, state regulators, etc. – compete for scarce resources, pass the buck, defend turf, and inadequately supervise.  Sure, the Fed should be strengthened.  True, it’s worthwhile to have some bureaucratic competition to keep the Fed honest.  But streamlining is needed, and they have decided not to press for any.    It seems the kid gloves Obama wears when handling Iran, he uses as well with the financial bureaucracy, members of Congress, and the financial industry.

Interestingly, the OECD forecasts Euro area economies to contract more this year (4.8%) than the U.S. economy and not to grow at all next year.  Unemployment is expected to be higher (around 12%) than in the U.S.  This looks to be in part due to the reluctance of governments in the region to stimulate their economies as much as was done in the U.S., China, and the U.K.  It is also due to their dependence on trade, which has contracted so much, and perhaps to structural rigidities in the labor and product markets.

In any event, the OECD report is useful in highlighting current trends and in pointing out risks and challenges.  Take its 2010 forecasts with a huge grain of salt.  Use it to make your own intuitive leaps about whether or not the global economy is bottoming out.  And, consider that what is needed across the planet includes:  medium-term fiscal consolidation plans drawn up and announced right away; scrapping ideological spending initiatives such as health care reform; continued emphasis on cleaning up bank balance sheets; and resisting any calls from the left or the right for trade protectionism.  Happy reading…

The other meeting in Latin America

April 20, 2009
Interamerican Development Bank 50th Anniversary Meeting in Colombia last month
Interamerican Development Bank 50th Anniversary Meeting in Colombia last month

The Summit of the Americas in Port of Spain, Trinidad included the much-publicized American initiative to open up to Cuba.  President Obama continued to present his new, more acceptable face of America, put forth with grace since his inauguration in January.  He even unleashed his charm offensive against Venezuela’s irascible and mercurial Hugo Chavez, joking and smiling with him for the cameras, united perhaps in their unrelenting criticism of Obama’s predecessor, though Obama never quite used the term “el diablo.”

Yet the less-publicized hemispheric meeting took place at the end of March in Medellin, Colombia, the occasion of the 50th anniversary meeting of the Board of Governors of the Interamerican Development Bank (the IDB or BID, according to its Spanish or Portuguese acronym), the regional multilateral lender that comprises 48 countries, 27 Latin American and Caribbean nations that borrow, and the rest, including the U.S., Asian and European countries, that lend.

The meeting, which included appearances by U.S. Treasury Secretary Geithner and former U.S. President Clinton, concluded with a call by the Board for a capital increase to help member countries weather the global financial crisis.  Why not?  The IMF did so well at the G-20 meeting last month.  Of particular interest to readers are two research reports released by the IDB discussing the economic and social impact of the financial crisis on the economies of the region.  Likewise the IDB publishes LatinMacroWatch, data tables for 26 member countries.

China made its presence known, its first official presence at the IDB annual assembly, with a speech by its central bank governor and two of its state banks signing project finance agreements with the IDB.  My colleague Chris Herbert discusses China’s initiatives in the region in more depth in a recent Rising Powers post.

IMF: Christmas comes in April

April 1, 2009
Source: CNN

G-20 leaders are debating not whether to give more money to the IMF, but how much.  The Brazilian Finance Minister is on record asking for US$750 billion more; the U.S. is reportedly in the same ballpark; Japan has already agreed to ante up US$100 billion; others are talking about a smaller overall Christmas gift of only US$250-500 billion.  Stephanie Flanders, the BBC economics editor, discusses this and other agenda items for tomorrow’s G-20 summit. 

The G-20’s main order of business tomorrow will be solving the global financial crisis, and in addition to capitalizing the IMF, the size of countries’ fiscal stimulus commitments and the makeup of financial regulatory reform are on the agenda.  A BBC article outlines the dynamics of the summit, providing a rough agenda of the day tomorrow and noting the protests surrounding this critical meeting.  More detail on protests is reported in this CNN piece.