Archive for the ‘OECD’ Category

Israel’s economy: weathering the storm

November 10, 2009
Source: Google Images
Source: Google Images

Much news and commentary you hear about the State of Israel has to do with geopolitics and the Arab-Israeli conflict (see my colleague Ben Moscovitch’s blog on this site for a nice selection.)  Settlements, will Abbas run or not, Iran’s plans to wipe Israel off the map, Israel’s thoughts about taking military action against Iran, the Goldstone Report on the war in Gaza, films about the war in Lebanon, and on and on. 

Not that this hyper-news about Israel is not important and interesting.  But, let’s step back and look at Israel from a “rising power” perspective — half highly indebted socialist country/half cutting-edge hi-tech and health sciences capitalist upstart.  Its economy has proven itself resilient to the intifada, to the tech bust of nearly a decade ago, and now to the US-led global meltdown. 

How so?  It’s about policy, stupid.  Sound economic policy, begun in the 1980s with a classic monetary stabilization program that reduced inflation, and deepened only a few years ago, by none other than Benjamin Netanyahu, as finance minister, with his Thatcherite restructuring of the economy (e.g., increasing the labor force participation rate by creating incentives for the religious to work) and his shift to a rules-based fiscal policy.  Israel still has a high government debt burden — above 80% of GDP.  But that is down from above 100% not long ago.  Meanwhile the rest of the world has caught up to Israel’s debt levels (with the U.S. now surging higher). 

On the external front, the country couldn’t look better — $60 billion in foreign exchange reserves, a current account surplus, and “net external creditor” status, that is, Israel’s claims on foreigners exceed foreigners’ claims on Israel (oh, how the U.S. would love to have that balance sheet!)

So, in spite its modest size, constrained by the country’s small population, the Israeli economy dwarfs those of many of its much poorer and poorly run neighbors.  Have a look at the Fitch press release below referencing a recent report on Israel and its sovereign credit outlook.

Fitch Affirms State of Israel at ‘A’/’A+’; Outlook Stable   
06 Nov 2009 8:22 AM (EST)

Fitch Ratings-London-06 November 2009: Fitch Ratings has today affirmed the State of Israel’s Long-term Foreign and Local Currency Issuer Default Ratings (IDR) at ‘A’ and ‘A+’ respectively with Stable Outlooks. The Short-term Foreign Currency IDR is affirmed at ‘F1’ and the Country Ceiling at ‘AA-‘.

“Israel has fared better than many other small, open economies in the recent global economic and financial downturn, suffering only a mild recession compared to rated peers in Europe and Asia,” says Paul Rawkins, Senior Director in Fitch’s London-based Sovereigns team. “Nonetheless, the downturn has exposed Israel’s key vulnerability to shocks, namely a high public debt ratio that looks set to exceed 80% of GDP in the wake of wider fiscal deficits in 2009-10.”

Fitch says an improved macroeconomic policy framework, coupled with structural reforms since the last recession in 2001-02, laid the foundations for strong growth in 2004-08, in line with the ‘A’ median of 5%, rendering the economy markedly more resilient to shocks. With the exception of Bahrain, China and Poland, Fitch expects Israel to be the only country in the ‘A’ range to escape an outright recession in 2009. This performance is attributed largely to aggressive monetary and exchange rate policies, aided by a relatively trouble-free banking sector and an absence of asset price bubbles. Structurally, Israel’s high-tech manufacturing and services sectors have proved unexpectedly resilient to declining global investment demand, presaging a near record current account surplus in 2009.

Israel’s high public debt ratio remains the key constraint on its sovereign ratings. The adoption of rules-based fiscal policy in the wake of the last recession has served Israel well; limits on the growth of public expenditure and a ceiling on the state (i.e. central government) deficit facilitated a contraction in general government debt to 78% of GDP at end-2008 from a peak of 100% in 2003. Even so, this ratio remains high relative to the peer group median of 37%, although it is not the most extreme (‘A-‘ rated Greece exceeds 100% of GDP). Moreover, considering the mildness of its recession and an absence of financial sector-related support, the current external shock has taken a heavy toll on the public finances, chiefly on the revenue side. Fitch expects Israel’s general government deficit to widen to 6%-7% of GDP in 2009-10, on a par with rated peers Malaysia and the Czech Republic, which have experienced much steeper recessions, while pushing general government debt up to over 84% of GDP by end-2010.

While Israel’s experience with fiscal rules has been mixed, the current framework has entrenched fiscal discipline and together with signs of a strong economic recovery, suggests Israel’s powerful public debt dynamics could reassert themselves by 2011, forestalling any further deterioration in the public debt/GDP ratio. The government envisages a sharp narrowing in the state deficit to 3% of GDP in 2011 (from 6% in 2009), but still hopes to adhere to tax cuts over the medium term. Fitch expects some revision to the fiscal rules, with greater prominence being given to the Maastricht public debt/GDP ratio of 60% of GDP. From a rating standpoint, a positive rating action would require a decline in the debt/GDP ratio to a level nearer to the ‘A’ median. Conversely, a prolonged rise in the debt/GDP ratio and/or sustained fiscal easing would prompt a negative rating action.

Externally, the Government of Israel became a net external creditor for the first time in 2008, although it still falls short of ‘A’ norms on this measure. Burgeoning international reserves – these have more than doubled to USD60bn since end-2007 – have been the key factor behind this status change for the sovereign, facilitated by a strong current account surplus and buoyant net capital inflows. The economy as a whole also passed a new milestone in 2008, registering a surplus of external financial assets over liabilities for the first time. Israel expects its standing on the international stage to be further enhanced by OECD membership in the near future.

Contact: Paul Rawkins, London, Tel: +44 (0) 20 7417 4239; Richard Fox, +44 (0) 20 7417 4357

Media Relations: Peter Fitzpatrick, London, Tel: + 44 (0)20 7417 4364, Email:

Additional information is available on

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…

Are Status-quo Powers’ AAA ratings vulnerable?

June 11, 2009

Standard & Poor's Logo    Source: Bloomberg

S&P thinks so.  Moody’s and Fitch do not.

Actually, it is more nuanced than that.  A number of what we might call Status-quo or even declining, though still formidable, great powers — including the U.S., U.K., Germany and France – have sustained dramatic negative consequences from the global recession, including rapidly rising government debt levels.  It is a time of testing our assumptions about what makes a great power, what makes a strong economy, and what makes a wealthy society.  And, however painful, we must revise our assessments of relative power and sovereign creditworthiness as needed.   

No doubt such rising powers as China, India and Brazil are poorer – especially in terms of per capita income, but among advanced countries, the economic growth outlook over the medium term looks dismal, as government seeps into more corners of the economy, controlling banking systems and industrial companies, which if not reversed, could eventually stifle private initiative.  In addition, if gaping government deficits are reversed over the medium term via higher taxes, rather than through spending cuts, the government’s stranglehold on the economy will persist.  No matter what, things should get a lot worse before they get better.  Whether or not they get better is in the hands of policy makers.

The U.S. and its allies in Europe are undergoing exactly what Paul Kennedy warned against over twenty years ago in his book, The Rise and Fall of the Great Powers.  Sovereign financial solvency is the foundation on which military and political power can be projected, and this foundation crumbles when governments ignore deteriorating finances.  Governments today must act quickly to cut deficits, once signs of a durable recovery are clear.

The rating agencies remain relatively sanguine.  With the exception of S&P, they don’t expect the major countries to lose their coveted AAA status, as Japan did over a decade ago.  Moody’s even points out that if all AAA’s deteriorate together, they can all remain AAA because ratings are comparative.  However, what is required right now is to compare these AAA’s to lower-rated credits, for example, to such emerging markets as China and Singapore, Hong Kong, Korea and Saudi Arabia.  In spite of what a revision of the relative assessment of, say, the U.K. versus Kuwait might say for how wrong sovereign analysts were in the past, this reassessment must be done.

As for the U.S. and the U.K., the two economies experiencing the textbook example of the current crisis — with declining real estate values, indebted consumers, and failing banks — Fitch Ratings says they:

“possess strong capacity for adjustment, thanks partly to supply-side flexibility, a track record of fiscal consolidation, as well as exceptionally strong balance sheet and financing flexibility.”


 “Benchmark borrower and reserve currency status are two key features of this financing flexibility.”

 About the U.K. and the U.S., Moody’s says, they:

 “are being tested because of a shock to their growth model and large contingent liabilities. However, in our opinion, these countries display an adequate reaction capacity to rise to the challenge.”

Yet S&P a couple of weeks ago revised the Outlook on the U.K.’s AAA rating to Negative, saying that:  

“in light of the challenges to strengthen the tax base and contain public expenditures, the U.K. government debt burden could approach 100% of GDP by 2013 and remain near that level thereafter. The rating could be lowered if we conclude that, following the forthcoming general election, the next government’s fiscal consolidation plans are unlikely to put the U.K. debt burden on a secure downward trajectory over the medium term.”

S&P, in its report of June 4, forecasts the U.K.’s government debt burden to rise above most other AAA’s, including the U.S., by 2011.  Although the U.K.’s exposure to the current crisis is similar to America’s, its boom in credit to the private sector surpassed that which occurred in the US, with domestic credit to the private sector (and public corporations) representing approximately 200% of GDP in the U.K. versus approximately 150% in the U.S. and a AAA median closer to 130%.   The run-up in U.K. government debt is expected to be even more dramatic than in the U.S.   

Likewise, the U.K.’s GDP growth outlook looks worse in the coming years than its AAA peers’.

Paul Kennedy warned us that “The relative strengths of the leading nations in world affairs never remain constant, principally because of the uneven rate of growth among different societies and of the technological and organizational breakthroughs which bring a greater advantage to one society than to another.”  And, that history shows, “a very significant correlation over the longer term between productive and revenue-raising capacities on the one hand and military strength on the other.”

Kennedy argued that:  1) competition and commercial advances in western Europe in the centuries up to the 16th allowed this region to eclipse other power centers – Ming China, the Ottoman Empire, Mogul India, Muscovy, and Tokugawa Japan – which suffered from excessive centralization of authority; 2) the Habsburgs over-extended themselves militarily relative to their weakening economic base in the 150 years up to the mid 17th century; 3) Great Britain emerged as an economic superpower and a military power that could balance rivalries in Europe, by virtue of innovation in banking, shipping and manufacturing; 4) rapid shifts in economic power up through the turn of the 20th century made for unstable relationships among the rising and status-quo powers; and 5) the the U.S. economy has been in relative decline since the middle of the 20th century with the emergence of the rising powers. 

 The more rapid the shifts in relative power, the more unstable the international system can be – risking war – as the distribution of authority and responsibility rushes to catch up with power realities.  The relative decline of such powers as the U.S. and Europe over the long term cannot be avoided, as poorer nations such as China gain technological know-how to rapidly increase per capita income.  However, the speed and size of the relative decline and its management (i.e. through diplomacy) will determine how shocking this change will be (i.e. through war or through peace). 

Which is all to say that AAA sovereigns, such as the U.K. and U.S., would be well-advised to seek substantive fiscal consolidation (read: cut deficits, especially through spending cuts), once there is confidence the worst of the financial crisis is over.

See:  Standard & Poor’s report on the United Kingdom of June 4, 2009, Moody’s report “How Far Can Aaa Governments Stretch Their Balance Sheets” of February 2009, and Fitch’s report “High-Grade Sovereigns and the Global Financial Crisis” of March 17, 2009.

Are people happy in the Rising Powers?

May 11, 2009

OECD Quality of Life Ranking: Subjective Wellbeing.  % of respondents reporting high evaluation of their life, in the present and future.

Among residents of the BRIC nations, Brazilians are the happiest, followed by Russians, whereas the Chinese are the least happy, followed by the Indians, according to a recent OECD report.

The OECD released its 2009 Factbook with charts and tables of economic and social indicators for its 30 members, countries “committed to democracy and the market economy,”  as well as other countries, many of them applying for membership.  In it, the organization ranks countries based on the relative “happiness” of their citizens. 

The OECD used data from a Gallup World Poll conducted in 140 countries around the world last year, that asked respondents whether they had experienced six different forms of positive or negative feelings within the last day (per a Forbes article). Sample questions included: Did you enjoy something you did yesterday? Were you proud of something you did yesterday? Did you learn something yesterday? Were you treated with respect yesterday? In each country, a representative sample of no more than 1,000 people, age 15 or older, were surveyed. The poll was scored numerically on a scale of 1-100. The average score was 62.4.  The assessment was about happiness in the present and future.

Top ten OECD members in terms of life satisfaction were dominated by northern European countries:








New Zealand



High per capita income, low unemployment, a social safety net, a relatively short workweek, and democracy appear to be key determinants of happiness.  Yet culture could play a role as well, as does good family and community life.  One interesting aspect of the study was the divergence of present and future happiness perceptions in some cases (see chart), which could be a measure of a people’s optimism.  Brazilians appear to be an optimistic lot, with one of the highest evaluations of their future wellbeing among the 34 countries in the OECD report.