Efic’s Chief Economist on emerging markets
Are you thinking of expanding your business into an emerging market? Efic’s Chief Economist, Cassandra Winzenried, talks about the broader macroeconomic and country risks facing Australian export businesses wanting to expand overseas.
Which emerging markets are the key ones for growth in the next 2-3 years?
Emerging and Developing Asia is expected to remain the world’s most dynamic region, by a very considerable margin. The IMF expects an expansion of 6.5% this year and next. This is great news for Australian exporters, given they benefit disproportionately from important geographic and strategic links to the region.
In particular, China is set to remain the most important engine of global growth—accounting for about 30% of the expected global expansion over the next several years. GDP is projected to expand by 6.6% this year—its slowest pace of growth since 1990. This owes to dual headwinds—trade tensions externally and the deleveraging campaign domestically. But despite the enduring and engineered economic slowdown, real GDP output remains strong, and that owes to the enlarged size of the economy. Indeed, last year China grew by the size of Canada’s entire economy in PPP terms.
China’s economic slowdown is offset by continued strong prospects for India and ASEAN. India suffered two major shocks in the last two years which saw economic activity take a deep hit. First, demonetization in 2016 saw 85% of cash in circulation made redundant overnight. Then the new nationwide GST, which replaced multiple taxes last July, caused short term disruption. But the Indian economy was recently characterised as ‘an elephant starting to run’. Overall growth is projected to increase from 6.7% in 2017 to 7.3% in 2018 and 7.5% in 2019. This is essentially a return to long term average growth rates. It also makes India the fastest growing major economy.
Meanwhile, growth in the ASEAN group of economies is expected to stabilise at around 5.3%. These export-facing economies will be among the largest beneficiaries of stronger global growth given their links into global supply chains. In particular, Vietnam, the Philippines and Indonesia are expected to outperform over the forecast horizon.
Are there any risk trends that businesses should be aware of?
Global growth is expected to peak at 3.9% this year and next—its fastest pace since 2011. But as a country risk economist, I’m paid to worry. And as the global cyclical upswing approaches its two year mark, the pace of expansion has become less synchronised, and the downside risks have become more salient. Three risks dominate. But these are interlinked—if one materialises, it could trigger the others.
- Higher funding costs. This could cause disruptive asset price fluctuations and reversals of capital flows, particularly to emerging
markets with weaker fundamentals and/or higher political risks. This risk has been exacerbated by a global debt binge—global debt topped
US$247 trillion in Q1 2018 or 320% of GDP, up from 230% on the eve of the GFC.
- An escalating trade war. Higher trade barriers make tradable goods less affordable, disrupt global supply chains, and slow the spread
of new technologies—all of which lowers productivity. Indirectly, escalating trade policy rhetoric has spiked uncertainty, which has ill
effects on business and financial market sentiment, thereby denting investment
- Geopolitical tensions. This is a long list. But includes for instance, fundamental political challenges that we’re seeing in Europe regarding migration and fiscal governance. Indeed, the sell-off in Italian bonds in May once again turned the spotlight on deep structural challenges and thin buffers at the national level.
Apart from the risks that could derail the global economy, business operating risks depend on the country you are talking about. For example, Australian businesses exporting to Papua New Guinea might face payment delays given ongoing foreign exchange shortages. Australian business operating in Vietnam may face issues related to the soundness of banks.
When assessing risk for an Efic transaction, what do you look at?
To some degree that varies based on the solution Efic is providing. For instance, if we’ve been asked to provide a buyer credit, that is lending money to a sovereign to purchase an Australian good, then we would be looking at a wider range of risk factors relative to a project finance deal where an asset or project is operating in a country but we’re not relying on the government repaying us. Country risks related to bonding are lesser again.
More generally, we analyse a country’s macroeconomic stability. For example, the GDP growth and inflation profile, and the size and composition of the economy. If the economy is heavily commodity dependant it will likely suffer from fluctuations in global asset cycles.
We also look at how well the economy is being managed. For instance, how effective is monetary policy and the regulatory and legal environment, and how severe are political risks.
And then we will look at the country’s finances. That is, how leveraged is the private and public sector, what is the external debt and reserves position, is the current account in deficit and how far has the currency deviated from its long term average?
How do country risks affect access to finance for Australian businesses?
It’s a fairly basic premise that if a country is inherently risky then a lender needs a higher rate of return to be able to provision accordingly for that risk.
If we at Efic are dealing with a country that is deemed to be more risky by lenders, then it will be more costly. And the availability of finance may be lesser.
You mentioned that higher funding costs could affect global growth, can you explain this a little more and the potential impact it could have?
A decade of ultra-low global interest rates has encouraged an unprecedented accumulation of debt, particularly in emerging markets. This is fine while the global economy is powering along and global interest rates are low. But US economic momentum suggests that the Federal Reserve will continue to raise interest rates over the next several years. Higher interest rates will see funds diverted to increasingly hefty interest payments, thereby dampening growth. Tightening global financial conditions could also cause large and destabilising exchange rate movements and reversals of capital flows.
Countries that have higher fiscal and current account deficits and countries that have, in particular, idiosyncratic political and policy problems are particularly vulnerable. For example, recent disruptive slumps in the Argentinian peso and Turkish lira have been a manifestation of these issues.
However, we’re heartened by the fact that Australia’s largest emerging market export destinations, China, India, Indonesia, Malaysia and Vietnam—representing collectively over 40% of exports—are relatively well placed to handle financial market turbulence. Most Asian emerging markets dramatically improved their macroeconomic fundamentals following the Asian Financial Crisis. In particular, by liberalising exchange rate regimes and instituting credible inflation targeting regimes, building foreign exchange reserves, and lowering public debt and current account deficits. This substantially reduces the risk of contagion to our neighbourhood.
Cassandra is Efic’s Chief Economist, primarily responsible for providing economic and political insights for Australian businesses transacting overseas. She joined Efic via Commonwealth Treasury and private sector consulting. See Cassandra’s LinkedIn profile.