July 2, 2013 7:12 pm

Risks of a hard landing for China

To sustain demand, Beijing might need to take actions that its new leaders neither want nor expect
©Ingram Pinn
The new Chinese leadership is trying to manage one of the most difficult of economic manoeuvres: slowing down a flying economy. Recently, difficulties have become more apparent, with the attempt of the authorities to bringshadow banking” under control. Yet this is part of a bigger picture: the risk that a slowing economy might even crash. Indeed, the expressed desire of China’s new government to rely on market mechanisms raises the risks.
In a recent note, David Levy of the Jerome Levy Forecasting Center has asked the crucial question: what is China’s stall speed? The general view is that it is straightforward for China to move from 10 per cent to, say, 6 per cent growth over the coming decade. The implicit assumption is that “a rapidly expanding economy is like a speeding train; let up on the throttle and it slows down.
It continues to roll along the track as before, just not as rapidly.” He argues, instead, that China is more like a jumbo jet: “In recent years, a couple of engines have not been working well, and the pilot is now loath to keep straining the remaining good engines. He is allowing the plane to slow down, but if it slows too much, it will fall below stall speed and drop out of the sky.”

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Thus, after 2008, net exports ceased to be a driving force for the economy. Investment took up the slack, particularly in 2009.

That led to a further jump in the share of spending on investment in gross domestic product, from an already extraordinarily high 42 per cent in 2007 to an absolutely amazing 48 per cent in 2010. The jet fuel driving this investment engine was an explosive growth of credit: loans rose at an annual rate of close to 30 per cent during 2009. The policy was highly successful. But, with booming net exports a thing of the past, the Chinese authorities now also wish to reduce the reliance on credit-fuelled investment. The engine that the Chinese economy now has left is consumption, private and public.

In fact, figures for quarterly contributions to the growth of demand suggest that the desired slowdown has gone impressively smoothly, so far (see charts). But the challenges of a move to annual growth of 6 per cent remain huge.

First, investment in inventories must fall sharply, since its level depends on the growth of an economy, not on the level of activity. Think about it: in a stagnant economy, inventory accumulation would normally be zero. Again, other things equal, an economy growing at 6 per cent would need 60 per cent of the investment in inventories of one growing at 10 per cent. The immediate impact of this adjustment would be a sharp decline in investment in inventories, before their growth resumed at 6 per cent a year, from the now lower level. Moreover, businesses might well fail to anticipate the economy’s slowdown altogether, particularly after years of far higher economic growth. They would find themselves burdened with rapidly rising inventories and would then be obliged to slash inventories, and so levels of output, even further.

Second, investment in fixed capital must also fall sharply. Investment might have to fall by 40 per cent: all other things equal, in China that would imply a 20 per cent decline in GDP, which would evidently entail a deep (and unexpected) recession. Those responsible for investment might well fail to adjust quickly, because they expected the 10 per cent annual rate of growth to return. That would support the economy for a while, but at the expense of soaring excess capacity. As in the case of inventories, that would then cause a still bigger investment fall.

Third, an investment-induced reduction in demand and activity is also likely to have a large downward impact on profits. That would impair corporate solvency and lower investment still further. Finally, a decline in the rate of economic growth, particularly one preceded by a very large credit boom, might have unexpectedly grim effects on the state of balance sheets. China’s private sector is already relatively highly indebted (see charts). Such debt should be manageable, provided the economy continues to grow at 10 per cent a year. In such a dynamic economy, the timing of new projects hardly matters. But, in a more slowly growing economy, the jump in bad debts might prove huge.

The World Bank’s latest Global Economic Prospects argues that “ongoing rebalancing efforts remain a priority as does engineering a gradual decline in its unsustainably high investment rate”. But, “should investments prove unprofitable, the servicing of existing loans could become problematicpotentially sparking a sharp uptick in non-performing loans”. Even if the government rescued the financial sector, those responsible for lending would surely become more cautious. The growth of off-balance sheet finance, to which the authorities have recently reacted, seems certain to make this even harder to manage.
None of this is to argue that China cannot continue its catch-up growth, in the medium to longer term. The point is, instead, that the structure of an economy growing at 6 per cent will, inevitably, be quite different from that of one growing at 10 per cent. One must not think of such an adjustment as proportional. On the contrary, the economy that would emerge might have consumption at, say, 65 per cent of GDP and investment at just 35 per cent. So consumption would have to grow substantially faster than GDP, while investment would grow far more slowly. This would mean a different distribution of income: substantially higher shares of household disposable incomes and lower shares of profits in GDP. It would also necessitate a different structure of production, with relatively fast growth of services and relatively slow growth of manufacturing.
The new Chinese government is, in effect, now engaged in the task of redesigning the jumbo jet, as it comes into land, with half of the engines working poorly. The market is most unlikely to deliver such a huge change smoothly. The sole reason I find to trust the landing will work as hoped is that the authorities have handled so many arduous tasks in the past. But it is going to be very tricky. In order to sustain demand, the government might find itself compelled to do some thingsrun very large fiscal deficits, for example, – that its new leaders neither want nor now expect. At least, forewarned is forearmed.

Copyright The Financial Times Limited 2013

The Global Trust Déficit

Peter Blair Henry

01 July 2013

 This illustration is by Tim Brinton and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

NEW YORKIn their preoccupation with fiscal deficits, developed-country policymakers continue to neglect a different, yet equally critical, shortfall: the trust deficit between advanced and emerging economies when it comes to global governance.
For decades, developed-country shareholders at the International Monetary Fund and the World Bank used loan conditionality to spur economic reformsoften including contentious fiscal-austerity measures – in the so-called Third World. Through pragmatic, sustained reform efforts, countries like Brazil, China, and India turned their economies around to achieve stunning increases in GDP growth – from an average annual rate of 3.5% in 1980-1994 to 5.5% since then.
But, although developing countries now account for more than half of global GDP growth, advanced countries have yet to admit them to leadership roles that reflect their growing influence in the world economy.
The failure so far of the US Congress to ratify the IMF reform package agreed to by G-20 finance ministers and central-bank governors in 2010 is the latest breach of trustone that makes the promise of adequate representation for emerging economies seem like a shell game. America’s unwillingness or inability to ratify the package – which includes doubling the IMF’s funding quota and shifting 6% of the new total, together with two directorships, to developing countriesundoubtedly contributed to the decision by the BRICS (Brazil, Russia, India, China, and South Africa) to establish their own development bank.
In fact, a backlash against Western hegemony in global governance has been brewing for years, with developing countries increasingly turning away from the IMF in favor of creating alternative, regional sources of funding. The Association of Southeast Asian Nations (ASEAN), together with China, Japan, and South Korea, established the Chiang Mai Initiative in 2000, and Latin American countries launched negotiations on the Banco del Sur in 2006.
The accelerating erosion of emerging economies’ trust in the Bretton Woods institutions is particularly problematic now, given slow growth and continued economic weakness in advanced countries. While the world economy is expected to grow by 3.3% this year, average annual growth in the advanced countries is projected to be just 1.2%.
Developed and developing countries alike would benefit from greater economic-policy coordination. While regional groups may obtain some short-run benefits by pursuing narrower interests outside of multilateral channels, neither emerging nor advanced economies can fulfill their long-run potential in an environment characterized by isolationism and a zero-sum mentality in areas like trade and exchange-rate policy.
Policy coordination, however, depends on trust, and building trust requires advanced-country leaders to keep their promises and offer their developing-country counterparts opportunities for leadership. Instead, developed countries have been taking actions that compromise their legitimacy.
For example, after spending decades encouraging developing countries to integrate their economies into the global market, advanced countries now balk at trade openness. Indeed, despite pledges not to erect trade barriers after the global economic crisis, more than 800 new protectionist measures were introduced from late 2008 through 2010. G-8 countries, the supposed champions of the global free-trade agenda that dominates the World Trade Organization, accounted for the lion’s share of these measures.
Some question the leadership ability of the BRICS. But many emerging markets are already leading by example on important issues like the need to shift global financial flows from debt toward equity. Mexico, for example, recently adoptedahead of schedule – the changes in capital requirements for banks recommended by the Third Basel Accord (Basel III), in order to reduce leverage and increase stability.
For too long, developed countries have clung to their outsize influence in the international financial institutions, even as their fiscal fitness has dwindled. By ignoring the advice that they so vehemently dispensed to the developing world, they brought the world economy to its knees. Now, they refuse to fulfill their promises of global cooperation.
Leaders in developed and developing countries alike must deepen their commitment to economic reform and integration. But only by giving emerging economies a real voice in global governancethereby reducing the trust deficit and restoring legitimacy to multilateral institutionscan the global economy reach its potential.

Peter Blair Henry is Dean of New York University’s Stern School of Business and the author of Turnaround: Third World Lessons for First World Growth.

jueves, julio 04, 2013



Showdown in Egypt

Omar Ashour

02 July 2013

 This illustration is by Pedro Molina and comes from <a href="http://www.newsart.com">NewsArt.com</a>, and is the property of the NewsArt organization and of its artist. Reproducing this image is a violation of copyright law.

LONDONWith massive anti-government protests across Egypt on June 30 – a year to the day after Egyptians elected their first-ever civilian president – a diverse and decentralized movement has challenged President Mohammad Morsi’s hold on power as never before. Hundreds of thousands were mobilized to take to the streets, with many storming and burning down the Cairo headquarters of the ruling Muslim Brotherhood.
At the end of the day, the president was given an ultimatum. The firstrevolutionarystatement of Egypt’s new grassroots Tamarod (rebel) movement demanded that Morsi leave within two days or face a march on the presidential palace. “In the name of 22 million citizens, we declare that Mohammad Morsi is no longer the legitimate President of Egypt.” The protesters then appealed to “the institutions of the state, the army, the police, and the judiciary to side with the popular will.”
The army has spoken, issuing an ultimatum of its own to Morsi: Address the protesters’ demands or face a military solution to the crisis. As the day ended, Morsi’s office declared that it had not been consulted prior to the army’s statement, and tens of thousands of the president’s supporters demonstrated in several cities simultaneously at midnight.
So what will happen next? And what impact will the Tamarod movement and the army intervention have on Egypt’s precarious democratization process?
The path to today’s crisis was predictable. Morsi won the presidential election with only 51.7% of the vote, while the other 48.3% included very powerful forces, including figures from the Mubarak regime and their supporters. Opposition to Morsi hardened following the annulled November 2012 constitutional declaration, by which he had sought sweeping powers allegedly to protect the country’s infant elected institutions against a politicized judiciary.
The lack of tangible material gains for ordinary Egyptians also fueled public anger. All of the presidential candidates had made wild promises; but the absence of significant achievement, such as resolving the country’s chronic shortages of gas and electricity, helped to fuel the massive anti-Morsi mobilization. Incompetence during a political transition has a high price.
But Morsi is not entirely without accomplishments or supporters. Last August, he culled the leaders of the Supreme Council of the Armed Forces (SCAF). On the economic front, the Egyptian Central Bank’s report for the period of July 2012 to March 2013 indicates that the balance-of-payments deficit fell from $11.2 billion to $2.1 billion, owing to rising tourism revenues and debt forgiveness.
This improvement did not trickle down to ordinary citizens, and there was no effective media and communication strategy to capitalize on it. But Morsi’s core supporters remain committed.
Whereas only a few hundred showed up to support the fraudulently elected Mubarak during the revolution, hundreds of thousands of Egyptians rallied for two consecutive weeks in Rab‘a al-‘Adawiyya square, near the presidential palace, to express their solidarity with Morsi.
If Morsi survives in office, he will have to rely on the army to guarantee his government’s safety. He will also need a massive show of strength from his supporters.

But this would mean returning the army to the center of politics – and thus sacrificing the gains from Morsi’s imposition last August of greater civilian control. And the army’s ultimatum indicates that the military is moving in the direction of a coup.
Mobilization of Morsi’s Muslim Brotherhood and other Islamist supporters is also risky. Indeed, the revolutionary step of steering once-armed Islamists toward electoral and constitutional politics could be reversed in ongoing power struggle.
If Morsi does not remain in power, much will depend on how he is removed. Reliance on street mobilization and army intervention to bring down an elected leader who has support on the ground is unlikely to lead to a positive outcome. On the contrary, that patternseen in Spain in 1936, Iran in 1953, Chile in 1973, Turkey in 1980, Sudan in 1989, and Algeria and Tajikistan in 1992usually leads to military dictatorships, civil wars, or both.
But there is also Charles de Gaulle’s precedent of a peaceful exit by an elected president. The massive protests in France in 1968 led to an early parliamentary election, which de Gaulle’s supporters won decisively. But de Gaulle later resigned of his own volition, over an issue of minor importance.
The problem with this precedent is that Morsi does not have de Gaulle’s background, and Egypt’s chaotic political transition of 2013 is far from France’s consolidated democracy of 1968. French Gaullists did not face persecution; several Egyptian opposition figures have already vowed that Morsi and the Muslim Brothers will. That raises the stakes of political survival considerably, especially given the absence of any credible guarantor of constitutional norms and behavior.
Moreover, a possible replacement for Morsi is not very clear. Parts of the opposition speak of a transitionalpresidential council.” But that idea failed once already, during the SCAF’s rule (February 2011-June 2012), owing partly to the lack of popular mobilization behind a uniting figure(s), but mostly because of the egos – indeed, megalomanía – of the politicians involved.
Morsi will almost certainly not be removed without the involvement of the army and the security establishment. And the winners will probably try their best to block the Islamist forces from a comeback, implying another cycle of no-holds-barred political – and perhaps physical combat, in which democracy serves as a mask to legitimize the exclusion, and possibly the destruction, of one’s political opponents.

Omar Ashour, a Senior Lecturer in Arab Politics in the Institute of Arab and Islamic Studies at the University of Exeter and a Non-Resident Fellow at the Brookings Doha Center, is the author of The De-Radicalization of Jihadists: Transforming Armed Islamist Movements and From Good Cop to Bad Cop: The Challenge of Security Sector Reform in Egypt.

July 2, 2013 5:21 pm
Crude at $100 defies commodities sell-off
On the face of it, oil has defied gravity. Amid a deepening sell-off in commodities that has sent gold and industrial metals tumbling, crude has been impassive.
As a transport fuel, oil is closely linked to the ups-and-downs of the world economy. Yet, benchmark Brent has held steady above the $100 a barrel level even as metals have floundered amid concern at slowing Chinese growth and the prospect of reduced emergency support from the US Federal Reserve.
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For producers and consumers alike, the question is whether this resistance to falling prices in other commodities markets is temporary or evidence of more lasting resilience.

In the bullish corner stands the International Energy Agency. It has warned oil prices will have to rise over the next three months to accommodate demand from new refineries in Saudi Arabia and China.
Faster growing countries beyond Europe and the US have been adding refining capacity at breakneck pace in recent years, and these are likely to ramp up production regardless of the outlook for the global economy.
Crude supply would struggle to keep up with refining demand until price effects helped rebalance the market,” the industrialised countries’ energy watchdog said in its most recent oil market commentary. That could see prices heading back towards their high for the year of almost $120.

But the IEA view stands in contrast to the downbeat mood prevailing elsewhere in a market that is generally preoccupied with the twin threats of surging North American supply, and moderating demand from a slowing China.

In this more bearish view, the US shale revolution, along with higher output from Iraq, is likely to keep a lid on prices in the medium term. Due to a number of factors, that are increasingly well understood, oil is unlikely to break into a higher trading range,” says Edward Morse, head of commodities research at Citi.

In the short term, much will ride on which of these two interpretations holds sway in Washington, where pressure is growing to limit Iranian oil production further.

Iranian exports have halved since US-led sanctions were imposed at the start of 2012, with relatively little impact on the price of oil. But legislation currently before Congress would require a further cut of 1m barrels a day within a year, in effect reducing Iranian exports to zero.
The new US energy secretary Ernest Moniz told Reuters over the weekend that “markets could be quite resilient to” a further decline in exports, thanks to rising output elsewhere.

But, for some, this is a misreading of the market, and one which risks sending oil prices much higher. The reason is that the oil market may be tighter than it appears and that looking at levels of spare production capacity alone is misleading.

While light and sweet crude oil is in plentiful supply globally thanks to surging output from US shale fields, medium and sour crude oils are not, particularly in Europe, where the price of Brent, a blend of North Sea oils, is set. The EU has completely cut off imports of medium-heavy Iranian over the past 18 months while increased demand for Russian crude from domestic refineries and from Asia has limited the flow of Urals oil to Europe.

“Those arguing that shale can compensate for lost Iranian production are comparing apples and oranges,” says Yasser Elguindi, oil analyst at consultants Medley Global Advisors. “The argument doesn’t account for major differences between grades.”

Questions also remain over the level of spare production capacity available to compensate for any further reductions in Iranian output.

The case for further action against Tehran assumes that Saudi Arabia stands ready to increase output to support sanctions against its theological and strategic rival, as it did last summer. But Saudi output has already climbed to 9.6m b/d in May, according to the IEA, a jump of more than 200,000 b/d from April, which took production to a level not far short of the record highs seen last year.
Domestic Saudi demand is expected to rise still further over the summer, as the kingdom burns more oil to generate electricity for air conditioners. Although the Saudi can sustainably produce 12.3m b/d according to the IEA, it aims to maintain a large chunk of spare capacity at all times.

“Even if Saudi Arabia replaces Iranian oil barrel for barrel, the consequent reduction in spare capacity would create a risk premium in the market,” says Robert McNally, a former White House official, now head of the Rapidan Group. He argues that the US needs to prepare itself for higher oil prices as a result of tougher sanctions on Iran.

Even without further reductions in Iranian exports, the market is inching up on perceptions of growing risk in the Middle East. Brent has climbed $2 to within reach of $104 a barrel this week, as mass protests in Egypt have raised concerns about disruptions to tanker travel through the Suez Canal, a key choke point for the oil trade. Crude at $100-plus could be here for a while yet.

Copyright The Financial Times Limited 2013.