Week in Review

October 22, 2018

Global Roundup

Venezuela stops accepting dollars for oil payments following U.S. sanctions. The government of this oil-rich but struggling country, looking for ways to circumvent U.S. sanctions, is telling oil traders that it will no longer receive or send payments in dollars. (WSJ)

China local governments' hidden debt could total $5.8 trillion. Off-balance-sheet borrowings by Chinese local governments could be as high as 40 trillion yuan ($5.78 trillion) and amount to "a debt iceberg with titanic credit risks," S&P Global Ratings said in a report on Oct. 16. (CNBC)

Recovery in Latin America and the Caribbean has lost momentum. Economic recovery in Latin America and the Caribbean has stalled, amid escalating trade tensions, tighter financial conditions and volatile commodity markets, according to the IMF. (IMF)

U.S. blames Europe for lack of progress in trade talks, threatens car tariffs. Senior U.S. and EU officials blamed each other on Oct. 17 for a lack of progress in ongoing trade talks, reviving the possibility of fresh tariffs on European cars, said the American representatives. (EurActiv)

U.S. regains crown as most competitive economy for first time since 2008. The U.S. economy sits atop the World Economic Forum’s annual global competitiveness survey for the first time since the 2007-2009 financial crisis, benefiting from a new ranking methodology this year, the Swiss body said. (HSN)

Peace remains remote prospect for Libya. Since the 2011 revolution and the overthrow of Muhammar Gaddhafi, Libya has been engulfed by violence and political instability. Recent clashes that erupted in the capital have once again raised concerns about the future of the country. (Global Risk Insights)

Round of talks ends sans Brexit pact ahead of summit. A flurry of talks between Britain and the European Union ended on Oct. 14 without a Brexit agreement, leaving the two sides three days to close a gap in their positions before a make-or-break summit. (Business Mirror)

German growth slowing in 2019 as “air is getting thinner.” Germany’s Chambers of Industry and Commerce DIHK on Oct. 18 cut its 2018 growth forecast to 1.8% from 2.2% and predicted a slowdown to 1.7% next year as Europe’s largest economy faces mounting risks at home and abroad. (HSN)

Export finance: Why does it take so long to get paid? You have shipped your product, payment is due, and the buyer claims they have made payment. As far as you can see, however, nothing has happened. Does this sound familiar? Here’s what might be causing the delay. (Shipping Solutions)

Venezuela: A refugee crisis in for the long haul. For the past two years, the Trump administration has focused on slashing the number of refugees entering the United States. These efforts have singled out top-sending—and predominantly Muslim—countries including Syria and Iraq. Yet, in the past two years, new refugee crises have popped up throughout the world; one of the most quickly unraveling of which is just across the Caribbean Sea in Venezuela. (Lawfare)

How the U.S.-China power competition is shaping the future of AI ethics. As artificial intelligence (AI) applications develop and expand, countries and corporations will have different opinions on how and when technologies should be employed. First movers like the United States and China will have an advantage in setting international standards. (Stratfor)

China's GDP growth slows to lowest rate in years. The National Bureau of Statistics said that while growth has slowed, it still managed to remain relatively steady. Beijing has decided to focus on consumer spending to ride out a trade spat with the United States. (Deutsche Welle)

Argentina's Macri is stuck between the IMF and a hard place. Argentine President Mauricio Macri is used to seeing bad poll numbers as he struggles to drive through an unpopular austerity program that has cut fuel subsidies, raised taxes and sent utility bills soaring. (Reuters)



Is the European Trade Deal Unraveling?

Chris Kuehl, Ph.D.

To be honest, it has become very hard to determine what is going on with trade deals these days. The patterns that once dictated the development of trade pacts have all but vanished, and nobody is quite sure what has replaced them.

The old system tended to be highly circumspect and diplomatic. There were plenty of areas of disagreement, but the disputes were somehow played down as all the parties involved stated how eager they were to work out deals.

The goal seemed to be maintaining friendships and alliances, while trying to advance and protect one’s own economic growth. Trade talks under President Donald Trump and the Make America Great Again banner seem determined to alienate and infuriate trade partners; but in the final analysis, a pact emerges anyway that seems to meet the demands of everybody.

Nobody offered much hope for a reworked North American Free Trade Agreement (NAFTA), but we are now looking at the United States-Mexico-Canada Agreement and noting how similar it is to NAFTA. It is not a done deal by any stretch because now it has to be ratified, but there has been a start.

Meanwhile, the surprise trade agreement that was essentially reached between Trump and European Commission President Jean-Claude Juncker now looks to be in peril. Is it or is this more jockeying for position?

When Juncker arrived in the U.S. several weeks ago, the consensus view was that he was just here to express the anger of the EU about the threats made by Trump over cars, steel, aluminum and a few other commodities and items. The U.S. seemed poised to ban European cars from the U.S. along with blocking steel and aluminum. The threats continued and might have eventually led to an even larger number of banned and taxed products.

The meeting careened off in an entirely different direction as Trump and Juncker met and emerged all smiles and handshakes. The threat to stop cars was abandoned. It was also hinted that steel and aluminum would be next on the list of things to be granted access. This is where things stood until this week and the collapse of talks between the top negotiators for the U.S. and Europe.

European Commissioner for Trade Cecilia Malmström asserts the U.S. is dragging its feet and has not moved forward on any real trade deal and still dangles the threat of import bans.

U.S. negotiator—U.S. Ambassador to the European Union Gordon Sondland—asserts Europe is also dragging its feet and has not moved forward on any real trade deal. The U.S. accuses Malmström of trying to wait out the U.S. elections to see if Trump will be weakened, while the Europeans assert Sondland and Commerce Secretary Wilbur Ross have decided to wait to see if Chancellor Angela Merkel is weakened further by splits in her coalition in Germany. Both sides are playing the same game.

The U.S. upped the tension a little with the statement that it was looking to set up a trade deal with the U.K. That had been shelved for a while as the British remained confident they would find a way to develop a Brexit plan; but now that this looks less and less likely, the U.K. may elect to throw its lot in with the U.S. and truly walk away from Europe.

Is this a ploy to get more cooperation from the EU? Is it a knee-jerk reaction to the antagonism directed at Britain? Is it something Trump will forget about next week? It is really unclear.



Budget a Test of EU’s Authority

The PRS Group

Investors have displayed understandable caution since May, when the left-leaning, anti-austerity M5S and the League, a right-wing regionalist party in Italy with strong euroskeptic tendencies, formed a populist coalition government under the leadership of Prime Minister Giuseppe Conte, a respected law professor with no formal party affiliation. Sovereign bond yields are currently at their highest level in more than four years and rising, while the local stock market has lost altitude after hitting a multi-year high earlier in 2018.

The government’s recently unveiled “budget of change” will do nothing to reassure the markets. In contrast to the previous government’s deficit target of 0.8% of GDP, the new spending plan sets a goal of holding deficits to the equivalent to 2.4% of GDP in 2019–2021. Although comfortably below the EU’s 3% of GDP ceiling, the projected shortfalls will increase a gross public-sector debt burden that already exceeds 130% of GDP, a prospect that ensures a confrontation with the European Commission.

Giovanni Tria, the independent minister of economy and finance, argued that the deficit must be held to no more than 1.6% of GDP in order to comply with an EU requirement that the debt burden be set on a sustained downward track. However, he was forced to retreat under pressure from the coalition parties, a defeat that will diminish the sense of reassurance that his presence in the Cabinet was intended to provide.

The details of the budget are not yet known, but are likely to satisfy the key campaign pledges of M5S and the League, including a minimum basis income, a flat tax and the reversal of an unpopular reform that increased the retirement age.

M5S leader Luigi Di Maio, who serves as co-deputy prime minister along with his League counterpart, Matteo Salvini, has predicted that the significant increase in the investment budget will contribute to an acceleration of growth at a pace that results in a reduction in the debt-to-GDP ratio. However, critics have stated that the economic gains touted by di Maio are unlikely to materialize without reforms that boost the efficiency of state spending and address the structural impediments that hamper productivity growth, neither of which appear to be on the government’s policy radar.

Tensions between the coalition partners are likely to increase as both the EU and credit-ratings agencies put pressure on the government to adopt measures required to reduce the debt burden, testing the unity of the governing alliance. Polling data showing a near doubling of voter support for the League, which is now running ahead of M5S in the popularity stakes, figures to add to the intensity of internal policy battles, heightening the risk that the coalition will collapse before the completion of its four-year term.

The analysis above is taken from the September 2018 Political Risk Letter (PRL). The best-in-class monthly newsletter, written by the PRS Group, provides concise, easy-to-digest briefs on up to 10 countries, with additional recaps updating prior month’s reports. Each month’s Political and Economic Forecasts Table covers 100 countries, with 18-month and five-year forecasts for KPIs such as turmoil, financial transfer and export market risk. It also includes country rating changes, providing an excellent method of tracking ratings and risk for the countries where credit professionals do business. FCIB and NACM members receive a 10% discount on PRS Country Reports and the PRL by subscribing through FCIB.


Election Calendar

Ireland, President, Oct. 26

Georgia, President, Oct. 28

Brazil, President, Oct. 28

USA, Senate, Nov. 6

USA, House of Representatives, Nov.6

Guam, Legislature, Nov. 6

Madagascar, President, Nov. 7

Fiji, Parliament, Nov. 14

Guinea-Bissau, National Assembly, Nov. 18

Brexit: A Blind Date Is Better Than a Bad Breakup

On July 26, the EU rejected the Brexit deal proposed by the U.K., known as the Chequers Plan. In response, the EU proposed two solutions: a Norway-type agreement or a Comprehensive-Economic-and-Trade Agreement-type agreement with EU membership for Northern Ireland.

For the moment, the U.K. has rejected both proposals. Importantly, Euler Hermes does not exclude the risk of early elections before March 2019.

In light of recent events, the trade credit insurer published a new study analyzing the likelihood of a “no deal.” Given the lack of unity in British Brexit policies, Euler Hermes increased the likelihood of the “no deal” to 25%.

This higher uncertainty already bears financial costs, notably on the pound sterling, it says. “We calculate that the GBP/EUR would reach a low of 1.06 to 1.09 at the peak of tensions in November–December. This would mean a 3% depreciation per month on average until a deal is made.”

The study finds it could also cut U.K. GDP growth by as much as 0.1 percentage points per quarter over the next two quarters, while pushing companies to reinforce their contingency stocking in an environment of low domestic demand. Therefore, Euler Hermes revised its GDP growth forecast by 0.1 percentage points in 2018 and 2019 to 1.3% and 1.2%, respectively.

The more this uncertainty shock persists, the more it damages the economy because it can result in negative wealth effects through tighter financial conditions, a weaker consumer demand and fragile business profitability, the study cautions.

Euler Hermes’s central scenario (70% probability) continues to be a last-minute agreement by January 2019, which would ratify the 21–month transition period. An agreement is likely to give temporary relief to financial markets, especially to the pound, it says. “We estimate the pound to euro exchange to rebound to 1.14 by April 2019.”

Euler expects the political declaration on the future trade relationship agreement with the EU to lack concrete details and refers to it as a “Blind Brexit” because a formal trade agreement would not be published until the end of the transition period, planned for December 2020.

The study’s most probable scenario would be an “Extensive FTA” similar to Norway following the transition period. This scenario would avoid Ireland’s dislocation and allow conservatives to keep their majority in the Parliament.

Should the EU and the U.K. not find an agreement by March 29, 2019, in the absence of an extension of Article 50, the U.K. would exit the EU under the WTO conditions, which the study gives a 25% probability for this scenario.

Euler Hermes would expect the pound to depreciate by 20%. Two extra minutes of additional controls at the border (in addition to the current two minutes) would translate into 32 km or five hours of queues, which would more than triple the existing ones, it says. WTO conditions would translate into 4% to 5% of mutual import tariffs. Moreover, because all trade agreements need approval from all states that signed the deal, a transition phase will be necessary.

Over and above these bureaucratic hurdles, damage will be caused by the fact that extremely interconnected supply chains with the EU countries will become obsolete, the study finds. This would lead to massive investment stops and production relocations over time. Financial services would also be heavily impacted.

Overall, Euler Hermes expects U.K. GDP growth to fall by 1% in 2019 in this no-deal scenario. On the other side, top EU losers in exports of goods would include Germany (~EUR8bn), the Netherlands (~EUR4bn), France (~EUR3bn) and Belgium (~EUR3bn).



Week in Review Editorial Team:

Diana Mota, Associate Editor and David Anderson, Member Relations