Week in Review

May 27, 2019

Global Roundup

Wow Air collapse decimates Iceland’s economy. It’s not often that an entire economy is thrown off course by a single corporate event. But that’s what appears to have happened in Iceland. (Bloomberg)

Theresa May quits: U.K. set for new PM by end of July. Theresa May has said she will quit as Conservative leader on June 7, paving the way for a contest to decide a new prime minister. (BBC News)

China denounces U.S. “rumors” and “lies” about Huawei ties to Beijing. China, on May 24, denounced U.S. Secretary of State Mike Pompeo for fabricating rumors after he said the chief executive of China’s Huawei Technologies Co. Ltd. was lying about his company’s ties to the Beijing government. (Reuters)

Parliament frustrates new Ukraine president's election reform. Lawmakers dealt an early blow to Ukraine’s new President Volodymyr Zelenskiy on May 22 by rejecting proposed changes to the electoral system ahead of a snap parliamentary election due in July. (Reuters)

Mnuchin says further U.S. tariffs on China at least a month away. The United States is studying how proposed tariff increases on roughly another $300 billion in Chinese imports will affect consumers and is at least a month away from enacting them, U.S. Treasury Secretary Steven Mnuchin said on May 22. (Reuters)

Australia’s ruling coalition wins 3rd term. Australia’s ruling conservative coalition won a surprise victory in the country’s general election defying opinion polls that had tipped the center-left opposition party to oust it from power and promising an end to the revolving door of national leaders. (AP News)

Nigeria’s ambitious “economic recovery plan” is not going according to plan. After Africa’s largest economy suffered a recession in 2016—its first in over two decades, the government came up with an answer. Or at least it thought it did. (Quartz)

Korea's economic outlook in six charts. With strong fundamentals, Korea’s economy has performed well in recent years, but short-term growth is now moderating, and long-term growth is facing headwinds. Fiscal and monetary policies should boost growth, and structural policies should foster inclusion and enhance productivity. (IMF)

British Steel collapses into insolvency. British Steel has fallen into insolvency proceedings, putting thousands of jobs at risk after its pleas for an emergency state bailout were rejected. (Financial Times)

Chinese export growth may see short-term boost as trade war restarts. While markets worldwide have been rattled by this week’s rapid escalation of tensions between the U.S. and China, Chinese export growth is likely to move to the upside in the short term as businesses rush to get orders out before the next round of tariffs hit. (HSN)

Global shadow banking growth increases systemic risks. Bank credit profiles have generally improved since the financial crisis, with increased capital and liquidity and more conservative underwriting standards. However, system-wide risk has not necessarily been reduced, with shadow banking exhibiting notable post-crisis growth, driven by bank regulation, low interest rates, the favorable economic backdrop and the growth of financial technology. (Fitch)

Duterte’s opposition in disarray following Philippines mid-terms. Renowned for once toppling a dictator, the opposition is struggling to break Duterte’s hold on the popular imagination. (Interpreter)

Tariffs, Trade and Politics

Chris Kuehl, Ph.D.

The Trump administration has been very busy on the trade front of late, and it has become a little challenging to keep up. The headline conflict has been with China with the imposition of tariffs and the counter imposition of tariffs on the part of the Chinese.

The long, drawn out set of negotiations ended with no deal and an escalation of the conflict. This has created a great deal of consternation within the U.S. business community as well as with the global economy. Importers are scrambling and so are exporters as they contend with the Chinese reaction.

At the same time these talks are breaking down, there has been sudden progress in other areas of trade. The U.S. is preparing to end the restrictions on imported steel from both Mexico and Canada as part of the effort to get the new U.S. Mexico Trade Agreement off dead center. The threat to impose tariffs on European cars and car parts has been delayed for at least six months, and there has been a little bit of renewed interest in some regional trade deals in parts of Latin America, South Asia and even Africa. This leaves the question of Trump trade policy hanging.

To be honest, there has always been a high level of political gamesmanship involved with tariffs and trade policy in general. The fact is that any given trade relationship will provide both winners and losers in a given country. That is the very nature of trade theory—comparative advantage.

The basic idea is that a country sells what it is best at producing and buys that which it is not good at producing. This equation changes all the time as nations gain new advantages and encounter new disadvantages. It is also important to note that just because comparative advantage is efficient does not mean that everyone in a given nation will be thrilled by the prospect of giving that production up.

There are many reasons a country may want to protect a given industry—even if domestic production is less than efficient and it would technically be better to import that item. The most common rationale is to protect the domestic business so that jobs will be preserved, but there may be other considerations.

Many nations want to preserve national security by insulating technical companies and others seek to protect food production or other output. Then, there are the more overtly political motivations. The protected sector or company may have political clout. There are always desires to reward other nations for being good allies and punish nations for political activity that goes counter to preferred strategy.

In order for a tariff or trade restriction to really work, it has to be nearly permanent. The idea is that restricting imports will make it easier for domestic producers to invest and expand as they will be able to count on that market. If the tariff is temporary, there is no motivation to invest as it is assumed that lifting the tariff will make it harder to compete.

Nations would likely orient towards total protection were it not for the demands of the consumer. If a company has no fear of foreign competition, there is little incentive to lower prices or even to provide a better product or service and the consumer is at the mercy of the domestic producer. In the U.S., the consumer has been dominant and has demanded access to the global marketplace. That creates inevitable tension between the domestic producer and that consumer.

Trump’s tariffs and trade restrictions have been temporary, and the policy has been exceedingly mercurial. The tariffs on steel and aluminum have been altered a dozen times in less than a year. The latest announcement indicates that tariffs on steel from Canada and Mexico will be lifted. That means the four-largest importers of steel into the U.S. will now escape tariff restrictions (Canada, Brazil, South Korea and Mexico). Does this protect the U.S. steel and aluminum industry? Not as much as when these nations did not have an exemption. It is assumed that Trump got something from these nations in return, but thus far, that has not been made clear.

The reaction to the latest policy move has been predictably varied as there has been enthusiasm from the manufacturing community as they are steel and aluminum users and now have greater access restored. The steel and aluminum producers are less thrilled although they are still receiving some protection from the likes of Russia, China, Turkey and others.

Right now, consumers are the ones losing. They have been denied access to competitive products from overseas, but there has been little incentive for domestic producers to get further engaged as they do not know when the tariffs might be lifted. The fact is companies expect differing trade policies when there are different governments in place, but the constant changing under Trump has been very hard to deal with and most are simply standing pat. This results in higher prices for the consumer.

Turkey: Opposition Shows Signs of Life

PRS Group

Local elections were held in late March against the backdrop of the continuing fallout from a convergence of negative factors that pushed the economy into recession in the second half of 2018. Under the circumstances, it was not surprising that pre-election polls revealed an erosion of support for President Recep Tayyip Erdoğan’s Islamist AKP, a mere nine months after the People’s Alliance, a coalition of the AKP and the secular MHP, romped to victory at presidential and legislative elections held in June 2018.

The results from the March 31 elections confirmed that the People’s Alliance remains the dominant political force in the country, but the opposition finished on top in five of Turkey’s six largest cities, including Ankara and Istanbul, which by themselves account for 25% of the national population and 40% of the country’s GDP. However, constitutional changes that replaced the old parliamentary system of governance with one that concentrates power in the presidency provide Erdoğan with substantial latitude to crush manifestations of the popular will that undermine the AKP’s interests, as long as he frames anti-democratic moves as necessary to ensure domestic stability. A key question going forward is whether the president is prepared to tolerate limited challenges to the AKP’s monopoly on political power, thereby enabling democracy to survive and possibly flourish in the coming years. On that score, the early signs are troubling.

The AKP-controlled municipal council in Ankara has already attempted to push through legislation reducing the powers of the mayor. Although the measure was vetoed, such a naked power grab at this early juncture points to the high potential for an extremely contentious relationship between the mayor and a hostile council majority that could trigger a political crisis.

Elsewhere, the AKP refuses to recognize the official results of the mayoral election in Istanbul, where opposition candidate Ekrem İmamoğlu defeated AKP veteran Binali Yildirim by less than 14,000 votes, out of more than eight million ballots cast. Electoral officials rejected a demand to hold a fresh election, and confirmed İmamoğlu’s victory in mid-April. However, the AKP continues to insist that the race was marred by fraud, and police have reportedly detained the municipal registrar and individuals alleged to have illegally cast ballots.

The possibility that the AKP’s efforts to shore up its position might contribute to an increased near-term risk of political instability at home does not appear to be encouraging Erdoğan to adopt a less confrontational posture toward Turkey’s NATO partners, who are greatly displeased by the government’s plan to purchase air and missile defense systems from Russia. President Donald Trump has threatened to impose sanctions on Turkey under U.S. legislation that penalizes countries that do business with the Russian intelligence or defense sectors, and the Pentagon has warned that Turkey will suffer unspecified “grave consequences” if it goes through with the deal.

Given the role that the threat of U.S. sanctions played in the lira’s steep fall last year—in that case prompted by a dispute involving Turkey’s detention of a U.S. pastor on charges of spying and abetting terrorism—the warnings from Washington of punitive action over the S-400 carries a high risk of sending the lira once again into a steep slide. Erdoğan’s penchant for meddling in economic affairs only heightens the danger of a retreat by investors.

The analysis above is taken from the April 2019 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.

2019 FM Global Resilience Index Compares Risk in 130 Countries

The 2019 edition of the FM Global Resilience Index released last week added a new driver, corporate governance, to its ranking of 130 countries and territories by the resilience of their business environments.

Corporate governance is one of 12 economic, risk and supply chain-related measures driving the 2019 FM Global Resilience Index rankings. Singapore, ranked 21st overall, occupies the top spot in the new corporate governance category, which reflects the strength of a country’s auditing and accounting standards, conflict of interest regulation and shareholder governance.

Two African countries were the biggest year-over-year movers in corporate governance. Rwanda, called “the Singapore of Africa,” climbed 50 places in corporate governance (from 79th to 29th), contributing to this year’s biggest rise in the overall Index: 35 places (from 107th to 72nd). The rise makes Rwanda the highest-ranked African country for corporate governance.

South Africa fell eight places in the overall Index (from 39th to 47th), in part due to its 20-place drop in the corporate governance ranking (from 14th to 34th).

These moves are particularly relevant as global business leaders eye the African market. South Africa attracted 446% more foreign direct investment (FDI) in 2018 than in 2017, even as global FDI receded. United States businesses and investors made more foreign direct investments in Africa in 2017 than did their counterparts from any other country.

Norway retains its No. 1 position in the overall resilience ranking among a mostly reshuffled Top 10. Norway is followed by Denmark (ranked 2nd), Switzerland (3rd), Germany (4th), Finland (5th), Sweden (6th), Luxembourg (7th), Austria (8th), Central United States (9th) and the United Kingdom (10th).

The bottom three countries in the Index are Ethiopia (128th), Venezuela (129th) and Haiti (130th)—all unchanged from last year.

The United States is viewed as three regions in the Index because of their varying exposures to natural hazards. The Eastern region comes in 11th, and the Western region comes in 22nd.

After Rwanda, the 2019 Index’s top risers are Thailand (89th to 73rd) and the Dominican Republic (93rd to 71st). The top fallers are Trinidad (68th to 89th), El Salvador (103rd to 117th) and the newly named Republic of North Macedonia (78th to 100th).

Cybersecurity, a board-level concern, is a key ingredient of resilience and is reflected in the Index. After another year of major cyberattacks, several developed countries strengthened their positions in the inherent cyber risk category, including Germany (up 24 places to 54th), France (up 12 to 89th), Australia (up 11 to 62nd) and the United States (up 9 to 32nd).

The Index, available at www.fmglobal.com/resilienceindex, is designed to help chief financial officers (CFOs) and other business leaders choose resilience as they manage their own risk, site facilities, extend supply chains and cultivate customers, FM Global says.

“Resilience is critical for CFOs as trade conflicts, weakening economies, national elections, Brexit and evolving climate risks prompt companies to rethink their locations and partners,” said Kevin Ingram, executive vice president and chief financial officer at FM Global.

Week in Review Editorial Team:

Diana Mota, Associate Editor and David Anderson, Member Relations