Week in Review

August 19, 2019

Global Roundup

J.P. Morgan says new U.S. tariffs will test China’s ability to prop up its economy. New U.S. tariffs on Chinese goods could deal another blow to the Asian economic giant—and it’s not clear how much more Beijing can do to prop up its economy, an economist from J.P. Morgan said on Aug. 16. (CNBC)

The chilling economic effects of Brexit uncertainty are intensifying. Figures released on Aug. 9 showed that Britain’s GDP shrank in the second quarter. And a growing body of research suggests that Brexit-related uncertainty is doing subtle but serious economic damage. (Economist)

Negative yields: Sweden leads the world below zero. While sub-zero rates have not led to rack and ruin for the banking industry, as many feared, it is not obvious that the policy has been a success. And exiting it may be harder than expected. (Financial Times)

Bond market smells recession amid intensifying global stress. Compared to the free-swinging and sometimes emotional stock market, the bond market is supposed to be the sober and measured one. (Business Mirror)

U.S. retreats on Chinese tariff threats. Some tariffs to be delayed until Dec. 15 on items including smartphones, laptop computers and toys. (WSJ)

South Korea to remove Japan from trade list. South Korea said on Aug. 12 that it has decided to remove Japan from a list of nations receiving preferential treatment in trade, in what was seen as a countermeasure to Tokyo’s recent decision to downgrade Seoul’s trade status amid a diplomatic row. (Business Mirror)

China's economic outlook in six charts. China’s economic growth is moderating and is projected to be 6.2% in 2019. In its latest annual assessment of China’s economy, the IMF found the quality of growth had improved in three ways in 2018. (IMF)

Argentina's Macri shelves sales taxes as he seeks to cut left's lead. Argentine President Mauricio Macri, smarting from a bruising primary election loss, announced on Aug. 15 an end to sales taxes on basic food products until the end of the year in a bid to salvage his re-election prospects and end an economic crisis. (Reuters)

Argentina suffered the second-biggest crash since 1950 for any stock market—and the nation is again on the brink of a financial crisis. The S&P Merval Index plummeted 48% Aug. 12, the second-largest single-day drop for any stock market since 1950. (Markets Insider)

Tech suppliers shift away from China despite Trump tariff delay. HP Inc.-laptop maker Inventec Corp., said it will to shift production of notebooks for the U.S. market out of China within months, adding to the tech industry’s exodus as the world’s two largest economies escalate their trade war. (Bloomberg)

Hong Kong risks an economic fate worse than recession. Already hurting from the U.S.-China trade war, Hong Kong’s economy could be facing something much worse than a recession. (Bloomberg)

The United States is losing Latin America to China. In Latin America, hard power is of limited utility; soft power through economic and diplomatic influence will carry the day in the region. (National Interest)

Hong Kong protests will be “settled or crushed” ahead of China national celebrations, analyst says. The months-long protests in Hong Kong could come to an end soon, according to strategist David Roche, who said they will “be settled or crushed” before October 1—the 70th anniversary of China’s National Day. (CNBC)

Argentina Lurches Back into Crisis

Chris Kuehl, Ph.D., NACM Economist

The latest election in Argentina shocked the sitting president and much of the region as Mauricio Macri was able to poll only 33% of the primary votes as compared to his populist challenger, Alberto Fernandez, who gathered 47%.

At this point, it is clear that the populist would win the presidency in October’s election. It was only a few years ago that Macri was hailed as the man who would rescue the nation from the disastrous economic policies put in place by his predecessor, Cristina Fernandez de Kirchner. Now, she is the running mate of the man who could win a first-round victory at the end of October (only 45% support is required). The population is not happy with the economic realities in Argentina and is blaming Macri for them. The voter now seems to believe that returning to the previous set of policies would be an improvement—all evidence to the contrary.

The disaster that was the Argentine economy under Fernandez has apparently been forgotten because the new incarnation of that party is suggesting nothing new. The damage to the economy was extensive as exports plummeted, unemployment soared, debt levels rose dramatically and the country became an international financial pariah. Farmers grew so frustrated by the export restrictions that they destroyed their output rather than accept the prices set by the government. Wages fell, businesses went into bankruptcy and the value of the peso collapsed.

The people around Cristina Fernandez were as corrupt as any seen in the country for decades, and the entire nation was teetering on the edge of utter economic collapse. Macri had been the mayor of Buenos Aires and had been seen as clean and a reformer. Initially, his market reforms had the desired impact and the economy improved as international investment came back. The problem is global economics turned sour for the Argentine economy along with everybody else’s.

Trade with Brazil fell off when Jair Bolsonaro won the election and the Brazilian economy started to falter. The European market dried up as the eurozone nations saw growth fall to less than 1%, and the U.S. has not picked up any of that slack. Then came the real death blow. The Argentine economy depends heavily on its agricultural exports. Over the years, the focus of that business has been China. The Chinese still buy from Argentina, but their slowdown has meant less demand for goods from all the nations that once supplied the rapidly growing Chinese market. The lack of an active export market has gutted the Argentine economy. Unfortunately, there is very little that can be done about it.

The nostrums offered by the populists are the same as offered before. Taxes on the “rich” will be hiked. What that really means is the middle class, as the rich will either shelter their incomes or flee as they have in the past. The government will borrow heavily through the sale of bonds that will carry very high yields as they are considered very risky. The previous Fernandez government defaulted on bonds and only the most risk-tolerant will invest now, but not without forcing the government to offer very high interest rates that it can ill-afford to pay back—setting up another default. There will be export restrictions on farm output to ensure domestic food prices stay low, but it will not work out that way as the farmers will simply refuse to produce if they can’t get paid. The last time this was tried, the farmers were expected to produce even though it cost them twice what they would be paid.

Global investors are already pulling back, and the stampede will truly begin later in the year if Macri’s numbers do not improve. There is one faint hope—that these primary numbers are really just protest numbers. The voter could be sending a signal of distress now, but will not want to return to the bad old days and will support Macri in the end. If one adds the 8.5% of the primary vote earned by the former Economy Minister Roberto Lavagna to the 32.7% for Macri, one gets 41.2, just short of what the populists are getting. It all depends on how willing voters are to be fooled into thinking that failed policies from the past will work this time.

New Shipping Regulation Only Months Away

A new shipping regulation is creeping up in the rearview mirror with just months to comply or face penalties. While the new regulation is aimed at protecting the environment and those living near ports, there are many implications surrounding the new guideline for the amount of sulphur in a ship’s fuel oil.

Krista Gauer, credit analyst with Houston-based O’Rourke Petroleum, has started receiving credit line increase requests, but they’re not detailed in regard to pricing and fuel supply and demand. O’Rourke often gets fuel from the refinery and then supplies it to shipping companies either midstream or dockside. IHS Markit expects low sulphur fuel to be priced at roughly $680 a ton, which is 30% higher than regular fuel.

IMO 2020 goes into effect Jan. 1, 2020, and was established several years ago to reduce air pollution and promote healthy living. The sulphur content in fuel will need to be reduced by about 85% from the current levels (3.5% mass by mass to 0.5% m/m). Penalties for carrying noncompliant fuel oil will take effect March 1, 2020. Liquified natural gas, marine gas oil and scrubbed high sulphur fuel are all alternatives to the current fuel in use. Since Jan. 1, 2015, the Emission Control Areas, such as North America and Northern Europe, have limited sulphur emissions to 0.1%.

“There is no free ride to reducing emissions,” states an IHS Markit report, referring to the cost of using safer fuel. Depending on several factors, including the size of the ship, the total cost per ship of scrubbing high sulphur fuel ranges between $2 million and $8 million. “The volatility in prices will create trading opportunities and fuel consumers will need increased credit lines from fuel producers,” said Aftab Saleem, director of risk analytics advisory with KPMG, in a Forbes article.

Gauer started receiving the requests in the last several weeks. She did preliminary credit bumps in March and April prior to the initial requests due to IMO 2020, but she expects the credit line increases to continue as 2020 nears. IHS Markit expects upward of 90% of ships to comply with IMO 2020; however, there is already one country that will not. Indonesia announced in late July it will not enforce IMO 2020.

“Fuel prices for fuel with a maximum of 0.5% is more expensive and will increase operational costs of the ship, that will affect the logistics costs and prices of goods,” said a Ministry of Transportation official, according to Reuters. The country will allow ships flying the Indonesian flag to continue using fuel with a maximum of 3.5% m/m within territorial waters.

—Michael Miller, NACM managing editor

Hong Kong: Autonomy under Threat 

The PRS Group

Hong Kong’s reputation as one of the most hospitable places for doing business has been brought into question by a campaign of mass public protests triggered by an extradition measure that threatened to further erode the legal autonomy that is a fundamental element of the “one country, two systems” model. Although Chief Executive Carrie Lam has withdrawn the offending legislation, the political demonstrations have persisted, with protesters demanding genuine democracy for the special administrative region, and officials in Beijing signaling that they are in no mood for compromise and are losing patience. 

The Chinese government has displayed restraint to date, reflecting Beijing’s acknowledgment that direct intervention to end the disruptive protests would trigger immediate capital flight and undermine confidence in the independence of Hong Kong’s legal and financial systems, and would also complicate efforts to end the tariff war with the U.S. by concluding a comprehensive trade agreement. That said, Beijing cannot make any major concessions to the protestors without inviting demands for reform on the mainland, where episodes of unrest, while limited, are frequent, a risk that would be especially high with the mainland economy growing at the slowest pace in nearly three decades. 

Government officials in Hong Kong and Beijing will attempt to wait out the protests, as they did when confronted by the so-called Umbrella Movement in 2014, counting on the approach of legislative elections in 2020 to prompt the redirection of political energy toward less provocative forms of activism. However, the elections are still more than a year away, and the militancy already exhibited by some protestors suggests that at least some elements among the demonstrators are intent on provoking conflict. 

Hong Kong’s reputation has been tarnished by a corruption scandal surrounding irregularities related to the applications of two companies for listing on the local stock exchange. Although there is no suspicion surrounding any other employees at HKEX, the negative attention could raise questions about Hong Kong’s role as a major investment hub, particularly at a time when political tensions are already tarnishing its brand. 

Year-on-year real GDP growth slowed to just 0.6% in the first half of 2019, as private consumption nearly came to a halt, while private investment and both exports and imports registered declines. The positive headline figure was almost entirely attributable to an increase in government consumption. 

The ongoing political unrest will continue to dampen investment in the second half of the year, and with an escalation of the U.S.-China trade war more likely than a resolution, any positive contribution from trade will be minimal. A favorable base effect may help to boost the growth rate in the second half of the year, but annual real expansion is likely to come in below 2%, and could be significantly lower if China resorts to direct intervention to quell the unrest in the SAR. 

The analysis above is taken from the July 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.

 Week in Review Editorial Team:

Diana Mota, Associate Editor and David Anderson, Member Relations