Tag Archives: IMF

Hungary’s Rating Downgrade Is No Surprise

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The Hungarian government’s erratic policies and populist rhetoric have come home to roost. Moody’s downgraded the country’s sovereign rating to ‘junk’ late yesterday, citing deteriorating growth prospects and a lack of clarity over how the government will rein in public debt. (See Moody’s press release.)

The other ratings agencies still place Hungary on the lowest rung of the investment grade ladder, but I expect that will soon change. The downgrade is no surprise. I’ve dedicated a fair number of posts over the past six months to describing Hungary’s economic and political problems. Some of the links are below:

Hungary’s last-ditch request for IMF help was too little, too late. As I previously noted, the government publicly trumpeted its interest in a deal before notifying its own central bank – or even the IMF itself – which suggests it was merely a ruse to delay a ratings downgrade. (See my Weekly Mishmash: November 22)

Despite the downgrade, the government does not appear to be coming to its senses. Disturbingly, it seems more out-of-touch than ever based on the Economy Ministry’s latest statement:

“Since the decision by Moody’s has no realistic basis, the Hungarian government can only interpret this as being part of a financial attack against Hungary.” (reported by Zoltan Simon and Abdras Gergely of Bloomberg)

There’s no doubt that eurozone turbulence has compounded Hungary’s already serious economic woes, but the real culprit here is the government and its policies. From the effective nationalisation of private pension assets to its ill-conceived mortgage relief plan, the government has consistently shown disregard for the country’s long-term economic health and an unwillingness to take any responsibility.

According to Bloomberg, the yield on Hungary 10-year yields jumped over 9.5%. This rise in borrowing costs and the slide in the forint will accentuate the country’s economic woes. As one reader aptly commented a few weeks back, Hungary is ‘circling the drain.’  Its significant reserve cushion diminishes the threat of a near-term default. However, the government has large chunks of debt coming due next year (see figure below).

Source: Hungary Government Debt Management Agency (AKK)

Will the government swallow its pride and agree to a condition-laden standby agreement with the IMF? It may, but the country is in need of major structural reforms, and I don’t see the current Fidesz-led government having the political will to implement them.

The Weekly Mishmash: November 22

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1. BRICs’ rapid growth tips the global balance
Jim O’Neill, Goldman Sachs

Jim O’Neill is best known for coining the term BRICs a decade ago, when he predicted Brazil, Russia, India and China would be the world’s future growth drivers. He highlights the critical importance of population dynamics in making his call: “Simply applying the most credible estimates of long-term demographic trends, especially for the working population, is the intellectual cornerstone of the argument for the BRICs’ potential.”

EM Muser: Demographics is an oft-ignored area of economics so it’s interesting to hear O’Neill cite it as a ‘cornerstone’ of his BRIC thesis. I think it’s paramount for long-term investors to look at a country’s population dynamics.

The demographic profiles of EMs vary greatly. Many countries in Eastern Europe have profiles similar to those of advanced economies. This will make it hard for them to avoid the public finance strain, productivity loss and slowing economic growth typically associated with aging populations. However, other EMs are still enjoying a demographic divided given their young and growing populations (eg. Brazil, Indonesia, Turkey).  (See my related post: The Double Whammy: Debt and Demographics)

2.  IMF Is No Cure-All for Hungary
Gergo Racz, WSJ Emerging Europe

Hungary surprised markets when it expressed interest in a new IMF agreement. The announcement marks a sharp U-turn from last year when the government abruptly broke off talks with the lender. Even if an agreement is reached, the post notes that the country’s fundamentals remain poor and its sovereign credit rating still teeters on the edge of ‘junk’.

EM Muser: This appears to be a ploy by the government to delay a sovereign credit rating downgrade. The fact that the government publicly expressed interest in an IMF deal before notifying its own central bank – or even the IMF itself – lends support to this idea.

Hungary wants an deal with no strings attached – that is, with no austerity measures. However, I find it hard to believe the IMF will go along without demanding some sort of structural reforms, which the country badly needs. In the meanwhile, the ploy may work, at least temporarily, as the mere prospect of a deal should help prevent borrowing costs from spiking dramatically. (See my recent posts on the country: Hungary’s Latest Debt Relief Plan: From Bad to Worse and Hungary’s Vicious Circle: Anemic Lending and Weak Growth).

3. Argentina: Balance of Payments Crunch?
Daniel Volberg, Morgan Stanley

Volberg describes the significant fall in Argentina’s international reserves, which have declined by more than $5bn since July. While he does not foresee a full-blown currency crisis, he does note several areas for concern, including the country’s deteriorating balance of payments and an acceleration in investors pulling money out of the country following the tightening of capital controls in late October.

Mr. Volberg believes the government’s currency policy could go one of two ways. The good scenario would involve a rise in interest rates to compensate investors for a weakening of the peso in an effort to keep capital from fleeing, while a bad scenario would feature a more severe tightening in capital controls along with a multiple exchange rate regime.

EM Muser: Argentina poses something of a conundrum. I discussed analysts’ widely varying perspectives on the country’s economic success last week. (See The Weekly Mishmash: November 13). On the positive side, the economy expanded by 7.7% in the year through September. However, this fast growth does not appear sustainable.

It’s increasingly clear that the administration’s policies are draining investor confidence and prompting capital to flee the country. President Cristina Fernandez Kirchner is due to announce her new cabinet in early December, which should give more insight into the government’s future policy direction.

4.  Brazil: ‘Pacification’ of Favelas Not Just a Media Circus
Fabiana Frayssinet, Inter Press Service

Last week, roughly 3000 heavily-armed soldiers and police took over Rio de Janeiro’s largest slum, Rocinha. Officials hailed it as a “recovery of territory” by the state.

The occupation is “part of a new security strategy that provides for a permanent community policing presence as well as services and projects for social improvement and infrastructure in favelas, replacing the traditional policy of head-on warfare on the drug gangs.” According to the article, Rio has some 750 favelas with 1.5 million people, about one-third of the city’s total population. The goal is to occupy 40 of them by 2014.

EM Muser: This is huge positive step forward for Brazil that hasn’t received much international attention. I lived in the country about a decade ago and still remember the power of the drug gangs. These are no common thugs. They have anti-aircraft missiles and were powerful enough to shut down Rio on a number of occasions – a pretty mean feat considering it’s a city of roughly 6 million people. In more recent years, they have managed to shoot down police helicopters.

Drug gangs effectively control large swathes of the city, and it’s encouraging to see authorities finally stepping in. In some ways, their hand has been forced. Brazil is hosting the World Cup in 2014 and the Olympics in 2016. These events represent a coming-out part of sorts for the country, and authorities can’t afford to let Brazil’s image be tainted by public security problems.

5.  Putin is booed at martial arts fight
Charles Clover, FT

The crowd unexpectedly heckled Russian President Vladimir Putin at a live televised fighting event. “Mr Putin was seeking to boost the popularity of the hegemonic United Russia party in forthcoming parliamentary elections on Dec 4, but the spectacle showed that the gulf between the regime and the people appears to be widening.”

EM Muser: This is not the first time one of Putin’s publicity stunts has gone awry. Last month, his spokesman admitted that Putin’s discovery of ancient Greek ceramic pieces on a dive in August had been staged (see here). Despite these stumbles, Putin still enjoys a 61% approval rating according to a recent poll and is expected to return to the presidency in 2012.

The Weekly Mishmash: November 2

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1. Regional Economic Prospects: October 2011

European Bank for Reconstruction and Development (EBRD)

Economic fundamentals in emerging Europe are generally better than before the onset of the crisis and the EBRD does not expect another region-wide recession. But it also believes the region now faces greater downside risks.

“[E]xternal shocks may be more severe than in 2008/09 on account of higher stress in the euro zone, including the banking systems, particularly under the downside scenario. There is a risk that the ability of bank groups to pass on support to their subsidiaries in the transition region may be constrained by their national governments. This could result in a substantial reversal of bank debt flows and a large contraction of credit in the region, with potentially severe consequences for output.”

EM Muser: Similar to my recent post (Is the CEE Better Prepared This Time Around?), the EBRD questions whether CEE countries will prove more resilient this time around and hones in on the potential for a severe disruption in cross-border banking flows.

The EBRD advises increased policy coordination along the lines of the Vienna Initiative in 2009, when Western European parent banks collectively pledged to maintain their exposure to the region’s hardest hit countries. The Vienna Initiative was a novel idea that pulled the region back from the brink of a full-fledged crisis. However, such an initiative could prove more difficult to implement this time around given the heightened stress on Western European banks stemming from the eurozone debt crisis.

2. The Past, the People and the Policies

Spyros Andreopoulos, Morgan Stanley

The author examines the forces that have shaped the thinking of today’s central bankers. He notes that the most prominent – Ben Bernanke (US), Adam Posen (UK), Athanasios Orphanides (ECB) – have spent a large amount of time studying ‘depression economics’ – eg. the Great Depression and Japan’s more recent slump. As a result, they believe in avoiding deflation at all costs and in avoiding premature tightening that could tip the economy back into recession.

Andreopoulos notes that this line of thinking comes with certain risks: “In particular, erring on the side of caution likely implies exiting too late, which in turn means elevated medium-term inflation risks. Yet, it is rational for a risk-averse central bank to prefer the lesser of two evils…”

EM Muser: Andreopoulos focuses on advanced economies, but his points are also useful in understanding recent actions of emerging market central banks. Like advanced economies, they face a delicate balancing act.

As the global backdrop darkens, EM central bankers understandably want to cushion the blow on their economies. And since monetary policy works with a lag, several (eg. Brazil, Indonesia, Israel and Turkey) decided to preemptively cut their policy rates, surprising many analysts. (See my post: Giving Turkey’s Central Bank the Benefit of the Doubt). Notably, Turkey has since backtracked and raised its lending rate on Oct 20 due to a sharp depreciation in the lira.

As with advanced economies, cutting rates is a gamble as it raises inflation risks down the line, especially for EM central banks that have fought hard to gain credibility. However, for many, this is the lesser of two evils given the threat of a new global recession.

3. China labour costs soar as wages rise 22%

Simon Rabinovitch, FT

Official data showed minimum wages in the world’s most populous country rose by an average of 22% this year. Labour costs are starting to rival those in other emerging markets, and Vietnam and Bangladesh are among the beneficiaries that are luring low-cost manufacturers and winning market share.

EM Muser: The jump in minimum wages relates to government efforts to calm social tensions and stimulate domestic consumption. However, the rise may backfire as the Economist magazine reports that some businesses, short of cash, are simply not paying their workers. (See: Unpaid wages in China: Can’t pay, won’t pay).

China will continue to offer relatively cheap labour for now, but questions are growing about how long it will last given the country’s demographics. According to UN data, China will add roughly 18 million people to its working-age population in 2011-20, which is paltry compared to the 114 million people added over the past decade.

4. Brics split on euro zone rescue

Carolyn Cohn, Reuters

Emerging markets aren’t going to be the white knights for the eurozone that many had hoped. India and Russia, in particular, are wary of investing in the European Financial Stability Facility (EFSF), although they may still extend financial support through the IMF.

EM Muser: This should not come as a surprise. First, it would be very hard for BRIC leaders to sell their populations on the need for a European bailout when their per-capita incomes are so far below the euro area average.

Second, the big emerging markets have not coordinated well on the international stage, which makes it unlikely the BRICs could successfully reach a joint agreement on a bailout plan. For example, Brazil’s finance minister Guido Mantega let slip in September that a BRIC rescue of the eurozone was a possibility. However, he had failed to consult with the other BRICs before his pronouncement.

The BRICs could exert more influence if they presented a more united front. For example, this spring, many EMs would have loved to place one of their own as head of the IMF. However, they disagreed on who. Europe and the US were better coordinated and managed to stick Christine Lagarde in the top spot. (See my related post: Why Emerging Markets Are Not in the Running for Top IMF Job)

IMF’s Latest Growth Forecasts for China Look Overly Rosy

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The overriding consensus is that China is investing at an unsustainably fast pace. The symptoms include empty malls, shoddily built railways and ghost cities. This investment-led growth model can’t continue indefinitely. The debate for most analysts is not if China will slow, but when and by how much.

As a result, I was surprised by the IMF’s latest forecast that shows growth remaining quite robust over the next five years. China’s economy is expected to grow by over 9% annually in 2012-16, as shown below.

Figure 1:  The IMF sees real GDP growing at an average annual rate of 9.4% over the next five years

Source: IMF World Economic Outlook Database, September 2011

At the same time, the IMF envisages investment falling only slightly as a share of GDP to 46.2% in 2016 from an estimated peak of 48.7% this year. That implies investment will continue to grow strongly (at an average annual rate of roughly 8%) through 2016, even though most analysts agree that China is already over-investing, such that capital is being directed toward activities (eg. ‘white elephant’ construction projects) that are doing nothing to enhance the country’s productive capacity and long-term growth potential.

Figure 2: China’s investment to GDP ratio is far and away the highest among the big EMs, highlighting the economy’s reliance on investment-led growth

Source: IMF World Economic Outlook Database, September 2011

Figure 3: The IMF does not expect any significant shift from the investment-led growth model over the next five years

Source: IMF World Economic Outlook Database, September 2011

I can appreciate the challenges the IMF faces in developing its forecasts. In the same way that it was hard to put a date on when the US housing bubble would pop, it’s also hard to time China’s slowdown and its severity. Nevertheless, a forecast of steady, above-9% GDP growth through 2016 appears overly rosy, especially considering a recent IMF report where the institution acknowledges the risk that over-investment poses to sustainable economic growth.

“[C]ontinued high investment could, down the road and absent sufficient progress in rebalancing, create excess capacity, given uncertain demand prospects in advanced economies, thus risking a hard landing that reverberates beyond China.” (See IMF Country Report, July 2011, pages 5-6) In effect, the IMF appears close to contradicting itself. Very little movement is expected in the investment-to-GDP ratio over the next five years, meaning the IMF does not expect any significant rebalancing toward consumption. At the same time, the institution foresees growth holding steady over the period.

What is interesting is that even the 12th draft of China’s five year plan for 2011-15 stands in sharp contrast to the IMF forecast. The plan foresees GDP growth slowing to an average of 7% annually and targets a rise in domestic consumption.

What Do Analysts Think?

Most China watchers believe some sort of correction is unavoidable, although they do not necessarily see a slowdown as imminent. A number seem to think  the breaking point could come soon after 2013 – a year of transition in the Communist Party leadership.

Patrick Chovanec – an economics professor at Tsinghua University – sees a slowdown as inevitable. “China will have a correction, China needs a correction.” He notes, “There is a tug-of-war between those who say keep lending and let growth continue, versus those who are more concerned about inflation and want to rein it in.” This sounds like the typical battle of words before a bubble pops.

Michael Pettis – a Wall Street veteran and finance professor at Peking University – also sees a slowdown in the offing, but not this year or next: “[A]s long as the Chinese government retains its capacity to raise debt we are not going to see a sharp slowdown in economic growth – at least until 2013.  Any indication that the economy is slowing too quickly will be met with a relaxation of credit controls, and the concomitant rise in investment will spur growth. “

Nouriel Roubini – the New York-based economist who correctly predicted the popping of the US housing bubble – is one of the brave souls to put a date (at least sort of) on China’s slowdown. He sees the bubble bursting after 2013, which is when the change in political leadership is due. “Once increasing fixed investment becomes impossible – most likely after 2013 – China is poised for a sharp slowdown.”

The IMF: An Increasingly European Institution

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Christine Lagarde, France’s former finance minister, now formally helms the IMF. This was no big surprise (See May blog post: Why Emerging Markets Are Not in the Running for Top IMF Job)

Increasingly, the IMF looks like an institution run by and for Europeans. As seen in the chart below, the vast majority of the IMF’s outstanding loans are to European countries.

Source: IMF

Why Emerging Markets Are Not in the Running for Top IMF Job

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Emerging markets’s economic clout is growing, but their influence in international financial institutions (IFIs) has not kept pace.  These economies accounted for almost half of global GDP (on a purchasing power parity basis) in 2010, a sharp increase from their 37% share a decade earlier. Nevertheless, they have only achieved modest reform of IFIs, and no emerging market candidate has ever headed the IMF or World Bank. The recent arrest of Dominique Strauss-Kahn and his subsequent resignation as IMF head has brought this issue to the fore.

Will an emerging market candidate replace DSK? The short answer is no. French finance minister Christine Lagarde looks almost certain to fill the coveted post.  The most obvious reason for this is that emerging markets’ voting power at the IMF does not match the new global economic reality. However, tradition and a lack of unity among emerging markets themselves are also important factors. Ultimately, the institutions created after World War II, including the IMF and World Bank, will reform or become irrelevant.

Lopsided Voting Power

The US and Europe continue to dominate the IMF through their superior voting power as seen in the graphs below.

*Australia, Canada, Czech Republic, Denmark, Hong Kong, Iceland, Israel, Japan, Korea, New Zealand, Norway, Singapore, Sweden, Switzerland, Taiwan, UK (based on IMF definition of advanced economies outside the US and Euro area)

The IMF trumpeted 2010 as “the year of reform,” even though there was not much change. The IMF claims that 6% of the voting power will be transferred to emerging markets in coming years. However, critics have noted that some of this transfer results from reduced voting shares for other developing economies, meaning advanced economies will still control a sizeable majority – around 55% – of total votes. Moreover, the US will retain its veto over key IMF decisions.  Details on the current formula for allocating votes is available here.

Tradition

The IMF and World Bank can trace their origins back to the 1946 Bretton Woods Conference following World War II. Since that time, a European has always stood at the helm of the IMF, while the US has appointed the World Bank head.

There is a raging debate right now about whether a European should remain in the top spot. See Wolfgang  Munchau for the arguments in favour of a European candidate and Martin Wolf who takes the opposing view. The main gist of Munchau’s argument is that a European is better positioned to lead the institution right now given the turmoil in the euro zone periphery and given that most of the IMF’s outstanding loans are to European countries. Like Wolf, I find this argument to ring hollow. There are plenty of economists and policymakers in other parts of the world who are capable of leading the institution and who would have the advantage of being able to deal with the euro zone problems in a more objective manner than a European. Where were the voices calling for an Asian IMF head during the Asian financial crisis in the late 1990s?

Emerging markets do not speak with one voice

It’s easy to pin blame on the US and Europe for not devolving more power to emerging markets, but lack of unity among these countries is a key reason why IMF reform has limped forward at such a slow pace. Statements from various emerging market leaders highlight the collective action problem.

Mexico’s Agustín Carstens put himself forward as a candidate to replace DSK, but Brazil and Peru balked. So there was not even regional solidarity, much less emerging market solidarity. Asia fared somewhat better, with Thailand and the Phillipines appearing to unite behind Singapore’s finance minister, Tharman Shanmugaratnam.

Simon Johnson hits on the issue in a recent Bloomberg column: Who will provide the diplomatic initiative to organise emerging markets behind a single candidate? So far no one is stepping up.  Until that happens, emerging markets will continue to face a collective action problem that results in them punching below their weight in the world’s international financial institutions.