Monday, 8 February 2016

SWF divestment, oil prices and Shifting Wealth in reverse

From a total of $ 1.8 trillion in 2000, global foreign exchange reserves reached a peak of $ 12 trillion by mid-2014. China alone stockpiled reserves from $ 170 billion in 2000 to $ 4 trillion in August 2014, in order to contain appreciation pressures. High oil and metal prices, a result of China´s rapid industrialization and urbanization, funded not only the build-up of FX reserves mostly invested in US Treasury bills but also fueled real assets recycled into world equities, property, and collectibles.  So oil-loaded sovereign wealth funds (SWFs) became an alternative to merely accumulating official foreign exchange reserves, with the explicit mandate to invest “excess” reserves in higher-yielding assets (Reisen, 2008)[1].  Surging exports and oil prices produced a significant shift in the world’s net wealth in favour of those emerging economies running surpluses; mostly held by governments, assets were also de-privatised. In 2008, I had dubbed this process ´Shifting Wealth´, a term still popular at the OECD (OECD, 2010)[2].
´Shifting Wealth´ is going into reverse these days. Since mid-2014, both emerging economies´ FX reserves and SWF assets have dropped a result of lower commodity prices and lower gross capital inflows. The slowdown and rebalancing in China and tumbling commodity prices have started to produce a gradual melting of foreign assets being held by the world´s nouveaux riches. China´s FX reserves a now down by $ 800 bn to $3.2 trn, still the world´s largest. Saudi FX reserves have tumbled from $ 2.8 trn to $ 2.3 trn, Russia´s from $ 0.6 trn to $ 0.37 trn. From their peak reached in mid-2014, these three countries alone have lowered FX reserves by $1.5 trn. While everybody worries about a US Fed in tightening mode, it is largely ignored that the shrinking balance sheets of emerging economies´ central banks have tightened global liquidity considerably, especially since mid-2015.
Since then, the broader markets for risk assets have stalled and are nowadays tumbling.  The FT cites asset managers who find that “Sovereign wealth funds drive turbulent trading”, to explain sharply lower stock markets since early 2016: “We know that sovereign wealth funds are under pressure to sell and that is contributing to the market pressure we are seeing”. And “Sovereign wealth funds have become forced sellers”. These statements are in strong contrast to those who have hailed SWFs as ideal long-term investors for infrastructure finance or development banks, not least for their long-term liabilities. SWFs as forced sellers were not conceived to happen. In a 2008 speech, the World Bank president, Robert Zoellick, had called on SWFs from the Middle East and Asia to invest 1 percent of their assets in Africa.

Table 1: SWF assets, end 2014 v end 2015, $bn
* China Investment Corporation, SAFE, HK Monetary Authority, National Social Security Fund
** Abu Dhabi Investment Authority, Investment Corporation Dubai, Abu Dhabi Investment Council
*** Gov´t of Singapore Investment Corporation, Temasek

Table 1 tries to shed some light on the obscure world of SWFs. Except for Saudi Arabia and Norway, there is little evidence for melting SWF assets until end 2015. This finding may be due to incomplete records, dollar movements and hide developments up to and since mid-2015 as only year-end data are available. And the table doesn´t reveal whether SWs have already withdrawn from equities and driven up their cash in the wake of higher risk aversion and tightening global liquidity. Although it seems to confirm the stability of SWF assets despite commodity headwinds, Table 1 hides a big warning for holders of risk assets worldwide: You ain´t seen nothing yet!

Table 2: Fiscal breakeven Brent prices, $/barrel
2014 (avg $/b 99.9)
2015 (avg $/b 53.6)
2016 (avg. $/b 42.5)
Memo: Nigeria
Source: Deutsche Bank Research, Updating fiscal breakevens for EM oil producers, 29 January 2016

Oil dependent governments may start to raid their SWFs to prop up their economies and political survival as tax receipts fall on the back of the fall in the price of oil. An interesting analysis by Deutsche Bank has calculated the fiscal breakeven points for various oil-producing countries. It shows that fiscal adjustments have happened and are expected for the future in those countries. But the fiscal adjustment is just too painful and limited to stem the fiscal breakeven Brent price above the estimated brent price/barrel. Note that the current Brent price hovers around $30/barrel and is thus far below the price that Deutsche Bank estimate for the average of 2016. So beware of those “anti-cyclical” “long-term” investors, the oil-loaded SWFs.

Monday, 4 January 2016

Boom, Doom, Gloom & Africa

"Africa´s Boom is Over", pronounced an article in Foreign Policy on New Year´s eve. One of the conclusions: "Without the commodities boom, the actual failure of Africa’s development has now been laid bare". The gloom echoes recent forecasts by the IMF, notably its Regional Economic Outlook: Sub-Saharan Africa 2015, released last October. An often-used conceit, just as in the IMF´s WEO released the same month, is that of "headwinds" that Africa encounters as raw material prices have crashed and large emerging economies are slowing down. Africa counts 10 net oil exporters and 15 net nonrenewable exporters among its 54 countries. While these 29 countries do not constitute a majority of Africa in terms of country numbers, they command a large majority of Africa´s GDP and population.

While the winds of change connected to the slowdown in the majority of emerging countries (with the notable exception of India) may well imply considerable headwinds, the rebalancing of China in particular may also provide backwinds for Africa. China´s reforms aim at rebalancing the composition of growth in China toward consumption and away from investment. Such reforms are compatible with a rise of the real exchange rate (higher prices for nontraded services relative to tradable manufactures), of inflation-adjusted wages and of the level of domestic absorption in China. Such a process may affect Africa in several ways:

·         The price of energy and industrial commodities drops as a result of both the slowdown and the rebalancing. The biggest winners are those countries with either large energy import needs or relatively fewer commodity exports, such as Kenya and Tanzania (where the fuel share of imports exceeds 25%), and to a lesser extent Ethiopia and Mozambique. Africa’s centre of economic gravity is thus likely to shift from west to east, to the less commodity-dependent economies of Ethiopia, Kenya, Mozambique, Tanzania, and Uganda. Investment finance will follow this shift, reinforced by the peripheral outreach of China´s One Belt One Road initiative that includes East Africa for infrastructure finance[i].
·         Prices for soft commodities should be supported by China´s rebalancing as coffee, tea and protein-based (soya, for example) are consumed and imported more than before. However, the supply elasticity of soft commodities is higher than for exhaustible resources, so the price impact should be contained. Still, higher export volumes (at stable prices) will translate into higher export proceeds and government revenue in African soft-commodity producers.
·         To the extent that rising wages in China lead to higher labour unit cost, external competitiveness in low-end manufactures will be eroded. With incentives for some industries to move offshore, part of this relocation will involve sub-Saharan Africa (such as to the East African  garment-production). China could expand its current presence in sub-Saharan Africa’s pilot special economic zones, or encourage creation of new ones. The relocation of Chinese firms into Africa should lead to increases in factor productivity and shifts in global trade shares from China to Africa. Thus, all of Africa might experience positive effects as countries in the region are able to build domestic industries based on China relocating a portion of its manufacturing base permanently to the region. 

To be sure, the relocation process takes time, and it takes longer for the gains to be realized than the immediate income losses suffered by commodity exporters. But it´s not all doom and gloom in Africa.

[i] China’s new Silk Road Fund is an acknowledgement of this. It seeks to facilitate trade links with a number of frontier and emerging markets through a USD 40 billion infrastructure investment fund. In Africa, the fund is targeting the economies along the eastern seaboard, which suggests a shift away from China’s traditional focus on securing natural resources towards one more focused on exploring the opportunities for establishing a manufacturing hub in the region.


Tuesday, 1 December 2015

FfD3 Hopes Meet EM Slowdown in Africa

Just a little while ago (last July), they were so hopeful when adopting the Addis Ababa Action Agenda of the Third International Conference on Financing for Development (FfD3):

“We, the Heads of State and Government and High Representatives, gathered in Addis Ababa from 13 to 16 July 2015, affirm our strong political commitment to address the challenge of financing and creating an enabling environment at all levels for sustainable development in the spirit of global partnership and solidarity. We reaffirm and build on the 2002 Monterrey Consensus and the 2008 Doha Declaration.”

… and so on…  The SDG tanker had been set on course, and little attention seems to have been  given to the slowdown in most large emerging economies (EM) nor to the risk that ample liquidity driven by OECD monetary policy will not last forever. Poor countries´ challenging economic backdrop dominated by falling commodity prices, lower demand from China and the prospects of the Fed eventually hiking rates, all that was largely ignored in the official FfD3 documents

But consider the prospects of mobilizing foreign and domestic resources in Africa, which has become increasingly China centric over the last 15 years. According to the IMF latest (October 2015) Regional Economic Outlook on Sub-Saharan Africa, aptly subtitled “Dealing with the Gathering Clouds”, Africa´s recent good macro performance has rested on three pillars: high commodity prices; associated capital inflows; and better policies and institutions. Wasn´t the Fund consulted during the FfD process? Or was it simply ignored?

Figure 1: Commodity Prices August 2015, 2016 Projections
% change since January 2013

Source: IMF (2015), “Dealing with the Gathering Clouds”, October.

The first pillar, commodity prices, has broken over the last three years (Figure 1). Sub-Saharan Africa counts 8 net oil exporters and 15 net nonrenewable exporters. The prices of their main export staple - fossil fuels and metals - have crashed by between more than 60 and 30 percent during that period. Oil exporters are hard hit: If oil exports constitute 40 percent of a country´s GDP, an annual drop in oil prices by 25 percent translates into an income effect of minus ten percent. To be sure, commodity prices may fall even further; they may stagnate from now on; and they may rise again. Only the rise of commodity prices would alleviate African producers. Don´t bet on it, says Carmen Reinhard (2015)[1]: price declines typically retain downward momentum. By the end of the boom, many commodity exporters had already initiated investment projects to expand production. As these investments bear fruit, the increased supply will sustain downward pressure on prices. For minerals, short-term supply is price-inelastic: a result of near-insurmountable barriers to exit and a significant proportion of fixed costs.

The second pillar, net capital inflows, is so far surprisingly unaffected prima facie. The IMF WEO, released last October, still projects a small surplus (0.4% of GDP) in the capital account for Sub-Saharan Africa. DB Research[2] produces fresh evidence that Eurobond issuance by Sub-Saharan African frontier sovereigns (excluding South Africa) has held up remarkably well in 2015.

Figure 2: Change in Debt Service Cost, Sub-Saharan Africa 2015

However, issuers had to offer significantly higher yields than previously and yields on secondary markets jumped to multi-year highs (Figure 2):
·         While Emerging Market Bond Index Global (EMBIG) spreads have moved up since October 2014 by less than 100 basis points (bp), sub-Saharan sovereign bond spreads have risen by between 120 bp (South Africa) and almost 500 bp in Zambia.
·         As all outstanding sovereign Eurobonds in SSA are denominated in USD, any depreciation will have a direct effect on the local currency value of debt service payments. This is potentially even more harmful for interest burdens than rising spreads. The drop since summer 2014 against the USD has been most severe for the Zambian kwacha, the Angolan kwanza, the Namibian dollar, the Ugandan shilling and the Tanzanian shilling which lost between 51% and 20% yoy against the USD, as of November 2015. Zambia has been hit hardest: debt service cost rose in 2015 by 18 percentage points of GDP (left hand scale in Fig. 2) and by 106% in local currency terms (right hand scale).

The difference between rising local currency cost of Eurobonds – around 20% on average in SSA - and the drop in growth rates to low single digits makes for terrible debt dynamics, which is unlikely to be compensated by a corresponding surplus in the non-interest account.[3]

This leaves us with the third pillar, better policies. In the realm of development finance, this translates above all into improved tax collection. Recent IMF analysis (“Dealing with the Gathering Clouds”) suggests that the median country in sub-Saharan Africa might have a potential for another 3 to 6.5 percentage points increase in tax revenue. AID spel

[1] Reinhard, Carmen (2015), “The Commodity Roller Coaster”, Project Syndicate, 9 November.
[2] Masetti, Oliver (2015), „African Eurobonds: Will the Boom Continue?“, Deutsche Bank Research, Research Briefing, 16th November, Frankfurt/Main.
[3] Debt dynamics for a country´s local currency debt-GDP ratio eD/Y are driven by e(r-n)D + (G-T), with e the real exchange rate, r real interest cost, n real growth rate, D/Y the debt-GDP ratio and (G-T) the non-interest deficit. The same debt-dynamics equation can be applied to public finance.

Sunday, 8 November 2015

Africa´s Resource Gaps are Tightening

The structural slowing of potential output growth in emerging market economies that led to lower commodity prices has been simulated in the latest IMF WEO, released in October 2015 (Scenario Box 1, p 25). In particular, the marked decline in investment and growth in China—together with the generalized slowdown across emerging market economies—implies a sizable weakening of commodity prices, particularly those for metals, resulting in a weakening of the terms of trade for commodity exporters. Lower expected growth leads to lower investment. Africa´s resource mobilization might tighten via the various resource constraints for investment and output. The Bacha (1990) three-gap model has highlighted the foreign-exchange constraint, the private domestic-saving constraint and the fiscal constraint[1].

Countries at early stages of development (optimally) pursue an investment-based strategy, which relies on existing firms and managers to maximize investment.  Most of Africa is still at that early stage. High domestic savings and investment rates have underpinned latecomer development in the 19th century in Europe and in the 20th century in Asia. In Africa growth after 2000 tended to be higher in countries with higher investment shares in GDP, as discussed at length in AEO 2014),and investment tended to be higher in countries with higher national savings. 

Table 1: Variables to Determine Financing Needs
Structural, rigid short term
·         Import content of investment
·         Crowding-in coefficient 
·         Global interest rate
Policy, rigid short term
·         Private savings 
·         Remittances 
·         Net factor payments abroad 
·         Net capital inflows: of which
direct foreign and portfolio equity investment
·         Private investment 
·         Exports 
·         Imports
·         Exchange rate, in monetary union
Policy, manageable
·         Public investment 
·         Change in FX reserves 
·         Exchange rate, unless monetary union
·         Net capital inflows, of which
Loans, foreign bonds and aid inflows

The gap model provides a consistent list of variables that matter for resource mobilization in Africa. To be sure, only some of those variables can be influenced by policy, at least in the short term. Therefore, the gap equations also provide the basis – as was their historical motivation 50 years ago already – to quantify Africa´s public financing needs. Table 1 attempts to classify the variables into three categories, although the underlying distinctions may be fluid and somewhat arbitrary: structural (rigid short term); policy (rigid short term); and policy (manageable). 

Investment in Sub-Saharan Africa has traditionally been constrained by low domestic savings. Only in the ´golden decade´ of the 2000s the region recorded a saving rate that averaged almost a fifth of its combined output.  Since 2009, Africa´s saving rate has been declining, and the IMF projects for 2015 the domestic savings rate to drop even further (Table 2), to a meagre 15.4 percent of GDP. This compares to an average saving rate of 31.9 percent projected for the total of emerging and developing countries in 2015. Sub-Saharan Africa is the developing region with the world´s lowest saving rate. First and foremost, investment and future output are saving constrained.

 Table 2: Financial Balances 2001-08 and 2015p,
SS Africa and Total Emerging and Developing Countries (EMDC)
- percent of GDP -

As domestic investment is projected to remain sustained at more than 20 percent of GDP in the Fund projections but savings are depressed, the current account is pushed into deficits, exceeding five percent of combined GDP in Sub-Saharan Africa. The projected deficit on Africa´s current account is consequently considerable, mostly financed by running down official reserves. This begs the danger of currency attacks, with subsequent currency mismatches and balance-sheet recession.

[1] Edmar l. Bacha (1990), “A three-gap model of foreign transfers and the GDP growth rate in developing countries”, Journal of Development Economics, Vol. 32, Issue 2, April, pp. 279–296, doi:10.1016/0304-3878(90)90039-E. While it can be objected that the gap model is too structuralist, it seems relevant in the current African situation as several constraints can be taken as given for short-term analysis.

Monday, 28 September 2015

Headwinds ahead for Piketty´s r>g?

Fast rewind some 40 years back:  The initial opening of China and India to world markets really became felt from the 1980s – a ‘one-off’ event that integrated 2 billion people or 40% of global labour force in the global market economy. The opening to trade increased the share of workers with basic education in the world labour force and lowered the world average capital/labour ratio. The relative endowments of other countries were thus shifted in the opposite directions, which tended to move their comparative advantage away from labour-intensive manufacturing (Wood and Mayer, 2012[1]).
The impact on real wages in advanced countries is easily captured in a simple Cobb-Douglas production function. With factor shares a third each for labour, capital, and Know How (Mankiw, Romer & Weil, 1992[2]), I had estimated that the mechanical opening impact on global real equilibrium wages was round 16.5% (Wolf, 2006[3]). A doubling of the global labour force with basic skills had halved labour productivity on impact; multiplied with the labour share of 0.33 produced the result[4]. Moreover, a sharp increase in the prime working age population added to the larger global labour force. The joint effect of the initial opening of the Asian giants and demographic factors pushed real wages lower and inequality much higher in the advanced economies.
Meanwhile, the drop in capital per labour combined with global imbalances supported corporate profits, capital returns and interest rates. Francis and Veronica Warnock had shown that international capital flows have an economically important effect on the most important price in the largest economy in the world, that of the ten-year U.S. Treasury bond[5]. Their analysis indicated that roughly two-thirds of the impact comes directly from East Asian sources. In addition, some of the foreign flows were owed to the recycling of metal- and petrodollars, as oil and metal exporters benefited from China´s motorization, urbanization and industrialization.
In his celebrated book[6], Thomas Piketty had established that capitalism had a fundamental force for divergence and greater wealth inequality, summed up in the inequality r>g. The formula relates the rate of return on capital (r) to the rate of economic growth (g), where r includes profits, dividends, interest, rents and other income from capital; g is measured in income (wages) or output. Note that Piketty in his book had conceded that the inert trend towards higher inequality was reversed between 1930 and 1975, due to some rather ´unique´ circumstances. Interestingly, 1975 coincides with the beginning of Shifting Wealth Phase I, which has come to an end a couple of years ago. Maybe, those circumstances that had disturbed that inert capitalist trend toward higher inequality were not that ´unique´, after all?
A new fascinating study headed by Charles Goodhart[7] marshal evidence to answer the question “Is Piketty history? We think so”.  The study focuses on the projected trajectory of global working age population (see Figure). Just as a larger labour pool pushed real wages lower and inequality up in the advanced countries, it is argued, a smaller labour force will lead to rising wages, a larger share of income for labour and a decline in inequality. The yearly rise in global working age population growth has peaked around 2005 at 70 million people; the rise is projected to drop to 30 million by 2040. China will actually face a shrinking labour force pool very soon, while Africa and India continue to see a rising labour force. Migration to advanced countries can dampen the positive wage effect but it must be massive (as in Germany currently).

Working Age Population, 1950 – 2040
yearly changes in million

Source: Morgan Stanley Research, based on UN Population Database

While the depressive impulse on wages is likely to attenuate as a result of changing labour force dynamics, the Morgan Stanley study foresees also an ageing-driven drop in capital returns. The advent of an ageing society will lead to a greater proportionate fall in personal saving than in personal sector investment (housing). The corporate sector is predicted to respond by raising the K/L ratio, i.e., by adding capital to compensate for the factor of production that is getting scarcer and more expensive. The overall rise in the K/L ratio, as the growth of the working population falls, is consistent with some decline in capital returns. However, interest rates are projected to rise as ageing lowers ex ante saving. As a result, the Piketty formula r>g might be replaced by w>r, with wages rise exceeding capital returns and inequality trends abating in advanced countries. Now that would run against against new conventional wisdom! 

[1] Wood, Adrian and Jörg Mayer, “Has China de-industrialized other developing countries?”, Review of World Economics, Vol. 147, 325 – 350.
[2] Mankiw, N.G., D. Romer and D.W. Weil (1992), “A Contribution to the Empirics of Growth”, Quarterly Journal of Economics, Vol. 107.2, May, pp. 407 - 437.
[3] Wolf, Martin (2006), „Answer to Asia´s rise is not to retreat“, Financial Times, 14 March. Martin cites slides of my Basel University lectures.
[4] δw* = δY/L = 1/3(-0,5) = 0,165, derived from Y = αL (1)K;  with δK/L = -0,5; L/Y = 1/3.
[5] Warnock, F. and V. Warnock (2006), “International Capital Flows and U.S. Interest Rates”, NBER Working Paper No. 12560, October.
[6] Piketty, Thomas (2013), Le capital au XXIe siècle, Paris: éditions du Seuil, August.
[7] Goodhart, C., M. Pradhan and P. Pardeshi (2015), Could Demographics Reverse Three Multi-Decade Trends?, Morgan Stanley Research, Global Issues, 15 September. Thanks to Prof. Goodhart for providing me with a copy.