Continental shift – economic outlook

Global growth is in low gear, and the drivers of activity are changing which raises new policy challenges for all, according to the latest World Economic Outlook (WEO) report from the International Monetary Fund (IMF). The picture is mixed across the world and the good news for readers of Commercial Risk Africa is that SubSaharan Africa (SSA) is in the best shape of all—more of that later. Otherwise the overall picture appears to be one of a flattening and convergence rather than the stark contrast we have seen in recent times as Europe and the US threatened to fall into contraction while Asia, Latin America and Africa enjoyed a boom.hideThe IMF says that advanced economies are growing again but must continue financial sector repair, pursue fiscal consolidation and spur job growth. Emerging market economies face the dual challenges of slower growth and tighter global financial conditions. This issue of the IMF’s latest WEO report examines the potential spill-over from these transitions and what it believes are the appropriate policy responses. It also explores how output co-movements are influenced by policy and financial shocks, growth surprises, and other linkages. And, the report assesses why certain emerging market economies were able to avoid the classical boom-and-bust cycle in the face of volatile capital flows during the global financial crisis, not least in Africa. Converging global picture The overall convergence following the period of stark global contrast is pretty clear. The IMF makes the following top level predictions for the world: The US and Canada: A modest recovery Europe: Supporting the fledgling recovery Asia: A lower growth trajectory Latin America and the Caribbean: Growth is subdued Commonwealth of Independent States: Slower growth amid weak external and internal demand Middle East, North Africa, Afghanistan & Pakistan: Growth hinges on improvements in oil production and confidence SubSaharan Africa: Continued dynamism The outlier is obviously SSA, which remained robust in 2012–13 and is expected to accelerate again in 2014 which the IMF says reflects strong domestic demand in most of the region. It is of course not all plain sailing and risk managers who work for companies with interests and activities in the region would do well to keep a close eye on the details and differing national, regional and sectoral trends. The WEO report warns, for example, that spill-over from sluggish external demand, reversal of capital flows and declines in commodity prices are contributing to somewhat weaker growth prospects in many countries relative to its April 2013 report. “Policies should aim to rebuild room for policy manoeuvring where it has been eroded, and more broadly to mobilise revenue to address social and investment needs. To achieve sustainable and inclusive growth in the medium term, governments should deepen structural reforms and give priority to infrastructure investment and social spending,” advised the WEO. Risk managers tend to have a habit of looking for the bad of course but let’s not forget that the headline news is good before we take a closer look at the outlook for SSA according to the IMF. Overall, growth is projected to increase from about 5% in both 2012 and 2013 to 6% in 2014. This represents a more than half a percentage point downward revision for 2013 relative to the April 2013 WEO for the whole region and close to half a percentage point downward revision for 2014 for the middle income countries. Temporary blip There can be no doubt that what is thankfully forecast to be a temporary blip can be blamed on forces outside of Africa. It was fascinating to see that, a few days before the WEO report was published in mid-October, the African Governors of the World Bank Group and the IMF met in Washington DC to basically tell the Americans and Europeans to pull their socks up and get on with structural reform or else they would damage African growth prospects. Imagine reading those kind of words only 15 years ago—quite a reversal. “We are deeply concerned about the increased downside risks to the global economy and how they impact on us. These downside risks have been amplified in our countries against the backdrop of limited fiscal space, continued decline in commodity prices, declining trade flows and reduced access to concessional funding,” stated the African Governors. “We are also worried about uncertainty regarding the unwinding of unconventional monetary policies and the threat of potentially devastating budgetary challenges in the US which if left unaddressed could derail the fragile recovery. Therefore, we call on policymakers in advanced economies to be aware of negative spill-over of their policy actions and ensure that stimulus exit strategies are communicated clearly,” they continued. And Europe did not escape the tongue-lashing either. “At the same time, we also call upon policy-makers in Europe to urgently complete their reform agenda, including financial sector repair, measured pace of fiscal consolidation and policies that foster global demand,” continued the African Governors. But, as noted above, while risks clearly lurk threatening to peg the SSA growth story back to more ‘normal’ levels there is certainly no need to panic. The pace of growth is expected to pick up again in 2014 and ‘strong investment demand’ continues to support growth in most of the region, said the IMF. The global WEO report is partly based on more focused regional reports. In the case of Africa, the IMF published “Regional Economic Outlook: Sub-Saharan Africa” also in October. This report stated: “The softer outlook for 2013 reflects both a more adverse external environment—characterised by rising financing costs, less dynamic emerging markets and less favourable commodity prices—and diverse domestic factors, including slower investment and weakening consumer confidence in some cases, and adverse supply developments in others.” It added that inflation is expected to maintain its downward trend for a third consecutive year, toward less than 6% for the region by the end of 2014. This offers ‘benign’ prospects for food prices throughout the region and the continuation of prudent monetary policies, stated the IMF. What risks? As noted by the World Bank African Governors, most of the major risks to the outlook for the region stem from external factors, stated the fund’s report. These risks include a further weakening in the emerging market economies that have become some of SubSaharan Africa’s new economic partners and a similar further decline in advanced economies. Commodity price falls would also have a depressing effect on the region, pointed out the IMF. Chapter One of the IMF’s African report presents two alternative scenarios under which large but ‘plausible’ temporary international commodity price shocks are considered. The IMF reckons that a downside scenario would not derail growth at the regional level. But it does believe that growth and current account balances could be ‘significantly affected’ in some resource-intensive countries. “Domestic risks, such as those related to weather and other supply-side shocks or political events, pose important risks to individual countries and perhaps their immediate surroundings, but are less of a threat at the regional level,” concluded the IMF report. Wider deficits Widening current account deficits in SSA since 2008 do not seem to pose immediate concerns, except in a few countries, said the IMF. It explained that, in the aftermath of the global crisis, current account deficits in SSA widened significantly. In most cases this reflected increased investment in export-oriented activities and infrastructure, particularly for development of energy supply and natural resource extraction and lower saving in some countries. “These current account deficits have been largely financed with foreign direct investment, and, except in a few cases, have not resulted in higher external indebtedness,” said the IMF. In the medium term, as investments mature and export capacity increases, current account deficits are expected to narrow; however, in some cases, measures to increase domestic saving would be warranted also. External debt—reduced significantly among low-income countries by debt forgiveness—remains low by historical standards in most countries,” it added. The IMF said that ‘revenue mobilisation’ remains a priority in most countries to help fund priority social and capital spending, and in some cases also to help strengthen buffers. It pointed out that most countries in the region are not constrained from financing by high debt levels, but the IMF still believes that some could find it tricky to raise financing in a downturn. Efforts to keep inflation under control should continue in several countries, added the report. “Countries facing balance of payments pressures arising from declining commodity prices and capital flow reversals should let their currencies adjust where feasible, with foreign exchange intervention limited to preventing disorderly market conditions,” advised the IMF. “All countries should step up efforts to further improve the domestic business climate by streamlining regulations and reducing red tape, and work to improve their economic statistics,” it continued. International companies that have set up shop in Africa and use global programmes to cover their risks will hope that insurance regulators across Europe will take note of that advice. Commodity price pressure The IMF also pointed out that it is often argued that high global commodity prices have fuelled SSA growth. The report noted, however, that while this may be true for many countries, several non resource-rich low-income countries have also been able to sustain high growth rates for a relatively long period. The report therefore decided to focus on a group of six countries that managed to grow fast despite being relatively resource poor: Burkina-Faso, Ethiopia, Mozambique, Rwanda, Tanzania and Uganda. The report’s authors identified several key characteristics that are common to these countries. These are: Improved macroeconomic management; Stronger institutions; Increased aid; and Higher investment in human and physical capital. The experience of these countries demonstrates that improvements in macroeconomic policy, combined with structural reforms and reliable external financing, can foster productive investment and stimulate growth, argued the IMF report. But, despite the robust growth achieved so far in these countries, they still face low productivity and capital stocks, significant infrastructure gaps and limited structural transformation, it added. “Addressing these challenges will require sustained policy efforts and continued growth,” concluded the IMF. Volatile capital flows The third chapter of the report examined the evolution of portfolio and cross-border bank flows in so-called SSA ‘frontier markets’ since 2010. It discussed the various policies that these countries have designed and implemented to reduce risks that stem from the inherent volatility of these flows. The analysis found that, in the past three years, foreign portfolio flows to SSA’s frontier economies have grown considerably and the current bout of global financial market turbulence has so far left most of these countries relatively unscathed. “This muted impact reflects, in part, strong fundamentals and prospects in these economies, but it may also reflect their relatively small and illiquid financial markets,” concluded the IMF team. They argue that, as frontier economies in the region become more integrated with global financial markets, they will also become increasingly vulnerable to global financial shocks. “If the global turmoil persists, risks of contagion and possible reversals may increase,” stated the authors. The IMF therefore recommends that ‘frontier markets in the region strengthen policy frameworks to ensure that access to capital markets is beneficial, with the appropriate combination of policies depending on country-specific circumstances’. Among the key policy recommendations are the following: Enhance monitoring by improving data; Enhance macroeconomic and financial policies to provide policy room in case of capital flow surges or reversals; Improve capacity to effectively use macroprudential policies to prevent systemic financial sector risks that may arise from volatile capital flows; Reinforce the toolkit of capital flow management measures. This bullish outlook was backed up by a report just published by the World Bank’s Multilateral Investment Guarantee Agency (MIGA) focused on political risk, insurance and breach of contract. This report similarly pointed out that Foreign Direct Investment (FDI) in emerging economies had slowed down somewhat in 2013 possibly partly because of an expected monetary easing in the US in particular as it claws its way out of recession. The idea is that investment in emerging markets will be less attractive when potential returns start to recover in the US and other developed markets as interest rates begin to claw back up. But the fact remains that FDI in SSA and Asia remains healthy. The World Bank reports that SSA and South Asia have shown healthy growth this year, achieving 19% and 21% increases in FDI inflows, respectively. In contrast, FDI flows into Europe and Central Asia are expected to fall by 16% this year. The World Bank also reported that South-South investment continues to climb which is good news for Africa as external investment flows are diversified and not so exposed to mature market crashes or stagnation. FDI outflows from developing economies reached a record level of US$164bn in 2012. This represented a record share of 12% of global FDI outflows. Negative paradox The MGIA report pointed out that the improving performance of high income economies may have some ‘paradoxically negative’ consequences for developing ones. “Critically, improved growth in high-income economies has increased the likelihood that their monetary easing policies will come to an end in the near future. In anticipation of that, yields on US Treasury bills have been rising, increasing their attractiveness to investors and causing a portfolio shift from developing to high-income economies,” stated the MGIA. This has caused a reduction in private funds moving to developing economies, and countries that have relied on foreign private flows are now ‘especially vulnerable,’ stated the report. The MGIA pointed out that the quest for yield had applied both to debt as well as to equity flows. Between 2007 and 2013, SubSaharan African countries raised $14bn from sovereign bond issues. The global low interest rate environment was a ‘boon’ to these efforts to raise capital, suggested the MGIA. “While such cheaper finance now looks to be waning, evidence indicates that the reduction is temporary and reflects a shorter-term adjustment process to the end of the monetary cycle, following which it could be expected to recover, reflecting the ongoing yield potential in developing economies,” it added. The investment agency said that estimates for 2013 and 2014 indicate that private capital flows have stagnated but a rebound is projected in 2015. However, the MGIA warns that risks arise if the adjustment process in developing economies is too rapid, or if it exposes serious vulnerabilities in the countries where it occurs. “While some countries may be more at risk than others, overall developing economies appear better equipped than previously to withstand the effects of private capital outflows, should these occur on a larger scale than in the past,” concluded the MGIA on this topic. Overall therefore it seems that the biggest risk to continued dynamic growth in SSA is political and social, not economic. This was strongly backed up by a survey of global CEOs and directors carried out by The Economist Intelligence Unit earlier this year that found that macroeconomic instability and political risk are clearly the biggest potential constraints on emerging markets. Interestingly though the combination of the World Bank and IMF analysis and forecasts and this survey suggests that the economic instability will come from the US and Europe not from Africa itself. This leaves political risk as the clear number one risk to SubSaharan Africa’s growth story for 2014 and beyond.

Continental shift – economic outlook

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