Thursday, September 19, 2013

IIF Meeting in Paris (V) – Global economy outlook

On June 25 and 26, 2013, the Institute of International Finance held its spring membership meeting in Paris. During a fifth roundtable, the participants discussed the changing landscape for institutional investors.

Hung Q. Tran, Executive Managing Director, IIF


In his introduction, Hung Q. Tran refers to the normalization of the global economic outlook.

The US economy is back to trend growth, namely due to a strong recovery of the household sector. He holds that the FED should stop supporting the US economy via accommodative monetary policies, in view of 2.5 % trend growth and less than 2 % inflation. However, as a consequence of a FED’s policy change, financial markets will, in the near future, most likely experience a high level of instability and volatility.

Positive evolutions in the European economy are declining economic imbalances among EU countries and improving current and fiscal account balances, especially in Southern European countries. Adverse developments exist as regards increasing unit labor costs, namely in France and Netherlands, as well as declining interbank lending.

In emerging markets, Hung expects a small decline of investment flows in 2013 and 2014, due to declining growth rates and lower profitability. A key concern for these countries is also the credit growth, especially where banks’ loan book quality is deteriorating and non-bank lending is exploding.

Finally, Hung identifies the declining marginal contribution of debt to growth as the major medium and long term challenge for the US and other developed economies: In other words, any new percentage point of debt will, over time, contribute less and less to economic growth.


The extraordinary measures taken by the FED and all the central banks were in response to the extraordinary weaknesses of the economy after an extraordinarily severe financial crisis.”

In my view, tapering off has been long overdue.”

I think we have a long way to go to that normal [monetary policy] situation.”

The US household is now richer than ever before – higher than the peak before the financial crisis.”

The longer the recession persists, the more non-performing corporate loans will increase.”

The glass [the economic situation in Europe] is half fuller but still half empty.”

It cannot be said that China has a deepening financial sector – it is a bit too deep at the moment.”

The limitation of credit lending and the expanding financial sector is difficult to do with a soft landing.”

The global economy growing at 3 % is dangerous […] because any shock – national or man-made – could get it quickly into recession. […] We are now basically flying without a parachute or without a safety-net – it is worry-some.”

Ramon Aracena, Chief Economist of the Latin America Department, IIF


Ramon divides Latin America, from an economic angle, into three areas:

  • Pacific alliance countries (Columbia, Chile, Mexico, and Peru) have well balanced and consistent macroeconomic policies in place and pursue precise inflation targets. Because of their strong fiscal positions, they will be able to withstand economic policy normalization in the US.
  • On the other end of the spectrum, Venezuela’s and Argentina’s economic institutions lack independence, the countries expropriate property rights regularly, and their governments pursue “populistic anti-market policies”. As they show declining trend growth, these countries will be vulnerable to tapering in the US.
  • Brazil stands in-between the above groups of countries: It might suffer economically because the country is not very open to international trade, its monetary policy lacks consistency, and the Government strongly intervenes in the economy.


The main problem in Brazil now is a confidence problem.”

[Brazil needs] a balanced and coordinated monetary, fiscal, and quasi-fiscal policy, all of them moving in the same direction.”

The problem Brazil is having is that the policy adjustments will be much more difficult to implement […] because of social unrest and social pressures.”

Latin America ranks very badly in terms of competitiveness across the different regions.”

David Hedley, Deputy Director of the Africa and Middle East Department, IIF

David reports on the economic situation in Africa and identifies four major risks for the continent:

  • Inflation remains in excess of 8 %.
  • Current account deficits are important, often in excess of 10 % of GDP.
  • Vulnerability to commodity prices, for example in Kenya, Ghana, and Tanzania
  • Large fiscal deficits are difficult to control, especially because infrastructure needs in African countries are tremendous.

Positive for African countries are, on the other side, the currently declining debt servicing costs, due to recent successful bond placements.

In a spotlight on South Africa, David explain the country’s prevailing monetary policy dilemma: As a matter of fact, South Africa has reasons for both lowering and raising interest rates. Weak economic activity and the need to create jobs suggest lower interest rates while inflation at roughly 5.6 % and depreciating exchange rates back high interest rates.

Lubomir Mitov, Chief Economist of the European Department, IIF


Lubomir’s presentation focuses on central Europe:

In the realm of recessions in Western European countries, central European countries currently experience a sharp drop in foreign direct investment inflows. Furthermore, as European banks deleverage, bank lending in these countries has dropped sharply. Additional internal factors such as weak consumer and business confidence as well as weak domestic demand contribute to fairly sluggish economies in this region.

As reported by Lubomir Mitov, central banks can do little to tackle these problems. They require structural reforms, which are problematic for governments to implement, because of tight fiscal budgets.


There is one single issue which is of importance in the region [Central Europe] – the really disappointing growth performance.”

Fixed investment has been declining almost everywhere [in Central Europe].”

Because the slowdown [of the economy] seems to be mostly structural, policy challenges have become more difficult.”

To summarize, we have very constraint policy options.”

Under these circumstances [unemployment at records lows, inflation at record highs (about 7 %), and pressure on wages] fiscal and monetary policy [in Russia] can do little to boost growth but can do a lot to further push inflation up.”

The odds for a major financial dislocation [in Ukraine] have really increased sharply and are rising. And we are really talking about something big here.”

This [high current account deficits in Turkey in the range of 6-7 % of GDP] is not an alarming situation as long as capital inflows are coming but could become really difficult to handle when capital flows go out.”

What makes Hungary really vulnerable is the very large exposure to foreign exchange risk.”

Patrick Artus, Chief Economist, Natixis

Patrick primarily explains the differences between monetary policies in the US and in Europe.

First, the European Central Bank has traditionally adopted a monetary policy not comprising the purchase or holding of government bonds. Second, different monetary policies in the US and Europe can be explained by the hierarchy between long-term rates and nominal growth: Long-term rates below nominal growth rates have a positive effect on the economy because de-leveraging will become easier and asset prices will go up. The US FED benefits from such a situation whereas Europe, at present, experiences the opposite.

Natixis’ chief economist concludes that it would not be wise for the ECB to follow expansionary monetary policies of the type adopted in the US or Japan. The reasons are the following:

  • Extremely low level of potential growth in Europe (Nominal potential growth of 2 % per year as opposed to 4.5 % per year in the US) which makes it difficult to bring long-term growth rates below potential growth.
  • High debt to GDP ratios in Europe
  • In the US, credit demand has been growing again since 2011. At the same time, credit demand in Europe has collapsed.

According to Patrick Artus, possible solutions for solving the European crisis consist of

  • making European capital markets less segmented country by country;
  • making the quality of banks' balance sheets more transparent;
  • improving technical progress in Europe;
  • making labor markets less rigid and more flexible.


The austerity policies [in Europe] probably – or visibly – have not lead to very successful results.”

There is very little excess liquidity in the Euro area. There is a lot of excess liquidity in the US and Japan.”

The ECB is very much aware of the moral hazard effects that could arise if it were to start buying very aggressively on the government bond markets.”

[Long-term rates below nominal growth] is what is behind the [economic] recovery in the US.”

In theory, there are no clear-cut effects of a very large monetary expansion on the economy.”

My personal view on Japan is that what's been done [the monetary policy] is very detrimental to the Japanese economy and this is very much going in the wrong direction.”

I am absolutely convinced that we will end up with a Yen crisis. At some stage, the balance sheet of the Bank of Japan will become so large that people will start to get out of the Yen. This is an extremely dangerous risk the central bank is taking.”

Europe is so different from the US that it is very unlikely that, what worked in the US, would be efficient in Europe.”

The big problem [for obtaining a fiscal stimulus in Europe] here is the segmentation of capital markets.” “If you want a fiscal stimulus, it's mostly on a country by country basis.”

There is a very significant negative effect of [a high] Debt/GDP ratio on potential growth. […] I am very much worried about what's going on with debt/GDP ratios in Europe.”

You cannot force someone to borrow more if he doesn't want to.”

We have to work on the structures of Europe. Monetary policy will not help very much doing that.”

The effects of very expansionary monetary policies are extremely ambiguous and extremely difficult to credit.”

Paul Donovan, Senior Global Economist, UBS Investment Bank


Paul talks about China and highlights lower growth prospects for the country. In his view, this is mainly due to declining demographics and limited natural resources. This lower growth rate as such is, however, not a major problem for China, because its Inflation has remained lower than expected and helps keeping social stability.

Nevertheless, in the long run, China should keep an eye on its debt level whose growth might become unsustainable.


I don't come with good news […]; I come with less bad news.”

In the longer term, China's growth is clearly lower [around 5.5 % or, in a risk case scenario, about 2 %].”

A natural disaster is good for growth. […] It is not good for standards of living.”

You [the Chinese government] don't want a credit bubble in the first year in office [now], you want it in the ninth year in office.” Therefore, the Chinese government will not allow a credit bubble to burst now.”

I am not worried by the stock of debt in China. Debt of 200 % of GDP is not a problem. This is domestically owned debt.”

Inter-generational wealth transfers can be reversed very easily. There are many ways we can transfer wealth between the generations – something I remind my father of on a weekly basis.”

We cannot have the level of credit growth [in China] that we have seen in the past.”