Wednesday, September 26, 2012

Bloomberg: BRICs Biggest Currency Depreciation Since 1998 To Worsen
CNNMoney: Will China’s Real Estate Bubble Burst?
FT: China Manufacturers Face Fall in Demand
FT: Chinese Manufacturing Hits Nine-Month Low
FT: China Moves to Lift Property Market
FT: Chinese Property Market Rebounds
FT: Fate of China Property is Global Concern
HSBC: HSBC China Manufacturing PMI
National Bureau of Statistics of China: Sales Prices of Residential Buildings in 70 Medium and Large-sized cities in July
Reuters: China Factor Surveys Signal Economic Growth Easing into Q3
WSJ: Murky Outlook for Dim Sum Market
WSJ: Wage Rises in China May Ease Slowdown
WSJ: Yuan is Luring Bets of a Drop

China’s Economy Shows Signs of Strain

Recent economic indicators show that China’s economic growth was much slower than expected in the first half of this year, and analysts predict that gross domestic product (GDP) growth will slow again next quarter to somewhere below 7.5%—GDP grew 7.6% in the second quarter. Two important issues affecting the Chinese economy are: (1) increased government restrictions in the housing industry, and (2) decreased demand for Chinese products. These relatively poor economic numbers have led the Chinese government to engage in economic stimulus measures such as interest rate cuts and increased spending on investment projects.

Concerns about a housing bubble (rapid increase in housing prices) in China’s developed cities have led the government to clamp down on the housing sector by prohibiting purchases of second homes, toughening mortgage qualifications, imposing residency restrictions, and increasing down payments on property. The housing market in China’s most developed cities, where housing prices are high, accounts for only 25% of the market as a whole. In the rest of the country (the other 75% of the market), however, housing prices are relatively affordable. Yet, government policies designed to correct housing prices in China’s largest cities are discouraging developers from building houses in the rest of the country because the policies lower developers’ profit margins, particularly in rural areas. Moreover, people are discouraged from buying homes due to purchasing restrictions, and many investors do not want to purchase new real estate when property values are on the decline. Decreases in home construction and sales hurt the Chinese economy because property construction accounts for 15% of China’s GDP, and about 10% of economic growth last year is directly attributable to the housing sector. Furthermore, reduction in property construction has a domino effect upon other industries, including steel, heavy machinery manufacturers, and the energy sector.

China’s manufacturing sector already faces tough challenges because demand for Chinese products is decreasing. In the first half of the year, wages for Chinese workers went up 13% from last year, and analysts expect wages to double by 2015 from 2011 levels and triple by 2017. Companies must increase the prices of their products to account for these wage increases. Consequently, many foreign consumers now order these goods from other Asian countries where wages and prices are lower. For example, Euro zone, American and Russian demand for Chinese exports dropped 30% this year. HSBC’s purchasing manager’s index (PMI) (number that is calculated based on purchasing executives’ responses to questionnaires regarding new orders, output, employment, suppliers’ delivery times, and stock of items purchased) for China’s manufacturing sector was posted at 47.6 in August, its lowest level since March 2009, and down from 49.3 in July. Any number below 50 indicates that the manufacturing sector is contracting. HSBC also reported that new orders for goods had declined along with the number of manufacturing jobs. If low demand for Chinese products continues, many more Chinese workers will lose their jobs, which could strain China’s domestic market because these workers will purchase fewer goods.

The Chinese government is introducing various policies to help address the problems in the housing and manufacturing sectors. To help the housing sector, the government has been subsidizing the construction of millions of apartments. However, somewhere between ten and sixty-five million apartments remain empty due to the government’s purchasing restrictions. Chinese Premier Wen Jiabao has also promised to give exporters a tax rebate to help ease the pressure on the manufacturing industry. Furthermore, the government has cut interest rates twice this year, approved numerous investment projects, and lowered the amount of money that Chinese banks must keep on hand. Such measures should encourage lending and development projects. Many analysts also predict that the Chinese government will employ monetary easing policies such as lowering interest rates on loans even further and increasing the money supply. This will make Chinese exports more affordable on the world market because the value of the yuan against foreign currencies will decrease.

Wednesday, September 19, 2012

Fiscally Cautious Countries Hesitate to Join Eurozone Amid Fears of Future Bailouts

Bloomberg: Bulgaria’s Stability Will Attract Investment, Barroso Says
Bloomberg: Lithuania to Adopt Euro when Europe is Ready, Kubilius Says
European Commission: Enlargement Website
European Commission: Economic and Financial Affairs Website 
WSJ: Bulgaria’s Lesson for Euro-Skeptics
WSJ: Bulgaria Shelves Plan to Join Ailing Euro Bloc

Fiscally cautious European Union (EU) member countries, including Bulgaria, Lithuania, and Latvia, have recently postponed plans to adopt the euro as their official currency due to concerns over future bailouts for weaker members. There are 27 member countries in the EU, 17 of which have adopted the euro (the Eurozone). The remaining ten countries, with the exception of the United Kingdom (U.K.) and Denmark (who both “opted-out” of the euro), are expected to replace their national currencies with the euro when their economies meet the Eurozone’s  entrance criteria. This criteria includes debt-to-GDP (gross domestic product) ratios below 60%, deficit-to-GDP ratios below 3%, stable exchange rates, low consumer price inflation, and low long-term interest rates.

However, on September 3, 2012, Bulgaria, which joined the European Union in 2007, indefinitely postponed its plans to join the Eurozone. Although the country remains one of the region’s poorest member states, its current debt-to-GDP ratio of 15.3% is one of the lowest in Europe. Although Bulgaria’s leadership anticipates meeting the criteria necessary to join the Eurozone by 2013, the government has decided to keep its own national currency (the lev) for the time being. Bulgaria’s Finance Minister, Simeon Djankov, attributes this decision to the uncertainty of future bailouts, such as those for struggling countries like Spain and Greece. Djankov commented that, “The public rightly wants to know who would we have to bail out when we join?” He went on to say that if his country joined the Eurozone, the lack of fiscal discipline among the region’s weaker members to reduce their deficits and debts could negatively impact Bulgaria’s relatively strong economic growth rate.

Bulgaria’s announcement follows decisions made in August by the Lithuanian and Latvian governments to postpone their own plans to adopt the euro. Lithuania and Latvia, who both joined the EU in 2004, expect to meet the criteria necessary to join the Eurozone by 2014. However, Lithuania’s Prime Minister, Andrius Kubilius, stated that the country would not adopt the euro until there is a stable situation in the Eurozone and it is clear the group is ready for expansion. Similarly, Latvia’s Prime Minister, Valdis Dombrovskis, also backed away from switching to the euro in 2014. Dombrovskis attributed Latvia’s decision to the Eurozone’s failure to control member countries that choose to violate rules on budget deficits, debt, and inflation. If Eurozone countries do not bring their deficits and debts under control, the need for more bailouts would hurt fiscally conservative countries like Latvia.

The decisions by Bulgaria, Lithuania, and Latvia are not evidence that EU member countries find a single, common currency undesirable. Rather, the decisions reflect concern about their liability for future bailouts of weaker countries, and the uncertainty surrounding the Eurozone’s resulting move toward tighter financial integration among members. Bulgaria, Lithuania, and Latvia’s desire for a common currency is demonstrated by the fact that these countries currently tie the exchange rates of their national currencies to the euro. This allows the countries to experience many of the benefits that come from participation in the Eurozone’s monetary union, while avoiding many of the problems associated with bailouts and the loss of control over their own financial decisions.

Saturday, September 15, 2012

Canada’s Flaherty Remains Skeptical of Global Risks Despite Positive Economic Indicators

On Friday, August 31, 2012, Canada’s Finance Minister Jim Flaherty reported positive economic indicators and acknowledged global risks that threaten the Canadian economy. Flaherty announced the country’s second-quarter gross domestic product (GDP) growth rate of 1.8%, the best among the G7 countries (Canada, France, Germany, Italy, Japan, the United Kingdom, and the United States). Statistics Canada credits business investment for this growth, which grew by 2.3% compared to last quarter.

Flaherty also announced that the government’s budget deficit—a negative balance between government revenues (e.g. taxes) and government spending—is 1.14 billion Canadian dollars (C$), which is half of last year’s C$2.26 billion budget deficit. Canada slashed its budget deficit by increasing its tax revenues and decreasing its government spending. Tax revenues in June 2012 increased 4.2% to C$20.49 billion compared to June 2011 due to increases in the income tax rate and the Employment Insurance rate—a percentage of Canadians’ earnings paid to the Employment Insurance system in exchange for unemployment benefits. Government spending in June 2012 declined 1.3% to C$19.07 billion compared to June 2011, which was largely due to a 14% spending cut in the defense department.

Despite an increased GDP growth rate and a decreased budget deficit, Flaherty warned that the Canadian economy still faces the risk of an economic downturn. Because Canada competes on a global scale, it faces risks in the global economy. For instance, the on-going European debt crisis and the slow expansion of emerging economies caused the prices of commodities to fall, as investors fear that the demand for commodities will continue to decrease if Europe and emerging economies fail to stimulate their economies. These risks affected Canada as the prices of Canada’s commodities fell by 5.1% compared to last year.

Flaherty reassured Canadians that if these risks create a downturn in the economy, the government would resort to actions it took during the 2008 financial crisis. In 2008, the government boosted spending on infrastructure projects and decreased income tax rates to protect jobs and encourage consumer spending. These measures helped ease the recessionary blow. However, because the Canadian economy currently has positive growth rates and the government is on track to meet budget projections, these measures are not needed at this time.

Wednesday, September 12, 2012

Newly Elected Egyptian Government Requests IMF Help to Boost Economy

BBC: Egypt Requests $4.8bn Loan from Visiting IMF Chief
Bloomberg: Egypt: Currency Account Deficit Widens As Tourism, FDI Fall
Brookings: Egypt and the IMF: Turning a new Page?
Business Week: Egypt Offers 3-Year T-Bonds as Brotherhood Backs IMF Loan Talks
Central Bank of Egypt: Egyptian Treasury Bonds Auction
Chicago Tribune: Egypt’s President Rules out Currency Devaluation 
IMF: IMF to Discuss New Loan Program With Egypt, Says Lagarde
IMF: Egypt International Reserves and Foreign Currency Liquidity
New York Federal Reserve: Currency Devaluation and Revaluation 
Reuters: Yields on Egyptian 266-day T-bills Climb
Swiss Info: Egypt Seeks $4.8 billion IMF Loan for Stricken Economy

On August 22, 2012, Egypt's new President Mohamed Mursi requested a $4.8 billion dollar loan from the International Monetary Fund's (IMF) Managing Director Christine Lagarde. Egyptian Prime Minister Hisham Qandil said that he expects the $4.8 billion loan to be for a term of five years, have an interest rate of 1.1 percent, and a grace period of 39 months. The Egyptian economy has suffered in recent years due to the political unrest following the Arab Spring, and the newly elected Mursi is exploring ways to kick-start the Egyptian economy and avoid a devaluation of the Egyptian Pound.

President Mursi believes the IMF loan will contribute to Egypt’s economic stability in the short term and be a signal to the world that Egypt is once again a politically and economically stable place to invest and travel. After the ouster of long time President Hosni Mubarak, foreign investors and travelers avoided Egypt because of the unpredictable financial and social climate. Foreign direct investment in Egypt (money invested by foreign businesses) fell by 90%, and travel to Egypt fell by 18% in 2011-12. Thus, the IMF loan will signal to investors that Egypt is ready to start dealing with its serious economic and political problems.

The $4.8 billion loan will be a welcome infusion of cash to the faltering Egyptian economy. Egypt has spent more than half of its foreign currency reserves (funds held in international currencies by the Central Bank) to maintain the value of its currency by purchasing its own bonds, which effectively raises the value of the Egyptian Pound. So far, the currency has lost only five percent of its value on the international market despite a much larger drop in foreign investment and travel. However, if Egypt were to run out of foreign reserves and not be able to defend the value of its currency, the likely depreciation of the Pound would make key imported food staples, such as wheat, tea, and sugar, more expensive to purchase. This would likely contribute to social and political unrest.

Despite Mursi’s actions to stabilize the economy, foreign investors do not yet consider Egypt to be a stable investment. Egyptian treasury bills’ interest rates are a good measure of investor sentiment because they reflect the risk of Egyptian default that investors expect. As of August 26, 2012, the interest rate on 266-day Egyptian treasury bills climbed by two tenths of a percent to 15.863 percent. By contrast, the interest rate on a one-year U.S. treasury bill is only .19 percent. The Mursi administration is hoping that the IMF loan will help address investors’ concerns by helping to quell political and social unrest and promote financial reforms.

The new Egyptian President has made efforts to improve the Egyptian economy, and continues to take steps to make Egypt financially stable. However, the world market does not yet see the stability Mursi seeks. After meeting with President Mursi, the IMF’s Managing Director said that getting Egypt’s economy back on track will not be an easy task, but that that the IMF stands ready to help. An IMF mission will visit Cairo in September to hold discussions and the parties plan to reach an agreement in November.

Wednesday, September 05, 2012

Troubles With India’s Power Grid

The Economist: An Area of Darkness
The Economist: The Future is Black
The Economist: Powerless
Ernst & Young: Ready for the Transition
FT: Fantasies of Power in Muddle-Along India
NatGeo: Indian Power Outage Spotlights Energy Planning Failure
NYT: An Electrical Grid is Pressed to Its Limit
RBI: RBI Releases Annual Report for 2011–12
WSJ: India’s Power Network Breaks Down
WSJ: Investment in Infrastructure is Plunging

On July 30 and 31 of this year, two blackouts in northern and eastern India caused more than half of the country’s population to lose power for multiple hours. Power outages of shorter duration and effect have become a daily part of Indians’ lives, and they are indicative of serious problems with India’s power supply system. India’s power grid will become a hindrance to future economic growth if India does not address the grid’s weaknesses. Underinvestment in energy infrastructure, a poor system of energy allocation, and environmental and resource constraints on India’s power supply are some of the problems with India’s power supply chain.

The Indian government must invest in energy infrastructure to accommodate a modern industrialized economy that is heavily reliant upon electricity and connectivity for daily business operations. Many industries in India are struggling in part because India’s power supply chain is unreliable, outdated and non-existent in many parts of the country. Currently, 300 million people are permanently without power, and, in the areas that do have power, supply is consistently below the levels needed to keep the electricity running without interruption. For example, some villages only have electricity for four to six hours a day. The distribution of the electricity from the grid to users is also problematic because the government sets artificially low electricity prices that bankrupt state-owned firms responsible for distribution, and thus, these firms cannot afford to purchase all of the needed electricity from the power companies. Moreover, the delivery system itself needs updating to address reliability concerns, which could cost about $110 billion to accomplish, according to one study. Despite these issues, the government plans to invest only 2.1 trillion rupees (about $38 billion) this year in infrastructure, down from 3.9 trillion rupees (about $70 billion) last year.

The way that India allocates energy is also flawed. States give a daily estimate to the government of how much power they expect to need the following day. The government imposes fines if states exceed the quotas calculated based on these daily forecasts, but these fines are not enough to maintain energy discipline. When demand upon the grid exceeds the available capacity, generators automatically shut down in the areas of excess demand to prevent damage to the system. Many government officials and analysts blame the power outages on the fact that some Indian states exceeded their electricity quota and triggered large numbers of generator shut downs. However, India’s power grid does not have enough capacity to tolerate much demand volatility.

India’s electricity capacity has been strained by environmental and resource issues. This year’s drought negatively affected hydroelectric power generation and increased demand for electricity at the same time. Farmers have had to increase their normal electricity usage in order to hydrate their crops, and they have no incentive to conserve energy because they receive free electricity. Coal production, which state-owned Coal India controls, has also been inadequate. Thus, for power companies to keep up with demand, they have to purchase coal from foreign sources, which is more expensive than domestic coal. Low coal production has a significant effect upon the country’s power supply because about 70% of India’s power is coal generated.

In its current state, India’s power grid will be unable to cope with the demand for electricity, which is likely to double by 2020. Currently, India’s plans for developing energy infrastructure depend on nuclear energy and coal. Nuclear energy is unpopular, especially in light of the nuclear disaster in Japan last year. Moreover, the most modern coal-based power plants require a higher grade of coal than that found in India. This hurts demand for domestic coal sources and creates financial difficulties for the companies investing in such modernizing projects. India must address the investment, allocation and capacity problems that are hurting the power supply chain to guarantee its ascendency to developed nation status.

Corporate Bond Issuances in Europe’s Economic Periphery Face Challenges

Bloomberg: Santander Defies Spain Woes to Sell First Bonds Since March
FT: Peripheral Corporates Eye Bond Sale Window
MarketWatch: Cash-rich Mull Spanish, Italian Corporate Bonds
Reuters: Bond Comeback No Easy Feat for Spanish Corporates
Reuters: DBRS Downgrades Spanish Banks After Sovereign Rating Cut
WSJ: Beware a Corporate-Bond Reversal

Some corporations headquartered in Europe’s economic periphery, which includes Spain and Italy, have experienced difficulties issuing corporate bonds since the first quarter of this year. Other peripheral companies have recently been able to issue corporate bonds, but at much higher interest rates than in the past. Corporations typically issue interest-bearing bonds (bonds that periodically pay interest) to investors in exchange for money. They use this money to refinance existing debt, fund operations, or invest in growth. However, uncertainty surrounding the European sovereign debt crisis has limited investors’ demand for these types of bonds throughout much of 2012.

Investors’ hesitation is due in part to the increased likelihood of downgrades in sovereign debt credit ratings. Countries, like Italy and Spain, issue debt to investors and private credit rating agencies, such as Moody’s and DBRS, publish ratings assessing the investment quality (risk) of that debt. They also rate the debt issued by private companies. A rating agency might downgrade a country’s debt to “junk” status (the lowest grade) if it believes a country will default on its debt (be unable to repay debt or make interest payments). This downgrade will negatively impact the ratings for corporate debt issued in that country. This is because rating agencies often link the debt rating of a company to the debt rating of the country where it is headquartered.  For example, DBRS recently downgraded Spain’s debt to an “A (low)” rating due to its poor economic outlook. As a result of this downgrade, DBRS automatically downgraded several Spanish banks to an “A” rating, one notch above Spain.

Due to their higher risk of default, junk bonds must pay a higher interest rate to investors than investment grade (non-junk) bonds. A downgrade to junk status is problematic for corporate bonds because many investment fund managers are prohibited by fund prospectuses (legal agreements with investors) from investing fund resources in more risky assets, such as junk bonds, despite their higher interest rates. These fund managers must instead focus on less risky and more liquid, or easily tradable, investment grade bonds. According to Bank of America Merrill Lynch, there are approximately €200 billion of investment grade corporate bonds traded in Italy and Spain. If these countries are downgraded to junk status, there would likely be too few investment funds willing and able to invest in junk bonds to absorb this amount of downgraded corporate debt.

Thankfully, many companies in peripheral countries have plenty of cash on hand to operate in the near term without issuing new bonds. However, if investors remain mostly unwilling to purchase new corporate bonds due to the risk of sovereign downgrades in the coming months, it could cause several problems. First, peripheral companies will eventually need to issue new bonds to successfully refinance existing debt. Second, credit rating agencies worry companies without the ability to issue new bonds could run out of money to pay off existing debt and fund future operations. Thus, in order to keep strong debt ratings, credit rating agencies require companies to prove they still have the ability to issue new debt to bond investors. Finally, if companies in Europe’s periphery have trouble issuing new bonds, or can only issue bonds at relatively high interest rates, it could make them less competitive in the long term. These companies would have higher overall interest costs and less ability to expand and grow than companies headquartered in Europe’s economic core—e.g., Germany.

Although they are in the periphery, some Italian and Spanish corporations have recently benefitted from increased investor demand for their bonds. Spurred on by the European Central Bank president Mario Draghi’s remarks that he would do “whatever it takes” to support the euro, some investors are turning to corporate bonds issued by large, financially stable corporations in peripheral countries to put their growing cash holdings to work. For example, Italian bank UniCredit SpA issued €750 million in bonds on August 14. In Spain, Banco Santander SA raised €2 billion from the sale of bonds on August 21. These were the first transactions of their kind since the first quarter of 2012 in either country. Throughout the rest of 2012, analysts expect corporations in Europe’s periphery to issue as much as €10 billion worth of bonds.

Despite the recent increase in investor demand, even financially strong peripheral companies are paying significantly higher interest rates on debt today than they were one year ago. This also is primarily due to the risk of sovereign downgrades in the near future. For example, many investors and analysts fear Italy or Spain could be downgraded to junk status as early as this month. The fear of a sovereign downgrade for Spain is one of the reasons investors demanded Banco Santander pay them an interest rate on the bonds it issued in August that was 1.4 percentage points higher than on bonds the bank issued in March. Given these high interest rates, it is unclear if other financially strong companies in Europe’s periphery, including Spain’s Telefonica, will take advantage of the increase in investor demand and issue bonds in the near future, or wait for more favorable market conditions to return.

Tuesday, September 04, 2012

The United States’ Housing Market Shows Improvement

The United States’ housing market has been in a decline since the housing bubble burst in 2007, sending property values in a drastic downward spiral. However, this past week, the National Association of Realtors announced that the sales of existing homes in the month of July increased 10.4% compared to July of last year, while sales of new homes in the month of July increased 25.3% compared to July of last year. Housing prices also rose across the country, as the median price of an existing home jumped to $187,300, or 9.4% over this time last year.

Several factors explain the turn around. First, employment in the U.S. grew by 163,000 jobs, or 0.12% in the month of July. Job growth contributes to an increase in home sales as Americans have more discretionary income—money remaining after a consumer pays off his or her expenses. Americans also feel more secure about their finances, which makes them more likely to make a long-term investment in a home. Second, the current low interest rates allow buyers to purchase a home at a more favorable price over time because they do not have to pay as much interest on their mortgage. Third is the limited supply of existing homes for sale. Currently, there are 2.4 million homes for sale, which is a 24% drop over this time last year. The main reason for such a low number is that homeowners are reluctant to sell their homes at current prices (the median price of an existing home in July 2012 was $187,300), which are far below the pre-recession levels (the median price of an existing home in July 2006 was $238,100). Due to the low number of existing homes for sale, the prices of homes increased this past month as demand exceeded supply. The low supply also contributed to an increase in the construction of new homes—a 21.5% increase in July over the previous year—to compensate for the low number of existing homes for sale.

Although the United States’ housing market showed improvement this past month, the market still has a long way to go to reach pre-recession levels. Currently, home sales are 40% below pre-bubble-burst levels. Moreover, economists, such as the National Association of Realtors’ chief economist Lawrence Yun, predict that home sales for 2012 will be about 4.6 million. This prediction is approximately 1 million sales below the healthy annual pace. Thus, although the United States’ housing market showed improvement, the market is still far from achieving a full recovery.