The oval office in Washington will soon shift its focus on defining Obama’s legacy as the presidential campaigning intensifies. Obama and his administration would be pleased with the results of their two tenures where they managed to overcome multiple global financial crises and prevail over the challenge of managing one of the highest unemployment rates in their domestic economy. Other than the Republican presidential candidates, there would be reassurance on the future of the American economy as Federal Reserve evaluates raising interest rates as a stimulus for much desired inflation.
However, all is not well beyond the American shores; Europe, China and Opec face a perfect storm and extreme turbulence emanating from varied sources. Each of these regions is managing economic implications stemming from dollar strength and local economic realities and challenges.
To Brexit or not to Brexit: 10 Downing Street is not an envious address these days as Britain attempts to negotiate full access to the European single market without being an EU member. Her Majesty’s Treasury has identified three detrimental possibilities where the contraction of economy will range from 3.4% to 9.5% if Brexit becomes a reality.
The people favouring Brexit are relying on the premise that the UK will be able to negotiate with much more freedom free trade agreements with emerging economies where it still continues to have political influence. The Swiss, China agreement must be providing further confidence to the hawks as they try to convince the detractors of full independence of governance on their economy. If the UK was to remain a full part of the EU, it would, with reluctance need to follow regulations regarding free movement of people across Europe and also pay to access the wider market. The middle road of bilateral agreements with multiple countries, similar to Turkey, Canada and Switzerland would provide the UK with more control over their economy but would struggle when it competes with their former compatriots for market access into the EU zone. It would be interesting what the UK decides, however, its best bet would be to face the crosswinds as part of the EU rather than fear devalued currency and contraction of economy. The EU would also be cautiously looking at these developments knowing well that if the UK leaves, the Greek exit would not be far behind.
Too much debt is bad debt: China’s debt situation is precarious and structurally not sustainable. China finances its municipalities, provincial governments and state enterprises by public debt which has been estimated at 230% of GDP of which distressed assets are exceeding USD 200bn. Add to this recipe, an asset growth rate of 15% per annum (twice the growth rate of nominal GDP growth), a potentially mature real estate bubble and undercapitalised banking sector and you have turbulence that needs to be managed by a constant flow of cash by the Peoples Bank of China.
Growth or the lack of it is making matters worse for Beijing. With China’s growth rate at its lowest in the last 25 years and a dynamic shift of the industry from predominantly manufacturing to an even split between its industry of strength and services industry is unnerving for an ambition of continuous growth.
Sustainable growth will now depend on whether Beijing will allow its State owned Enterprises (SOE) to default and subsequently fail especially in sectors that are saturated or will it bail them out and go through the measures of cutting two million jobs in coal and steel sector. These are hard decisions and half-hearted attempts of debt to equity swap will be counterproductive. Historically, China managed this set of challenges in 1990’s when Banks and SOEs were re capitalised and asset management companies were created to isolate bad debt.
China has taken positive measures to introduce local issuance of municipal bonds, which are local government capital market issues, to create transparency of debt and expenses of government machinery. The challenge today is two-fold, China has become too large and cross winds of global economy have very bleak projection of global economic growth. Beijing has to consolidate its local economy before taking valuation advantage of acquiring foreign assets.
Oil wars - no one ready to blink: Doha talks seem to have had the right notion behind them, get everyone together and convince Opec that reducing production will balance the oil market. The thought process proved to have merit and the required outcome was witnessed when Kuwait oil production was reduced due to a completely different reason. It was this suspension of production that after two years, supply, not demand moved the oil prices. Opec continues to pump oil unabated, however, Saudi, the greatest supporter of pump oil to maintain market share, has shrunk in 9 of their 15 top markets. The internal battle to keep pumping more and sell in each other’s back yards is increasingly becoming a foreign policy tool, making Opec an insignificant platform.
The two largest producers, Russia and Saudi, in the meantime are battling economic challenges of liquidity. Saudi has last week reached out to the international markets the first time since 1991, post Gulf War, to avail a $10bn syndicated loan. This debt will ease the head winds and cash flow for a few months, however the Kingdom will clearly need to evaluate a larger ticket in the capital markets and also offer part of Aramco, its crown jewel to investors. All of these measures will provide short-term solutions, however, oil will only balance with supply side corrections.
Conclusion: These three themes may look independent but it is becoming very clear that key economies of the world are facing serious threats of liquidity and growth. There is a lot of irrational thought that is going in to manage the increased burden of European Union membership in the UK; the management of debt and stalling growth in China; and management of oil production at Opec lead by its largest producers. Global economy will not be kind to sub optimal solutions and repercussions of these trajectories will be disastrous. Band-aid solutions will not work, it’s time to consolidate and look for the high and long road to recovery.
* Salman Gulzar is head of corporate banking at Mashreq Qatar.
Salman Gulzar
