Back to the Future?
October 07, 2009
By Gerard Minack | Australia
The RBA has marginally eased off the monetary accelerator, lifting the cash rate target by 25bp to 3.25%. More importantly, the accompanying statement suggests that economic conditions will quickly return to trend. If the RBA is correct, then there may be significantly more rate increases coming than investors now expect. My view, however, is that the bank is too optimistic about the outlook.
The RBA today delivered on its recent rhetoric that, with the emergency over, there was no need to maintain interest rates at emergency levels. However, the accompanying statement was more upbeat. It said more than just that the emergency was over, it intimated that conditions will return to normal, and fairly quickly. Here are the key sections from the statement, with my emphasis added (in italics):
"Prospects for Australia's Asian trading partners appear to be noticeably better [than for developed economies]. Growth in China has been very strong, which is having a significant impact on other economies in the region and on commodity markets. For Australia's trading partner group, growth in 2010 is likely to be close to trend."
"Medium-term prospects for investment appear, moreover, to be strengthening. Higher dwelling activity and public infrastructure spending is also starting to provide more support to spending. Overall, growth through 2010 looks likely to be close to trend."
"In late 2008 and early 2009, the cash rate was lowered quickly, to a very low level, in expectation of very weak economic conditions and a recognition that considerable downside risks existed. That basis for such a low interest rate setting has now passed, however. With growth likely to be close to trend over the year ahead, inflation close to target and the risk of serious economic contraction in Australia now having passed, the Board's view is that it is now prudent to begin gradually lessening the stimulus provided by monetary policy."
In short, this statement is not just saying that the emergency is over; it says that in many respects next year will be a ‘back to trend' year. Back to trend implies that more than just a marginal easing off on the monetary accelerator is required. In theory, this would imply rates moving back to neutral. Rightly, of course, the RBA has emphasised that any removal of the stimulus will be gradual. But a return to neutral policy would imply a much more aggressive sequence of rate increases than most in the market - myself included - now expect.
I don't agree with the RBA's world view, and I'm also not confident that domestic conditions will quickly return to trend.
The simple point is that the past year has seen the most aggressive combination of monetary and fiscal stimulus in living memory. In part because of unprecedented debt levels, the sharp reduction in mortgage rates produced a massive swing in household interest payments. There was also aggressive and rapid fiscal stimulus. According to OECD data, Australia's discretionary fiscal stimulus this year was the largest in the OECD.
This double-barreled response certainly worked more effectively than I was expecting, and Australia has clearly fared better than almost every other developed economy. But it remains an open issue how growth will fare as this stimulus fades.
The RBA is right to note that the region has also performed better than elsewhere, and better than most expected. But here, too, the issue is whether that better-than-expected 2009 performance will be sustained into 2010, particularly as the developed economies are likely to be lackluster. My hunch is that much of the regional stimulus is designed to provide a buffer until developed economy demand recovers. If this recovery is tepid - as the Morgan Stanley team expects - then there is scope for regional growth to disappoint. Today's worse-than-expected trade data confirm that global conditions remain weak, despite the better-than-expected headline growth numbers through the region.
Short-rate markets moved to price in more rate increases after today's announcement. Another increase is fully priced by year-end, and a move to over 4.5% is expected by mid-2010. This seems too aggressive, given my world view, but is less of a stretch if the RBA's view is correct. I would still bet against both.
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Stimulus and FDI
October 07, 2009
By Daniel Volberg & Luis Arcentales | New York
In Latin America, few economies have weathered the economic crisis as well as Colombia - as a result, we are upgrading our forecasts for GDP growth in 2009 and 2010. When the external shock hit in 4Q08, activity in Colombia contracted at a sequential 1.4% non-annualized pace, a fraction of the slump experienced in Brazil (-3.4%), Chile (-2.4%) and Mexico (-2.4%). Not only was the 4Q decline relatively mild in Colombia, but economic activity also quickly returned to the growth path this year by expanding modestly by 0.3% in 1Q and 0.7% in 2Q (see "Colombia: Looking Past the Bottom", EM Economist, June 26, 2009). Indeed, we are upgrading our growth outlook for Colombia and expect it to be one of the few major economies in the region - along with Peru - that may post positive GDP growth this year. We are revising upwards our GDP growth forecasts to 0.5% (from -0.9% previously) for 2009 and to 4.1% (from 2.6% previously) for 2010.
Growth Composition
Upon closer examination, Colombia's growth resilience may not be broad-based. In fact, the economy was hit hard by the global downturn, with private consumption sequentially contracting in both 1Q and 2Q. We find that the economic resilience has been largely driven by two factors:
• First, the overall GDP growth resilience is, in part, a function of the severe downturn in the domestic economy, generating a positive growth contribution from net exports. Private consumption contracted in both 1Q and 2Q at a sequential pace nearing 1% non-annualized; meanwhile, fixed investment - after experiencing two quarters of severe declines - improved only slightly in the June quarter. And destocking knocked off, on average, one full percentage point from annual GDP growth during 1H09. Indeed, when the central bank surprisingly slashed its intervention rate to 4.0% on September 25, it warned that in 2Q both household consumption and private investment had performed below projections. Not surprisingly, the slump in household consumption has dragged down import demand and - when coupled with the relative resilience in commodity exports - helped to push up the growth contribution of net exports that partly offset the slump in private sector domestic demand and the drag from inventories. In fact, net exports contributed 0.8% to overall growth in 1Q and 1.8% in 2Q.
• Second, economic stimulus provided by the policymakers was another key factor helping to keep the economy afloat. The authorities provided two kinds of stimulus: monetary and fiscal. On the monetary side, the central bank slashed interest rates by a total of 600bp since November 2008, with 400bp of cuts between February and May. This monetary policy easing has resulted in stabilization of credit growth at near 4% sequential annualized growth in the three months through July. Looking ahead, as the full effect of past rate cuts filters through to the economy - and following the late September surprise cut, we suspect that rates are likely to stay at the current 4.0% until 2H10 - we expect consumer and business credit to continue to rebound, laying the foundation for a more dynamic domestic demand recovery down the road.
But while the full effects of the monetary stimulus may only be felt with a lag, the fiscal stimulus has already had a significant impact in sustaining Colombia's growth dynamic. The first half of this year saw a remarkable surge in investment in infrastructure by both public and private hands, ranging from oil-related projects to roads and water works. And the most robust growth has been in public investment - the authorities project near 51% growth in public investment this year, more than five-fold their projection for private infrastructure investment growth (near 9%). In 2Q, outlays in civil projects skyrocketed by 42.0% compared to the same period in 2008. Indeed, in terms of magnitude, the boost from civil projects to total GDP growth in 1H09 was almost as important as the contribution from net exports. Looking ahead, we expect investment in civil projects to continue providing support to the economy in the coming quarters - the authorities have clearly communicated their focus on executing planned infrastructure spending.
Infrastructure to the Rescue
Outlays in infrastructure projects experienced a sharp upturn in 1H09, rising 26.9% from a year earlier, consistent with the government's plan that envisioned combined private and public infrastructure spending worth 8.3% of GDP this year. Indeed, absent the boost from civil projects, the Colombian economy would have sunk close to 2% in 1H09 rather than undergoing a modest 0.5% annual decline. Though nearly 75% of the total increase in civil works during that period came from just two groups - ports (+49.5%) and mining (+44.7%, including oil) - other areas also posted sizeable gains, such as construction and repair of railroads & airports (+43.3%), investment in fixed-line (19.5%) and mobile (+3.5%) telecommunications infrastructure, and new road building (+12.5%). What is clear is that the authorities in Colombia did not waste time and took the global downturn as an opportunity to continue upgrading Colombia's infrastructure in an effort to offset the cyclical downturn while laying the groundwork for a higher pace of sustainable long-run growth. But given the importance of public infrastructure investment to Colombia's recent growth dynamic and given that Colombia's structural fiscal deficits remain one of the key challenges for economic policymakers, some may wonder about the sustainability of Colombia's growth resilience in the months and quarters ahead.
We expect infrastructure investment to remain a strong driver of economic growth in the months and quarters ahead. It is true that Colombia's structural fiscal deficits may prove fertile ground for doubters who may have reservations about the ability of Colombia's policymakers to continue to provide fiscal stimulus support and thus sustain the economy's growth resilience in the months and quarters ahead. However, the authorities, despite facing what we expect to be a fiscal shortfall of near -3.5% of GDP in 2010, are unlikely to have difficulties financing the necessary public investment projects. After all, the deficit is in line with the -3.7% of GDP average of the last five years. And the authorities have stated their commitment to maintain the level of infrastructure investment at 4.3% of GDP next year. In fact, some projects recently approved by the government's National Economic and Social Policy Council (CONPES) include near 2.0% of GDP of investment in port expansion and road repair, expansion and construction over the next few years. In short, we suspect that, given the high risk that the global economy will remain weak in 2010, the authorities will continue to effectively execute their public investment plans in order to provide support to the domestic growth dynamic.
Abundance of FDI
While public investment can be an important short-term cushion in the midst of a cyclical downturn, we are turning more constructive on Colombia's growth prospects because of continued strong flows of foreign direct investment (FDI). While net FDI was cut in half in the first six months of this year - to US$2.2 billion from US$4.4 billion in the same period of 2008 - virtually this entire drop is explained by an increase in Colombian investment abroad. In fact, inward FDI fell by only a tenth in 1H09, to US$4.9 billion from US$5.4 billion in the same period last year. The resilience in FDI inflows is a key strength for the Colombian economy, as it searches for drivers to sustain growth beyond stimulus spending. In fact, after tallying up the expected FDI projects, we find that, in the first six months of the year, Colombia saw roughly half of all the expected FDI inflow, setting 2009 to be a year with continued strong inflows as in the recent past - we expect full 2009 FDI inflows to reach US$9.4 billion or 4.1% of GDP. And while much of the FDI inflows continue to flow to commodity-related sectors such as oil and mining - we expect these two sectors to account for over half of all FDI inflows this year - other sectors such as infrastructure, power generation and retail are also benefitting from strong FDI, as Colombia continues to offer a solid business climate and well-crafted economic management combined with a wealth of natural resources and a continued drive for deregulation and privatization of state-owned enterprises.
Looking ahead, we expect strong FDI inflows to support economic growth next year. Tallying up next year's FDI projects that we know about, we come away with an indication that foreign investment should continue to provide strong support for the country's currency and growth dynamic. We expect US$7.8 billion in FDI inflows to enter Colombia next year, less than in 2009 but still a robust pace of investment inflows. With continued strong FDI inflows and the government's ramped up public investment program, we see important ingredients for continued growth resilience in Colombia. When combined with our expectation that business and consumer sentiment should begin to recover as global markets heal while the global economy rebounds, we are turning significantly more constructive on Colombia's growth prospects next year.
Upgrading Our Forecasts
We are revising upwards our GDP growth forecasts for Colombia for 2009 and 2010. For this year, we are revising our GDP growth projection to 0.5%, from -0.9% previously. For 2010, we now expect growth of 4.1% rather than our previous forecast of 2.6%. Amid components, the biggest driver of the upwards revision is our more constructive outlook for investment, as continued robust public investment and FDI are coupled with a resurgence of private investment amid a healing global economy and recovering business sentiment. And the stronger growth leads to better tax collection as we update our forecasts for the fiscal accounts - for 2009, we now expect the central government to run a deficit of -4.0% of GDP (from -4.5% previously), and for 2010, we expect a deficit of -3.5% of GDP (from -3.9% previously). We are also adjusting our inflation forecast for 2009 to 3.1% (from 3.9% previously), as price pressures proved more subdued than we expected despite the resilience in growth, largely on the back of little inflation pass-through from the currency depreciation. Given subdued inflationary pressure and the surprise cut by the central bank last week, we expect interest rates to remain on hold for an extended period of time and are updating our interest rate forecast for 2009 to 4.0% (from 4.5% previously). Looking ahead, we expect rates to remain on hold until 2H10 when the central bank starts tightening monetary policy to yield our new forecast for year-end rates at 5.5% (from 5.25% previously).
Bottom Line
While Latin America has been relatively resilient in this global downturn, Colombia has outperformed the region as the authorities injected fiscal and monetary stimulus while the many years of solid economic management have paid off with FDI resilience. Looking ahead, prudent policymaking should continue - we expect continued strong public investment in 2010 - while the global recovery should lift local expectations and help bring back domestic investment spending. In this context, we now expect stronger growth this year and next and are upgrading our GDP growth estimates to 0.5% (from -0.9% previously) for 2009 and to 4.1% (from 2.6% previously) for 2010.
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