Trends for the world economy in 2012 and investment flows into BRIC countries

Center for Macroeconomic Analysis and Short-term Forecasting, Moscow, Russia1

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Trends for the world economy in 2012 and investment flows into

BRIC countries


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1. The World Economy 2012: New Cycle Means

New Risks?


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1. The World Economy 2012: New Cycle Means New Risks? 1. The World Economy 2012: New Cycle Means New Risks?

Developed economies for a year stand on the brink of new economic cycle

But the progress falters under the burden of government and financial sector problems, provoking risk aversion for investors

Most likely, the cycle will proceed as new, and these problems will stay unresolved, bound to turn up later


4

While unsure, the recovery in developed countries is slowly proceeding, the US heading headfirst and both Japan and EA lagging

1.1. Industrial production, 01/01/2000=100

1.2. Unemployment rate, %

Source: IMF International financial statistics Source: IMF International financial statistics


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1.6. Total money base of largest developed countries, US$ tn

Source: IMF

The money central banks issued most likely would stay even as the credit multiplier increases


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US EA Japan growth rate % (right axis)


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So far, the multiplier stays very low, though some increase in US is visible

1.3. EA MB and M3 growth rates, % yoy 1.4. MB and M2 growth rates, % yoy

Source: ECB

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М3 зоны евро Денежная база зоны евро


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Source: Fed


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Corporate debt ratios for both US and EA are at 10-15-year lows

Trade balance stabilization and strong personal consumption in the US in 2011 suggest grounds for new growth cycle

Rates of growth in China won’t skyrocket as the government finishes deflating bubble, there are problems with shifting to consumption-based growth, but “low” still means 8+% for China (and not to forget expected US growth)



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1.6. EBITDA for main US industries, 2000 prices, 31/03/00=100

Source: US Census Bureau

EBITDA for US has recovered, for EA lags behind but not totally subdued


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Durable goods production Manufacturing Mining (right axis)


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1.7. US corporate debt, 2000 prices, 31/03/00=100

Source : US Census Bureau

…as the debt levels grow steadily…


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Durable goods production Manufacturing Mining (right axis)


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1.8. Debt to EBITDA, main US industries


Debt/EBITDA stays at 2000 lows.


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Durable goods production Mining Manufacturing


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1.10. Profit/Sales in US industries


While profitability is already at expansion phase levels….


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1.9. US household debt service ratios, % of income

Source: Fed

…household DSR stays pretty low


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1.10. Delinquent credit in US banks, % of assets

And the wall of delinquencies is basically overcome


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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Total business loans consumer loans loans secured by real estate

Source: Fed


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1.11. Loan to deposit ratio

Source: Fed, ECB

At the same time, credit activity at US and EA banks is clearly subdued


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1.12. Credit portfolio as a share of total assets

Liquid assets are preferred to credits as risk aversion is strong


Source: Fed, ECB

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1.13. Capacity utilization vs unemployment, %


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US Capacity utilizationEuro area capacity utilization survey (quarterly, intrapolated)US Unemployment SA inverted, right axisEU-27 unemployment inverted, right axis

Source: Fed, ECB


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1.14. Baltic Dry and Harpex indices

While dry bulk costs were untouched by the slowdown of 2011, container costs were sharply down


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Baltic Dry HARPEX (container costs, right axis)


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GDP yoyGDP yoy, % , % UNUN IMFIMF WBWB 20112011

World (PPP)World (PPP) 3.6 3.3 3.4 3.8

USUS 1.5 1.8 2.2 1.7

EAEA 0.4 -0.5 -0.3 1.6

JapanJapan 2.0 1.7 1.9 -0.9

ChinaChina 8.7 8.2 8.4 9.2

IndiaIndia 7.7 7.0 6.5 7.5

BrazilBrazil 2.7 3.0 3.4 2.9

RussiaRussia 3.9 3.3 3.5 4.1

Oil, $/bOil, $/b 100.0 99.1 98.2 104.2

1.15. Main economic forecasts for 2012


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2. Global savings: from “glut” to deficit?


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Three arguments for less saving in the long-term: world population ageing, esp. in developed countries,

increases retired-to-workers ratio; losses the pension savings took after the financial crisis

of 2008 and probable sovereign debt crises of 2008-2011 forgone investment gains, e.g. negative real rates as a

consequence of ZIRP+QE in reserve currencies

One argument for less money going to emerging markets: developed world needs more money to refinance

growing public debt and restart new credit cycle

2. Global savings: from “glut” to deficit?2. Global savings: from “glut” to deficit?


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Мир

2.1. Retired-to-working ratio, world, %


World population ageing, esp. in developed countries, increases retired-to-workers ratio


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2.2. Global liquid financial asset structure, %

2006 2010

$ tn % $ tn %

Equity market cap 55 30.7 54 25.6

Sovereign debt 28 15.6 41 19.4

Financial institutions debt 35 19.6 42 19.9

Nonfinancial institutions debt 7 3.9 10 4.7

Securitised credit 14 7.8 15 7.1

Nonsecuritised credit 40 22.3 49 23.2

Total 179 100.0 211 100.0

Source: MGI.


Losses the pension savings took after the financial crisis of 2008 and probable sovereign debt crises of 2008-2011


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“What incentive does a US bank have to extend maturity to a two- or three-year term when Treasury rates at that level of the curve are below the 25 basis points available to them overnight from the Fed?

What incentive does PIMCO or banks have to buy five-year Treasuries at 75bp when the maximum upside capital gain is 2 per cent of par and the downside substantially more?”

- Bill Gross, PIMCO



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As more and more sovereign debt in developed countries needs refinancing, emerging markets will experience outflow of capital sourced in developed markets, i.e. “home bias” for the debt will strengthen

This means governments should concentrate on stimulating the potential of internal savings rather than seeking overseas financing, especially financing for the emerging markets



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2.3. Financing needs of developed countries in 2012,

$ bn

2.4. Financing needs of developed countries in 2012,

% GDP

Source: IMF, Fiscal Monitor 2011

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Ирландия

Греция

Португалия

Испания

Великобритания

Германия

Италия

Франция

Япония*

США*

*10 млрд. долл

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Ирландия

Греция

Португалия

Испания

Великобритания

Германия

Италия

Франция

Япония*

США*

*10 млрд. долл



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Gross national savingGross national savingGross fixed capital Gross fixed capital

formationformation

Brazil 19.3 18.1

Russia 28.0 20.6

India 34.2 31.7

China 52.0 41.9

Compare to: EU 21.3 20.4

2.5. Saving and investment avg. 2006-2010, % GDP

Not all BRIC countries have internal resources for investment, thus more investment in infrastructure may mean less investment elsewhere


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Can FDI help? Various studies (based on Danning, Akamatsu etc.) suggest FDI are the source of quality governance and tech transfer, not so much a financing tool

In 2006-2010, average yearly FDI inflow into BRIC countries was less than 3% GDP or less than 10% of investment

Two differing approaches to attracting the funds to long-term investment (including infrastructure) are widespread (e.g. Walsh, Park and Yu 2011), so-called centralized and decentralized



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Centralized is either government investment or its advanced version, directed loan-based: used in China with public banks+PBC, in Brazil with

BNDES (esp.after PAC)+pensions

Centralized form reqs: healthy budget (little evidence of investment in

infrastructure to create short-term budget gains concentrated banking system

+ creating off-budget development institutions not tied by system-wide banking regulations

some insulation from external shocks as banking system becomes somewhat distorted and vulnerable as it takes on infrastructure risk



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Decentralized is based on a mature market for long-term debt and equity instruments Increasingly used in China (highway SPV), much less for

Brazil, in the debt part – basic for Chile and Korea

Decentralized long-term financing reqs: Large long-term internal funds (i.e. fully-funded pension

scheme or the like) Institutional environment for long-term open market financing (i.e. market-makers + risk management regulatory practices)

Institutional environment for long-term open market financing (i.e. market-makers + risk management regulatory practices)

Framework for private involvement (PPP, concessions etc.)



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3. The case of Russia – a path to decentralized

financing model


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Relatively low (20+% GDP) gross fixed capital formation rate for an emerging economy

Significant difference between gross savings and investment

Banking system has very small share of long-term deposits, almost all are callable

Bond market has plenty of long-term bonds, but most long-term have embedded call after 2 years, making them lower-medium-term instead

3. The case of Russia3. The case of Russia


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Currently, the model is highly centralized: main infrastructure investment is budget-sourced development institution (VEB) is the primary non-

budget financing source almost no long-term debt market most pension savings are locked into low-yield

government bonds Banking system is deconcentrated (CR4=45 but

CR20=65 etc.) and syndication is underdeveloped rates are unstable due to exchange-rate targeting

policy



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Thus, the way to decentralized system is unlocking pension savings and the funds dispersed inside banking system

The market for long-term lending needs to be created: VEB (DI) should co-finance market-makers both for

the long-term bond market and standardised syndicated loan market

The industry standards (lex mercatoria) need to be developed:

Self-regulating organizations (like LMA/ LSTA

APLMA), debt covenants, law issues – starting with the market makers



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Once there is liquidity in long-term bond and credit syndication secondary markets (e.g. via credit mutuals) – money managers (including VEB) may be allowed to use pension savings to ramp up the markets for syndication and long-term bonds

The experience is based on case studies of financial market developments by EBRD (in CEE), KfW (in Germany), BNDES (in Brazil), NAFIN (in Mexico)

We estimate doubling of credit syndication market to $25 bn a year in 3 years, at the cost of $15 bn (0.2% GDP a year) in credits, LT bond stimulus is comparable



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Conclusions


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The economy in 2012 looks to the upside and ZIRP is on the side of long-term international investment in emerging markets

However, the long-term prospects are gloomy: the global savings glut could turn into deficit developed markets will need more long-term

funds to fix sovereign debt problems than today, ergo home bias for the debt markets

Thus, perspectives of international capital going into the infrastructure are not impressive

ConclusionsConclusions


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However important, FDI flows and international financing are insufficient to finance long-term investment in developing countries

Thus, developing countries should finance long-term development, including infrastructure, out of internal sources

The potential for increase in investment is present almost in all BRIC countries



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Most investment in long-term investment projects in BRIC is centralized via development institutions, government funds or pet banking systems

pension savings are utilized in China and Brazil, much less in India and Russia

elements of decentralized model are present in all BRIC countries, but all of them lack a complete set of elements

the decentralized model is an infrastructure in itself, and thus is a long-term prospect to build


Москва 2007

Macroeconomic background for S&T forecastMacroeconomic background for S&T forecast

International workshopInternational workshop““Long-term S&T forecastLong-term S&T forecast””

IRU-HSEIRU-HSE, 2011, 2011

ЦМАКП

4040

1. 1. WhyWhy « «economy-centriceconomy-centric»?»?General government expenditures*

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1.3. The need for clear priorities

Расходы на R&D expenditures 2009 (PPP USD bn)

R&D workforce 2009(‘000 work years)

R&D expenditure per researcher 2009 (‘000 PPP USD)

* - 2008 R&D expenditure data.

1. 1. WhyWhy « «economy-centriceconomy-centric»?»?

Upfront “pro rata” R&D financing raise as existing R&D institutions’ research profiles are conserved would only deepen dispersion of funding and unlikely to achieve any “quantum leaps”In research quality.

Upfront “pro rata” R&D financing raise as existing R&D institutions’ research profiles are conserved would only deepen dispersion of funding and unlikely to achieve any “quantum leaps”In research quality.

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Sources of R&D funding 2009 (%)


We do not expect significant budget R&D expenditure raises. Therefore, new funding can only come from private sector. This implies a change in existing research objectives (and research profiles) towards private demand both for applied and, in part,for fundamental science.

We do not expect significant budget R&D expenditure raises. Therefore, new funding can only come from private sector. This implies a change in existing research objectives (and research profiles) towards private demand both for applied and, in part,for fundamental science.

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Economic impact (growth of hi-tech exports) of Russian R&D expenditures is insufficient relative to other countries

Russian Federation

Azerbaijan

Armenia

Belarus

Georgia

Kazakhstan

Ukraine

Australia

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Fmr Fed. Rep. of Germany

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ЦМАКП

4444

Developing methodology stage 1 (2011)

Developing methodology stage 1 (2011)

Estimate model inputs stage 2 (2011)

Estimate model inputs stage 2 (2011)

Tentative forecastStage 3 (2012)

Tentative forecastStage 3 (2012)

Long-term industry development potential forecasts

Stage 4 (2012)

Long-term industry development potential forecasts

Stage 4 (2012)

«Macro-driven» S&T and innovation forecast

Stage 5 (2013)

«Macro-driven» S&T and innovation forecast

Stage 5 (2013)

Final stage macroeconomic forecastStage 6 (2013)

Final stage macroeconomic forecastStage 6 (2013)

Industry forecasts

Industry forecasts S&T forecasts

S&T forecasts

Tentative industry forecastsTentative industry forecasts

Final stage industry forecastsFinal stage industry forecasts

Updated S&T

forecasts

Updated S&T

forecasts

World economic policies

forecasts

World economic policies

forecasts

Long-term cycle S&T forecasts

Long-term cycle S&T forecasts

World economy and geopolitical forecasts

World economy and geopolitical forecasts

CMASF Partners

2. 2. Our research planOur research plan


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Payroll (PPP USD.)

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pay per single worker"EU-7", 2008 г.

"EU-7": Austria, France, Germany, Italy, Spain, Netherlands, Sweden

3. 3. Our goalsOur goals: : solutions to labour productivity problemsolutions to labour productivity problem

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3. 3. Our goalsOur goals: : solutions to energy efficiency problemsolutions to energy efficiency problem

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wholesale electricity price for industry, Germany 2007

Electricity cost (cent/kWh) and mtoe-per-dollar-of-GDP energy intensity index (2011=100)

3. 3. Our goalsOur goals: : search for new sources of economic growthsearch for new sources of economic growth

GDP growth components (average growth rates, %, “baseline no-policy” scenario)

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Private Consumption Government Consumption Investment Export Import Inventories+Errors GDP


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Exports commodity structure (%)

3. 3. Our goals: export potentialOur goals: export potential

Export growth potential, forecasts by industry (2030/2011, times)

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33 32 31 31 31 32 32 32 33 33 33 34 34 34 35 35 35 36 36 37 37

62 4961

16151413131217

7

3532

0

10

20

30

40

50

60

70

80

90

100

2008

2010

2012

2014

2016

2018

2020

2022

2024

2026

2028

2030

Oil, gas, petroleum products Machinery&equipment Other goods

4.0

3.8

3.7

3.6

3.3

3.3

3.0

2.7

2.6

2.6

2.4

2.3

1.8

1.7

1.7

1.2

1.2

1.2

1.0 1.5 2.0 2.5 3.0 3.5 4.0 4.5

Производство машин и оборудования

Производство транспортных средств и оборудования

Производство электро- и оптического оборудования

Сельское хозяйство, охота и лесное хозяйство

Рыболовство и рыбоводство

Производство пищевых продуктов

Производство изделий из кожи, обуви

Текстильное и швейное производство

Деревообработка

Производство резиновых и пластмассовых изделий

Химическое производство

Производство стройматериалов

Металлургическое производство и металлоизделий

Целлюлозно-бумажное производство, полиграфия

Добыча нетопливно-энергетических полезных ископаемых

Добыча топливно-энергетических полезных ископаемых

Производство нефтепродуктов и ядерных материалов

Прочие производства

3. Что мы хотим получить: импортозамещение3. Что мы хотим получить: импортозамещение

Import elasticity to domestic demand components

1.1

0.7 0.8

0.5 0.50.4

0.70.6 0.6

0.70.70.60.9

1.0

1.7

4.3

1.8

3.2

1.6

1.0

1.0

1.1

8.2

0.2

3.1

4.0

2.5

0.4

3.2

0.7

0.80.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

Machinery imports to investment Consumer imports to private consumption

Documents

Trends for the world economy in 2012 and investment flows into BRIC countries