COFACE Country Risk Conference 2015
Behind the gloomy atmosphere lies recovery
On January 27, 2015, COFACE held its annual « Country Risk 2015 » conference. During the event, various speakers attempted to define a growth scenario for the global economy while warning of potential risks for this year.
J. M. Pillu, CEO of COFACE, identified three causes of the problems undermining the global economy. First, the macroeconomy: the recovery is proving to be long, laborious, and uneven, while the specter of deflation is looming in many parts of the world. Secondly, the microeconomy: SMEs must be strong and innovative at a time when business failures remain frequent. Finally, the world is experiencing a crisis of confidence in many respects: the Russian-Ukrainian crisis, the drastic fall in oil prices, the depreciation of the euro against the dollar, the demonstrations in Hong Kong, etc.
The eurozone faces the challenge of deflation
Before addressing the issue of the deflation trap in the eurozone, we might ask why the ECB—like its counterparts in the developed world—has a positive inflation target. In theory, this target makes it easier to absorb deflationary shocks and allows nominal income to grow so that, ceteris paribus, the weight of debt decreases and relative prices adjust more easily.
In mid-2009, the eurozone experienced its first episode of deflation. In December 2014, the eurozone technically plunged back into deflation, but this time the situation is very different. What can be done to force inflation back towards the ECB’s 2% target? The aim is also to avoid falling into the secular stagnation that has characterized Japan for two decades, despite the policies put in place, including Abenomics. According to J. Pisani-Ferry, Commissioner-General for Strategy and Forward Planning, the answer lies in coordinating monetary and fiscal policies in the eurozone and in a timetable for far-reaching structural reforms. Monetary policy, under the impetus of the ECB, is acting against deflation. It is doing so belatedly, within the limits of its mandate, but with determination. Fiscal policy should be mobilized in the short term so that its effects are visible in the medium term. However, the efforts made by each of the eurozone countries are struggling to convince and lack coordination. The Juncker plan is an initial response to this lack of fiscal federalism. However, this investment program is limited in scope and relies on considerable leverage. To be useful, the Juncker plan must not be a mere financial instrument. It must finance large-scale investments involving a certain degree of risk in order to reconcile banks with risk, particularly through leverage. Beyond this policy mix, eurozone countries need structural reforms to increase their medium-term growth potential. However, some of these reforms may have adverse effects on inflation in the short term and are difficult to implement in an economic climate clouded by the various crises that the Old Continent has experienced since 2007. Furthermore, coordinating these reforms across the monetary union is hampered by very different political agendas and a lack of supranational unity—the rise of extremist political parties is a good example of this.
In the developed world, SMEs and innovation are synonymous with growth
Since the financial crisis of 2007-08, businesses, particularly European SMEs, have been hit by a double whammy: a lack of domestic demand on the one hand and a lack of global demand on the other. However, the SMEs that have survived these difficult years are now more resilient. As the recovery begins, SMEs find themselves in a somewhat paradoxical situation. They need more growth to strengthen themselves, but without them there will be no real recovery, as they account for a significant share of GDP value added. However, the situation varies from country to country in the eurozone. German SMEs are larger, more specialized, and more internationalized than their French, Italian, or Spanish counterparts. Other disparities exist, particularly with regard to financing, investment, vocational training, legislation, taxation, etc. Italian companies find it more difficult to obtain financing than French companies; Apprenticeships in Germany are better suited to the needs of businesses than in France. Payment terms, which vary from one country to another, can hinder the development of SMEs. The need for tax reform is becoming urgent, particularly in Italy, where taxation is very heavy, and in France, where SMEs lack visibility. In France, the CICE and CIR reforms could well be emulated in other European countries in order to promote innovation.
Innovation, another key theme of this conference, should also be synonymous with growth. The technological transformations we have witnessed in recent years are happening very quickly, faster than the decision-making bodies that are supposed to regulate them… Innovation can be divided into four distinct categories: (i) information technology (automation of the knowledge economy, mobile internet, cloud computing, etc.); (ii) robotics (3D printing, autonomous vehicles, etc.); (iii) new technologies (nanotechnologies, new skills, etc.); (iv) energy storage (electric batteries, renewable energies, etc.). Certain challenges are associated with these innovations: the speed of development and their monetization, to name but a few. In recent years, connected objects have invaded our daily lives, but only a small fraction of these innovations have made it into our homes, as many projects have ended in failure. Beyond these connected objects, the digital revolution is driving progress in industry and the healthcare sector, particularly thanks to big data. However, innovation has not always been accompanied by positive externalities. Creative destruction, a process defined by J. Schumpeter in 1942, is an example of a negative externality linked to innovation. Furthermore, the precautionary principle has often been put forward in France, particularly in the digital economy and in unconventional oil extraction techniques. In some countries, such as the United States, where consumer interests tend to take precedence over those of citizens, innovations such as » big data » have developed rapidly, while in Europe they have come up against personal data protection principles. In Europe, the emphasis is more on the potential dangers of innovation.
In the emerging world, political tensions are undermining confidence
According to Y. Zlotowski, Chief Economist at COFACE, the problems that plagued emerging economies in 2014 are likely to persist in 2015. Current account deficits will continue to widen and political uncertainty in certain regions of the world is likely to have an impact on exchange rates. Latin America is likely to continue to disappoint in macroeconomic terms, while growth in emerging Asia will remain strong. Emerging European countries will find themselves in an intermediate position, benefiting from the positive externalities of a weak euro, while at the same time the situation in Russia could be detrimental to them.
In 2014, Russia joined the club of fragile countries, alongside South Africa, Brazil, India, Indonesia, and Turkey. The Russian situation is unlikely to improve in 2015 as the difficulties faced by the Kremlin remain: Standard & Poor’s downgraded Russia’s sovereign debt to speculative grade on January 26. Indeed, beyond a lack of investment and declining demographics, the fall in oil prices will continue to weigh on Russian government revenues. Furthermore, Western sanctions could push exports towards China and India. However, strengthening economic relations with China is not a long-term solution for Russia, as it is with the European Union (EU) that relations need to be improved. The EU is Russia’s largest trading partner and also its largest investor, with nearly 75% of foreign direct investment in Russia coming from the EU. As a result, European companies that export to Russia are severely affected by economic sanctions. Ukraine is the other big loser in this Russian crisis, as its industry is heavily exposed to the Russian market. This unstable situation, particularly in eastern Ukraine, does not bode well for the structural reforms that are urgently needed in the country.
The round table dedicated to the issue of the Chinese slowdown focused on microeconomic issues (corporate debt, overcapacity, etc.) rather than macroeconomic ones. Chinese GDP growth reached 7.4% in 2014 and could fall below 7% this year. This slowdown can be explained by several factors. First, the real estate market is losing momentum, despite having been one of the biggest contributors to growth over the past two decades. Second, overcapacity in the manufacturing sector and rising capital costs are also likely to weigh on growth. In addition, the Chinese authorities have signaled their intention to shift to a growth model that is more focused on domestic consumption than on exports and investment. The Chinese economy is indeed in this transition phase, and fears about its landing should not be excessive. However, China is facing disinflationary pressures that will not help it curb the rise in non-performing loans. Furthermore, shadow banking, which could account for up to a third of private debt, is not helping to clean up the Chinese credit market. Beyond these economic considerations, China must also make progress in terms of transparency and the fight against conflicts of interest, an area in which President Xi Jinping has promised advances as part of his anti-corruption campaign. Still on the domestic front, rising inequality, emerging protests by Hong Kong’s youth, reforms of the healthcare, education and justice systems, and the environmental crisis are all challenges that China will have to tackle one by one in order to grow with its people and not without them.
Conclusion
2015 will be a year of recovery. However, growth trajectories will continue to diverge. Led by the United States, the developed world should experience a slow but steady recovery, while emerging economies could find themselves in an environment where confidence remains fragile. The eurozone will have to contend with deflation, while the United States will have to decide on the tightening of its monetary policy. China, for its part, should be able to steer a soft landing, while Russia may seek to assert its sovereignty more strongly.
BSI Economics ( Julien Moussavi)
