The world’s largest central bank, the US Federal Reserve, has hinted it may start slowly easing off its US$85 billion monthly bond-buying plan, a scheme that has flooded financial markets with cheap cash since 2009.
Here, Ludovic Subran, the chief economist at Euler Hermes, the world’s largest trade credit insurer, talks about the risks involved in tapering, why GCC companies should trade more with the Mediterranean and Africa and Turkey’s vulnerability to a current account crisis.
What will the impact likely be when the US Federal Reserve begins to taper quantitative easing?
The Fed will trigger a new phase in the global economy when it begins tapering. For a start, the dollar will become less expensive than it is now. Since the Fed announced it was considering tapering, some countries have already started tampering with their currencies, countries with large current account deficits like Turkey, Brazil and India. Large emerging markets have been through so many crises so I don’t expect countries to be stopping capital outflows or inflows. The only thing I expect is that there will be a higher risk for the private sector, which has been investing in these countries, and a higher risk for the banks that have been using cheap lending to finance their economies. We need to wait and see what the magnitude of the tapering will be and the magnitude will depend on the speed with which the Fed and other central banks start withdrawing cash.”
You’ve likened the world economy to a drug addict in recent years. What do you mean by that?
The world economy has been through many addictions. The financial crisis in 2008 and 2009 happened because the world economy was on one kind of drug, which was the financial market going far too fast for the real output gap of the world. Then came another type of addiction, which was the fiscal stimulus. We had the IMF touring the world and saying countries should start spending 5 per cent of their GDP to ensure they didn’t fall into a recession, that was another type of addiction. Then as a new response there was the idea to use monetary policy to stimulate the economy. The type of unorthodox monetary policy the size and magnitude we’re seeing now is unheard of. We’ve seen central banks like the Bank of England, the Bank of Japan and the Fed printing money. All central banks have paid approximately 30 per cent of GDP and have that in their liabilities on their balance sheet.
Top of global investor’s concerns recently has been the US debt standoff and the euro-zone crisis but you have suggested there are also potential risks relating to the high current account deficit in countries such as Turkey, Indonesia, India, Mexico, Colombia and Brazil. What do you mean?
A current account deficit is the sum of your trade deficit and fiscal deficit, so it is the import bill, plus the spending of the government. Therefore, it is a proxy of the needs of the economy. You can finance it through debt or through reserves. If you take the example of Turkey, it is a major emerging economy that has been vulnerable to shocks for years. In 2001, it had a huge credit bubble that pricked and policies since then have been focused on discipline in terms of monetary and fiscal management to make sure that the economy is more stable. Investment in infrastructure, education and jobs has been backed up with rigorous fiscal and monetary management. Turkey is not a risky country but it is a vulnerable country because of the 2001 crisis. If it goes to the international market to get cash to cover its short-term rolling debt it gets it at a high price because it is graded low by the ratings agencies and was below investment grade for years. It also gets very short-term repayments. So when Turkey issues bonds it does six months or one year maximum. It cannot do 15 years like some countries. As it has frequent repayments if you have one problem like an earthquake, unrest or more expensive dollar financing you become at risk.
Working for a trade credit insurer, you are keen to boost levels of global trade. What can be done to raise low levels of intra-regional trade in the Middle East and North Africa?
The GCC has strong trade links with Asia already but there are opportunities to extend ties within the Mediterranean region. The GCC could export approximately $20bn a year additionally to the Mediterranean region and import approximately the same. There is potential to weave GCC trade with a region that has been suffering but has huge needs of goods. Currently, exports to southern Europe from the GCC are somewhere around 2 per cent [of total exports] for the UAE, mostly being oil. If you add North Africa and Turkey it is maybe 4 per cent. This is an area to grow. There are 250 million people in countries around the Mediterranean, with wealth similar to the US and an area where there could be return on investment.”
You also believe there are huge opportunities for countries from the GCC to export more to Africa. Could you please elaborate?
If you look at a country like Egypt, with a population of 80 million people, it has the potential to import approximately $560 million more over the next 10 years. Even if you get a small portion of that it means huge profits for companies. It doesn’t happen overnight but the potential is huge for retailers and providers of household equipment and furniture, all of the things people start buying after food. Africa is not perfect but it is less risky than it was five or 10 years ago as it has sustained high growth rates and invested in lessening the corruption and business environment over the years. Change is happening from the bottom up. People want more of the goods they see on TV, they want better connectivity, so basically people are asking for less import bans and fewer monopolistic companies to make sure they get the right price for goods.”
Against the backdrop of the current turmoil, what is the biggest risk to overseas companies investing in Egypt?
In Egypt the biggest risk is that nobody will be held accountable for what they owe. If you have a sovereign buyer, a state-owned company, they may decide to not pay you now because nobody can be accountable for the non-payments down the road. In terms of private sector companies, the risk is that there’s very little cash in the country. Foreign reserves are at their lowest, import cover – a measure of cash in the economy to cover imports – is flirting with the three month level, which is really a record low. If you are a company in Egypt, first it’s very hard to get access to financing but secondly you cannot even be sure you can withdraw cash from your bank to pay what you owe. The other risks are that there is still massive looting in the economy, real purchasing power has plummeted as people are losing jobs and there are no tourists. We still insure risk in Egypt and monitor risk there but we advise against existing clients taking new risk in Egypt.”
You have warned about the risk of the “sun-setting” on industrialisation plans. Can you please elaborate?
A good example of this is South Africa. It is the fastest-growing economy in Africa and is a major emerging market, which has grown through commodities and services. But it didn’t build the industries necessary to give jobs to its people, to create innovation, diversify its exports or produce goods that it could supply local households with. To that extent, South Africa missed its industrial revolution, even though it had the cash from its commodities to invest. I do believe that every country has to go through some sort of industrial revolution at some point. For a country like the UAE or Saudi Arabia there is a need to build an industrial base to employ people but more importantly that gives the soundness that they can count as a big manufacturer in the world. This region needs to see which sectors they can specialise in. It also has positive spin-offs like innovation and financing. I would focus on chemicals, pharmaceuticals and anything else that is energy intensive.”