Monthly Overview / August 2019
In this month’s issue:
A large dividend transfer to the government confirms the central bank’s declining independence
The well-capitalised Reserve Bank of India (RBI) decided to transfer USD 24.4 bn to the fiscal accounts of Modi’s government, a sum consisting of dividends (70% of the total) and excess reserves.
The transfer of RBI dividends is not exceptional. However, the timing and the magnitude of the payment are more so. Considering the closer relation between RBI and the government, such a payment is not surprising. Indeed, PM Modi has increasingly been putting pressure on the central bank governor. During Modi’s first mandate, that culminated last December with the decision of the previous governor, Mr. Patel, to step down due to a profound disagreement with Modi on the allocation of the RBI’s reserves. The new RBI governor looks more pliant to PM Modi and, with the latest remittance, he gives the signal that he could support the economy and the federal budget whenever deemed necessary. The economic and fiscal situation is indeed currently all but rosy, with steadily declining GDP growth data over the past three quarters, record high unemployment and a widening fiscal deficit due to lower revenues. Therefore, such a significant transfer of about 1% of GDP is certainly a welcome boost to the recently re-elected Modi and to the public finances. Though in theory he could this money productively, with a long-term perspective, for example to invest or to recapitalise fragile state banks, in practice, Modi is expected to allocate a large share of it to plug current budget holes.
This is probably a new episode highlighting the growing politicisation of the economy that has been observed in India over the past years, notably with the questionable revision of past GDP growth figures, political pressures to relax lending to state banks, four cuts in interests rates this year or the RBI’s interim dividend payment of USD 4 bn last February during Mr. Modi’s election campaign. Governmental pressures to reduce the independence of the central bank are witnessed in other large countries (e.g. US, Turkey…) and are not welcome – The RBI governor is appointed by the government, though. They could favour populist measures, undermine the RBI’s credibility, create uncertainty and ultimately harm the monetary policy effectiveness.
Analyst: Raphaël Cecchi – firstname.lastname@example.org
Is the storm coming? Dark clouds over Lebanese economy
In recently months the economic clouds hanging over the Lebanese economy have grown darker. First of all, the gross reserves held by the central bank have been falling. Secondly, Fitch Ratings downgraded the sovereign rating by two notches to CCC – deep into junk territory. Thirdly, the last data (June 2019) on the stock of non-resident deposits at the commercial banks indicate that they have remained broadly flat. Furthermore, the government was only able to pass the 2019 budget at the end of July as it was opposed by various interest groups who were challenging the consolidation efforts included in the budget. Lastly, while the budget was approved and includes consolidation efforts, the IMF still predicts that i will lead to a deficit of 9.75% of GDP at the end of 2019. Infighting among coalition partners seems to be inhibiting deeper reforms. Most recently it was a dispute between two Druze parties that prevented the government cabinet to hold sessions for two weeks in the beginning of August.
For Lebanon these are all important elements to watch as they are indicative of the difficulty in which the economy finds itself. At the heart is the issue that the government keeps running large public deficits that have pushed up to the public debt level to more than 150% of GDP by the end of 2018. Without strong and persistent consolidation efforts public debt is predicted to rise further to unsustainable levels. With the 2019 budget the Lebanese government for the first time claims to implement significant reforms. Nevertheless, deficits are expected to remain large. Furthermore, the large public deficits which the country funded by attracting non-resident deposits from the Lebanese diaspora living abroad, by borrowing abroad and by incentivising Lebanese banks to repatriate funds they previously held abroad. This explains why non-resident deposits at the commercial banks are an important indicator to watch as they are the most important lifeline funding the economy. When the inflow of deposits slowed in the past, Lebanese banks responded on multiple occasions by offering higher interest rates in coordination with the Lebanese Central Bank, a step that they have also took in June this year. The question is however if this is a sustainable policy.
In January 2019, the debt built up combined with the political gridlock and the lack of reforms already made investors worry that a bond restructuring would be imminent, which created panic on the bond market. Panic only cooled with the formation of the government, the pledge of bold consolidation measures and the promise of financial support from the Gulf States. Currently we are witnessing a similar situation as the bond yields have risen to their highest rate in more than a decade.
For Lebanon it is important to keep a steady inflow of non-resident deposits or at least avoid a reversal of deposits and thus avoid any confidence crisis in the banking sector erupting. As the Lebanese banks are overexposed to the sovereign, this means trust in the government’s repayment capacities should remain strong, something that is currently clearly under pressure. The availability of a bailout package is often seen as an important cushion that could provide support. In April 2018 western states agreed to put forward around USD 10 bn in concessional loans (and USD 0.8 bn in grants) as a bailout package. Whether the funds can act as a sufficiently large cushion is however unsure. First of all, the funds have not yet been released as the Lebanese government first needs to implement significant reforms. And it is not yet sure if the reforms taken in the 2019 budget will be seen as sufficient. Secondly, while the size of the aid package is large in absolute value, it is relatively small when taking into account the time period over which it will be released (12 years), the size of the Lebanese economy and the gross refinancing needs of the economy. Therefore additional bailouts are likely to be necessary. Here, the Gulf countries might play an important role, although obtaining additional bailouts funds from Saudi Arabia and the United Arab Emirates is likely not to be a walk in the park given the strong role Hezbollah currently plays in the government.
Credendo already downgraded the MLT political risk category of Lebanon to category 7 in January 2019. Currently the main pressure is therefore on the short-term political risk classificati0n, which is currently still in category 5. Pressure for a downgrade is increasing. Firstly, due to the fall in the gross foreign exchange reserves (although they remain large). Secondly, due to the deterioration and opacity of the balance sheet of the central bank given that is increasingly takes on foreign currency liabilities, but does not publish data on their size and term structure. Thirdly, due to the more difficult refinancing capabilities of both the sovereign and the Lebanese banking sector, and lastly due to the built-up in short-term external debt.
Analyst: Jan-Pieter Laleman – email@example.com
What are the main drivers of ST political risk?
Credendo’s short-term political risk assessment largely reflects a country’s liquidity situation and takes into account any risky short-term political situations. The short-term political risk of Belarus is currently in category 5 on a scale from 1 to 7 (the highest risk). This classification reflects an improvement of some indicators but also the widening of the current account deficit and the risk arising from Russia’s tax manoeuvre.
Positive evolution of short-term external debt and gross foreign exchange reserves
Over the past few years, the financial and macroeconomic policies have improved significantly. Short-term external debt has decreased in relative and absolute terms and accounts for less than 30% of current account receipts. The gross foreign exchange reserves have increased over the last years (cf. graph 1) and reached 2 months of import cover in May 2019 – its highest relative level since 2013. Thanks to these positive developments, the gap between the shorter-term external resources and short-term external obligations of Belarus has narrowed. This positive picture is somehow tarnished by the rising current account deficit.
Risk arising from the current account balances
Indeed, in 2019 the current account deficit is expected to widen to 4% of GPD (from 2.3% in 2018) on the back of a less favourable external environment and imports related to the construction of a nuclear power plant. In particular, trade tensions with Russia – Belarus’ main export market – have affected exports of food products to Russia. Looking ahead, food exports to Russia are unlikely to remain subdued. After all, Russia is becoming more self-sufficient thanks to its successful import-substitution strategy which was aimed at developing its agriculture and food production.
On top of that, the net oil trade surplus – arising from the fact that Belarus was used to buying cheap crude oil imports from Russia, refining it in Belarus and then selling it to Europe at market price – is under pressure. Indeed, last year Russia decided to introduce a mineral extraction tax which would apply to domestic production and exports. This new tax is going to replace the export duty on oil and oil products over a five-year period and thus reduce the energy subsidies provided to Belarus over a period of five years. Such move implies a rise in input prices for the Belarussian oil refineries. For 2019, the impact on the current account balance is estimated at around 1% of GDP.
In addition, the tax manoeuvre implies a loss of export duties on oil products for the Belarussian authorities (this affects public revenues and thus fiscal balance). Without compensation – which is under negotiation – and once the transition will be completed (in 2023) the direct impact of the tax manoeuvre on fiscal and current account balances is estimated at about 1.3% and 3.9% of GDP respectively.
Taking into account the improvement and risks, Belarus’ short-term political risk is expected to remain stable in the forthcoming months.
Analyst: Pascaline della Faille – P.dellaFaille@credendo.com
Ongoing protests put short-term risk classification under pressure
President has trouble tempering political protests
One year after fierce political protests erupted, President Jovenel Moïse remains unable to defuse the situation. The protests originally started in July 2018, when fuel subsidy cuts were announced. As Venezuela’s deliveries of subsidised oil came to a full stop a couple of months beforehand, the government needed to buy oil at full price on international markets. Though the price hikes were suspended the day after the announcement – before they could even be implemented – unrest lingered. In the following months, protests regularly flared up, fueled by the fast-rising inflation, high poverty, goods shortages and corruption scandals.
Now the president is trying to appease unrest by appointing yet another prime minister (Fritz William Michel). If confirmed by the parliament, Michel – a little-known bureaucrat from the Ministry of Economy and Finance – will become Moïse’s fourth prime minister in less than three years. Nonetheless, the chances are that the protests will not die down, as a new cabinet is unlikely to bring about material change to policymaking, when placed under constant pressure from an angry opposition. Moreover, the protests focus on the resignation of the President, who refuses to step down. Indeed, Moïse, whose term is scheduled to end in 2022, pledged to serve the remainder of his term, something only a quarter of Haiti’s presidents accomplished. The ongoing political unrest could also have an impact on the local and legislative elections scheduled for October this year, as the organisation of elections remains uncertain without a government in place and an approved budget.
Short-term risk classification is under pressure
The short-term risk classification is under pressure due to the ongoing political unrest. The moderate short-term risk classification of Haiti (4/7) can be explained by a fairly low short-term external debt level, adequate foreign exchange reserves (in December 2018, they covered roughly 5.5 months of imports) and a relatively wide current account deficit (estimated at almost 4% of GDP in 2019). However, the ongoing protests and their potential escalation put pressure on Credendo’s short-term risk classification. Besides, next to a possible escalation of protests, downside risks loom over Haiti. Firstly, a harsh crackdown on immigration by Trump would impact the Haitian economy. Roughly two thirds of the current account receipts come from private transfers. Therefore, a crackdown on immigrants in the US or on their remittances would negatively affect the current account balance and foreign exchange reserves. Furthermore, private transfers support consumer spending and economic growth. If they were to decline, economic growth would be likely to decrease as well. Secondly, the country is highly vulnerable to natural disasters. The island not only sits in the middle of the Caribbean hurricane belt but is also prone to earthquakes and droughts.
Worst classifications for systemic commercial risk and medium- to long-term risk
Haiti is classified in Credendo’s worst category for systemic commercial risk (category C). Rampant corruption and a rather low level of legal protection are indeed affecting the business environment. Additionally, Haiti’s economy, which is forecasted to have a lacklustre real GDP growth of 1.5% in 2019, might even be pushed into a recession due to the persistent political instability. Furthermore, the currency has been depreciating sharply since last year. It has lost about 30% of its value vis-a-vis the USD since August 2018 (last observation on 5 August 2019). As a consequence, the country’s inflation is estimated to have reached a high level of 18% in May. All these elements explain the high-risk classification for systemic commercial risk.
Unsurprisingly, in light of the ongoing events, the medium- to long-term risk classification remains firmly in category 7/7.
Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com
Shipping, refining, bunkering will all be shaken by the entry into force of the IMO 2020 regulation as from 1 January next year
In a move to reduce air pollution by ships, the International Maritime Organisation (IMO), the United Nations’ specialised agency responsible for the safety of shipping and the prevention of marine and atmospheric pollution by ships, decided to lower the limit of the sulphur content of the marine fuel to 0.5% mass by mass (m/m) from the current 3.5% cap, which has been in vigour since 1 January 2012. The new regulation, called IMO 2020, was adopted in October 2016 and will come into force as from 1 January 2020. While the use of marine fuel in some designated Emission Control Areas is already subject to a cap of 0.1% m/m of sulphur, the new IMO 2020 measure applies worldwide. The measure is considered as a major shake-up for the shipping and the oil refining sectors.
In case of non-compliance with the sulphur cap rule by carriers, the IMO itself has no authority to enforce the regulation but enforcement is being left to the discretion of individual member states, meaning to port authorities, in practice. Although there is some lobbying to delay the implementation date of the measure, the IMO website announces that there can be no change in the 1 January 2020 implementation date.
Carriers are left with 3 main possibilities to comply with the regulation: burning compliant low-sulphur marine fuel, installing scrubbers or using LNG or methanol as fuels.
The adoption of the third option will be neglected by carriers because sufficient LNG or methanol supply infrastructures are still missing in ports around the world, as the use of gas for powering ships is in its infancy. Retrofitting an existing fuel oil vessel with an LNG engine is also a complicated, costly operation. As a result, this option makes more economical sense for new watercrafts.
The use of exhaust gas cleaning systems, also called scrubbers, is another option for the shipping industry. Ships equipped with scrubbers can continue to burn high-sulphur bunker fuel and comply with the 0.5% m/m sulphur limit. The cost of installing scrubbers is reported to vary from USD 1 m to USD 10 m per vessel, depending on the number and capacity of the main engines. The share of vessels equipped with scrubbers is expected to remain limited to a small percentage of the global fleet, at least in the first years following the implementation of IMO 2020. Due to the increased demand, scrubber manufacturers will not be able to deliver enough devices on time. It is also worth noting that the use of open-loop scrubbers, which is probably the cheapest way to comply with the IMO 2020, has already been prohibited in some regions and ports, such as China’s coastline and Fujairah, and will be banned in Singapore as from the beginning of 2020. More ports are expected to follow. Open-loop scrubbers, contrary to closed-loop scrubbers, pump water in the sea to clean the fuel and drop out the waste in the sea. Closed-loop scrubbers, which store wash water for later discharge, are still accepted in most ports.
Burning compliant low-sulphur marine fuel will therefore be the most straightforward way to comply with the new regulation. Heavy fuel oil (HFO) with a high sulphur content represents the vast majority of marine fuel currently sold. In order to comply with the IMO 2020 regulation, carriers can switch to burning either marine gas oil (MGO), a pure distillate product, or ultra-low sulphur fuel oil (ULSFO) of 0.1% maximum sulphur content. Although ULSFO is inexpensive in comparison to MGO, its lower availability as well as concerns about fuel stability issues risking to damage engines with sediments should prevent it from being used to a large extent following the start of the IMO 2020 period.
Therefore, switching to MGO will probably be the preferred solution in the first months (or even years) following the enforcement of the IMO 2020. Today, prices of MGO with a maximum sulphur content of 0.5% are about 40% higher than those of IFO 180 (a high-sulphur fuel oil type), according to the ‘Global 20 Ports Average’ bunker fuel prices (see chart 1). Consequently, fuel costs for the shipping sector should increase by several tens of percent as a result of the higher fuel prices and the switch from HFO with a high sulphur fuel content to MGO. According to estimates made by the energy consultancy agency Wood Mackenzie, global shipping fuel costs are likely to rise by 25% and, if no vessels added scrubbers and all ships complied with the rules, the spike could be as high as 60%.
Whatever the way to comply, marine transport costs will significantly increase while fuel costs already represent more than half of the operating costs of the shipping sector. As a result, freight rates will increase, as many shipping companies have announced that the rise in costs will have to be passed on to customers. Some are already doing this through the adjustment of their fuel surcharges. For the remaining increase in cost, they will have to cut into profit. As the IMO is also pushing for the imposition of stricter targets of CO2 emissions from ships, shipowners could be further shaken by other environmental regulations. Investment decisions are difficult to take. Indeed, in terms of CO2 impact, LNG- or methanol-propelled vessels are more interesting.
Another major risk related to relying to a large extent on the use of compliant fuel is the fact that the refining industry could be unable to supply enough of the compliant fuels as from 1 January 2020, leading to shortages. In that respect, refineries able to extract a higher share of the compliant MGO and heavy fuel oil will benefit from the move, as the demand and refining margins for those products will increase and as they could gain market shares from small, independent refiners. US Gulf Coast refineries and complex ones in the Middle East are well placed for the shift as they produce a higher share of lighter, low-sulphur fuels from each barrel of crude. European refineries that supply a high portion of middle distillates should also benefit. On the contrary, refineries in Russia could lose market shares as the country, which is among the top exporters of marine fuels, deals with the high-sulphur Ural crude.
Regarding the bunkering companies (i.e. the industry supplying the fuel used by ships), besides the necessary adaptation in terms of the range of products sold and in bunkering infrastructures, the IMO 2020 could impact their financial structure, as a large proportion of bunker fuel sales are made to shipowners and carriers on credit. The question remains as to whether the sector will be able to face that heightened demand of credit.
Analyst: Florence Thiéry – firstname.lastname@example.org
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