Monthly Overview / November 2019
In this month’s issue:
- Country Risk: Lebanon, Sri Lanka, The Caribbean and Pacific islands, Bolivia
- Country Risk Updates: Aruba
- Sector: Steel sector
A confidence crisis triggered by an economic storm, with currently no end in sight
In recent weeks, the dark clouds that were hanging over the lebanense economy have transformed into all-out storm. Initally triggered by a reduction in non-resident deposits flowing into the Lebanese economy and by a lack of credible reforms to reduce the strucutrally large fiscal deficit, the situation has now escalated into an all-out confidence crisis. The crisis has led to doubts over the country’s sovereign creditworthiness and the health of its banking sector. At the same time, the economic troubles have led to protests in the country. The protest are now entering their fifth week. The anti-government protests are driven by complaints about economic conditions. The have already led to the resignation of Prime Minister Saad Hariri on 29. October 2019. On Monday, they further escalated when anit-government protesters clashed with Hezbollah supporters who oppose the curent protests.
The current crisis is both economic and political and will prove difficult to solve. At the heart of the economic crisis lies the issue that the government has kept running structurally large fiscal deficits. These averaged around 8.5% of GDP over the period 2012-2018. The large public deficits and the significant imports needs of the country have led to large current account deficits which the country has funded by attracting non-resident deposits has slowed in the past, Lebanese banks have responded on multiple occansions by offering higher interest rates in coordination with the Lebanese Central Bank. This happened for example last June when investors were offered a juicy 14% interest rate if they risked depositing funds in a three-year Lebanese term account.
While this strategy worked for a number of years, the inflow of non-resident deposits slowed in 2018 and at the start of 2019. Additionally, investors have grown increasingly concerned about the government’s inability to reduce the large fiscal deficit. As the Lebanese banking sector is heavily exposed to sovereign risk, this has also led to distrust, putting an end to the years of trust the Lebanese economy enjoyed as a stable financial centre.
The outcome has been a clear drop in confidence in both the Lebanese pound (which is pegged to the US dollar) and the banking sector among the population and foreign deposit holders. This has triggered a bank run and a run on the Lebanese pound. The Lebanese Central Bank currently holds gross reserves sufficient to cover 11 months of import coverage but has been in practice faced with a liquidity squeeze, as years of financial engineering have led to a deterioration of its balance sheet and thus much lower usable reserves (estimated to be only USD 6–8 bn). Thus they have been unable to meet all the demands to exchange Lebanese pounds into US dollars. This has led to foreign exchange shortages and the introduction of restrictions by the Lebanese banking sector that limit the conversion of Lebanese pounds to USD. The result has been a parallel exchange-rate regime that developed on the black market where Lebanese pounds trade at a steep discount. Additionally, importers are increasingly facing difficulties obtaining hard currency to pay suppliers.
As far as the political crisis is concerned, the protests were originally triggered by the government’s announcement to impose a tax on WhatsApp calls but are reflective of much more structural issues, as there is strong discontent among the population over the mismanagement of the Lebanese economy. Initially the protests led to the abolition of any new taxes in the budget proposed by Prime Minister Saad Hariri. Later on, they led to the resignation of his government. Therefore, the economic crisis has further escalated into a political crisis as the different sectarian political parties and protesters demanding an end to sectarian politics and a technocratic government will need to agree on a new government. Reportedly, Saad Hariri would like to head a new government that would consist of both technocrats and less controversial politicians but it is unclear if he will gain sufficient support and if this would meet protesters’ demands. A purely technocratic government might not be the solution, as this government would still need to push legislation through the deeply sectarian parliament.
The formation of the last government took 9 months, involved careful negotiations between the various political factions and resulted in a unity government with 30 ministries; this time there is not as much time. Even if a government were to be formed rapidly and urgent reform measures were taken, it is becoming increasingly unlikely that Lebanon would be able to overcome the economic troubles by itself without restructuring part of its bloated public debt load (public debt stood at around 150% of GDP at the end of 2018). A bailout package could avoid this but Western creditors that put together the USD 11 bn soft loan package in 2017 made it conditional on clear economic reforms, which so far have not happened. For the countries in the Gulf, structural reforms are also likely to be a condition. While Saudi Arabia voiced support for the Lebanese economy in January, it has not put together a clear package since then. Here the main source of uncertainty is how they will deal with Hezbollah, which is likely to be present in any future government in Lebanon and is backed by Iran and strongly opposed by Saudi Arabia. Currently Credendo has maintained Lebanon in category 6/7 for short-term political risk, after downgrading it last October. However, given the current crisis situation, this rating is clearly under pressure and a further downgrade is increasingly likely.
Analyst: Jan-Pieter Laleman – email@example.com
The Rajapaksa family’s return to power: will the past repeat itself?
On 16 November, Gotabaya Rajapaska (SLPP party), former Defence Secretary and brother of former President Mahinda Rajapaksa (2005–2015), convincingly won a peaceful presidential election with 52.3% of the votes ahead of the strongest opposition candidate, Sajith Premadasa, who took 42.9% of the votes. The parliamentary election, due by August 2020 at the latest, could be held earlier – possibly in February – as the current government is likely to be dissolved. Given the SLPP’s probable victory, Mahinda Rajapaksa, who is particularly popular among the majority Sinhalese population, is likely to be appointed by his brother and return to power, this time as Prime Minister.
Gotabaya Rajapaksa has clearly capitalised on the failure of the former government to prevent the country’s worst terrorist attack last Easter. The magnitude of the shock for the population and of the impact on tourism meant that ensuring national security suddenly became top priority for most voters in the presidential election. Based on their reputation for doing what has to be done, which in particular brought them success at the end of the civil war in 2009, the “Rajapaska candidate” had a high chance of being elected. The Rajapaksa clan could soon rule the country with Mahinda Rajapaska as PM if their SLPP party wins the next parliamentary election as expected. Political stability should be the main positive aspect of this political development. Indeed, permanent infighting between former President Sirisena and PM Wickremesinghe has largely hindered economic policy since 2015. Apart from that, the return of the Rajapaksa family is marred by uncertainty and risks of a return to the populist policies of the past.
This is particularly worrying as it is happening at a time of economic weakness and global trade gloom. Gotabaya will diverge from his predecessor’s policies and reverse a number of them. He made populist fiscal promises during his campaign, announcing various tax cuts and higher social spending. Those measures could not only cause the further deterioration of the already poor fiscal sustainability of a country burdened by the second highest government debt in Asia (83% of GDP expected at the end of 2019) and huge interest payments depriving the government of more than 45% of its revenues, but would also call into question fiscal consolidation under the current IMF programme (ending next June). Moreover, as Sri Lanka is expected to tap the international markets in the coming years, a loose fiscal policy would negatively affect investor sentiment and make the financing of its higher external debt service more difficult.
Internally, Gotabaya will focus on restoring order and tightening national security. The risk is that he could emulate what his brother did when he was President, making the regime more repressive – which would mean a crackdown on political and media criticism – and fuelling ethnic and religious tensions. The latter has become more sensitive since the Easter terrorist attack. Among his first major political moves, Gotabaya could reverse the rebalanced political system under the Sirisena presidency (e.g. a two-term presidential limit) by once again strengthening the President’s constitutional executive powers. Foreign policy is also likely to change direction. Although he claims to remain neutral, Gotabaya, like his brother, is expected to be somewhat more inclined to favour China than India diplomatically and when attracting FDI. Moreover, under Rajapaksa’s rule, relations with the UN, USA and EU could turn sour again over alleged human rights abuses in the final weeks of the civil war, which ended in 2009. Gotabaya played an active role as Defence Secretary and has pledged to free war heroes and police officers.
The coming months will tell whether Gotabaya will follow in his brother Mahinda’s footsteps, with all the risks it entails, or whether he will opt for a more pragmatic, conciliatory and balanced approach. Sri Lanka’s risk outlook is likely to reflect the chosen trajectory. Credendo’s MLT political risk rating remains unchanged at 5/7.
Analyst: Raphaël Cecchi –firstname.lastname@example.org
The Caribbean and Pacific islands
Climate change leading to rapidly increasing risks in the most vulnerable countries
The Caribbean and Pacific islands: major victims of climate change
Climate change, translated into a continued global rise in temperatures due to human activities, is happening, and at an accelerated pace. In the coming years and decades, the severity and the frequency of extreme weather events, from hurricanes and cyclones to severe droughts and floods, are expected to increase. This is especially the case for the Pacific and Caribbean islands situated in the hurricane belt, which are considered the world’s most vulnerable states to climate change. Climate scientists expect hurricanes like Irma and Maria in 2017 and Dorian in 2019 (the fiercest hurricanes ever recorded, which pummelled the Caribbean) to become more common. As a result, the impact of natural disasters on small islands will be exacerbated.
Small Caribbean and Pacific countries are disproportionately affected by natural disasters (hurricanes or cyclones). According to the IMF, the average estimated disaster damage as a ratio to GDP is 4.5 times greater for small states than for larger ones. The main reason is that small states have fewer resources to cope with the aftermath of such natural disasters. On top of that, on small islands, the majority of the population and economic activity tends to be clustered close to the coastline, which is more vulnerable to floods. Hence, a natural disaster such as a hurricane strike can easily translate into a deep macro-economic and fiscal crisis, with an increasing frequency of extreme natural disasters meaning that those small island countries have less time and financing to recover and rebuild buffers between natural disasters.
Impacts of natural disasters on country risks
The probability of a hurricane or cyclone strike is high in the Caribbean and the Pacific Ocean, where it can negatively impact a country’s transfer and non-payment risk. The economic and financial impact of extreme natural disasters can be felt through multiple channels. The first obvious impact is on real GDP growth and nominal GDP, because of lower productivity due to damaged physical infrastructures, depressed tourism activity and weaker agriculture output, two traditionally key sectors for islands. On average, about 9% of natural disasters in small countries involve damage of more than 30% of GDP – often well above 100% of GDP for smaller islands – which makes the ex post recovery challenging and longer, and eventually reduces the growth potential.
Public finances are also very much impacted by the resulting high economic recovery spending and unanticipated needs for immediate social protection. Therefore, natural disasters widen fiscal imbalances and swell public debt. This happens even when governments are insured against hurricanes (e.g. high coverage under the Caribbean Catastrophe Risk Insurance Facility). In some cases, it translates into public debt default and renegotiation, as with Grenada – a country characterised by high public debt – after it was hit by hurricane Ivan in 2004.
Note that ‘t’ is the year the natural disaster struck.
At the level of the current account balance, small islands tend to deteriorate as a result of reduced export capacity, tourism and agriculture receipts, while imports rise (notably agriculture and capital goods) if buoyed by reconstruction programmes. The negative impact on the current account balance tends to span across years and could persist especially if there is a slump in tourism because of more frequent and severe natural disasters. Capital outflows, deterred investment and a more volatile exchange rate are also potential negative consequences that could hit the balance of payments of those countries.
Experience – e.g. with Vanuatu and Tuvalu after Cyclone Pam in 2015 – shows that rapid external debt accumulation is not uncommon in countries experiencing a series of natural disasters. This may reflect a weak underlying fiscal stance, with disaster-related borrowing exacerbating already weak debt dynamics. In the Eastern Caribbean Currency Union, the external debt-to-GDP ratio rises by almost 5 percentage points on average the year a storm strikes. However, a jump in external debt might be more pronounced in the case of a large hurricane. Here as well, the higher external debt is unlikely to decline again in the years that follow.
Note that ‘t’ is the year the natural disaster struck.
The impact is not just limited to macro-economic indicators. A major natural disaster can also affect the political environment if the population is not satisfied with the pace of reconstruction or blames inefficiency or a lack of pre-emptive action on the part of the government. Social stability can also be affected by protests and unrest, rising unemployment and poverty in the aftermath of a natural disaster.
Small islands have very limited buffers
It is worth pointing out that several factors can mitigate those negative impacts. The size of an economy is the main mitigating factor. When a storm strikes a small country, it generally affects a large section of its territory and population, while the impact in larger countries can be contained to relatively smaller areas. This also explains why small Pacific and Caribbean islands are so vulnerable to extreme natural disasters. Resilient infrastructures are of paramount importance as well. Currently, no small island can rely on resilient infrastructures to protect them against the bigger natural disasters expected in the coming decades. Another buffer lies in strong foreign exchange reserves as they smooth the impact of a hurricane or cyclone strike, act as a buffer against capital outflows and decrease the need for external lending. Moreover, financial protection reduces the impact of recovery and reconstruction costs on public finances. At a multilateral level, for example, technical and financial support from the World Bank and the IMF is available to small countries experiencing natural disasters. In the Caribbean, the Caribbean Catastrophe Risk Insurance Facility (CCRIF), which has 17 members and was set up in 2007, was the world’s first regional risk-pooling financial institution offering insurance against the most prevalent natural disasters in the region. Disbursements do not cover all the losses but offer significant support to insured countries. Nevertheless, the Caribbean and Pacific islands currently invest little in ex ante resilience-building (i.e. before a natural disaster hits) and rely heavily on post-storm recovery efforts due to high costs. Moreover, insurance will not completely mitigate the impact of a natural disaster.
Credendo’s MLT political risk ratings affected
Through the various channels of contagion mentioned previously, climate change and the associated more severe and frequent natural disasters are integrated into Credendo’s country risk assessment. They bring the most vulnerable countries into higher MLT political risk categories, as is the case for the Caribbean and Pacific islands. During a recent update, Credendo’s ratings for some of the small Pacific islands – namely the Solomon Islands, Tonga and Vanuatu – were downgraded to category 6/7.
Looking ahead, although the impact on the small Caribbean and Pacific islands remains by far the greatest, the accelerating climate change can be expected to increase risks in developing countries in the future, especially in Africa, Asia and Latin America.
Analysts: Jolyn Debuysscher – email@example.com
Raphaël Cecchi – firstname.lastname@example.org
Re-election of President Morales fuels unrest while economic challenges loom
Incumbent President Evo Morales – first elected in 2005 – has been declared the winner of the presidential elections that took place at the end of October. Morales secured 47% of the vote and a lead of 10.6 percentage points ahead of Carlos Mesa, who came second. With this election result, Morales has narrowly avoided a run-off. On top of that, Morales’ party (Movimiento al Socialismo) has won an absolute majority in both houses of Congress, but it has lost its two-thirds majority.
Since the presidential elections, the country has been paralysed by protests, road blockades and labour strikes. A suspicious 24-hour pause during the vote counting has fuelled accusations of fraud. On top of that, given that Morales lost a referendum in 2016 and defied the term limits by means of a decision by Bolivia’s constitutional court, there have been claims of creeping authoritarianism. Numerous countries and the Organization of American States (OAS) have expressed concerns about the elections.
Morales looks determined to cling to the presidency until 2025. The President has accepted an election audit by the OAS but it is unclear when the outcome of the audit will be announced. The ongoing unrest is unlikely to unseat Morales as he controls the main levers of power. However, the continuing political unrest is a threat to domestic economic activity. Real GDP growth (estimated at 3.9% in 2019) has already slowed in recent quarters as falling growth in Latin America has sapped demand for Bolivian exports. The political unrest will make it even more difficult to govern while important decisions have to be made. The large fiscal deficit is expected to swell to almost 8% of GDP this year, which is likely to increase public debt to an elevated 58% of GDP. Hence, fiscal consolidation will be key in the coming years while polarisation will render policy-making difficult. Furthermore, in the past 5 years, foreign exchange reserves have decreased by a stunning 60% to roughly 5 months of import cover in September 2019. Although it is still a healthy level, the pace of the decline is putting strong pressure on the currency peg. In the coming years, the elevated current account deficits will continue to weigh on foreign exchange reserves and the currency peg. Economic diversification away from gas (which accounts for about a third of total export revenues) will therefore be important as well.
Given the political unrest and continued decline in foreign exchange reserves, Credendo’s outlook for Bolivia for both short-term and long-term political risk is negative.
Analyst: Jolyn Debuysscher – J.Debuysscher@credendo.com
Downgrade of medium- to long-term political risk classification from 3/7 to 4/7
A special relationship with the Netherlands
Aruba – a former Dutch colony – is an autonomous and self-governing country within the Kingdom of the Netherlands. It seceded from the Netherlands Antilles in 1986 and has had “status aparte” since then. Aruba voluntarily halted the legal process to separate the island from the Kingdom of the Netherlands in 1990 and, as such, independence is unlikely in the medium term. That being said, relations with the Netherlands mainland have been under some strain in recent years. The public budget and migration-related issues are the main sources of friction.
Aruba holds general elections every 4 years. The last elections (2017) brought about a coalition government made up of Movimiento Electoral di Pueblo and the much smaller Pueblo Orguyoso y Respeta and Network of Electoral Democracy. This is the first coalition government in 16 years. Indeed, since 2001 the island had been led by consecutive majority governments. Furthermore, for the first time in Aruba’s history, the government is headed by a female prime minister, Evelyn Wever-Croes.
One of the most tourist-dependent countries in the world
Aruba is a small, open economy whose exchange rate is pegged to the USD (kept at USD 1.8 for the last 30 years). The island is heavily dependent on tourism: 87% of the economy depends directly or indirectly on tourism. Hence, the island is one of the most tourist-dependent countries in the world. Around 70% of tourists come from the US, making the island very sensitive to the US economic cycle. On the upside, the island is located outside the hurricane belt, which means tropical storms are a rare event and do not impact tourism revenues.
However, Aruba was not always so dependent on tourism. Before the last refinery was closed in 2012, oil refining was also a dominant sector in Aruba. A re-opening of the refinery would diversify the economy and give it a boost. Citgo Petroleum (the US subsidiary of Venezuelan state-owned oil firm PDVSA) signed an agreement on the reactivation of the refinery. However, the US sanctions and the ongoing deep economic crisis in Venezuela render a reopening unlikely in the foreseeable future.
Challenges for economic growth
The economy has witnessed several recessions since 2008. The global financial crisis and the end of oil refining have led to economic contractions. Since 2016, the island has been recovering gradually thanks to strong growth in tourism from the US. That being said, economic growth remains relatively sluggish. In 2019, a real GDP growth of 0.7% is expected while in the coming years it is forecast to increase only mildly to around 1%. The main reasons for these pessimistic growth forecasts are the slowing global – and especially US – economy and planned fiscal consolidation due to the dire state of public finances. Fierce competition from other tourist destinations in the Caribbean also hampers the possibility of strong growth in tourism revenues. In addition, an important downside risk is the ongoing economic crisis in Venezuela, which lies 30 kilometres away from Aruba. The risk of a sizeable influx of migrants (though the border is closed between the two countries) could have a significant negative impact on growth forecasts.
Public finances in a dire state
The island’s public finances are in a dire state. Weak economic activity and the government’s policy response after the global financial crisis have taken their toll. Public debt has more than doubled, from 41.7% of GDP in 2008 to 84.5% of GDP at the end of 2018, which is a high level. Since 2015, the government has tried to enact fiscal consolidation. As a consequence, the primary balance has turned positive since 2015. However, as the fiscal deficits have remained sizeable, public debt has not decreased to below the level of the end of 2015. In November 2018, the government proposed a new fiscal consolidation plan which spans 2019-2021. The agreement on fiscal consolidation was made together with the Netherlands, adding some credibility to the plan. Thanks to the fiscal consolidation plan, the fiscal deficit is expected to narrow to 0.8% of GDP in 2019 before further decreasing to -0.5% of GDP in the medium term. Consequently, public debt is expected to fall as well, to a still elevated 75% in the next 5 years. Nevertheless, the consolidation plan is very ambitious and it could be difficult to adhere to the agreement. First, in 2017 and 2018 fiscal targets were missed despite an agreement with the Netherlands being in place since 2015. Indeed, fiscal slippages led to an increase in public debt in 2017, which in turn led to strong tensions with the Netherlands. Second, compared to the historical experience of other countries, Aruba’s adjustment is large. Furthermore, the projected downward path of public debt remains vulnerable to weaker than expected economic growth. Last, protests are not unlikely and could derail consolidation efforts, especially in the light of the elections of 2021.
Oil prices and tourism revenues as main drivers of the current account balance
Tourism revenues are a vital source of export revenues, accounting for almost 80% of current account receipts. Food and offshore financial services are to a far lesser extent sources of export revenues. This small export base makes the current account balance of this small Caribbean island especially vulnerable to shocks related to the tourism industry. On the import side, oil is the main source of import expenditure. High oil prices partly pushed the current account deficit to a high level, notably in 2013 and 2014. In the past 4 years, however, the current account balance has been in positive territory thanks to higher tourism revenues and lower oil prices. The current account balance is expected to fall into negative territory again as of 2019. Indeed, high imports due to infrastructure projects are likely to keep the current account balance in a slight deficit at least until 2023. Thereafter, reduced oil imports thanks to the implementation of energy-saving technology, an expected increase in tourism and ongoing fiscal consolidation are expected to help the current account balance reach a surplus.
High external indebtedness
External debt has increased in recent years as fiscal deficits have been financed through a mix of domestic and external issuances. External debt stood at roughly 90% of GDP at the end of 2018 – a high level – while external debt service is rather elevated. External debt ratios will only increase moderately in the coming years due to the expected growth of tourism receipts and nominal GDP. Foreign exchange reserves stood at 4 months of imports in August 2019. This is generally a healthy level but to safeguard the peg with the USD over the medium term, nominal foreign exchange reserves should increase. That being said, fiscal consolidation and structural reforms are expected to support the accumulation of foreign exchange reserves in the coming years.
Downgrade of medium- to long-term political risk classification from 3/7 to 4/7
Past recessions, the dire state of public finances and high external indebtedness have negatively affected the macro-economic fundamentals of the Caribbean island. Lacklustre growth forecasts and enduring high external indebtedness are forecast in the medium to long term while the island is not likely to be able to diversify its small export base in the foreseeable future. In view of this, Credendo has downgraded the medium- to long-term political risk classification from 3/7 to 4/7.
Analyst: Jolyn Debuysscher – email@example.com
Very low prices hitting company margins
The steel industry worldwide
China is the biggest producer and consumer of steel. Its domination has been increasing over time, and it is currently responsible for 45% of global production (in terms of value) and 49% of global consumption. The Chinese steel sector is still struggling with the scourge of overcapacity, leading to overcapacity worldwide. The European Union is in second place with 17% of global production (in terms of value). Japan is the closest follower at 12%. Then come India (7%) and the USA (5%). China’s share of global production is expected to increase over time on the back of growing production while that of other countries is expected to decline (mainly due to lower production), except in India. Therefore, China is comfortably settled in its leadership seat.
Globally, 56% of the world’s steel consumption is dedicated to building, infrastructure and transport, 15% to mechanical equipment and 12% to automotive sector, with other metal products (11%), domestic appliances and electrical equipment (both 3%) accounting for the rest, according to the World Steel Association. Steel prices are therefore dictated by the demand from those sectors. Still, the current slowdown affecting the global economy is the most severe since the crisis of 2009. Global industrial production is slowing down very rapidly and global trade has reached a post-crisis low. And to stir up trouble, the ongoing trade war between China and the USA is an additional cause for concern for international trade. Indeed, the bursts of tariffs that they both apply represent an extra burden for importing firms, increasing their costs, reducing economic activity and, ultimately, reducing the demand for metal (including steel). Besides, the European manufacturing sector is facing uncertainties and a marked slowdown, as shown by the various European countries’ Purchase Manager Index (PMI) contractions. Finally, a sword of Damocles still hangs over the European car industry, which is a big consumer of steel: the White House has not yet decided whether it will apply tariffs on imports of European cars into the USA. Although the easiest way for them was through the application of Section 232, this option is no longer possible because the deadline was 13 November 2019. If Mr Trump still wants to put tariffs on imports of European automobiles, he will have to find another way. We cannot say that the danger is definitely averted, but it has been removed for the time being, bringing relief, but still leaving uncertainty.
Given the ongoing global economic slowdown, global overcapacity and continuing trade tensions, we expect the steel price to decline further, as it has been doing since August 2018 (see graph 1). Looking ahead, one of the main risks for the steel industry is a larger than currently expected downturn in economic activity.
From the point of view of inputs, iron ore and coking coal are the raw materials most intensively used in steel production, representing about 60% of producers’ costs in the USA and China. Since a Vale dam collapsed in Brazil at the beginning of 2019 – combined with other incidents reducing the production of iron ore in Australia – the price of iron ore has skyrocketed. It increased by 65% between mid-January and mid-July 2019, impacting producers’ margins, and has since decreased (see graph 2). We expect the price of iron ore to stabilise at around CNY 85/MT which is relatively high (the YTD average is CNY 91/MT while the 2017-2018 average is CNY 68/MT), and decrease further in 2020. Steel producers with integrated iron ore production should not be affected as much by the price increase. Iron ore production is expected to increase in Brazil, leading to lower iron ore prices both in Brazil and globally, as the country is a big iron ore exporter.
Most of the producers (except Japan and the Eurozone) do not seem to have been impacted by the raw material cost increase, since the margins have remained stable or increased. The margins in China are weak but should improve in the coming years. In the year ahead, Indian steel producers are expected to benefit from strong local demand for steel, hence their margins are likely to increase. In contrast, in the Eurozone the demand from the machinery and automotive sectors is weak, which is likely to weigh on margins. Moreover, there is no regional giant in the Eurozone that can compete with foreign steel-making firms. Other problems for the European steel-making industry are that they have higher energy and raw material costs than their foreign competitors and they face stricter environmental regulations, which put them under additional pressure, while European policies to protect the local steel industry from inflows (mainly from China and Turkey) do not seem effective1.
To sum up we can say that the global steel sector is in trouble. The economic slowdown, trade uncertainty, the trade war between China and the United States and global overcapacity in the steel sector are the main reasons for the three-year low affecting steel prices. Europe appears to be the worst affected, because of its exposure to international trade, weak internal demand and production costs. Given the sharp drop in prices, the competition will be all the harder between the different players in the sector. The survival and/or geographical presence of some companies is in jeopardy. We can expect payment difficulties and further consolidation, mainly in South East Asia and, if allowed, in the European Union.
1 In September 2019, total steel imports by European countries were 128% higher than the record low in 2009, according to Bloomberg
Analyst: Matthieu Depreter – firstname.lastname@example.org
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