Macro

In this briefing:

1. Beto’s Emergence: Pragmatic Policymaking Suddenly Seems Possible (Just 24 Short Months From Now)
2. Growing Pains & PBoC Cut/US-China Clash/Railways & Airports & Bonds/More Babies Please/Moon Landing
3. Philippines: Time to Mull over the Risks of the ‘twin Deficit’ Syndrome
4. Strong U.S. Employment Report For December Should Alleviate Concerns About The Outlook
5. The Eurozone at 20 Part 1: Is It Working?

1. Beto’s Emergence: Pragmatic Policymaking Suddenly Seems Possible (Just 24 Short Months From Now)

As market scrutiny focuses on the short-term effects of current trends – i.e., slowing global growth, the US government shutdown and the Trump ‘trade war’ – an overlooked longer-term prospect is that the US political outlook may finally be improving. 

Since Hillary Clinton’s sensational loss in 2016, the Democrat Party has been in disarray about whom to nominate for president in 2020, and this in turn has fostered the specter of President Donald Trump serving through 2024.  However, new polls now show that the Democrats may already be uniting behind a potential nominee who is not only vetted and viable, but also reasonably centrist (especially on economics).  This is the former three-term congressman from El Paso, Texas: Beto O’Rourke (no relation to this insight writer). 

O’Rourke’s emergence is significant because it can reduce perceptions of risk surrounding the 2020 election and, more importantly, offer prospects for sounder policymaking and international re‑engagement starting 24 months from now.  In particular, O’Rourke (like Obama) supports free trade and he voted for the Trans Pacific Partnership (TPP).  In contrast to redressing perceived grievances through ruinous tariffs, the TPP offered hope for bringing about equitable economic relations through positive inducements.  If the pact were to develop and expand with US participation, benefits to membership might become clear – which might eventually elicit interest from China and achieve the cooperation that Trump has fitfully pursued through coercive means.  In any event, the prospect of less US protectionism post‑2020 suggests that the recent downturn for exporters (e.g., Apple) may be, in the grand scheme, a blip – not the start of a secular decline.   

2. Growing Pains & PBoC Cut/US-China Clash/Railways & Airports & Bonds/More Babies Please/Moon Landing

China News That Matters

• PBoC responds to disappointing start to another year of slowing growth
• Talks planned but US-China “clash of civilisations” deepens
• Ever faster trains, new airports from Beijing to Antarctica – and more debt
• Two-child policy fails to avert demographic crisis
• Beijing nails first ever landing on moon’s far side

3. Philippines: Time to Mull over the Risks of the ‘twin Deficit’ Syndrome

• We remain upbeat on 2019 growth prospects (6.5%-6.6%) amid fading inflation risk. However, we don’t see a return to the ‘sweet spot’ with the risks of swelling macro imbalances as highlighted in our macro strategy piece recently. Domestic demand, which will underpin growth prospects, has a larger impact on the trade shortfall rather than oil price fluctuations.

• Anticipated costs from a hefty current account gap would be the sustained compression of official reserves with a corresponding peso liquidity drain. Managing the hefty current account deficit likely to probe more than 3% of GDP as investment- driven growth persists, would require the combination of a weaker PHP and positive, real interest rates. Aside from attracting portfolio flows, real interest rates would encourage private sector savings in our twin deficit situation. Positive real rates could also curb the private sector’s strong debt appetite. A staggered 2% bank reserve cut anticipated this year when monthly inflation is closer to 5% or less, would provide partial relief to peso liquidity loss arising from the BSP’s net dollar sales in the inter-bank FX market.

• Fiscal deficit has to be kept in check and within the range of 3% of GDP. Public sector credit risk has been buoyed by the implementation of the 2nd phase of excise hikes on diesel and gasoline products this year amid low oil prices. More fiscal reforms are pending in Congress that could be delayed by the mid-term elections. 

• Against a backdrop of hefty fiscal and external gaps, it’s premature to contemplate lower policy rates with receding inflation risk. The full impact (or pass-through) of the cumulative 175bp hike in lowering inflation expectations to within the BSP’s inflation target range of 2-4%, has yet to be seen. While BSP’s policy bias may ‘sound’ dovish in the new year, maintaining its policy rate at 4.75% amid receding inflation, would signal policy focus on lingering macro stability issues.

• PHP may revisit historic highs of 55-56 on the back of swelling macro imbalances in the near-term although correction to the 54-55 range would depend much on the US Fed finally declaring an end to its rate tightening cycle and thus, terminate the strong USD episode, with BSP sticking to its current policy rate.

• We continue to like ‘steepeners’ in the long end as debt supply from the government and private corporate debts to fund ambitious investment plans would likely persist. The expected backdrop of upbeat growth prospects coupled with our view of the BSP ending its monetary tightening cycle (ahead of the Fed) amid waning inflation risk, bode well for local equities and short-duration bonds.

4. Strong U.S. Employment Report For December Should Alleviate Concerns About The Outlook

Ahead of Friday’s employment report for December pessimism about the economic outlook was running high.  The employment report, however, showed unambiguous strength in the U.S. economy with a surge in payrolls, broad-based employment gains by sector, faster wage growth, and a sharp increase in hours worked.

5. The Eurozone at 20 Part 1: Is It Working?

As we reach the 20th anniversary of the introduction of Euro, now is a good time to assess the success or failure or the single European currency. From the perspective of employment it is fair to say the Euro has been nothing short of a catastrophe. Over the past 20 years the average rate of unemployment in the Eurozone has been 9.4%, or about 3 times higher than the level most economists would consider to be a normal level of frictional unemployment. The total number of man-years of lost output as a result of unemployment now mounts to over 280 million of which perhaps 185 million man-years of unemployment are structural rather than frictional. Given current productivity levels those 185 million lost man-years could account for up to USD 6 trillion of lost output. That is a heavy cost the blame for which arguably lies with the politicians who pushed ahead with a largely political project while ignoring the obvious economic ramifications of the single currency. As is nearly always the case when analyzing the Eurozone the average and the total hide a wide range of outcomes between countries.

In this briefing:

1. Philippines: Time to Mull over the Risks of the ‘twin Deficit’ Syndrome
2. Strong U.S. Employment Report For December Should Alleviate Concerns About The Outlook
3. The Eurozone at 20 Part 1: Is It Working?
4. FLASH: UK Partially Recovers into 2018 Yearend
5. Strong Revenues / Benign CPI / Indrawati’s Award / Prabowo’s Arabic / Scandals Mount / Tsunami Toll

1. Philippines: Time to Mull over the Risks of the ‘twin Deficit’ Syndrome

• We remain upbeat on 2019 growth prospects (6.5%-6.6%) amid fading inflation risk. However, we don’t see a return to the ‘sweet spot’ with the risks of swelling macro imbalances as highlighted in our macro strategy piece recently. Domestic demand, which will underpin growth prospects, has a larger impact on the trade shortfall rather than oil price fluctuations.

• Anticipated costs from a hefty current account gap would be the sustained compression of official reserves with a corresponding peso liquidity drain. Managing the hefty current account deficit likely to probe more than 3% of GDP as investment- driven growth persists, would require the combination of a weaker PHP and positive, real interest rates. Aside from attracting portfolio flows, real interest rates would encourage private sector savings in our twin deficit situation. Positive real rates could also curb the private sector’s strong debt appetite. A staggered 2% bank reserve cut anticipated this year when monthly inflation is closer to 5% or less, would provide partial relief to peso liquidity loss arising from the BSP’s net dollar sales in the inter-bank FX market.

• Fiscal deficit has to be kept in check and within the range of 3% of GDP. Public sector credit risk has been buoyed by the implementation of the 2nd phase of excise hikes on diesel and gasoline products this year amid low oil prices. More fiscal reforms are pending in Congress that could be delayed by the mid-term elections. 

• Against a backdrop of hefty fiscal and external gaps, it’s premature to contemplate lower policy rates with receding inflation risk. The full impact (or pass-through) of the cumulative 175bp hike in lowering inflation expectations to within the BSP’s inflation target range of 2-4%, has yet to be seen. While BSP’s policy bias may ‘sound’ dovish in the new year, maintaining its policy rate at 4.75% amid receding inflation, would signal policy focus on lingering macro stability issues.

• PHP may revisit historic highs of 55-56 on the back of swelling macro imbalances in the near-term although correction to the 54-55 range would depend much on the US Fed finally declaring an end to its rate tightening cycle and thus, terminate the strong USD episode, with BSP sticking to its current policy rate.

• We continue to like ‘steepeners’ in the long end as debt supply from the government and private corporate debts to fund ambitious investment plans would likely persist. The expected backdrop of upbeat growth prospects coupled with our view of the BSP ending its monetary tightening cycle (ahead of the Fed) amid waning inflation risk, bode well for local equities and short-duration bonds.

2. Strong U.S. Employment Report For December Should Alleviate Concerns About The Outlook

Ahead of Friday’s employment report for December pessimism about the economic outlook was running high.  The employment report, however, showed unambiguous strength in the U.S. economy with a surge in payrolls, broad-based employment gains by sector, faster wage growth, and a sharp increase in hours worked.

3. The Eurozone at 20 Part 1: Is It Working?

As we reach the 20th anniversary of the introduction of Euro, now is a good time to assess the success or failure or the single European currency. From the perspective of employment it is fair to say the Euro has been nothing short of a catastrophe. Over the past 20 years the average rate of unemployment in the Eurozone has been 9.4%, or about 3 times higher than the level most economists would consider to be a normal level of frictional unemployment. The total number of man-years of lost output as a result of unemployment now mounts to over 280 million of which perhaps 185 million man-years of unemployment are structural rather than frictional. Given current productivity levels those 185 million lost man-years could account for up to USD 6 trillion of lost output. That is a heavy cost the blame for which arguably lies with the politicians who pushed ahead with a largely political project while ignoring the obvious economic ramifications of the single currency. As is nearly always the case when analyzing the Eurozone the average and the total hide a wide range of outcomes between countries.

4. FLASH: UK Partially Recovers into 2018 Yearend

• The UK’s services PMI rebounded by 0.8 points to 51.2 in Dec-18, which was above Consensus expectations but consistent with historical payback after large falls.
• I still expect the ONS to report growth in the equivalent services sectors of 0.5% in 4Q18, despite the PMI continuing to point weaker than that.
• Unfavourable rounding helps constrain my forecast for Nov-18 GDP growth to 0.1% m-o-m. Recent downside news in energy output reversed the upside from retail.

5. Strong Revenues / Benign CPI / Indrawati’s Award / Prabowo’s Arabic / Scandals Mount / Tsunami Toll

Relatively benign inflation benefits Widodo as the 17 April election approaches, but a succession of scandals in ministries threatens to weaken his image for clean governance.  Prabowo is suffering embarassment from a proposal for a Koran-reading contest (he is illiterate in Arabic) — while Widodo’s readiness to take part sets a negative precedent for upholding  pluralism.  Indrawati is The Banker’s 2019 Finance Minister of the Year, despite the problematic investment climate.  Revenue collection was strong in 2018, suppressing the fiscal deficit to 1.8% of GDP.

Politics: Hard‑line Islamic backers of Gerindra Chair Prabowo Subianto risked appearing hypocritical when Acehnese clerics proposed a Koran‑reading contest for presidential contenders.  The foreign‑educated Prabowo is apparently unable to read Arabic, and he rejects the contest.  In contrast, campaign aides to President Joko Widodo gleefully agreed to it, perceiving an opportunity to impugn Prabowo’s religious credentials Widodo himself is non-committal, but the stance of his campaign officials serves, in effect, to legitimize the Acehnese practice of requiring that leaders be literate in Arabic.  The president and his advisors are again willing to sacrifice principles of pluralism to make perceived campaign gains (Page 2).  Authorities debunked a claim from a Partai Demokrat official that a voting‑fraud conspiracy is underway.  The episode reflects poorly on a prominent Demokrat vice secretary general, Andi Arief – but, for the pro‑Prabowo alli­ance, it deflects critical press attention from Prabowo’s Koran‑reading predicament (p. 3).  In a speech in Jakarta, Prabowo reiterated dire environmental warnings (p. 5).  Finance Minister Sri Mulyani Indrawati is The Banker’s 2019 Finance Minister of the Year (p. 5). 

Disasters: The Sunda Straits tsunami, triggered by the eruption of Anak Krakatau Volcano, caused 437 fatalities on 22 December (p. 6). 

Justice: For the third time in six months, a ministry faces investigation from the Anti‑Corruption Commission (KPK).  Unseemly revelations affect the Public Works Ministry, as investigators believe that kickbacks occurred on the procurement of water pipes for disaster relief in Palu.  Corruption in disaster relief is potentially subject to capital punishment.  The succession of ministerial‑level scandals risks jeopardizing Widodo’s crucial image for clean governance (p. 7).  The sentence for PT Nusa Konstruksi Enginiring Tbk (NKE) fell short of what prosecutors sought (p. 7). 

Policy News: At last, the administration is invoking new reformist rules on managing the civil service, by dismissing 480 personnel convicted of corruption.  A joint ministerial decree on the matter shows welcome attention to issues of institutional dysfunctions (p. 9).

Economics: Fueled by commodity prices, state revenues attained 100 percent of the budget target in 2018, while spending reached 97 percent – producing a deficit equivalent to 1.8 percent of GDP (p. 10).  Inflation was low again in December, resulting in a 3.1 percent annual rate for 2018 (p. 11). 

Jakarta: The odd‑even license‑plate restrictions on traffic will remain in effect for at least another three months (p. 13). 

In this briefing:

1. Future Metals Curve in China
2. India: Big Shortfall in Tax Collections, but Fiscal Deficit Likely to Be Contained
3. FLASH: UK PMI Builds on Inventories in Dec-18
4. Are US Stocks A Buy Yet?

1. Future Metals Curve in China

Metals are an important part of China’s economic prowess. Specifically, metals are a spoke in the economic wheel with fortunes of commodities and real estate all centered around metals. As we look at metals futures, we see that most metals futures are very flat.

2. India: Big Shortfall in Tax Collections, but Fiscal Deficit Likely to Be Contained

Tax revenues in India are running sharply lower than budget estimate. At current run rate, tax revenues would miss the budget estimate by almost US$19bn or 0.7% of GDP. This short-fall is almost entirely due to weaker GST revenues. Direct tax revenues are running broadly inline with the estimate suggesting the economy is doing fine. This short-fall however will not result in a material widening of the fiscal deficit. The government has been remarkably conservative in spending so far with expenditure growth running well below budget estimate. Non-tax revenues are also running ahead of full year estimate. This coupled with higher small savings collections will mean that Government borrowings will be lower than budget estimate even if the fiscal deficit is modestly higher and that will be a relief to the bond market. However, the quality of deficit is worsening with the government resorting to even more questionable routes (the PFC-REC transaction is a case in point) to achieve its disinvestment target. Additionally, it has started to resort to off-balance sheet financing with the loan to the ailing Air India from the NSSF. The numerical focus on fiscal deficit is resulting in wrong precedents being set and government finances becoming more opaque.

3. FLASH: UK PMI Builds on Inventories in Dec-18

• The UK’s manufacturing PMI increased by 0.6-points to 54.2 in Dec-18, contrary to Consensus expectations of a decline towards the weaker euro area readings.
• Inventory accumulation was mostly responsible for the headline strength. Car manufacturing weakness may offset this in Q4, though, and energy looks set to weigh on overall industrial production.

4. Are US Stocks A Buy Yet?

• 5%-like rallies on Wall Street are signs of a bear market not a bull market
• Bull markets require strong liquidity and low risk appetite, neither yet apply
• Risk appetite readings at minus 12.6 are still above the minus 40 criterion for an upturn
• Recent large fall in risk appetite consistent with upcoming economic recession

In this briefing:

1. India: Big Shortfall in Tax Collections, but Fiscal Deficit Likely to Be Contained
2. FLASH: UK PMI Builds on Inventories in Dec-18
3. Are US Stocks A Buy Yet?

1. India: Big Shortfall in Tax Collections, but Fiscal Deficit Likely to Be Contained

Tax revenues in India are running sharply lower than budget estimate. At current run rate, tax revenues would miss the budget estimate by almost US$19bn or 0.7% of GDP. This short-fall is almost entirely due to weaker GST revenues. Direct tax revenues are running broadly inline with the estimate suggesting the economy is doing fine. This short-fall however will not result in a material widening of the fiscal deficit. The government has been remarkably conservative in spending so far with expenditure growth running well below budget estimate. Non-tax revenues are also running ahead of full year estimate. This coupled with higher small savings collections will mean that Government borrowings will be lower than budget estimate even if the fiscal deficit is modestly higher and that will be a relief to the bond market. However, the quality of deficit is worsening with the government resorting to even more questionable routes (the PFC-REC transaction is a case in point) to achieve its disinvestment target. Additionally, it has started to resort to off-balance sheet financing with the loan to the ailing Air India from the NSSF. The numerical focus on fiscal deficit is resulting in wrong precedents being set and government finances becoming more opaque.

2. FLASH: UK PMI Builds on Inventories in Dec-18

• The UK’s manufacturing PMI increased by 0.6-points to 54.2 in Dec-18, contrary to Consensus expectations of a decline towards the weaker euro area readings.
• Inventory accumulation was mostly responsible for the headline strength. Car manufacturing weakness may offset this in Q4, though, and energy looks set to weigh on overall industrial production.

3. Are US Stocks A Buy Yet?

• 5%-like rallies on Wall Street are signs of a bear market not a bull market
• Bull markets require strong liquidity and low risk appetite, neither yet apply
• Risk appetite readings at minus 12.6 are still above the minus 40 criterion for an upturn
• Recent large fall in risk appetite consistent with upcoming economic recession