The External Environment for Developing Countries

Transcription

1 The External Environment for Developing Countries Overview July 21 Financial markets have calmed in the last weeks despite several more mark-downs to sovereign credit ratings** and the upcoming release of banking stress tests results, performed on 91 commercial banks across the Euro Area. Equity markets have moved higher and spreads (CDS and those vis-à-vis the German Bund) have narrowed for the more seriously affected countries. A brighter economic spot in Europe surging German export orders and shipments (5%, saar) in May has lifted spirits to a degree. Though Germany will display strong GDP gains for the second quarter, the same may not be the case for partner ERM countries; and sustaining export growth will be difficult. The IMF has lowered its projections for Euro Area growth for 211, citing continuing fiscal ills, rising credit costs and related spillovers. basis points 1,2 1, 8 6 CDS spreads for selected economies Spreads on credit default swaps Average of Brazil, Russia, China, Turkey, and Indonesia Greece Portugal Ireland Spain Italy Developing-country production growth easing industrial production, ch% (3mma, saar) 25 Developing countries World 4 2 Oct-9 Dec-9 Feb-1 Apr-1 Jun-1 Source: JP Morgan and World Bank data -35 Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Source: DECPG. Signs point to easing global growth in the second quarter and the second half of the year. China announced a reduced rate of GDP growth at 1.3% (y/y) for the second quarter from an 11.9% pace in the first. Production advanced 9.8% in the second quarter (saar), down sharply from 19% in the first, as the effects of stimulus measures faded and authorities tightened their stance on the housing market. Across the OECD, recent indicators point to less favorable second-quarter growth for the United States (weak consumption), Japan (faltering exports) and Europe (dormant domestic demand). Global PMI indices are less upbeat, and proxies for retail sales show high-income countries in the doldrums. World production and trade are beginning to lose momentum, at 1-15% rates (saar), from growth rates three times that pace at the start of 21. Commodity prices, capital flows and exchange rates responding to potentially weaker growth. Oil prices have been exceptionally volatile, echoing changes in sentiment regarding growth (and oil demand), and averaged $78/bbl for the first weeks of July essentially December 29 levels. Agricultural markets remain well supplied, and metals prices too are affected by shifting sentiments especially regarding Chinese demand. Until underlying trends become clearer to markets, trading within bands is a likely scenario. Debt flows increased modestly in June to $17 billion from $12 billion, with all of the increase in developing corporate bond issuance; sovereigns were absent from the market. The euro has recouped 8.5% of its earlier dollar losses, to stand at $ by July 2, bolstered by recent positive policy actions in Europe. And since its un-pegging from the dollar, the RMB has gained.8% in the ensuing month if sustained for the coming year, this would imply a 1% gain vis-à-vis the USD. **Moody's downgraded Portugal's debt rating two notches to A1, citing the government s weakening financial picture. The rating was left on a stable outlook basis. The agency also cut Ireland's credit rating one level, citing a significant loss of financial strength. Despite the downgrades, CDS spreads for Greece, Portugal, Ireland and Spain narrowed in July Developing ex China High-income OECD This brief was prepared by the Development Economics Prospects Group (DECPG) with colleagues from PRMTR and IFC (Risk/ Economics). The team is comprised of Mick Riordan (OECD, currencies), Jean-Pierre Chauffour, Allen Dennis, Mariem Malouche and Deborah Winkler (trade), Shane Streifel (commodities), Dilek Aykut (finance), Cristina Savescu (IP) and Sabah Mirza (Annex). Dilek Aykut authored the Focus section on European banking. The report was prepared under the guidance of Andrew Burns of DECPG. This note reflects the views of the team, but is not formally cleared by the World Bank Group.

2 Global Indicators (Percentage change per annum, unless otherwise specified) 28 29e 21f 211f GDP volume: World Memo item: World GDP at PPP weights High-income countries Developing countries Industrial production: World High-income countries Developing countries Export volume (GNFS): World High-income countries Developing countries Trade Prices ($): Manufacturing (MUV) Oil ($/bbl) Non-oil commodities Nominal interest rates: $LIBOR (6m percent p.a.) LIBOR (6m percent p.a.) Financial flows FDI ($billion) 583 Gross Capital flows a ($billion) Equity placement ($bn) Bond financing ($bn) Lending ($bn) Source: DECPG, July, 21. Estimates and projections for 29 through 211 based on GEP-21 up- Note: a. Gross inflows 21 based on preliminary year-to-date figures. Figures in bold represent July 22, 21 page 2

3 OECD Developments IMF WEO updates show stronger global and advanced economy growth for 21 than in April projections. Prospects for Europe have been marked down, however, on fiscal issues and potential spillovers. Announced European fiscal reductions amount to $16 billion over The most-affected economies account for one-half of the cuts, or 4.5% of their GDP. Core CPI for several OECD economies is moving toward deflation. WEO Update lowers growth outlook for Europe in Difference from April WEO World GDP Advanced Econ Euro Area Germany Spain Japan United States Source: IMF, WEO Update, July 8, 21. G-2 agrees to the principle of growth friendly fiscal consolidation Fiscal balances, %GDP F 211F OECD Fiscal Euro Area Fiscal U.S. Fiscal Japan Fiscal Public sector financial liabilities, %GDP F 211F OECD Debt Euro Area Debt Source: DECPG staff estimates. U.S. Debt Japan Debt WEO July-21 Update marks down Euro Area growth. In a recent interim assessment of the global economy, the IMF sees growth for the advanced economies that is.3 points ahead of the April WEO projections at 2.6% for 21. This is grounded in better-than expected performance and prospects for the United States, Japan and Germany. At the same time, the Fund views 211 as substantially weaker for the Euro Zone as a group, as the effects of fiscal consolidation dampen growth in the most affected Area economies, with potential spillovers through realand financial channels. The Fund notes that downside risks are now much greater than earlier thought, with financial stress, increased funding costs and broader spillover to activity the major tensions. DECPG s June Global Update at PPP weights (those used by the IMF) views global growth more subdued at 4.2% in 21 and 4% by 211. The recent G-2 meeting reached consensus on a growth friendly approach to budget cuts. IMF suggestions that one shoe does not fit all and the U.S. Administration s view that recovery is too fragile for traditional budget cuts, received some support from European principals. Greece, Ireland, Portugal and Spain announced measures to reduce budget shortfalls by some $82 billion, or 4.5% of their GDP through 211. Larger EU countries are also moving toward deficit reduction, with cuts amounting to $75 billion. These range from 1.8% of GDP for Italy, 1.6% for the United Kingdom and 1% for France through 211. The budget consolidations are targeted to achieve sustainable public debt-levels, and in turn hoped to stave off still more unfavorable consequences from the ongoing European fiscal distress. Select OECD core CPI moves lower on muted goods prices tied to weaker demand core-cpi: OECD, USA, Euro Area, Spain, Japan and Ireland, ch% (3m/3m saar) USA Euro Area Spain Japan Ireland Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Source: Thomson/Datastream and DECPG calculations Deflation and disinflation across OECD countries. Long-term core-price deflation problems of Japan and Ireland are known, and tied in the first case to persistent slack in domestic demand, lack of effective financial intermediation, long-seated issues in the services sector, etc; and in the latter, to the housing crunch, financial crisis and strong austerity measures. Increasingly, however, the Euro Area as a group and Spain in particular, have seen core price inflation moving toward zero. Over the remainder of 21 and into 211, these countries could witness a more distinct fall into deflation, given current expectations for meager economic growth and continuing banking sector difficulties. The United States and several Scandinavian countries could also be on track to breach the zero mark by 211. July 22, 21 page 3

4 Indicators for the United States point to weaker second-quarter growth that earlier thought: a band of 2-3% (saar). Soft labor markets led to two months of falling retail sales. From the first quarter to the second, retail volumes dropped 5 points of annualized growth to 2.6% (saar). In contrast, a number of conditions favor a step-up in capital spending. Growth and jobs are likely being restrained by large declines in bank lending Progress in reducing U.S. layoffs stalls adding downward pressure on retail sales unemployment claims, 4-wk average [L] ; retail sales (x-auto) volume, ch% saar [R] unemployment claims [L] retail sales (x-autos) volume [R] Jan-8 Jun-8 Nov-8 Apr-9 Sep-9 Feb-1 Jul-1 Source: U.S. Departments of Commerce and Labor. U.S. investment to pick-up in second quarter with orders, exports and output higher capacity utilization (%) [L], growth of orders, production and export volumes (saar) [R] capacity util [L] cap-goods orders [R] exports [R] production [L] Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Source: U.S. Department of Commerce. U.S. bank lending continues decline hitting business without access to bond markets 1,7 1,6 1,5 1,4 1,3 Commercial & industrial loans ($billions) [L] ; percentage change (y/y) [R] C&I loans [L] percentage change (y/y) [R] 1,2-25 Jan-8 Jun-8 Nov-8 Apr-9 Sep-9 Feb-1 Jul-1 Source: Federal Reserve of St. Louis Labor markets soften; retail falls. Data for the last weeks uncover a stall-out in U.S. labor markets with initial unemployment claims increasing once more and private sector job creation an anemic 83, in June. Hourly earnings growth is meager (1.7% in June (y/y)) and personal income has increased only 2% over the year to May contrasted with the like period of 29. On these grounds, plus concerns over developments in Europe, consumer confidence has waned. And together with negative wealth effects from recent equity market declines, retail outlays dropped sharply over May/June. Sales fell 1.1% in May and.5% in June (m/m). And when expressed in volume terms (excluding volatile autos), sales dropped to growth of 2.6% in the second quarter against 7.6% in the first (saar). Second quarter GDP outturns will reflect this strong downshift. Conditions ripe for investment pick-up? Relapse in consumer outlays is one factor dampening prospects for a pick-up in business investment as is the 1 point falloff in capacity utilization between precrisis levels and today. But increasingly favorable corporate earnings, low bond market rates for highly -rated firms, continued strong overseas demand for capital goods and still solid conditions in manufacturing could serve to boost corporate spending on equipment and technology (having advanced 12.7% in the first quarter (saar)). Capital goods orders jumped 4% in May (m/m), up 3% on an annualized basis; while export momentum is running at 15% (saar). And manufacturing output held at a 1% growth pace as of June all factors conducive for an escalation of investment spending. Decline in commercial bank lending hits smaller firms and job creation. Federal Reserve data on commercial and industrial loans outstanding with U.S. non-bank clients highlights a massive decline from pre-crisis levels to today. Loans dropped from $1,65 billion in late-october 28 to $1,2 billion by June 3, 21, a falloff of $45 billion or 27%. This has carried negative effects for those smaller firms lacking access to bond markets or other nonbank sources of finance. Indeed, the decline in lending reflects both weaker demand and a reluctance among banks to increase risky exposures at this time. Fed Chairman Ben Bernanke stated on July 13, To support the recovery, we need to find ways to ensure that creditworthy borrowers have access to needed loans. Latest data suggests that the decline in lending has bottomed out, however, with growth improving by 5 points to (minus) 15% at end June. July 22, 21 page 4

5 Strong shifts in exports for Germany and Japan in May will come to alter GDP growth for the second quarter: Germany to the positive, Japan to the downside. European domestic demand remains moribund, and those countries most affected by the crisis have witnessed a sharp 8-point average decline in consumer sentiment. Japan s export growth dropped from 6% at the start of 21 to 2 by May (saar), on easing Asian imports. German exports surge on weaker euro and foreign demand for capital goods export orders, export volumes and manufacturing output, ch% (saar) 65 5 export orders exports manufacturing output Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Source: Eurostat. Euro Zone houshold spending continues in the doldrums retail sales volumes: Euro Area, Germany, France (mfg gds), Italy, ch% (y/y) Euro Area Italy France Germany Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Source: Eurostat. Japan sees sobering slump in machinery orders, exports and manufacturing output machinery orders, export volumes and manufacturing output, ch% (saar) 6 45 manufacturing output exports machinery orders Jan-8 May-8 Sep-8 Jan-9 May-9 Sep-9 Jan-1 May-1 Source: Japan Cabinet Office. A bright spot in Europe. Amid the tensions of the European fiscal crisis, a sudden burst of growth in German exports to destinations outside of the EU has lifted equity markets and investor confidence. Shipment volumes surged to a 5% annualized rate in the three months to May from 2% in the first quarter (saar). This development reflects strong external demand, especially in Asia, for German capital goods and autos, amplified by the 12% depreciation of the euro/dollar exchange rate since the turn of the year. Export orders show strong follow-through, growing 45% in May (saar), while business has pushed factory output to 25% growth, strongest since unification. Whether improved export performance can be sustained is uncertain given the increasingly cloudy global outlook; spillovers to consumption and investment will also face headwinds. Area household spending sluggish. Though the worst of the great recession is behind, European households, especially those in Germany, continue to spend as though unemployment were at double digits and rising. Euro Area retail volumes advanced in May to stand.4% above year-earlier levels, restrained by declines in Germany (-.9%) and slowing from auto-incentive induced highs in France (1.8%, y -y). EC consumer confidence deteriorated in May and June to a reading of (minus) 17.3 in the latter month from (minus) 15 in April, tied to spreading fiscal difficulties. From the third quarter of 29, consumption has exerted a.6 point drag on GDP growth. Recent developments suggest that second quarter contributions may be modestly positive, but the effects of fiscal consolidation have yet to appear in the flow of data releases. Japan s export powerhouse slips. On top of election results unfavorable for the new DPJ administration, news that Japanese exports, machinery orders and manufacturing production fell sharply, signaled that Japanese GDP was likely to stumble into the second quarter. Net exports powered recovery to date, with 3-to-4 points of growth added to GDP from the third quarter of 29 through the first of 21. Much weaker import demand in China, other Asia and Europe, and a 7.5% appreciation of the yen led to a stunning fall in export volumes in May, shifting annualized growth from 58% in January to 18% in the latter month (saar). Orders dropped by the largest amount on record in May, falling from an advance of 4% in the first quarter to a decline of 4% in May (saar). And manufacturing output echoed the slowdown, easing to growth of 12%. July 22, 21 page 5

6 Industrial Production Retail sales volumes have begun to moderate in a number of countries, undercut by jobless recoveries in the OECD. Developing countries industrial production has surpassed pre-crisis output levels, while the United States and Europe do not appear to be on track to regain such growth paths at this juncture. The inventory cycle may be at an end in the United States, with stocks consistent with underlying demand Recovery in retail sales eases on weak labor markets in high-income countries Jan-4 Dec-4 Nov-5 Oct-6 Sep-7 Aug-8 Jul-9 Recovery continues through April / May but may be slowing Industrial production, index August 28= High-income Retail sales proxy, ch% (y/y) Developing countries Global Sources: Thomson Datastream and DEC Prospects Group 7 China Other developing 6 Other high-income USA 5 Euro Zone Japan Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Sources: Thomson Datastream and DEC Prospects Group Positive contributions of inventories to U.S. growth may be coming to an end Contribution to total business sales growth (manufacturing, wholesale and retail), 1 seasonally adjusted Jan-7 Jul-7 Jan-8 Jul-8 Jan-9 Jul-9 Jan-1 Sources: U.S. Census Bureau and World Bank DEC Prospects Group Global retail volumes slowed in May, on weaker growth in high-income; up more than 1% in developing countries. High-income countries retail sales have been undercut by weak job creation and expiry of fiscal stimulus measures. Consumer demand fell.4% in Japan in May (y/y) following scale-back of the eco-points system that led consumers to buy eco-friendly durable goods. Weak U.S. labor market conditions, low personal income growth, and a plunge in consumer confidence (1 point fall in the Conference Board s measure, to a still positive 52.9 in June) resulted in monthly declines in retail sales of.5% in June in following a drop of 1.1% in May, while CPIdeflated retail sales declined of.4% and.9%, respectively. IP recovery continued in April/May, with developing countries regaining pre-crisis levels; growth in China eased to 13.7% in June. Recovery in Europe and the United States continues to lag, not auguring well to close the gap with precrisis production growth trends. Recent PMI surveys and weak U.S. employment data suggest a slowing in growth may be in store, as indeed U.S. manufacturing output declined.4% on the month in June the largest falloff in a year. Japanese activity appears to be slowing as well. While worrisome, especially in the context of the debt situation in Europe which has yet to appear in IP data such slowing has been expected as the bounce back factors that lifted production out of recession fade. But June PMI indicators remain in positive territory suggesting continued growth and are higher than the average levels observed during the past two recoveries (22-3 and 24-7). U.S. inventory restocking appears to be diminishing suggesting that stocks are consistent with underlying demand. The contribution of inventories to business sales growth remains positive at one percentage point in May, but down sharply from an 8.2 percentage-point contribution in November 29. Restocking (after a severe drawdown in the acute phase of the crisis) added 1.9 percentage points to GDP in 21-Q1 versus 3.8 percentage points in 29-Q4. Business sales remain well below their pre-crisis growth path, but are still expanding rapidly (12.7% annualized during the three months ending in May), as are inventories (5.9% annualized over the same period). Such growth rates contrast with long-term averages of 4.3% and 3% for sales and inventories, respectively. July 22, 21 page 6

7 International Trade With the exception of China, the global trade recovery that began in early 29 is running out of steam. The recent depreciation of the euro is doing little to boost Europe s lackluster performance. And China s import growth is easing, as inventories of raw materials are high and economic activity slows. A renewed appetite to make bilateral trade deals could help open markets, but remains an inferior solution to a revived Doha Source: DEC Prospects Group. U.S. and Japanese exports slow as East Asian demand decelerates import and export volumes, ch% (3mma, saar) Dec-9 Jan-1 Feb-1 Mar-1 Apr-1 May-1 Source: DEC Prospects Group. Source: WTO. China M NIE M USA exports JPN exports EU imports Global trade recovery running out of steam. The only developing regions for which export volumes advanced during May were East Asia and Latin America. Exports from East Asia grew 7.5% compared with April 21, driven by China s strong 1.3% gain, whereas regional exports excluding China picked-up just.5% (m/m). Exports from South Asia decreased by more-than 6% since March, mainly due to a decline in exports from India, but remained 12% above January 28 levels. And shipments from Europe & Central Asia, the Middle East and North Africa, and Sub-Saharan Africa remained sluggish and below January 28 levels. Developing country imports declined by almost 1% between April and May 21. Import demand in Europe (just approaching positive territory) also remains a drag on global trade growth. Asian imports and world trade in 21. During the first half of 21 imports into China and highincome Asian economies grew by an average 56%- and 36% respectively (saar), compared to average deceleration of 5% in Europe. This spurred global export expansion, including from developing economies. But economic activity is slowing in Asia. Since February, industrial production has decelerated in part due to waning of the inventory cycle and a winding down of stimulus packages. Still, capital goods exports from the G-3 economies are growing at a rapid pace 2%-, 22%- and 29%- for the United States, Germany and Japan respectively in the 3 months to May (saar). This suggests that investment spending in developing countries remains quite robust. Preferential trade agreements become instrument of choice. All regions have been active in negotiating new preferential trade agreements (PTAs), including East Asia and the EU (with India, Canada and South Korea). The U.S. administration is also negotiating a Trans-Pacific Partnership with seven Asia-Pac nations, while pressing Congress for approval of previously negotiated PTAs with South Korea, Panama and Colombia. Estimates by Adler and Hufbauer of the Peterson Institute, indicate that roughly 18% of additional U.S. trade growth over has been the result of preferential tariff liberalization, twice as much as due to multilateral tariff liberalization. A more aggressive PTA strategy, especially with the big blocs (Europe, ASEAN and Latin America) could be part of the solution to doubling U.S. exports as envisaged in the Obama Administration s New Export Initiative, but it is no substitute for concluding Doha. July 22, 21 page 7

8 Commodity Prices Oil prices have been volatile the past two months, but prices around $75/bbl in July are essentially unchanged from December 29. Crude oil stocks remain high, particularly in the United States, and OPEC spare capacity has remained above 6mb/d. Oil demand, however, has been very strong rising by a large 3.2% or 2.7mb/d in the second quarter. Growth has been especially strong in China and, more recently, in the United States. Oil price and OECD stocks $/bbl million bbl Price Stocks Jan- Jan-2 Jan-4 Jan-6 Jan-8 Jan-1 Growth in world oil demand (y/y) 4 mb/d Other Other Asia China OECD 1Q 1Q2 1Q4 1Q6 1Q8 1Q1 Oil prices unchanged from December 29. Crude oil prices (World Bank average) have been volatile the past two months, ranging from $68 to $87/bbl. Prices had risen through April on improving fundamentals, but have since receded due to concerns about the global economic recovery and falling prices of other assets. Prices in July are near $75/bbl and essentially unchanged from December. Despite a recovery in demand, crude oil stocks remain high, particularly in the United States. In addition there were 115mn barrels of crude and product at sea at end-june, down 1% from this year s high in May. Futures prices for December 218 fell to $88/bbl in early July amid the drop in spot prices, but have now moved above $9/bbl. Global oil demand growth picks up. World oil demand has grown the past three quarters, rising a robust 3.2% (y/y) or 2.7mb/d in 21-Q2 which partly reflects low levels a year earlier. China s oil demand surged 19% or 1.4mb/d in 21-Q1, slowing to 1% or.9mb/d in the second quarter. Much of the gain is due to a once-off jump in naphtha for new petrochemical capacity. While China and other Asian growth has slowed, demand has been expanding in other regions. OECD demand turned positive in the second quarter, rising 1.7% or.7mb/d. Virtually all of the gain originated in the United States where demand increased 3.3% or.9mb/d. Demand in the FSU, the Middle East and Latin America all advanced by around 5%. The IEA expects world demand growth to slow in the second half of the year to a more typical pace of 1.5% mb/d OPEC spare capacity Jan-1 Jan-3 Jan-5 Jan-7 Jan-9 Jan-11 OPEC spare capacity edges higher. OPEC spare capacity has been above 6mb/d since early 29, following the organization s large cuts in output due to the slump in demand. Spare capacity is concentrated in Saudi Arabia, with the Kingdom holding 3.9mb/d or more-than 6% of the surplus. Nearly 1mb/d also lies in the UAE, Kuwait and Qatar, with notional amounts elsewhere. OPEC s production has held near 29mb/d the past 1 months, with the group benefiting little from the rebound in demand. The key factor has been the unexpected strength in non-opec supply growth, with production up more than 1mb/d (y/y) in the first half of 21 after an.8mb/d gain last year. OPEC capacity is expected to increase.5mb/d in the second half of the year, with one-half in Saudi Arabia, and with notable gains in Angola and Qatar. July 22, 21 page 8

9 Agriculture prices are weak, on generally favorable food supply, but rubber, cotton and Arabica coffee prices increased due to supply tightness in China and Brazil (coffee). Metals prices have stabilized after dropping from mid-april highs; but demand prospects are clouded by the Euro crisis and potential slowing of growth in China. Bulk freight rates are falling quickly on slowing demand and rising vessel capacity =1 Agriculture Prices Raw Materials Beverages Food 1 Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 Jan-11 $/ton 6, 5, 4, 3, 2, 1, 14, 12, 1, 8, 6, 4, 2, Nickel price and LME stocks Price Stocks Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan-1 ' tons 18 Ocean Bulk Freight - Baltic Dry Index Jan-5 Jan-6 Jan-7 Jan-8 Jan-9 Jan Agriculture prices fall for a second month on ample supply. Agriculture prices for the first half of 21 declined 2% (from December 29), as most markets are generally well supplied. Nearly all main indices dropped the past two months. Food prices are down 9% in 21-H1 with grains prices off 18% on ample global supplies. Beverage prices were flat overall, but a 1% drop in tea prices and 8% decline in cocoa, were offset by large gains in coffee prices particularly Arabica, (21%), due to low stocks and prolonged drought in Central America. Only raw material prices posted a large gain in the first half, up 15%, with nearly 2% increases in both rubber and cotton. Rubber prices increased on weather-related supply problems in China and Southeast Asia, while cotton prices are higher on expected shortfalls in global production. Metals prices steady the past month. Base metals prices have trended sideways the past month following large declines that began in mid-april on concerns about the pace of economic recovery and slowing import demand in China. For the first half of 21, base metals prices were down 7%, with lead and zinc plunging more than 25% on slowing demand, rising stocks and excess production. Some metals prices are dipping into the upper portion of their costs curves, notably aluminum. Nickel and tin prices are up more than 1% in 21-H1 due to strong demand and falling stocks. Nickel prices have been buoyed by ongoing strikes in Canada and strong stainless steel production and stocking cycles, but this now appears to be waning. Gold prices jumped to record real highs in June on safehaven buying, but have since softened slightly. Bulk freight rates drop on rising vessel capacity and slowing demand. Bulk commodity freight rates have plunged near 6% since late-may due to slowing import demand in China and increasing vessel supply. The carrying capacity of the dry bulk fleet is expected to rise 16% this year, and recent easing of port congestion is also swelling effective vessel supply. China s demand for raw materials is slowing due to an oversupply of domestic steel and expected cooling in the property market. Iron ore imports by China fell 15% in the last two months, leading to a drop in spot ore prices of more than a third. China s steel output is also slowing because of the removal of a 9% export rebate on 48 steel products on July 15th, as authorities wish to reign in exports. July 22, 21 page 9

10 International Finance International debt flows to developing countries improved slightly in June, due to increased bond issuance by emerging market (EM) corporates. EM companies have been quite successful in accessing international bond markets in 21, benefiting from increased investor appetite. According to the BIS, international banks already favored developing countries in terms of both international and local-currency claims during 29. Subdued June recovery in cross-border debt flows $ billion H1 Total H1 Total H1 Apr May Ju n Total Bonds Banks Lat. America E. Europe Asia Others $ billion 28 Q EM corporates increasingly relied on international bond markets in Q2 Source: Dealogic Corporate (Private and Public) Sovereign 28 Q3 28 Q4 29 Q1 29 Q2 29 Q3 29 Q4 21 Q1 International banks' claims in developing countries rose in 29 $ trillions Local currency claims Source: Bank for International Settlements 21 Q2 International claims International debt flows: subdued recovery in June **. Cross-border debt flows improved slightly in June to $17 billion from $12 billion in May, which month was depressed tied to the fuller unfolding of European debt problems. All of June s increase was in corporate bond flows, with 14 corporate issuances and no sovereign participation in the market. Mexican American Movil issued a $3.1 billion Euro bond, the largest corporate bond this year. Early data suggests bond issuance has picked up in July, with sovereign issuances by Poland ($1.6bn) and Mexico ($1bn) and several corporate issues during the first two weeks. Bank lending remained depressed at $9 billion, concentrated in resource-related sectors. Firsthalf 21 banking numbers show marginal improvement, but lending is still one-half of it 27 levels. [** Equity flows are not available for this month s tabulations due to technical considerations; will return in the September report]. EM corporate bonds up sharply in 21. In the first half of 21, EM corporate issuance totaled $53 billion, almost twice the $29 billion of the like period of (pre-crisis) 28. And July s activity has been strong at $1 billion by the second week of the month. At the moment, international bond markets offer a favorable alternative to subdued bank lending. Spreads for emerging market corporates have narrowed from 1,14 basis points in October 28 to 37 basis points by July 21, reflecting investors improved appetite for EM assets. The increase in EM corporate issuance in the first half of 21 stands in stark contrast to developments in the high-income countries, where corporate issuance declined in the United States and Europe by 29% and 33% against year-earlier levels respectively. International banks expanded their claims in developing countries in the final quarter of 29. According to newly published data, Bank for International Settlements (BIS) reporting banks increased their international and local currency claims in developing countries by $5-and $49 billion respectively during 29 s fourth quarter. This stands in contrast to the more-than $8 billion contraction in claims to high-income countries, suggesting that banks shifted funds to faster growing emerging economies. There is significant variation across developing regions, with claims declining in Central and Eastern Europe, while increasing in East Asia and Latin America. With the latest BIS data, change in total claims with developing countries marks $3 billion in 29, a turnaround from a more-than $12 billion falloff during 28. July 22, 21 page 1

11 Currencies and inflation A step-down of crisis tensions allowed the euro to recoup a portion of its losses vs. the dollar. Recent indicators pointing to weaker U.S. growth is a factor supporting the recent gains for both euro and yen. Since its uncoupling from the U.S. unit at mid-june, the Chinese RMB has gained.8% against the dollar and.4% vs. the yen. Flows to safe haven can be seen in the $2.4 trillion net flow into U.S. Treasures since January 29. Euro losses start to dissipate in July yen gains appreciably vs dollar in the month USD per Euro (inverse) [Left] and Yen per USD [right] Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul USD/Euro (inverse) yen/usd Source: Thomson/Datastream and DECPG calculations. End of dollar-fix for Chinese RMB yields modest gains vs U.S. unit Index, RMB cross-rates, March 1, 21=1 USD per RMB, daily: March 1 to July LCU per RMB US dollar Euro Yen USD per RMB Source: Thomson/Datastream and DECPG calculations. Net U.S. capital flows show dramatic flight to quality in the 6 months to March net annualized flows in billions U.S. dollars Q1-29 Q2-29 Q3-29 Q4-29 Q1-21 Net FDI + Equity U.S. Treasuries Net Other Flows Financing requirement Source: Department of Commerce. Euro firms on recent positive policy actions. As Euro-Area fiscal difficulties evolved from the start of 21, the euro dropped a cumulative 16.5% against the dollar to stand at $ on June 6. The series of positive policy actions on the part of the EU/IMF, the ECB, and governments of countries under particular pressure applying austerity measures, and coming to market with successful bond sales, has served to ease concerns about low-case scenarios in Europe. From June troughs the euro has since recouped 8.5% of its dollar value ($1.2933) and trends appear to be continuing in this direction. The yen has also gained versus the dollar since mid-june, up 6.5% to Election defeat by the DPJ in Japan, and associated loss of Lower House policy making capacity is a large disappointment for the country. Readings on end of the RMB peg. China s decision to un-peg the renminbi from the dollar on June 19 has resulted in appreciation of the currency vis-àvis the dollar of.8% in the ensuing month though with substantial volatility. If the pace of appreciation observed to date is sustained for the coming year, the RMB will have gained 1% vs. the U.S. unit. Unpegging re-established the exchange rate regime that was in pace between mid-25 to mid-28 a managed float with reference to a basket of currencies. Simple econometric work by DECPG staff points to a basket comprised of dollar, yen and euro, with estimated weights of 4%, 3% and 2% respectively. China s move indicates that the authorities consider recovery sufficiently on track; and in long term perspective, a movement to an increasingly market determined exchange rate. Flows to safe haven continue, an underpinning for the dollar. U.S. Treasury data for the first quarter, which tracks sales and purchases of a wide array of long-term securities by U.S. residents and overseas investors, underscores a continuing and massive flow into U.S. Treasury bonds. During the first quarter of 21, foreigners were net purchasers of $7 billion in USTs, more-than covering U.S. external financing requirements of $44 billion. This comes on the heels of foreign UST purchases moving from $2 to $6 billion in the final quarter of 29. Of note, net equity and FDI flows have been consistently negative over the period, with residual flows (banking and various derivatives (futures, options etc)) moving sharply to outflow in the last two quarters. Such funds may include those redirected to emerging market assets in the last months. July 22, 21 page 11

12 Focus: European banks face financing pressures The cost of interbank euro-denominated borrowing has continued to rise, even after demand eased with the repayment of large ECB loans. Upward pressure on EURIBOR is largely due to significant depletion of excess liquidity in the market. The contribution of counterpart risk is believed to be limited, and expected to be further alleviated by the European bank stress tests, of which results are to be announced on July 23rd. Euro Interbank Offer rates continued to rise, while Euribor/Eonia spread eased slightly.9 percent percent month Euribor (left axis) Euribor/Eonia spread (right axis).5 Jan-1 Feb-1 Mar-1 Apr-1 May-1 Jun-1 Jul-1 Source: Bloomberg Excess reserves at the ECB declined significantly in recent weeks billion Jan-9 Apr-9 Jul-9 Oct-9 Jan-1 Apr-1 Jul-1 Source: Bloomberg basis points 1,2 1, CDS spreads for selected economies Spreads on credit default swaps Oct-9 Dec-9 Feb-1 Apr-1 Jun Average of Brazil, Russia, China, Turkey, and Indonesia Greece Portugal Ireland Spain Italy Source: JP Morgan and World Bank data Euro interbank offer rates have been on the rise since early May 21. Following the ECB s withdrawal of 442 billion in long-term bank financing, European interbank rates (EURIBOR) increased fairly sharply, now standing at.87 basis points (close on July-19), but still lying well-below the effective ceiling created by the ECB s 3-month window, which is available in unlimited quantities at 1%. Despite increasing Euribor rates, the spread between 3-month Euribor and overnight (Eonia) rates has remained relatively stable, and in line with early-21 levels. This suggests that increasing risk premiums have not contributed to the increase in Euribor rates witnessed to date. Funding requirements have been pushing up short-term rates. On July 1, 1,121 Euro-Zone commercial banks repaid the one-year 442 billion ECB emergency loan that was earlier provided to shoreup the financial system and boost credit flows. Repayments were smoothly managed. 17 banks refinanced 132 billion using the ECB s 3-month lending facility; 78 banks relied on the Central Bank s 6-day funding windows for 111 billion. In the following week, a further 45 billion of the ECB loan was repaid. While very sharp increases in demand for funds have eased since the repayment, the operations led to a depletion of excess liquidity in the market by an estimated 25 billion. As banks increasingly rely on the commercial interbank-market, short-term funding rates are likely to increase further in coming months. Bank stress tests may alleviate some of the uncertainty related to the health of the European banking system. The possible high levels of European commercial banks exposure to risky European sovereign debt has led concerns about solvency of such banks, and to an increase in counterparty risk. After Greece in mid-june, Moody's also cut sovereign ratings for both Portugal and Ireland in July. Despite the downgrades, CDS spreads for Greece, Portugal, Ireland, Spain and Italy narrowed in recent weeks. Some of the uncertainty will be eased when the results of the Bank stress tests are announced after markets close on Friday July 23rd. The tests cover 91 European banks 65% of the region s banking industry assessing how they would cope with another economic downturn and losses on government bonds. The tests assume a 3 percentage point deviation from the European Commission s economic forecasts over two years (1% in 21 and 1.7 % in 211) and a deterioration of sovereign debt risk as compared to market prices in early May. July 22, 21 page 12

13 Table A.1 Global industrial production growth (constant prices; percent; seasonally adjusted annual rates except monthly figures which are in percent change over previous month a/) Average Q2 Q3 Q4 Q1 Feb Mar Apr May World High-income countries Industrial countries United States Japan Euro Area United Kindgom Other high income Hong Kong (China) Singapore Taiwan (China) Developing countries East Asia and Pacific China Indonesia Thailand Malaysia Europe and Central Asia Russian Federation Turkey Poland Czech Republic Latin America and Caribbean Brazil Mexico Argentina Colombia Middle East and North Africa Saudi Arabia Iran Egypt. Algeria South Asia India Pakistan Bangladesh 5.6 Sri Lanka. Sub-Saharan Africa South Africa Nigeria Memo: OECD 1.5. Developing excl. China Developing oil exporters Dev. non-oil exporters Asian high tech exporters a In general, series refer to industrial production excluding construction (e.g. manufacturing, mining and utilitites). Where this is not available the closest proxy is used, often manufacturing output or oil output, if the country is a major oil producer. July 22, 21 page 13

14 Table A.2 Demand conditions in high-income countries (US dollar values unless otherwise indicated; percent change; seasonally adjusted annual rates except monthly figures, which are m/m change) Weight Average Q2 Q3 Q4 Q1 Feb Mar Apr May Real GDP High-income countries Industrial countries United States Japan Euro Area United Kindgom Other high income Hong Kong (China) Singapore Taiwan (China) Real merchandise imports High-income countries Industrial countries United States Japan Euro Area United Kindgom Other high income Hong Kong (China) Singapore Taiwan (China) Import Prices High-income countries Industrial countries United States Japan Euro Area United Kindgom Other high income Hong Kong (China) Singapore Taiwan (China) Real effective exchange rates a Euro Area United States Japan United Kindgom Canada Hong Kong (China) Korea, Rep Singapore Taiwan (China) Switzerland a/ JP Morgan Trade Weighted Indices (Real, Broad basis). Data are averages of monthly data for the period in question. July 22, 21 page 14

15 Table A.3 Global credit conditions (percent unless otherwise indicated a/) Average Latest Q2 Q3 Q4 Q1 Mar Apr May Jun 21-Jul Policy Rates United States Japan Euro Area United Kindgom Ten year bond United States Japan Euro Area United Kindgom Spreads (Basis points) b,c Developing countries East Asia and Pacific China Indonesia Thailand Malaysia Europe and Central Asia Russian Federation Turkey Poland Czech Republic Latin America and Caribbean Brazil Mexico Argentina Colombia Middle East and North Africa Saudi Arabia Iran Egypt Algeria South Asia d India Pakistan Bangladesh Sri Lanka Sub-Saharan Africa South Africa Nigeria Gross inflows e Developing countries East Asia and Pacific Europe and Central Asia Latin America and Carribean Middle East and North Africa South Asia Sub-Saharan Africa a/monthly figures are simple averages of the daily figures, except the last month, which are the values reported on the mentioned date. Quarterly and Annual figures are simple averages of the monthly figures. b/average values for Spreads are for the period c/aggregates as defined by JP Morgan. July 22, 21 page 15

16 Table A.4 Commodity price indices (current US dollar index,index unless otherwise indicated; a/) Weights b Average Q3 Q4 Q1 Q2 Mar Apr May Jun Energy Coal, Australia Crude oil, average Natural gas, Europe Non-energy Agriculture Beverages Cocoa Coffee, arabica Coffee, robusta Food Fats and oils Palm oil Soybean meal Soybeans Grains Maize Rice, Thailand, 5% Wheat, US, HRW Other food Bananas, US Sugar, world Raw materials Cotton ("A" Index) Rubber, Singapore Sawnwood, Malaysia Fertilizers Triple superphosphate Metals and minerals Aluminum Copper Gold Nickel Memo: Crude Oil (US$) a/ The World Bank primary commodity price indices are computed from export values in US dollars for low- and middle-income economies, rebased to 199. b/ Energy and gold prices are not included in the index. July 22, 21 page 16