Countries’ Participation in Global Value Chains Can Lead to Account Surpluses, ECB Study Says

A new study from the European Central Bank (ECB) finds that economies that participate in global value chains more than their trading partners also have larger current account surpluses or smaller current account deficits.

This finding has important policy implications, the ECB said, as it “…implies that persistent deviations from a balanced current account do not, as is often argued, reflect domestic distortions, but are in fact welfare-maximizing outcomes against the background of differences in economies’ competitiveness. As a consequence, policies aimed at narrowing global imbalances should focus on measures that facilitate participation in global value chains.”

However, an economy’s participation in global value chains only affects its current account balance if the former changes relative to that in the rest of the world, the bank concluded.

After the global financial crisis, trade surpluses and deficits declined sharply; G20 economies saw their average absolute current account balance relative to GDP fall to 3.9% in 2015 from 4.7% in 2007. Also, rebalancing in account balances after the crisis was seen in advanced and emerging economies, the ECB said.

In the past couple of years, current account balances in some countries, such as the U.S. and China, have begun to widen again, with the U.S.’s deficit growing and China’s surplus increasing, for instance, though global trade imbalances have remained fairly stable thanks to lower commodity prices, the bank said.

More recently, analysts have detected a slowdown in the prior rise of global value chains. Possible explanations include reductions in the length of companies’ supply chains aimed at improving risk management, the adoption of local content requirements and other regulations, and changes in demand, the ECB explained. Moreover, “the observed slowdown in the fragmentation of production across borders has been a global phenomenon and is unlikely to impact global current account configurations.”

Other findings from the ECB paper:

•    Evidence suggests that the impact of global value chain participation on current account balances is economically significant. For example, about a quarter of the large U.S. current account deficit during the run-up to the global financial crisis that cannot be explained by other fundamentals can be explained by its limited relative participation in global value chains.

•    Participation in global value chains appears to boost growth, amplify cross-country monetary policy spillovers and render an economy’s income distribution more uneven.

– Nicholas Stern, senior editor

Growth Expected for Global Oil Field Services and Drilling Sector

After two years of stress and declining earnings, the global oil field services (OFS) and drilling sector’s 2017 earnings before interest, tax, depreciation and amortization (EBITDA) is expected to grow between 6% and 8%. In a new report, Moody’s Investors Service has revised its outlook on the industry to stable from negative. Recovery is in the offing for oil prices and upstream spending. Signs of optimism are to be found in expected improvements in OFS operating margins and an expansion of upstream drilling budgets.

"While OFS companies will remain stressed in regions with high production costs and excess service capacity, the broader operating environment will become less dreadful as higher energy prices keep spurring U.S. rig activity and stabilizing international markets," said Moody's Vice President Sajjad Alam.

Certain businesses and markets are expected to undergo further declines in revenue and EBITDA, however; recovery will not be uniform. Onshore international markets are expected to stabilize with accelerated oil field activities by the U.S. and Canada, but offshore operations will decline. Analysts expect OFS to regain pricing power by the second half of this year in regards to onshore equipment utilization. Declining investments and project deferrals are likely to continue in the realms of deepwater and ultradeepwater operations.

Furthermore, smaller companies that are specialized or regionally focused continue to face tough business conditions in 2017. More than half of its rated OFS companies have very weak credit quality, Moody’s said. Survival prospects for will be challenged in a slow recovery environment because of the difficulty in repairing balance sheets quickly enough to avoid default.

– Adam Fusco, editorial associate

Smaller Firms in Emerging Markets Impacted by Macro Conditions, RBI Study Finds

Corporate leverage ratios in emerging market economies (EMEs) like India have been on the rise in recent years, and when considered against low global growth, reduced commodity prices and the risk of policy rates rising in advanced economies, they raise policy concerns in such nations.

Corporate leverage in EMEs climbed to about 55% of GDP during 2009 to 2014, from about 49% of GDP from 2003 to 2008, and was accompanied by lower earnings in a weak macroeconomic environment, according to a new study by the Reserve Bank of India (RBI) entitled “Corporate Leverage in EMEs: Has the Global Financial Crisis Changed the Determinants?”

The study essentially evaluated the drivers of corporate leverage in a broad swatch of sectors in Brazil, China, India, Indonesia, Malaysia, Mexico, the Philippines, Russia, South Africa and Thailand before and after the Great Recession.

“Firm-specific factors such as profitability, tangibility, market-to-book value ratio and firm size emerge as important determinants of corporate leverage,” the report’s authors concluded. “Our results imply that firms with more tangible assets found tapping the equity market more lucrative and were thus less leveraged in the pre-financial crisis period. In the post-crisis period, however, tangibility ceases to be a significant determinant of corporate leverage, possibly suggesting that debt-issuing conditions were lucrative for all firms, irrespective of whether they had high or low levels of tangible assets.”

Further, firm size was a significant factor with respect to debt buildup in the post-financial crisis period, implying that larger firms are more leveraged after the crisis. For smaller firms, “…leverage buildup was higher for firms with lower tangible assets but higher growth potential in the post-crisis period, while these factors were not influential in the pre-crisis period. More importantly, in the case of small firms, the coefficients of world GDP growth and the Fed shadow rate are statistically significant only in the post-financial crisis period, which indicates the influence of global developments on small firms in the post-crisis period,” the RBI said. This conclusion is at odds with a more “mainstream” view that firm-level factors are the key factors in determining corporate leverage after the crisis.

“In the face of interest rate and unhedged currency risks, issues relating to the servicing of debt can quickly snowball into a systemic financial stability concern,” the RBI said. “Against the backdrop of recent history, which showed that the deleveraging process is almost always lengthy, costly and painful, the challenges for policymakers include ring fencing their financial sector from possible effects of the deleveraging process.”

– Nicholas Stern, senior editor

Optimism Among Small Businesses Remains High

Small business optimism is at one of its highest levels in 43 years. Anticipation mounts for policy changes from the U.S. government in regards to health care law, tax reform and regulatory relief, according to the National Federation of Independent Business (NFIB) Small Business Optimism Index.

“It is clear from our data that optimism skyrocketed after the election because small business owners anticipated a change in policy,” said NFIB president and CEO Juanita Duggan. “The sustainability of this surge and whether it will lead to actual economic growth depends on Washington’s ability to deliver on the agenda that small business voted for in November. If the health care and tax policy discussions continue without action, optimism will fade.”

Nearly half of small business owners expect conditions to improve in the near term. Though the index fell slightly in February, it follows an increase in January and the largest month-over-month increase in the survey’s history in December, NFIB said.

Recording the first positive reading since early 2015, business owners reporting high sales improved four percentage points. Those expecting higher real sales fell three points, but the category remains positive after a 20-point gain in December.

Capital spending was up, reaching the second-highest reading since 2007. New equipment, vehicles and improvement or expansion of facilities led the items for capital outlays. Small businesses are ready to invest, Duggan said.

“Small businesses will begin to turn optimism into action when their two biggest priorities, health care and small business taxes, are addressed,” she said. “To small business, these are both taxes that need reform. It is money out the door that strangles economic growth.”

– Adam Fusco, editorial associate

FOMC Raises Rates, Potentially Leading to Higher Dollar Exchange Value

The Federal Open Market Committee (FOMC) raised the federal funds rate target by 25 basis points, setting in place a firmer path to raise rates three times this year.

By raising rates in March, the FOMC steers clear of the complications to raising rates later that an unforeseen event, like a surprise French election, could bring, said Wells Fargo Chief Economist John Silvia.

The FOMC anticipates minimal changes to real GDP growth and inflation in the near term. “Meanwhile, in our view, the FOMC’s full employment target has been more or less met. One of the three FOMC policy pillars is that policy should look forward,” he said. “We expect the FOMC to work on this pillar as an improving economy pushes inflation toward the Fed’s two percent goal.”

On a global scale, the U.S. rates act as a benchmark for global investors “… as changes in U.S. rates alter yield spreads between sovereign debt returns as well as defining exchange rate risk between countries,” he said. “With out-of-sync economic cycles, the actual and expected interest rate/growth differentials for the U.S. support the case for the dollar’s increase in value over the last six months as well as a further increase over the next six months.”

Elsewhere around the world, central banks like the European Central Bank and the Bank of Japan aren’t in a position to raise rates, so actions by the Federal Reserve won’t be followed, leading to a higher exchange value for the dollar, Wells analysts said. This in turn will promote financial capital outflows. “China is in a more difficult situation since a stronger dollar would increase bilateral trade imbalances and incentivize further capital outflows—difficult results in today’s context,” Silvia said.

– Nicholas Stern, senior editor

SWIFT GPI Achieves Another Milestone

The Federal Reserve Banks in the United States and The Clearing House have developed local market practices for their participants that use the SWIFT global payments innovation (gpi) service. SWIFT gpi gives to banks the ability to offer faster, more transparent and traceable cross-border payments, with features that include same-day use of funds and end-to-end payment tracking. The service was launched last month.

Because gpi payments carry additional information to flag them as gpi, member banks need a local market practice for the payments to be exchanged through local clearing systems that do not use SWIFT. Now that these practices are in place for the major USD clearing systems, efficiency of tracking will be greatly increased, SWIFT said.

“By using a market practice to include a gpi tracking reference in the Fedwire Funds Service messages they send, our participants that are also SWIFT gpi members can be in a position to extend the benefits of SWFT gpi to funds transfers that are made through the Fedwire Funds Service,” said Nick Stanescu, senior vice president and head of payments product management for the Fedwire Funds Service and the National Settlement Service.

“The Clearing House is pleased to join the world’s payments market infrastructures in providing greater transparency in payments through SWIFT’s gpi initiative,” said Jim McDade, senior vice president of product management at The Clearing House. “Our commitment includes aligning CHIPS formats with the gpi U.S. market practice, which will ensure payments carry the required information needed for the tracking of domestic and cross-border wire payments, from origination through to the credit to the ultimate beneficiary’s account. This transparency will improve efficiency, security and customer service.”

SWIFT will continue to engage other infrastructure communities for future gpi tracking, including the Bank of Japan Financial Network System and SIX’s Swiss Interbank Clearing.

– Adam Fusco, editorial associate

U.K. Business Outlook at Its Highest Since Mid-2015

The United Kingdom is gaining business confidence after seeing a four-year low in October. Data collected in February shows a confidence level of 52% compared to 39% last fall, according to the most recent Markit UK Business Outlook. The less than favorable outlook was partially due to last summer’s referendum that ended with the U.K.’s decision to leave the European Union.

The outlook survey for manufacturing and services is based on responses from about 12,000 providers. Business sentiment is at its highest since June 2015. U.K. manufacturers were 55% confident, which is second to Brazil among the 12 countries rated by IHS Markit. The positive outlook can be traced to improving client demands among other factors.

Private sector firms are more positive about growth prospects for the next year, according to IHS Markit Senior Economist Tim Moore. U.K. private sector companies also saw an 8% increase in employment expectations, which is at its highest since fall 2015. U.K. companies are expected to raise prices at the fastest rate since late 2009, said Moore. Private sector firms expected to increase output prices is at 42%. Firms expected to increase input prices during the next 12 months is at 54%, which is its highest since early 2011.

-Michael Miller, editorial associate

Asia’s Infrastructure Needs $26 Trillion by 2030

Developing Asia’s infrastructure will cost $26 trillion over the next 14 years. The region needs $1.7 trillion per year from 2016 to 2030 to maintain growth momentum and combat poverty and climate change, according to Asian Development Bank (ADB).

The infrastructure projects include transport, power, telecommunications, water supply and sanitation. Nearly $15 trillion will be used for power, while transport will see $8.4 trillion. Telecommunications and water and sanitation will need investments of $2.3 trillion and $800 billion respectively, according to ADB.

In 2009, ADB estimated the annual investment at $750 billion. The reason for the increase can be attributed to using 13 more ADB member countries and updated prices in the current report. More than 60% of ADB’s estimated infrastructure work, or $16 trillion, is for East Asia. The Pacific, as a percentage of the gross domestic product (GDP), led all regions needing investments valued at 9.1% of the GDP.

Philippine President Rodrigo Duterte said he plans to spend $170 billion for 5,000 projects. China recently committed $3.4 billion for three infrastructure projects in the Philippines. Malaysia’s capital city, Kuala Lumpur, is already planning new rail lines. A 720-kilometer railway is also in the works in Indonesia. India’s government said last summer it needs to invest more than $1.5 trillion over the next 10 years for an infrastructure gap and to connect hundreds of thousands of villages with roads by 2019.

– Michael Miller, editorial associate

Long-Term Public Debt Challenge Remains in U.K.

The U.K.’s economy has looked resilient despite predictions of doom and gloom following Brexit, particularly as the Office of Budget Responsibility (OBR) recently updated its growth forecast for 2017 to 2% from 1.4% last fall.

But Fitch Ratings still sees long-term challenges ahead in terms of reducing public debt, and the ratings agency has taken this factor into account in giving the U.K. a negative outlook on its sovereign ‘AA’ rating. The firm also has a dimmer view of the growth it anticipates coming from the U.K. this year and next—1.5% and 1.3%, respectively—as it expects weaker foreign investment stemming from lingering Brexit jitters.

“Currently we assume that the government debt-to-GDP ratio will peak in 2018, but that would still leave the U.K. with one of the highest public debt ratios among highly rated ('AAA' and 'AA') sovereigns,” Fitch analysts said.

Also, the OBR anticipates that general government gross debt as a share of GDP will stay mostly at the same level for the next two years and start dropping in fiscal 2019/2020. “This underlines the scale of the challenge of putting the debt ratio on a downward path,” Fitch said.

– Nicholas Stern, senior editor

Exit Risk Low in Euro Area, but Could Rise This Year

The chance of a country other than Greece choosing to leave the European Union is low, but could increase as the year proceeds due to the rise of anti-EU parties in the area.

In a new report on how euro-area risk is reflected in its ratings, Moody’s Investors Service said that such parties, though unlikely to gain enough electoral support to seek exit from the euro area, might still influence political agendas. The report addresses how the ratings agency would determine that a departure from the union, if followed by a currency redenomination, was a default. Such a scenario would not automatically result in a default. Moody’s said it would focus on changes in the value of debt obligations relative to the original contractual promise. If investors were offered securities of diminished value relative to the original, then it would conclude that a default had occurred.

Exit risk is indicated in Moody’s euro area bond ratings and euro area country ceilings. The country ceilings mainly reflect the risk of a country exiting the union and redenominating all domestic debts into a new, weaker currency.

“Ultimately, the single currency is a political construct that relies on sustained popular support among member states,” said Colin Ellis, chief credit officer at Moody’s. “Any evidence that such popular support was waning in key member states could weigh on popular support elsewhere in the euro area, increasing credit risks.”

– Adam Fusco, editorial associate