Risks to Australia’s Sovereign Credit Rating Include China Slowdown, Commodity Price Fall

Australia is set to see its gross public debt ratio peak in 2018 and the fiscal surplus to come into balance by 2021, reinforcing Fitch Ratings improving outlook for the sovereign and its 'AAA'/Stable rating.

Still, Fitch analysts expect Australia’s deficit to shrink at a slower pace than forecast in the Mid-Year Economic and Fiscal Outlook, mostly thanks to their subdued forecasts for real GDP growth and commodity prices. “The economy should be supported by buoyant employment growth, the fading drag from mining investment and improved non-mining investment prospects,” analysts said.

“However, weak wage growth will weigh on household consumption, while slowing growth in China is likely to constrain commodity price rises and Australia's export growth.”

The government has downgraded its growth forecast for fiscal 2018 to 2.50% from 2.75%, while it expects growth to rise again in fiscal 2019 to 3% and remain at that level until fiscal 2022.

The nation’s economy and fiscal performance face risks from negative global economic developments, especially a slowdown in China or a drop in commodity prices, Fitch said. “Risks might also stem from a faster-than-expected rise in U.S. interest rates, which could lift borrowing costs and pressure domestic liquidity conditions, given the banking system's reliance on international wholesale funding. High household debt levels could make the economy especially sensitive to rising rates,” analysts said.

Australia’s buffer against economic shocks has deteriorated over the last decade, while debt ratios have grown—in 2007, the government’s gross debt was less than 10% of GDP, while it’s likely to reach 42% next year, Fitch said.

– Nicholas Stern, managing editor

Bank of Israel Ponders Digital Currency

The Bank of Israel is considering adopting a digital currency as a way to create a faster payments system and reduce the amount of cash in the economy, according to a recent report in Reuters, which cited an unnamed central bank source.

While no decision has been made yet, the source told Reuters that the government was ready to legislate or include the matter in its 2019 budget and economic package if the central bank provided its’ final approval.

Such a currency would presumably be safe, centralized and follow anti-money laundering laws, the source told Reuters, thus distinguishing it from a cryptocurrency like Bitcoin, which is decentralized.

“Central banks around the world are examining (the use of digital currencies) so we should as well,” the Israeli source told Reuters.

In Israel, the underground economy is estimated at nearly a quarter of national output, and the nation has been looking at ways to address the issue for years, Reuters said. The Bank of Israel last month asked for proposals to create an infrastructure to support immediate payments in the country, like ones that are used in Britain and Sweden.

– Nicholas Stern, managing editor

Regulatory Headwinds Could Bring Risks to Clearing Houses, Central Counterparties

The potential fallout from a hard Brexit, and growing exposure to clearing houses and central counterparties (CCPs) may soon bring added regulatory oversight and scrutiny to the sector, according to a new report from Fitch Ratings.

Overall, Fitch’s outlook for the sector remains positive thanks to CCPs liquidity levels, robust risk management and, so far, supportive regulatory environment. Generally, large global clearing houses have profited from a supportive regulatory environment that’s allowed for participants to centrally clear transactions, rather than do so in an over-the-counter fashion on a bilateral basis, Fitch analysts said. That in turn has led to a steady increase of market participants’ exposures to CCPs. The Commodity Futures Trading Commission (CFTC) recently showed through regulatory stress tests that the world’s largest CCPs have adequate liquidity resources to complete their settlements at the end of the day should a severe market stress occur.

"Regulatory stress tests are an important and standardized measure of CCPs' resilience, but the tests incorporate the use of committed credit lines that could be extended by commercial banks, which may be also CCPs' largest clearing members," said Evgeny Konovalov, director in Fitch's Financial Institutions group.

CCPs ‘skin in the game,’ or the amount of allocated capital resources are still relatively small in the world’s largest organizations—bringing more to the party would be a positive for CCP’s risk profiles, and serve to maintain margin and counterparty standards in a growingly competitive environment, Fitch said.

“An area to watch in 2018 will be the implementation of MIFID II/MIFIR requirements for open and non-discriminatory access to trading venues and CCPs,” analysts said. “These provisions may pose a challenge to national CCPs' currently well-entrenched franchises and lead to a re-distribution of clearing volumes to the larger international CCPs.”

A hard Brexit scenario could inspire EU regulators to demand direct oversight over the clearing of euro derivatives, which would bring complications to cross-border supervision of CCPs, Fitch said.

– Nicholas Stern, managing editor

Take Heed: The EU’s New Private Data Regulation May Impact Your American Business

The European Union’s General Data Protection Regulation (GDPR), one of the world’s most stringent personal data protection laws on the books, will have implications for companies in the U.S. and elsewhere.

Passed in the EU parliament in April 2016, the steep fines—up to 4% of global revenue or €20 million, whichever is greater—that can be levied for violating its precepts go into effect May 28, 2018.

Essentially, the GDPR marks a significant shift in how companies treat the data of EU citizens, requiring organizations to clearly understand what information they have about private individuals, who has access to the information, where the data resides and how it is used; and then take steps to protect that private-user data, known as Personally Identifiable Information (PII), according to an article in eWeek.

PII can include credit card numbers, Social Security numbers, birthdays and home addresses—all of which are collected online and in the course of ordinary business operations, eWeek said.

The GDPR includes a “right to be forgotten,” a 72-hour data breach reporting period, and strong ‘opt-in’ consumer consent requirements, among other provisions. “Any U.S. company that has a web presence (and who doesn’t?) and markets their products over the web will have some homework to do,” a Forbes article said. Article 3 of the GDPR says that if your company collects personal data or behavioral information from someone in an EU country when the data is collected, your company is subject to the requirements of the GDPR, the article noted.

Also, a financial transaction doesn’t have to take place for the law to be effective. PII collected for a marketing survey, for instance, is protected under the regulation. Note that a business would have to specifically target a data subject in an EU country—generic marketing isn’t protected, Forbes said. So if the marketing is in the language of the EU country and there are references to EU users and customers, a webpage would be considered targeted marketing and the GDPR would apply.

U.S.-based hospitality, travel, software services and e-commerce firms are going to need to look closely at the regulation and how it will apply to them, Forbes warned. Also, any U.S. company that’s singled out a market in an EU country and has local web content will need to pay attention. Sound like you?

– Nicholas Stern, managing editor

Inventories’ Influence on GDP Growth in Recent Expansion Likely to Recede

Inventories have never been as much of a factor in GDP growth during expansions over the last 35 years as they have been in the current cycle, but that influence is waning.

Inventories boosted GDP growth by 0.8 percentage points in the most recent quarter, according to a special report by Wells Fargo. “The combination of the most-tepid growth backdrop in the post-WWII era, the unique changes in the energy sector (both technological and price swings) as well as a continued evolution in inventory management have all played a role in elevating the importance of inventories in this cycle,” wrote report authors Tim Quinlan, senior economist, Sara House, economist, and Shannon Seery, economic analyst. But now in its late stage, the expansion will likely be driven by other factors returning to more normal, long-term rates.

Dating back to the 1980s, the contribution of inventories as a share of the overall growth rate—especially in a slow GDP growth environment—is equivalent to 45% of GDP growth; much higher than the 27% to 34% seen in prior expansions, the Wells analysts said.

Looking toward the end of 2018, Wells expects modest inventory building with quarterly jumps from $40 billion to $50 billion. “Our base-case scenario is informed by our prior study of late-cycle inventory dynamics which suggests a slowing in the pace of inventory investment.”

During this cycle, inventory swings in the energy sector have been an important driver. Crude inventories boosted by shale supplies began growing in 2014. By the first quarter of 2015, inventories from energy—as reflected in government data for the mining, utilities and the construction sectors—boosted topline GDP by 1.5 percentage points. Energy sector inventories began to slow and then decline over the past three quarters, while inventories of manufactured and wholesale petroleum products after adjusting for inflation were 7% higher, year-over-year, in the third quarter, compared to the 25% annual gain seen in the final quarter of 2016.

Meanwhile, nonfarm business inventories also jumped to the largest annual gain on record in 2015, driven in part by slowing sales, the Wells analysts said. That inventory-to-sales ratio began to decrease in mid-2016, however, and has since dropped to its lowest level in nearly two years as businesses cut back on inventory investment. Still, elevated inventory levels in some industries, such as metals, machinery, chemicals and energy products, suggest a reduction in the pace of inventory building in the near term.

Retail inventories relative to sales have been at more healthy levels in recent years, hitting a 20-year low in the third quarter, Wells said.

But in the coming year, stronger growth is expected to bring businesses to add to inventories. “The pace is not expected to be as jaw-dropping as earlier in the expansion when businesses got out over their skis then subsequently had to dial back their inventory building. The relative importance of inventories as a growth driver should recede as broader growth picks up, the volatility in the energy sector fades a bit and as businesses appear to be taking a more deliberate approach to stockpiling.”

– Nicholas Stern, managing editor

China’s New Carbon Emissions Plan Could Hit Profitability of Higher Emitters

China’s plan to create a national carbon emissions trading platform will probably hit the profitability of coal-dependent power producers with high emission rates over the long term due to increasing emission costs and lower power generation.

On the other hand, the platform will in the long term probably grow the profitability of renewable energy producers and coal-dependent power products with low emission rates thanks to higher power generation and carbon credit revenue, said Moody’s Investors Service in a new report. “The new platform will have no immediate impact on the ratings and outlooks of power producers rated by Moody's because any meaningful effects will likely come in 2020 or after when the platform becomes fully functional,” Moody’s analysts said. “But power producers may increase future capital expenditures if the government sets higher emission reduction targets, which will accordingly raise their leverage.”

According to China’s National Development and Reform Commission (NDRC), announced Dec. 19, the trading platform will be set up in Shanghai and Hubei provinces. The NDRC has a three-stage development plan, including a Pilot Run Stage that will take a year of testing. There’s no set time limit for the Perfection Stage to bring the platform up to required standards. No emission targets have been set so far.

The plan will begin with the power sector, Moody’s said. Producers with more than 26,000 tons of annual carbon emissions will be subject to the plan’s requirements, including approximately 1,700 entities with total emissions of over three billion tons and amounting to roughly 30% of China’s total emissions in 2016. More sectors are anticipated to be added to the plan later. Power producers with lower emission rates will be eligible to generate more power or sell surplus emissions permits for added revenue.

The national platform will complement the development of the Green Power Certificate program, Moody’s said. “In the longer run, Moody's expects the plan will encourage power producers to adjust power generation mix to optimize profitability based on prevailing emission levels of their coal-fired generation units. This will lead to lower carbon emissions for the entire sector.” The ratings firms also anticipates trading among coal-dependent power producers will likely be more active than it will between renewable energy producers and coal-dependent power producers due to the relatively large demand and supply of carbon quota.

– Nicholas Stern, managing editor

Tax Bill’s Limitation in Interest Expense Deductibility Greatly Impacts Highly Leveraged Firms

The impact of the limitation in the deductibility of interest expense in the reconciled U.S. tax bill will be more severe for highly leveraged firms, according to a new report by Fitch Ratings.

The change in net income under the reconciled bill, which will be voted on likely later this week, should be neutral to slightly positive for issuers with leverage 5.0 times or below, analysts said. The bill would limit the deduction of interest to 30% of EBITDA until 2021, after which the limitation of deduction would apply to 30% of EBIT. The non-deductible portion of interest expense can be carried forward for five years, and would reduce the effects for issuers with growing EBITDA or who are reducing debt, Fitch said.

Fitch estimates, based on a sample of 575 leveraged loan and high-yield issuers, that 37% of issuers will lose a portion of their interest deductions under the EBITDA definition. Also, 27% would be unable to deduct 20% or more of their interest and 10% would be unable to deduct 50% or more.

If EBIT is at 30%, there’s a bigger hit with the limitation of interest deduction, Fitch said. Without that depreciation buffer, 64% of the Fitch sample would lose a portion of their interest deduction, while more than half would be unable to deduct 20% or more of their interest and 40% would be unable to deduct half or more.

“We believe the limitation on interest expense deduction is unlikely to have a significant effect on debt issuance (speculative grade and investment grade), both from a supply and demand viewpoint,” Fitch analysts said. “Demand for corporate debt, including leveraged finance products, will likely remain robust as investors continue to seek yield on their investments. This will provide attractive markets for issuers. Even with the limitation, the cost of debt (before any tax benefit) is typically well below the cost of equity and the limited corporate tax deduction on interest expense will provide an offset.”

– Nicholas Stern, managing editor

Multi-Million Dollar Business Email Compromise Scam Targeted Suppliers, Vendors

A Nigerian man has pleaded guilty to U.S. prosecutors for defrauding more than $25 million from companies that were convinced through business emails to send payments via large wire transfers to accounts in China.

According to the report in The Guardian and Reuters, District Judge Paul Crotty in Manhattan sentenced David Chukwuneke Adindu to three years and five months in prison for taking part in the business email compromise scam. Adindu had impersonated executives or vendors of companies, and directed employees of those companies to make large wire transfers. Prosecutors said he’d resided in Guangzhou, China and Lagos, Nigeria, while working with others to carry out the frauds from 2014 to 2016.

Among the fraudsters’ targets was an unnamed New York investment firm, where in June 2015 an employee received an email claiming to be from an investment adviser at another firm asking for a $25,200 wire transfer. The employee later discovered the email was phony and didn’t send a second requested transfer request for $75,100, The Guardian said.

Other scams were carried out by exchanging information regarding bank and email accounts, and scripts for requesting wire transfers, reported SC Cybercrime. According to the International Business Times, Adindu sent phishing emails to companies, including in the U.S., by impersonating supervisors or third-party vendors linked to the company.

– Nicholas Stern, managing editor

A Tale of Two Retail Sectors: Risks in Europe vs. the U.S.

Parts of the retail sector are at risk both in the U.S. and in Europe, but different forces are affecting the credit profiles of firms at home and across the pond. The market penetration of e-commerce models great (Amazon) and small, as well as the level of overcapacity in store networks are important factors that distinguish these risks, according to a new report by Fitch Ratings.

In Europe, the retail sector has the most at-risk issuers (rated 'b-*'/Negative or below), but there have been fewer defaults than in the U.S. and the ratings agency expects credit profiles there to stabilize next year.

Established, brick-and-mortar retailers in the U.S. are being dogged by increased competition from other specialty, off-price retailers like TJX and Ross Stores, while fast-fashion, online competitors and significant physical retail space overcapacity are having their impact as well, Fitch said. Store sales density for these incumbents is dropping, and profit margins are drooping as they invest more in online features and increasing price markdowns. “These trends are mitigated by cost-cutting and store closures,” Fitch analysts said. “In contrast, consumption patterns and online retail sales penetration vary widely across Europe and shopping space per capita across the continent is much lower than in the U.S.”

European retailers like Inditex and H&M have more room to expand and suffer only marginal hits on profit, Fitch said. Still, Amazon and other online retailers such as Zalando, ASOS or Shop Direct are knocking at the door and present longer-term threats to store-based retailers in Europe.

“The more successful European non-food retailers tend to have a well-developed omni-channel platform with a smaller physical footprint than their more traditional peers, benefiting from agile supply chains allowing them to stay responsive to fast-changing consumer preferences,” analysts said.

In the European food retail sector, Fitch believes companies are operating with 15% to 20% more space than they require; retailers are addressing the issue by closing stores or sub-letting space.
Despite the pressures they face, the credit profiles of European retailers should mostly stabilize in 2018 as they adjust business models and extend debt-maturity profiles, analysts said.

– Nicholas Stern, managing editor

Many Companies Not Prepared for the Risk Brought by the EU’s New Customer Data Rule

The European Union’s (EU) General Data Protection Regulation (GDPR) will give European customers the ability to control all of the personal data businesses store and process about them. Many companies, however, will not be prepared to meet the requirements when the GDPR takes effect in May 2018, leaving them exposed to potentially millions in fines.

The GDPR will give European customers the power to control all data collected about them, from name, address and phone number to purchasing history, web browsing activity, and real-time location. Companies loaded down with legacy enterprise systems housed in various silos can’t adequately track how and where they store this information; many are working to redo their IT infrastructure to prepare for the impending GDPR inquiries. Gartner predicts that by the end of 2018, more than half of the companies affected by the GDPR will not be in full compliance.

That will be key because according to a new global study of 7,000 customers across the EU by software firm Pegasystems Inc., 82% of European consumers plan on using their rights under the regulation to view, limit or erase the information businesses collect on them. Customer awareness is still fairly low, but among those who do know something about the GDPR, 90% want direct control over how companies use their data, and 89% want to see the data companies store about them.

Survey participants ranked the ability to see what data is collected and stored about them as the most important aspect of the GDPR (47%), while 22% want the ability to erase such data. Ninety-three percent of respondents said they would erase their personal data if they weren’t comfortable with how they thought companies used it.

By country, 90% of respondents from Italy said they planned on enforcing their GDPR rights, while 89% of those from Spain, 86% from France and 74% from the U.K. said they would do so.

– Nicholas Stern, managing editor

Negative-Yielding Debt Has Sticking Power, Despite Growth in Eurozone, U.S.

The world’s supply of negative-yielding sovereign debt is still at elevated levels, even though the European Central Bank (ECB) plans to cut monthly asset purchases in an environment of eurozone economic gains.

As of Dec. 4, 2017, there was $9.7 trillion of negative-yielding sovereign debt outstanding, up from $9.5 trillion on May 31, 2017 and $9.3 trillion a year ago, said Fitch Ratings in a new report. Analysts anticipate 2.3% and 2.2% GDP growth in the area in 2017 and 2018, respectively, while growth this year has exceeded their forecasts. The gains have spurred ECB officials to plan a slowdown of asset purchases to €30 billion per month beginning in January. “However, these changes have not led to materially higher yields on government debt for short- or long-term maturities in the eurozone,” Fitch said.

Total negative-yielding debt in Europe has increased over the last six months to a year, with much of the growth being attributable to the appreciation of the euro relative to the U.S. dollar, the ratings agency said. Yields in Japan and Europe are mostly flat, or marginally lower in aggregate, compared to six months and a year ago.

The continued monetary easing by the ECB is probably having an impact on global financial markets. “ECB net purchases of public-sector debt securities have been roughly 3.5 times the volume of net issuance on average in 2016 and 2017, forcing holders of eurozone debt to purchase other assets, such as U.S. treasury securities. While long-term yields in the U.S. remain low, they remain well above core eurozone yields that are near their 2017 lows,” Fitch analysts said. Meanwhile, on Dec. 4, the spread between U.S. and German 10-year government bond yields was just over 200bps.

Buy and hold fixed-income investors in medium- and long-term sovereign debt are being challenged in this low-rate environment. Foreign investment has likely contributed to a rapidly flattening yield curve in the U.S. as the Fed continues to raise the Funds rate slowly. Demand from investors has put downward pressure on U.S. yields, with the 10-year treasury remaining mostly flat in recent months.

“Meanwhile, yields on shorter-term securities have risen rapidly, bringing the spread between benchmark 2-year and 10-year U.S. treasury securities to 57bps on Dec. 4, the tightest since before the financial crisis,” Fitch said. “This is despite the fact that U.S. GDP growth has exhibited strong momentum and outperformance in 2017, similar to the eurozone.”

– Nicholas Stern, managing editor

Small Business Optimism Surges in November, Signaling Growth in ‘18

Small Business Optimism climbed to its highest level in 34 years in November, buoyed by the prospects of significant tax cuts. The National Federation of Independent Business (NFIB) Index of Small Business Optimism increased 3.7 points on the month to 107.5, and reached the second highest mark in its’ 44-year history.

Eight of the 10 index components improved in November, with the lion’s share of the gains going to a 16-point jump in Expected Business Conditions and a 13-point rise in Sales Expectations.

“The improvement in small business confidence is meaningful and suggests employment growth and business fixed investment should maintain strong momentum going into the New Year,” said Wells Fargo senior economist Mark Vitner. “The improvement in Small Business Optimism suggests tax reform may provide a more meaningful boost to economic growth in 2018.”

Small business owners have consistently highlighted taxes and regulation as their most important barriers to success—a recent political climate focused on reducing the impact of existing regulations and scaling back the adoption of new regulations, has boosted small business confidence, Vitner explained. Tax reform on the edge of passage only boosts such confidence.

Some owners said they believe now is a good time to expand; 27% of those in the November survey said as much, marking a four-point gain from October, the Wells economist said. Stated plans to increase employment also rose, by six points in November. “While hiring plans rose, actual hiring moderated. Thirteen percent of firms reported hiring workers, while 10 percent said they reduced employment,” Vitner said.

Finding qualified workers seems to be a problem for employers, as 52% reported they either hired to tried to hire workers in November, but 44% said they found few or no qualified candidates. The hiring problem has been more acute in the construction and manufacturing sectors.

– Nicholas Stern, managing editor

Asian Liquidity Stress Indicator Improves in November

Moody’s Investors Services’ Asian Liquidity Stress Indicator (LSI) decreased in November, a sign of improvement in speculative-grade liquidity.

"The Asian LSI improved in November to 26.4% [from 27.6% the prior month], largely due to the addition of new issuers, but remains weaker than the long-term average of 23.1%," said Brian Grieser, a Moody's vice president and senior credit officer. "The momentum in high-yield issuance continued in November, with rated issuance totaling $1.9 billion in the month, raising year-to-date issuance to a record $33.9 billion."

The number of rated high-yield companies with Moody’s weakest speculative-grade liquidity score (SGL-4) decreased to 39 from 40, while the total number of rated high-yield companies increased to 148 from 145.

For North Asian high-yield companies, the liquidity stress sub-indicator decreased to 27.8% in November from 28% in October, Moody’s said. The Chinese sub-indicator stayed stable at 28.7% from 28.9%, while the Chinese high-yield industrials subsector decreased to 40% from 43.2%, with new ratings assignments during November being the deciding factor.

In South and Southeast Asian high-yield companies, the liquidity stress sub-indicator decreased to 23.5% in November from 26.9% the month prior.

– Nicholas Stern, managing editor

Tax Reform to Help Tech Companies

The planned tax reform is a credit positive for the U.S. technology sector and will give tech companies additional financial flexibility, said Fitch Ratings. Much of the repatriated cash will go to shareholders rather than toward debt reduction or acquisitions, which could be credit negative in the short term, added the credit ratings agency.

Fitch predicts the tax rate reduction will cause tech companies to send cash overseas mainly for shareholder returns. It also expects offshore cash will not increase acquisition activity or leave cash on balance sheets.

Two of the largest cash piles—Oracle and Microsoft—will see their supplemental adjusted net leverage ratios “converge but decline over time as greater access to cash flow enables management to achieve target shareholder returns while reducing gross leverage to levels more appropriate for ratings.” Tech debt issuance will decline over the long term since most of the recent debt increases were to support shareholder returns.

Meanwhile, Moody’s Investors Services said the tax reform could be negative for states. State tax revenue will grow 2% to 3% over the next 12 to 18 months, but new tax regulations are an unknown, according to Moody’s. “The federal policy environment is becoming increasingly credit negative for states since many potential changes would affect state finances and challenge states as they plan future budgets.” Additional federal changes to Medicaid and the North American Free Trade Agreement could also have a negative impact at the state level.

-Michael Miller, editorial associate

Oil and Gas Production Will Remain Strong, with Supply Dampening Prices

A steady stream of oil and natural gas production should serve to aid the energy industry in its slow recovery, though excess supply is likely to tamp down price increases in 2018, according to a new report by Moody’s Investors Service.

"Prolonged oversupply will constrain oil prices in the next one to two years, though OPEC-led production cuts have now stabilized around price-supportive levels," said Steve Wood, Moody's managing director for oil and gas. "We expect prices to remain within the $40 to $60 per barrel band through 2019, assuming continued compliance with global production targets."

For natural gas, large reserves are expected to start yielding returns for many producers at $3.00/MMBtu as demand increases, Wood said. Storage levels are improving and U.S. production is anticipated to grow again in 2018 after the plateau seen this year.

The ratings agency’s outlook for the integrated oil and gas sub-sector over the next year to year-and-a-half is stable, while EBITDA should grow by approximately 5%, despite constrained investment conditions. Positive free cash flow could entice major European companies to reinstate cash dividends.

The outlook for the exploration and production sector remains positive, with EBITDA expected to grow more than 10% in 2018, as higher capital spending helps ramp up production volumes, according to Moody’s.

The midstream outlook is also positive, with EBITDA estimates for 2018 between 8% and 10%. Capital spending and production in the sector will increase, Moody’s reported. Potential headwinds include state and local regulations.

The refining and marketing sector of the industry has a stable outlook. EBITDA should grow 5% to 7% next year, as strong distillery demands are likely and should help ease high inventory levels, Moody’s said.

– Nicholas Stern, managing editor

Overcapacity Discipline Is Key to Maintaining Growth in Global Shipping

Ongoing overcapacity in the global shipping industry is among the factors keeping Fitch Ratings analysts from changing their negative outlook on the sector.

Container and bulk shipping are showing positive signals of growth, but the staying power of this trend remains cloudy “due to limited adherence to capacity discipline in the sector,” Fitch analysts said in a new report. Supply and demand dynamics are likely to support container, bulk and liquefied natural gas (LNG) shipping rates, but tanker rates could stall.

“The tanker shipping segment is the most exposed following a glut of new vessel deliveries in 2017,” Fitch said. “We expect demand for tankers to grow by around 4% in 2018, helped by rising global oil consumption, higher U.S. exports and declining oil inventories. But this would still only broadly match the expected growth in tanker supply. Rates therefore may not fall further, but a sustained increase is unlikely.”

Rates for container shipping have been raised this year, but again, overcapacity threatens continuation of the trend, which has fluctuated historically, analysts said. The ratings agency expects supply to grow by more than 5.5% in 2018, backed by stable capacity discipline and potential consolidation in the sector over the medium term.

A recent recovery in the rates for dry bulk shipping could also be transient, but Fitch believes demand will outpace the growth in vessel supply next year. “The market balance will be helped by the low level of new vessel orders for the last three years. China will remain the key driver for dry bulk commodities imports and trade, and the sector is therefore particularly sensitive to Chinese GDP growth, which we expect to be 6.4% in 2018,” Fitch said.

– Nicholas Stern, managing editor

Moderate Policy, Funding Capacity to Aid APAC Power Sector Transition to Renewables

The outlook from Moody’s Investors Service for the power sector in the Asia-Pacific (APAC) region through 2018 is stable, but as regional governments begin to tackle carbon transition risks, business conditions across the region will begin to diverge.

"The key factors supporting our stable outlook for the power sector in APAC are the steady market structures or consistency of returns in the region," said Mic Kang, a Moody's vice president and senior analyst. "Growing demand for electricity will help most Moody's-rated power companies with dominant or stable market positions maintain adequate dispatch volumes, despite challenges from renewables. As for the higher environmental costs associated with carbon transition policies, such costs will remain manageable, because of the gradual implementation of initiatives, cost pass-through and/or compensation through subsidies."

Carbon transition policies will become an important driver of business conditions in APAC, as each country’s target emissions level and the deadline to reach it will affect its exposure to carbon transition risks, Moody’s said. China’s thermal power generators are likely to face the biggest issues in the region while the sector faces overcapacity as it moves rapidly into renewables.

Sector reforms in most APAC countries are suggesting only modest changes to the way companies operate through 2018, which should help reduce the associated risks with liberalization policies, analysts said. Meanwhile, the power companies will see greater funding diversity that will allow them to expand capacity and develop renewables. “Given their large investment needs, a multi-pronged approach that combines bank loans with institutional debt capital will help boost private sector debt capacity.” Moody's says that “while corporate-type debt will remain dominant through 2018, debt funding across APAC will gradually include more project bonds.”

– Nicholas Stern, managing editor

Despite Recent Downshift, Long-Term Chinese Overseas Corporate Acquisitions to Remain

Chinese corporates’ foreign investments are likely to grow over the long term, despite a dramatic drop in such investments during the first nine months of 2017. That’s because Chinese authorities are likely to support overseas acquisitions of companies looking for advanced technology and strategic assets and to create jobs that enhance the country’s Belt and Road Initiative, according to a recent report by Fitch Ratings.

Year-over-year, Chinese corporate outbound activity dropped by 42% in the first three quarters of the year, thanks to the government’s tightened approval process related to its desire to limit capital outflows since the end of 2016. Overseas mergers and acquisitions in property, hospitality, and sports and entertainment saw a drop of nearly 70%.

Some of these restrictions on investments are likely to continue into 2018, while increased scrutiny from overseas regulators and regulatory uncertainty in the U.S. pose added headwinds to Chinese investments overseas, analysts said.

Still, many Chinese companies are at an early stage in terms of the interest in expanding overseas investments, while the Belt and Road Initiative is expected to continue interest in overseas M&A activity, Fitch said. Indeed, investments related to this initiative have increased in 2017.

Analysts at the ratings firm also believe Chinese overseas M&A will shift from energy and commodities to consumption-driven sectors like health care, consumer goods and high-end manufacturing. “It was notable that five out of China's top 10 overseas acquisitions in 2016 were in the computer and software and manufacturing sectors, and none was in the mining sector,” Fitch said.
 “Private companies have overtaken state-owned enterprises (SOEs) in overseas M&A transaction value, while appetite is switching away from resource-rich markets such as Australia, Canada, South America and Africa, in favor of the U.S., Europe and developed Asian economies.”

– Nicholas Stern, managing editor