The Weekly Update

Where is global growth headed? The International Monetary Fund (IMF) has recently warned governments around the world that they cannot rely on low or negative interest rates alone to avert recession and drive growth. Citing factors such as low productivity, the lack of firepower from monetary policy and persistently low inflation, the IMF is worried that there are still a number of factors that could blow global growth off course. What is a realistic growth rate though? With population growth slowing around the globe, it is going to be virtually impossible to attain the growth rates that were achieved in the past. The Japanese working age population started shrinking in 1995, but that hasn’t stopped the government and the BoJ from attempting to boost growth to unrealistic levels.

Whilst the IMF supports the policy of negative interest rates it believes it should not be the only economic policy that should be used. Boosting reforms to raise productivity and employment, as well as not being overly aggressive with austerity measures if countries can afford it are areas that should be addressed. Hammering home the point the IMF was making was US Treasury Secretary, Jack Lew. He said, “All major economies need to deploy a full toolkit of economic policy measures, including monetary and fiscal policies and structural reforms, to address weak demand, boost employment and raise standards of living,” adding, “While the US economy is on a solid path, the global recovery remains uneven and downside risks have become more pronounced due in large part to a continued shortfall in aggregate demand.” Whether the shortfall in aggregate demand is permanent phenomena remains an open question.

Creditors are clearly in a better position to boost demand through investment; debtors are less able to do this. However, investors frequently find it difficult to distinguish the strong credits from the weaker ones. Commodity exporters are a classic case in point. Hypothetically, what would be the official creditor position of someone who has a year’s salary in their bank but many years’ salary worth of valuable commodities buried in their backyard? Technically it would just be the one year’s salary - which is the equivalent to how we all traditionally measure countries’ government debts; but there’s an obvious omission in such accounting methods. For a number of governments with vast oil reserves who are facing moderate deficits, concerns for their creditworthiness have grown to levels which perhaps have yet to fully account for the funds they could raise should they decide to privatise such assets or sell rights to such deposits.

To continue our illustration, clearly someone with money in their account is, in terms of credit risk, a more attractive lending proposition compared to someone who already has unserviceable and increasing debts, even if their current expenditure is a fraction higher than their recently diminished income. Such is the rationale for why we deem the Net Foreign Asset position of whole countries as an important metric to consider when evaluating a country's future ability to pay - its level and trend can offer an early warning sign to debtholders. Yet more investor protection exists if a country has proven subterranean commodities worth many multiples more than their Sovereign Wealth Fund assets?

Take Saudi Arabia as an example; with the drop in recent and forecasted oil prices the country is expected to run sustained deficits for the next few years. Current estimates see those drawdowns slowing as early as next year, partly due to rising oil forecasts but also due to ongoing domestic reforms. The Government continues to have a large creditor buffer (equivalent to around a year’s GDP) which it has accumulated over the past decade and the country as a whole has Net Foreign Assets of 170% of GDP according to our estimates. Also historically they proven themselves able to weather prolonged low oil prices. But a potential IPO of Saudi Aramco would bring oil revenues forward causing an immediate jump in such statistics as the existing government’s net credit. Obviously this is a stock and flow equation and a part sale now would mean sustained lower revenues in the future but with around 1,000 barrels of proven reserves per capita in addition to natural gas reserves, even at current oil prices, the authorities have at least half a million dollars of assets per inhabitant in financial flexibility. As such there is significantly less cause for immediate concern and integral quasi-sovereign issues like Saudi Electricity, although on negative review by some rating agencies and susceptible to downgrade, offer attractive spreads of 300 over Treasuries for A1 rated paper.