Global saving deficit and financing infrastructure in BRIC economies

Center for Macroeconomic Analysis and Short-term Forecasting, Moscow, Russia1

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Global saving deficit and financing infrastructure in

BRIC economies


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1. The World Economy 2012: New Cycle Means

New Risks?


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1. The World Economy 2012: New Cycle Means New Risks? 1. The World Economy 2012: New Cycle Means New Risks?

Developed economies for a year stand on the brink of new economic cycle

But the progress falters under the burden of government and financial sector problems, provoking risk aversion for investors

Most likely, the cycle will proceed as new, and these problems will stay unresolved, bound to turn up later


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While unsure, the recovery in developed countries is slowly proceeding, the US heading headfirst and both Japan and EA lagging

1.1. Industrial production, 01/01/2000=100

1.2. Unemployment rate, %

Source: IMF International financial statistics Source: IMF International financial statistics


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1.6. Total money base of largest developed countries, US$ tn

Source: IMF

The money base central banks issued most likely would stay even as the credit multiplier increases


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US EA Japan growth rate % (right axis)


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So far, the multiplier stays very low, though some increase in US is visible

1.3. EA MB and M3 growth rates, % yoy 1.4. MB and M2 growth rates, % yoy

Source: ECB


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Source: Fed

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М3 зоны евро Денежная база зоны евроEAM3

EAM3EAMB

EAMB


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Corporate debt ratios for both US and EA are at 10-15-year lows

Trade balance stabilization and strong personal consumption in the US in 2011 suggest grounds for new growth cycle

Rates of growth in China won’t skyrocket as the government finishes deflating bubble, there are problems with shifting to consumption-based growth, but “low” still means 8+% for China (and not to forget expected US growth)



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1.6. EBITDA for main US industries, 2000 prices, 31/03/00=100

Source: US Census Bureau

EBITDA for US has recovered, for EA lags behind but not totally subdued


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Durable goods production Manufacturing Mining (right axis)


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1.7. US corporate debt, 2000 prices, 31/03/00=100

Source : US Census Bureau

…as the debt levels grow steadily…


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Durable goods production Manufacturing Mining (right axis)


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1.8. Debt to EBITDA, main US industries


Debt/EBITDA stays at 2000 lows.


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Durable goods production Mining Manufacturing


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1.10. Profit/Sales in US industries


While profitability is already at expansion phase levels….


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Durable goods production Mining Manufacturing

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1.9. US household debt service ratios, % of income

Source: Fed

…household DSR has not reached the bottom


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1.10. Delinquent credit in US banks, % of assets

And the 2008 wall of delinquencies is basically overcome


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2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

Total business loans consumer loans loans secured by real estate

Source: Fed


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1.11. Loan to deposit ratio

Source: Fed, ECB

At the same time, credit activity at US and EA banks is clearly subdued


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US EA


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1.12. Credit portfolio as a share of total assets

Liquid assets are preferred to credits as risk aversion is strong


Source: Fed, ECB

0.50

0.55

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1.13. Capacity utilization vs unemployment, %


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US Capacity utilizationEuro area capacity utilization survey (quarterly, intrapolated)US Unemployment SA inverted, right axisEU-27 unemployment inverted, right axis

Source: Fed, ECB


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1.14. Baltic Dry and Harpex indices

While dry bulk costs were untouched by the slowdown of 2011, container costs were sharply down


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Baltic Dry HARPEX (container costs, right axis)Source: Baltic Exchange, Harpers


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GDP yoyGDP yoy, % , % UNUN IMFIMF WBWB 20112011

World (PPP)World (PPP) 3.6 3.3 3.4 3.8

USUS 1.5 1.8 2.2 1.7

EAEA 0.4 -0.5 -0.3 1.6

JapanJapan 2.0 1.7 1.9 -0.9

ChinaChina 8.7 8.2 8.4 9.2

IndiaIndia 7.7 7.0 6.5 7.5

BrazilBrazil 2.7 3.0 3.4 2.9

RussiaRussia 3.9 3.3 3.5 4.1

Oil, $/bOil, $/b 100.0 99.1 98.2 104.2

1.15. Main economic forecasts for 2012

Source: UN, IMF, WB


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2. Global savings: from “glut” to deficit?


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Three arguments for less saving in the long-term: world population ageing, esp. in developed countries,

increases retired-to-workers ratio; losses the pension savings took after the financial crisis

of 2008 and probable sovereign debt crises of 2008-2011 forgone investment gains, e.g. negative real rates as a

consequence of ZIRP+QE in reserve currencies

One argument for less money going to emerging markets: developed world needs more money to refinance

growing public debt and restart new credit cycle

2. Global savings: from “glut” to deficit?2. Global savings: from “glut” to deficit?


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Мир

2.1. Retired-to-working ratio, world, %


World population ageing, esp. in developed countries, increases retired-to-workers ratio

Source: UN


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2.2. Global liquid financial asset structure, %

2006 2010

$ tn % $ tn %

Equity market cap 55 30.7 54 25.6

Sovereign debt 28 15.6 41 19.4

Financial institutions debt 35 19.6 42 19.9

Nonfinancial institutions debt 7 3.9 10 4.7

Securitised credit 14 7.8 15 7.1

Nonsecuritised credit 40 22.3 49 23.2

Total 179 100.0 211 100.0

Source: MGI.


Losses the pension savings took after the financial crisis of 2008 and probable sovereign debt crises of 2008-2011


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“What incentive does a US bank have to extend maturity to a two- or three-year term when Treasury rates at that level of the curve are below the 25 basis points available to them overnight from the Fed?

What incentive does PIMCO or banks have to buy five-year Treasuries at 75bp when the maximum upside capital gain is 2 per cent of par and the downside substantially more?”

- Bill Gross, PIMCO



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As more and more sovereign debt in developed countries needs refinancing, emerging markets will experience outflow of capital sourced in developed markets, i.e. “home bias” for the debt will strengthen

This means governments should concentrate on stimulating the potential of internal savings rather than seeking overseas financing, especially financing for the emerging markets



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2.3. Financing needs of developed countries in 2012,

$ bn

2.4. Financing needs of developed countries in 2012,

% GDP

Source: IMF, Fiscal Monitor 2011


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51

54

324

389

538

359

471

601

383

0 100 200 300 400 500 600

Ireland

Greece

Portugal

Spain

United Kingdom

Germany

Italy

France

Japan*

United States*

*10 млрд. долл

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11

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21

59

30

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0 5 10 15 20 25 30 35 40 45 50 55 60

Ireland

Greece

Portugal

Spain

United Kingdom

Germany

Italy

France

Japan*

United States*

*10 млрд.


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Gross national Gross national savingsaving

Gross fixed capital Gross fixed capital formationformation

CompareCompare to: to: FDI*FDI*

Brazil 19.3 18.1 2.2

Russia 28.0 20.6 3.5

India 34.2 31.7 2.3

China 52.0 41.9 3.7

Compare to: EU 21.3 20.4 4.1

2.5. Saving and investment rates avg. 2006-2010, % GDP

Not all BRIC countries have internal resources for investment, thus more investment in infrastructure may mean less investment elsewhere except for the FDI increase*not directly comparable as FDI is part of balance of payments, not national accounts data


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Can FDI help? Many studies suggest FDI are the source of quality governance and tech transfer, not so much a financing tool

For 2006-2010, average yearly FDI inflow into BRIC countries was less than 3% GDP or less than 10% of investment

Two differing systems of attracting the funds to long-term investment (including infrastructure) are widespread (e.g. Walsh, Park and Yu 2011), so-called centralized and decentralized



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Centralized system is either government investment or its advanced version, directed loan-based: used in China with public banks+PBC, in Brazil with

BNDES (esp.after PAC)+pensions

Centralized form reqs: healthy budget (little evidence of investment in

infrastructure to create short-term budget net gains) concentrated banking system

+ creating off-budget development institutions not tied by system-wide banking regulations, like BNDES or VEB

some insulation from external shocks as banking system becomes distorted and vulnerable as it takes on risks connected to directed long-term loans (infrastructure)



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Decentralized is based on a mature market for long-term debt and equity instruments Increasingly used in China (highway SPV), much less for

Brazil, in the debt part – basic for Chile and Korea

Decentralized long-term financing reqs: Large long-term internal funds (i.e. fully-funded pension

scheme or the like) Institutional environment for long-term open market financing (i.e. market-makers + risk management regulatory practices)

Institutional environment for long-term open market financing (i.e. market-makers + risk management regulatory practices)

Framework for private involvement (PPP, concessions etc.)



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3. The case of Russia – a path to decentralized

financing model


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Gross fixed capital formation rate is relatively low (20+% GDP) for an emerging economy

Significant difference (8% GDP) between gross savings and investment

Banking system has very small share of long-term deposits, almost all are redeemable at notice

Bond market has plenty of long-term bonds, but most long-term have embedded call after 2 years, making them de facto lower-medium-term instead of long-term

3. The case of Russia3. The case of Russia


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Currently, the system is highly centralized: main infrastructure investment is budget-sourced development institution (VEB) is the primary non-budget

financing source almost no long-term debt market most pension savings are legislatively locked into low-

yield government bonds banking system is deconcentrated (CR5=50%) while

syndication market is underdeveloped rates are unstable due to exchange-rate targeting policy



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The way to decentralized system is unlocking pension savings and the funds dispersed inside banking system to engage in financing of large long-term projects

Market for long-term lending needs to be created: VEB (DI) should co-finance market-makers both for the long-

term bond market and standardised syndicated loan market The industry standards (lex mercatoria) need to be developed:

• Self-regulating organizations (like LMA/LSTA/ APLMA), debt covenants

• Market makers are instrumental in creating the market



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As the market makers emerge and long-term bond and credit syndication secondary markets (e.g. by using credit mutuals) are made liquid:

– money managers (including VEB) may be allowed to use mandatory pension savings to ramp up the markets for syndication and long-term bonds

The experience is based on case studies of financial market developments by EBRD (in CEE), KfW (in Germany), BNDES (in Brazil), NAFIN (in Mexico)

Solntsev et al. (2011) estimate this will lead to 100% credit syndication market growth in Russia to $25 bn a year in 3 years, at the cost of $15 bn (0.2% GDP a year) in credits, LT bond stimulus is comparable



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Conclusions


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The economy in 2012 looks to the upside and ZIRP is on the side of long-term international investment in emerging markets

However, the long-term prospects are more gloomy: the global savings glut could turn into deficit in

10-15 years developed markets will consistently need more

long-term funds to fix sovereign debt problems than today, ergo home bias for the debt markets

Thus, perspectives of international capital going into the infrastructure are not impressive

ConclusionsConclusions


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However important, FDI flows and international financing are insufficient to finance long-term investment in developing countries

Thus, developing countries should finance long-term development, including infrastructure, out of internal sources

The potential for increase in investment is present almost in all BRIC countries



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Most investment in long-term investment projects in BRIC is centralized via development institutions, government funds or pet banking systems

pension savings are utilized in China and Brazil, much less in India and Russia

elements of decentralized model are present in all BRIC countries, but all of them lack a complete set of elements

the decentralized model is an infrastructure in itself, and thus is a long-term prospect to build


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Global saving deficit and financing infrastructure in BRIC economies

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