War and Economy

By Luis Fierro Carrion (*)

Twitter: https://twitter.com/Luis_Fierro_C

The Russian invasion of Ukraine has exacted a heavy human toll, with tens of thousands of Ukrainian civilians killed, apart from some 20,000 Russian troops (as of April 13, according to Ukrainian sources). In the besieged city of Mariupol alone, the Mayor indicated that more than 20,000 civilians could have been killed. The number of injured could reach more than 100,000, and there are more than 11 million displaced people (of which about 5 million have left Ukraine).

Apart from this, the war has brought considerable economic losses, with the destruction of homes, infrastructure, roads, etc. It is estimated that more than USD 100 billion worth of infrastructure has been destroyed in Ukraine. The World Bank estimates that Ukraine's Gross Domestic Product (GDP) could fall by 45% as a result of the war, due to the collapse of production and exports in much of its territory. The poverty rate could rise from 1.8% of the population to about a third.

The Russian economy, subject to severe sanctions by NATO countries and other allies (Japan, South Korea, Australia, etc.), could fall by 11.2% in 2022, according to the World Bank.

If the war is prolonged and escalated, the drop in GDP could reach 75% in the case of Ukraine and 20% in the case of Russia.

Other countries severely affected will be the neighbors of Ukraine and Russia, including Belarus (-6 %) and Moldova (countries in which Russian troops also operate, in the former at the invitation of its dictator, in the latter due to the occupation of the Transnistria area). 

The growth projection for Central Europe (Bulgaria, Croatia, Hungary, Poland and Romania) will be reduced from 4.7% to 3.5%, due to the influx of refugees, the increase in commodity prices and the deterioration of business confidence. Refugee influx fluctuates between 4% of the pre-war population (Hungary) to 15% in the case of Moldova; Almost two and a half million people have entered Poland, equivalent to 6% of the pre-war population.

At the global level, it is estimated that the GDP growth rate will fall from 4% to 3%, mainly as a result of the effects on world trade, and the rise in the prices of fuel and food.

Price increases have been especially pronounced for commodities in which Russia and Ukraine are key exporters, including: natural gas, coal, oil, fertilizers, wheat, aluminum, iron ore and palladium.

In Latin America and the Caribbean, the Inter-American Development Bank (IDB) estimates that the growth rate will fall by one point in 2022, from 2.1% to 1.2%, and there could be a contraction of 0.4 % in 2023.

The growth scenarios for each country depend on various factors, from their commercial links with Russia and Ukraine, to their level of indebtedness; but in general, the IDB expects it to decrease compared to the pre-war scenario.

The high price of hydrocarbons and cereals will benefit the countries that export these products, while the importers, particularly those in Central America and the Caribbean, will suffer higher inflation.

Russia and Ukraine are important markets for several of the products that Latin America and the Caribbean exports, such as dairy products and meat (Southern Cone), fruits (for example, bananas, in the case of Ecuador) and flowers.

Around 20% of the region's total fertilizer imports come from Russia, as do more than 5% of iron and steel imports.

Another collateral effect will be the rise in international interest rates, as a result of the higher inflation faced by countries such as the United States and Europe.

In the case of Ecuador, the impacts will be contradictory: a positive effect due to the rise in the price of oil, a negative effect due to the increase in the price of fertilizers and the closure of the markets for bananas and flowers. The World Bank increased its 2022 growth forecast to 4.3%  (the second fastest growing country in Latin America, after Colombia).

But uncertainty will be the global and regional tone, subject to how the Russian invasion and the aftermath of the COVID-19 pandemic evolve.

(*) Translation of my column published in Diario "El Universo" on April 15, 2022'

https://www.eluniverso.com/opinion/columnistas/la-guerra-y-la-economia-nota/

Russia's flagship warship the Moskva has sunk

A successful bond restructuring in Ecuador

By Luis Fierro  (*)

The government of Ecuador announced on August 3^rd that it had obtained the consent (favorable “votes”) of 97.85% of the holders of external debt bonds in favor of a bond swap, much higher than the required 66 % (95.42% in the case of the 2024 bonds, which required 75%). The term was extended until August 7^th to allow those who had not given their consent to join the exchange.

This is undoubtedly excellent news for Ecuador, and the team of Minister Richard Martínez, as well as the country's financial and legal advisers, should be congratulated.

Through the agreement, the series of 10 bonds (originally maturing between 2022 and 2030) will be exchanged for three new bonds, which mature in 2030, 2035 and 2040 (the repayments of capital are distributed in five years, in each case).

There will be an immediate reduction in the amount of principal owed by $ 1.54 billion (a 9% decrease from the original amount of $ 17,375 million), but it is estimated that the arrangement will allow a reduction in net present value (NPV) of 41,7% (based on a discount rate of 10 % per year).

This saving is produced mainly by the reduction of interest rates from an average of 9.2% per year to 5.3% per year, to which is added the aforementioned 9 % reduction of the principal; and the extension of the terms (from an average of 6.1 years to 12.7 years). It also reflects the postponement of the payment of the suspended interest payments in the March-August period ($ 818 million), which will be paid with interest-free bonds between 2026 and 2030.

The discount rate is the opportunity cost of money: you are indifferent to receiving 90 now or 100 a year from now. It is related to the average return on capital in an economy. Some analysts prefer to use a higher rate (12%), although the World Bank uses a discount rate of 5% for the cost-benefit analysis of its projects (currently there are few legal activities that guarantee an annual return greater than 5%).

Two investment funds, GMO and Contrarian Capital, filed a lawsuit in a court in the Southern District of New York, arguing that the government's proposal was coercive. The two funds were part of a "Steering Committee" of holders who claimed to represent about 25% of the bonds, which presented a proposal that was less advantageous to Ecuador. But after Judge Caproni dismissed their arguments and did not give way to a "temporary restraining order" to stop the vote, even the two plaintiff funds accepted Ecuador's initial offer.

All this occurred, in addition, in the midst of the confrontation between the government of Argentina and its bondholders. The Argentine government offered a 47% reduction in net present value, and the bondholders counter-offered a 44% reduction. On August 4 (one day after Ecuador) an agreement was announced for a 45.2% reduction in VPN (using the same 10% discount rate).

The lower discount in the case of Ecuador could be attributed to the fact that the IMF had not considered the country's external debt unsustainable, unlike Argentina.

It is important to clarify is that the restructuring of the bonds will not imply the inflow of new funds to the country. It does reduce the debt service burden, by $ 1,361 million in 2020, and a total of $ 10 billion through 2025 (kicking forward the bulk of amortizations).

But it does not contribute in any other way to reducing the fiscal deficit or closing the financing gap, estimated at $ 4 billion. For this, a new program is being negotiated with the IMF, the same one that will take into account the reduction of the debt in bonds, as well as the fiscal consolidation efforts already made; but will likely seek a greater deficit reduction and structural reforms.

New $ 2.4 billion loans from Chinese banks have also been announced; as well as postponing the payment of the principal of $417 million that was due in 2020-21. In the case of the bilateral debt with China, a reduction in the principal and the interest rate of the current loans is not expected, although the interest rate of new loans is expected to be lower. The G-7 has urged China to join the debt relief efforts associated to the global pandemic under the Paris Club (China does not belong to this creditor forum).

It would be unfortunate if the next government returned to increasing the debt, as the Correa and Moreno governments did. Correa quadrupled the public debt (going from $ 10,234 million in December 2009 to $ 41,894 million in May 2017). Part of the blame also falls to the investors, who until last year lent money to Ecuador given the high expected rate of return, despite the risk of being a country that competes with Argentina and Venezuela for the world record of debt defaults.

(*) A shorter version of this note was published in Spanish in “Diario El Universo” on August 7^th.

https://www.eluniverso.com/opinion/2020/08/07/nota/7932633/reestructuracion-bonos

 

On the universal basic income (I prefer a minimum guaranteed income)

By Luis Fierro

With the COVID-19 pandemic, there have been calls to establish a universal basic income (UBI).

See, for example, this article by Guy Standing in The Economist:

https://www.economist.com/by-invitation/2020/05/20/guy-standing-on-how-lockdowns-make-the-case-for-a-basic-income

Andrew Yang also made it a centerpiece of his campaign for the Democratic nomination.

Here is my reaction:

1. I am in favor of a guaranteed minimum income, as it is applied in some European countries (France, Germany, and more recently, Spain).

2. This income should be given to those who earn less than the minimum income (which, in turn, should be less than the minimum wage - let’s say 70 % of the minimum wage). It should not be given “to all individuals, regardless of income”, as the article proposes.

3. I am more favorable to an “earned income credit” as applied in the United States, that provides an extra-income to low-income workers. This is better, as it creates incentives for working.

4. I am not in favor of increasing capital taxation (beyond reverting the Trump tax cuts).

5. I am in favor of a wealth tax (or equity tax), levied especially on those with a net worth above $1 million (excluding their residence). Though some decry the wealth tax as distorting, in fact it is applied in several “capitalist” countries (such as Norway, Switzerland, Netherlands and Spain). Many other countries, including the United States, have the “property tax”, focused on real estate, and which does NOT exclude the residence or properties below a certain threshold.

6. A wealth tax would compensate those workers who have lost their jobs due to automation (in many cases, increasing the wealth of the billionaires, such as Amazon’s Bezos).

7,  Even though I would benefit, I am not in favor of continuing to hand out "stimulus checks" to most of the population. It is much more important to extend the additional unemployment benefit, which should replace most of the pre-pandemic income.

8. Developing countries, such as Ecuador, cannot afford to provide a generous minimum guaranteed income (although Ecuador currently does provide a cash transfer of $60 to most low-income families). I would propose eliminating the fossil fuel subsidies altogether (they have been substantially reduced by the Correa and Moreno governments), and, in its place, increasing the cash transfer (Bono de Desarrollo Humano) and guaranteed minimum pension (even for those who did not contribute to the social security system). 

9. A carbon tax (a tax on greenhouse gas emissions) would be the best source to fund a minimum guaranteed income.

Here is an article by Paul Buchheit making a similar argument:

https://www.commondreams.org/views/2018/03/19/2-financial-wealth-tax-would-provide-12000-annual-stipend-every-american-household

Photo: Yuri Keegstra/Flickr/cc

Quarantine, Death and Reactivation

By Luis Fierro Carrión (*)

There is an etymological similarity between the Spanish (or Italian) words "quarantine" and "lent" (cuaresma).

For Christians, Lent is a 40-day period of penance, reflection, fasting, and abstinence, between Ash Wednesday and Holy Thursday.

Jews commemorate Passover, which was the liberation from slavery in Egypt and the survival of the 10 plagues, including the death of the firstborn, from which the Jews were saved by placing lamb blood on their doorsteps, to indicate their faith (the “Angel of Death” passed over those homes). Christians believe in the death and resurrection of Jesus.

These ceremonies are linked to pagan practices on death and rebirth of life, reflecting the passage from winter to spring in the Northern Hemisphere (Easter eggs and chocolate bunnies reflect this emphasis on fertility).

Quarantine refers to the 40-day isolation of people and property suspected of carrying the bubonic plague in Venice, during the 14th century pandemic (the worst pandemic in recorded history, in terms of percentage of the population that died).

In 2020, a forced quarantine of the population has been put into effect in many countries of the world, starting with China. In the case of Ecuador, these measures were taken as of March 12, with the suspension of classes, mass events and flight restrictions; and a curfew from March 17. We have already had more than 40 days of these restrictions (as of May 4, a system of "traffic lights" was established by municipalities, but as of May 7^th all remained in "red", or full lockdown and curfew).

Despite the restrictions, there were a large number of excess deaths, most of which can be attributed to COVID-19 (perhaps a fraction correspond to people with other illnesses or accidents who did not have access to hospitals, especially in the provinces of Guayas and Santa Elena).

Between January and April, in the province of Guayas there were 10,655 deaths above the average in the same period of 2018-19. The following was Santa Elena, with 613 excess deaths; Manabi 385; Pichincha 308; and El Oro 146; in Santo Domingo de los Tsachilas, Pastaza and Galapagos there were 2-4 excess deaths. In the other provinces, the number of deaths decreased, probably due to fewer deaths from accidents and homicides (for which reason it is also possible that the figure attributable to COVID-19 exceeds 12 thousand).

Considering a case fatality rate between 1 and 2%, this would mean that there have already been more than 600,000 cases of COVID-19 in Ecuador (even with a high case fatality rate of 3%, taking into account the poor health infrastructure , we would have more than 400,000 cases). Considering that until May 6 only 81 thousand tests had been taken, the official figures for COVID-19 cases and deaths have scant meaning.

The economic impact of the quarantine will be devastating. According to Econ. María de la Paz Vela in a seminar organized by the consulting firm Multiplica and Revista Gestión, Ecuador's GDP could fall by 7% (I estimate between 11 and 15%, based on a prolonged recession that would also continue to impact the price of oil and other exports). Adequate employment will fall from 38.8% to 35.4%, while open unemployment would increase to 3.8% to 9%. The poverty rate, which had already risen from 22% in 2017 to 25% in December, would now rise to 35% (reversing a decade of progress).

Tax revenue would drop by $ 7 billion; the fiscal deficit would triple to $ 8,652 million; financing requirements would reach $ 17 billion. This makes unavoidable a process to renegotiate the external debt (with private and bilateral creditors), and rollover the internal public debt. The government has proposed a “Humanitarian Law” to raise funds from people with the higher incomes, and from companies with profits of more than $ 1 million, but the fate of the law in the National Assembly seems uncertain.

Exports would fall by 26%, but imports would only decrease by 13%. Remittances from emigrants would drop by 9%. A reduction of the international reserves is estimated at $ 1 billion.

The IMF approved a quick financing loan for $ 663 million; The IDB has approved $ 700 million, and $ 500 million is expected from the World Bank [plus a $ 6 million grant] and $ 300 million from CAF [later increased to $400 million]. An announced Chinese loan (of up to $2 billion) has not yet crystallized.

Resources will be required for economic reactivation. The creation of a guarantee fund for bank loans to SMEs has been proposed, with resources from IDB Invest, IFC, CAF, EIB and other entities.

A gradual reactivation requires making way for Internet sales, home delivery or pick up at the door of stores, and home delivery of food and prepared food.

(*) This is the English translation of an opinion column published on May 11th in Diario El Universo of Ecuador:  

https://www.eluniverso.com/opinion/2020/05/11/nota/7837575/cuarentena-muerte-reactivacion

La recesión que se viene (y ya llegó a 20 países)

Por Luis Fierro Carrión (*)

Hay varios indicadores que han encendido ya una alarma roja de que se viene una recesión económica mundial.

Para comenzar, existen ya 9 países que se encuentran en recesión, entre ellos el Ecuador (si nos atenemos a los pronósticos del FMI, de una caída de 0.5 % en 2019).

Según el estudio "Perspectivas Económicas Mundiales" del Banco Mundial, los siguientes países tendrán una contracción económica en el 2019:

Nicaragua                       -5.0
Irán                                 -4.5
Zimbabwe                      -3.1
Guinea Ecuatorial        -2.2
Sudán                             -1.9
Argentina                      -1.2
Turquía                          -1.0
Ecuador                           0.0 (-0.5 % para el FMI)

A ellos se suma Venezuela, para quien ni siquiera hace un pronostico, pero que se estima que continuará su colapso económico (el FMI estima que la economía venezolana se contraerá en 25 % en 2019, sumando un colapso del 60 % desde 2014). 

Si tomamos en cuenta el PIB per cápita, habría que sumar otra decena de países: Haití, Liberia, Trinidad y Tobago, Líbano, Namibia, Angola, Sudáfrica, Swazilandia o Eswatini, Rusia y Omán.

Varios de los países mencionados atraviesan un fuerte conflicto interno (Venezuela, Nicaragua, Sudan), o enfrentan sanciones internacionales (Irán, Rusia, Venezuela).

Pero otros se ven afectados por la caída de precios de productos primarios de exportación, tal como el petróleo (que afecta a Irán, Sudán, Ecuador, Trinidad y Tobago, Angola, Rusia, entre otros).

El pronóstico global del Banco Mundial es de un crecimiento del 2.6 %, pero esto refleja especialmente las altas tasas de crecimiento económico en China (6.2 %), India (7.5 %) y otros países del Sur de Asia (6.9 %).  Hay otras regiones en las cuales el crecimiento promedio es mínimo:  Medio Oriente y el Norte de África (1.3 %; contracción en términos per cápita), Europa y Asia Central (1.6 %), y América Latina y el Caribe (1.7 %, aunque este promedio excluye a Venezuela - de incluirse, estaríamos ya hablando de un estancamiento).

Considerando que la tasa de crecimiento de la población global es de 1.2 %, el crecimiento mundial per cápita seria de apenas 1.4 %.

En el caso de Europa, la proyección de la Comisión Europea para Italia es de un crecimiento de apenas 0.1 %, y que en Alemania caería a 0.5 %.  Otros indicadores (confianza empresarial, producción industrial) señalan que en estos países ya se inicio una recesión. 

Según el Banco Mundial, "El comercio internacional y la inversión han sido inferiores a lo previsto al inicio del año, y la actividad económica en las principales economías avanzadas, en particular en la zona del euro, y en algunos grandes mercados emergentes y economías en desarrollo ha sido menor de lo que se anticipaba." (http://www.bancomundial.org/es/news/immersive-story/2019/06/04/the-global-economy-heightened-tensions-subdued-growth).

Un indicador de que se viene la recesión es la "inversión de los rendimientos" de los bonos, cuando los bonos de largo plazo tienen una tasa menor a los de menor plazo. Este fenómeno ha llevado a Rabobank a estimar la probabilidad de recesión en 83 %, el nivel mas alto registrado desde 1985 (incluso mayor al registrado antes de las ultimas tres recesiones).

Entre otros factores, se atribuye la posible recesión a:

1.  Caída del comercio internacional, como resultado de las "guerras comerciales" lanzadas por Trump (y la incertidumbre generada por sus políticas erráticas). 

2. Acumulación de deuda, y aumento de la morosidad de los créditos.

3. Impacto de la caída de los precios de productos primarios en países exportadores.

4. Sobre-valoración de mercados de valores frente a promedios históricos (al igual que otros activos, como las viviendas). 

5. Impacto de desastres naturales, en muchos casos exacerbados por el cambio climático (inundaciones, sequías, ciclones, etc.)

6. En alguna medida, el simple hecho de que ciclicamente ya toca una recesión, tras una década de expansión.

"Motivos de particular preocupación son la disminución del crecimiento del comercio mundial, que llegaría al nivel más bajo desde la crisis financiera hace una década, y la caída de la confianza empresarial", dice el mismo estudio del Banco Mundial.

Continua afirmando que "Los elevados niveles de deuda son cada vez más un motivo de preocupación. Muchas economías emergentes y en desarrollo se han endeudado excesivamente y sus reducciones de la deuda pública conseguidas con tanta dificultad antes de la crisis financiera mundial se han revertido. La deuda de las economías emergentes y en desarrollo ha aumentado un promedio de 15 puntos porcentuales, hasta llegar al 51 % del PIB en 2018" (cabe anotar que el endeudamiento publico también ha aumentado en Ecuador, hasta llegar al 49 % del PIB).

Un tema de preocupación, tanto en los países avanzados como en los países en desarrollo, es el menor espacio fiscal y monetario para enfrentar una futura recesión.  Las tasas de interés en los países avanzados ya se encuentra en niveles muy bajos (incluso negativa en algunos países); y en varios países hay elevados niveles de déficit y endeudamiento, que complicarían llevar adelante políticas expansivas.

(*) Economista de la PUCE, posgrados de la Universidad de Oregon y la Universidad de Texas en Austin. Fue funcionario del Banco Interamericano de Desarrollo (BID) de 1997 a 2013, y representante del Ecuador en el Directorio del FMI en 2006. Asesor en temas de financiamiento climático y para el desarrollo. Estas son mis opiniones personales, que no reflejan las de institución alguna.

The slowdown of the Chinese economy

A version of this article was published in Spanish in "Revista Gestión" (http://www.revistagestion.ec/).

The slowdown of the Chinese economy

By Luis Fierro Carrión

In recent months, alarm bells have been going off about the likely slowdown of the Chinese economy, which could have negative effects for the world economy, and in particular for commodity exporters such as Ecuador and other Latin American countries.

During 33 years (1979-2012), the average annual growth rate of China was close to 10 %, and it became the second largest economy in the world.  The GDP per capita increased from $250 in 1980 (measured in purchasing power parity) to $9,185 in 2012 - that is, it had a 36-fold increase!

This extraordinary growth reflected diverse trends:  the reincorporation of China into the world market; the capitalist development (within a Communist political regime); urbanization; industrialization; opening towards foreign direct investment and joint ventures, etc.  There were some particular characteristics of the hybrid Chinese model, such as the expansion of state-owned enterprises (SOE), financed by the equally state-owned development banks.

But in part this accelerated growth simply reflected starting off at such a low base, after many decades of economic stagnation, "cultural revolution", state ownership of the means of production, and military conflicts.

The official growth rate target for 2013 is 7.5 %, but it is likely that this figure will not be met.  The longer term prospects for the future are even less auspicious, as economists believe that China is entering into what is know as the "middle income growth trap".

The rapid urbanization process seems to have reached excessive levels, with high urban rates of pollution:  16 of the 20 most contaminated cities of the world are located in China, and the life expectancy in Northeastern China has started to decrease as a consequence of respiratory and other illnesses associated with pollution.

Workers are starting to demand higher salaries and better working conditions, which will make a model based on cheap labor untenable.  Investment - that is as high as 50 % of GDP - is facing decreasing returns, as the labor surplus is falling.  The Chinese stock market index (SSEA) has fallen by 8 % since December 2012.  The state-owned financial system is facing increasing disequilibrium   And the population is ageing, and growing at a slower rate (with the added problem of having more males than females).

The slowdown in China has already had a negative effect on the prices of commodities.  The price of metal products, for example, has fallen by 6.5 % thus far in 2013, and the price of gold by 26.2 %.  This has affected commodity producing countries, such as Australia, Brazil, Peru and Chile; and it could also affect oil exporters, if the same trend starts to be felt in the oil market (the price of the West Texas Intermediate benchmark has fallen by 7.9 % in the month to November 12, although it is still up for the year).

What can countries such as Ecuador do to confront the Chinese slowdown?  Diversify its productive matrix and its commercial partners; depend less on commodities, and more on the increase of productivity of manufacture and services; depend less, as well, on Chinese financing, which will probably become less available and more expensive as China experiences growing economic and financial difficulties.