David James Connolly
World Risk Developments November 2021
World—Economic growth will be constrained by supply into 2022
Persistent global supply chain disruptions are creating shortages of components and goods, and volatile raw materials prices, denting the global recovery. High shipping costs and global port congestion are placing additional pressure on Australian importers and exporters. Despite some recent easing, bulk shipping freight indices remain double the levels of this time last year (Chart). Even at these rates, on-time delivery is rare. Container ports in Southern California reported a record 111 ships waiting to berth this month, up from a pre-pandemic record of 17 ships. One Australian port terminal reported just 10% of vessels arriving in their designated berth windows in FY2021. Some exporters are struggling to meet their contractual obligations, while others are being squeezed out altogether, according to the ACCC.
These disruptions are partly due to an unprecedented bounce in global demand for consumer goods as economies recover from the impacts of COVID-19, and as consumers have had reduced opportunities to spend on services. The demand for goods has been exacerbated by fiscal and monetary fiscal stimulus, and in some cases elevated household savings. At the same time, supply is being hampered by factory and port closures amid COVID-19 outbreaks, new distancing and quarantine requirements, and labour shortages. This demand and supply mismatch is exacerbated by the relatively little slack built into the system. Complex and decentralised cross-border supply chains and shipping movements normally run lean and just-in-time, thereby aiming to maximise efficiency.
As such, in contrast to the aftermath of the GFC, the current global economic recovery is being constrained by supply instead of demand. These headwinds should begin to ease with increased vaccine coverage and new COVID-19 treatments. Likewise, a withdrawal of fiscal stimulus and redistribution of consumer spending from goods to services will likely ease pressure on global logistics demand. An investment boost in production capacity should eventually translate into more capacity and higher productivity. However, significant risks remain surrounding the path of COVID-19, global financing conditions and continued fiscal support.
Emerging markets—Australia’s major export markets recovering, but risks remain high
The IMF expects economic activity will return to pre-pandemic levels for many emerging markets (EMs) in 2022, supported by progress in COVID-19 vaccination. But growth will decelerate next year, and the recovery will remain uneven. High commodity prices will support some EMs, but those reliant on tourism and functioning global supply chains will take longer to recover. The global recovery is also highly vulnerable to future shocks, including from new variants of COVID-19. The pace of vaccine rollouts, vaccine efficacy against future strains, the ability of countries to increase vaccine coverage and maintain fiscal support will be important in determining the pace and timing of the recovery.
Debt repayment risks will remain high as external financing conditions tighten, particularly for governments reliant on foreign currency borrowing. Although the IMF expects inflation to moderate in 2022 as current supply disruptions ease, sticky food and energy costs could lead to more aggressive monetary tightening that undermines growth and debt sustainability. The COVID-induced deterioration in public finances leaves limited space to further stimulate many economies. Muted economic momentum and adverse financial conditions may also lead to the risk of political tensions and social unrest in some countries.
International institutions and financial market analysts, including the IMF, World Bank and S&P Global Ratings, use a range of indicators to assess the EMs most exposed to these risks, as shown in the table. Using data from external sources:
External position—what is the external debt and reserves position? Is the current account in deficit and how far has the currency deviated from its long term average?
Domestic position—how leveraged is the private and public sector?
Economic stability—what is the growth and inflation outlook? How reliant is the country on commodity exports, given the volatility in global commodity prices?
Policy effectiveness—how effective is the regulatory environment and how severe are political risks?
Market implied ratings—market risk premiums on foreign currency denominated bonds are used to give an indication of market risk appetite.
Based on these indicators, many EMs—including major Asia Pacific export markets such as Malaysia, Philippines and Indonesia—are less exposed. This reflects relatively robust external buffers, lower sovereign risk, effective macroeconomic policymaking and stronger growth prospects beyond the pandemic. Vietnam’s diverse economy, numerous free trade agreements, integration in global supply chains, competitiveness in production and stable political environment supports a robust economic outlook. China, Thailand and India have some capacity to withstand further global economic and financial volatility. But there are pockets of vulnerability in each country. For example, Thailand’s reliance on struggling tourism, China’s highly leveraged property sector, and India’s high public debt.
By contrast, more exposed countries start from a relatively weaker position to handle downside risks related to a resurgence of the COVID-19 pandemic, renewed global economic weakness, tighter global financing conditions and, in a few countries, political and social tensions.
Australia—Net zero emissions by 2050 would alter export profile
Around 85% of Australian exports last year went to countries that have set net zero emissions pledges (Chart). The International Energy Agency suggests that the most technically feasible, cost-effective and socially acceptable pathway to reach net zero by 2050 entails fossil fuels falling from 80% of total energy supply in 2020, to just over 20% in 2050. Indeed, over 40 countries pledged to eventually phase-out investment in new coal power generation domestically and internationally at the COP26 climate summit—including South Korea (13% of Australia’s coal exports in FY2021), Vietnam (5%), Netherlands (3%) and Indonesia (2%).
The scenario envisages energy efficiency, wind and solar providing around half of the emissions savings to 2030. They continue to deliver emissions reductions beyond 2030, but the period to 2050 sees increasing electrification, hydrogen use and deployment of carbon capture and storage, for which not all technologies are commercially available today. As such, annual energy sector investment, which averaged US$2.3 trillion globally in recent years, jumps to US$5 trillion by 2030. Greater investment and the transition to clean energy sources will create new export opportunities for Australia, given its plentiful resources, economic capability and trade connectivity. This includes supply of critical minerals into the clean energy supply chain, next generation green technologies (such as green hydrogen and carbon sequestration), renewable energy, and climate resilience products and services.
Australia—Exports resilient to geopolitical shocks
Australian exporters are on the frontline of trade disruptions resulting from increasing strategic competition. Over the past 18 months, China has implemented trade disruptive measures targeting over a dozen Australian agricultural and mineral products. This has limited access for many exporters to an attractive market offering sheer size and complementarity with Australia’s economy. Nevertheless, Australia’s export performance has been resilient. While record commodities prices and a bumper agricultural harvest have helped, many industries that experienced trade disruptions measures are successfully mitigating their losses.
New academic research explores how exporters were able to adapt to the demand shock of losing access to China’s market. Exporters pursued three strategies—reallocation, deflection, and transformation. Reallocation was the most common strategy and relatively seamless for bulk commodities with deep global markets. For instance, cotton was redirected to Bangladesh and Vietnam while certain mineral ores and concentrates were redirected to Europe and Japan (Chart). Strong demand and supply dynamics helped many industries in this process—essentially just a reordering of international trade flows. Deflection involved using alternative routes to market. For instance, cattle being redirected to Australian abattoirs that still had market access. Transformation involved changing production processes to sell unaffected products. For instance, barley farms planted canola instead.
Australia’s export resilience owes to the international competitiveness and agility of Australia’s export industries—underpinned by an open, dynamic and rules-based multilateral trading system. Australia continues to use the World Trade Organisation (WTO) to monitor and challenge trade practices where they do not align with members’ WTO obligations. To this end, Australia has initiated WTO dispute settlement proceedings challenging China’s measures concerning Australian barley and wine.
Emerging markets—Public spending cuts to weigh on economic growth
Large fiscal stimulus programs provided significant support to emerging market (EM) economies through the COVID-19 pandemic. With borrowing costs at historical lows, fiscal deficits have swelled and public debt has surged. More than two thirds of EM economies are in debt booms, according to the World Bank. On average, the increase in government debt is similar in magnitude to past debt accumulation periods, but has already lasted three years longer. History shows that about half of such debt booms were associated with financial crises either during the boom itself or in the two years after the end of the boom. Sovereign debt distress can spread to commercial banks, reflecting large bank holdings of government debt. Bank failures would damage the flow of credit to businesses and consumers and potentially further undermine government balance sheets if bail outs ensue.
Moving forward, many EMs are planning to make large spending cuts to consolidate public finances (Chart). This reduces risks of a financial crisis, but will likely weigh on near term GDP growth. Cutting back on support measures for households and businesses may hit consumption and investment. Reduced government spending could also raise political and social tensions in countries that are trying to reduce social inequalities. If inflation pressures prove more persistent, sovereign bond yields are likely to rise more sharply, increasing debt servicing costs and leaving even less room for public investment. The Institute of International Finance estimates fiscal consolidation will subtract 0.5 percentage points from EM GDP growth in 2022, after adding 1.2 percentage points in 2021.
The timing and pace of fiscal consolidation in EMs will depend on the spread of COVID-19 and the pace of vaccination. As a group, the IMF expects EM debt to remain about 15 percentage points higher in 2026 than pre-pandemic levels. Higher public debt for longer will make it challenging for many EMs to stimulate their economies if future shocks arise.
Indonesia—Reform momentum will help sustain economic recovery
Indonesia's parliament approved a new tax law in October, including raising the value-added tax to 11% from 10% in 2022, adding a new higher personal income bracket, implementing a carbon levy and freezing corporate tax rates at 22%. According to the Ministry of Finance, the new tax laws will generate IDR139 trillion in additional government revenue next year (about 1% of GDP) and support greater tax compliance and revenue growth over time. Indonesia’s sharp rise in public debt in the wake of the pandemic has made it even more important to raise government revenue, which as a share of GDP is substantially lower than most other emerging markets, including in Asia (Chart).
Boosting revenue will be key to supporting government spending on education, infrastructure, health, and social safety nets, thereby sustaining the economic recovery beyond the pandemic. Major reforms to remove bureaucratic and regulatory obstacles to investment, address labour market rigidities, make it easier to do business and spur foreign investment are advancing with an online system for risk-based business licensing. Government transformation plans in energy, infrastructure, health and education provide new opportunities for growth, trade and investment.
Effective implementation of policies could strengthen growth over time. The Indonesian economy is forecast to grow 4.8%-5.9% in 2022 buoyed by high commodity prices, low cost of capital and recovery from the pandemic. With COVID-19 under control for now and increasing economic reform, a growing Indonesian economy is positive for Australian exporters and investors. Indonesia is Australia’s 13th largest export partner, taking $7.1 billion of goods and services exports in 2020 (1.6% of total exports). Risks to the outlook include a commodity price reversal and rising global interest rates.
 Range of forecasts published by IMF, World Bank, OECD and ADB.
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David James Connolly