Panorama+Risque+Pays+Mars+2013 GB RVB(1)

8/12/2019 Panorama+Risque+Pays+Mars+2013 GB RVB(1)

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p a n o r a m aTHE COFACE ECONOMIC PUBLICATION

Spring 2013

Country Risk

In this Panorama, Coface highlights the radical transformation of risks inemerging countries. While traditional country risk (sovereign risk, externalvulnerability) has appreciably declined, three new risks are appearing andneed to be monitored:

The risk of political instability

This risk has grown as emerging country societies now have newdemands and increasingly the means of expressing them. So with thehelp of a renewed framework for assessing political risk, Coface candemonstrate that there is still a high risk of instability in countries in the

North African/Middle Eastern region. Venezuela, Russia, China, Nigeriaand Kazakhstan are facing significant pressures for change too.

The risk of creeping protectionism

This protectionism (financial but also trade) is the result of exogenousshocks which have affected emerging countries since 2008. It could, infuture, involve possible payment deadlines for importers but also morebarriers to entry for foreign businesses wanting to take advantage of theemerging economies vigorous domestic demand. Argentina, Russia and,to a lesser degree, India, are the countries to watch.

Banking credit risk

Bank credit has been very dynamic in the emerging countries, to the point

of forming real bubbles in the business and household credit markets.Coface points out the countries where there is a danger of such creditbooms. Some Asian emerging countries, buoyed by a very favourablegrowth dynamic, have credit markets that need watching. Chile, Turkey,Russia and Venezuela are also recording excessive credit growth.

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be modied at any time. The information, analyses and opinions contained in the document have been compiled on the basis of our understanding and interpretation of the discussions.

However Coface does not, under any circumstances, guarantee the accuracy, completeness or reality of the data contained in it. The information, analyses and opinions are provided

for information purposes and are only a supplement to information the reader may nd elsewhere. Coface has no results-based obligation, but an obligation of means and assumes no

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CONTENTS

/02 Transformation ofemerging country risk,

by Julien Marcilly et

Yves Zlotowski

/02 More polarised societies

/06 Economies more protected

/10 Excessive credit growth

FOCUS

/05 The Arab Spring two years on:

North Africa and the MiddleEast in constant turmoil,

by Pierre Paganelli

/07 Effects of capital controls:The example of Brazil,

by Axelle Fofana


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Lehman Brothers collapse and its consequences onadvanced economies have radically changed the country riskassessment. Risks associated with most advanced countrieshave distinctly increased, particularly because of the explo-sion of their public debt and their weak economic growth.Conversely, emerging countries have appeared less risky:their public debt has continued to decline despite the crisis,their foreign currency liquidity has remained very comfort-able and growth has been robust. Long-term trends confirmthis: the median potential growth rate of emerging eco-

nomies more than doubled from the 1970-1989 period to the1990-2007 one, rising from 1.5 to 3.5%. At the same time,the standard deviation of GDP growth fell from 4.25 to 3.25%.In other words, emerging country growth rates are nowstronger than they were, with less marked fluctuations.

But their strong fundamentals have not prevented economicactivity in the emerging countries from taking a temporaryhit due to the recession of the main advanced economies in2008-2009. This has had secondary effects on their growthvia different channels (trade, investment, banks). Confrontedwith this temporary shock, the reactions of the economies

and businesses of the emerging countries have been asdiverse as they have been many, but can nonetheless besummarised in a single word: resistance, although this resist-ance has taken several forms. Politically, the rise in unemploy-ment and increased inequality resulting from the crisis is oneof the triggers of the protest movements in the Middle Eastand North Africa. Economically, this resistance was at firstcharacterised by the rise of protectionism in various forms(for example trade protectionism, capital controls) and alsoresulted in far-reaching economic stimulus measures, mainly

through monetary policies. These measures then led to anexcessive credit growth in several emerging countries.

These recent changes underline the fact that the nature ofthe risks in the emerging countries has profoundly altered:traditional country risk (sovereign risk, external vulnerability)seems to have diminished, but new risks have appeared. Inthis Panorama we focus particularly on three of these newrisks, which result in part from the 2008-2009 global crisisand which are affecting emerging countries today: politicaland social risk, protectionism risk and credit bubble risk.

New grounds for political tension in emergingcountries

The wave of Arab revolutions has had a seismic effect on tra-ditional country risk. As a general rule, political upheavals arepoorly anticipated both by private observers and by academicresearchers. The regimes of Hosni Mubarak in Egypt (Presidentfrom 1981 to 2011) or of Zine El Abedine Ben Ali in Tunisia(Tunisian Head of State from 1987 to 2011), were consideredstable. Only the periods of succession were seen as potentiallyproblematic. Unrest could arise from endogenous changesin the political regime itself, but not from exogenous societalpressures.

The globalisation of protests has also caused surprise. Througha subtle process of imitation and representation, the Tunisianrevolution was followed by similar uprisings: Egypt, Libya andYemen have had their authoritarian regimes overthrown. More-over, demonstrations have been held in Bahrain, Morocco andJordan. But this wave goes beyond the Arab countries alone:in late December 2012, because of legislative elections,unprecedented protest movements developed in Russia. In

2011 and again in 2012, India was shaken by protests against

corruption and then against violence inflicted on women. In2012, South Africa was the scene of an unusually violent socialmovement in the mines. These various episodes of tensionseem dissimilar. However, these protests whether or not theyresult in revolutions express a form of social exasperation with

institutions under notice to account for their actions. Since theTunisian revolution, the societies of emerging countries havegiven voice to their latent concerns. What is it in this area thathas been ignored or underestimated by the framework forassessing country risk?

Political and institutional demands

The traditional social and economic indicators (unemployment,inequalities, inflation, GDP per capita) remain key variables.However, they do not entirely account for the reasons for theexasperation. It is interesting to note that the Egyptian rev-olution took place after years of record growth for Egypt (2) andthat Tunisia seemed to be a model of reform. The IMF acknowl-

edges in a recent publication(3)

that the strategy of separating

MORE POLARISED SOCIETIES(1)

(1) This section was written with the contribution of Guillaume Baqu.

(2) Between 2006 and 2008, the GDP annual average growth rate in Egypt was 7%.Between 1998 and 2008 Tunisian GDP per capita in dollars rose from 2336 to 4345 (source:IMF).

Transformation ofemerging country riskJulien Marcilly, Yves ZlotowskiFinalised on 6 March 2013


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political and economic reforms has not worked. Without a sys-tem of checks and balances by society, reforms and growthhave increased inequalities and sustained frustration. MarwanMuasher quotes the example of privatisations, which in a defi-cient system of governance, is tantamount to the grabbing of

public assets by an elite close to the government. All in all,reforms aimed at economic liberalisation promoted by inter-national institutions may have had devastating consequences,when they have not been accompanied by political reforms.

We also note that the slogans of the demonstrators often referto governance. The corruption issue is often cited (4). The youngTunisian vegetable seller, Mohammed Bouazizi, who set fire tohimself at Sidi Bouzid in December 2010, had had his scalesand his merchandise confiscated because he was in a prohibitedplace (the taxi rank outside the governors office). Mr Bouazizisact had a massive impact, firstly because of its tragic anddesperate nature, but also because it embodied a significantsituational deadlock frequently experienced by citizens. In thisparticular case, the barriers to entry handicapped the small-

scale entrepreneurship synonymous with survival. Society hadbecome incapable of allowing essential initiatives (economicor political) to develop and the obstacles were such that theycould only be overcome by a disruptive act.

The people of emerging countries are asking for political andinstitutional reforms allowing them greater political and eco-nomic participation. They are demanding democracy asdefined by Armatya Sen, that is to say a demand for participa-tion, for deliberation and for new aspirations to be taken intoaccount. It is therefore more far-reaching than the demand forformal elections and it is for this reason that this demand alsooccurs in countries which have democratic institutions, likeIndia. The obstacles to participation in political or economiclife are not the result merely of the absence of freedom of

speech. They are also sometimes the result of less formal invis-ible rules (for example, failure to safeguard property rights,corruption and invasive administrative harassment, barriersto the socio-economic and political development of women,of the young) which have become intolerable.

Profound cultural changes often ignored

If the demand for democracy (in the broad sense) hasbecome increasingly important in emerging countries, it isalso because societies have more means of instigating it.The depth of civil society in authoritarian political systemshas been underestimated. Economic prosperity plays adriving role by freeing citizens from the concerns of meresurvival. This evolution of needs is characterised by the

famous pyramid developed by the psychologist AbrahamMaslow, representing a hierarchy of individuals needs basedon the idea that these needs evolve as they are satisfied.When survival needs are met, other needs must also besatisfied (security, belonging, esteem, achievement, in theorder defined by Maslow). The rise in the education of theyoung is also an essential driver of frustrations. Theresearcher, Florence Gaub, in her summary of the lessons

to be drawn from the Arab spring (5) gives considerableweight to the frustration linked to the arrival of young grad-uates on job markets unable to absorb them: Althoughdescribed as strong, Tunisian state institutions were finallyincapable of filling the gap which the educational reforms

had created between expectations and reality. Finally, therole of women in Arab societies has evolved profoundlyand many of them were present in the demonstrations,both in Egypt and in Tunisia. The demographer, PhilippeFargues, a specialist in the Arab world notes that in theMENA region, whereas in the past a high fertility rate waslinked to early marriages and the low participation ofwomen in the economythe fertility rate fell from 7 childrenper woman in 1960 to 2.9 in 2008 (6). Democratic demandstherefore also concern gender, since profound demo-graphic changes have changed the role of women in Arabsocieties.

Finally social networks are a new way of expressing frus-tration. Internet access in many emerging countries has

literally exploded. Social networks play two roles. They area means of rapid mobilisation, easy to use and poorly con-trolled by the authorities. But, further upstream, they aresimilar to a democratic experiment allowing many youngpeople to express themselves freely in an admittedly virtualbut non-hierarchical world. Gradually the discrepancybetween the obstacles in real society and the freedomexperienced on the screen has become difficult to accept.It should be remembered that the Russian activist and dis-sident Alexey Navalnyi made his reputation, among otherthings, thanks to his Rosspil site, which suggested toRussian citizens that from the end of 2010 they list, bymeans of completely official public documents, misappro-priation of funds by the administrations in the area of publicprocurements.

Towards a redefinition of the indicators of political risk

From this rapid analysis, the indicators of political risk seemto us to be of two kinds: pressures for change can be meas-ured by variables which represent the degree of intensityof economic, social and political frustrations in a givencountry. Inequalities, the scale of unemployment, politicalfreedoms, and corruption constitute the multidimensionaldrivers of these frustrations. However, the existence ofthese tensions, even if very intense, does not mean thatsocial disruption will occur. The capacity of societies totransform these pressures into effective change requiresthe development of instruments which themselves allow

the expression, channelling and mobilisation of these dis-contents. The development of such instruments, of anessentially cultural nature, has played a key role in Arabcountries. It is about the level of education, increased accessto the Internet, urbanisation, the fertility rate and the rate ofwomens participation in the labour market. In our analysis,these cultural changes are a measure of a societys capacityto transform frustration into political action.


(3) See especially Muasher M. (2013), Freedom and Bread Go Together, in the specialnumber devoted to Middle Eastern countries The Middle-East: Focus on the Future,

Finance & Development, March 2013.(4) The subject of corruption was at the centre of the Russian demonstrations of December2011 and January 2012. The fight against corruption was behind the movement led by themilitant Anna Hazare, which led to massive torchlight vigils in Delhi in 2011.

(5) F. Gaub (2012) Lessons Learnt: Understanding instability: Lessons from the ArabSpring, AHRC Policy Series n9, Arts and Humanities Research Council, Report for the

History of British Intelligence and Security Research Project December 2012.(6) Ph. Fargues (2008), Emerging Demographic patterns across theMediterranean andtheir Implications for Migration through 2030, Migration Policy Institute, TransatlanticCouncil on Migration, November.


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In the instrument module, the proportion of young peo-ple and the participation of women have a relatively higherweighting of over 30%.

The political risk must therefore combine two types ofmodule, as summarised in the following table. Each ofthese modules pressures for change and instruments ofchange is composed respectively of a combination of 6and 7 elements, the total weighting of which comes to100%. In the pressures module, the level of unemploy-ment, corruption and freedom of expression ( expressionand responsibility ) have the most important relative

weighting, i.e. more than 20%.

The graphs combine the two modules: the pressures forchange (X-axis) and the instruments of change (Y-axis).Numerous Sub-Saharan African countries are in the lowerright hand part of the table. Strong pressures for changeare associated with a relatively weak presence of the

instruments. We can interpret this result as follows: thefrustrations are immense but the capacity of societies toprovoke political disruption is relatively limited. On theother hand, many of the countries of the North Africa/Mid-dle East region (Syria, Iran, Lebanon, Jordan, Algeria,Egypt, Tunisia, Saudi-Arabia) are situated in the top righthand part of the graph, which shows a combination ofstrong pressures for change and significant instruments,

resulting in large-scale political changes or recurrentdemonstrations, as in Jordan. One of the major challengesis that the political transitions need to be capable of deal-ing with the frustrations which gave rise to them, which isthe source of the recurrent instability in post-revolutionaryTunisia and Egypt.

If we place 30 emerging countries selected by their impor-tance, the North Africa/Middle East region is again clearlydistinguished from the other regions occupying the topright hand part of the graph. We note that Nigeria,Venezuela, Russia, Kazakhstan and China have pressuresfor change at a level above or equal to the Tunisian andEgyptian situations. This configuration calls for two com-ments:

In systems characterised by uncertain political transitionsas in Venezuela (a topical case in the context of the deathof Hugo Chavez announced at the beginning of March2013), the polarisation can be virulently expressed whenelections are held.

The capacity of state institutions to respond to a highfrustration level varies and are not taken into account inthis diagram. Systems, whether or not democratic, aresometimes able to reform themselves without disruption.However, political regimes which are undergoing enor-mous pressures for change and strong popular mobilisa-tion can choose the path of radical repression, as in thecases of Iran and Syria. The existing regimes then take therisk that disruptions will be even more violent and desta-bilising than the Tunisian and Egyptian revolutions.Repression has in fact led to bloody civil war in the Syriancase. The respite from the disturbances in Iran proba-bly will not last.

Continued page 6


GDP per capita *

Inflation *

Unemployment *

GINI **

Expression and responsibility **

Control of corruption **

Higher education rate **

Adult literacy rate **

Internet access **Proportion of young people **

Fertility rate **

Urbanisation rate **

Female participation rate **

Pressures for

change

Instruments

for change

* Source: IMF

** Source: World Bank

70

60

50

40

30

20

20 30 40 50 60 70 80 90

Pressure

Tools

Sub-Saharan Africa

Middle East and North Africa

Countries in italic: Only 90% of aggregates comprising the synthetic indicator available

Source: Coface

70

60

50

40

30

20

30 emerging countries

(2011 GDP)

40 50 60 70 80

Pressure

Tools

Countries in italic: Only 90% of aggregates comprising the synthetic indicator available

Source: Coface


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Pierre Paganelli

(continued)

In Morocco, in response to growing political and socialdissatisfaction and in the light of the uprisings in the Arabworld, constitutional reform initiated by King MohamedVI in mid-2011, is aimed at rebalancing the monarchy

by strengthening the powers of the prime minister andParliament. It does not, however, essentially change theprerogatives of the Moroccan monarch, who remainspopular. A small part of the population, however, com-plains of corruption and clientelism, protest movementsimplicating in this respect certain members of the Kingsclose entourage. The legislative elections at the end of2011 resulted in a relative majority of the (Islamist) Justiceand Development Party, the nomination of its leader asprime minister and the formation in early 2012 of a gov-ernment coalition with three secular parties. In thisframework, the implementation of the new constitutionseems to be on track, but the search for greater social

justice will be more problematic, involving a risk of rising

tensions.The apparent Algerian exception

Popular protests are recurrent in Algeria, without pre-senting a real threat to the regime. After the trauma ofthe hidden civil war of the nineteen-nineties, the popula-

tion aspires more to peace than to a revolutionary expe-rience, despite popular discontent. Moreover, thanks to ahydrocarbon windfall, the government has the means toease political and social opposition by, for example, tak-ing various measures from early 2011, such as public sec-

tor wage rises or increased subsidies. In this context theMay 2012 legislative elections, marked by a high level ofabstention, did not lead to the dominance of the Islamistparties, as the ruling nationalist coalition kept its majority.The next important date will be the April 2014 presiden-tial election in which President A. Bouteflika is notexpected to seek a fourth term. After the ousting, in early2013, of the leaders of the two main government coalitionparties, the outcome of his succession is unpredictableat this stage. Moreover, despite a relatively improvedsecurity situation, the activism of radical Islamist groupshas intensified on the countrys southern borders, as wasshown by the attack on the In Amenas gas complex inJanuary 2013.

Before any improvement, the situation is likely to deteri-orate, especially in the countries at the forefront ofchange, namely Tunisia and Egypt. After decades ofauthoritarian regimes, the transition processes will belong and it will take time for stable political systems toemerge in countries that have experienced uprisings.

Since the fall of Lehman Brothers, the emerging countrieshave put in place an unprecedented series of capital controlsto mitigate the shocks suffered by emerging countriesbalances of payments in 2008. The data available from theIFI (International Finance Institute) indicate that net port-folio flows (7) reached a record outflow level of 120.6 billiondollars in 2008. Two years later, in 2010 the net flows werepositive and reached a record net inflow level of 90.8 billiondollars. This volatility of speculative flows is destabilising:massive inflows lead to strong currency appreciation,

which affects the manufacturing sectors competitiveness.Sudden outflows are dangerous for businesses or banksexposed to exchange rate risk. The capital controls intro-duced therefore result from this volatility. Moreover, thedeterminants of this volatility are exogenous to the emerg-ing countries. Unlike the crises of the nineteen-nineties, thedynamic of the capital flows is actually the result of thesubprime crisis and the Feds unconventional policy (quan-titative easing) and the Eurozone sovereign crisis. Theadvanced countries are the epicentre of these drivingforces. Accordingly, capital controls, in a way legitimised,are considered as a means of protection against shocks forwhich the emerging countries are not responsible.


(7) The portfolio flows correspond to purchases by non-residents of bonds or shares(as a small proportion of an entitys total capital). They are volatile by definition.

Capital flows and current account balance

in emerging countries

100 000

50 000

0

-50 000

-100 000

-150 000

5

4

3

2

1

0

-1

-2

Inward portfolio(Mn USD)

Current account balance(% GDP) Right hd

Source: IIF

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

e

2013

f

2014

f

Growing use of capital controls

FOCUS

ECONOMIES MORE PROTECTED


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Indeed, the doctrine of international financial institutions hasvery noticeably evolved along with the return of capital con-trols. In November 2012, the IMF (8) (after several fruitlessattempts, as they were heavily criticised by India and Brazil,which considered their positions insufficiently favourable tocapital controls) published a balanced institutional view,which acknowledged the potential benefits of controls.These are no longer considered as an ineffective and provi-

sional expedient. Their relevance is of course discussedaccording to the case, but it is seen as being linked to thematurity of the financial sectors, which can, if they are stillweak, benefit from the protection they provide. Moreover,the IMF stresses the fact that reform must also come fromthe countries exporting speculative capital. The doctrine asa whole calls into question the systematically positive char-acter of financial openness.

The measures taken in the wake of the 2008 crisis encom-pass three different types of capital control to meet differentneeds. The first (like the Brazilian tax) is the use of instru-ments for the regulation of markets which act directly on thecapital flows themselves via taxation or restrictive measures.Taxation mainly targets the exchange rate and, in the light

of this objective, its effectiveness is a matter for debate(cf. box). The second type of control consists in limiting con-vertibility. This is about restricting residents access to foreignexchange (or conversely of non-residents to the domesticcurrency), as illustrated by the measures introduced inArgentina. Finally, a third group of measures falls within thefield of the prudential regulation of banks. These measurestend to limit bank exposure to exchange rate risk (as in the

case of measures taken in South Korea). In the Korean case (9),the aim is to protect a banking system very exposed to thevolatility of the won.

The wave of capital controls must be seen as a resort topragmatism. The authorities of emerging countries no longerhesitate to use unorthodox measures and will no longer becontent with discretionary interventions on the foreignexchange market. Firmer regulation of financial openness isbecoming a tool for combating excessive currency appreci-ation or for protecting the financial system. In practice thisalso means greater difficulty in gaining access to foreign cur-rencies. Many countries have made it more difficult to obtainimport licences or have restricted importers access to foreignexchange (China, Argentina, Brazil). This growing use ofrestrictive measures which can, admittedly, be justifiedfrom a macroeconomic point of view is likely to result inlonger payment delays for exporters. More generally, capitalcontrols signal the end of an ideology which systematicallyfavours market liberalisation solutions. Since the crisis finan-cial opening up is no longer considered as a panacea, eitherby emerging countries or by international financial institu-tions. And the general questioning of the systematic opening

up of capital markets increasingly applies also to the marketfor goods and services.

Source: Datastream

Axelle Fofana

The Brazilian real appreciated strongly between the endof 2008 and July 2011, going from BRL2.6 for a USD to1.53. This appreciation resulted mainly from an upwardtrend of capital inflows into Brazil since the spring of2009, in a context of abundant global liquidity andinvestors search for yields. Net capital flows therefore

climbed from 3 billion dollars to nearly 23 billion dollars (10)

between March 2009 and January 2013 (see graphbelow). Though the country attracts many foreign directinvestments, the proportion of the most volatile portfolioinvestments also increased over the period.

Effects of capital controls:The example of Brazil


(8) International Monetary Fund (2012), The Liberalization and Management of CapitalFlows: An Institutional View, November 14.

(9) In November 2012, the external liabilities of the South Korean banking system repre-sented 187% of external assets (source: IMF).

(10) Net capital flows expressed as a 3-month sum.

60

50

40

30

20

10

0

-10

-20

-30

-40

01-08 01-09 01-10 01-11 01-12 01-1301-07

Brazil: Net capital flows (USD billion)

Foreign direct investment

Other investment and nancial derivatives

Portfolio investment

Financial account balance

FOCUS


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Axelle Fofana

(continued)

In order to limit the appreciation of the real, deemeddamaging to the competitiveness of the manufacturingsector, the Brazilian authorities introduced several capitalcontrol measures from 2008:

A financial transactions tax (IOF) of 1.5% on foreigninvestments on the local bond market was passed inMarch 2008. Abolished in 2008, when the real wassubject to downward pressures, the tax was then rein-stated in October 2009 (2%) and increased in October2010 (6%). Meanwhile, a 2% tax was levied betweenOctober 2009 and December 2011 on foreign invest-ments in equities, in order to affect all portfolio inflows.These measures were abolished at the end of 2011 in thecontext of a strong depreciation of the real, with thereturn of global risk aversion.

Loans contracted abroad were also subjected to the taxon financial transactions. At first 2%, the tax on borrow-

ing with a maturity of one year went up to 6% in March2011. This tax was extended to securities with up to 2years maturity in April 2011, then to up to 5 years matu-rity in March 2012. The government then reasserted itsintention of curbing an over-appreciation of the Braziliancurrency in a context of a global decline in risk aversion.

However, although these control measures had littleeffect on exchange rates, they nevertheless improved thequality of the inflows:

The introduction of controls on portfolio flows in March2008, October 2009 and October 2010 could not staveoff the medium term appreciation of the Brazilian cur-rency (see graph below). According to Jinjarak, Noy andZheng (2012)(11), this low impact is explained by the fact

that the introduction of capital controls was not consid-ered as different from the policy usually conducted by thegovernment and that it had been largely anticipated byinvestors.

However, new taxes were set up in March 2012 and thereal fell by 10% against the dollar in the course of the year.The introduction of these taxes could partly explain thisdevelopment. This assertion, however, needs qualifying

because the central bank also intervened on the foreignexchange market and conducted a more accommodativemonetary policy. Moreover Brazil benefitted fromincreased risk aversion from late 2011 and saw itsexchange rate depreciate (BRL2 for USD1 in late 2012against 1.75 a year earlier).

Spillover effects on FDIs: The recent literature has con-cluded that taxes on foreign investments in local equityand bond markets have effectively led to a reduction inthe growth of portfolio investments in Brazil. They havehad a spillover effect on foreign direct investments, whichreached a historic peak of nearly 68 billion dollars in2011(12). These spillover effects have limited the impact ofcontrol measures on the exchange rate, but this change

in the nature of capital inflows has also proved beneficial:the introduction of these controls discouraged speculativecapital inflows in favour of foreign direct investments, aless volatile financing source, enabling Brazil to compen-sate for the weakness of its domestic investment.

Spillover effects on neighbouring countries: Accordingto the Bank of France (13), capital controls are the sourceof spillover effects on neighbouring countries localfinancial markets. The rise in the tax on bond portfolioflows by Brazil would therefore explain the totality ofthe rise in flows on Mexican bonds in October 2010:while the tax on foreign investments in the Brazilianbond market rose from 2% to 6% in October 2010,inflows on Mexican bonds rose from 3.7 billion dollars in

September to 5.1 billion dollars in October. The flows onBrazilian bonds fell from 4.2 to 2.2 billion dollars at thesame time. Similar developments have been observed inChile, Colombia and Peru.


(11) Jinjarak, Noy and Zheng (2012), Capital controls in Brazil: Stemming a tide witha signal? , Working Paper, School of Economics and Finance, Victoria, University ofWellington.

(12) Net FDI flows over a year.

(13) Lambert F., Ramos-Tallada J. and Rebillard C. (2011): Capital controls andspillover effects: Evidence from Latin-American countries, working paper of theBank of France N 357, December.

2,6

2,5

2,4

2,3

2,2

2,1

2,0

-1,9

-1,8

-1,7

-1,6

-1,5

Evolution of the Brazilian real vs US dollar exchange rate

Source: Datastream

Implementation or increase of the IOF

tax on foreign direct investments in

local bonds and equities

Withdrawal of the tax

FOCUS

01-06 01-07 01-08 01-09 01-10 01-11 01-12 01-13


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The protectionism level remains high

Trade protectionism is also a risk affecting companies in

emerging countries as well as businesses which export tothese countries. According to the WTO, the introduction ofprotectionist measures increased markedly in the after-math the 2008-2009 global crisis. The experience of thegreat depression of the nineteen-thirties shows that meas-ures restricting trade tend to become permanent, thoughinitially they are intended to be temporary (see Eichen-green and Irwin (14)). The recent period confirms this: thoughthe number of new measures grew less strongly in 2012 (15),the number of existing restrictive measures continues toincrease and now affects 4.4% of the imports of the G20countries. According to the independent estimates of theGlobal Trade Alert (GTA)(16), the effect of the measurestaken since November 2008 is even more significant andwill affect at least 10% of the G20 country imports. This

increase is explained by the fact that only 21% of the meas-ures introduced in the G20 countries since 2008 have beenabolished.

Argentina and Russia are by far the mostprotectionist countries

The term protectionism covers very diverse measures. It cov-ers all the measures aimed at favouring domestic producersor disadvantaging foreign businesses. The types of measurescan therefore be very varied: tariff measures (taxes) or non-tariff ones (quotas, standards), direct (taxes) or indirect (sub-sidies). The main measures taken in emerging countriesduring the last two years reflect this diversity. They concern

preferential access to public markets for domestic businesses(Brazil, India, South Africa), import quotas (Argentina, Brazil,Russia) and taxes on imports (China, Argentina). These meas-ures have not only been taken at the national level: Mercosur,for example, authorised its member countries to increase thecommon external tariff for 200 products in 2012. This diver-sity in the types of measures taken makes it difficult to itemisethem. For example, China varies the level of VAT refundsmade to businesses in certain sectors in order to influencetheir profitability and to favour their exports. Therefore itchanged the level of these refunds thirteen times between2007 and 2010, so that 71% of Chinese exports were affectedby these changes in 2010, against only 4% in 2007. So it is dif-ficult to take into account every change in the level of VATapplied to Chinese exporting companies.

This is why there are no exhaustive lists of the protectionistmeasures adopted in the world. Outside the WTO, the GTA isan exception: it lists all protectionist measures taken sinceNovember 2008, which restrict international trade as wellas those which favour it. By subtracting the second from thefirst, we can deduce a net number of existing protectionistmeasures by country (see chart below). These data show thatArgentina and Russia are by far the most protectionist coun-tries (respectively 180 and 136 measures). India completes thepodium (91). At the other end of the scale, Mexico and SouthAfrica are countries with few such measures (only 21 each).Turkey is also relatively open to trade while Chinas degree ofprotectionism seems moderate (72). By way of comparison,the developed countries have on average more protectionist

measures (between 90 and 115). Finally, Brazil is a case apart:It does not seem very protectionist with regard to this overallindicator, but it is worth noting that a number of importantmeasures favouring trade offset partly the numerous restric-tive measures introduced particularly in 2012. For example inthe car sector the Brazilian government decided to increaseby 30% a tax on vehicles with a local content below 65%,to deal with the increase in the number of imported ones.

It also went back on the free trade agreement with Mexico inthe motor industry and imposed quotas. A minimum localcontent of 65% was imposed for oil-related services andequipment, at the risk of raising the equipment cost necessaryfor the exploitation of new deep sea oil fields. The Braziliangovernment finally adopted tax exemptions for the industriesmost affected by competition from imports such as textiles.

These measures pose a risk toopportunities for businesses

The reasons for protectionism are known: it is about acountry protecting employment in the short term by pro-tecting a sector of activity weakened by a slowdown inworld demand and/or a deterioration of its competitive-ness. This is particularly the case for many emerging coun-tries, which experienced a growth slowdown in 2009related to the Lehman Brothers crisis, as well as a signifi-cant appreciation of their currency since 2009. Apart fromthese external factors, the current rise in protectionism hasits origin in the changes in emerging countries growthstrategies: after undergoing a contraction in world trade in2009, some emerging countries decided to favour sectorsrelated to their domestic demand. From this perspective,protectionist decisions are aimed at protecting thesedeveloping sectors. Finally, certain emerging countries arefurther restricting their commodities exports, so as to con-tain prices on the local market and therefore stimulatehousehold consumption and reduce businesss productioncosts. Export restrictions on rare earth elements and coalin China, of cotton in India or of wheat in the Ukraine areinstances of this strategy.


(14) Eichengreen B. et Irwin D. (2009): The Slide to Protectionism in the Great Depression:Who Succumbed and Why? , National Bureau of Economic Research, working paperN 15142, July.

(15) The restrictive measures introduced in the G20 countries between May andOctober 2012 affected 0.4% of the regionss imports compared with 1.1% during theprevious 6 months.

(16) Global Trade Alert is a supplier of independent data on world trade which is led bythe CEPR (centre for research on economic policy).

Trade protectionism is a risk

for companies

Net Number of Protectionist Measures by Country

200

160

120

80

40

0

Argen

tina

Russ

ia

India

Hungary

Po

lan

d

China

Indones

ia

Braz

il

Kaza

khs

tan

Sou

thAfrica

Turkey

Mex

ico

Source: GTA


10/12

But, though the reasons for such measures seem obvious,their effects on the countrys growth are ambiguous. Onthe one hand, they can be considered as a necessary stepfor temporarily protecting a developing countrys fledglingindustries. But on the other hand, they have negativeeffects on growth, if they end up protecting decliningsectors. This in effect reduces the resources available forpromoting the development of sectors of activity generat-

ing longer term growth.More generally, protectionism is likely to have a negativeeffect on companies sales exporting to countries whichimpose such measures. But at a global level, the effects

seem limited for the time being: the WTO predicts a 4.5%growth in world trade in 2013, after 2.5% in 2012. This is inline with a moderate GDP growth, which confirms thattrade cycles coincide with GDP growth ones. However, inthe context of the international division of productionprocesses, particularly in the manufacturing sector, a con-tinued increase in the number of protective measureswould have disastrous effects on world trade: protectionist

measures on a particular type of product are likely to haveconsequences for the whole production chain at worldlevel and would therefore harm the activity of all the busi-nesses participating in this process.

The private sector debt level is another risk affecting theemerging economies. Though attention is currently focussedon the high public debt in the bulk of advanced economies,let us not forget that the countries most affected by theeffects of this global crisis often had as a point in commonthe fact that they had previously experienced a private sectorcredit boom (for example Iceland, the Ukraine, the Balticcountries, Spain, the United States).

Currently, some emerging countries are undergoing verysustained credit growth to companies and households. Eventhough the structures of emerging countries are differentfrom those of the advanced economies, there is a risk that anexcess of company and household debt could have compa-rable effects on growth in the medium term.

The collateral effects of expansionary monetarypolicies

There are several reasons for this tendency for the continu-ous growth of credit to the private sector in emerging coun-tries. First of all, monetary policies have been expansionaryin emerging countries since the 2008-2009 crisis. Thesepolicies have favoured sustained growth of bank credit tothe private sector. Certain countries, which had cut their keyrates very significantly at the end of 2008 and in 2009, didnot raise them again when a strong economic recovery andinflation materialised in 2010 and 2011. Their key rates there-fore are still at very low levels, as, for example, in some Asiancountries: Thailand, the Philippines, Indonesia and South

Korea. Next, other countries had higher interest rates until2011 and therefore had room for monetary manoeuvre, butfor the most part used them in 2012 (Brazil, India). This ledon average to very accommodative monetary conditions inemerging countries: real interest rates remained close tozero (and even occasionally negative) at the time of themarked pick up in growth in 2010 and 2011. They are still atrelatively low levels for emerging countries as a whole at themoment (see chart below).

Besides these expansionary monetary policies, deficiencies interms of prudential rules for banks and policies aimed atfavouring financial sector development have also played arole in the recent credit expansion. For example, there was nominimum income or minimum age in Indonesia for holdinga bank card until 1 January 2013, while the number of cardsper person was unlimited. Moreover, there was no minimumrequired contribution in order to obtain a mortgage loan until2012.

The dangers associated with credit booms

Pointing the finger at the negative effects of credit to the pri-vate sector on the economy is in principle contradictory,insofar as this is an instrument for financing businesses andhouseholds and therefore investment and consumption.A credit growth acceleration must therefore favour more sus-tained economic growth. A recent IMF study (17) confirms this:an increase in the level of financial development is associatedwith less volatile economic growth (measured by the stan-dard deviation of the GDP growth rate). However, this studyalso emphasises that, beyond a certain threshold, the corre-lation between financial development and GDP volatilitybecomes negative. The threshold is reached when the thetotal volume of credit to the private sector to GDP ratioexceeds 100%.


(17) International Monetary Fund: World report on financial stability , chapter 4,October (2012)

Average Real Interest Rates Including 23 Emerging Countries*

(Key rate - inflation in %)

01-07 07-07 01-08 07-08 01-09 07-09 01-10 07-10 01-11 07-11 01-12 07-12

3,0

2,5

2,0

1,5

1,0

0,5

0,0

-0,5

-1,0

-1,5

-2,0

* China, India, Indonesia, Malaysia, Philippines, South Korea, Taiwan island, Thailand, Brazil, Colombia,

Peru, Mexico, Czech Republic, Hungary, Poland, Russia, Turkey, South Africa, Chile, Uruguay, Hong Kong,

Israel, Kazakhstan.

EXCESSIVE CREDIT GROWTH

Source: Datastream


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But the growth of this ratio also needs to be taken into accountin order to assess the credit boom risks (18). This is because, if acountrys credit growth increases very rapidly, this is likely togenerate increased risks in the banking sector, even if the levelof the total outstanding amount is relatively low. For example,credit grew by over 30% a year on average in Russia between2006 and 2011. Admittedly, this strong growth in part illustratesa financial catch-up process, the total outstanding credit over

GDP, reaching only 40% of GDP in late 2011. But it can also leadto a rise in non-performing loans, if this very sustained andrapid rise in credits granted is synonymous with a greater flex-ibility on the part of the banks in granting credit to householdsand businesses. In other words, in the case where credit growthto the private sector is durably greater than that of nominalGDP, the difference between the two corresponds to an excessof liquidity, which is not absorbed by the good market. It istherefore invested in asset markets (financial or property) andlikely to favour the formation of bubbles in these segments. Totake this into account, the IMF defines a credit bubble as aperiod during which the growth of this ratio significantlyexceeds its long term average (19) or when it increases by morethan 20 points in a year.

Let us, however, remember that not all credit booms give riseto financial crises - quite the contrary: the proportion of creditbubble episodes which have resulted in a crisis within 3 yearsis one third according to the IMF. The probability that the coun-tries in question will experience at least one prolonged periodof GDP growth below their potential for 6 consecutive yearsat the end of a credit boom is, according to the same source,60%. During this period, the negative shock on growth is onaverage 2.2 points per annum. This confirms that periods of abubble lead to the over-indebtedness of certain sectors ofactivity and hence to an adjustment of these when growthslows, even if a crisis is avoided. These adjustments are oftenexplained by a tightening of bank credit conditions followinga crisis or a period of marked economic slowdown: havingsuffered losses as a result of defaulting by businesses and

households, they restrict credit to the private sector and there-fore limit the latters investment capacity.

Diagnosing credit bubbles

To identify credit boom risks, we looked both at the initiallevel of credit to the private sector over GDP and at itsevolution. We judged that the countries likely to suffer thenegative effects linked to a credit boom are those charac-terised by a ratio greater than 100% and/or a rise in this ofat least 10 points in the course of the last year 20).

These criteria have the merit of making it possible to carryout an overall classification of the emerging countriesaccording to the credit boom risk. But the limit of this

analysis is that it does not take into account more qualita-tive criteria: apart from the level of outstanding credit andits growth, the composition of these loans has an impacton the risks associated with credit expansion. For example,the countries for which the proportion of credits to the pri-vate sector denominated in foreign currency is high aremore vulnerable in the event of a credit bubble. Turkey is asignificant example of this. Likewise, inadequate prudentialrules (as in Russia) are also liable to aggravate the risksrelated to strong credit growth.

A combination of the level of outstanding creditand its dynamics

In the following chart, we are interested in both the amountof credit to the private sector (X-axis) and its evolution(Y-axis).

Firstly, a very large majority of emerging countries have aratio below the level of 100% previously referred to, so that

the credit growth to the private sector plays a positive roleon GDP growth. But some are above or very close to thisthreshold. Estonia, for example, belongs to this group.

Then, by observing the evolution of the ratio of credit to theprivate sector over GDP for all the emerging countries, weconclude that several countries are today in a credit boomsituation as we define it, or are very close to it. They aretherefore facing a significant risk of a financial crisis or ofdurably weaker growth in the medium term. This concerns inparticular Chile (+15 points between mid-2011 and mid-2012),Russia (+10 points) and Turkey, Venezuela and Cambodia (+9points each). Several South American countries are also atrisk according to this criterion (Guatemala, Honduras).

Finally, the countries most at risk are those which meet thesetwo criteria: credit to the private sector relative to GDP is ata high level and is growing rapidly. They are therefore themost likely to undergo a crisis or at least a period of weakergrowth. Numerous Asian countries come into this category orare very close to it: China, Malaysia, Korea, Thailand, Singaporeand Vietnam. Lebanon and Guatemala also belong to it.

The capital account openness is an aggravatingfactor

Besides the level and growth of the credit to the private sec-tor to GDP ratio, other indicators must be taken into accountin order to assess the vulnerability of a country facing anexcess of credit to businesses and households. In particular,

countries with a very open capital account are more at risk ofsuffering a financial crisis in the event of a credit bubble, ascapital flows are likely to limit the effects of any monetarytightening measure decided by the central bank. So, in thecase where central banks of these countries tighten theirmonetary policy to limit the credit growth, these capital flowswill limit their effects. The increase in foreign investments,especially on the local bond markets, eases the financing con-ditions for businesses and households. These capital flowstherefore limit the channels for the transmission of monetarypolicy: long-term government bond rates fell in 2010 inMalaysia, South Korea and Brazil, even though the centralbanks of these countries raised their key interest rates.

In this context, Chinas weak openness to foreign capital hasbeen a factor minimising the risk resulting from the stronggrowth of credit to the private sector in recent years. By con-trast, Malaysia, South Korea and Thailand appear to be morevulnerable countries with regard to this criterion. The Islandof Taiwan is in an intermediate position.


(18) See for example BNP Paribas: Country Risk Overview, Economic Research Depart-ment, February (2012)

(19) Difference between the growth achieved and average long term growth above a 1.5standard deviation and growth of the ratio of credit to the private sector over GDP above10 points.

(20) Year from mid-2011 to mid-2012.


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The countries most at risk are in Asia

In summary, the existence of credit bubbles does not meanthat a crisis is imminent in countries which are experiencingit, but it does imply that a risk of a marked adjustment ofgrowth (through a crisis or in a more gradual way) is probable

there in the medium term. Several Asian countries seemto be particularly exposed to this risk, followed by Chile,Russia and Turkey.

The growth resilience as well as the improvement of the mostimportant external sovereign and external fundamentalsdoes not mean country risk has disappeared in emergingcountries. This study highlights the rise of new risks, whichmust be closely watched in 2013 and 2014. In order to monitorthese changed risks, Coface is focusing on new indicators. Inparticular, our political and social diagnosis underlines thepersistent character of the risk of instability in the MiddleEast and North Africa. Our overall credit bubble indicator

highlights the Asian countries. Finally, the protectionism riskalso needs to be watched in the emerging world, especiallyin Argentina and Russia.


Private sector credit to GDP ratio (in %)

1-year

increase in the

private sector

credit to

GDP ratio

(in pp)

Singapore

China

Vietnam

Korea

Lebanon

Chile

Russia

TurkeyCambodia

Venezuela

Mexico

Indonesia

South Africa

Brazil

India

Taiwan

Thailand

Malaysia

25%

20%

15%

10%

5%

0%

-5%

-10%

0% 20% 40% 60% 80% 100% 120% 140% 160%

Emerging countries: Private sector credit

to GDP ratio (2012, source: IMF)

Source: IMF

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